CEO Incentives and Customer‐Supplier Relations

Abstract

This study explores how suppliers adjust their relation‐specific investments (RSI) in response to the different risk‐taking incentives provided by the customer firm to its CEO, during normal and transition periods. We investigate this relation using 17,553 customer–supplier transactions over the 1993–2013 period. We find strong evidence consistent with the risk‐taking argument. Specifically, we find that an increase in the risk‐taking incentives of customer CEOs leads to a decline in suppliers’ RSI in normal periods, but an increase in RSI during transition periods. We employ the FAS‐123R mandate to show that an exogenous reduction in customer CEO's incentive pay increases suppliers’ RSI. We reaffirm the effect with the passage of the Sarbanes–Oxley Act as a secondary quasi‐natural experiment. Finally, we examine several scenarios that either amplify or attenuate the observed relation, based on factors such as financial constraints, distress, growth opportunities, industry competition, and other firm characteristics. Our study contributes to the literature that examines the interplay between corporate policy and product market relationships.

Supplier dependence and R&D intensity: The moderating role of network centrality and interconnectedness

“…The firm age, as a proxy for a firm's accumulated knowledge base, was chosen because the years that a firm has operated represent opportunities to build a dependent relationship with key customers (Kim et al, 2015; Patel, 2011). Moreover, due to the nature of an industry and competition landscape, focal firms' dependence upon key customers can mimic their peer firms in the same industry (Emery and Marques, 2011; Gu et al, 2017; Wang and Shaver, 2014). Thus, we used the industry peer firms' average supplier dependence as the second instrumental variable.…”

“…Data on supplier firms and major customer firms were obtained from Standard & Poor's Compustat segment customer database, which is updated every year. The database has been widely used in prior research into supplier dependence upon major customers (e.g., Ak and Patatoukas, 2016; Dhaliwal et al, 2016; Gu et al, 2017; Irvine et al, 2016; Kim, 2017; Radhakrishnan et al, 2014). The segment database is one of the most inclusive databases, offering complete information on major customers, including name, type, and revenue.…”

“…The investments involve resources that are committed to production for a major customer and thus represent costs that a supplier firm cannot fully recover unless they maintain the relationship (Irvine et al, 2016). Such investments are risky because of high switching costs (Gu et al, 2017). When suppliers are heavily dependent upon a few large customers, the switching cost is too high for them to consider alternative new methods or new ideas.…”

“…Our data cover business activities of the sample firms over the period 1993 to 2015. Following Gu et al (2017), who utilized the segment database, we chose 1993 as the initial year. We are interested in any supplier firm's R&D expenditures that might be influenced by a level of dependence upon major customers.…”

“…Second, reliance on major customers requires a supplier to make relationship‐specific investments that are specific to the customers (Gu et al, 2017), which leads to high financial distress costs and low cash flow for the supplier (Huang et al, 2016). The investments involve resources that are committed to production for a major customer and thus represent costs that a supplier firm cannot fully recover unless they maintain the relationship (Irvine et al, 2016).…”