Unintended Effects Of Random Inspection

As China’s economic development enters a critical transition period,dealing with the relationship between the government and market and further stimulating the vitality of the market are vitally important.Important meetings,for example the 18 th national Congress,19 th National Congress,fifth Plenary Session of the 19 th CPC Central Committee,have repeatedly stressed the need for government agencies to further streamline administration to delegate power and to speed up the transformation of government functions.In this context,The General Office of the State Council issued the “Notice on The Promotion of Random Inspections and of Regulation in Process and Afterwards” in August 2015,marking the formal implementation of the “Double Random and One Open” supervision system.“Double Random and One Open”strategy is a key step in improving process and afterwards oversight,is a major decision made by The State Council and the CPC Central Committee and has been included in the Government Work Report for three consecutive years since 2016.Responding to the call,the CSRC issued“the List of CSRC Random Inspection Items” in November 2015,randomly selecting at least5% of listed companies for on-site inspection every year since 2016.Because of the close relationship between securities supervision and the development of capital market,it is necessary to investigate the economic consequences of securities supervision system.Few literatures,however,can identify the cause-effect of securities regulation,the randomness and externality of the random regulatory system provide a perfect causal identification scene for testing the economic consequences of this regulation.This paper makes use of the “Double Random and One Open” regulation initiated by The State Council to study the economic consequences of the capital market random inspection from the two perspectives of listed companies’ financial report disclosure behavior and capital market performance,and finds the unintended effects.Specifically,this paper takes 2012-2020 as the interval to investigate the impact of random inspection system on earnings management behavior,stock liquidity and cost of equity capital of listed companies.The reason for starting from these three perspectives is to refer to the layout of existing literature,and to consider that the mission of securities supervision is to improve the quality of listed companies and protect investors,as well as the close connection of the above three within the framework of literature.Theoretically,both positive and negative logics exist on how the dual-random regulation of listed companies affects the disclosure behavior of financial reports and the performance of capital market.On the one hand,after the inspection,the listed company might reduce financial report disclosure quality,improve the degree of earnings management because of the reduced attention from the regulatory side and the exist of the “three years exempted from inspection”policy.The result of this situation would be the decrease of stock liquidity and the increase of cost of equity;On the other hand,listed companies may perceived higher regulatory risks due to detailed and comprehensive inspection,and then improve the quality of financial report disclosure and reduce the degree of earnings management.Also,they may actively transmit positive signals to obtain the trust of investors,which is ultimately reflected in the improvement of stock liquidity and the reduction of the cost of equity capital.Therefore,this research topic is a topic with “tension” in theory,and needs further empirical evidence.This paper draws the following conclusions:Firstly,this paper tests the internal validity of the random inspection system of listed companies of the CSRC from three aspects: institutional background,first-hand interview materials and empirical test;On this basis,this paper studies the impact of random supervision on earnings management behavior of listed companies.The research shows that the degree of earnings management of listed companies through random inspection is improved,and this unintended effect is stronger in companies with stronger earnings management incentives,and weaker in companies with better internal and external governance.Specifically,among the companies with high equity pledge ratio of controlling shareholders,the companies with motivation to avoid losses and the companies with stock-financed acquisition,the companies are more likely to improve earnings management.In the companies with high shareholding ratio of institutional investors,companies cross listed in H shares or B shares,and in stateowned enterprises,companies will not improve the degree of earnings management;In the listed companies with more analysts,more media focus and fewer jurisdiction under the CSRC,earnings management tend not to be increased after the inspection.In addition,this paper also finds that companies are more likely to receive non-standard audit opinions from accounting firms after inspection,and the correlation of their earnings value is low.Secondly,this paper studies the impact of random inspection on stock liquidity of listed companies.The research shows that the stock liquidity of listed companies decreases,and this unintended effect is weaker in companies with better internal and external governance.Specifically,in companies with a high proportion of institutional investors,companies cross listed in H shares or B shares,and state-owned enterprises,the liquidity of companies passing random inspection is less reduced;The stock liquidity decrease less in the firms