SEC monitoring of foreign firms’ disclosures in the presence of foreign regulators

SEC comment letters indicate that the SEC has reviewed the firm’s filings and identified a disclosure issue. Using the existence of an SEC comment letter as a proxy for SEC monitoring, we document a negative association between the level of SEC monitoring of foreign firms and the strength of those foreign firms’ home-country institutions, consistent with the idea that the SEC implicitly shares its regulatory duties with international securities regulators. We find that foreign cross-listed firms are subject to lower monitoring intensity than foreign firms listed only on US exchanges, but do not find a statistically significant difference in monitoring between foreign firms listed only on US exchanges and US firms. These findings suggest that it is the presence of another regulator that drives the intensity of SEC monitoring. We also find that US investor holdings are positively associated with the level of SEC oversight, suggesting that the SEC focuses its resources on firms that pose a greater risk to US investors. Collectively, our analyses show that two countervailing forces drive the SEC’s choice to monitor foreign firms. On the one hand, the SEC reduces monitoring intensity when it can rely on the public and private enforcement institutions in the foreign firm’s home country. On the other hand, the SEC provides increased monitoring of certain foreign firms when investors on US exchanges have greater investment exposure in those firms.     

The oversight role of regulators: evidence from SEC comment letters in the IPO process

This study investigates how regulatory oversight affects the price formation of initial public offerings (IPOs). We provide evidence on the oversight role of the US Securities and Exchange Commission (SEC) by examining the effects of comment letters issued by the SEC in the process through which companies are initially listed. We find that IPO issuers reduce their offer price if they receive comment letters. The reduction in price from the IPO filing date to the final issue date is greater when the IPO firm has more correspondence with the SEC. The pricing impact of SEC comment letters is more pronounced for IPO issuers with greater hyping incentives. Moreover, we find that IPO firms that receive more comment letters have similar levels of underpricing and outperform over the long run after the issue date, compared with IPOs with fewer comment letters.     

Changes in corporate cybersecurity risk disclosures after SEC comment letters

Gao et al. (2020) examined the content and linguistic characteristics of public companies' cybersecurity risk disclosure practices as well as factors that may drive disclosure trends. In this paper, we extend Gao et al. (2020) by exploring SEC comment letter practices related to cybersecurity risk disclosures and investigating how SEC comment letters lead to changes in companies’ cybersecurity risk disclosures. Coinciding with newly issued cybersecurity guidelines, SEC comment letters related to cybersecurity disclosure deficiencies spiked in 2011. On average, it takes about 26 days for a registrant to respond to a comment letter and only 10 percent of registrants respond within the recommended 10-day period. Most comment letters (75 percent) are resolved within one round of communication. Multiple rounds of communication are often required when deficiencies surround disclosure of a cyber breach. Though 81 percent of registrants respond to comment letters related to cybersecurity breaches by claiming that there was no need for disclosure as the breaches were not material, the SEC will likely reject that claim and require the registrant to provide the required detail. We find evidence that the SEC uses comment letters to signal that the staff wish to see an explicit statement in the registrant’s cybersecurity risk disclosures on whether or not the firm suffered security breaches during a reporting period. The SEC scrutinizes cybersecurity risk disclosures to verify they are sufficient subsequent to a published security breach. Firms change their disclosure behavior one year after receiving a comment letter. Specifically, the length of cybersecurity risk disclosures increases, specificity increases, and readability and clarity improve one year after a registrant receives a comment letter that points to deficiencies in the firm’s cybersecurity risk disclosures.     

SEC confidential treatment and regulatory filing reviews

We study the interplay between the redaction of information from regulatory filings and SEC monitoring of the redacting firms. We find that redactions are associated with more intense SEC monitoring, as evidenced by higher incidence of comment letters and a longer letter resolution process. Hand collected data indicate seller firms that redact information from their sales, licensing, and royalty contracts are more likely to receive revenue recognition-related comment letters, suggesting spurious correlation is not a likely explanation of the inference. We supplement our findings by providing evidence that redacting firms tend to manage proprietary information disclosure, withholding proprietary information that should be made public under extant rules and regulations. Our findings shed light on how various SEC monitoring processes interact and support one another, offering a novel look on the interaction between a firm’s management of proprietary information disclosure and regulatory oversight.     

