Short-selling and corporate default risk: Evidence from China

We examine the deregulation of short-selling in the Chinese stock market, and find that short-selling activities can reduce the default risk of the underlying companies. Such an effect is more pronounced when the information disclosure is worse and the corporate governance is weaker for the shortable companies, and also when the short-selling on the companies' stocks is more active. These results support the notion that short-selling can improve a company's financial management by contributing to its information transparency and corporate governance. Moreover, we find that it takes a longer time (over two years) for the short-selling activities to finally entice the improvements and reduce the risk. In addition to the reduced default risk, shortable companies also have better access to credit and debt capital. Our results stay robust after propensity score matching is applied and the effect of margin-trading is controlled.