Short Selling Threats and Non-GAAP Reporting: Evidence from a Natural Experiment

This study examines how short selling threats affect firms’ non-generally accepted accounting principles (non-GAAP) reporting quality. From 2005 to 2007, the SEC implemented a Pilot Program under Regulation SHO, in which one-third of the Russell 3000 index stocks were randomly chosen as pilot stocks and exempted from short-sale price tests. As a result, short selling threats increased considerably for pilot stocks. Using difference-in-differences tests, I find that pilot firms respond to the increased short selling threats by reducing the use of low-quality non-GAAP exclusions, resulting in an improvement in the quality of overall non-GAAP exclusions. Further tests show that this effect of short selling threats is more pronounced for smaller firms, firms with lower institutional ownership, firms with lower analyst coverage, and firms with lower ratios of fundamental value to market value. These findings suggest short sellers play an important monitoring role in disciplining managers, as evidenced by the non-GAAP reporting choices of managers.