This overview is based on the paper titled “Short selling and financial reporting quality: “Evidence from Chinese AH shares”. Authored by Haiyan Jiang and Jun Chen, published in the Journal of Contemporary Accounting and Economics
Can short selling stocks sell out managers?
Short selling is the financial marketplace practice of betting that a share’s price will decline. An investor will borrow to then sell a share; buying it back once the price has decreased before returning the share to the lender – pocketing the profit gained. Short selling of shares sends signals to the market that the firm’s performance has weakened and therefore the price of its stock is expected to decline. Due to the impact to financial markets, recent literature observed that short sellers can play a role monitoring managerial behaviours and firms' decision making. Managers weary of short sellers will proceed carefully with business activity as to maintain the stock price. To contribute to recent literature, our paper’s objective is to explore the impact short sellers have on the regulatory quality of firms' financial reports, specifically earnings management. Earnings management is an accounting tactic used to produce favourable financial reports; which can prove unreliable to investors.
Chinese listed firms provide the means for investigation as shares are categorised by their trading currency and market location. Chinese shares traded in this way provide a platform of differing regulatory environments which will allow for meaningful comparisons. A- shares are listed on either the Shanghai or Shenzhen stock exchange and are denominated in the Chinese yuan renminbi. B- shares are also listed on either the Shanghai or Shenzhen stock exchange but instead are traded in foreign currencies. Whilst H- shares are listed on the Hong Kong Ssock exchange and are traded in the Hong Kong Dollar. This paper will compare cross listed shares known as AH- shares as they are listed on both the Hong Kong and either one of the Shanghai or Shenzhen exchanges and will be subject to each stock market’s trading requirements.
Our findings highlight the differences in A-share and H-share markets; with short sales impacting earnings management reporting more in the A- share market. This is due to the weaker quality of regulations in A-share markets. To conclude our results, the presence of short sellers does restrict management behaviour and specifically earnings management by imposing monitoring in environments with weaker internal controls.
This study may be of benefit to investors assessing firms' performance as we have found that the presence of short sellers can be viewed both negatively and positively. A high volume of firms' stocks shorted does bear bad news, however, the silver lining is that firms' earnings management activities are lessened. This analysis focused on Chinese listed firms, but researchers may extend this investigation into the global market.