Supplier Internal Control Quality and the Duration of Customer-Supplier Relationships

Abstract

Internal controls influence information quality and thus can affect the ability of supply chain partners, who rely on a collaborative system of information sharing, to reliably contract. Using SOX-related internal control assessments as a proxy for internal control quality and U.S. GAAP-mandated major customer disclosures from 2004 to 2012, we find that supplier internal control quality influences the duration of supply chain relationships. Specifically, our evidence demonstrates that: 1) poor internal control quality increases the likelihood that customer-supplier relationships terminate in the following year; 2) timely remediation of control weaknesses by suppliers attenuates the likelihood of termination; and 3) the effect of internal control quality on relationship duration is affected by customer dependency and control weakness severity. Results are robust to propensity score matching techniques and alternative proxies for relationship termination and internal control quality. Overall, our findings are consistent with customers viewing strong supplier controls as an important, albeit overlooked, contracting element that has significant implications for supply chain relationships.