Trade Credit in Distrust: Evidence from Financial Restatements

Abstract

We argue that distrust significantly increases people's perceived information asymmetry and has important economic consequences. By using the occurrence of financial restatement as a proxy for significant trust reduction in financial information, we show that firms rely more on trade credit as an external financing choice after restatements because suppliers have an information advantage and better address information asymmetry problems. After comparing the predictability of sales by trade credit before and after restatements, we find that the informativeness of trade credit about firms' prospects changes during restatement periods. In the pre-restatement periods, firm sales monotonically increase with trade credit. In the post-restatement periods, firms with the most trade credit do not have the best future performance, while firms with the least trade credit experience the lowest subsequent sales. We also find that investors in the stock market do not realize such informativeness change and underreact to the valuable negative information from suppliers.