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

91 Pages Posted: 6 Aug 2012 Last revised: 2 Oct 2015

See all articles by Massimo Massa

Massimo Massa

INSEAD - Finance

Bohui Zhang

The Chinese University of Hong Kong, Shenzhen

Hong Zhang

Singapore Management University - Lee Kong Chian School of Business

Date Written: October 9, 2014

Abstract

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

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

Massimo Massa

INSEAD - Finance ( email )

Boulevard de Constance
F-77305 Fontainebleau Cedex
France
+33 1 6072 4481 (Phone)
+33 1 6072 4045 (Fax)

Bohui Zhang (Contact Author)

The Chinese University of Hong Kong, Shenzhen ( email )

Hong Zhang

Singapore Management University - Lee Kong Chian School of Business ( email )

50 STAMFORD ROAD
Office 4087, Lee Kong Chian School of Bu
Singapore, 178899
Singapore

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