SEC comment letters related to permanently reinvested earnings

In this paper, we examine how permanently reinvested earnings (PRE) and disclosure transparency surrounding PRE influences external monitoring from the Securities and Exchange Commission (SEC). Our research is motivated by increased congressional and SEC scrutiny into companies with substantial PRE via their foreign operations. We hypothesize that firms are more likely to receive a PRE-related comment letter if they have large amounts of PRE, a large estimated hypothetical tax on repatriation, increases in PRE, and have less transparent disclosures related to the hypothetical tax on PRE. We find that the estimated hypothetical tax on repatriation and the transparency of PRE disclosures are determinants of receiving a PRE-related comment letter. Further analysis shows that cash-constrained firms with a large estimated hypothetical tax on repatriation are more likely to receive a PRE-related comment letter. Our research contributes to a growing body of research into the external monitoring role of the SEC in the form of comment letters.     

Regulatory Transparency and Regulators’ Effort: Evidence from Public Release of the SEC's Review Work

Using the public release of comment letters on EDGAR to capture a regime shift toward regulatory transparency, we examine whether an increase in transparency affects regulators’ effort and work performance. We find that the SEC staff reviews more filings and more documents per filing following the disclosure regime shift. These effects are incrementally stronger for firms with comment letters that are expected to attract greater investor or public monitoring. Furthermore, under the new regime, reviews are more timely. Upon the regime switch, the likelihood of a restatement (receiving a comment letter) decreases (increases) for filings that are reviewed. After receiving a comment letter, a firm with signs of potential fraud is more likely to be investigated, and this effect becomes more pronounced under the new regime. Altogether, our findings suggest that publicly disclosing regulators’ work output can mitigate moral hazard (i.e., increase regulators’ work input), improving their work performance.     

Responses to SEC comment letters on cybersecurity disclosures: An exploratory study

Cybersecurity comment letters issued by the Securities and Exchange Commission (SEC) may ask companies to disclose additional or clarifying information about their cybersecurity incidents, risks, and corresponding controls, where appropriate. Although responding to the comment letter in the form of disclosing more information about cybersecurity can better signal a company’s security posture to investors and comply with regulations, it may also expose a company to higher levels of cybersecurity risks because of disclosing proprietary cybersecurity information. Using a sample consisting of 52 cybersecurity comment letters issued between 2011 and 2019 and their no-letter-matched companies, our findings suggest that comment letter companies change their disclosures regarding cybersecurity, as required by the SEC. However, as shown in the short-term cumulative abnormal returns around response letter days, the stock market reacts negatively to the responses. Our results provide policy implications by showing that market participants may not react positively to transparency.     

Strategic Subsidiary Disclosure

Although subsidiary disclosures in firms’ filings with the Securities and Exchanges Commission (SEC; Exhibit 21) represent the most granular required public disclosure of a firm's geographic footprint, little is understood about the quality of the disclosure, and anecdotal evidence suggests firms may not fully comply with the disclosure requirements. We use data provided by multinational firms to the Internal Revenue Service regarding their foreign subsidiary locations to explore the accuracy of public subsidiary disclosures on Exhibit 21 of Form 10-K per SEC rules. The overall incidence of nondisclosure is low, suggesting that most firms comply with Exhibit 21 disclosure rules, and that for most applications, Exhibit 21 disclosures provide a reasonable proxy for locations of significant subsidiaries. Nevertheless, there is some evidence of nondisclosure, particularly when subsidiaries are in tax havens, when the firm is more highly scrutinized in the media, or when the firm has other characteristics consistent with low-quality disclosures such as SEC comment letters.     

预防性监管与公司产能过剩--基于年报问询函的研究证据北大核心

本文研究年报问询函这一预防性监管制度能否推动公司去产能,并探究其作用机制和经济后果。研究发现,相比未被问询的公司,被问询的公司收函后产能过剩水平显著下降;该结果在媒体负面报道较多的公司、地方政府治理水平较高的地区中更为明显,表明年报问询函通过降低市场、政府与公司间的信息不对称,强化市场和政府的治理效应,进而有效促使公司去产能。影响机制检验表明,年报问询函主要通过优化资源配置、减少代理问题作用于去产能。经济后果方面,年报问询函会提升被问询公司的生产效率和经营业绩。     

The effect of disclosure committees on non-GAAP reporting quality

I examine whether company-implemented disclosure committees help to improve non-GAAP reporting quality. I find that firms with disclosure committees provide higher quality non-GAAP performance metrics and that the exclusions used to calculate their non-GAAP numbers are less persistent for future operating income and operating cash flows. Moreover, I find that firms with disclosure committees are less likely to receive SEC comment letters about non-GAAP disclosure. For firms that receive comment letters about non-GAAP reporting, disclosure committees can help to improve non-GAAP reporting quality. Comparing the influence of audit committees and disclosure committees, I find that audit committee financial experts have stronger monitoring effects than those on disclosure committees. Meanwhile, legal experts on disclosure committees provide similar monitoring compared to audit committees’ financial experts. Finally, the interaction between audit committee financial experts and disclosure committee legal experts produces the strongest effect on non-GAAP reporting quality. In sum, my analyses suggest that disclosure committees can provide important monitoring of non-GAAP reporting.     

