Readability of Notes to Consolidated Financial Statements and Corporate Bond Yield Spread

Abstract

We examine the association between readability of ‘Notes to consolidated financial statements’ (Notes) in annual reports and corporate bond yield spread. We find that less readable narrative disclosure of Notes is significantly associated with greater bond yield spread. In addition, the association becomes stronger for firms in high-tech sectors or those with higher equity volatility, whereas it becomes weaker for firms with higher profitability or those with the reporting location of Notes being outside of the 10-K format file. We also provide evidence that Notes readability is helpful in explaining the puzzle of a positive yield spread always appearing when the bond approaches its maturity in practice. Overall, our results suggest that the Notes readability has a substantial association with bond yield spread and its term structure.

Keywords: Notes to consolidated financial statements (Notes); Narrative disclosure readability; Notes readability; Bond yield spread; Credit risk; Term structure

JEL Classification: G32; M41; G33