The Corporate Governance Effect Of Short Selling

On March 31,2010,regulators in China officially implemented the buying-on-margin and securities-lending system in Chinese stock market,which substantially changed the way in which Chinese stock markets operate.Prior to this,investors in Chinese stock markets can only go long in a stock,and short-selling is prohibited;buying-on-margin only increases the leverage of going long transactions,but securities-lending,on the other-hand,completely differs from the going-long only system in the past.Therefore,the implementation of the "Pilot Measures for Securities Companies'Buying-on-Margin and Securities-Lending Business" in fact introduces the securities lending transactions into Chinese stock markets and ushers in the short selling mechanism in Chinese stock markets.The launch of the securities lending transactions allows investors to profit from the opposite direction of stock price movement,that is,investors can profit by focusing on the negative information of the target company,thus encouraging investors to exploit the negative information of the company.Through securities-lending transactions,investors can take advantage from decreases in stock price resulting from the negative news regarding the public company,therefore acting as a deterrent to the opportunistic behavior by management of public companies.Consequently,the company's negative news and the resulting decreases in stock price have an immediate impact on the behaviors of management of public companies,including management turnover and even the hostile takeovers by corporate raiders or competitors.The short-selling mechanism has long existed in Europe and the United States.There are two important problems in the study of short-selling mechanisms in the context of European countries and America:(1)The variation of level of short-selling is very low,therefore it is difficult to test the effect of short-selling mechanisms on corporate governance,and only the costs of short-selling are examined(Fang et al.,2016).At the same time,it is impossible to test whether the restrictions on short-selling have any effect;(2)because the short selling mechanism already exists,the existing research can only compare the differences of to the corporate behaviors with respect to the level of short selling interests across different companies.Unfortunately,there is an endogeneity problem,that is,there may be unobserved factors,affecting the both company's short selling interests and corporate financial behavior,so that there is only an association between the level of short selling and the company's financial behavior,but not a causal relationship.The securities lending transactions launched in China is a natural experiment in Chinese stock markets.Against the backdrop of the implementation of securities lending transactions in China's stock market,one can examine the effect of the securities lending transactions on corporate governance.At the same time,being a natural experiment,China's stock market securities lending transactions is an external shock to the system,therefore,this change does not suffer from the endogeneity issue mentioned above;in addition,China's securities lending transactions are implemented in stages across different public companies.It is an event at multiple points in time,which can further reduce the influence of unobservable factors on the research design,thus greatly improving the reliability of the research conclusions.There are many dimensions related to corporate governance.This paper investigates the corporate governance effects of the securities lending transactions from three different perspectives:(1)examine impact of the securities-lending business on the public company from the perspective of corporate tax avoidance behavior;(2)examine the impact of securities-lending business on corporate innovation;(3)examine the impact of securities-lending on stock price crash risk.There is no literature on the impact of shorting-selling on tax avoidance both in China and abroad.There are some papers that study the impact of short-selling mechanism on corporate innovation and its impact on stock market performance,but these studies focus primarily on investment in innovation,and do not focus on innovation output.The increase in innovation output does not mean an increase in investment innovation.It may also be that investment in is decreased,but innovation output is increased,that is,innovation efficiency has improved.In terms of the impact of short selling mechanisms on stock market performance,the findings in the literature are inconclusive.One of the possible reasons is that these studies suffer from the endogeneity problem as discussed before.Taking the advantage of the natural experiment related to the implementation of securities lending business in China's stock market,we survey the relevant literature,and briefly expound the relevant institutional background,then use the basic regression model,the difference-in-difference.This study examines the impact of the launch of the securities lending business on corporate tax avoidance,corporate innovation and stock market performance.Our findings are as follows:(1)The securities lending business provides investors with a new source of making profit,that is,investors can profit by researching on the negative information of the target company,thus encouraging investors to exploit the negative information of the company.Through securities-lending,investors can take advantage from drop in stock price resulting from the negative news regarding the public company,therefore act as a deterrent to the opportunistic behavior of management.In this way,the company's negative news and the resulting decline in stocks have an immediate impact on the company's management,including management changes and even the company's hostile takeovers.Corporate tax avoidance has always been the focus of attention of the regulatory authorities.The research in this paper finds that the securities lending business can restrict the tax avoidance behavior of listed companies,indicating that the securities lending business has the role of corporate governance in restricting the negative behavior of the company.(2)The securities lending business achieves the role of corporate governance by encouraging investors to expend resources on researching negative information about the company.The fundamental reason is that the securities lending business can improve the transparency of the company and restrict the unethical behavior of management.Under this pressure,the company's management behavior is more in line with the company's value.Innovation is an important guarantee for the long-term development of enterprises.Innovation success is good news,and innovation failure is bad news.The lending business can encourage management to do its best to make innovations good news,not bad news,because bad news can directly affect the management's interests under the securities lending business.The research in this paper finds that the securities lending business can reduce the company's innovation investment and improve the company's innovation output.Combining these two aspects,the securities lending business can improve the company's innovation efficiency,indicating that the securities lending business has a corporate governance role in promoting the company's positive behavior.