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Motives for corporate philanthropy propensity: Does short selling matter?
International Review of Economics and Finance xxx (2018) 1–13
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Motives for corporate philanthropy propensity: Does short selling matter? Deshuai Hou a, Qingbin Meng b, *, Kai Zhang b, Kam C. Chan c a b c
School of Accounting, Capital University of Economics and Business, Beijing, 100070, China School of Business, Renmin University of China, Beijing, 100872, China Department of Finance, Western Kentucky University, Bowling Green, KY 42101, USA
A B S T R A C T
We examine the impact of short selling on a firm's CP propensity in a sample of Chinese firms. Drawing from the strategic view of CP literature, we postulate that when a firm faces weaknesses, it has incentive to use CP to divert public attention. Our results, as expected, suggest that when there is a surge in short selling, a firm is more likely to make CP in a given year. The findings are robust to endogeneity concerns and different measure of CP propensity. Sub-sample analyses use corporate transparency, operating results, corporate governance, and prior security violation suggest that when a firm is less transparent, having poor operating performance, an ineffective corporate governance, and anticipated future security violation, it is more likely to using CP to divert the public attention.
1. Introduction In addition to the traditional view of corporate philanthropy (CP) as an altruistic activity, an emerging body of literature examines CP as a part of a larger corporate strategy. Studies show that CP brings tangible and intangible benefits to a firm such as a good corporate image and reputational capital (Saiia, Carroll, & Buchholtz, 2003; Wang & Qian, 2011; Zhang, Zhu, Yue, & Zhu, 2010b, 2010a), relational capital with governments and the public (Shleifer & Vishny, 1994; Sanchez, 2000), tax benefits (Duquette, 2016; Navarro, 1988; Schwartz, 1968), improve corporate efficiency (O'hagan & Harvey, 2000; Porter & Kramer, 2002), among others. A few studies suggest that firms leverage their CP activities to alleviate weakness of their operations. For instance, Chen, Patten, and Roberts (2008) suggest that CP is a substitute for a firm's corporate social responsibility deficiency. Koehn and Ueng (2010) report that, after earnings restatements, firms use CP to divert public attention. The extant literature studies CP as a strategy to garner internal benefits or take it a tool to cover up a firm's bad operating outcomes. That is, firms use CP to internalize benefits or remedy deficiencies in their internal operation weakness. It is not clear how external tangible factors in the financial market affect a firm's CP decisions. Given both internal and external contributing factors shape and affect a firm's operations and activities, it is worthwhile to examine how external factor in the financial market contributes to a firm's CP. In a parallel body of literature, several studies suggest that short sellers are able to uncover a firm's negative information so as to engage in profitable short selling activities (Blau & Pinegar, 2013; Callen & Fang, 2015; Drake, Myers, Myers, & Stuart, 2015; Engelberg, Reed, & Ringgenberg, 2012; Francis, Venkatachalam, & Zhang, 2005; Maffett, Owens, & Srinivasan, 2016). Short sellers are informed traders so that a surge in short selling is a realization of the underlying weakness of the shorted firm (Francis et al., 2005; and; Karpoff & Lou, 2010). In addition, short selling restriction not only reduces market liquidity, but also leads to informed traders
* Corresponding author. E-mail addresses: [email protected] (D. Hou), [email protected] (Q. Meng), [email protected] (K. Zhang), [email protected] (K.C. Chan). https://doi.org/10.1016/j.iref.2018.07.009 Received 24 May 2018; Received in revised form 24 July 2018; Accepted 25 July 2018 Available online xxxx 1059-0560/© 2018 Elsevier Inc. All rights reserved.
Please cite this article in press as: Hou, D., et al., Motives for corporate philanthropy propensity: Does short selling matter?, International Review of Economics and Finance (2018), https://doi.org/10.1016/j.iref.2018.07.009
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turning to other trading products, which reduce the information efficiency of stock market (Le & Zurbruegg, 2016). Most importantly, when short selling of a stock increases, other market participants notice and accelerate their discovery of firm negative information. The spillover effect leads to an increase in selling pressure of the stock in the market (Shyu, Chan, & Liang, 2018). Subsequently, there are adverse impact of short selling on stock price, such as increase in corporate financing cost, and negative impact on management incentives (Callen & Fang, 2015; De Angelis, Grullon, & Miehenaud, 2017; Grullon, Michenaud, & Weston, 2015; Henry & McKenzie, 2006; Maffett et al., 2016; Safieddine & Wilhelm, 1996). Hence, a natural question is what a firm will do to strategically counter a surge in short selling. In the long-run, a firm can improve operation and/or restrain value destroying activities to counter short selling. These long-run activities, however, will take time to be effective in alleviating the immediate impact of short selling. Instead, we hypothesize, in the short-run and when facing a surge of short selling, a firm shifts into some activities to divert the attention on the negative information of the firm. These activities represent a quick fix. Among many possible quick fix activities, CP is at the discretion of the management and it is one of the few easiest strategies to deploy, especially CP has shown to be effective to achieve the goal of diverting public attention and able to paint a good image of a firm. Few studies explore the relation between short selling and CP of a firm, however. Our study fills this gap by studying how short selling, an external tangible factor, affects a firm's CP propensity. The objective of this paper is to examine the relation between short selling and CP propensity using a sample of Chinese firms. The Chinese environment provides a good setting for our analysis with two reasons. First, short selling in China is costly.1 It is more likely that short selling is an informed rather than a speculative trading strategy in China (Meng, Li, Jiang, & Chan, 2017). Hence, short sellers are informed and they have strong incentives to uncover negative firm information. Therefore, the motivation for a firm to do something quick, such as CP activities, to divert public attention to counter a surge of short selling is strong. Second, China has had short selling deregulation since 2010. The short selling literature mainly uses annual average short selling data for research, but in practice, short selling traders may adopt short-term trading strategies (Diether, Lee & Werner, 2009). Therefore, it is important to use daily short selling to fully identify the impact of short selling on stock prices (Boehmer & Wu, 2013). Unlike other markets, China is only one of the few emerging markets that allow short selling with daily short selling data disclosure. Hence, we can conduct the necessary data to conduct our analysis. Therefore, the findings provide guidance to other emerging markets when they evaluate the impact of short selling and the relation between CP and short selling. We offer several findings. First, short selling and CP propensity are positively correlated. The results remain the same after accounting for endogeneity between short selling and CP propensity and they are robust using a change no CP in t-1 to some CP in t. Second, we document that when a firm has low corporate transparency (audited by a non-Big 4 auditor, low institutional ownership, or low stock price synchronicity) and operating weakness (low cash flow, low sales growth, or low profitability), it has a higher CP propensity when facing a rise in short selling. The results suggest that management engages in opportunistic CP activity and hope to divert public attention to counter the potential adverse impact of short selling, especially if the firm is less challenging to do so (because it is not transparent) or if the firm has material operating weakness. Third, we find that when a firm has weak internal corporate governance (CEO/chairman duality, bad ownership wedge, low independent director ratio, or independent directors have many absences from board meetings) or has a security violation but yet being discovered by the China Securities and Regulatory Commission (CSRC), it has a high CP propensity when facing a rising in short selling. The findings, again, suggest that when a firm provides an easy environment for management to engage in opportunistic behavior or the incentive to divert bad news is strong, it is more inclined to conduct more CP. In sum, the additional findings from corporate transparency, operating weakness, internal corporate governance, and security violations corroborate with the hypothesis that management uses CP as a diversion instrument. When it is more challenging to engage in opportunistic behavior or there is no need to engage in diversion (e.g., security violations have already been exposed), a firm does not conduct CP. Last, the impact of an increase in short selling confines to firms switching from no CP to some CP. Our paper makes three contributions to the literature. Overall, our findings echo those in the CP literature that a firm makes CP to divert the public attention to cover up its operating weakness by painting a good corporate image. We complement the literature by documenting that a firm uses CP to react to external tangible factor (short selling) in additional to response to the internal factors (such as operating weakness). In addition, we show that firms use CP to counter the adverse impact of rising short selling, suggesting that investors need to aware such practice and cautiously interpret the motivation behind a firm's CP activities. Third, we document that when a firm is more transparent and has strong corporate governance, its management engage in less opportunistic CP activities. Thus, it is always a good public policy to encourage firms to be more transparent and having strong corporate governance. 2. Literature review and hypothesis development We have three different perspectives to develop our testable hypothesis. The first is related to agency theory. According to Jensen and Meckling (1976), management has incentives to engage in opportunistic activities to gain private benefits. The most common opportunistic activities are the covering up or delaying negative information disclosure (Kothari, Shu, & Wysocki, 2009; Pastena & Ronen, 1979). It is natural that these cover ups are not perfect. Thus, in a market that allows short selling, short sellers are able to profit from their negative information production. To counter the short sellers, management has incentives to engage in activities to divert
1
According to Meng et al. (2017), as of February 2015, the regulations on short selling in China include: (1) a short seller needs to have an account with a brokerage
firm for at least 18 months with a minimum balance of about US$80,000, (2) the brokerage firm needs to provide assessment on risk tolerance of the short seller, (3) the borrowed stock incurs a fee of 10.6%, and (4) the maximum short selling period is six months with a 50% margin. 2
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public attention and to convey a good corporate image to the public. A number of CP studies document that firms use CP to gain moral and reputational capital (Brammer & Millington, 2005, 2006; Godfrey, 2005), and garner public trust and investor goodwill (Koehn & Ueng, 2010). That is, CP is an effective tool for a firm to gain legitimacy to the society and brings good image to itself. Most importantly, CP does not need a long time to plan. A firm can make decision on CP quickly to meet their discretionary need. Similar to Koehn and Ueng (2010), we argue that a firm uses CP to cover up operation weakness in order to divert public attention or to gain goodwill from investors and the public. When short sellers expose these operation weaknesses via short selling, management use CP to divert the attention of investors. It is especially the case if the negative information from operation weakness has not yet disclosed to the public but a small number of informed investors, such as short sellers, begin to take trading decisions against the firm. Thus, for self-interest, when short selling accumulates, management begins to drum up more CP as a response. Hence, CP propensity increases. Our first testable hypothesis is: H1A.
If a firm uses CP as a cover up tool in response to short selling, short selling and CP propensity are positively correlated.
The second perspective considers the wealth maximization of the firm. When facing a surge in short selling, management realizes a possibility of rising operating risk due to the uncovering of negative firm information by short sellers. The uncovered negative information may make it challenging for the firm in terms of financing, raising capital, obtaining trade credit, among others. Firm management feels the need to preserve more internal resources to weather anticipated adverse outcomes of short selling on firm operation. Thus, a firm limits its CP and CP propensity is less. The alternative hypothesis to H1A is: H1B.
Ceteris paribus, a firm decreases its CP propensity when short selling increase
The third perspective considers CP as a natural corporate behavior. CP literature suggests that CP is a reflection of good social citizen. It is a pure result of social corporate responsibility, a common good, and a reflection of a firm's altruism (Berkowitz & Daniels, 1963; Varadarajan & Menon, 1988; Campbell, Gulas & Gruca, 1999). Thus, a firm's management views CP activities as a form of corporate social responsibility. Hence, CP does not depend on any outside factors. That is, short selling does not affect a firm's CP propensity. Therefore, the alternative to H1A is: H1C.
