Short-sale refinancing and earnings response coefficient: evidence from China

• DOI: https://doi.org/10.1108/IJAIM-03-2020-0030
• Pages: 127-146
• Published date: 15 September 2020
• Date: 15 September 2020
• Subject Matter: Accounting methods/systems,Accounting & finance,Accounting/accountancy
• Author: Tingli Liu,Ying Jiang,Lizhong Hao

Short-sale ref‌inancing and

earnings response coef‌f‌icient:

evidence from China

Tingli Liu and Ying Jiang

College of Economics and Business Administration,

Beijing University of Technology, Beijing, China, and

Lizhong Hao

Pamplin School of Business, University of Portland, Portland, Oregon, USA

Abstract

Purpose –Although short selling has been legalized in China for nearly 10 years, due to the existence of

short-sale constraints, its impact on corporate governance of listedcompanies remains unclear. This paper

aims to examine the impact of short-sale ref‌inancing on earningsquality after the short-selling constraints

have been released.The authors further explore whether this impact is subjectto the nature of property rights

and shareholdingstructures.

Design/methodology/approach –This study is based on a sample of A-share f‌irms in China for the

period 2014–2016. The authorsuse earnings response coeff‌icients (ERC) as a proxy for earnings quality. To

empirically examine thisissue, a matching sample is generated by using propensity score matching method

(PSM) to reduce sampleselection bias.

Findings –This study provides evidence that deregulation of short selling has positive external ef fect

on corporate governance. The results indicate that the potential short-selling opportunities can

effectively suppressearnings manipulation and improve earnings quality. However,the impact of short

selling on earnings quality varies for companies with different nature of property rights and

shareholding structure.

Originality/value –To the best of the authors’knowledge, this is the f‌irst study to investigate the

relationship between shortselling and earnings quality in the unique setting of short-saleref‌inancing. This

study providesnew evidence on the impact of short selling at the micro level and calls for further deregulation

of short selling. In addition,this study contributes to existing studies on short-saleref‌inancing by examining

an emergingmarket.

Keywords Propensity score matching, Earnings quality, Short selling, Short-sale ref‌inancing

Paper type Research paper

1. Introduction

In the USA, investors can borrow stocks directly from institutionalshareholders, brokers or

dealers and then sell these stocks that they do not already own (Dechow et al.,2001).

However, short selling was not allowed in China before 2010.If investors wanted to borrow

stocks, they had to borrow through China Securities Finance Corporation (CSF). CSF does

not operate securitiestrading, but helps listed companies to f‌inance and borrow stocks (from

institutional shareholders, index funds, insurance companies and social security funds),

playing the role of a “middleman.”The process by which CSF borrows stocks from

institutional shareholders then lends them to listed companies is called short-sale

ref‌inancing, while the process by which listed companies lend funds or securities to

individual investorsis called securities margin trading.

Earnings

response

coef‌f‌icient

127

Received3 March 2020

Revised13 August 2020

Accepted13 August 2020

InternationalJournal of

Accounting& Information

Management

Vol.29 No. 1, 2021

pp. 127-146

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-03-2020-0030

The current issue and full text archive of this journal is available on Emerald Insight at:

https://www.emerald.com/insight/1834-7649.htm

Short selling, as an important securitieslending mechanism, is considered as an integral

part of the capital market. On March 31, 2010, China Securities Regulatory Commission

adopted the policy that allows securities margin trading, which effectively ended the

traditional single-lateral market in the past 20years. This change marks the legalization of

short-sale transactions in China’s securities market. After f‌ive expansions of pilot stocks

range, the number of qualif‌ied f‌irms in bothShanghai Stock Exchange (SSE) and Shenzhen

Stock Exchange (SZSE) had increased from 90 initially to 950. By December 2014, the total

balance of securitiesmargin trading had broken through the trillion mark.

To alleviate the supply-side constraintsof short selling, CSF has implemented more rules

on short-sale ref‌inancing beginning since February 28, 2013. In the f‌irst phase, 90 pilot

stocks are qualif‌ied for short-sale ref‌inancing, including 40 stocks from SZSE and 50 stocks

from SSE (hereafter called short-sale ref‌inancing stocks as qualif‌ied stocks or eligible

A-share). After three expansions,the number of short-sale ref‌inancing stocks is basicallythe

same as the number of securities margintrading.

Figure 1 shows the evolution of the turnover of qualif‌ied stocks during the period from

February 28, 2013 to December 31, 2017. The vertical axis represents the turnover of

qualif‌ied stocks, and the horizontal axis represents time. From the adoption of short-sale

ref‌inancing until the middle of 2015, the overall transaction volume shows an increasing

trend. The fastest growth rate of turnover occurred from mid-2014 to mid-2015. The main

reason was that the stock market was gradually showing a bull market from the beginning

of 2015, and aggressive investors continue to be bullish, whileconservative investors think

that prices are alreadyat a high level.

Figure 2 shows the f‌luctuation in volume of short-sale ref‌inancing from February 28,

2013 to December 31, 2016. It presents a steady upward trend in term of the proportion of

short-sale ref‌inancingvolume being divided by the short-selling volume. After excluding the

impact of individual stock prices, thecontribution of short selling mechanism to expanding

the supply side is very intuitive. Therefore, we believe that short-sale ref‌inancing plays an

important role for short sellingmechanism in China.

Regulators and the professional community greatly concern the impact of short selling on

securities market and corporate governance. It is also an empirical question in academic

research that whether short selling is associated with corporate governance and earnings

quality. With earnings quality as an entry point, which is considered as a comprehensive

measure of corporate governance, we construct our treatment and control groups using

Figure 1.

Lending volumefor

short-saleref‌inancing

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