(3)Stock price is determined by expectations from investors regarding the public company's valuation.It is the result of the joint action of investors and directly affects the interests of investors.In recent years,stock price crash risk has received great attention from investors and is also the focus of attention of the regulatory authorities.The securities lending business encourages investors to dig out the company's negative information,so that the company's hidden bad news is reduced,and thus stock price crash risk is also reduced.The research in this paper finds that the securities lending business can indeed reduce stock price crash risk,indicating that the corporate governance effect of the securities lending business has also been reflected in the stock market.(4)The corporate governance role of the securities lending business is to encourage investors to explore the negative information of the company.The result must be to improve the transparency of the company's information.The research in this paper finds that the transparency of corporate information after the launch of the securities lending business has indeed been significantly improved,indicating that the negative news of the company that the securities lending business encourages investors to explore and the decline in stocks it brings directly affect the management of the company.It truly reflects the corporate governance role of the securities lending business.The above research conclusions are robust to changing the event window from 3 years before and after the launch of the securities lending business to 1 year before and 2 years after,using different metrics and using the propensity score matching method(PSM)to reconstruct the sample.The conclusions of this paper are very stable.This paper makes the following contributions.First of all,this paper expands the literature on short selling mechanism and corporate behaviors,systematically revealing the corporate governance effect of securities lending business from the perspective of positive behavior,negative behavior and stock price crash risk;this paper focuses on the event of launch securities lending transactions in Chinese stock markets.Such a quasi-natural experiment can better solve the endogeneity problems existing in short selling research,thus improving the reliability of the research related to the securities lending transactions.Secondly,this article is the first to study the impact of the securities lending transactions on corporate tax avoidance,enriching the research on corporate tax avoidance.In the past,the research on tax avoidance was mainly focused on agency cost.The factors on corporate tax avoidance behavior were investigated primarily from the perspective of corporate governance and executive compensation incentives.However,there is no literature on the short selling mechanism of resulting from securities lending to study corporate tax avoidance behavior.Furthermore,this paper further expands the existing research on short selling and corporate innovation.Although a small amount of literature has studied the impact of short selling on innovation(He and Tian 2014;Quan Xiaofeng,Yin Hongying 2017),these studies only focus on innovation output,but do not pay attention to innovation input.The increase of innovation output does not represent the improvement of innovation efficiency.This paper further examines whether the short selling mechanism can improve the innovation efficiency of enterprises from the perspective of innovation investment,so as to more comprehensively examine the impact of short selling mechanism on corporate innovation.Finally,this paper expands on existing research on short selling mechanisms and stock price crash risk.Stock price crash risk will lead to huge losses of investors'wealth,which will damage the healthy development of the capital market.Therefore,stock price crash risk has always been an important topic of concern for academics,regulators and the public(Chen et al.,2001).The literature has focused on company-level factors(such as information transparency,accounting robustness,etc.)to study the stock price collapse risk(e.g.,Jin and Myers,2006;Kim and Zhang,2016),but research on the market level needs further to be done to improve our understanding.The research in this paper also has important empirical implications.First of all,this paper provides theoretical support for the practical effect of Chinese-style buying-on-margin and securities lending,and has important practical significance for the improvement of short selling mechanism.The development of China's capital market is not long,the level of speculation and volatility of the stock market is very high,the stock market system is still not perfect,and the market information environment is opaque.Therefore,whether Chinese-style buying-on-margin and securities lending can improve stock pricing like Western European countries,and thus the interests of small and medium investors,remains to be empirically examined.This paper comprehensively examines the impact of China's differentiated external market environment and Chinese-style buying-on-margin and securities lending in the stock market,and provides empirical evidence for the academic debates about the economic consequences of buying-on-margin and securities lending.It also provides a theory for improving the buying-on-margin and securities lending mechanism in China.Secondly,this paper provides theoretical reference and policy support for China to further deepen the financial system reform.This paper empirically examines the mechanism and influence degree of margin financing and securities lending on business operations from the micro level,especially the impact of corporate innovation behavior and innovation efficiency.The research conclusions of this paper show that buying-on-margin and securities lending,as an innovative financial instrument,can improve the innovation efficiency of public companies,that is,it can substantially promote the business activities of public firms.Therefore,the conclusions of this paper indicate that the reform of the financial system can promote the development of the real economy,which has important practical implications for the deepening of the financial system reform in China at this stage.Currently,China is in the period of economic structural transformation.The"13th Five-Year Plan"clearly states that it is necessary to speed up the formation of a stock market with solid basic systems,effective market regulation,and adequate protection of investor rights.The introduction of the securities lending business can prompt the timely release of negative information about corporate value,forcing management to constrain its opportunistic behavior,compressing tax avoidance space,and protecting the interests of investors and promoting the effective allocation of market resources.Therefore,the introduction of the securities lending mechanism as a mechanism to promote information dissemination is of great significance for further improving the health of China's stock market.However,China's current stage of buying-on-margin and securities lending market is relatively small,the development of margin financing and securities lending business is not rational,and the number of pilot securities firms can be limited.It has become a major problem in the current development of margin financing and securities lending business.This paper suggests that China should introduce a market-oriented"bond-to-security"mechanism as soon as possible to increase the source of funds and stocks;gradually expand the scope of stocks under the margin of financing and securities lending,and propose to extend the scope of the underlying stocks to the constituent stocks of the CSI 800 Index or the corresponding index products;consider different levels of short selling standards for different types of stocks.