Chained Innovation: Response to Customer Covenant Violations

66 Pages Posted: 2 Sep 2020 Last revised: 15 Jun 2023

See all articles by Srinivasan Selvam

Srinivasan Selvam

EDHEC Business School - EDHEC Infrastructure Institute

Kelvin Jui Keng Tan

University of Queensland - Business School; Financial Research Network (FIRN)

Date Written: June 15, 2023

Abstract

This paper examines whether financial constraints relax customer inhibitions to share nonmonetary incentives with suppliers (e.g., proprietary information that is difficult to codify in bankruptcy) to enhance competitiveness and foster supplier innovation. Using United States data, we find that suppliers of customers violating loan covenants become more innovative, specialize in niche areas, and exhibit greater tendencies to cite and coordinate their own innovation with customers. These benefits are more pronounced when frictions to information flows between trading partners are lower and when customers perceive a lower value of protecting proprietary information. Furthermore, innovative suppliers have more durable relationships with covenant violating customers. We substantiate our empirical results with a survey. Overall, our evidence shows how mechanisms (i.e., debt covenants) to address one set of incomplete contracts between lenders and borrowers can spill over to another set of incomplete contracts (customer-supplier) and in the process, affect relationship-specific investments such as innovation.

Keywords: Innovation, Customer-Supplier Relationship, Debt Covenant Violations, Firm Performance

JEL Classification: O30, L14, L24, G32, G33

Suggested Citation

Selvam, Srinivasan and Tan, Kelvin Jui Keng, Chained Innovation: Response to Customer Covenant Violations (June 15, 2023). Available at SSRN: https://ssrn.com/abstract=3659886 or http://dx.doi.org/10.2139/ssrn.3659886

Srinivasan Selvam (Contact Author)

EDHEC Business School - EDHEC Infrastructure Institute ( email )

One George Street
07-02
Singapore
Singapore

Kelvin Jui Keng Tan

University of Queensland - Business School ( email )

Brisbane, Queensland 4072
Australia

Financial Research Network (FIRN) ( email )

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

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