The Power of Words: How SEC Comment Letters to Foreign Issuers Affect the Capital Markets

In our recent paper, we find that the tone of language in Securities and Exchange Commission (SEC) comment letters after enforcement reviews has capital market implications, which are amplified or abbreviated based on the strength of a given country’s enforcement.

In the financial reporting realm, foreign firms listed on U.S. stock exchanges account for a significant percentage of market capitalization. They often attract particular scrutiny, however, because their accounting quality is weak compared with that of U.S. firms[1]. In an effort to enhance informational transparency and promote the overall compliance with U.S. reporting regulations, the SEC conducts periodic corporate-filing reviews and issues comment letters when disclosure deficiencies are identified.

Comment letters provide timely feedback on firms’ financial reporting quality, and SEC comments are resolved faster than are alternative SEC enforcement tools. All SEC filers are subject to this review process, and comments relate to compliance with SEC reporting guidelines, detection of any corporate misconduct, application of accounting standards, and any lack of clarity or other shortfalls in corporate disclosure. In general, comment letters are unstructured and consist of qualitative information devoid of statistics.

Past research on financial disclosure documents the power of language in influencing stock market activity. Relevant studies have emphasized the tone of the words used by corporate managers[2], news media,[3] and analysts[4]. We consider the largely unexplored area of a regulator’s language in responding to company disclosure. Since the regulator’s language is required to follow defined linguistic patterns set by the SEC[5], lack of prior research could be a potential impediment to a better comprehension of the SEC’s practices. Thus, understanding the tone of SEC language is important to market participants due to the increased demand for additional qualitative information in corporate disclosures.

To measure the SEC’s tone in comment letters, we use a textual analysis and create a customized negative and positive list of words designed specifically for the U.S. regulatory context. We further test our customized regulatory dictionary against two general-purpose (General Inquirer and Diction 7) and two domain-specific[6] dictionaries frequently cited in analyses of corporate narratives. For a better understanding of the tone of regulatory content, we also break down the SEC’s overall language into negative and positive tone measures. In this vein, we investigate whether our regulatory tone dictionary has a greater predictive ability in explaining market reactions to comment letters than do alternative word lists.

We next consider the link between SEC Comment letters and the strength of securities enforcement in the country where a company is based. Foreign firms cross-listed in the U.S. generally operate in an environment where the home and host countries’ regulators regime interact. More specifically, U.S.-listed foreign firms are subject to stringent U.S. financial reporting requirements while operating under different and often weaker rules in their home countries. Thus, the foreign firms’ financial reporting can still be shaped by the home country’s regulatory regime. Indeed, prior studies provide strong evidence that home country enforcement is essential to enhancing corporate accounting quality and could influence firms’ financial reporting in U.S. markets[7]. To this end, we also examine whether home country enforcement is associated with capital market responses upon the release of SEC comment letters.

To address our main research questions, we collected a sample of 1,324 comment letter reviews filed for 330 U.S.-listed foreign firms and released by the SEC between 2005 and 2014. Our findings suggest that:

  • Capital markets do pay attention to the tone of regulatory language. Consistent with the psychology of judgment, when forming impressions, negative tone, in contrast to positive language, elicits significant stock-price responses upon comment letter dissemination.
  • Our dictionary, which was specifically designed for the U.S. regulatory context, has a greater predictive ability in explaining market reactions to comment letter announcements relative to alternative word lists employed in finance and accounting studies.
  • Foreign firms’ strong domestic enforcement is related to stronger market reactions upon the dissemination of SEC comment letters.
  • Foreign firms applying U.S. GAAP generate more negative investor reactions following an SEC staff request for amendments than after to a simple SEC request.

Our findings have the following implications for enforcement agencies, companies, lenders, and investors:

  • The SEC and foreign firms should be aware that the tone of comment letters requesting amendments to filings causes a significantly higher negative market reaction only for foreign firms applying U.S. GAAP. This might provide an incentive for firms to choose International Financial Reporting Standards.
  • Companies should be aware that any market reactions to the release of SEC letters are conditioned on the tone of the language used, an important factor to consider in their overall strategy for dealing with comments.
  • Lenders that use firms’ equity as collateral, should closely monitor and the interaction between the firm and the regulator.
  • Portfolio decisions should consider the quality of enforcement in a company’s home country, at least for those companies prone to questionable accounting practices.


[1] Lang, M., & Stice-Lawrence, L. (2015). Textual analysis and international financial reporting: Large sample evidence. Journal of Accounting and Economics, 60, 110-135.

[2] Loughran, T. I. M., & McDonald, B. (2011). When is a liability not a liability? Textual analysis, dictionaries, and 10-Ks. Journal of Finance, 66, 35-65.

[3] Tetlock, P. C. (2007). Giving content to investor sentiment: The role of media in the stock market. Journal of Finance, 62, 1139–1168

[4] Huang, X., Teoh, S. H., & Zhang, Y. (2014). Tone management. The Accounting Review, 89, 1083-1113.

[5] Since the SEC implements the Plain Writing Act, we expect its own documents to employ clear and comprehensible language and thus, to be free of corporate tactics such as impression management and report obfuscation (Senate and House of Representatives of the U.S.A. (2010). Plain Writing Act of 2010. In U.S. 111th Congress (Ed.), Public Law 111-274).

[6] Henry, E. (2008). Are investors influenced by how earnings press releases are written? Journal of Business Communication, 45, 363-407 and Loughran, T. I. M., & McDonald, B. (2011). When is a liability not a liability? Textual analysis, dictionaries, and 10-Ks. Journal of Finance, 66, 35-65.

[7] Srinivasan, S., Wahid, A. S., & Yu, G. (2015). Admitting mistakes: Home country effect on the reliability of restatement reporting. The Accounting Review, 90, 1201-1240.

This post comes to us from Daniel Giamouridis, global head of scientific implementation at Bank of America Merrill Lynch (BofAML); Kleopatra Koulikidou, a PhD candidate at International Hellenic University; and Stergios Leventis, a professor at International Hellenic University. It is based on their recent paper, “The Power of Words in Capital Markets: SEC Comment Letters on Foreign Issuers and the Impact of Domestic Enforcement,” available here. The views expressed in this post and in their recent paper do not necessarily reflect the views of BofAML.