focused by a larger number of analysts,firms with less negative news reports and those firms taken charged by China’s top-10 accounting firms.This paper finds that the possible influencing channels are information disclosure quality and corporate risk.In addition,this paper also found that after the random inspection,the accuracy of analysts’ prediction decreased.Finally,this paper studies the impact of random regulation on the cost of equity capital of listed companies.The research shows that the cost of equity capital of listed companies increases after the inspection,and this unintended effect is weaker in companies with better internal and external governance.Specifically,in companies with high shareholding ratio of institutional investors,companies with cross listing of B shares or H shares,and state-owned enterprises,the cost of equity capital increases less;The cost of equity capital has increased less in the firms focused by a larger number of analysts,firms with less negative news reports and those firms taken charged by China’s top-10 accounting firms.This paper tests the possible influence channels and finds that random inspection can improve the cost of equity capital by affecting the information quality and firm risk of enterprises.In addition,this paper finds that the profitability of companies decreases after the inspection.From the perspective of institutional motivation,the “double random” inspection system launched by the State Council is intended to form an immediate “deterrent effect” to the regulated subjects and improve the behavior compliance of which.The empirical results found an unintended effect,however.That is,listed companies took advantage of the regulatory gap exempted from inspection to take speculative behavior after inspection,and the capital market performance of those firms also decreased.This paper may have the following contributions:(1)This paper provides causal inference for the economic consequences of securities regulation.Leuz and Wysocki(2016)reviewed the literature on capital market regulation and believed that the literature that can illustrate the economic consequences of the regulatory system is still scarce.But the random regulatory system provides a better scenario for identifying the economic consequences of supervision for three reasons: first,the random supervision scenario distinguishes the treat group and the control group by random selection,forming a better causal identification scenario;Second,the initiation of random regulatory system is exogenous relative to the capital market.In the past,policy changes in the capital market were usually caused by market failure or economic crisis.These trigger factors may directly affect the company’s financial reporting behavior and capital market performance.But the random regulatory system is initiated by the State Council and is not caused by factors in the capital market,thus a good “exogenous shock” policy for the study of corporate behavior and capital market performance;Third,the random regulatory system does not involve changes in rules,but only changes in law enforcement.Previous policy changes usually involve a series of changes ranging from rules,enforcement and punishment,and it is difficult to distinguish the effect of enforcement.But the random regulatory system does not involve the change of rules and regulations,but only the change of enforcement,which is conducive to the investigation of the economic consequences of the enforcement of securities law.(2)This paper earlier studied the economic consequences of random regulatory system in capital market.In the past,few countries have adopted the form of “random supervision” in capital market supervision,and there is a lack of articles using the random regulatory system of capital market as the research scene in the literature.Compared with the previous securities supervision system,the random regulatory system has at least the following distinctive characteristics: first,from the intervention stage,it is a preventive daily supervision that is not determined by the characteristics of the company.Second,the random regulatory system greatly controls the supervision cost.With the increasing number of regulatory subjects and the concealment of fraud means,the securities regulatory authorities in various countries are facing more and more serious resource constraints.The random regulatory system is a supervision method that fully considers and controls the supervision cost and is expected to become the development direction of capital market supervision in the future and can provide enlightenment for capital market regulators facing resource constraints all over the world.In addition,new regulatory policies often face unintended economic consequences.This paper supplements the literature on the unintended effects of regulatory policies.Finally,this paper provides empirical evidence for the theoretical framework of random inspection proposed by Varas et al.(2020).(3)This paper may provide enlightenment for improving the random regulatory system of capital market.New regulations are usually accompanied by unintended effects.In the process of implementation,front-line regulatory evidence and big data empirical evidence are needed to improve and revise the regulatory system.This paper examines the economic consequences of random supervision from the perspectives of financial report disclosure behavior of listed companies and capital market performance,and finds unintended effects,which provides some enlightenment and reference to improve the “Double Random and One Open” supervision system of capital market.