Examining the Examiners: SEC Error Detection Rates and Human Capital Allocation

Abstract

<jats:p>The ability to detect misreporting is an important aspect of financial reporting regulation. I derive a measure of SEC error detection rates using information from comment letter reviews. Conditional on the SEC issuing a comment letter, I find that the review team detects an error resulting in a restatement in 4.6 percent of cases, while firms eventually restate financial reports for 13.6 percent of periods under review. My measure of SEC error detection rates is the ratio of reviews that detect an error to total reviews that could have detected an error. I document a positive association between detection rates and review team size. Using a novel approach to identify examiner characteristics, I show that this association is driven by the number of accountants on the review team. I find an economically insignificant association between individual examiner performance and economic or career incentives.</jats:p>

Can securities supervision reduce corporate tax avoidance?

“…The extant comment letter literature mainly investigates the effectiveness of the securities supervision system with the nature of the SEC comment letter from the aspects of the information environment, audit pricing, internal control, and rotation of the chief financial officer [ 11 – 13 ]. The common perception is that SEC inquiries can improve corporate governance by reducing the level of information asymmetry.…”

“…This paper uses theoretical and empirical analysis to test the impact of Shanghai and Shenzhen Stock Exchange tax-related comment letters on corporate tax avoidance. The primary reason for selecting Chinese listed firms as the research object is that extant literature mainly focuses on SEC comment letters [ 5 , 11 – 13 ], with a lack of attention on the Chinese stock exchange comment letters. The effectiveness and coverage of the Chinese stock exchange inquiry system may have different regulatory backgrounds compared with the SEC; On the other hand, the monitoring of corporate tax avoidance behavior is an urgent practical problem to be solved by central governments around the world.…”

Does Financial Statement Comparability Facilitate SEC Oversight?

“…We only consider restatements that were filed after the date of the first comment letter but before the comment letter dissemination date, as these are the restatements that are most likely to be filed in response to the SEC's comment letter process. Following Kubick (2021), we infer that the comment letter directly leads to the restatement when a topic of the comment letter matches a restatement topic. 32 To test the likelihood a comment letter identifies a material misstatement, we restrict our analysis to observations in which CL_Acct=1 and CL_Core=1 and examine the association between High_Comp and restatements induced by comment letters (CL_Acct_Restatement, CL_Core_Restatement).…”

“…A dummy variable that equals one if an accounting-related (core earnings-related) comment letter directly resulted in a restatement and zero if it did not. We consider a comment letter to directly result in a restatement if the firm restated its financial statements after the first comment letter but before the comment letter dissemination date and a topic in the comment letter matches a topic of the restatement (following the matching provided in Kubick (2021)).…”

“…Kubick (2021) uses Audit Analytics topic keys to match and notes that 89.6% of the time, the matching results in the same classification as in hand collection. This outcome suggests that this matching procedure accurately captures when restatements were made in response to comment letters.…”