Abstract
In this paper, we examine the impact of earnings management on the behavior of short sellers around the time of earnings announcements. Our major finding is that activity-based earnings management (real earnings management) is a type of accounting information short sellers exploit. In addition, we find that the interaction between real earnings management and information asymmetry in the market also contributes to the decision process of short sellers. Short sellers target firms with high levels of real earnings management, particularly when information asymmetry concerning the firm is most severe. We also find weak evidence that short sellers trading on announcement day have some information advantage that most likely stems from processing public information rather than accessing private information. Our findings have implications to the capital market participants. If short sellers take a long position in low earnings management firms and a short position in high earnings management firms, they may earn positive abnormal returns.
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