Pilot Firms Research Articles

Market Pressure and Multinational Corporations’ Tax-Motivated Decisions: Evidence from an SEC Experiment

We examine the role of capital market pressure in firms' international tax-motivated decisions. We use two exogenous events to identify the relation: the temporary lifting of short selling restrictions for randomly selected pilot firms under SEC Regulation SHO (called Pilot firms) and the repatriation tax holiday under the American Jobs Creation Act that occurred in this time period. We document that the Pilot firms are more likely to respond to the tax holiday only when they have foreign losses or generally do not repatriate foreign earnings. We also find that Pilot firms repatriate more, on average. This evidence is consistent with managers generally facing a conflict between self-serving international investment decisions and value-enhancing tax-motivated investment decisions, but this situation is mitigated by greater monitoring by active short sellers that occurs when short-selling restrictions are absent.

The effect of short sale constraints on analyst forecast quality: Evidence from a natural experiment in China

We examine the effect of short selling on analyst forecast quality following the pilot program in China in 2010 that allows short selling for selected companies. We find that reduction in short sale constraints significantly improves analyst forecast quality for these pilot-firms when compared to non-pilot firms. Specifically, analyst forecast errors for pilot firms are smaller and forecast dispersions are narrower. Further, we show that the improvement of analyst forecast quality is more prominent for firms with lower prior price efficiencies and disclosure quality, and in locations with lower institutional development. Our findings suggest that short selling activities serve an important role in facilitating the speed of information incorporation and improving the information environment faced by firms.

CEO Confidence Matters: The Real Effects of Short Sale Constraints Revisited

This paper investigates the role of managerial biases in the real effects of limits to arbitrage. In a natural experiment setting with Regulation SHO, we find that the lifting of short sale constraints leads to a significant decrease in CEO confidence for pilot firms, and this result is more pronounced for pilot firms with financial constraints and stronger corporate governance. We further find that the real effects of Regulation SHO documented in the literature are primarily driven by such decrease in CEO confidence. Underconfident CEOs of pilot firms tend to decrease corporate investments, reduce earnings management, and improve social performance and employee relations following the removal of short sale constraints. Overall, we identify CEO confidence as a psychological channel through which capital market frictions influence corporate decisions and CEO investment behavior.

Short Selling and Firms' Disclosure of Bad News: Evidence from Regulation SHO

ABSTRACT As informed traders, short sellers enhance the informativeness of stock prices, especially related to bad news, potentially reducing the benefits and increasing litigation and reputational costs of withholding bad news by managers. We exploit a quasi-natural experimental setting provided by the introduction of SEC regulation SHO (Reg-SHO), which significantly reduced the constraints faced by short sellers for an effectively randomly selected subsample of U.S. firms (pilot firms). Relative to control firms, we find pilot firms increase the likelihood of voluntary bad news management forecasts, provide these forecasts in a more timely manner, and accelerate the release of quarterly bad earnings news. Each of these effects is stronger for subsamples of moderate (compared with extreme) bad news, firms facing high (relative to low) litigation risks, and firms with a forecasting history. Similar effects are not observed for voluntary good news forecasts. A range of robustness tests reinforce our results. JEL Classifications: G14; D22; K22; K41; M40.

Short Sellers and Long-Run Management Forecasts

We examine how short sellers affect long-run management forecasts using a natural experiment (Regulation SHO) that relaxes short-selling constraints on a group of randomly selected firms (referred to as pilot firms). We find that compared to other firms, the pilot firms issue more long-run good news forecasts but do not change the frequency of long-run bad news forecasts. The increase in good news forecasts is greater when the pilot firms have higher quality forecasts, more uncertainty about firm value, or higher manager equity incentives. Overall, these results and the results of additional analyses indicate that the reduction in short-selling constraints and the increase in short-selling threat induce managers to enhance disclosures through more long-run forecasts, primarily in the case of good news, to discourage short sellers.

Financial Constraints and Industry Dynamics

It is well-established that financially constrained firms scale down their investment activity. The lost investment opportunities, however, could potentially be captured by other firms that are less financially constrained. We test this proposition using the Reg SHO pilot regulation, which relaxed short-selling constraints for about 30% of firms and thus tightened their financial constraints. Following the introduction of the regulation, pilot firms indeed reduced their investments, while their direct competitors increased their investments, expanded their market share, and became more profitable. We conclude that opportunities lost due to financial constraints could be salvaged by competing firms.

Can Short Selling Constrain the Shift between Accrual-Based and Real Earnings Management?

We study the causal effects of short selling on real earnings management by exploiting an exogenous shock to short selling costs under the pilot program of Regulation SHO. We find the removal of short selling constraints leads to a reduction of real earnings management in pilot firms relative to non-pilot firms during the pilot program period. The effect is more pronounced in firms where managers are more entrenched and institutional ownership is lower. Furthermore, the effect is significantly stronger among firms with more analyst coverage. Combined with existing evidence on accrual-based earnings manipulation, our paper completes the picture of how short selling affects earnings management and indicates that short selling is superior to several other governance mechanisms, such as securities analysts, in constraining earnings management in that it does not lead to a shift from accrual-based earnings management to real earnings management.

