Capital market frictions and conservative reporting: Evidence from short selling constraints

Accounting conservatism and short selling: Evidence from China

“…This study contributes to a growing literature on the capital market's feedback effects on firms’ financial reporting decisions (Fang et al., ; Li & Zhang, ; Martin & Roychowdhury, ; Massa et al., ; Young, ). The previous research most closely related to our study is that of Young (), who examines the effects of short selling on US firms’ conservative reporting in relation to Reg. SHO .…”

“…Short selling tends to curb earnings management, increase price informativeness and make it difficult for a firm's managers to hide bad news. Removing short selling constraints can make it easier for stock prices to reflect bad news (Gilchrist et al., ; Young, ). A straightforward prediction is that the managers of firms on the pilot short‐selling list will respond to the positive shocks of price declines from short selling by decreasing their levels of conditional conservatism as a means to delay the recognition of bad news in earnings.…”

“…A straightforward prediction is that the managers of firms on the pilot short‐selling list will respond to the positive shocks of price declines from short selling by decreasing their levels of conditional conservatism as a means to delay the recognition of bad news in earnings. However, equity investors could anticipate this result, and then they may demand an increase in conditional conservatism (Young, ). In particular, LaFond and Watts () show that equity investors demand more conservative earnings reports as a means of mitigating agency problems.…”

“…Young () finds that a decrease in short‐selling constraints is associated with a decrease in conditional conservatism. Our conclusions are somewhat different from those of Young (), but they are consistent with those of several studies that have shown the important disciplining effect of short sellers on financial reporting (Fang et al., ; Li & Zhang, ; Martin & Roychowdhury, ; Massa et al., ). Additionally, we find both an ex‐ante positive and an ex‐post negative effect of short selling on accounting conservatism.…”

“…Our findings also complement previous studies, first by showing that the effect of short selling on increased conditional accounting conservatism is not due to a reduction in unconditional conservatism, and second by demonstrating that this important effect is also dependent on firm ownership. Young () is silent on these important issues. Our results remain robust when we measure accounting conservatism by using a piecewise accruals‐cash model (Ball & Shivakumar, ).…”