We find evidence that short interest is positively related to future crash risk.
The evidence is in line with the view that short sellers detect bad news hoarding.
Additional findings show that the relation is more salient for specific subsamples.
Empirical support is provided for the main relation observed above.
Using a large sample of U.S. public firms, we find robust evidence that short interest is positively related to one-year ahead stock price crash risk. The evidence is consistent with the view that short sellers are able to detect bad news hoarding by managers. Additional findings show that the positive relation between short interest and future crash risk is more salient for firms with weak governance mechanisms, excessive risk-taking behavior, and high information asymmetry between managers and shareholders. Empirical support is provided showing that the relation between short interest and crash risk is driven by bad news hoarding.
Study Links Earnings Manipulation to Success in Corporate Accounting
10 August 2015
Accounting Today Online
Willingness to manipulate earnings helps individuals succeed in corporate accounting, according to a new academic study. The study’s authors contend that individuals who ascend to positions of authority in corporate accounting are predisposed by their personality and values to manage earnings and are hired and promoted for that very reason.
This paper shows that agency problems result from controlling-minority shareholder conflicts have a nonlinear causal relation with firm cash holding, and this relation hinges critically on the strength of investor protection. Using a direct measure of controlling shareholder’s entrenchment behavior, our theoretical work in a two-period static model and empirical analysis using Chinese financial data during 2000-2013 shows that the relation between controlling shareholder tunneling and cash holding is significantly U-shaped, and this relation is more significant with stronger investor protection. Also, The inflation point of the U-shape is inversely propotional to the strength of investor protection, which is smaller with stronger investor protection. In general, our findings reinforce the importance of informal investor protection mechanisms in mitigating agency problems and affecting firms’ cash policies in an emerging markets with undeveloped legal systems.
Even Fraud-Savvy Investors Often Look for the Wrong Red Flags
29 June 2015
New research identifies the types of investors who are vigilant about corporate fraud, but finds that most of those investors are tracking the wrong red flags – meaning the warning signs they look for are clear only after it’s too late to protect their investment. The work was performed by researchers at North Carolina State University, George Mason University, the University of Virginia and the University of Cincinnati.
“Individual investors get hurt if they own stock in fraudulent companies that cook the books, such as Enron,” says Dr. Joe Brazel, a professor of accounting at NC State and lead author of a paper on the work. “But we wanted to know how investors think about fraud and whether they try to protect themselves.” Continue reading →
We shared this story of the Monkey in the Buddhist book Journey to the West.. he had to overcome various obstacles with the team in the journey of knowledge and education, including the powerful Centipede who had a thousand eyes that shone on Monkey, searing him very badly.. Badly hurt, he sought the help of Goddess of Mercy who directed him to Mother Hen god fairy who in turn passed him a special gift/weapon: the Needle. When the Centipede uses the thousand eyes again when they meet, Monkey uses the Needle which worked its way by poking the thousand eyes.
From the Buddhist interpretation to the book Journey to the West, this story is about how when we are accused and bullied by a powerful person who would use all sorts of diversionary tactics and scrutiny (eyes and mouths) to destroy us, the only way is the Needle, which stands for the Truth in public.
Consider this: A company uses cash to buy government bonds, subsequently depositing the bond in a bank, a seemingly very harmless transaction. Is this potential accounting fraud?
What is undisclosed is this company, Olympus, colluded with the LGT bank manager to use the bond as a collateral to lend to two shell companies created by Olympus. These shell companies then use the borrowed money to acquire toxic assets at cost from Olympus, thus allowing Olympus to avoid recognizing impairment losses on these underwater securities should they be marked to market in both the immediate period and in the long-term. Continue reading →
Decision Support Systems. Jun2015, Vol. 74, p78-87. 10p.
Abstract: Corporate financial fraud has a severe negative impact on investors and the capital market in general. The current resources committed to financial fraud detection (FFD), however, are insufficient to identify all occurrences in a timely fashion. Methods for automating FFD have mainly relied on financial statistics, although some recent research has suggested that linguistic or vocal cues may also be useful indicators of deception. Tools based on financial numbers, linguistic behavior, and non-verbal vocal cues have each demonstrated the potential for detecting financial fraud. However, the performance of these tools continues to be poorer than desired, limiting their use on a stand-alone basis to help identify companies for further investigation. The hypothesis investigated in this study is that an improved tool could be developed if specific attributes from these feature categories were analyzed concurrently. Combining features across categories provided better fraud detection than was achieved by any of the feature categories alone. However, performance improvements were only observed if feature selection was used suggesting that it is important to discard non-informative features.
This paper tests the proposition that politicians and their affiliated firms (i.e., firms operating in their province) temporarily suppress negative information in response to political incentives. We examine the stock price behavior of Chinese listed firms around two visible political events—meetings of the National Congress of the Chinese Communist Party and promotions of high-level provincial politicians—that are expected to asymmetrically increase the costs of releasing bad news. The costs create an incentive for local politicians and their affiliated firms to temporarily restrict the flow of negative information about the companies. The result will be fewer stock price crashes for the affiliated firms during these event windows, followed by an increase in crashes after the event. Consistent with these predictions, we find that the affiliated firms experience a reduction (an increase) in negative stock return skewness before (after) the event. These effects are strongest in the three-month period directly preceding the event, among firms that are more politically connected, and when the province is dominated by faction politics and cronyism. Additional tests document a significant reduction in published newspaper articles about affected firms in advance of these political events, suggestive of a link between our observed stock price behavior and temporary shifts in the listed firms’ information environment.
We hypothesize that short selling has a disciplining role vis-à-vis firm managers that forces them to reduce earnings management. Using firm-level short-selling data for thirty-three countries collected over a sample period from 2002 to 2009, we document a significantly negative relationship between the threat of short selling and earnings management. Tests based on instrumental variable and exogenous regulatory experiments offer evidence of a causal link between short selling and earnings management. Our findings suggest that short selling functions as an external governance mechanism to discipline managers.