Short selling and financial reporting quality: evidence from Chinese AH shares

This paper investigates whether the monitoring function of short sale on firms’ financial reporting quality is conditional on the regulatory quality of the markets, and the strength of internal control at firm level. Using data on Chinese cross-listing AH-shares over the period of 2010–2015, we find that short sale restricts accrual earnings management in A-share markets but not in the H-share market. This difference is explained by the relative inferiority of the A-share markets’ regulatory quality, and is accentuated when the cross-listing AH-share firms have weak internal control. Taken together, the results indicate that short-sellers impose strong monitoring on reporting quality when they perceive a great likelihood of managerial expropriation in a weak legal environment, or in firms with weak internal control.