The Effect of CEO’s Risk-Taking Incentives on Relationship-Specific Investments by Customers and Suppliers

Abstract

A firm’s customers and suppliers make relationship-specific investments (RSI) whose value reduces if the firm undertakes risky investments. We hypothesize that the risk-taking incentives in the firm CEO’s compensation will lower the RSI by firms up and down in the vertical channel. We provide significant evidence that customer/supplier RSI declines with the risk-taking incentives of the firm’s CEO. Moreover, we find that RSI is more sensitive to the CEO’s risk-taking incentives when they are more likely to increase the firm’s cash flow volatility. Our findings are robust to correcting for endogeneity and several measures for RSI and risk taking.