Ceteris paribus, a firm's CP propensity is not related to short selling
We examine the three competing testable hypothesis with a sample of Chinese firms. 3. Data and methods 3.1. Data We include all the shortable stocks in the Shanghai and Shenzhen from March 2010 to December 2015. Then, based on the corporate social responsibility and the annual reports of listed companies, we hand-collected data on charitable donations from related companies and excluded samples that could not be judged whether charitable donations were public charitable donations. In addition, short-selling volume can better reflect the process characteristics of short-selling behavior and hence, volume is more informative. However, because some shortable stocks have too few trading days with short volume, we exclude firms with less than 30 weeks of short selling activities. Due to regulatory information, we exclude financial firms. After identify 2555 firm-years, we examine the CP of each firm in a given year. The short selling information is from CSMAR and other financial information is from WIND.
3.2. Methods 3.2.1. Key variable definitions Our focus is the propensity for a firm to engage in CP. We define a (1, 0) variable, CP_DUMMY, with a value of 1 if a firm made CP in a given year and zero otherwise. To capture short selling in a year, we use the average weekly number of shorted shares to the total outstanding shares in a year (SHORT_RATIO). 3.2.2. Basic empirical model To examine the validity of H1A, H1B, or H1C, we use the following regression model: CP_DUMMYi,t ¼ α0 þ α1SHORT_RATIOi,t þ Σαj*Control variablesi,t þ εi,t
(1)
If H1A is valid, then α1 should be positive. For H1B to be valid, α1 should be negative. If a firm considers CP as a pure altruistic activity (H1C), then α1 should be insignificant. We use a set of control variables to account for their respective impact on a firm's propensity to make CP. These variables include: return on assets (ROA), market-book ratio (MB), leverage (LEVERAGE), free cash flow (CASHFLOW), sales growth (GROWTH), government subsidy (SUBSIDY), and firm size (SIZE). The detailed definitions are presented in the Appendix. With the exception of leverage, we expect the coefficients of these control variables are positive. We estimate Eq. (1) by a logitistic regression.
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Table 1 Descriptive statistics. This table presents the descriptive statistics of major variables. Variable definitions are presented in the Appendix.
CP_DUMMY SHORT_RATIO (in one-tenth of one %) ROA BM LEVERAGE CASHFLOW GROWTH SUBSIDY SIZE
Mean
Std
Min
Max
Q1
Median
Q3
0.267 0.6545 0.039 1.740 0.524 0.397 2.133 0.272 22.713
0.442 0.7971 0.063 2.862 0.219 21.125 131.935 2.198 1.675
0.000 0.0003 0.691 0.030 0.016 1051.675 6665.310 0.000 18.859
1.000 4.3600 0.346 21.916 1.280 30.835 30.399 22.142 27.087
0.000 0.1357 0.012 0.419 0.362 0.115 0.036 0.000 21.544
0.000 0.3505 0.031 0.835 0.534 0.481 0.119 0.000 22.517
0.000 0.8552 0.066 1.807 0.687 0.925 0.447 0.000 23.773
4. Results and discussions 4.1. Core findings We present the descriptive statistics of the sample in Table 1. The mean of CP_DUMMY is 0.267, suggesting that there are 26.7% of our sample making CP for all years. In terms of SHORT_RATIO, an average firm in a typical year has 0.065% of shares sold short in a given week. The standard deviation of SHORT_RATIO is 0.7971, showing some variations of short selling among different stocks. For the results of correlation coefficients in Table 2, we find that they are 0.099 and 0.071 between CP_DUMMY and SHORT_RATIO using Pearson and Spearman methods. They are significant at the 1% level. The positive correlation provides preliminary support to H1A. We present the results for the relation between short ratio and CP propensity in Table 3. For both simplified and full models in columns (1) and (2), the coefficients of SHORT_RATIO are positive and significant at the 1% and 5% levels. The findings support H1A. Other variables, if significant, carry the expected signs. For instance, the coefficients of ROA, CASHFLOW, GROWTH, and SIZE are all positive and significant at the 1%, 5%, or 10% levels. The positive significant coefficients are consistent with notion that when a firm is profitable, has sufficient cash, experiences high growth, or is larger, it is more likely to have more CP. 4.2. Robustness check 4.2.1. Exogenous events In the early stage of short sale deregulation, brokerage firms could not borrow shares from clients to lend shares to short sellers. In 2013 and after, brokerage firms are able to do so. Thus, the impact of short selling becomes fully effective after allowing borrowed shares. The permission of borrowing shares is an exogenous shock for the impact of short selling on CP propensity. Hence, if the impact of SHORT_RATIO on CP_DUMMY remains intact after the borrowing shares deregulation, the endogeneity concern is minimal. The findings in Table 4 show that the coefficient of SHORT_RATIO is positive and significant at the 5% level after the permission of borrowing shares in column (2). Thus, it is the impact of SHORT_RATIO on CP_DUMMY and not the other way around. 4.2.2. Instrumental variable method Although we closely follow the literature to control a set of control variables, there may still be problems with missing variables. Hence, the results in Table 3 may have missing variables that may lead to endogenous. To mitigate the bias, we adopt a two-stage least square estimation. The results are presented in Table 5. We use the number of months a stock become shortable (HORIZON) as the instrumental variable. The logic is that short sellers need time to research on the negative information of a shortable stock. When a stock is only newly shortable, short sellers are unable to immediately engage in negative information production. According to the Shanghai Stock and Shenzhen Stock Exchanges implementation rules for margin trading, the stock exchanges will gradually select stocks that meet the requirements into the shortable pool. Therefore, being a short-selling stock has a degree of exogeneity. That is, regardless of when a stock becomes shortable, it is unlikely related to a firm's own behavior. Therefore, whether a firm engages in CP does not depend on the number of months a stock become shortable. Thus, HORIZON explains SHORT_RATIO but it is unrelated to CP_DUMMY. In column (1), we show the results using HORIZON as the instrumental variable to generate a predicted short selling variable (PRED_SHORT_RATIO). In column (2), we use the PRED_SHORT_RATIO to replace SHORT_RATIO as the explanatory variable. The coefficient of PRED_SHORT_RATIO in column (2) is positive and significant at the 10% level, suggesting a positive impact of short selling on CP propensity. Overall, the findings in Tables 4 and 5 show that the results in Table 3 are not due to endogeneity between short selling and CP propensity. In addition, the control variables in Tables 4 and 5, if significant, carry the same signs as those in Table 3. 4.2.3. Further robustness check: unexpected CP The results in Tables 3–5 use the CP propensity as the dependent variable. The objective is to show a firm's intent from making CP to a surge in short selling. To be robust, we use the unexpected CP (UNEXPECTED_CP) in year t the dependent variable. We measure UNEXPECTED_CP as a (1, 0) dummy variable in the year t with a value of 1 if a firm has CP in year t but having no CP in t-1. The UNEXPECTED_CP variable captures a sudden change of intent in using CP. We present the findings in Table 6. From both the simplified and full models in columns (1) and (2), the coefficients of SHORT_RATIO are positive and significant at the 1% level, suggesting that 4
D. Hou et al. Table 2 Pearson and Spearman correlation coefficients. This table presents the correlation coefficients among major variables. The upper triangle shows the Spearman correlation coefficients while the lower triangle presents the Pearson coefficients. Variable definitions are presented in the Appendix. *, **, and *** indicates 10%, 5%, and 1% significance, respectively.
5
CP_DUMMY SHORT_RATIO ROA BM LEVERAGE CASHFLOW GROWTH SUBSIDY SIZE
CP_DUMMY
SHORT_RATIO
ROA
BM
LEVERAGE
CASHFLOW
GROWTH
SUBSIDY
SIZE
1.000 0.099*** 0.030 0.348*** 0.245*** 0.041 0.019 0.079*** 0.422***
0.071*** 1.000 0.010 0.003 0.07*** 0.012 0.017 0.013 0.094***
0.008 0.032 1.000 0.178*** 0.423*** 0.008 0.064** 0.014 0.046*
0.335*** 0.006 0.419*** 1.000 0.586 0.079*** 0.014 0.103*** 0.503***
0.237*** 0.024 0.487*** 0.758*** 1.000 0.048* 0.003 0.090*** 0.511***
0.115*** 0.048* 0.294*** 0.088*** 0.204*** 1.000 0.001 0.010 0.061**
0.073*** 0.049* 0.051** 0.105*** 0.007 0.254*** 1.000 0.003 0.060**
0.078*** 0.022 0.037 0.098*** 0.080*** 0.096*** 0.053** 1.000 0.143***
0.407*** 0.121*** 0.023 0.679*** 0.501*** 0.172*** 0.160*** 0.118*** 1.000 International Review of Economics and Finance xxx (2018) 1–13
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International Review of Economics and Finance xxx (2018) 1–13 Table 3 Short selling and the propensity to donate. This table presents the impact of short selling on the CP propensity. Variable definitions are presented in the Appendix.*,**, and*** indicates 10%, 5%, and 1% significance, respectively. (1)
(2)
CP_DUMMY SHORT_RATIO
330.662*** (2.64)
268.165** (1.97) 4.557** (2.16) 0.013 (0.35) 0.312 (0.43) 0.003* (1.94) 0.063* (1.66) 0.008 (0.21) 0.458*** (5.03) 13.806*** (-6.88) Yes Yes 1576 667.70326 0.2957
ROA BM LEVERAGE CASHFLOW GROWTH SUBSIDY SIZE CONS Year Industry Obs Log likelihood Pseudo R2
0.025 (0.04) Yes Yes 1600 741.52119 0.2267
Table 4 The impact of allowing borrowed stocks in short selling on the relation between short ratio and CP propensity. This table presents the results of the regulatory change in borrowed stocks in the short selling. China did not allow using borrowed stocks until 2013. Variable definitions are presented in the Appendix. *, **, and *** indicates 10%, 5%, and 1% significance, respectively. (1)
(2)
Before allow using borrowed Shares (2010–12)
After allowing using borrowed shares (2013–15)
CP_DUMMY SHORT_RATIO ROA BM LEVERAGE CASHFLOW GROWTH SUBSIDY SIZE CONS Year Industry Obs Log likelihood Pseudo R2
2635.851 (0.87) 4.841 (1.00) 0.029 (0.16) 0.736 (0.42) 0.374 (1.29) 0.137 (-0.69) 0.057 (-0.94) 0.574** (2.53) 14.559*** (-2.80) Yes Yes 174 79.355807 0.2741
244.860** (2.19) 4.000** (2.22) 0.013 (-0.32) 0.066 (0.11) 0.002 (0.43) 0.080* (1.72) 0.019 (0.69) 0.511*** (7.48) 14.903*** (-9.29) Yes Yes 1400 578.04981 0.2530
when short ratio surges, a firm suddenly makes CP when it made no CP at all in the previous year. Hence, our findings in Table 3 are robust to alternative variable to capture the intent of using CP to cover up operating weakness. 4.3. Moderating role of corporate transparency We study the moderating effect of corporate transparency of a firm on the impact of short selling on CP propensity. If a firm is not 6
