Risk Management with Supply Contracts
59 Pages Posted: 17 Apr 2017
Date Written: April 2017
Purchase obligations are forward contracts with suppliers and are used more broadly than traded commodity derivatives. This paper is the first to document that these contracts are a risk management tool and have a material impact on corporate hedging activity. Firms that expand their risk management options following the introduction of steel futures contracts substitute financial hedging for purchase obligations. Contracting frictions – such as bargaining power and settlement risk – as well as potential hold-up issues associated with relationship-specific investment affects the use of purchase obligations in the cross-section as well as how firms respond to the introduction of steel futures.
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