Does Board Independence Reduce Informed Short Selling Prior to Earnings Announcements? Evidence From Quasi-Natural Experiment

Abstract

Independent boards improve financial disclosure quality and reduce the opacity of information between insiders and outsiders, which lowers the incentives of informed traders that benefit from the information gap. We test this conjecture by estimating short sellers’ predictions of the direction of unexpected quarterly earnings. We find that short sellers’ predictions are less accurate in firms with independent boards relative to firms with non-independent boards. Furthermore, short-selling excess returns in firms with independent boards are insignificant. A quasi-natural experiment using the exogenous shock to board independence represented by the Sarbanes-Oxley Act of 2002 provides further support for these findings. We also show that a decrease in both information asymmetry and information leakage in firms with independent boards are potential reasons for a decrease in the accuracy of short sellers’ predictions. Further analyses show that the effects of independent boards are stronger in firms with larger information asymmetry and also in firms that have poor governance mechanisms. Sub-sample analyses suggest that these results are not driven by the idiosyncrasies of unusual periods such as the 2007–2009 global financial crisis.

Keywords: short selling, board independence, unexpected earnings

JEL Classification: G28, G30, G34