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Counterparty risk in material supply contracts

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Abstract

This paper explores the sources of counterparty risk in material supply relationships. Using long-term supply contracts collected from SEC filings, we test whether three sources of counterparty risk?financial exposure, product quality risk, and redeployability risk?are priced in the equity returns of linked firms. Our results show that equity holders require compensation for exposure to all three sources of risk. Specifically, offering trade credit to counterparties and investing in relationship-specific assets increase the firm?s exposure to counterparty risk. Further, we show that contracts with protective financial covenants and product warranties mitigate the transmission of risk. Overall, we provide evidence on the channels of supply-chain risk, and we show that shareholders recognize the role of contractual features in mitigating counterparty risk.

Suggested Citation

  • Nina Boyarchenko & Anna M. Costello, 2014. "Counterparty risk in material supply contracts," Staff Reports 694, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednsr:694
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    Cited by:

    1. Rahaman, Mohammad M. & Rau, P. Raghavendra & Zaman, Ashraf Al, 2020. "The effect of supply chain power on bank financing," Journal of Banking & Finance, Elsevier, vol. 114(C).
    2. Ting Chen & Hagit Levy & Xiumin Martin & Ron Shalev, 2021. "Buying products from whom you know: personal connections and information asymmetry in supply chain relationships," Review of Accounting Studies, Springer, vol. 26(4), pages 1492-1531, December.

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    More about this item

    Keywords

    supply contracts; counterparty risk premia; financial covenants;
    All these keywords.

    JEL classification:

    • G19 - Financial Economics - - General Financial Markets - - - Other
    • L00 - Industrial Organization - - General - - - General
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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