Corporate Governance and Short Sales

Chapter one in this study examines the relation among short sales activity and the CEO dismissals, its disclosure, and replacement choice. The study includes several monthly and annualized short sales metrics: short interest ratio, SIR, measured as the shares held short as of settlement date divided by outstanding shares and short cover ratio, SE, measured as the monthly shares held short as of settlement date divided by the volume traded as well as regression modeled abnormal activity from 1992 to 2018. The results suggest informed trading in the pre-announcement period, revealing SIR and abnormal short interest ratio metrics significantly increase in the year and months prior to a turnover. While the short sales positions significantly increase when controlling for overall outstanding stocks, short sellers avoid revealing their positions by limiting their short sale activity when controlling for volume traded. This avoidance prevents triggering a short squeeze and unleashing upward price pressures. Further, the study reveals short sales positions are significantly larger preceding forced turnovers and industry outsider replacements. The effect is robust to multiple estimators such as modeling the turnover disclosure choice and replacement separately or simultaneously (e.g., event study, binomial, and multinomial logistic regressions). The results are robust to the implementation of instrumented regressions. Overall, the study provides evidence short selling can be considered as a feasible corporate governance mechanism. Chapter two explores the effect of short sale constraints in earnings management under an experimental regulatory shock. The chapter expands previous research by assessing the role of impending increases in short sales and the trade-off among earnings management tools including accruals, real earnings management, REM, and classification shifting. Previous research finds that on average firms facing the prospect of potential larger short sales tend to reduce their accruals management; however, we find this fact does not translate in complete avoidance of earnings manipulation; instead, firms turn to alternative earnings management tools such as REM and classification shifting. Additionally, we find that in a subset of suspect firms, which barely met their past earnings benchmarks, the relation between impending short sales and accruals is reversed. The study provides evidence of the trade-off between accruals, REM, and classification-shifting suggesting firms engage in an earnings management pecking order when deciding which tools to apply. In general, short sales seems to discipline the market of financially healthy firms constraining their ability to engage in accruals management; however, we find firms resort to alternative earnings management tools such as REM and core expenses classification shifting to achieve their earnings targets. Our findings suggest impending short sales do not appear to impact suspect firms\u27 accruals management. Overall our studies offer evidence short sellers provide external monitoring and have an important yet limited role in corporate governance. Their activism shapes CEO turnover decision, disclosure and replacement choices as well as limiting earnings management