Essays on the flow of distress along the supply chain

This dissertation is composed of three essays which examine the effects of a firm's bankruptcy on its suppliers and customers. Suppliers and customers are considered to be stakeholders of the firm with which they trade and face potential costs if the firm files for Chapter 11. In the first essay, I examine the puzzle that while there is plenty of anecdotal evidence to show that upstream and downstream trading partners face costs when their trading partner is distressed, the existing literature seems to find that contagion effects are relatively small in magnitude. I propose and test a method which potentially reduces noise in the inputs used to determine wealth effects. I show that both suppliers and customers of filing firms experience significantly greater negative wealth effects due to the trading partner's distress than what has been documented in the existing literature. In the second essay, I examine the following question: how do supplier and customer stock price effects vary in the cross section when the trading partner becomes distressed and files for bankruptcy? I find evidence consistent with the hypothesis that the impact of the filing firm's distress on upstream and downstream firms depends on whether the bankrupt firm is economically distressed or financially distressed. The results show that both customers and suppliers of distressed firms face switching costs which vary significantly with the probability of successful reorganization of the filing firm, and these costs are higher when the degree of reliance and product specialization are greater. The third and final essay examines the trade credit policy of suppliers when their trading partner is distressed and files for Chapter 11. Trade credit is an economically important source of short-term funds for firms. I study empirically whether the data demonstrate that suppliers support customers in times of distress by continuing to extend credit or whether distressed customers are denied trade credit by suppliers who want to protect their own cash position. Evidence indicates that suppliers may continue to support their distressed customer by extending short-term credit depending on the probability of reorganization.