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International Review of Economics and Finance xxx (2018) 1–13 Table 5 Two-stage least squares. This table presents the results for the two-stage least squares to mitigate possible endogeneity of short selling and CP propensity. We use the number of months a stock become shortable (HORIZON) as the instrumental variable to generate a predicted value of short ratio in column (1). Then, column (2) uses PRED_SHORT_RATIO to replace SHORT_RATIO as the main explanatory variable. Variable definitions are presented in the Appendix.*,**, and*** indicates 10%, 5%, and 1% significance, respectively. (1)
(2)
First stage
Second stage
SHORT_RATIO
CP_DUMMY
PRED_SHORT_RATIO HORIZON ROA BM LEVERAGE CASHFLOW GROWTH SUBSIDY SIZE Cons Year Industry Obs Log likelihood Adj-R2 Pseudo R
546.700* (1.67) 0.009*** (11.89) 0.847 (0.24) 0.738*** (-4.66) 2.469* (1.72) 0.003 (-1.14) 0.001*** (4.66) 0.014 (-0.18) 0.276 (1.13) 7.800 (-1.53) Yes Yes 2373
4.178* (1.84) 0.029 (0.67) 0.422 (0.57) 0.003** (2.00) 0.066 (1.58) 0.009 (0.21) 0.390*** (3.52) 12.837*** (-5.61) Yes Yes 1513 635.28563
0.305 0.3022
Table 6 Further Robust check: The impact of short ratio on corporate sudden shift from no to some donation. This table presents the results of using a firm's sudden shift from no to some donation from t-1 to t as dependent variable (UNEXPECTED_CP). Variable definitions are presented in the Appendix.*,**, and*** indicates 10%, 5%, and 1% significance, respectively. (1)
(2)
UNEXPECTED_CP SHORT_RATIO
601.631*** (4.57)
ROA BM LEVERAGE CASHFLOW GROWTH SUBSIDY SIZE CONS Year Industry Obs Log likelihood Adj-R2
Yes Yes 1582 332.905 0.087
7
535.268*** (3.91) 0.669 (-0.36) 0.160** (-2.27) 0.100 (0.12) 0.004 (0.18) 0.054 (0.96) 0.004 (0.09) 0.132 (1.52) 7.800*** (-3.49) Yes Yes 1558 323.976 0.101
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transparent, management is less challenging to engage in opportunistic behavior to cover-up operating weakness (Lang & Maffett, 2011). Hence, a low transparency firm suggests that management is easier to use CP as a diversion tool when facing high short selling. Conversely, if a firm is highly transparent, investors have more information on the firm management (Dasgupta, Gan, & Gao, 2010). Then, investors are easier to deflect firm management's diversion through CP. To examine the moderating role of corporate transparency, we follow the literature using Big 4 auditor, institutional ownership, and stock price synchronicity to capture the extent of transparency of a firm. Specifically, if a firm has a Big 4 auditor, a high percent of institutional ownership, and a low stock price synchronicity, then it provides more information to the market. It is because a Big 4 auditor is able to do a better job than a non-Big 4 auditor in providing accurate financial information (Gul, Kim, & Qiu, 2010). Thus, the Big 4 audited firm is more transparent than that of a non-Big 4 audited one. Similarly, a high institutional ownership in a firm suggests that the firm is more transparent (Healy & Palepu, 2001; Shleifer & Vishny, 1997). It is because institutional investors have more resources and are motivated to conduct through research on a firm. Therefore, a high institutional ownership is more involved in the governance of the firm so that they can restrain management opportunistic behavior. Finally, Morck, Yeung, and Yu (2000) and Jin and Myers (2006) document that stock price synchronicity is negatively correlated with firm-specific information. Thus, a low synchronicity suggests that analysts are able to disseminate more firm-specific information to the market so that the firm is more transparent (Chan & Hameed, 2006; Xu, Chan, Jiang, & Yi, 2013). We follow Morck et al. (2000) and Jin and Myers (2006) to calculate the synchronicity of a stock as: For each calendar year, we estimate the following linear regression, Ri;t ¼ α þ β1 Rm;t þ β2 Rm;t1 þ β3 RI;t þ β4 RI;t1 þ εi;t
(2)
where Ri,t is the weekly return on A-shares traded either on the Shanghai or Shenzhen Exchange for firm i at time t. Rm,t and RI,t is the value-weighted A-share market return and industry return, respectively. We calculate the weekly industry return using all firms within the same industry of the ith firm but not including the firm itself. Eq. (2) has lagged industry and market returns to mitigate the possibility of non-synchronous trading biases (French, Schwert, & Stambaugh, 1987; Scholes & Williams, 1977). We follow Morck et al. (2000) to calculate stock price synchronicity (SYNCH) as: SYNCHi ¼ log R2i 1 R2i
(3)
A high SYNCH indicates that the firm is highly correlated with the market, which means that the stock price does not capture much firm-specific information. R2i is the coefficient of determination from the estimation of Eq. (2) for firm i in year t. We present the results in columns (1) to (6) in Table 7. Consistently across columns (2), (4), and (5), when a firm has poor transparency (i.e., have a non-BIG 4 auditor, low institutional ownership, and high stock price synchronicity), the coefficients of Table 7 The moderating effect of corporate transparency. This table presents the results on the moderating effect of corporate transparency on the impact of short selling on CP propensity. If a firm has a Big 4 auditor, a high percent of institutional ownership, and a low stock price synchronicity, then it provides more information to the market. For the institutional ownership and stock price synchronicity, we use the median to classify “High” vs. “Low”. Variable definitions are presented in the Appendix.*,**, and*** indicates 10%, 5%, and 1% significance, respectively. (1)
(2)
(3)
(4)
(5)
(6)
CP_DUMMY Big 4 auditor
SHORT_RATIO ROA BM LEVERAGE CASHFLOW GROWTH SUBSIDY SIZE CONS Year Industry Obs Log likelihood Pseudo R2
Institutional ownership
Stock price synchronicity
Yes
No
High
Low
High
Low
103.564 (0.19) 423.975 (-1.01) 3.594 (0.71) 0.083 (-1.27) 2.947 (1.44) 0.011 (-0.25) 0.077 (0.51) 0.011 (-0.20) 11.537*** (-2.64) Yes Yes 352 157.323 0.326
559.438*** (3.72) 2909.076 (0.68) 5.187** (2.34) 0.045 (0.54) 0.246 (0.32) 0.003** (2.57) 0.068* (1.76) 0.009 (-0.18) 10.203*** (-4.40) Yes Yes 1223 482.558 0.198
186.306 (0.90) 4.508 (1.46) 0.027 (-0.42) 0.230 (-0.21) 0.014 (0.33) 0.094* (1.91) 0.077* (1.80) 0.594*** (5.22) 17.448*** (-6.87) Yes Yes 799 342.264 0.316
355.779* (1.91) 4.077 (1.54) 0.032 (0.62) 0.181 (0.21) 0.002* (1.77) 0.045 (0.66) 0.061 (-1.14) 0.452*** (3.82) 13.321*** (-4.94) Yes Yes 759 311.164 0.291
422.986*** (2.67) 7.446** (2.51) 0.036 (-0.65) 1.277 (1.51) 0.000 (-0.01) 0.077 (0.97) 0.001 (-0.02) 0.413*** (4.86) 13.033*** (-6.67) Yes Yes 820 354.818 0.310
112.985 (0.67) 3.192 (1.52) 0.050 (0.74) 0.888 (-1.03) 0.002 (0.39) 0.082 (1.30) 0.042 (0.86) 0.637*** (6.01) 17.946*** (-6.71) Yes Yes 731 293.987 0.303
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SHORT_RATIO are positive and significant at the 1% or 10% levels. In contrast, in columns (1), (3), and (6) with sub-samples of high transparency firms, the same coefficients are not significant. The findings suggest that the impact of short selling on CP propensity is more pronounced for firms with low transparency. These low transparency firms have weaknesses so that they are more inclined to use CP to divert attention from a surge in short selling. 4.4. Moderating effect of firm operating performance If the underlying reasoning of H1A is valid, we expect that when a firm has poor operating performance, it is more likely to use CP as a diversion tool. We examine this fundamental logic by using sub-samples with respect to a firm's operating performance. Specifically, we use a firm's cash flow adequacy ratio, sales growth rate, and gross profit margin to gauge its operating performance. If a firm has an above the respective median cash flow adequacy ratio, sales growth rate, and gross profit margin ratio, it has a good operating performance. Conversely, it has a bad operating performance. We expect that when a firm has poor operating performance, short sellers are more active in engaging short selling of the firm's stock. Thus, the firm is more motivated to use CP as a diversion tool per H1A. We present the findings in Table 8. Across columns (1), (3), and (5) for the sub-samples of good operating performance, the coefficients of SHORT_RATIO are not significant. In contrast, for the sub-samples of poor operating performance firms in columns (2), (4), and (6), the same coefficients are positive and significant at the 5% or 10% levels, indicating that when a firm has a poor performance, it has a higher propensity to engage in CP activities. Therefore, the findings in Table 8 corroborates with those in Table 3. 4.5. Moderating effect of corporate governance If a firm has a good corporate governance system, it can enhance financial and operational transparency (Prommin, Jumreornvong, & Jiraporn, 2014), restrain management's opportunistic behavior (Cohen, Krishnamoorthy, & Wright, 2002), and reduce default risk (Ali, Liu, & Su, 2018). If CP is a diversion tool, we expect the impact of short selling on CP propensity is more pronounced for weak corporate governance firms. Hence, we partition the full samples into sub-samples of good vs. bad corporate governance using CEO/chairman duality, ownership wedge, independent director ratio, and the number of independent director absence in board meetings. Bushman, Piotroski, and Smith (2004) and Dechow, Sloan, and Sweeney (1996) document that CEO/chairman duality weakens internal control and lowers the internal monitoring effectiveness. Pagano and R€ oell (1998) and La Porta, Lopez-de-Silanes, and Shleifer (1999) show that a low ownership wedge does not align the interests of shareholders and management. Thus, the firm's corporate governance has ineffective. Beasley (1996) and Davidson, Goodwin-Stewart, and Kent (2005) report that independent directors are effective in exercising their monitoring duties. Therefore, a low independent director ratio is not good for firm monitoring. Vafeas (1999) find the attendance of independent director in board meeting contributes to firm value. Table 8 The moderating effect of firm operating performance. This table presents the results on the moderating effect of firm operating performance on the impact of short selling on CP propensity. If a firm has a high cash flow, a high sales growth, or a high gross profit margin, then it has better operating performance. We use the median to classify “High” vs. “Low”. Variable definitions are presented in the Appendix.*,**, and*** indicates 10%, 5%, and 1% significance, respectively. (1)
(2)
(3)
(4)
(5)
(6)
CP_DUMMY Cash flow
SHORT_RATIO ROA BM LEVERAGE CASHFLOW GROWTH SUBSIDY SIZE CONS Year Industry Obs Log likelihood Pseudo R2
