Can Short Sellers Constrain Opportunistic Non-GAAP Reporting?

Abstract

Prior research finds an association between short selling volume and aggressive non-GAAP earnings disclosures but does not explore whether increased short selling pressure actually constrains aggressive non-GAAP reporting. Attribution of causality is problematic in this setting, due to multiple self-selection issues. Firms self-select into providing non-GAAP disclosures, and they also decide the timing of these disclosures strategically. Furthermore, short sellers carefully select the stocks they want to short. We exploit a randomized natural experiment—the SEC’s Regulation SHO—as an exogenous shock to mitigate endogeneity concerns and investigate the causal effect of short selling on the proliferation of aggressive non-GAAP earnings. The specific starting and ending dates of Regulation SHO allow us to conduct two separate difference-in-differences (DiD) tests. Our double DiD analyses indicate that the threat of increased short selling prompted by Regulation SHO significantly curbs managers’ aggressive non-GAAP disclosures. However, the regulation does not affect non-GAAP exclusions that are presumed to be nonstrategic and informative. We find that short sellers’ disciplining effect is stronger when the pre-disclosure information environment is relatively impoverished and corporate governance is weak. Our results are robust to extensive sensitivity testing. Overall, we find strong evidence that the threat of increased short selling constrains aggressive non-GAAP reporting.

Keywords: Non-GAAP earnings, short sellers, Regulation SHO, earnings management

JEL Classification: M41 ˖ D53 ˖ G14