Annual report readability and trade credit

Abstract

Purpose The purpose of this study is to examine the influence of the readability of annual reports on firms’ ability to obtain trade credit from suppliers. Particularly, the authors conjecture that annual report readability helps firms obtain more trade credit from suppliers. Design/methodology/approach The authors use the Gunning Fog Index as the primary measure of annual report readability and the ratio of accounts payable to the book value of total assets as the measure of trade credit. Findings Results from the study of 4,754 firms during the 2004–2016 period indicate that suppliers extend more trade credit to firms with more readable financial reports. The authors’ results are robust to alternative measures of trade credit and annual report readability. The authors’ results remain robust when we control for firm fixed effects and potential endogeneity problems using the instrumental variable approach. A further test shows that the level of trade credit is higher for firms in business service industries, and that this relation is weakened when firms disclose less readable 10-K filings. Originality/value The authors’ findings provide new insight into the role of financial report readability in firms’ ability to obtain trade financing from suppliers. The authors’ results are also in line with the SEC’s encouragement that firms use plain English and easy language in financial reporting.