Sales growth rate
Gross profit margin
High
Low
High
Low
High
Low
23.128 (0.11) 5.559** (2.00) 0.094* (1.81) 0.180 (0.17) 0.032 (0.68) 0.148** (2.40) 0.038 (0.68) 0.477*** (4.36) 16.115*** (-6.29) Yes Yes 812 335.266 0.328
330.181** (2.08) 6.688* (1.66) 0.101 (-1.52) 0.074 (0.07) 0.004*** (3.04) 0.242** (-2.52) 0.020 (-0.45) 0.580*** (4.36) 15.771*** (-5.32) Yes Yes 747 312.519 0.294
133.768 (0.69) 5.160* (1.75) 0.045 (0.73) 0.165 (0.16) 0.095** (-2.06) 0.100 (0.29) 0.035 (-0.93) 0.438*** (4.78) 12.894*** (-5.68) Yes Yes 751 304.604 0.333
382.159** (2.17) 3.892 (1.42) 0.017 (0.26) 0.078 (0.09) 0.049 (1.26) 0.022 (0.39) 0.053 (1.07) 0.509*** (3.68) 13.396*** (-4.51) Yes Yes 758 329.485 0.283
112.456 (0.62) 1.043 (0.44) 0.028 (0.63) 0.571 (-0.62) 0.030 (-0.99) 0.155*** (3.22) 0.047 (0.97) 0.468*** (5.08) 15.324*** (-7.26) Yes Yes 811 352.637 0.318
388.155* (1.90) 7.008 (1.45) 0.026 (0.27) 1.441 (1.25) 0.150** (2.29) 0.003 (-0.03) 0.037 (-0.56) 0.593*** (3.86) 16.566*** (-4.75) Yes Yes 731 289.720 0.299
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Table 9 The moderating effect of internal corporate governance. This table presents the results on the moderating effect of internal corporate governance on the impact of short selling on CP propensity. If a firm does not have CEO/chairman duality, good ownership wedge, high independent director ratio, or only small absence of independent director in board meetings, then it has good corporate governance. We use the median to classify “Good” vs. “Bad”, “High” vs. “Low”, or “Small” vs. “Large”. Variable definitions are presented in the Appendix.*,**, and*** indicates 10%, 5%, and 1% significance, respectively. (1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
CP_DUMMY
SHORT_RATIO ROA BM LEVERAGE CASHFLOW GROWTH SUBSIDY SIZE CONS Year Industry Obs Log likelihood Pseudo R2
CEO/chairman Duality
Ownership wedge
No
Yes
Good
113.551 (1.01) 5.333*** (2.95) 0.008 (-0.18) 0.651 (1.00) 0.003 (0.38) 0.042 (0.85) 0.008 (0.29) 0.549*** (7.81) 15.546*** (-9.27) Yes Yes 1308 548.005 0.318
857.148* (1.81) 0.531 (-0.11) 0.008 (0.05) 0.593 (-0.32) 0.120 (-0.54) 0.036 (0.24) 0.029 (-0.41) 0.216 (0.96) 8.204** (-1.96) Yes Yes 197 89.356 0.199
195.775 (1.04) 6.785*** (2.78) 0.000 (0.01) 0.525 (0.56) 0.013 (-0.36) 0.041 (0.63) 0.012 (-0.22) 0.423*** (3.64) 13.271*** (-4.98) Yes Yes 774 346.419 0.289
Independent director ratio
No. of independent director absence in board meeting
Bad
High
Low
Small
large
371.926* (1.86) 2.961 (0.92) 0.069 (0.89) 0.189 (-0.17) 0.003* (1.75) 0.081* (1.74) 0.062 (1.27) 0.520*** (4.29) 15.068*** (-5.52) Yes Yes 785 305.226 0.325
78.584 0.39 1.113 0.46 0.002 (-0.04) 1.127 (-1.19) 0.003** 2.17 0.101 (-1.08) 0.036 0.71 0.616*** 5.84 16.490*** (-6.42) Yes Yes 695 291.634 0.311
449.015*** 2.65 7.532** 2.55 0.002 (-0.03) 1.239 1.39 0.001 0.04 0.106** 2.09 0.012 (-0.20) 0.431*** 3.54 14.192*** (-5.14) Yes Yes 849 353.475 0.312
95.059 0.56 4.303 1.58 0.055 (-0.96) 0.304 (-0.33) 0.003*** 3.05 0.045 (-0.64) 0.024 0.57 0.568*** 5.07 16.279*** (-6.72) Yes Yes 889 350.278 0.322
450.633** 2.1 4.385 1.53 0.043 0.83 0.681 0.69 0.001 0.04 0.097* 1.71 0.019 (-0.27) 0.452*** 4.39 13.777*** (-5.31) Yes Yes 673 302.192 0.287
Table 10 The impact of corporate security violation. This table presents the moderating effect of security violation. We use the actual security violations by the CSRC to identify two sub-samples. At time t, we identify firms with: (1) convicted security violations before t and (2) firms without prior convicted security violations prior to t but they have convicted violations in tþ1. In column (1), these convicted firms are not eligible to receive government subsidies. Thus, we do not use the subsidy as a control variable. Variable definitions are presented in the Appendix.*,**, and*** indicates 10%, 5%, and 1% significance, respectively. (1)
(2)
CP_DUMMY
SHORT_RATIO ROA BM LEVERAGE CASHFLOW GROWTH
Had previous convicted violations by CSRC
No previous convicted violations but have convicted violations in the future by CSRC
939.331 (1.20) 6.597 (0.66) 0.673 (-1.14) 2.242 (0.55) 0.029 (-0.23) 1.545 (-1.14)
186.063** (2.53) 0.924 (-0.93) 0.056** (2.53) 0.703** (-2.15) 0.013 (-0.59) 0.039 (1.23) 0.017 (-1.39) 0.013 (-0.31) 0.307*** (13.27) Yes Yes 88 21.045 0.578
SUBSIDY SIZE CONS Year Industry Obs Log likelihood Pseudo R2
0.853* (1.72) 22.222** (-2.20) Yes Yes 94 23.991 0.551
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Overall, we expect that when there is a CEO/chairman duality, low ownership wedge (below median), low independent director ratio (below median), or a large number of independent director absence (below median) in board meeting, the corporate governance level of the firm is poor. We present the results in Table 9. For columns (2), (4), (6), and (8), for firms in sub-samples of poor corporate governance, we find that the coefficients of SHORT_RATIO are positive and significant at the 1%, 5%, or 10% levels. In contrast, the same coefficients are not significant for firms in sub-samples of good corporate governance (columns (1), (3), (5), and (7). In sum, the findings suggest that the impact of short selling on CP propensity occurs primarily among poor corporate governance firms. 4.6. Does it matter if a firm has prior security violation? With a large database, we are able to focus on a small sub-sample on the prior security violation. If H1A is valid, we expect that the incentive of using CP is strong among firms that incur security violation in the future. We use the actual security violations by the CSRC to identify two sub-samples. At time t, we identify firms with: (1) convicted security violations before t and (2) firms without prior convicted security violations prior to t but they have convicted violations in tþ1. We are able to find 94 and 88 firms using the former and later criteria. The sub-sample (1) represents firms having no incentive to divert any public attention because the security violations had been publicized. For the sub-sample (2), firms have strong incentive to divert public attention in hoping to cover-up their misdeed. The results are presented in Table 10. In column (1), these convicted firms are not eligible to receive government subsidies. Thus, we do not use the subsidy as a control variable. As expected, the coefficient of SHORT_RATIO is not significant for the firms that had previously convicted security violations. These firms have already had a tarnished image. The incentive to divert attention from a surge in short selling is weak. Thus, it is not motivated to use CP to conduct any cover-up. In contrast, the coefficient of SHORT_RATIO is positive and significant at the 5% level for the firms that had no previously convicted violations but they will have future convicted violations. They have incentive to use CP to divert attention. The findings in Table 10 corroborate with the results in Table 3, supporting H1A. 4.7. Account for firms with strong altruism It is possible that some firms simply have strong desire to be a good corporate citizen. They simply make CP. To account for this possibility, we partition the sample into two sub-samples based on their CP propensity. Specifically, by examining the financial statements during 2009–2015, if a firm makes some CP in at least five years out of seven years, we classify it as a high CP propensity firm. Otherwise, it is a low CP propensity firm. We conjecture that, for the high CP propensity sub-sample, the firms do not use CP as a diversion tool to cover up their weak operation. Hence, the coefficient of SHORT_RATIO is expected to be insignificant. In contrast, for Table 11 The impact of short ratio on CP propensity in high and low CP sub-samples. This table presents the moderating effect of high vs. low CP propensity sub-samples. Specifically, by examining the financial statements during 2009–2015, if a firm makes some CP in at least five years out of seven years, we classify it as a high CP propensity firm. Otherwise, it is a low CP propensity firm. Variable definitions are presented in the Appendix.*,**, and*** indicates 10%, 5%, and 1% significance, respectively. (1)
(2)
CP_DUMMY
SHORT_RATIO ROA BM LEVERAGE CASHFLOW GROWTH SUBSIDY SIZE CONS Year Industry Obs Log likelihood Pseudo R2
High CP propensity
Low CP propensity
2.421 (-0.01) 4.245 (1.49) 0.011 (-0.28) 0.809 (0.85) 0.003** (2.42) 0.022 (0.29) 0.016 (-0.41) 0.386*** (3.70) 11.846*** (-4.76) Yes Yes 854 445.703 0.240
564.999** (2.51) 5.112 (1.62) 0.055 (-0.37) 0.105 (0.08) 0.042 (0.99) 0.084* (1.77) 0.113** (2.47) 0.612*** (3.59) 17.127*** (-4.63) Yes Yes 682 199.651 0.177
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the low CP propensity sub-sample, the firms do not have strong altruism. Thus, when they make CP, they use it for strategic purpose. Overall, we expect H1A is more applicable for firms in the low CP propensity sub-sample. We present the findings in Table 11. As expected, the coefficient of SHORT_RATIO is not significant for the high CP propensity subsample while the same coefficient is positive and significant at the 5% level. Hence, the results support H1A. 5. Summary We examine the impact of short selling on a firm's CP propensity in a sample of Chinese firms. Drawing from the strategic view of CP literature, we postulate that when a firm faces weak operating result, it has incentive to use CP to divert public attention. Our results, as expected, suggest that when there is a surge in short selling, a firm is more likely to make CP in a given year. The findings are robust to endogeneity concerns and different measure of CP propensity. Sub-sample analyses use corporate transparency, operating results, corporate governance, and prior security violation suggest that when a firm is less transparent, having poor operating performance, an ineffective corporate governance, and anticipated future security violation, it is more likely to using CP to divert the public attention. Acknowledgments Meng acknowledges the financial support from the National Natural Science Foundation of China (Grant numbers 71772174 and 71302156). Zhang acknowledges the financial support from the Key Project of National Science Foundation of China (Granat number 15AJY007). Appendix. Variable definitions CP_DUMMY SHORT_RATIO ROA MB LEVERAGE CASHFLOW GROWTH SUBSIDY SIZE HORIZON UNEXPECTED_CP
A dummy variable with a value of 1 if a firm made CP in a given year and zero otherwise. The average weekly number of shorted shares in a year to the total outstanding shares return on assets market-book ratio Financial leverage free cash flow Growth rate of annual sales The amount of government subsidies Firm size Number of months the stock has been on the shortable list A dummy variable with a value of 1 if a firm shifts from no to some donation from t-1 to t.
