The benefits of the exchange inquiry letter as a regulatory tool, such as improved information quality, have been well documented. However, very little attention has been paid to whether any extra costs are incurred by such letters. This paper investigates how exchange inquiry letters could affect a firm’s operating performance, using a group of Chinese A-share firms from 2015 to 2019.
In this paper, we implement regression and textual analysis to investigate the effect of inquiry letters on firm operating performance and investment efficiency.
First, we find that these firms are experiencing deteriorating operating performance in the subsequent year after receiving and responding to inquiry letters. Second, such costs are more pronounced when inquiry letters are issued on more pages, with more words and with a high Fog Index. Additionally, we propose a channel via informed trading to explain this pattern. That is, inquiry letters can diminish informed trading, resulting in less price-based feedback from the market to managers. Consequently, this may lead to a lower investment efficiency, i.e. less efficient managerial decisions regarding future investments. Collectively, our study highlights that the benefits of regulations may come with inherent costs.
First, our paper provides new evidence on the potential costs of such regulatory tools, given that most prior literature mainly looks at the benefits. Such analysis can help better understand the comprehensive impact of exchange inquiry letters on firm value in China. Second, to our knowledge, this is the first study to implement textual analysis in the case of exchange inquiry letters in China. Therefore, our study can add new evidence to the literature on the effect of textual analysis on the managerial decision-making process. Third, this paper can help better understand how informed trading could affect firm performance via the information conveyed in exchange inquiry letters. Thus, our study sheds new light on the impact of exchange inquiry letters on informed trading.
