Buyer-Supplier Relationships and the Stakeholder Theory of Capital Structure

Abstract

Leverage affects a firm's liquidation decision and may therefore affect the value of relation-specific investments made by the firm's stakeholders (Titman, 1984). As a result, firms may want to maintain lower debt ratios if stakeholder relationships are especially important. We compile a database of firms' principal customers (those that account for at least 10% of sales or are otherwise considered important for business) from the Business Information File of Compustat 98 and test the predictions of this theory. We argue that a firm with suppliers that rely heavily on its purchases ("dependent suppliers") is likely to be particularly concerned about the effect its leverage ratio may have on the supplier firms' incentives to make specific investments. Consistent with our expectation, we find that the customers' leverage ratios are lower if their purchases from "dependent suppliers" constitute a higher proportion of their cost of goods sold. Moreover, consistent with Titman (1984) and Titman and Wessels (1988), only the proportion of purchases from suppliers in industries producing durable products (where specific investments are likely to be more important) drives this result. We also examine whether the supplier's leverage ratios are affected by the presence of principal customers. We find evidence of a negative relationship between the supplier's leverage ratio and the proportion of sales to principal customers; however, again, this result only holds for suppliers in industries producing durable products. Additional results suggest that firms producing durable products maintain lower leverage to attenuate potential stakeholder-driven costs associated with the loss of principal customers.

Keywords: Capital Structure, Stakeholder Theory, Principal Customers

JEL Classification: G32, L22