The monitoring of short selling: Evidence from China

In the world second largest economy, the largest emerging market, an environment that is characterized by a weak legal system, a high level of government intervention, and an underdeveloped but fast evolving financial market, we investigate whether short selling is associated with regulators’ enforcement actions and reduces the future crash risk. By using manually collected firm level lawsuit data, we find that short selling is positively associated with probability for the firm of being targeted or punished by CSRC (China Securities Regulatory Commission). In addition, we find short selling reduces the future stock price crash risk. These findings suggest that short selling monitoring provides supplementary monitoring power to the financial markets. Moreover, our results provide information that can inform policy making.