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The Invisible Hand of Short-selling: Does Short-selling Discipline Earnings Manipulation? _______________ Massimo MASSA Bohui ZHANG Hong ZHANG 2012/93/FIN The Invisible Hand of Short-selling: Does Short-selling Discipline Earnings Manipulation? Massimo Massa* Bohui Zhang** Hong Zhang*** * The Rothschild Chaired Professor of Banking, Co-Director of the Hoffmann Research Fund, Professor of Finance at INSEAD Boulevard de Constance, 77305 Fontainebleau Cedex, France. Email: Massimo.massa@ ** Senior Lecturer at University of New South Wales, Sydney, NSW Australia. Email: bohui.zhang@.au *** Assistant Professor of Finance at INSEAD 1, Ayer Rajah Avenue, 138676 Singapore. Email: hong.zhang@ A Working Paper is the author’s intellectual property. It is intended as a means to promote research to interested readers. Its content should not be copied or hosted on any server without written permission from publications.fb@ Find more INSEAD papers at /facultyresearch/research/search_papers.cfm Abstract We hypothesize that short-selling has a disciplining role vis-à-vis the managers forcing them to reduce earning manipulation. Using firm-level short-selling data over the sample period of 2002 to 2009 across 33 countries, we document a significantly negative relationship between lending supply and activism in the short sell market and earnings manipulation. Additional tests using ETF ownership as an instrument or based on market-wide shortselling restrictions further confirm that short selling potential strongly discourages earnings manipulation. Meanwhile, the impact is more pronounced for firms with weaker corporate governance. Collectively, our