The Invisible Hand of Short-Selling: Does Short-Selling Discipline Earnings Manipulation?

Abstract:     
We hypothesize that short selling has a disciplining role vis-à-vis the managers forcing them to reduce earnings manipulation. Using firm-level short-selling data over the sample period of 2002 to 2009 across 33 countries, we document a significantly negative relationship between lending supply and activism in the short-selling market and earnings manipulation. Using an instrumental variable approach as well as focusing on exogenous events (cross-sectional and time series regulatory and market restrictions), we provide evidence of a causal link from short selling potential to lower earnings manipulation. Overall, our findings suggest that short selling provides an external governance mechanism to discipline managerial incentives.

Number of Pages in PDF File: 66

Keywords: short-selling, earning manipulation, international finance, governance

JEL Classification: G30, M41

working papers series