Vertical Relationships, Hostages, and Supplier Performance: Evidence from the Japanese Automotive Industry

Drawing on the hostage model of Williamson (1983. "Credible Commitments: Using Hostages to Support Exchange." The American Economic Review 73: 519-540) and recent studies identifying equity affiliation as a robust hostage in the Japanese automotive industry, we examine the relationship between automobile assemblers and their suppliers under different demand conditions. Specifically, we explore the extent to which assemblers buffer their equity-affiliated suppliers from demand fluctuations to a greater extent than is the case for unaffiliated suppliers. Our empirical analysis suggests that assemblers buffered their affiliated suppliers from the effects of a negative demand shock in 1992-95, apparently favoring affiliates over unaffiliated suppliers during this period, as predicted by the hostage model. However, affiliates in our sample also more frequently adjust production to accommodate short-run demand fluctuations faced by the auto assemblers. We discuss how our findings relate to alternative theoretical explanations, such as those featuring differential supplier capabilities, risk aversion, or supply assurance in the face of sticky price adjustments.