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Specific Investment and Supplier Vulnerability: Theory and Evidence

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Abstract

Apart from the familiar holdup problem, we investigate another implication of specific investment that has not been examined systematically in the literature. That is, the presence of specific investment can make a supplier vulnerable to large negative shocks to its customer’s business. In a theoretical model, we demonstrate that this vulnerability causes the supplier to under-invest. A higher degree of specificity induces the supplier to invest more, and it leads to a lower mean and higher volatility in the supplier’s profit. Using panel data on over 5000 U.S. firms from 1990 to 2010, our empirical analysis shows the prevalence of the supplier vulnerability problem associated with specific investment.

Suggested Citation

  • Zhiqi Chen & Xiaoqiao Wang, 2016. "Specific Investment and Supplier Vulnerability: Theory and Evidence," Carleton Economic Papers 16-06, Carleton University, Department of Economics.
  • Handle: RePEc:car:carecp:16-06
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    More about this item

    Keywords

    specific investment; holdup problem; supplier vulnerability; profit volatility;
    All these keywords.

    JEL classification:

    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation
    • L24 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Contracting Out; Joint Ventures
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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