The Economic Consequences of Risk-Absorption in B2B Relationships: Evidence from Indirect Auto Lending
56 Pages Posted: 5 Feb 2024 Last revised: 26 Mar 2024
Date Written: January 10, 2024
Abstract
Risk absorption is common in inter-firm relationships. For example, manufacturers may cover small suppliers’ production cost risks, and suppliers might take on some buyers’ payment default risks. Risk absorption aims to enhance value and foster long-term partnerships. Despite recognizing this intention, there is limited research on the economic consequences for the risk-taker. The authors examine the costs and benefits of risk absorption in indirect car loan markets, where third-party lenders rely on auto dealers to reach consumers. In this scenario, risk absorption occurs when third-party lenders approve loans for high-risk consumers, allowing auto dealers to complete transactions, even for consumers who typically would not qualify for loans. Using a comprehensive dataset spanning three years from a third-party lender working with 1,550 dealers, the authors explore (1) the actual costs related to risk absorption by lenders, such as loan defaults and overdue payments, (2) how dealers reciprocate and/or exploit by assessing how lender risk absorption affects dealer referrals in terms of loan amounts (gains) and loan risk (losses), and (3) heterogeneity in how dealers respond to risk absorption. While lenders incur direct costs for offering favorable loans, dealers reciprocate by generating more loan applications in the future. However, the risk associated with referred loans also increases, possibly due to perceived leniency by the lender being exploited. Additionally, the authors find that as the relationship between a lender and a dealer extends, the reciprocal effects initially strengthen and then decline, while the direct cost and exploitation effect increase monotonically. These findings provide insights into lenders’ effectiveness in absorbing risks and strategies for managing relationships with dealers.
Keywords: business-to-business, risk absorption, indirect loan markets
JEL Classification: M31
Suggested Citation: Suggested Citation