From 2013 to 2015, China lifted the ban on margin trading for designated stocks based on apublic ranking index. Using a regression discontinuity design that exploits the threshold rules, I find that margin trading eligibility causes the stock share turnover and prices to increase. Moreover, firms react to this speculative pressure by manipulating earnings and reducing long-term investment. These effects are stronger for firms that are more prone to investor short-termism ex-ante. Consistent with managerial myopia, marginable firms later experience a decline in operating performance. My results suggest that margin traders, as short-term speculators, pressure the manager to focus on current earnings and take myopic actions.

After the Chinese stock market dropped one-third in three weeks in June 2015, reportedly driven by lack of liquidity due to the fire sales by margin buyers, the government used hundreds of billions of dollars to purchase shares directly in the secondary market. We validate that margin trading is associated with the surge of stock market before the crisis. We find that firms in systemically important industries, firms with more political ties, and firms with high risk of falling into liquidity spiral are more likely to be rescued. More importantly, compared with matched un-rescued firms, rescued firms did not have higher stock return, but experienced higher volatility, lower liquidity, and lower price efficiency afterwards. Market quality even deteriorated further after the subsequent sale of the purchased shares. Last, rescued firms experience a modest decline in operational performance, while capital structure and investment remained the same. Our evidence suggest that a direct purchase rescue in the secondary stock market could generate serious unintended consequences.

Stock market trading restrictions affect stock prices and liquidity directly through constraints on investors’ transactions and indirectly by altering the information environment. We isolate this indirect effect by analyzing how stock market restrictions affect corporate-bond prices. Exploiting the staggered relaxations of trading restrictions in the Chinese stock market as a quasi-natural experiment, we document that the easing of trading restrictions on a firm’s stock decreases the credit spread of its corporate bond. This effect is stronger for firms with less transparency or lower credit ratings. Our evidence suggests that the effect is likely due to improved stock price informativeness.

Using the introduction of margin trading in China, this study examines the effects of margin trading on the informativeness of trades and stock market liquidity. Using the methodology of Hasbrouck (1991 and 1993), I find that allowing investors to trade on margin leads to more informed trading. This increase in informed trading is mirrored by an increase in the adverse selection component of the bid-ask spread and a decrease in the relative weight placed on public information in trading decision. The discussed findings are more pronounced for stocks with relatively high levels of margin trading. Overall, the findings in the paper suggest that margin trading may lead to more information-based trading and lower levels of stock market liquidity.

China?s recent removal of short selling and margin trading bans on selected stocks enables testing of the relative effect of margin trading and short selling. We find the prices of the shortable stocks decrease, on average, relative to peer A-shares and cross-listed H-shares, suggesting that short selling dominates margin trading effects. However, there is negligible short sales activity and contrary to the regulators? intention, and recent empirical evidence, liquidity declines and bid-ask spreads increase in these shortable stocks. Consistent with Ausubel (1990), together these results imply uninformed-investors avoid these stocks to reduce the risk of trading with informed-investors.

China began allowing short selling and margin trading in 90 stocks in March 2010. This event provides an opportunity to test the relative effect of margin trading and short selling. We find the prices of these 90 stocks decrease, on average, relative to peer stocks in China and cross-listed H-shares, suggesting that short selling dominates margin trading effects. Contrary to the regulators? intention, and recent empirical evidence, liquidity declines in the shortable stocks. This may imply avoidance of these stocks by uninformed investors. There is also evidence of higher bid-ask spreads following the regulation change.