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Short Selling and Earnings Management: A Controlled Experiment

44 Pages Posted: 29 Jun 2013 Last revised: 21 Jun 2017

Vivian W. Fang

University of Minnesota - Twin Cities - Department of Accounting

Allen Huang

Hong Kong University of Science and Technology - Department of Accounting

Jonathan M. Karpoff

University of Washington - Michael G. Foster School of Business

Date Written: August 17, 2015

Abstract

During 2005 to 2007, the SEC ordered a pilot program in which one-third of the Russell 3000 index were arbitrarily chosen as pilot stocks and exempted from short-sale price tests. Pilot firms’ discretionary accruals and likelihood of marginally beating earnings targets decrease during this period, and revert to pre-experiment levels when the program ends. After the program starts, pilot firms are more likely to be caught for fraud initiated before the program, and their stock returns better incorporate earnings information. These results indicate that short selling, or its prospect, curbs earnings management, helps detect fraud, and improves price efficiency.

Keywords: Regulation SHO, Pilot Program, Short Selling, Earnings Management, Fraud Discovery, Price Efficiency

JEL Classification: G14, G18, G19, M41, M48

Suggested Citation

Fang, Vivian W. and Huang, Allen and Karpoff, Jonathan M., Short Selling and Earnings Management: A Controlled Experiment (August 17, 2015). Journal of Finance, Vol 71, No. 3 (June 2016), pp. 1251-1294. Available at SSRN: https://ssrn.com/abstract=2286818 or http://dx.doi.org/10.2139/ssrn.2286818

Vivian W. Fang

University of Minnesota - Twin Cities - Department of Accounting ( email )

321 19th Avenue South
Room 3-109
Minneapolis, MN 55455
United States

HOME PAGE: http://www.vivianfang.org

Allen Huang

Hong Kong University of Science and Technology - Department of Accounting ( email )

LSK Business School Building
HKUST
Clear Water Bay, Kowloon
Hong Kong
+852-23587559 (Phone)

HOME PAGE: http://www.AllenHuang.org

Jonathan M. Karpoff (Contact Author)

University of Washington - Michael G. Foster School of Business ( email )

Box 353226
Seattle, WA 98195-3200
United States
206-685-4954 (Phone)
206-221-6856 (Fax)

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