Analysis on the Impact of Capital Market Opening on Corporate Tone Manipulation

Abstract

Corporate tone manipulation – the strategic inflation of positive sentiment in narrative disclosures above what underlying financial fundamentals would predict – is a pervasive but under-regulated form of soft information distortion that can mislead investors and distort capital allocation. We examine whether liberalisation of capital markets, proxied by inclusion in China’s Shanghai-Hong Kong Stock Connect programme, disciplines corporate tone manipulation in listed enterprises. We employ a difference-in-differences design exploiting the staggered inclusion of A-share firms in Stock Connect as a quasi-natural experiment. We argue that capital market opening reduces tone manipulation through two main channels: increased analyst coverage that improves information intermediation and reduced information asymmetry, proxied by narrowing bid-ask spreads. We additionally hypothesise that the disciplinary effect is stronger for privately owned firms than for state-owned enterprises, suggesting fewer pre-existing governance limitations. Our study contributes to the literature on capital market liberalisation and to the growing literature on the quality of soft information in corporate disclosures. Our study has implications for regulators who may be interested in using market opening as a tool to improve the quality of narrative reporting.