Why Do Firms in Customer-Supplier Relationships Hold More Cash?

A firm is in customer-supplier relationships when its business depends on a small number of major customers/ suppliers. In this paper, we provide evidence that relationship-specific investments undertaken by firms in customer-supplier relationships are associated with high cash holdings in these firms. The evidence is consistent with the prediction of Titman's stakeholder theory that a firm relying on relationship-specific investments maintains a high cash reserve as a cushion to sustain its relationship-specific investments when negative shocks occur. Our findings suggest that relationship-specific investments are important determinants of the precautionary motive to hold cash.