Information Percolation and Informed Short Selling: Evidence from Earnings Announcements

Abstract

Firms typically disclose partial earnings-related information before their eventual earnings announcement (EA) dates. This paper employs a novel approach to decompose short selling prior to EAs into two components attributable to public, yet incomplete, vs. private information. We estimate that the relative informativeness of shorting activity based on these two information sources accounts for approximately 80% and 20%, respectively, of the shorting-related decrease in the EA return. We further show that the former is significantly related to fundamentals information whereas the latter is mostly to non-fundamentals. Importantly, the negative return predictability of shorting becomes more pronounced, the longer the firms implicitly delay their EA dates, indicating that short sellers profit from firms' strategic scheduling behavior. Moreover, the evidence illustrates the time-varying nature of short-sale constraints, ineffective following the release of public partial information but rising markedly right prior to the EAs. The overall findings support the proposition that short sellers exploit both public partial and private information as well as fundamentals and non-fundamentals information, but at different points in time during the information revelation process. The relative informativeness of decomposed shorting based on these various information sets, however, depends critically on the time-varying efficacy of short-sale constraints.

Keywords: incomplete information, informed trading, short selling, earnings announcement

JEL Classification: D82, G11, G14