A Study on the Impact of Rule of Law on the Governance Effect of Short-Selling Mechanisms—An Empirical Analysis Based on Chinese A-Share Listed Companies

This study uses samples of Chinese A-Shares non-financial listed companies from 2007 - 2019, combined with the phased implementation of the margin trading system as a quasi-natural experiment, to study whether short-selling mechanism is affected by the rule of law and how the rule of law moderates the impact of short-selling mechanism on the earnings management of non-financial listed companies of Chinese A-share. Short selling curbs both accrual-based and real earnings management (beta=-0.012 and-0.015), and it restrains real earnings management more. The rule of law has a positive moderating effect on this governance effect, the suppression of earnings fraud is significantly higher in high rule of law (DA: -0.018,REM:-0.020) compared to low rule of law (DA: -0.006,REM:-0.007) places. Heterogeneity analysis shows that the moderating effect is more pronounced on non-state owned firms and regulated industries. From the mechanism tests, this study can see that short selling restrains earnings management by improving the information transparency and reinforcing financing constraints. The analyst coverage and institutional ownership will boost the effect. This study proposes judicial coordination, different treatment for short sale targets, and to build a 'law-short selling' risk early warning mechanism.