Short Selling and the Spillover Effect of Restatement Filings: Evidence on Disclosure‐Processing Frictions

ABSTRACT This study examines whether short sellers respond to the spillover effect of restatement filings. We focus on exposed non‐restating clients, defined as firms audited by the same audit office as a restating client. We argue that a client restatement conveys adverse auditor‐office‐level information about audit quality, making exposed peers more salient as short‐selling targets and directing attention toward firms with elevated reporting risk. Consistent with this argument, we find that short selling increases in exposed non‐restating clients following a same‐auditor‐office client restatement. The evidence further suggests that restatement spillovers lower disclosure‐processing frictions for short sellers. The short‐selling response is stronger when the spillover is easier to recognize and use, and when exposed peers exhibit characteristics associated with lower audit quality and higher reporting risk. In addition, greater post‐restatement short selling predicts more negative future abnormal returns. Overall, the evidence suggests that short sellers use restatement spillovers to identify exposed firms with elevated reporting risk and to incorporate auditor‐office‐level audit quality concerns into their trading decisions.