Short-Selling Pressure and Aggressive Corporate Tax Avoidance

Abstract

We study how short-selling pressure affects tax aggressiveness using the pilot program on short sales in Regulation SHO. Using a difference-in-differences approach, we find that higher short-selling pressure significantly reduces tax aggressiveness. To explain the reduction, we offer a simple agency-theoretic model and provide evidence that when short-selling pressure increases, the likelihood of detecting questionable tax shelters increases, discouraging tax aggressiveness. Corroborating this evidence, we also find stronger (weaker) effects of short-selling pressure on firms subject to fewer (more) audits by the IRS before the pilot program. These findings suggest that short-sellers help reduce aggressive tax avoidance schemes.