The Initial Framework of Short Selling Mechanisms and Corporate Financial Irregularities in Publicly Traded Firms

Abstract

The efficiency of capital allocation in financial markets depends heavily on the integrity and transparency of corporate disclosure. Repeated financial irregularities have remained a major obstacle to the development of China's securities market. With the pilot launch of the margin trading and short selling system in 2010, short-selling mechanisms were formally introduced into China's capital market. This policy change was expected to improve external monitoring of listed firms and limit managerial behavior motivated by self-interest. Using a dataset of A-share publicly traded firms from 2010 through 2020, this study empirically tests the regulatory effect of short-selling mechanisms on corporate financial irregularities. It also examines whether this relationship changes with the quality of internal control systems and the structure of corporate ownership. The results indicate that the implementation of short-selling rules can significantly reduce financial irregularities in publicly traded firms. The pattern is stable. It remains true after multiple robustness checks. The heterogeneity analysis further shows that the restraining effect of short-selling mechanisms on financial irregularities becomes stronger when internal controls are of higher quality, which points to a complementary relationship between internal and external governance systems. A similar difference appears across ownership types. The governance effect of short selling is stronger in privately owned enterprises than in state-owned ones. These findings add to the research on market-based governance and offer practical support for improving short-selling regulations and increasing the deterrent effect against corporate irregularities in China's capital market.