Abstract:Taking the event of pilot margin trading in China as the research situation, this paper investigates how short selling affects internal control quality of listed Chinese firms. We have following findings: First, we find that after lifting the short selling constrain, the internal control quality of affected firms improved significantly and when the capital market supervision is weaker, the positive effect of short selling mechanism on internal control quality is more obvious. Second, we find that short sellers accumulate positions in firms that disclosing ICW or internal control quality deteriorates, which means that short sellers put great pressure on firms with signs of low internal control. The long standing of the short selling pressure promotes managers to remediate internal control deficiencies and build up internal control system. Last, we also perform a series tests about internal control objectives. We find that the reliability of financial reporting, the effectiveness of operation and the compliance with law and regulations have improved, being affected by the short selling pressure, while internal control quality plays a mediating role in this process. This paper has provided empirical evidence about causal relationship between short selling and internal control quality, which shed light on how capital market supervising mechanism affect internal control system, and deepens our understanding of economic consequences about short selling mechanism.