Does the Proximity of Principal Customers Affect Suppliers’ Capital Structures?

Abstract

This study examines how the capital structure of supplying firms is affected by their principal customers’ geographical proximity. As the costs of information acquisition, communication, and monitoring generally increase with distance, suppliers’ uncertainty regarding their customers’ business and sales contribution will increase with distance as well. Hence, we document a significant inverse relation between suppliers’ leverage and their headquarter-to-headquarter distance to customers. Our findings suggest that customer-driven business risk induces firms to lower their risk in the balance sheet. Results are in line with contagion effects of customer distress on suppliers (Hertzel et al. 2008) and stand a battery of robustness tests including controls for accounting standards, competition, locations of non-headquarter offices, political stability, and estimating systems of simultaneous equations.

Keywords: business risk, capital structure, geographic proximity, information and monitoring costs, principal customers

JEL Classification: G30, G34, L14