Capital Structure Along the Supply Chain: How Does Customer Leverage Affect Supplier Leverage Decisions?

The bargaining theory of capital structure implies that when firms raise their leverage, their suppliers will raise their own leverage in response, so as to maintain strength in negotiations with important customers. In contrast, the theory of firm-specific investments implies that when a customer raises its leverage, a firm will respond by lowering its own leverage to minimize the risk of bankruptcy. We test these theories by examining the relationship between the leverage decisions of suppliers and customers. We find that a firm’s leverage is positively associated with its customer’s leverage. Moreover, consistent with the bargaining theory, we find that the positive leverage relationship is stronger if the customer has a higher ex-ante bargaining power. We also find some support for the relation-specific investment theory of capital structure in that the positive leverage relationship is weaker if the supplier–customer relationship requires more relation-specific investments.