Apart from the familiar holdup problem, we investigate another implication of specific investment that has not been examined systematically in the literature. That is, the presence of specific investment can make a supplier vulnerable to large negative shocks to its customer’s business. In a theoretical model, we demonstrate that this vulnerability causes the supplier to under-invest. A higher degree of specificity induces the supplier to invest more, and it leads to a lower mean and higher volatility in the supplier’s profit. Using panel data on over 5000 U.S. firms from 1990 to 2010, our empirical analysis shows the prevalence of the supplier vulnerability problem associated with specific investment.

Additional Metadata
Keywords specific investment, holdup problem, supplier vulnerability, profit volatility
JEL Transactional Relationships; Contracts and Reputation; Networks (jel L14), Contracting Out; Joint Ventures; Technology licensing (jel L24), Financing Policy; Capital and Ownership Structure (jel G32)
Publisher Department of Economics
Series Carleton Economic Papers
Citation
Chen, Z, & Wang, X. (2016). Specific Investment and Supplier Vulnerability: Theory and Evidence (No. CEP 16-06). Carleton Economic Papers. Department of Economics.