Disruption and Rerouting in Supply Chain Networks

We study systemic risk in a supply chain network where firms are connected through purchase orders. Firms can be hit by cost or demand shocks, possibly leading to defaults. These shocks propagate through the supply chain network via input-output linkages between buyers and suppliers. Firms endogenously take contingency plans to mitigate the impact generated from disruptions. They reroute undelivered orders to alternative buyers and switch excess demand to different suppliers. We show that, as long as firms have large initial equity buffers, network fragility is low if both buyer and supplier diversification is low. We argue that vertical mergers reduce network fragility by decreasing contagion across tiers, while horizontal mergers may lead to a more fragile network if a non-systemically important firm fundamentally defaults