Regulatory risk and auditors’ reporting conservatism: Evidence from Chinese comment letters

We study how auditors respond to regulatory risk that arises when their clients receive comment letters from Chinese stock exchanges. Our results show that auditors are more likely to issue modified or conservative—but not excessively conservative—audit opinions to the recipients of comment letters. This reporting conservatism is especially pronounced when the regulatory risk perceived by auditors rises, such as when comment letters contain more questions, when more comment letters are issued, when the auditors must give opinions on specific issues, or when comment letters involve more auditor issues. Comment letters have been issued in China since 2013, but did not have to be disclosed until 2015. We find no significant difference in the impact of comment letters on auditor conservatism between pre- and post-disclosure periods. Further, the size of auditor firms has no significant effect on the impact of comment letters in post-disclosure periods. We interpret our results as supporting the regulation risk hypothesis.     

Textual classification of SEC comment letters

This study examines the impact of SEC comment letters on future financial reporting outcomes and earnings credibility. Naïve Bayesian classification identifies comment letters associated with future restatements and write-downs. An investor attention-based quantitative measure of importance, using EDGAR downloads, also predicts these outcomes. Disclosure-event abnormal returns, revenue recognition comments, and the number of letters in a conversation appear to be useful quantitative metrics for classifying importance in certain settings. This study also documents trends in comment letter topics over time and identifies topics associated with the textual and quantitative classifications of importance, providing insights into the factors that draw investor attention and that relate to future restatements and write-downs. Innocuous comment letters are associated with improvements in earnings credibility following comment letter reviews.

     

On the SEC's 2010 enforcement cooperation program

This study examines changes in SEC enforcement and firm cooperation after the SEC introduced its new cooperation program in 2010. While previous research shows that the SEC penalized cooperative firms prior to 2010, our results suggest that after that year, it rewarded cooperation, especially good faith actions. We also find that after 2010, the SEC increased mentions of cooperation in public speeches and publicized more details about firm cooperative activities in AAERs. Finally, we find some evidence that misconduct firms increased good faith cooperation after the SEC revised its cooperation program in 2010. Our findings suggest that having a more explicit leniency program improves its effectiveness.     

A new measure of accounting quality

This study develops a measure of accounting quality based on audit fees. Adopting a neoclassical view of the audit market, we argue that unexplained audit fees should contain information about accounting quality. We find that our measure of unexplained audit fees correlates positively with other empirical measures of quality. We further show that our measure of accounting quality is incrementally predictive of fraud, restatements, and SEC comment letters, controlling for other measures of quality. Overall, we believe that the information in audit fees can be used to provide an alternative measure of a firm’s accounting quality.     

Behavioral spillover between firms with shared auditors: The monitoring role of capital market investors

This paper examines the monitoring role of investors in the behavioral spillover between firms with shared auditors. Our context involves firms receiving U.S. Securities and Exchange Commission comment letters on issues relating to the recognition of revenue, gains, or losses (RRGL) in their 10-K filings and subsequently engaging in a higher degree of accounting conservatism. Investors of firms who did not receive a comment letter but share auditors with RRGL comment letter recipients react adversely to the release of these comment letters. Through the threat of downward stock price pressure on the value of Chief Financial Officers' equity compensation, investors induce the nonrecipients to also engage in a higher degree of accounting conservatism. When exposed to higher reputation and litigation risks, the shared auditors further contribute to the behavioral spillover between their clients by acting as informational intermediaries.     

Does preventive regulation reduce stock price synchronicity? Evidence from Chinese annual report comment letters

Based on a sample of Chinese A-share listed firms from 2015 to 2018, this paper studies the impact of annual report comment letters (ARCLs) on firm stock price synchronicity. We find that after firms receive ARCLs, their stock price synchronicity decreases. Moreover, the longer the ARCLs and the more negative the ARCLs’ tone, the lower the resulting stock price synchronicity. The mechanism test shows that after firms receive ARCLs, the firms’ information disclosure increases in quantity and quality, external media attention increases, and the firms’ governance improves, reducing their stock price synchronicity. Further research shows that this negative association is more significant in firms with higher information asymmetry. This paper shows that the ARCL, an innovative application of the capital market supervision philosophy, is conducive to improving the quality of listed firms and to the healthy development of the capital market.     

