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Short Sellers and Financial Misconduct


  • Foster School of Business, University of Washington and Lerner School of Business and Economics, University of Delaware, respectively. We thank especially Jerry Martin, who maintains the Karpoff-Lee-Martin database used in this study, and also Anup Agrawal, Uptal Bhattacharya, Hemang Desai, Karl Diether, Avi Kamara, Adam Kolansinski, Jennifer Koski, Srinivasan Krishnamurthy, Paul Laux, Paul Malatesta, Charu Raheja, Ed Rice, Ronnie Sadka, Katsiaryna Salavei, Mark Soliman, Ingrid Werner, two Journal of Finance referees, the Associate Editor, Campbell Harvey, and seminar participants at the 2008 CRSP Forum, Concordia University, Yale Law School, Binghamton University–SUNY, Rutgers University, Syracuse University, Temple University, University of Indiana, University of Washington, Vanderbilt Law School, and the California Corporate Finance Conference for helpful comments. We also thank the Q Group, The CFO Forum, and the Foster School of Business for financial support.


We examine whether short sellers detect firms that misrepresent their financial statements, and whether their trading conveys external costs or benefits to other investors. Abnormal short interest increases steadily in the 19 months before the misrepresentation is publicly revealed, particularly when the misconduct is severe. Short selling is associated with a faster time-to-discovery, and it dampens the share price inflation that occurs when firms misstate their earnings. These results indicate that short sellers anticipate the eventual discovery and severity of financial misconduct. They also convey external benefits, helping to uncover misconduct and keeping prices closer to fundamental values.

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