Specific investment, supplier vulnerability and profit risks

We investigate, theoretically and empirically, the impact of relationship‐specific investment on suppliers’ profitability and profit risks. In addition to the familiar holdup problem, we explore another facet of specific investment that has received little attention in the literature, namely suppliers’ vulnerability to customer risks. In a theoretical model, we demonstrate that the supplier vulnerability problem implies a negative relationship between the degree of specificity and the expected profit of a supplier, and a positive relationship between the degree of specificity and volatility of the supplier's profit. Using panel data on over 5,000 US firms from 1990 to 2010, our empirical analysis shows the prevalence of the supplier vulnerability problem.