Monday, October 8, 2012

MASSA Massimo, ZHANG Bohui, ZHANG Hong
The Invisible Hand of Short-selling: Does Short-selling Discipline Earnings Manipulation?
INSEAD Working Paper 2012/93/FIN

We hypothesize that short-selling has a disciplining role vis-à-vis the managers forcing them to reduce earning 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 sell market and earnings manipulation. Additional tests using ETF ownership as an instrument or based on market-wide shortselling restrictions further confirm that short selling potential strongly discourages earnings manipulation. Meanwhile, the impact is more pronounced for firms with weaker corporate governance. Collectively, our findings suggest that short selling provides an external governance mechanism to discipline managerial incentives.