Internal Control Effectiveness and Trade Credit

Abstract

In this study, we investigate whether trade credit is associated with internal control effectiveness. Using a sample of U.S. publicly listed firms over the period 2006-2018, we find robust evidence that internal control effectiveness firms have a lower level of trade credit. Our additional analyses show that the cost of equity capital moderates the relation between internal control effectiveness and trade credit. We also find evidence that internal control effectiveness firms make quicker payments for their trade credit contracts than other firms. In addition, we find that firms have a higher demand for trade credit when the firms have ineffective internal controls, disclose entity level internal control material weaknesses, and report internal control ineffectiveness related to trade credit accounts. Taken together, these findings suggest that internal control effectiveness plays an important role in trade credit-a special form of firms’ short-term financing source.

Keywords: internal control effectiveness; internal control weaknesses; trade credit; supplier financing.