Increasing the Tick: Examining the Impact of the Tick Size Change on Market Fee Venues

This paper investigates the effects of an increase in tick size on order and trading flow across market fee venues. Using the pilot firms in the SEC’s Tick Size Pilot Program, we document trade and order volume declines significantly on maker-taker fee venues after the tick size implementation. Further, our results indicate that the inverted fee venue, taker-maker, experiences a significant increase in both trade and order volume. Our results are consistent with Foucault, Kadan, and Kandel (2013) in that a tick size adjustment has a substantial influence in the market participation in maker-taker fee venues. Additionally, we analyze the effects of the tick size change on measures of hidden and algorithmic trading, finding that measures of both hidden and algorithmic trading decline with an increasing tick size, this is strongly moderated by the differences in the maker-taker and taker-maker fee venues.

The Impact of Financial Markets on Payout Policy: Evidence from Short Selling

We investigate the impact of the stock-price formation process on payout policy using the Regulation SHO pilot program which removed short selling constraints and increased the prospect of short selling for a random sample of pilot firms. We find that pilot firms are more likely to increase dividends during this program. Subsequent to the ending of the program, these firms are less likely to increase dividends but continue to pay dividends and the propensity to repurchase shares increases too. Consistent with signaling and agency-based models, our results are more pronounced for firms with higher information asymmetry and weaker governance. We also provide evidence of a substitution effect between dividend increases and repurchases. Importantly we find that pilot firms are less likely to smooth dividends and that dividends are more likely to be financed through debt when the prospect of short selling increases. Overall, this study shows that stock price dynamics within the secondary financial market have a significant and long-lasting impact on firms’ payout policy.

Short Selling and Readability in Financial Disclosures: A Controlled Experiment

We examine the causal effect of short-selling on a firm’s annual report readability using Regulation SHO, which relaxes short-sale constraints for a random sample of pilot stocks. Pilot firms’ annual report readability decreases during the experiment period. This short-selling effect on 10-K readability is more pronounced for firms that receive less investor attention and for firms with worse news. Pilot firms also increase the use of uncertainty words in 10-Ks during the experiment period. Our results suggest that firms produce less transparent 10-Ks that are more costly for investors to comprehend when short-sale constraints are less rigorous.

Third-party consequences of short-selling threats: The case of auditor behavior

This study examines how short-selling threats affect auditors. During 2005–2007, the SEC ordered a pilot program in which one-third of the Russell 3000 index firms were arbitrarily chosen to be exempted from short-sale price tests. As a result, these stocks faced significantly higher short-selling threats. We implement a difference-in-differences test with firm fixed effects to show that auditors react to the increased threats and charge higher audit fees to the pilot firms. Further, we find that the impact only exists when auditors are concerned with the bankruptcy risk or when managers are less likely disciplined by short sellers.

Third-Party Consequences of Short-Selling Threats: The Case of Auditor Behavior

This study examines how short-selling threats affect auditors. During 2005-2007, the SEC ordered a pilot program in which one-third of the Russell 3000 index firms were arbitrarily chosen to be exempted from short-sale price tests. As a result, these stocks faced significantly higher short-selling threats. We implement a difference-in-differences test with firm fixed effects to show that auditors react to the increased threats and charge higher audit fees to the pilot firms. Further, we find that the impact only exists when auditors are concerned with the bankruptcy risk or when managers are less likely disciplined by short sellers.

Short Selling and Firmss Disclosure of Bad News: Evidence from Regulation SHO

This study provides evidence that short selling influences the disclosure of bad news by firms. Managers have incentives to withhold or delay the release of bad news. As informed traders, short sellers enhance the informativeness of stock prices, especially related to bad news, which leads to lower information asymmetry between firms and outside investors, and thus reduces the benefits and increases the litigation and reputational risks of withholding bad news. We exploit the quasi-natural experimental setting provided by the introduction of SEC regulation SHO (Reg-SHO), which significantly reduced the constraints faced by short sellers for a randomly selected subsample of U.S. firms (pilot firms). Relative to control firms, we observe a significant increase in the likelihood of bad news management forecasts among the pilot firms. Managers also provide these forecasts in a more timely fashion. We also find that managers accelerate the release of quarterly earnings news especially when the news is bad. Further analyses reveal that Reg-SHO lifts the threshold of bad news disclosure by encouraging more timely disclosure of moderate bad news. And the effect of Reg-SHO on bad news disclosure is more significant when litigation risk is higher. A series of robustness tests reinforce our main results.

