Short Selling Threats and Corporate Default Risk: Evidence from the Chinese Stock Market

Abstract

Employing the staggered short-sale deregulation on the Chinese stock market as quasi-exogenous shocks, we find that short selling threats is associated with higher corporate default risk, especially for firms that are more financially constrained, with higher growth rates, and higher information asymmetries. In addition, firms with higher ex-ante default risk experience an increase in the cost of debt and a reduction in new debt financing following the regulatory changes. The increase in default risk does not appear in U.S. listed firms in the context of the Regulation SHO’s pilot program. Overall, our findings indicate that short selling can adversely affect firm prospects through increasing the likelihood of default, especially in an environment where investors are more alien to short selling, short sellers are more able to be manipulative due to weak investor protection, and firms are lack of effective tools to avoid downside risk.