Common Ownership and the Spillover Effect of Short Selling: Evidence from Corporate Fraud

This study focuses on the effect of an external policy shock in one firm on other common shareholder-owned firms. After China launched margin trading and short selling as an exogenous shock, we find that the probability and frequency of fraud in focal firms decrease significantly when one of the firms held by common shareholders was involved in such trading in the previous year. The results remain robust after several robustness tests. Mechanism analysis shows that improved information environment and reduced agency problems act as corporate fraud deterrents. This effect is stronger for companies with frequent shareholders’ meetings, firms with limited market development, and those in highly competitive industries. Overall, the empirical results show that focal firms’ behavior is affected by firms exposed to external policy shocks.