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Abstract We extend the current short‐selling literature on the disciplining role of short‐sellers by examining the effect of short‐selling on related‐party transactions (RPTs). Using data from the Chinese stock exchanges over the post‐short‐selling deregulation period of 2010–2017, we find a two‐faceted effect of short‐sales on RPTs in which short‐selling restrains detrimental RPTs but encourages beneficial RPTs. The findings reveal that short‐selling not only has a disciplinary effect but also induces managerial decisions that are beneficial to shareholders’ wealth. Additional analyses demonstrate that the two‐faceted effect depends on the strength of the external and internal governance mechanisms proxied by analysts following, media coverage, regional shareholder protection, and the firms’ internal control. Our findings are robust to a batch of tests conducted to alleviate concerns for endogeneity. A difference‐in‐difference test further confirms that the aforementioned effects result from the deregulation of short‐selling.
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