Can Financial Inquiry Letters Improve the Readability of Annual Reports? Evidence from Listed Companies with Directors’ Ties

Abstract

From the perspective of the readability of annual reports, this paper explores the governance effect of exchanges’ inquiry letters on the readability of annual reports. It is found that the inquiry letter of financial reports can play a significant regulatory role, not only improving the readability of annual reports of the inquired company（the sending company）, but also promoting the listed company（the receiving company）which has the relationship with the inquired company’s directors to improve the annual report disclosure behavior. Especially when the companies with high investor attention, more media reports and fierce product market competition are inquired, the receiving companies will greatly improve the readability of annual reports. The mechanism of action test confirms that the inquiry letter of financial reports reduces the earnings management of the inquired company and increases the cost of violation, which has a direct impact on the readability of the annual report of the inquired company; at the same time, the inquiry letter has an indirect impact on the readability of the annual report of the receiving company based on the connection between the transmission of information by the directors and the maintenance of their reputation.The possible marginal contributions of this paper are mainly as follows:（1）Existing research on the effect of inquiry letters on accounting information governance mainly focuses on the research on information quantity, earnings management and performance forecast. This paper extends it to the impact on the readability of the annual report of listed companies, enriching the research on the economic consequence of the inquiry letter system.（2）Existing research on the influencing factors of the readability of annual reports mainly focuses on the external environment such as litigation risks, social relations and product market competition, and the internal characteristics of the company. This paper explores the inquiry letter effect on the readability of annual reports from a new perspective of the supervision of the inquiry letter of exchanges’ financial reports, broadening the research on the factors that affect the readability of annual reports.（3）Existing studies on the indirect impact of inquiry letters only focus on the “contagion” of inter industry behaviors. In view of the existence of the social network relationship between enterprises, this paper puts the organizational imitation behavior in directors’ ties into the research scope of the indirect impact of inquiry letters, investigates the impact of the letter receiving behavior of the inquired company on the annual report disclosure decision-making of the directors’ affiliated company, makes up for the lack of the existing research on the indirect impact of inquiry letters, and enriches the research on the economic consequence of directors’ ties.（4）From the perspective of corporate external governance environment, this paper discusses the conditions and basis of the indirect impact of inquiry letters. While deepening the understanding of the relationship between corporate external governance mechanisms, it also provides policy basis for improving the supervision mechanism of inquiry letters and realizing the effective play of the supervision and governance mechanism of inquiry letters.