Supplier’s Relationship-Specific Investment and Customer’s Management Forecasts

• In Event: Financial Accounting and Reporting

Abstract

In this paper, I examine the effect of relationship-specific investment made by the supplier on the customer’s decision to issue management forecasts. Relationship-specific investment made by the supplier has a low value outside the relationship. Anticipating the sunk relationship-specific investment gives the customer more ex post bargaining power, the supplier can be reluctant to make relationship-specific investment ex ante, leading to underinvestment in relationship-specific assets by the supplier as well as economic loss for the customer. In order to avoid underinvestment by the supplier, the customer firm can use management forecasts to mitigate the supplier’s concern. I find that the likelihood and frequency of the customer firm to issue management earnings forecasts is positively associated with relationship-specific investment undertaken by its suppliers. Such positive association is less pronounced when supplier have a higher bargaining power. Lastly, I find that the issuance of management forecasts by the customer firm contributes to a longer-term customer-supplier relationship.

Author

• Kai Chen, University of Waterloo