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Motives for corporate philanthropy propensity: Does short selling matter? Deshuai Hou a, Qingbin Meng b, *, Kai Zhang b, Kam C. Chan c a b c
School of Accounting, Capital University of Economics and Business, Beijing, 100070, China School of Business, Renmin University of China, Beijing, 100872, China Department of Finance, Western Kentucky University, Bowling Green, KY 42101, USA
A B S T R A C T
We examine the impact of short selling on a firm's CP propensity in a sample of Chinese firms. Drawing from the strategic view of CP literature, we postulate that when a firm faces weaknesses, it has incentive to use CP to divert public attention. Our results, as expected, suggest that when there is a surge in short selling, a firm is more likely to make CP in a given year. The findings are robust to endogeneity concerns and different measure of CP propensity. Sub-sample analyses use corporate transparency, operating results, corporate governance, and prior security violation suggest that when a firm is less transparent, having poor operating performance, an ineffective corporate governance, and anticipated future security violation, it is more likely to using CP to divert the public attention.
1. Introduction In addition to the traditional view of corporate philanthropy (CP) as an altruistic activity, an emerging body of literature examines CP as a part of a larger corporate strategy. Studies show that CP brings tangible and intangible benefits to a firm such as a good corporate image and reputational capital (Saiia, Carroll, & Buchholtz, 2003; Wang & Qian, 2011; Zhang, Zhu, Yue, & Zhu, 2010b, 2010a), relational capital with governments and the public (Shleifer & Vishny, 1994; Sanchez, 2000), tax benefits (Duquette, 2016; Navarro, 1988; Schwartz, 1968), improve corporate efficiency (O'hagan & Harvey, 2000; Porter & Kramer, 2002), among others. A few studies suggest that firms leverage their CP activities to alleviate weakness of their operations. For instance, Chen, Patten, and Roberts (2008) suggest that CP is a substitute for a firm's corporate social responsibility deficiency. Koehn and Ueng (2010) report that, after earnings restatements, firms use CP to divert public attention. The extant literature studies CP as a strategy to garner internal benefits or take it a tool to cover up a firm's bad operating outcomes. That is, firms use CP to internalize benefits or remedy deficiencies in their internal operation weakness. It is not clear how external tangible factors in the financial market affect a firm's CP decisions. Given both internal and external contributing factors shape and affect a firm's operations and activities, it is worthwhile to examine how external factor in the financial market contributes to a firm's CP. In a parallel body of literature, several studies suggest that short sellers are able to uncover a firm's negative information so as to engage in profitable short selling activities (Blau & Pinegar, 2013; Callen & Fang, 2015; Drake, Myers, Myers, & Stuart, 2015; Engelberg, Reed, & Ringgenberg, 2012; Francis, Venkatachalam, & Zhang, 2005; Maffett, Owens, & Srinivasan, 2016). Short sellers are informed traders so that a surge in short selling is a realization of the underlying weakness of the shorted firm (Francis et al., 2005; and; Karpoff & Lou, 2010). In addition, short selling restriction not only reduces market liquidity, but also leads to informed traders
* Corresponding author. E-mail addresses: [email protected] (D. Hou), [email protected] (Q. Meng), [email protected] (K. Zhang), [email protected] (K.C. Chan). https://doi.org/10.1016/j.iref.2018.07.009 Received 24 May 2018; Received in revised form 24 July 2018; Accepted 25 July 2018 Available online xxxx 1059-0560/© 2018 Elsevier Inc. All rights reserved.
Please cite this article in press as: Hou, D., et al., Motives for corporate philanthropy propensity: Does short selling matter?, International Review of Economics and Finance (2018), https://doi.org/10.1016/j.iref.2018.07.009
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turning to other trading products, which reduce the information efficiency of stock market (Le & Zurbruegg, 2016). Most importantly, when short selling of a stock increases, other market participants notice and accelerate their discovery of firm negative information. The spillover effect leads to an increase in selling pressure of the stock in the market (Shyu, Chan, & Liang, 2018). Subsequently, there are adverse impact of short selling on stock price, such as increase in corporate financing cost, and negative impact on management incentives (Callen & Fang, 2015; De Angelis, Grullon, & Miehenaud, 2017; Grullon, Michenaud, & Weston, 2015; Henry & McKenzie, 2006; Maffett et al., 2016; Safieddine & Wilhelm, 1996). Hence, a natural question is what a firm will do to strategically counter a surge in short selling. In the long-run, a firm can improve operation and/or restrain value destroying activities to counter short selling. These long-run activities, however, will take time to be effective in alleviating the immediate impact of short selling. Instead, we hypothesize, in the short-run and when facing a surge of short selling, a firm shifts into some activities to divert the attention on the negative information of the firm. These activities represent a quick fix. Among many possible quick fix activities, CP is at the discretion of the management and it is one of the few easiest strategies to deploy, especially CP has shown to be effective to achieve the goal of diverting public attention and able to paint a good image of a firm. Few studies explore the relation between short selling and CP of a firm, however. Our study fills this gap by studying how short selling, an external tangible factor, affects a firm's CP propensity. The objective of this paper is to examine the relation between short selling and CP propensity using a sample of Chinese firms. The Chinese environment provides a good setting for our analysis with two reasons. First, short selling in China is costly.1 It is more likely that short selling is an informed rather than a speculative trading strategy in China (Meng, Li, Jiang, & Chan, 2017). Hence, short sellers are informed and they have strong incentives to uncover negative firm information. Therefore, the motivation for a firm to do something quick, such as CP activities, to divert public attention to counter a surge of short selling is strong. Second, China has had short selling deregulation since 2010. The short selling literature mainly uses annual average short selling data for research, but in practice, short selling traders may adopt short-term trading strategies (Diether, Lee & Werner, 2009). Therefore, it is important to use daily short selling to fully identify the impact of short selling on stock prices (Boehmer & Wu, 2013). Unlike other markets, China is only one of the few emerging markets that allow short selling with daily short selling data disclosure. Hence, we can conduct the necessary data to conduct our analysis. Therefore, the findings provide guidance to other emerging markets when they evaluate the impact of short selling and the relation between CP and short selling. We offer several findings. First, short selling and CP propensity are positively correlated. The results remain the same after accounting for endogeneity between short selling and CP propensity and they are robust using a change no CP in t-1 to some CP in t. Second, we document that when a firm has low corporate transparency (audited by a non-Big 4 auditor, low institutional ownership, or low stock price synchronicity) and operating weakness (low cash flow, low sales growth, or low profitability), it has a higher CP propensity when facing a rise in short selling. The results suggest that management engages in opportunistic CP activity and hope to divert public attention to counter the potential adverse impact of short selling, especially if the firm is less challenging to do so (because it is not transparent) or if the firm has material operating weakness. Third, we find that when a firm has weak internal corporate governance (CEO/chairman duality, bad ownership wedge, low independent director ratio, or independent directors have many absences from board meetings) or has a security violation but yet being discovered by the China Securities and Regulatory Commission (CSRC), it has a high CP propensity when facing a rising in short selling. The findings, again, suggest that when a firm provides an easy environment for management to engage in opportunistic behavior or the incentive to divert bad news is strong, it is more inclined to conduct more CP. In sum, the additional findings from corporate transparency, operating weakness, internal corporate governance, and security violations corroborate with the hypothesis that management uses CP as a diversion instrument. When it is more challenging to engage in opportunistic behavior or there is no need to engage in diversion (e.g., security violations have already been exposed), a firm does not conduct CP. Last, the impact of an increase in short selling confines to firms switching from no CP to some CP. Our paper makes three contributions to the literature. Overall, our findings echo those in the CP literature that a firm makes CP to divert the public attention to cover up its operating weakness by painting a good corporate image. We complement the literature by documenting that a firm uses CP to react to external tangible factor (short selling) in additional to response to the internal factors (such as operating weakness). In addition, we show that firms use CP to counter the adverse impact of rising short selling, suggesting that investors need to aware such practice and cautiously interpret the motivation behind a firm's CP activities. Third, we document that when a firm is more transparent and has strong corporate governance, its management engage in less opportunistic CP activities. Thus, it is always a good public policy to encourage firms to be more transparent and having strong corporate governance. 2. Literature review and hypothesis development We have three different perspectives to develop our testable hypothesis. The first is related to agency theory. According to Jensen and Meckling (1976), management has incentives to engage in opportunistic activities to gain private benefits. The most common opportunistic activities are the covering up or delaying negative information disclosure (Kothari, Shu, & Wysocki, 2009; Pastena & Ronen, 1979). It is natural that these cover ups are not perfect. Thus, in a market that allows short selling, short sellers are able to profit from their negative information production. To counter the short sellers, management has incentives to engage in activities to divert
1
According to Meng et al. (2017), as of February 2015, the regulations on short selling in China include: (1) a short seller needs to have an account with a brokerage
firm for at least 18 months with a minimum balance of about US$80,000, (2) the brokerage firm needs to provide assessment on risk tolerance of the short seller, (3) the borrowed stock incurs a fee of 10.6%, and (4) the maximum short selling period is six months with a 50% margin. 2
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public attention and to convey a good corporate image to the public. A number of CP studies document that firms use CP to gain moral and reputational capital (Brammer & Millington, 2005, 2006; Godfrey, 2005), and garner public trust and investor goodwill (Koehn & Ueng, 2010). That is, CP is an effective tool for a firm to gain legitimacy to the society and brings good image to itself. Most importantly, CP does not need a long time to plan. A firm can make decision on CP quickly to meet their discretionary need. Similar to Koehn and Ueng (2010), we argue that a firm uses CP to cover up operation weakness in order to divert public attention or to gain goodwill from investors and the public. When short sellers expose these operation weaknesses via short selling, management use CP to divert the attention of investors. It is especially the case if the negative information from operation weakness has not yet disclosed to the public but a small number of informed investors, such as short sellers, begin to take trading decisions against the firm. Thus, for self-interest, when short selling accumulates, management begins to drum up more CP as a response. Hence, CP propensity increases. Our first testable hypothesis is: H1A.
If a firm uses CP as a cover up tool in response to short selling, short selling and CP propensity are positively correlated.
The second perspective considers the wealth maximization of the firm. When facing a surge in short selling, management realizes a possibility of rising operating risk due to the uncovering of negative firm information by short sellers. The uncovered negative information may make it challenging for the firm in terms of financing, raising capital, obtaining trade credit, among others. Firm management feels the need to preserve more internal resources to weather anticipated adverse outcomes of short selling on firm operation. Thus, a firm limits its CP and CP propensity is less. The alternative hypothesis to H1A is: H1B.
Ceteris paribus, a firm decreases its CP propensity when short selling increase
The third perspective considers CP as a natural corporate behavior. CP literature suggests that CP is a reflection of good social citizen. It is a pure result of social corporate responsibility, a common good, and a reflection of a firm's altruism (Berkowitz & Daniels, 1963; Varadarajan & Menon, 1988; Campbell, Gulas & Gruca, 1999). Thus, a firm's management views CP activities as a form of corporate social responsibility. Hence, CP does not depend on any outside factors. That is, short selling does not affect a firm's CP propensity. Therefore, the alternative to H1A is: H1C.
