Short‐Selling Prior to Earnings Announcements

Abstract

This paper examines short-sales transactions in the five days prior to earnings announcements of 913 Nasdaq-listed firms. The tests provide evidence of informed trading in pre-announcement short-selling because they reveal that abnormal shortselling is significantly linked to post-announcement stock returns. Also, the tests indicate that short-sellers typically are more active in stocks with low book-to-market valuations or low SUEs. The levels of pre-announcement short-selling, however, mostly appear to ref lect firm-specific information rather than these fundamental financial characteristics. We believe that these results should encourage financial market regulators to consider providing more extensive and timely disclosures of short-selling to investors.

Short Selling during Extreme Market Movements

“…These combined results suggest that while short sellers are typically contrarian, some short sellers appear to trade in the direction the market moves indicating that short sellers become less sophisticated on these event days (Dennis and Strickland, 2002). Christophe, Ferri, and Angel (2004) show that pre-earnings announcement short selling relates inversely with post-earnings announcement returns and argue that short sellers are able to anticipate negative news events, such as unfavorable earnings announcements. Under this assertion, we test whether short sellers are able to anticipate these days with extreme market movements.…”

“…Research showing that short sellers are informed about future stock returns is robust (Diamond and Verrecchia, 1987;Senchack and Starks, 1993;Aitken et al, 1998;Desai et al, 2002;Christophe, Ferri, and Angel, 2004;and Boehmer, Jones, and Zhang, 2008). Diether, Lee, and Werner (2009) argue that informed investors are able to short stocks that become overvalued or out of line with their fundamental value while documenting the short sellers are contrarian in contemporaneous and past returns.…”

Can Mutual Fund Managers Pick Stocks? Evidence from their Trades Prior to Earnings Announcements

“…Ali, Durtschi, Lev, and Trombley (2004) examine institutional investors, broadly defined. Ke, Huddart, and Petroni (2003) follow trading by corporate insiders, and Christophe, Ferri, and Angel (2004) follow short sellers. Some differences with these papers include the fact that we stress the potential of this approach to address the joint hypothesis problem, and that we apply it to the study of individual mutual fund managers, a group of particular interest.…”

Local Bias in Google Search and the Market Response around Earnings Announcements

“…In addition, given their private information, we would expect local investors' trading to be more predictive of the upcoming earnings announcement (Christophe, Ferri, and Angel 2004), and thus we expect that more information about the forthcoming earnings announcement will be incorporated into price during the pre-announcement window (as in Drake, Roulstone, and Thornock 2012). Overall, we expect that for firms with higher local bias in search, bid-ask spreads and trading volumes will be higher in the preannouncement window, and returns in the pre-announcement window will be more predictive of the upcoming earnings announcement.…”

“…Local investors are more likely to anticipate the news in the coming announcement through their private information. Thus, if there is a higher 4 concentration of local investors, we would expect higher information asymmetry across investors and higher trading volumes before the earnings announcement due to preannouncement private information (e.g., following Copeland and Galai 1983, Easley and O'Hara 1992, Glosten and Milgrom 1985, Krinsky and Lee 1996, as well as preannouncement returns that anticipate the earnings news to a greater degree (e.g., Christophe, Ferri, and Angel 2004;Drake, Roulstone, and Thornock 2012). As with the event-window market response, we use four methods to analyze pre-announcement spreads, volume, and returns: cross-sectional analysis, propensity-score-matched pairs, an instrumental variable approach, and an analysis of changes.…”