Risk Management with Supply Contracts

Abstract

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 frictionssuch as bargaining power and settlement riskas well as potential holdup 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.

Different ways of managing risk as reported in 10‐Ks: A supervised learning approach

“…Panel C uses of a list of 42 six-digit North American Industry Classification System (NAICS) industries with traded futures from Almeida et al (2017), Appendix B). As expected, when using our text-based measure, we observe a marked difference between the share of derivative sentences among firms in industries with traded futures and those without, and the average share is about five times higher in the former group.…”

“…In Panel B Single industry in CS is one when only one four-digit SIC industry is reported in COMPUSTAT segments, Multi-industry in CS if more than one four-digit SIC reported. In Panel C No futures versus Futures indicates whether there exist traded futures for the six-digit NAICS industry as detailed inAlmeida et al (2017),…”

“…The literature is especially rich when it comes to precautionary cash holding(Almeida et al, 2014;Bates et al, 2009) and financial hedging(Bodnar et al, 1998;Geczy et al, 1997).2 There is also a set of theoretical articles that examines interactions: see, for example,Chod et al (2010) orBolton et al (2011). An important takeaway from the theoretical literature is that the value of one form of risk management potentially depends on the use of other forms of risk management.3Hankins (2011) shows how increased operational hedging as a result of mergers implied less financial hedging in a sample of bank holding companies Almeida et al (2017). show that purchase obligations, a form of supplier contracts, serve as a substitute for derivatives Hoberg and Moon (2017).…”

Inventory, fixed capital, and the cross-section of corporate investment

“…Although the development of my argument, for ease of exposition, abstracts from …nancing frictions, I do allow for the possibility that productivity news and the fund availability are likely correlated with each other and both can encourage …rms'investment (Poterba, 1988;Erickson and Whited, 2000;Alti, 2003). 4 Even if the signal that motivates a …rm's investment is about …nancial slack, rather than productivity, my main prediction continues to hold, because the manager of the …rm must decide on which type of factor investment to allocate more resources to, and, in doing so, the …rm's adjustment costs and the factor substitutability are arguably the key real-side constraints to consider in her decision.…”

“…4 Marginal Q is not readily available, because the partial derivative of V with respect to K is di¢ cult to evaluate due to non-linearities and interdependence of K and N in the value function V.…”