When Ignorance is Not Bliss: An Empirical Analysis of Sub-tier Supply Network Structure on Firm Risk
54 Pages Posted: 20 Dec 2015 Last revised: 10 Feb 2019
Date Written: January 19, 2019
Using a multi-tier mapping of supply chain relationships constructed from granular global, firm-to-firm supplier-customer linkages data, we quantify the degree of financial risk propagation from the supply network beyond firms' direct supply chain connections, and isolate structural network properties serving as significant moderators of risk propagation. We first document two baseline facts: (1) a significant proportion of tier-2 suppliers are shared by tier-1 suppliers; (2) risks of the focal firm are significantly associated with those of their tier-2 suppliers, with the association stronger as the degree of supplier sharing increases. We then construct a new network metric, the diamond ratio, to disentangle the effect of overlapping supply network structure from tier-2 suppliers' own risks. We show that the focal firms' risk levels are significantly related to their diamond ratios. Finally, we uncover causal relationships behind these associations using a new source of exogenous, idiosyncratic risk events in an event study setting. We show that as tier-2 suppliers are impacted by these events, focal firms experience negative abnormal returns, the magnitude of which is significantly larger when the impacted tier-2 suppliers are more heavily shared. Overall, our study uncovers the sub-tier network structure as an important risk source that has not been adequately managed by practitioners and quantifies the value of visibility into a firm's extended supply network. Our results also provide the microfoundation for the common structure in idiosyncratic risks, and suggest the importance of incorporating the effect of sub-tier supply network structure in the portfolio optimization process.
Keywords: Supply Chain Risk Management, Supply Network Structure, Sub-tier Supply Network
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