Ceteris paribus, a firm's CP propensity is not related to short selling
We examine the three competing testable hypothesis with a sample of Chinese firms. 3. Data and methods 3.1. Data We include all the shortable stocks in the Shanghai and Shenzhen from March 2010 to December 2015. Then, based on the corporate social responsibility and the annual reports of listed companies, we hand-collected data on charitable donations from related companies and excluded samples that could not be judged whether charitable donations were public charitable donations. In addition, short-selling volume can better reflect the process characteristics of short-selling behavior and hence, volume is more informative. However, because some shortable stocks have too few trading days with short volume, we exclude firms with less than 30 weeks of short selling activities. Due to regulatory information, we exclude financial firms. After identify 2555 firm-years, we examine the CP of each firm in a given year. The short selling information is from CSMAR and other financial information is from WIND.
3.2. Methods 3.2.1. Key variable definitions Our focus is the propensity for a firm to engage in CP. We define a (1, 0) variable, CP_DUMMY, with a value of 1 if a firm made CP in a given year and zero otherwise. To capture short selling in a year, we use the average weekly number of shorted shares to the total outstanding shares in a year (SHORT_RATIO). 3.2.2. Basic empirical model To examine the validity of H1A, H1B, or H1C, we use the following regression model: CP_DUMMYi,t ¼ α0 þ α1SHORT_RATIOi,t þ Σαj*Control variablesi,t þ εi,t
(1)
If H1A is valid, then α1 should be positive. For H1B to be valid, α1 should be negative. If a firm considers CP as a pure altruistic activity (H1C), then α1 should be insignificant. We use a set of control variables to account for their respective impact on a firm's propensity to make CP. These variables include: return on assets (ROA), market-book ratio (MB), leverage (LEVERAGE), free cash flow (CASHFLOW), sales growth (GROWTH), government subsidy (SUBSIDY), and firm size (SIZE). The detailed definitions are presented in the Appendix. With the exception of leverage, we expect the coefficients of these control variables are positive. We estimate Eq. (1) by a logitistic regression.
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Table 1 Descriptive statistics. This table presents the descriptive statistics of major variables. Variable definitions are presented in the Appendix.
CP_DUMMY SHORT_RATIO (in one-tenth of one %) ROA BM LEVERAGE CASHFLOW GROWTH SUBSIDY SIZE
Mean
Std
Min
Max
Q1
Median
Q3
0.267 0.6545 0.039 1.740 0.524 0.397 2.133 0.272 22.713
0.442 0.7971 0.063 2.862 0.219 21.125 131.935 2.198 1.675
0.000 0.0003 0.691 0.030 0.016 1051.675 6665.310 0.000 18.859
1.000 4.3600 0.346 21.916 1.280 30.835 30.399 22.142 27.087
0.000 0.1357 0.012 0.419 0.362 0.115 0.036 0.000 21.544
0.000 0.3505 0.031 0.835 0.534 0.481 0.119 0.000 22.517
0.000 0.8552 0.066 1.807 0.687 0.925 0.447 0.000 23.773
4. Results and discussions 4.1. Core findings We present the descriptive statistics of the sample in Table 1. The mean of CP_DUMMY is 0.267, suggesting that there are 26.7% of our sample making CP for all years. In terms of SHORT_RATIO, an average firm in a typical year has 0.065% of shares sold short in a given week. The standard deviation of SHORT_RATIO is 0.7971, showing some variations of short selling among different stocks. For the results of correlation coefficients in Table 2, we find that they are 0.099 and 0.071 between CP_DUMMY and SHORT_RATIO using Pearson and Spearman methods. They are significant at the 1% level. The positive correlation provides preliminary support to H1A. We present the results for the relation between short ratio and CP propensity in Table 3. For both simplified and full models in columns (1) and (2), the coefficients of SHORT_RATIO are positive and significant at the 1% and 5% levels. The findings support H1A. Other variables, if significant, carry the expected signs. For instance, the coefficients of ROA, CASHFLOW, GROWTH, and SIZE are all positive and significant at the 1%, 5%, or 10% levels. The positive significant coefficients are consistent with notion that when a firm is profitable, has sufficient cash, experiences high growth, or is larger, it is more likely to have more CP. 4.2. Robustness check 4.2.1. Exogenous events In the early stage of short sale deregulation, brokerage firms could not borrow shares from clients to lend shares to short sellers. In 2013 and after, brokerage firms are able to do so. Thus, the impact of short selling becomes fully effective after allowing borrowed shares. The permission of borrowing shares is an exogenous shock for the impact of short selling on CP propensity. Hence, if the impact of SHORT_RATIO on CP_DUMMY remains intact after the borrowing shares deregulation, the endogeneity concern is minimal. The findings in Table 4 show that the coefficient of SHORT_RATIO is positive and significant at the 5% level after the permission of borrowing shares in column (2). Thus, it is the impact of SHORT_RATIO on CP_DUMMY and not the other way around. 4.2.2. Instrumental variable method Although we closely follow the literature to control a set of control variables, there may still be problems with missing variables. Hence, the results in Table 3 may have missing variables that may lead to endogenous. To mitigate the bias, we adopt a two-stage least square estimation. The results are presented in Table 5. We use the number of months a stock become shortable (HORIZON) as the instrumental variable. The logic is that short sellers need time to research on the negative information of a shortable stock. When a stock is only newly shortable, short sellers are unable to immediately engage in negative information production. According to the Shanghai Stock and Shenzhen Stock Exchanges implementation rules for margin trading, the stock exchanges will gradually select stocks that meet the requirements into the shortable pool. Therefore, being a short-selling stock has a degree of exogeneity. That is, regardless of when a stock becomes shortable, it is unlikely related to a firm's own behavior. Therefore, whether a firm engages in CP does not depend on the number of months a stock become shortable. Thus, HORIZON explains SHORT_RATIO but it is unrelated to CP_DUMMY. In column (1), we show the results using HORIZON as the instrumental variable to generate a predicted short selling variable (PRED_SHORT_RATIO). In column (2), we use the PRED_SHORT_RATIO to replace SHORT_RATIO as the explanatory variable. The coefficient of PRED_SHORT_RATIO in column (2) is positive and significant at the 10% level, suggesting a positive impact of short selling on CP propensity. Overall, the findings in Tables 4 and 5 show that the results in Table 3 are not due to endogeneity between short selling and CP propensity. In addition, the control variables in Tables 4 and 5, if significant, carry the same signs as those in Table 3. 4.2.3. Further robustness check: unexpected CP The results in Tables 3–5 use the CP propensity as the dependent variable. The objective is to show a firm's intent from making CP to a surge in short selling. To be robust, we use the unexpected CP (UNEXPECTED_CP) in year t the dependent variable. We measure UNEXPECTED_CP as a (1, 0) dummy variable in the year t with a value of 1 if a firm has CP in year t but having no CP in t-1. The UNEXPECTED_CP variable captures a sudden change of intent in using CP. We present the findings in Table 6. From both the simplified and full models in columns (1) and (2), the coefficients of SHORT_RATIO are positive and significant at the 1% level, suggesting that 4
D. Hou et al. Table 2 Pearson and Spearman correlation coefficients. This table presents the correlation coefficients among major variables. The upper triangle shows the Spearman correlation coefficients while the lower triangle presents the Pearson coefficients. Variable definitions are presented in the Appendix. *, **, and *** indicates 10%, 5%, and 1% significance, respectively.
5
CP_DUMMY SHORT_RATIO ROA BM LEVERAGE CASHFLOW GROWTH SUBSIDY SIZE
CP_DUMMY
SHORT_RATIO
ROA
BM
LEVERAGE
CASHFLOW
GROWTH
SUBSIDY
SIZE
1.000 0.099*** 0.030 0.348*** 0.245*** 0.041 0.019 0.079*** 0.422***
0.071*** 1.000 0.010 0.003 0.07*** 0.012 0.017 0.013 0.094***
0.008 0.032 1.000 0.178*** 0.423*** 0.008 0.064** 0.014 0.046*
0.335*** 0.006 0.419*** 1.000 0.586 0.079*** 0.014 0.103*** 0.503***
0.237*** 0.024 0.487*** 0.758*** 1.000 0.048* 0.003 0.090*** 0.511***
0.115*** 0.048* 0.294*** 0.088*** 0.204*** 1.000 0.001 0.010 0.061**
0.073*** 0.049* 0.051** 0.105*** 0.007 0.254*** 1.000 0.003 0.060**
0.078*** 0.022 0.037 0.098*** 0.080*** 0.096*** 0.053** 1.000 0.143***
0.407*** 0.121*** 0.023 0.679*** 0.501*** 0.172*** 0.160*** 0.118*** 1.000 International Review of Economics and Finance xxx (2018) 1–13
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International Review of Economics and Finance xxx (2018) 1–13 Table 3 Short selling and the propensity to donate. This table presents the impact of short selling on the CP propensity. Variable definitions are presented in the Appendix.*,**, and*** indicates 10%, 5%, and 1% significance, respectively. (1)
(2)
CP_DUMMY SHORT_RATIO
330.662*** (2.64)
268.165** (1.97) 4.557** (2.16) 0.013 (0.35) 0.312 (0.43) 0.003* (1.94) 0.063* (1.66) 0.008 (0.21) 0.458*** (5.03) 13.806*** (-6.88) Yes Yes 1576 667.70326 0.2957
ROA BM LEVERAGE CASHFLOW GROWTH SUBSIDY SIZE CONS Year Industry Obs Log likelihood Pseudo R2
0.025 (0.04) Yes Yes 1600 741.52119 0.2267
Table 4 The impact of allowing borrowed stocks in short selling on the relation between short ratio and CP propensity. This table presents the results of the regulatory change in borrowed stocks in the short selling. China did not allow using borrowed stocks until 2013. Variable definitions are presented in the Appendix. *, **, and *** indicates 10%, 5%, and 1% significance, respectively. (1)
(2)
Before allow using borrowed Shares (2010–12)
After allowing using borrowed shares (2013–15)
CP_DUMMY SHORT_RATIO ROA BM LEVERAGE CASHFLOW GROWTH SUBSIDY SIZE CONS Year Industry Obs Log likelihood Pseudo R2
2635.851 (0.87) 4.841 (1.00) 0.029 (0.16) 0.736 (0.42) 0.374 (1.29) 0.137 (-0.69) 0.057 (-0.94) 0.574** (2.53) 14.559*** (-2.80) Yes Yes 174 79.355807 0.2741
244.860** (2.19) 4.000** (2.22) 0.013 (-0.32) 0.066 (0.11) 0.002 (0.43) 0.080* (1.72) 0.019 (0.69) 0.511*** (7.48) 14.903*** (-9.29) Yes Yes 1400 578.04981 0.2530
when short ratio surges, a firm suddenly makes CP when it made no CP at all in the previous year. Hence, our findings in Table 3 are robust to alternative variable to capture the intent of using CP to cover up operating weakness. 4.3. Moderating role of corporate transparency We study the moderating effect of corporate transparency of a firm on the impact of short selling on CP propensity. If a firm is not 6
