Financial Shocks in Production Chains
Interlocking balance sheets through accounts receivable and accounts payable provides incentives necessary to sustain long production chains. We construct a model of incentives in production chains which has the implication that upstream firms in the chain have higher accounts receivable. Further, the working capital of upstream firms are relatively more sensitive to the availability of credit. Using a large firm-level dataset for 15 European OECD countries and the United States, 2000-2009, combined with sector-level measures of relative position in production chains (“upstreamness”), we find strong empirical support for the model. Lack of credit matters for amplifying recessions in economies with long production chains.