The information effect versus governance effect of comment letters: Evidence from the cost of equity capital

Abstract

This paper uses a sample of comment letters issued and disclosed by the Shanghai and Shenzhen Stock Exchanges in China from 2015 to 2019 and empirically investigates the impact of comment letters on the cost of equity capital. The results show that the cost of equity capital raises after firms receive comment letters. However, when repeating the analysis using comment letters issued but undisclosed between 2013 and 2014, the observed effect dissipates, indicating an information disclosure channel. Moreover, the cost of equity capital is higher when the letters include more questions and demand independent opinions from auditors. Cross‐sectional tests show that this effect is influenced by investor protection, corporate information environment, and internal control quality. Additional tests show a negative association between the receipt of comment letters and both the likelihood and the amount of seasoned equity offerings, which can be attributed to the elevated cost of equity. Overall, our paper not only underscores the importance of public disclosure of government regulatory information, but also provides empirical evidence supporting the effectiveness of regulation by stock exchanges.