Risk Management with Supply Contracts

Purchase obligations are forward contracts with suppliers. This paper is the first to document that these contracts are a risk management tool and have a material impact on corporate hedging activity. Purchase obligations are used more broadly than traded commodity derivatives, even when firms approach financial distress. Firms that expand their risk management options following the introduction of steel futures contracts substitute financial hedging for purchase obligations. Further, firms that experience a negative shock to bank-provided liquidity increase their use of purchase obligations. This paper shows that firms use purchase obligations to manage risk, and that the availability of financial hedging options is an important determinant of hedging through purchase obligations. We gratefully acknowledge financial support from the GARP Risk Management Research Award Program. We would like to thank Söhnke M Bartram, Martijn Cremers, Andrea Gamba, Jose-Miguel Gaspar, Gerald Gay, Jayant Kale, Yelena Larkin, Omesh Kini, Harley (Chip) Ryan, Mark Weinstein, and participants at Florida State University, HEC Paris, Ivey School of Business, Lehigh University, the University of Arizona, University of Florida, the University of Southern California Finance Organization and Markets Conference, UK/UT Jim and Jack Conference, LUBRAFIN, and the EFMA meetings for thoughtful comments. We also thank Di Kang for research assistance.