Equities

Accruals and Short Selling: An Opportunity Foregone

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Accruals and Short Selling: An Opportunity Foregone

Working paper

This paper examines the extent to which short sellers use accrual data to forecast which stocks may decline in price. Previous research has shown that firms with high working capital accruals tend to underperform firms with low working capital accruals. Specifically, firms with high accruals have greater negative changes in earnings and negative abnormal returns over the following year.

Others have found that sell-side analysts fail to appreciate how high accruals affect future earnings; as a result, they are systematically more optimistic about the prospects for high-accrual firms. In a sample of 12,232 firm years included in the AMEX, NASDAQ and NYSE Short Interest reports for the period 1980–1998, high-accrual firms have significantly lower future returns.

Short sellers have particularly strong incentives to use accrual information since they can directly profit from the lower future performance of high-accrual firms. However, the evidence in this paper suggests that short sellers do not use the information content of current accruals to choose which stocks to short. Evidently, short sellers, like analyst and auditors, do not correctly anticipate the consequences of accrual information.

Transaction costs could explain this, since the high-accrual firms in my sample tend to be smaller, less liquid securities that are costlier to trade. However, even after controlling for these factors I do not find evidence that short sellers utilize accrual information. The finding that short sellers do not trade on the basis of accruals is robust to changes specifications, industry-year adjustments to the level of short sales and tests focusing on short activity around subsequent earnings announcements.

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