Taming the dragon: stock exchange comment letters and earnings volatility

Abstract

This study explores the impact of comment letters on earnings volatility motivated by the broad scope of stock exchange comment letters in China and regulators’ concerns regarding earnings-related issues. Using a manually collected sample of Chinese comment letters, we find that receiving a comment letter is associated with increased earnings volatility. Our baseline results survive a host of exercises to mitigate endogeneity, including difference-in-differences, propensity score matching, entropy balancing, and instrumental variables. Channel analysis reveals that comment letters are associated with increased earnings volatility through dampened supply chain stability (economic channel) and reduced use of earnings management to smooth earnings (accounting channel). Our findings contribute to the literature on comment letters in non-US economies and provide important and timely implications for regulators.