Can short sellers predict accounting restatements and foresee their severity

Date

2005-11-01

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Publisher

Texas A&M University

Abstract

This dissertation investigates whether short sellers establish short positions prior to accounting restatement announcements and whether the levels of short interest are related to the severity of restatements. Using 565 firms with restatement disclosure during the period of 1995 to 2002 and matched control firms with no restatements announcements, I find that the level of short interest is higher for the sample firms compared to the control firms in the months surrounding the announcements. The level of short interest increases as the restatement announcement date approaches and declines thereafter. Related to severity of restatement, I find that the level of short interest in the pre-disclosure period is higher for restatements involving fraud and the revenue accounts. There exists limited evidence that the pre-disclosure level of short interest is positively associated with the number of quarters restated and the magnitude of the restatements. Finally, I find cumulative abnormal returns surrounding the announcements are more negative for restatement firms that have a higher level of short interest. These results suggest that short sellers are highly sophisticated investors who can see through accounting manipulation and consequently profit from their knowledge.

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