Optimal Capital Structure, Relation-Specific Investment, and Supplier Competition

Abstract

This paper studies the relationship between firm leverage and supplier market structure by examining their joint impacts on bargaining and relation-specific investments. We find that firm leverage decreases with the degree of competition among suppliers. Specifically, leverage decreases with the elasticity of substitution between suppliers. Leverage also decreases with the number of suppliers when the elasticity of substitution is high, and increases with the number of suppliers when the elasticity is low. Empirical evidence supports these model predictions. We find that firm leverage is positively related to the number of supplying industries, and negatively related to the average number of suppliers per supplying industry. Moreover, we find that firm leverage is positively related to the degree of input goods heterogeneity.