Regional Industry Structure, Industrial Tax Burden, and the Effectiveness of the Replacing Business Tax with Value Added Tax Policy: Evidence from Listed Companies in China

Abstract This paper investigates the impacts of industrial tax burden and regional industry structure on the effectiveness of the replacing business tax (BT) with value added tax (VAT) policy in China. Using an event study, we find that the stock market reacts positively to the introduction of the replacing BT with VAT policy. Specifically, the market reactions are stronger for the modern service industry than for the transportation service industry because the tax burden in sub-industries of the service sector changes after the shift from BT to VAT. Also, due to disparities in regional industry structure, the policy receives a better reaction in the eastern region than in the central and western regions. We further examine the long-term effects of the replacing BT with VAT policy. The results show that the reform-induced comparative advantages of the first pilot firms in Shanghai diminish gradually as the policy is expanded nationwide. Our findings have meaningful implications for the improvement of the replacing BT with VAT policy and the development of the service and manufacturing industries.

Short Selling and Earnings Management: A Controlled Experiment

ABSTRACTDuring 2005 to 2007, the SEC ordered a pilot program in which one‐third of the Russell 3000 index were arbitrarily chosen as pilot stocks and exempted from short‐sale price tests. Pilot firms’ discretionary accruals and likelihood of marginally beating earnings targets decrease during this period, and revert to pre‐experiment levels when the program ends. After the program starts, pilot firms are more likely to be caught for fraud initiated before the program, and their stock returns better incorporate earnings information. These results indicate that short selling, or its prospect, curbs earnings management, helps detect fraud, and improves price efficiency.

The Impact of Short-Selling Pressure on Corporate Employee Relations

We show that randomly-selected Regulation SHO pilot firms respond to an increased threat of short selling by significantly improving their employee relations. Pilot firms enhance employee security to reduce the likelihood of employee-related negative publicity. The reduction of workplace concerns is most evident among pilot firms with higher degree of earnings manipulation, short interest potential, likelihood of labor disputes and employee whistle-blowing. Pilot firms experience better stock performance during the post Reg-SHO period after easing workplace concerns. Overall, our study provides novel evidence that the removal of short-selling constraints has a real effect on labor relations.

The announcement and implementation reaction to China's margin trading and short selling pilot programme

Purpose – The purpose of this paper is to investigate how the announcement and implementation of short sales and margin trading regulation affects Chinese stock returns and trading volume. On 31 March 2010, the Chinese regulators launched a pilot programme, allowing short sales and margin trading for 50 Shanghai Stock Exchange and 40 Shenzhen Stock Exchange stocks. Design/methodology/approach – This paper uses an event study approach to compare market model abnormal returns (ARs) of the pilot firms with two distinct matched firm samples. A volume event study is also conducted to examine abnormal trading activity surrounding the key events in the pilot stocks. Findings – Negative ARs follow both the announcement and implementation of short selling and margin trading. This suggests the negative impact of short sales dominates the positive impact of margin trading on an average. Volume also declines, which is consistent with uninformed investors’ seeking to avoid trading against informed traders. Originality/value – The paper appears to be the first to address the impact of both the announcement and implementation of short selling and margin trading rule changes on returns and liquidity using individual stock data.

Three strategies for customer value assessment in business markets

Purpose– The strategies to assess potential and realized customer value have received surprisingly little attention in management literature. The purpose of this paper is to examine potential customer value assessment strategies for business-to-business (B2B) firms and their special characteristics.Design/methodology/approach– The empirical part of the study draws from an exploratory, two-part field study involving three pilot firms, and seven best practice firms in customer value assessment. The research design followed an inductive, discovery-oriented grounded theory approach. Primary data were gathered through semi-structured interviews with 35 business managers from ten B2B firms.Findings– The study identifies three customer value assessment strategies adopted by firms in business markets: Emergent value sales strategy; Life-cycle value management strategy; and Dedicated value specialist strategy. These strategies highlight different ways of managing and coordinating organizational units in different phases of the customer value assessment process.Research limitations/implications– The study was conducted from the supplier's perspective and is context-bound to firms operating in B2B markets.Practical implications– Managers need to select an appropriate strategy for customer value assessment depending on market and offering characteristics, and assign clear responsibilities for value potential identification, baseline assessment, and long-term value realization.Originality/value– The extant literature on customer value lacks understanding on customer value assessment strategies. The present study identifies three strategies that illuminate the required resources and organizational units at different phases of the customer value assessment process.

Short Selling and Earnings Management: A Controlled Experiment

During 2005 to 2007, the SEC ordered a pilot program in which one-third of the Russell 3000 index were arbitrarily chosen as pilot stocks and exempted from short-sale price tests. Pilot firms’ discretionary accruals and likelihood of marginally beating earnings targets decrease during this period, and revert to pre-experiment levels when the program ends. After the program starts, pilot firms are more likely to be caught for fraud initiated before the program, and their stock returns better incorporate earnings information. These results indicate that short selling, or its prospect, curbs earnings management, helps detect fraud, and improves price efficiency.