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International Review of Economics and Finance xxx (2018) 1–13 Table 5 Two-stage least squares. This table presents the results for the two-stage least squares to mitigate possible endogeneity of short selling and CP propensity. We use the number of months a stock become shortable (HORIZON) as the instrumental variable to generate a predicted value of short ratio in column (1). Then, column (2) uses PRED_SHORT_RATIO to replace SHORT_RATIO as the main explanatory variable. Variable definitions are presented in the Appendix.*,**, and*** indicates 10%, 5%, and 1% significance, respectively. (1)
(2)
First stage
Second stage
SHORT_RATIO
CP_DUMMY
PRED_SHORT_RATIO HORIZON ROA BM LEVERAGE CASHFLOW GROWTH SUBSIDY SIZE Cons Year Industry Obs Log likelihood Adj-R2 Pseudo R
546.700* (1.67) 0.009*** (11.89) 0.847 (0.24) 0.738*** (-4.66) 2.469* (1.72) 0.003 (-1.14) 0.001*** (4.66) 0.014 (-0.18) 0.276 (1.13) 7.800 (-1.53) Yes Yes 2373
4.178* (1.84) 0.029 (0.67) 0.422 (0.57) 0.003** (2.00) 0.066 (1.58) 0.009 (0.21) 0.390*** (3.52) 12.837*** (-5.61) Yes Yes 1513 635.28563
0.305 0.3022
Table 6 Further Robust check: The impact of short ratio on corporate sudden shift from no to some donation. This table presents the results of using a firm's sudden shift from no to some donation from t-1 to t as dependent variable (UNEXPECTED_CP). Variable definitions are presented in the Appendix.*,**, and*** indicates 10%, 5%, and 1% significance, respectively. (1)
(2)
UNEXPECTED_CP SHORT_RATIO
601.631*** (4.57)
ROA BM LEVERAGE CASHFLOW GROWTH SUBSIDY SIZE CONS Year Industry Obs Log likelihood Adj-R2
Yes Yes 1582 332.905 0.087
7
535.268*** (3.91) 0.669 (-0.36) 0.160** (-2.27) 0.100 (0.12) 0.004 (0.18) 0.054 (0.96) 0.004 (0.09) 0.132 (1.52) 7.800*** (-3.49) Yes Yes 1558 323.976 0.101
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transparent, management is less challenging to engage in opportunistic behavior to cover-up operating weakness (Lang & Maffett, 2011). Hence, a low transparency firm suggests that management is easier to use CP as a diversion tool when facing high short selling. Conversely, if a firm is highly transparent, investors have more information on the firm management (Dasgupta, Gan, & Gao, 2010). Then, investors are easier to deflect firm management's diversion through CP. To examine the moderating role of corporate transparency, we follow the literature using Big 4 auditor, institutional ownership, and stock price synchronicity to capture the extent of transparency of a firm. Specifically, if a firm has a Big 4 auditor, a high percent of institutional ownership, and a low stock price synchronicity, then it provides more information to the market. It is because a Big 4 auditor is able to do a better job than a non-Big 4 auditor in providing accurate financial information (Gul, Kim, & Qiu, 2010). Thus, the Big 4 audited firm is more transparent than that of a non-Big 4 audited one. Similarly, a high institutional ownership in a firm suggests that the firm is more transparent (Healy & Palepu, 2001; Shleifer & Vishny, 1997). It is because institutional investors have more resources and are motivated to conduct through research on a firm. Therefore, a high institutional ownership is more involved in the governance of the firm so that they can restrain management opportunistic behavior. Finally, Morck, Yeung, and Yu (2000) and Jin and Myers (2006) document that stock price synchronicity is negatively correlated with firm-specific information. Thus, a low synchronicity suggests that analysts are able to disseminate more firm-specific information to the market so that the firm is more transparent (Chan & Hameed, 2006; Xu, Chan, Jiang, & Yi, 2013). We follow Morck et al. (2000) and Jin and Myers (2006) to calculate the synchronicity of a stock as: For each calendar year, we estimate the following linear regression, Ri;t ¼ α þ β1 Rm;t þ β2 Rm;t1 þ β3 RI;t þ β4 RI;t1 þ εi;t
(2)
where Ri,t is the weekly return on A-shares traded either on the Shanghai or Shenzhen Exchange for firm i at time t. Rm,t and RI,t is the value-weighted A-share market return and industry return, respectively. We calculate the weekly industry return using all firms within the same industry of the ith firm but not including the firm itself. Eq. (2) has lagged industry and market returns to mitigate the possibility of non-synchronous trading biases (French, Schwert, & Stambaugh, 1987; Scholes & Williams, 1977). We follow Morck et al. (2000) to calculate stock price synchronicity (SYNCH) as: SYNCHi ¼ log R2i 1 R2i
(3)
A high SYNCH indicates that the firm is highly correlated with the market, which means that the stock price does not capture much firm-specific information. R2i is the coefficient of determination from the estimation of Eq. (2) for firm i in year t. We present the results in columns (1) to (6) in Table 7. Consistently across columns (2), (4), and (5), when a firm has poor transparency (i.e., have a non-BIG 4 auditor, low institutional ownership, and high stock price synchronicity), the coefficients of Table 7 The moderating effect of corporate transparency. This table presents the results on the moderating effect of corporate transparency on the impact of short selling on CP propensity. If a firm has a Big 4 auditor, a high percent of institutional ownership, and a low stock price synchronicity, then it provides more information to the market. For the institutional ownership and stock price synchronicity, we use the median to classify “High” vs. “Low”. Variable definitions are presented in the Appendix.*,**, and*** indicates 10%, 5%, and 1% significance, respectively. (1)
(2)
(3)
(4)
(5)
(6)
CP_DUMMY Big 4 auditor
SHORT_RATIO ROA BM LEVERAGE CASHFLOW GROWTH SUBSIDY SIZE CONS Year Industry Obs Log likelihood Pseudo R2
Institutional ownership
Stock price synchronicity
Yes
No
High
Low
High
Low
103.564 (0.19) 423.975 (-1.01) 3.594 (0.71) 0.083 (-1.27) 2.947 (1.44) 0.011 (-0.25) 0.077 (0.51) 0.011 (-0.20) 11.537*** (-2.64) Yes Yes 352 157.323 0.326
559.438*** (3.72) 2909.076 (0.68) 5.187** (2.34) 0.045 (0.54) 0.246 (0.32) 0.003** (2.57) 0.068* (1.76) 0.009 (-0.18) 10.203*** (-4.40) Yes Yes 1223 482.558 0.198
186.306 (0.90) 4.508 (1.46) 0.027 (-0.42) 0.230 (-0.21) 0.014 (0.33) 0.094* (1.91) 0.077* (1.80) 0.594*** (5.22) 17.448*** (-6.87) Yes Yes 799 342.264 0.316
355.779* (1.91) 4.077 (1.54) 0.032 (0.62) 0.181 (0.21) 0.002* (1.77) 0.045 (0.66) 0.061 (-1.14) 0.452*** (3.82) 13.321*** (-4.94) Yes Yes 759 311.164 0.291
422.986*** (2.67) 7.446** (2.51) 0.036 (-0.65) 1.277 (1.51) 0.000 (-0.01) 0.077 (0.97) 0.001 (-0.02) 0.413*** (4.86) 13.033*** (-6.67) Yes Yes 820 354.818 0.310
112.985 (0.67) 3.192 (1.52) 0.050 (0.74) 0.888 (-1.03) 0.002 (0.39) 0.082 (1.30) 0.042 (0.86) 0.637*** (6.01) 17.946*** (-6.71) Yes Yes 731 293.987 0.303
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SHORT_RATIO are positive and significant at the 1% or 10% levels. In contrast, in columns (1), (3), and (6) with sub-samples of high transparency firms, the same coefficients are not significant. The findings suggest that the impact of short selling on CP propensity is more pronounced for firms with low transparency. These low transparency firms have weaknesses so that they are more inclined to use CP to divert attention from a surge in short selling. 4.4. Moderating effect of firm operating performance If the underlying reasoning of H1A is valid, we expect that when a firm has poor operating performance, it is more likely to use CP as a diversion tool. We examine this fundamental logic by using sub-samples with respect to a firm's operating performance. Specifically, we use a firm's cash flow adequacy ratio, sales growth rate, and gross profit margin to gauge its operating performance. If a firm has an above the respective median cash flow adequacy ratio, sales growth rate, and gross profit margin ratio, it has a good operating performance. Conversely, it has a bad operating performance. We expect that when a firm has poor operating performance, short sellers are more active in engaging short selling of the firm's stock. Thus, the firm is more motivated to use CP as a diversion tool per H1A. We present the findings in Table 8. Across columns (1), (3), and (5) for the sub-samples of good operating performance, the coefficients of SHORT_RATIO are not significant. In contrast, for the sub-samples of poor operating performance firms in columns (2), (4), and (6), the same coefficients are positive and significant at the 5% or 10% levels, indicating that when a firm has a poor performance, it has a higher propensity to engage in CP activities. Therefore, the findings in Table 8 corroborates with those in Table 3. 4.5. Moderating effect of corporate governance If a firm has a good corporate governance system, it can enhance financial and operational transparency (Prommin, Jumreornvong, & Jiraporn, 2014), restrain management's opportunistic behavior (Cohen, Krishnamoorthy, & Wright, 2002), and reduce default risk (Ali, Liu, & Su, 2018). If CP is a diversion tool, we expect the impact of short selling on CP propensity is more pronounced for weak corporate governance firms. Hence, we partition the full samples into sub-samples of good vs. bad corporate governance using CEO/chairman duality, ownership wedge, independent director ratio, and the number of independent director absence in board meetings. Bushman, Piotroski, and Smith (2004) and Dechow, Sloan, and Sweeney (1996) document that CEO/chairman duality weakens internal control and lowers the internal monitoring effectiveness. Pagano and R€ oell (1998) and La Porta, Lopez-de-Silanes, and Shleifer (1999) show that a low ownership wedge does not align the interests of shareholders and management. Thus, the firm's corporate governance has ineffective. Beasley (1996) and Davidson, Goodwin-Stewart, and Kent (2005) report that independent directors are effective in exercising their monitoring duties. Therefore, a low independent director ratio is not good for firm monitoring. Vafeas (1999) find the attendance of independent director in board meeting contributes to firm value. Table 8 The moderating effect of firm operating performance. This table presents the results on the moderating effect of firm operating performance on the impact of short selling on CP propensity. If a firm has a high cash flow, a high sales growth, or a high gross profit margin, then it has better operating performance. We use the median to classify “High” vs. “Low”. Variable definitions are presented in the Appendix.*,**, and*** indicates 10%, 5%, and 1% significance, respectively. (1)
(2)
(3)
(4)
(5)
(6)
CP_DUMMY Cash flow
SHORT_RATIO ROA BM LEVERAGE CASHFLOW GROWTH SUBSIDY SIZE CONS Year Industry Obs Log likelihood Pseudo R2
