The real effect of CSRC's random inspections on corporate financial fraud

Abstract

To optimise the regulatory approach, the China Securities Regulatory Commission (CSRC) introduced the double‐random inspection policy (DRIP), which mandates that the provincial branches of the CSRC randomly select at least 5% of local listed firms each year and randomly assign inspectors to conduct on‐site inspections of their information disclosure and corporate governance practices. This paper investigates the real effect of the DRIP on corporate financial fraud. Performing a multi‐period synthetic difference‐in‐differences model (SDID), we first find that the random inspections of CSRC have a positive causal effect on the probability of exposing corporate financial fraud. Furthermore, our heterogeneity analysis reveals that this effect is more pronounced for private firms and firms with poor accounting information quality. We then delve into the mechanisms through which random inspections affect corporate financial fraud. Our findings suggest that random inspections influence corporate behaviour by increasing media and investor attention, as well as prompting the issuance of inquiry letters by stock exchanges. Finally, we examine the economic consequences of random inspections and find that random inspections by the CSRC reduce firms' stock price crash risk.