The Informational Role of Internet-Based Short Sellers

Abstract

Short interest conveys short sellers’ opinions about firms’ financial reporting quality. Focusing on U.S.-listed Chinese firms whose financial reporting has raised enormous concerns of the U.S. regulators and investors, this paper studies a novel channel through which such opinions can be acquired, that is, the reports voluntarily published by short sellers. I find that targeted firms experience an average three-day cumulative abnormal return (CAR) of -6.1% and -13.4% for initial coverage of the firm. CARs are more negative when the reports contain first-hand evidence or allege more severe misconduct of the firms. Non-targeted firms also experience losses in value following short sellers’ reports, especially when they hire the same non-Big 4 auditors as targeted firms. Targeted firms suffer long-term stock price declines and are often subsequently subject to class action lawsuits and SEC enforcement. Short sellers tend to target firms that exhibit good operating and stock performances and that show red flags of financial misreporting. Short sellers’ reports convey valuable information independent of short interest, and short sellers are more effective than equity analysts who follow Chinese firms.