Managing liquidity along the supply chain: Supplier‐base concentration and corporate cash policy

• Published date: 01 September 2024
• Author: Lulu Di,Wei Jiang,Ju Mao,Yeqin Zeng
• Date: 01 September 2024
• DOI: http://doi.org/10.1111/eufm.12479

DOI: 10.1111/eufm.12479

ORIGINAL ARTICLE

Managing liquidity along the supply chain:

Supplier‐base concentration and corporate

cash policy

Lulu Di

1

|Wei Jiang

2

|Ju Mao

2

|Yeqin Zeng

3

1

Southwestern University of Finance and

Economics, Chengdu, China

2

Renmin University of China, Beijing,

China

3

Durham University, Durham, UK

Correspondence

Wei Jiang and Ju Mao, Renmin

University of China.

Email: jiangwei@rmbs.ruc.edu.cn and

maojumaoju@ruc.edu.cn

Funding information

National Natural Science Foundation of

China, Grant/Award Numbers:

72072071, 72102195, 72172009, 72272009

Abstract

We find that customer firms with more concentrated

supplier bases tend to hold higher levels of cash reserves.

The positive relation between supplier‐base concentra-

tion and cash holdings is more pronounced for firms

with nonstate ownership, higher market competition,

worse inventory efficiency, more relationship‐specific

investment, central positions in the production net-

works, and headquarters located in regions with lower

levels of financial development. Furthermore, we show

that debt issuance enhances firms' cash holdings when

they have concentrated suppliers, and supplier‐base

concentration increases firms' cash spending on R&D

investment. Our study highlights the importance of

supplier structure in shaping corporate cash policy.

KEYWORDS

cash holdings, source of cash, supplier‐base concentration, use

of cash

JEL CLASSIFICATION

G30, G32, L23

Eur Financ Manag. 2024;30:2376–2421.wileyonlinelibrary.com/journal/eufm2376

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© 2024 John Wiley & Sons Ltd.

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We appreciate the comments on an earlier version of this paper from the journal editor, an anonymous referee, Yin

Chao, Michael Guo, Guanming He, Guanmin Liao, Yukun Shi, Emma Sun, Yutao Wang, Junhong Yang, and Ran

Zhang. We also appreciate insights from seminar participants at Renmin University of China and Durham University

Business School. Lulu Di acknowledges the financial supports from the National Natural Science Foundation of China

(Grant No. 72102195). Wei Jiang acknowledges the financial supports from the National Natural Science Foundation of

China (Grant No. 72072071). Ju Mao acknowledges the financial supports from the National Natural Science

Foundation of China (Grant Nos. 72172009, 72272009).

1|INTRODUCTION

Managing liquidity to finance valuable projects is a critical challenge in financial management.

While cash reserves are the most common means by which firms ensure liquidity,

1

liquidity

management becomes increasingly challenging in light of rising uncertainty. Since the 1990s,

many firms have changed their traditional practice of purchasing from numerous suppliers and

have turned to relying on a small set of major suppliers (Bensaou, 1999; Choi & Krause, 2006;

Kim & Henderson, 2015; McMillan, 1990). With the increased prevalence of concentrated

supplier bases, McKinsey & Company (2010) and PwC (2013) report that how to manage and

mitigate supply chain uncertainty is one of the top trends that corporate managers foresee.

However, despite the importance of supplier‐base concentration, there has been limited

research on the relation between supply chain uncertainty and corporate cash policy due to the

data availability of firms' supplier information.

2

Utilizing unique data on supplier information

in the Chinese market, we aim to fill this gap in the literature by examining how supplier‐base

concentration affects customer firms' liquidity management, specifically their cash holdings.

There are two conflicting views on the relation between supplier‐base concentration and

customer firms' cash holdings. On the one hand, customer firms tend to hold more cash when

their supplier base is more concentrated. First, supplier‐base concentration can enhance major

suppliers' bargaining power, allowing them to charge higher prices and obtain more favorable

trade terms (e.g., Buffa, 1984; Porter, 1974,1985). As a result, customer firms' cash flow

uncertainty will increase, leading them to maintain more cash reserves. Second, customer firms

are exposed to higher operational risk when their supplier structure is more concentrated, as

suppliers with stronger bargaining power may deliver goods or services with lower quality or

not deliver them on time (e.g., Porter, 1974,1985). This reduces customer firms' inventory

efficiency and may lead them to hold more cash to mitigate operational risk. Last, increased

supplier‐base concentration can amplify customer firms' supply chain disruption risk, such as

natural disasters, employee strikes, major machine breakdowns, the COVID‐19 pandemic, and

geopolitical conflicts (Elmaghraby, 2000; Treleven & Bergman Schweikhart, 1988; Yang

et al., 2012). The adverse effects of such disruptions are exacerbated as supplier‐base

concentration increases (Bode & Wagner, 2015; Choi & Krause, 2006). In light of the increased

risk of supply chain disruption, customer firms may have a strong incentive to hold more cash

reserves.

