Short‐Selling Threats and Corporate Tax Avoidance: Evidence From Regulation SHO

ABSTRACT We examine the effect of short‐selling threats on tax avoidance. To establish causality, we exploit a quasi‐experimental setting where the US Securities and Exchange Commission's (SEC's) Regulation SHO (Reg SHO) pilot program relaxed an essential short‐selling constraint for a sample of NYSE‐listed pilot stocks, thus causing an exogenous increase in short‐selling threats in these stocks. Using quantile regression, we find that the relation between tax avoidance and short‐selling threats is significantly negative (positive) when tax avoidance is very high (low). This effect is observable for more opaque firms, firms whose managers have more job security concerns, and firms whose managers’ equity portfolios are more sensitive to share prices. Our results suggest that short sellers’ scrutiny of hidden agency problems underlying extreme tax avoidance would dampen stock price inflation and reduce managers’ welfare, thus motivating managers to reduce extreme tax avoidance in the first place.