Short Selling and Tax Disclosure: Evidence from Regulation SHO

Abstract

We use a regulatory shock to examine the extent to which the prospect of short selling affects tax disclosure. From May 2005 to August 2007, the SEC initiated a pilot program under Regulation SHO, which temporarily exempted one-third of the firms in the Russell 3000 index from short sale price tests, reducing the cost of short selling of pilot firms. We predict and find that before the pilot program, the disclosure attributes of the income tax footnotes of pilot firms are similar to non-pilot firms. During the pilot program, the readability of the income tax footnotes increases for pilot firms, and the choice of words describing tax activities changed for tax sensitive pilot firms. In further tests, we observe a stronger effect among pilot firms led by senior executives whose stock and option portfolio is more sensitive to changes in stock price. After the pilot program ends, the differences between pilot and non-pilot firms disappear. Overall, the results suggest that the prospect of short selling affects tax disclosure.

Keywords: regulation SHO; short selling; taxes; tax disclosure