Supply Chain Network Structure and Firm Returns

The complexity and opacity of the network of interconnections among firms and their supply chains inhibits understanding of the impact of management decisions concerning the boundaries of the firm and the number and intensity of its relationships with suppliers and customers. Using recently available data on the relationships of public US firms, this paper investigates the effects of supply chain connections on firm performance as reflected in stock returns. The paper finds that supply chain structure is closely related to firm returns at two levels, a first-order effect from direct connections and a second-order impact from systemic exposures through the network. For the first order effect, using a cross-sectional data set of the supply chain network and monthly returns, we show that a firm's return can be explained by its concurrent supplier returns, concurrent customer returns, own momentum, and supplier momentum, whereas customer momentum has little impact. A long-short equity strategy based on the supplier momentum yields monthly abnormal returns of 56 basis points. This result implies investors' limited attention to supplier firms relative to customer firms and gradual diffusion of information downstream as opposed to upstream in the supply chain. For the second-order effect, we find a market anomaly by grouping firms according to their centrality in the supply chain. Specifically, manufacturing firms that are more central in the network earn lower returns, while logistics firms that are more central in the network earn higher returns. This result holds for both eigenvector centrality and in-degree centrality (number of suppliers). We argue that centrality and multiplicity of suppliers have different risk implications for firms operating in different industries. More central firms in manufacturing choose their suppliers to operationally hedge shocks transmitted from other firms and earn lower returns due to lower systematic risk. On the contrary, more central firms in logistics are shock aggregators, earning higher returns due to their exposure to greater systematic risk. Our results are robust after controlling for common asset pricing factors