Sales growth rate
Gross profit margin
High
Low
High
Low
High
Low
23.128 (0.11) 5.559** (2.00) 0.094* (1.81) 0.180 (0.17) 0.032 (0.68) 0.148** (2.40) 0.038 (0.68) 0.477*** (4.36) 16.115*** (-6.29) Yes Yes 812 335.266 0.328
330.181** (2.08) 6.688* (1.66) 0.101 (-1.52) 0.074 (0.07) 0.004*** (3.04) 0.242** (-2.52) 0.020 (-0.45) 0.580*** (4.36) 15.771*** (-5.32) Yes Yes 747 312.519 0.294
133.768 (0.69) 5.160* (1.75) 0.045 (0.73) 0.165 (0.16) 0.095** (-2.06) 0.100 (0.29) 0.035 (-0.93) 0.438*** (4.78) 12.894*** (-5.68) Yes Yes 751 304.604 0.333
382.159** (2.17) 3.892 (1.42) 0.017 (0.26) 0.078 (0.09) 0.049 (1.26) 0.022 (0.39) 0.053 (1.07) 0.509*** (3.68) 13.396*** (-4.51) Yes Yes 758 329.485 0.283
112.456 (0.62) 1.043 (0.44) 0.028 (0.63) 0.571 (-0.62) 0.030 (-0.99) 0.155*** (3.22) 0.047 (0.97) 0.468*** (5.08) 15.324*** (-7.26) Yes Yes 811 352.637 0.318
388.155* (1.90) 7.008 (1.45) 0.026 (0.27) 1.441 (1.25) 0.150** (2.29) 0.003 (-0.03) 0.037 (-0.56) 0.593*** (3.86) 16.566*** (-4.75) Yes Yes 731 289.720 0.299
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Table 9 The moderating effect of internal corporate governance. This table presents the results on the moderating effect of internal corporate governance on the impact of short selling on CP propensity. If a firm does not have CEO/chairman duality, good ownership wedge, high independent director ratio, or only small absence of independent director in board meetings, then it has good corporate governance. We use the median to classify “Good” vs. “Bad”, “High” vs. “Low”, or “Small” vs. “Large”. Variable definitions are presented in the Appendix.*,**, and*** indicates 10%, 5%, and 1% significance, respectively. (1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
CP_DUMMY
SHORT_RATIO ROA BM LEVERAGE CASHFLOW GROWTH SUBSIDY SIZE CONS Year Industry Obs Log likelihood Pseudo R2
CEO/chairman Duality
Ownership wedge
No
Yes
Good
113.551 (1.01) 5.333*** (2.95) 0.008 (-0.18) 0.651 (1.00) 0.003 (0.38) 0.042 (0.85) 0.008 (0.29) 0.549*** (7.81) 15.546*** (-9.27) Yes Yes 1308 548.005 0.318
857.148* (1.81) 0.531 (-0.11) 0.008 (0.05) 0.593 (-0.32) 0.120 (-0.54) 0.036 (0.24) 0.029 (-0.41) 0.216 (0.96) 8.204** (-1.96) Yes Yes 197 89.356 0.199
195.775 (1.04) 6.785*** (2.78) 0.000 (0.01) 0.525 (0.56) 0.013 (-0.36) 0.041 (0.63) 0.012 (-0.22) 0.423*** (3.64) 13.271*** (-4.98) Yes Yes 774 346.419 0.289
Independent director ratio
No. of independent director absence in board meeting
Bad
High
Low
Small
large
371.926* (1.86) 2.961 (0.92) 0.069 (0.89) 0.189 (-0.17) 0.003* (1.75) 0.081* (1.74) 0.062 (1.27) 0.520*** (4.29) 15.068*** (-5.52) Yes Yes 785 305.226 0.325
78.584 0.39 1.113 0.46 0.002 (-0.04) 1.127 (-1.19) 0.003** 2.17 0.101 (-1.08) 0.036 0.71 0.616*** 5.84 16.490*** (-6.42) Yes Yes 695 291.634 0.311
449.015*** 2.65 7.532** 2.55 0.002 (-0.03) 1.239 1.39 0.001 0.04 0.106** 2.09 0.012 (-0.20) 0.431*** 3.54 14.192*** (-5.14) Yes Yes 849 353.475 0.312
95.059 0.56 4.303 1.58 0.055 (-0.96) 0.304 (-0.33) 0.003*** 3.05 0.045 (-0.64) 0.024 0.57 0.568*** 5.07 16.279*** (-6.72) Yes Yes 889 350.278 0.322
450.633** 2.1 4.385 1.53 0.043 0.83 0.681 0.69 0.001 0.04 0.097* 1.71 0.019 (-0.27) 0.452*** 4.39 13.777*** (-5.31) Yes Yes 673 302.192 0.287
Table 10 The impact of corporate security violation. This table presents the moderating effect of security violation. We use the actual security violations by the CSRC to identify two sub-samples. At time t, we identify firms with: (1) convicted security violations before t and (2) firms without prior convicted security violations prior to t but they have convicted violations in tþ1. In column (1), these convicted firms are not eligible to receive government subsidies. Thus, we do not use the subsidy as a control variable. Variable definitions are presented in the Appendix.*,**, and*** indicates 10%, 5%, and 1% significance, respectively. (1)
(2)
CP_DUMMY
SHORT_RATIO ROA BM LEVERAGE CASHFLOW GROWTH
Had previous convicted violations by CSRC
No previous convicted violations but have convicted violations in the future by CSRC
939.331 (1.20) 6.597 (0.66) 0.673 (-1.14) 2.242 (0.55) 0.029 (-0.23) 1.545 (-1.14)
186.063** (2.53) 0.924 (-0.93) 0.056** (2.53) 0.703** (-2.15) 0.013 (-0.59) 0.039 (1.23) 0.017 (-1.39) 0.013 (-0.31) 0.307*** (13.27) Yes Yes 88 21.045 0.578
SUBSIDY SIZE CONS Year Industry Obs Log likelihood Pseudo R2
0.853* (1.72) 22.222** (-2.20) Yes Yes 94 23.991 0.551
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Overall, we expect that when there is a CEO/chairman duality, low ownership wedge (below median), low independent director ratio (below median), or a large number of independent director absence (below median) in board meeting, the corporate governance level of the firm is poor. We present the results in Table 9. For columns (2), (4), (6), and (8), for firms in sub-samples of poor corporate governance, we find that the coefficients of SHORT_RATIO are positive and significant at the 1%, 5%, or 10% levels. In contrast, the same coefficients are not significant for firms in sub-samples of good corporate governance (columns (1), (3), (5), and (7). In sum, the findings suggest that the impact of short selling on CP propensity occurs primarily among poor corporate governance firms. 4.6. Does it matter if a firm has prior security violation? With a large database, we are able to focus on a small sub-sample on the prior security violation. If H1A is valid, we expect that the incentive of using CP is strong among firms that incur security violation in the future. We use the actual security violations by the CSRC to identify two sub-samples. At time t, we identify firms with: (1) convicted security violations before t and (2) firms without prior convicted security violations prior to t but they have convicted violations in tþ1. We are able to find 94 and 88 firms using the former and later criteria. The sub-sample (1) represents firms having no incentive to divert any public attention because the security violations had been publicized. For the sub-sample (2), firms have strong incentive to divert public attention in hoping to cover-up their misdeed. The results are presented in Table 10. In column (1), these convicted firms are not eligible to receive government subsidies. Thus, we do not use the subsidy as a control variable. As expected, the coefficient of SHORT_RATIO is not significant for the firms that had previously convicted security violations. These firms have already had a tarnished image. The incentive to divert attention from a surge in short selling is weak. Thus, it is not motivated to use CP to conduct any cover-up. In contrast, the coefficient of SHORT_RATIO is positive and significant at the 5% level for the firms that had no previously convicted violations but they will have future convicted violations. They have incentive to use CP to divert attention. The findings in Table 10 corroborate with the results in Table 3, supporting H1A. 4.7. Account for firms with strong altruism It is possible that some firms simply have strong desire to be a good corporate citizen. They simply make CP. To account for this possibility, we partition the sample into two sub-samples based on their CP propensity. Specifically, by examining the financial statements during 2009–2015, if a firm makes some CP in at least five years out of seven years, we classify it as a high CP propensity firm. Otherwise, it is a low CP propensity firm. We conjecture that, for the high CP propensity sub-sample, the firms do not use CP as a diversion tool to cover up their weak operation. Hence, the coefficient of SHORT_RATIO is expected to be insignificant. In contrast, for Table 11 The impact of short ratio on CP propensity in high and low CP sub-samples. This table presents the moderating effect of high vs. low CP propensity sub-samples. Specifically, by examining the financial statements during 2009–2015, if a firm makes some CP in at least five years out of seven years, we classify it as a high CP propensity firm. Otherwise, it is a low CP propensity firm. Variable definitions are presented in the Appendix.*,**, and*** indicates 10%, 5%, and 1% significance, respectively. (1)
(2)
CP_DUMMY
SHORT_RATIO ROA BM LEVERAGE CASHFLOW GROWTH SUBSIDY SIZE CONS Year Industry Obs Log likelihood Pseudo R2
High CP propensity
Low CP propensity
2.421 (-0.01) 4.245 (1.49) 0.011 (-0.28) 0.809 (0.85) 0.003** (2.42) 0.022 (0.29) 0.016 (-0.41) 0.386*** (3.70) 11.846*** (-4.76) Yes Yes 854 445.703 0.240
564.999** (2.51) 5.112 (1.62) 0.055 (-0.37) 0.105 (0.08) 0.042 (0.99) 0.084* (1.77) 0.113** (2.47) 0.612*** (3.59) 17.127*** (-4.63) Yes Yes 682 199.651 0.177
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the low CP propensity sub-sample, the firms do not have strong altruism. Thus, when they make CP, they use it for strategic purpose. Overall, we expect H1A is more applicable for firms in the low CP propensity sub-sample. We present the findings in Table 11. As expected, the coefficient of SHORT_RATIO is not significant for the high CP propensity subsample while the same coefficient is positive and significant at the 5% level. Hence, the results support H1A. 5. Summary We examine the impact of short selling on a firm's CP propensity in a sample of Chinese firms. Drawing from the strategic view of CP literature, we postulate that when a firm faces weak operating result, it has incentive to use CP to divert public attention. Our results, as expected, suggest that when there is a surge in short selling, a firm is more likely to make CP in a given year. The findings are robust to endogeneity concerns and different measure of CP propensity. Sub-sample analyses use corporate transparency, operating results, corporate governance, and prior security violation suggest that when a firm is less transparent, having poor operating performance, an ineffective corporate governance, and anticipated future security violation, it is more likely to using CP to divert the public attention. Acknowledgments Meng acknowledges the financial support from the National Natural Science Foundation of China (Grant numbers 71772174 and 71302156). Zhang acknowledges the financial support from the Key Project of National Science Foundation of China (Granat number 15AJY007). Appendix. Variable definitions CP_DUMMY SHORT_RATIO ROA MB LEVERAGE CASHFLOW GROWTH SUBSIDY SIZE HORIZON UNEXPECTED_CP
A dummy variable with a value of 1 if a firm made CP in a given year and zero otherwise. The average weekly number of shorted shares in a year to the total outstanding shares return on assets market-book ratio Financial leverage free cash flow Growth rate of annual sales The amount of government subsidies Firm size Number of months the stock has been on the shortable list A dummy variable with a value of 1 if a firm shifts from no to some donation from t-1 to t.
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