Information Percolation and Informed Short Selling: Evidence from Earnings Announcements

Abstract

This study examines short selling in stocks of firms that reveal partial earnings-related information prior to their eventual earnings announcements (EA). By decomposing short selling into two components where the first corresponds to the final partial earnings disclosure and the second captures the subsequent incremental short selling until just before the EA, we estimate that the relative informativeness of shorting activity based on public partial versus private information accounts for approximately 80% and 20%, respectively, of the short selling-related decrease in the EA return. Importantly, the negative return predictability of short selling significantly increases the longer a firm implicitly delays its EA. Further, our evidence indicates time-varying short-sale constraints, ineffective following the release of partial information but rising markedly just prior to the EA. The overall findings support the proposition that short sellers are skilled investors who profit from both public partial and private information. The informativeness of short selling, however, depends critically on the efficacy of short-sale constraints.

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

JEL Classification: D82, G11, G14