Supplier-to-Buyer Liquidity Insurance

Abstract

Problem definition: What role do suppliers play in insuring buyers' access to liquidity? We study how suppliers alleviate credit constraints for their downstream partners, and the role this type of liquidity insurance plays in buyers' cash management policies.

Academic/Practical relevance: Although the use of trade credit and other explicit means of financing buyers have been studied extensively in the literature, we show that suppliers play a critical, implicit role as well. Firms rely on their financially unconstrained suppliers' access to external markets as an alternative channel through which access to liquidity is secured. Unconstrained suppliers reduce the need for precautionary cash.

Methodology: We identify a causal mechanism using a two-pronged approach. Leveraging a unique supplier/buyer linked data set from France, we first use a treatment effects framework to match firms with unconstrained suppliers to those with constrained suppliers. Second, we use a difference-in-differences framework and exploit a 2006 legal reform that resulted in a substantial exogenous relaxation of credit constraints for some firms.

Results: Firms with financially unconstrained suppliers hold about 11% less cash than similar firms with financially constrained suppliers. Further results show that firms with unconstrained suppliers also receive more trade credit. A series of robustness checks rule out econometric concerns and alternative explanations, such as bargaining power, and our result is also robust when examining a sample of North American firms.

Managerial Implications: For buyers, our paper highlights a supplier's access to external channels of financing as an important criterion in supplier selection and the construction of a firm's supplier portfolio. For suppliers, access to liquidity may be a competitive advantage, but it may also expose them to moral hazard if buyers purposely shift the burden of accessing liquidity upstream.

Keywords: supply chain, cash, credit constraints, liquidity insurance, empirical, operations-finance interface