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Counterparty Risk in Material Supply Contracts

Author

Listed:
  • Anna Costello

    (Massachusetts Institute of Technology)

  • Nina Boyarchenko

    (Federal Reserve Bank of New York)

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 relationshipspecific assets increase a 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 show that shareholders recognize the role of contractual features in mitigating counterparty risk.

Suggested Citation

  • Anna Costello & Nina Boyarchenko, 2015. "Counterparty Risk in Material Supply Contracts," 2015 Meeting Papers 235, Society for Economic Dynamics.
  • Handle: RePEc:red:sed015:235
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    File URL: https://economicdynamics.org/meetpapers/2015/paper_235.pdf
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    References listed on IDEAS

    as
    1. Costello, Anna M., 2013. "Mitigating incentive conflicts in inter-firm relationships: Evidence from long-term supply contracts," Journal of Accounting and Economics, Elsevier, vol. 56(1), pages 19-39.
    2. Philippe Aghion & Patrick Bolton, 1992. "An Incomplete Contracts Approach to Financial Contracting," Review of Economic Studies, Oxford University Press, vol. 59(3), pages 473-494.
    3. Hertzel, Michael G. & Li, Zhi & Officer, Micah S. & Rodgers, Kimberly J., 2008. "Inter-firm linkages and the wealth effects of financial distress along the supply chain," Journal of Financial Economics, Elsevier, vol. 87(2), pages 374-387, February.
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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).

    More about this item

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets

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