The Invisible Hand of Short Selling: Does Short Selling Discipline Earnings Management?
Review of Financial Studies, Forthcoming
91 Pages Posted: 6 Aug 2012 Last revised: 2 Oct 2015
Date Written: October 9, 2014
We hypothesize that short selling has a disciplining role vis-à-vis firm managers that forces them to reduce earnings management. Using firm-level short-selling data for 33 countries collected over a sample period from 2002 to 2009, we document a significantly negative relationship between the threat of short selling and earnings management. Tests based on instrumental variable and exogenous regulatory experiments offer evidence of a causal link between short selling and earnings management. Our findings suggest that short selling functions as an external governance mechanism to discipline managers.
Keywords: short-selling, earning manipulation, international finance, governance
JEL Classification: G30, M41
Suggested Citation: Suggested Citation