Effects of customer horizontal merger on supplier capital structure decisions

• Published date: 01 December 2021
• Author: Mauro Oliveira,Palani‐Rajan Kadapakkam
• Date: 01 December 2021
• DOI: http://doi.org/10.1111/irfi.12337

ORIGINAL ARTICLE

Effects of customer horizontal merger on supplier

capital structure decisions

Mauro Oliveira

1

| Palani-Rajan Kadapakkam

2

1

School of Business, Trinity University, San

Antonio, Texas

2

College of Business, The University of Texas

at San Antonio, San Antonio, Texas

Correspondence

Mauro Oliveira, School of Business, Trinity

University, One Trinity Place, San Antonio, TX

78212.

Email: moliveir@trinity.edu

Abstract

We study the impact of a significant customer's merger on

the capital structure of suppliers using a sample of

U.S. firms that merged with rivals in the same industry. The

bargaining power theory of capital structure predicts that

suppliers will increase debt to decrease the surplus available

for negotiation when facing customers that gain buying

power by increasing their size through mergers. We find

that suppliers increase their financial leverage after the

effective date of their customer's merger. This increase is

economically significant, permanent, and unrelated to sup-

plier merger activity. We also find that greater concentra-

tion in the supplier's industry and higher supplier market

power are associated with lower increases in supplier's

leverage. Overall, the empirical evidence is consistent with

suppliers increasing their financial leverage to fortify their

bargaining power.

KEYWORDS

buyer power, capital structure, mergers, supply chain, takeovers

JEL CLASSIFICATION

G32; G34

1|INTRODUCTION

Increasing consolidation has been an important feature of the U.S. corporate sector over the last two decades. Con-

solidation can boost the bargaining power of a large customer vis-à-vis its supplier. A recent article in The Economist

cites the increased pricing power arising from consolidation as an important source of the high profits generated by

Received: 22 November 2019 Revised: 1 November 2020 Accepted: 15 November 2020

DOI: 10.1111/irfi.12337

© 2020 International Review of Finance Ltd. 2020

1464 International Review of Finance. 2021;21:1464–1491.wileyonlinelibrary.com/journal/irfi

U.S. firms.

1

An imbalance in bargaining power between a large customer and its supplier has the potential to foster

abusive buying practices such as insistence on extra discounts. When a firm becomes larger through a merger or an

acquisition, it may pursue a renegotiation of the formal and informal agreements previously established with its sup-

pliers, and it may even consolidate its purchases among fewer suppliers.

Investigating the impact of horizontal mergers in the supply chain, Fee and Thomas (2004) conclude that they

have only temporary effects on the operating performance of the merging firms and their suppliers. They conjecture

that suppliers take actions to restore their bargaining power and cite mergers as an example.

2

Bhattacharyya and

Nain (2011) provide supporting evidence for this conjecture by investigating the effects of customers' horizontal

mergers on supplier industries. They find that merger activity in supplier industries in a given year is positively related

to consolidation activity in customer industries in the previous 4 years. However, they do not investigate strategic

actions at the firm level. In this paper, we investigate an additional mechanism that suppliers have to counter the

increase in customer's bargaining power that customers obtain through horizontal mergers.

3

Specifically, we find evi-

dence that suppliers change their capital structure strategically by increasing leverage, in response to horizontal

mergers undertaken by their customers. Thus, our investigation also extends the literature that highlights the impor-

tance of the supplier-customer relationship in determining the capital structure of the supplier.

Pioneering literature examines three major motives for horizontal mergers: productive efficiency, monopolistic

collusion, and monopsonistic collusion (buying power).

4

Under the productive efficiency theory, merging customers

improve their efficiency in operating, marketing, or distribution activities, excluding purchasing. The resulting effect

for suppliers can be negative, positive, or neutral. For instance, merging firms may decrease their marginal costs,

which may result in lower prices and higher output levels. In this case, there is a higher demand for suppliers' inputs,

and there may be a need to finance increases in production capacity.

5

In a monopolistic collusion, industry competitors coordinate to reduce output and boost their output prices; con-

solidation in the industry can facilitate enhanced collusion. In this case, suppliers are either unaffected or have lower

demand for their output. Under monopsonistic collusion, horizontal mergers facilitate the ability of competitors to

coordinate lower input prices, increasing their buying power vis-à-vis their suppliers. The direct consequence for

suppliers is lower prices and revenues, and they may undertake strategic actions in response to customers' horizontal

mergers, as noted by Fee and Thomas (2004).

From the strategic capital structure perspective, Bronars and Deere (1991) propose that when firms negotiate

with a counterparty that has greater bargaining power, they may increase debt to decrease the amount of surplus

subject to negotiation between the two parties. The bargaining power theory of capital structure is supported by evi-

dence that firms increase their debt levels when they need to negotiate with strong nonfinancial stakeholders such

as unions (Matsa (2010) and Agrawal and Matsa (2013)). The consideration of supplier bargaining power is especially

relevant in the event of a customer's horizontal merger, since customers that are more concentrated may press their

suppliers to provide better trade terms, such as extra discounts, increased trade credit, and return of unsold goods.

The customer's insistence may be heightened if the supplier is perceived as having financial slack.

We hypothesize that a supplier increases its financial leverage in response to a customer's horizontal merger,

since the merger increases the bargaining power of the customer vis-à-vis its supplier. To test this hypothesis, we

examine the capital structure of retained and terminated suppliers before and after the customer's horizontal merger.

Terminated suppliers are those listed as suppliers before the merger but not after, while retained suppliers are listed

as suppliers both before and after the merger. If leverage changes for suppliers are driven by bargaining power or

productive efficiency considerations, we expect to observe changes only for retained suppliers but not for termi-

nated suppliers.

We use the SDC Platinum database to identify horizontal mergers between the years of 1980 and 2013 and the

Compustat Customer Segment database to identify suppliers. We document evidence that retained suppliers

increase their financial leverage after their customer's horizontal merger, but that terminated suppliers do not. In

addition, greater concentration in the supplier's industry and greater supplier market power are associated with

lower increases in financial leverage. Further, a big increase in customer bargaining power or a big decrease in

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