Short selling threat and corporate tax avoidance: Evidence from China

Taking the staggered introduction of margin purchasing and short selling pilot program in China as a natural experiment, this study tests its influence on managerial tax avoiding activities. We establish our tests on detailed discussions about the self-selection problems in our setting and use a difference-indifference method to identify the casual link. The results revel that the introduction of margin trading and short selling pilot program has significant monitoring effects on corporate tax avoidance. Tax avoiding activates experience a significant reduction after firms are selected into the pilot program. In addition, the phenomenon is more pronounced for firms whose managers hold shares and thus face direct wealth loss resulting from short selling. Also, we find that the phenomenon is more pronounced when firms are operated in looser tax enforcement areas. Further evidence shows that short sellers do target firms with aggressive tax avoiding activities while margin purchasers exhibit no trading interests, and thus the effect of the pilot program on tax avoidance can be safely attributed to the short selling threats. Finally, as the natural consequence of the reduction of complicated tax avoiding activities, we find pilot firms enjoy a more transparent information environment. © 2020, Editorial Board of Journal of Systems Engineering Society of China. All right reserved.