The Myth about Public versus Private Enforcement of Securities Laws - Evidence from Chinese Comment Letters

China presents a unique opportunity to study public enforcement of mandatory disclosure when private enforcement is largely absent. Using a hand-collected sample of comment letters (CLs) on annual reports issued by the Shanghai Stock Exchange, we first show that the price reaction to CL announcements is negative and significant, and that targeted firms are more likely to amend their annual reports compared to firms not in receipt of CLs. However, we find no significant effect of the Exchange’s oversight on targeted firms’ financial reporting practices, nor do we find any evidence of market discipline in terms of higher costs of capital for those firms. Finally, we show that targeted firms, especially those receiving more severe CLs, are more likely to receive CLs in the future and are also more likely to be sanctioned by the regulators. We conclude that public enforcement does not achieve its intended objectives in weak institutional environments.