The Invisible Hand of Short Selling: Does Short Selling Discipline Earnings Management?

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

Massa, Massimo and Zhang, Bohui and Zhang, Hong, The Invisible Hand of Short Selling: Does Short Selling Discipline Earnings Management? (October 9, 2014). Review of Financial Studies, Forthcoming, INSEAD Working Paper No. 2012/93/FIN, Asian Finance Association (AsFA) 2013 Conference, Available at SSRN: https://ssrn.com/abstract=2124464 or http://dx.doi.org/10.2139/ssrn.2124464