The Impact of Linguistic Distance and Financial Reporting Readability on Foreign Holdings of U.S. Stocks

Abstract

Using a sample of 75 countries, we show that foreigners invest less in U.S. stocks when investors are from countries with greater linguistic distance and when U.S. financial reports are more difficult to read. Our results suggest that linguistic distance and readability difficulty act as information processing frictions for foreign investors, even in the U.S. market where foreign investors should have the greatest ability, resources, and incentives to overcome translation and readability issues. Additionally, we show that foreigners invest more in U.S. Treasuries and consume more when facing greater linguistic distance and readability difficulty. These results are consistent with a “substitution effect” where foreigners increase their consumption and holdings of U.S. Treasuries because these alternatives avoid the linguistic distance and readability frictions associated with analyzing financial statements and investing in U.S. equities.