Supply chain hedging and the cost of debt

Abstract

This paper investigates the relation between the use of purchase obligations (POs) and the cost of debt. I hypothesize POs are hedging tools for risk management, mitigating firms’ downside risk by providing price protection and leading to a lower cost of debt. To test this hypothesis, hand-collected data from 10-K reports is used to identify the total amount of POs committed to suppliers. The demonstrate that firms with more POs are associated with a lower cost of debt, and this relation is more pronounced for firms with closer relationships with their suppliers, better information intermediation and smaller market share compared with industry peers. Further, tests using the initiations and suspensions of supply chain hedging as shocks and instrumental variable analyses are conducted to ensure that the findings are robust and account for endogeneity. Additionally, I find that higher PO usage is associated with higher cost stickiness and input price protection. Further analyses show that the price protection channel dominates the cost stickiness channel and resulting in a lower cost of debt. Overall, this paper suggests that the usage of purchase obligations as risk management tools significantly reduces the cost of debt.