Can Short Selling Constrain the Shift between Accrual-Based and Real Earnings Management?

Abstract

We study the causal effects of short selling on real earnings management by exploiting an exogenous shock to short selling costs under the pilot program of Regulation SHO. We find the removal of short selling constraints leads to a reduction of real earnings management in pilot firms relative to non-pilot firms during the pilot program period. The effect is more pronounced in firms where managers are more entrenched and institutional ownership is lower. Furthermore, the effect is significantly stronger among firms with more analyst coverage. Combined with existing evidence on accrual-based earnings manipulation, our paper completes the picture of how short selling affects earnings management and indicates that short selling is superior to several other governance mechanisms, such as securities analysts, in constraining earnings management in that it does not lead to a shift from accrual-based earnings management to real earnings management.