title: Textual Analysis and SEC Comment Letters
Creators: name: Ma, Wentao
Publisher: name: The Australian National University
Year: 2024

description: The Securities and Exchange Commission (SEC) sends comment letters (CLs) to firms during its regular reviews of firm financial statements and related disclosures, known as filing reviews. These letters communicate compliance with financial regulations and accounting standards. Upon receipt of a master letter (i.e., the first CL), firms must respond to the SEC, which may then send follow-up letters to continue communication until all its concerns are effectively addressed. This resolution process involves not only the firms' management, such as Chief Executive Officers (CEO) and Chief Financial Officers (CFOs), but also external professionals, such as auditors. Study 1 of this thesis examines whether the severity of the language used by the SEC in CLs affects the likelihood of CEO/CFO turnover during the SEC reviews. I term language severity as the extent to which the SEC communicates harshly and critically with a firm, as measured by the negative words of the Loughran and McDonald (2011) (L&amp;M) dictionary. Conducting textual analysis of 46,708 CLs from the SEC during 17,951 reviews from 2005 to 2019, I find that the severity of the language in the master letter sent by the SEC during each review is positively related to the likelihood of CEO/CFO turnover during the reviews. This likelihood decreases as the severity of the language from the master letter to the first follow-up letter decreases. These findings align with the notion that firms adjust their signaling to the SEC through CEO/CFO turnover according to the severity of the SEC's language during the reviews. Study 2 of this thesis examines whether the efficiency of resolving clients' SEC reviews affects the change in an audit office's market share in the local market for audit services, focusing on unaffected clients (i.e., clients that do not undergo these reviews) and potential clients. Resolution efficiency is measured using a principal component analysis of the SEC's language severity decrease, CL count, and review duration. I measure office market share as the proportion of its client numbers (audit fees) in the metropolitan statistical area. I find that as the efficiency of resolving clients' SEC reviews increases, an audit office's market share grows in the following year. Specifically, it reduces the likelihood of unaffected clients dismissing the office and increases the likelihood of the office acquiring potential clients in the following year. These findings document how the efficiency of resolving clients' SEC reviews contributes to audit offices' reputations within the local audit service market and, in turn, impacts the economic consequences for audit offices. Study 3 develops a specialized dictionary for supervising textual analysis of CLs. The L&amp;M dictionary is known for its effectiveness in capturing sentiment in business documents. However, CLs often contain many sentiment-neutral words used to describe firms' compliance issues. Thus, I propose a novel method to identify words in CLs that may be informative to researchers and investors but are overlooked by sentiment dictionaries. Using neural network modeling, I identify 934 words from 150,432 CLs. I then compare the performance of my dictionary with that of the L&amp;M dictionary. The results confirm that the words from my dictionary have greater power in explaining future restatements and internal control weaknesses than the L&amp;M dictionary. Overall, this thesis contributes to the literature on textual analysis of SEC CLs, management turnover, and the economic consequences of auditors. The findings highlight that firms assess CL content, which influences their decisions regarding management turnover and auditor-client contracting. This thesis also develops a measure of the efficiency of SEC review resolutions that accounts for the impact of CL content and creates a dictionary specific to the textual analysis of these letters, both of which are valuable for future research.