Do Short Sellers Front-Run Insider Sales?

Abstract

We find evidence of significant increases in short sales immediately prior to large insider sales, consistent with information leakage and front-running. We examine a number of alternative explanations that the increase in short sales is driven by public information about the firm or about the impending insider sale, but the evidence is inconsistent with these explanations. The result has implications for the enforcement of insider information regulations, and for timely disclosure of short sales information by stock exchanges.JEL Classification Code: G10, G14, G18, G30

Informed or speculative: Short selling analyst recommendations

“…5 In addition, we exclude recommendation changes that occur during the 10-day period after a previous recommendation change following Irvine et al (2007) and CFH. 6 After merging the Reg SHO and 2 In other studies, Karpoff and Lou (2010) find that short selling increases during the 19 months before an SEC investigation about financial misrepresentation is publicly announced while Khan and Lu (2008) report an increase in short selling immediately prior to insider sales and argue that short sellers front-run these inside trades. However, Chakrabarty and Shkilko (2008) only find abnormal short selling on days with insider sales and the event-day short selling is not able to identify the insider sales that have the largest future stock price decline, suggesting that the ability of short sellers to predict the negative news in insider trades is selective at best.…”

Short Selling and Corporate Tax Avoidance

“…5. Khan and Lu (2013) investigate potential sources of short sellers' information and find evidence consistent with leaked information from firm insiders.…”

“…Therefore, short sellers will not execute a transaction unless they expect that security's price to fall by a sufficient amount to compensate for the costs and risks of shorting (Diamond & Verrecchia, 1987). Prior literature suggests that short sellers hold an information advantage over retail investors and even analysts (Drake, Rees, & Swanson, 2011;Khan & Lu, 2013). When short sellers concentrate to bet on a specific security's price decline, this high short-interest level signals to the market that the targeted stock is overvalued relatively to its fundamentals, and the stock price is likely to decrease (i.e., greater stock price crash risk).…”

Information and Insurer Financial Strength Ratings: Do Short Sellers Anticipate Ratings Changes?

“…Christophe, Ferri, and Angel () and Christophe, Ferri, and Hsieh () examine shorting activity prior to earnings announcements and analyst recommendations, respectively, and find that short selling is abnormally high prior to both unfavorable earnings announcements and downward analyst recommendation changes. When examining short selling around insider sales, Khan and Lu () find abnormal short selling prior to insider sales. These previous findings substantiate the assertion that short sellers are sophisticated traders around information‐rich events.…”