Institutional Investors’ Reaction to SEC Concerns about IFRS and US GAAP Reporting

For the period of 2006 to 2008, we collect Comment Letters issued by the SEC that question the application of US GAAP by US firms or the application of IFRS by European firms registered with the SEC. We investigate whether institutional investors react to the letters by changing their holdings and whether their responses vary for US registrants and European registrants. We do this via a treatment‐effects model in which we test the hypothesis that institutional investors rebalance their portfolio holdings because they view Comment Letters as informative public signals. We find that institutional investors reduce their equity holdings when firms receive SEC Comment Letters, and their negative reactions are most marked for low turnover institutional investors, who we use to represent those informed investors most prepared to incur costs to closely monitor firms. Next, while noting that the number of Letters questioning application of IFRS are smaller in number relative to those questioning application of US GAAP, we investigate whether there are different reactions to Comment Letters questioning different standards. We show that there is a higher probability of the SEC questioning the application of IFRS as compared to US GAAP. After controlling for firm‐specific conditions that impact the issuance of a Comment Letter, we show that this higher probability has economic significance because institutional investors’ react more negatively to Comment Letters that question the application of IFRS as compared to US GAAP. A content analysis confirms the economic importance of the Comment Letters. We find that in almost half of all IFRS cases the Comment Letters request amendments to financial statements.     

Do stock prices reflect undisclosed financial statement information? Evidence from the OTCBB

I exploit a regulatory change that mandated that Over-the-Counter Bulletin Board (OTCBB) firms must comply with the reporting requirements of the 1934 Securities Exchange Act. I use this change to examine the association between equity values and financial statement data in voluntary and mandatory disclosure environments. Before the change, disclosure of financial statement information was voluntary for most of these firms. I study firms that initiate SEC filing after the change and classify them as disclosing and nondisclosing based on whether they voluntarily disclosed financial statement information before the regulatory change. In these firms’ initial SEC filings after the eligibility rule, they retroactively disclose financial statement information for the year prior to compliance with the rule. Thus I can observe previously withheld financial data. I find that the choice to voluntarily disclose is negatively associated with firm characteristics related to proprietary costs and with situations in which accounting information plays a less important role in resolving information asymmetry. For nondisclosing firms, I find evidence that equity values reflect financial statement data, even though this information was not publicly available, and that compliance with mandatory SEC disclosure requirements strengthens this association. For disclosing firms, I find evidence that suggests investors viewed their voluntary disclosure of financial statement data as credible and fail to find evidence that compliance with mandatory reporting requirements enhances this association.     

Employee well-being,firm leverage,and bankruptcy risk

Employees of liquidating firms are likely to lose income and non-pecuniary benefits of working for the firm, which makes bankruptcy costly for employees. This paper examines whether firms take these costs into account when deciding on the optimal amount of leverage. We find that firms with leading track records in employee well-being significantly reduce the probability of bankruptcy by operating with lower debt ratios. Moreover, we observe that firms with better employee track records have better credit ratings, even when we control for differences in firm leverage.     

The bright side of the internal labor market: Evidence from the labor cost stickiness of firms affiliated with privately owned business groups in China

We examine whether having an internal labor market can help a firm affiliated with a privately owned business group (POBG) reduce labor cost stickiness. Our findings suggest that, when a POBG-affiliated firm experiences a decrease in sales, it has lower labor cost stickiness than an otherwise equivalent firm that is not affiliated with a POBG. Specifically, we find that, on average, a POBG-affiliated firm entirely mitigates labor cost stickiness when it has a decrease in sales. In addition, we document that, to adjust its labor cost downward, a POBG-affiliated firm hires fewer employees, rather than paying lower wages. We show that the lower labor cost stickiness is due to movement of employees from the focal firm to other firms within the same POBG. When sales fall, the POBG reallocates excess employees at the focal firm to other firms within the business group via an internal labor market, and the focal firm thereby increases its per capita profit. Moreover, we find that agency cost mediates the impact of a POBG on labor cost stickiness. When the external market is less effective or the POBG headquarters have strong incentives, the effect of POBG affiliation on the reduction in an affiliated firm's labor cost stickiness is more salient.