Short-sale Constraints and Stock Price Crash Risk: Causal Evidence from a Natural Experiment

We identify the causality between short selling and stock price crash risk. Employing the difference-in-differences approach and a regulatory change from the Securities and Exchange Commission (SEC), Regulation SHO program, as an exogenous shock, we find that the lifting of short-sale constraints reduces the stock price crash risk, and the effect is stronger for the firms with more severe agency problems and greater information asymmetry. This study sheds light on the monitoring role of short selling in the equity market and its impact on corporate governance. In addition, our results have policy implications to security market regulators.