Discussion Paper

Counterparty Risk in Material Supply Contracts

Abstract: Forming long-term partnerships with customers and suppliers often creates a competitive advantage for firms because it permits resource sharing, eases financial constraints, and encourages investment in relationship-specific capital. While these relationships can be beneficial, they also increase firms? exposure to their counterparties? risk. In a recent Staff Report, Anna Costello of MIT and I study two important and unanswered questions about supply relationships. First, what specific characteristics of the trade relationship make a firm more vulnerable to adverse spillovers from their supply chain partners? Second, if managers understand these vulnerabilities, can they design contracts or diversify their partners in order to mitigate exposures to negative events along their supply chain?

Keywords: counterparty risk premia; Supply contracts; financial covenants;

JEL Classification: G1;

Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Liberty Street Economics

Publication Date: 2015-02-09

Number: 20150209