Two Essays on Short Selling and Private Information Flow


Student thesis: Doctoral Thesis

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Awarding Institution
Award date28 Jul 2021


Private information flow is a key dimension of a firm’s information environment. Investors demand higher returns to hold stocks with greater private information, leading to higher costs of capital to firms. However, extant evidence on the flow of private information about a firm is scarce in the literature, primarily due to the unobservable nature of private information. One possible way to capture private information flow about a firm is through the shorting activities, because short sellers are sophisticated investors who profit from private information about the future prospect of a firm. In this study, I try to investigate short selling and private information flow in two chapters.

The first chapter examines the effect of auditor regulatory oversight on short sellers’ private information advantage in an international setting. Utilizing a difference-in-differences research design, I find that PCAOB international inspections reduce the ability of shorting demand to predict negative future returns. This finding is consistent with the view that PCAOB inspections reduce private information advantage of short sellers by improving the quality of firm-specific public information. I further find that the effect of PCAOB inspections on return predictability of shorting demand is stronger for earlier-year inspections of PCAOB, for countries with more opaque information environment or countries with lower audit quality prior to PCAOB inspections. This study highlights the role of auditor regulatory oversight in facilitating the establishment of a level playing field by reducing firms’ private information flow in the stock market.

The second chapter investigates the relation between short selling and firm-level stock price crash risk. I focus on the short selling regulations around the world and examine whether the removal of short selling constraints help to incorporate bad news into stock price, deter managers’ opportunistic behavior, and reduce crash risk. I predict and find that the removal of short selling constraints is negatively related with stock price crash risk. Further, I provide evidence suggesting that the effect of short selling on stock price crash risk is more pronounced in more opaque countries. This study highlights the role of short selling in deterring bad news withholding and establishes a causal link between short selling and firm-level stock price crash risk in an international setting.

    Research areas

  • Short selling, Private information flow, PCAOB international inspections, Stock price crash risk, Bad news withholding