A seminar by Associate Professor Fangjian Fu from Singapore Management University
Title: Randomized On-Site Inspections and Shareholder Value
Abstract: Regulatory on-site inspections, effective and frequently used elsewhere, are less adopted by regulators in the capital market. Since 2016, Chinese regulators have randomly chosen 5% of public firms every year to inspect on-site their compliance with securities laws regarding information disclosure and corporate governance. We utilize this unique setting to examine how randomized on-site inspections affect shareholder wealth and find the following. (1) The aggregate market reaction to the announcement of this new policy is positive and significant, especially in regions with weaker legal institutions. (2) At the announcement of the random selection outcome, the stocks of firms selected for inspection react negatively, and the negative abnormal returns are more significant for firms that have better complied with the rules. (3) In the years following the on-site inspections, inspected firms reduce abnormal related-party transactions and earnings management; however, their costs of equity financing increase, corporate investments decrease, and operating performance and market valuations deteriorate. Although our findings confirm the positive value of the on-site inspection policy in general, they challenge whether randomization is an optimal means to select inspection targets. The selected firms bear high costs of the on-site inspections; however, the benefits are not evenly distributed across firms. Better targeting could improve the regulatory outcome.
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