Inventory as a Liquidity Provision Channel

Abstract

We propose the substitution hypothesis of inventory investment that predicts firms use of inventory to provide liquidity for financially constraint suppliers. Using the exhaustive data set of supplier information for Japanese listed firms, we find an increase in inventory financing when a supplier faces a financial constraint that is consistent with the hypothesis. In the empirical analysis, we use several identifications to overcome the endogeneity issue including regression discontinuity design, fixed-effect models, difference-in-differences, instrumental variable approach, and using an earthquake as an exogenous shock. Moreover, we find the relationship is more pronounced when suppliers belong to competitive markets. Lastly, we examine the impact of inventory on a customer’s subsequent financial performance when customers support troubled suppliers. We find no evidence that an increase in inventory to support troubled suppliers has a negative impact on customers’ performance.