Accounting conservatism and short selling: Evidence from China

Using China's short-selling pilot program as a quasi-experiment, we find that the prospect of short selling has significantly increased conditional accounting conservatism among firms that are eligible for short selling, consistent with a short sellers' disciplining effect hypothesis. When short selling takes position ex post, accounting conservatism starts to decrease with an increased downward pressure on stock prices. Moreover, the short-selling effect of increased conditional accounting conservatism becomes stronger for state-owned enterprises, and this effect is accompanied by an increase of unconditional conservatism. As corroborating evidence to support the disciplining hypothesis, we show that accounting conservatism is significantly decreased for firms that are removed from the short-selling eligibility list. Our results are robust after considering the endogeneity issue in measuring downward stock price pressure, and after constructing the control firms by using both a propensity score matching method and an alternative measure for accounting conservatism. Overall, we provide important evidence on the feedback effects that the capital market has on firm financial reporting.