The Impact of Short Selling on Accrual-Based and Real Earnings Management: Evidence from China

Posted: 23 Jun 2017 Last revised: 11 May 2020

See all articles by Huili Zhang

Huili Zhang

Beijing Normal University (BNU)

Jigao Zhu

University of International Business and Economics

Jie He

Zhongnan University of Economics and Law

Kam C. Chan

Western Kentucky University - Department of Accounting and Finance

Date Written: December 12, 2016

Abstract

We study the impact of short sales on accrual-based and real earnings management (EM). Based on the costs and benefits of using EM to hide negative information, we derive an analytical model showing that there are two possibilities: 1) a firm engages in less accrual-based and real EM when facing short-seller scrutiny (the informational efficiency hypothesis), or 2) a firm switches from accrual-based EM (a less sophisticated method) to real EM (a more sophisticated method), which we call the sophisticated information-hiding hypothesis. That is, there is a tradeoff between accrual-based and real EM in the presence of short sales. Using a natural experiment of the recent short sales deregulation in China, we show findings consistent with the latter reaction. Additional analysis suggests that the decrease in accrual-based EM and increase in real EM are driven primarily by firms with non-Big 10 auditors or firms not under shareholder or regulatory scrutiny. We interpret the findings as being consistent with the model prediction that for firms with weak inside and outside monitoring, the probability of detecting real EM is low, and thus the tradeoff between accrual-based and real EM prevails in the presence of short sales.

Keywords: Short Selling; Negative Information Hiding; Accrual-Based Earnings Management; Real Earnings Management; Crash Risk

JEL Classification: G10; M41

Suggested Citation

Zhang, Huili and Zhu, Jigao and He, Jie and Chan, Johnny, The Impact of Short Selling on Accrual-Based and Real Earnings Management: Evidence from China (December 12, 2016). Journal of Accounting and Public Policy, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2991140

Huili Zhang

Beijing Normal University (BNU) ( email )

19 Xinjiekou Outer St
Haidian District
Beijing, Guangdong 100875
China

Jigao Zhu

University of International Business and Economics ( email )

Room 412, Ningyuan Building
Huixindong street 10
Beijing, 100029
China

Jie He (Contact Author)

Zhongnan University of Economics and Law ( email )

No.143, Wuluo Road
Wuhan, Hubei 430073
China

Johnny Chan

Western Kentucky University - Department of Accounting and Finance ( email )

Bowling Green, KY 42101
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
1,364
PlumX Metrics