The Effect of Social Connections on Capital Structure in Supplier-Customer Relationships

Suppliers socially connected to major customers with relation-specific investments have higher leverage ratios compared to unconnected suppliers. The presence of connections partially reduces supplier underleverage observed in supplier-customer relationships with relation-specific investments. Consistent with the role of connections in bonding trading parties’ commitment, connections to major customers help to increase customer purchases, and supplier leverage increases are primarily observed in firms with high intensity of customer purchases. Consistent with the role of connections in mitigating information asymmetry, connected suppliers choose higher leverage primarily when information asymmetry is high. Overall, connections help strengthening implicit contracts through establishing trust between trading parties