Mitigating Incentive Conflicts in Inter-Firm Relationships: Evidence from Long-Term Supply Contracts

46 Pages Posted: 1 Mar 2013

See all articles by Anna M. Costello

Anna M. Costello

University of Michigan, Stephen M. Ross School of Business

Date Written: February 27, 2013

Abstract

Using a sample of long-term supply contracts collected from SEC filings, I show that hold-up concerns and information asymmetry are important determinants of contract design. Asymmetric information between buyers and suppliers leads to shorter term contracts. However, when longer duration contracts facilitate the exchange of relationship specific assets, the parties substitute short-term contracts with financial covenants in order to reduce moral hazard. Covenant restrictions are more prevalent when direct monitoring is costly and the products exchanged are highly specific. Finally, I find that buyers and suppliers are less likely to rely on financial covenants when financial statement reliability is low.

Keywords: Contracting, Covenants, Financial Reporting Quality, Hold-up, Information Asymmetry, Relationship Specific Assets

JEL Classification: D20, D82, G32, L14, L15, L22, M41

Suggested Citation

Costello, Anna M., Mitigating Incentive Conflicts in Inter-Firm Relationships: Evidence from Long-Term Supply Contracts (February 27, 2013). Journal of Accounting & Economics (JAE), Forthcoming, Available at SSRN: https://ssrn.com/abstract=2226090

Anna M. Costello (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

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