On the other hand, a more concentrated supplier base can facilitate cooperative

relationships between customer firms and their suppliers through cost savings due to

economies of scale and a reduction of administrative and transaction costs (e.g., Bensaou, 1999;

Burke et al., 2007; Kumar, 1996; Treleven & Bergman Schweikhart, 1988), which can result in a

reduction in cash holdings. First, under a cooperative relationship, higher supplier‐base

concentration can encourage suppliers to gain a better understanding of their customer firm's

unique technologies and products, enabling them to provide higher quality goods and services

at a fair price (Dyer & Singh, 1998; Moeen et al., 2013). Second, when customer firms establish

a cooperative relationship with suppliers, they can better communicate with them and gain

1

Meltzer (1963), Miller and Orr (1966), and Baumol (1952) provide earlier literature that focuses on the transaction

motivation to hold cash and find that firms tend to hold cash when they face high liquidity risks, because debt capacity

cannot provide the same degree of downside protection as cash holdings.

2

Itzkowitz (2013) is one of the few to focus on the relation between customer‐base concentration and corporate cash

holdings.

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information about potential future disruption risks. This can help them make contingency

plans to reduce the negative impacts of supply chain disruption risk and, therefore, reduce their

cash holdings. Despite these two opposite views, whether supplier‐base concentration leads to

an increase or decrease in customer firms' cash holdings remains an open empirical question.

To examine the effect of supplier‐base concentration on the cash holdings of customer

firms, we conduct our study using a comprehensive sample of publicly listed firms in China.

China's unique regulatory and market environment provides an ideal setting to gather

empirical evidence for our research question. Since 2007, the China Securities Regulatory

Commission (hereafter “CSRC”) has required all listed firms to disclose the combined

procurement from their top five suppliers as a proportion of their total annual procurement. In

contrast, it is difficult to examine the impact of supplier‐base concentration in the United States

(Patatoukas, 2012),

3

because listed firms in the United States are generally not required to

disclose their supplier information. To test our predictions, we hand‐collect data on the top five

suppliers' information disclosed in Chinese listed firms' annual reports.

Our study provides strong evidence that customer firms tend to hold more cash reserves

when their top five suppliers account for a larger percentage of their total procurement. Our

finding is robust to an alternative measure of supplier‐base concentration based on the

Herfindahl–Hirschman index, as well as alternative measures of cash holdings. To establish

causality, we conduct several identification tests, including two‐stage least squares (2SLS)

regressions with one instrumental variable, matching methods utilizing propensity scores and

entropy balancing, and a change model specification. Our results remain consistent in these

identification tests, providing strong support for a causal link between supplier‐base

concentration and corporate cash holdings.

We next analyze whether the positive relation between supplier‐base concentration and

corporate cash holdings exhibits any cross‐sectional variations. First, we find that the effect of

supplier‐base concentration on cash holdings is stronger for nonstate‐owned enterprises (non‐

SOEs). SOEs, given their special status in China, enjoy several competitive advantages over

non‐SOEs, such as access to scarce resources, operating with a soft budget constraint, and

wielding greater bargaining power. Consequently, non‐SOEs with concentrated suppliers tend

to have a stronger incentive to maintain higher cash reserves. Second, we find that the positive

relation is stronger for firms with weaker market positions. Supplier‐base concentration can

weaken customer firms' bargaining power, leading to an increase in future cash flow

uncertainty. Therefore, firms with weaker market positions have a stronger motivation to hold

cash to mitigate such risks. Third, we observe that the positive relation is more pronounced for

firms with worse inventory efficiency, supporting the view that supplier‐base concentration

increases operational risk. Fourth, we show that the positive relation is more prominent for

firms with more relation‐specific investment. A more concentrated supplier base can increase

supply chain disruption risks, and more relation‐specific investment can intensify these risks.

Hence, customer firms with more relation‐specific investment tend to hold more cash as a

precautionary measure. Fifth, we find that the positive relation is stronger for firms operating

in an industry that is more central to the inter‐sectoral production network of the Chinese

economy, suggesting that when central firms' supplier structure is less diversified, they need to

3

Patatoukas (2012) emphasizes the need for research on how supplier‐base concentration impacts customer firms. This

research can provide valuable insights into the ongoing debate about the advantages and disadvantages of broadening a

firm's supplier base.

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