Credit risk and companies' inter-organizational networks: Assessing impact of suppliers and buyers on CDS spreads

Abstract

Companies do not operate in a vacuum. As companies move towards an increasingly specialized production function and their reach is becoming truly global, their aptitude in managing and shaping their inter-organizational network is a determining factor in measuring their health. Current models of company financial health often lack variables explaining the inter-organizational network, and as such, assume that (1) all networks are the same and (2) the performance of partners do not impact companies. This paper aims to be a first step in the direction of removing these assumptions. Specifically, the impact is illustrated by examining the effects of customer and supplier concentrations and partners' credit risk on credit-default swap (CDS) spreads while controlling for credit risk and size. We rely upon supply-chain data from Bloomberg that provides insight into companies' relationships. The empirical results show that a well diversified customer network lowers CDS spread, while having stable partners with low default probabilities increase spreads. The latter result suggests that successful companies do not focus on building a stable eco-system around themselves, but instead focus on their own profit maximization at the cost of the financial health of their suppliers' and customers'. At a more general level, the results indicate the importance of considering the inter-organizational networks, and highlight the value of including network variables in credit risk models.