By Pan Jingyi, Principal Writer, China Business Knowledge @ CUHK

The ongoing trade disputes between China and the US since 2018 have triggered global supply chain disruptions. In response to the decoupling trend between the world’s two largest economies, many American companies are diverting their supply chains to alternative countries to reduce their reliance on China. Before the trade disputes, China saw its share of US imports peaked at 21.6 per cent in 2017.

This percentage dropped to 13.9 per cent in 2023, the lowest level in two decades. In contrast, over the same period, the US saw significant increases in import shares from third-party countries, such as Vietnam and Mexico.

Global supply chains face growing complexities as companies reassess their strategies in light of the US-China trade war. Businesses grapple with balancing efficiency and risk mitigation while identifying reliable and flexible supplier networks. The global supply chain realignment trend reflects shifting trade flows and evolving competitive dynamics among nations.

“Our findings suggest that suppliers in Vietnam and Mexico cannot fully substitute China in an end-to-end capacity and continue to rely on Chinese inputs, resulting in the maintenance of indirect connections between the US and China.”

Professor Wu Jing

The rapid shifts in the global supply chain have raised questions about whether third-party countries possess the same end-to-end supply chain capabilities as China, or if they are merely replacing China in certain segments of the supply chain while still depending on Chinese inputs. These questions open up the possibility that, despite efforts to reduce its supply chain reliance, Uncle Sam is still closely connected to China through third-party countries.

“We find that US importers’ indirect exposure to China through Vietnam increases by approximately 21 per cent, while through Mexico by about 5.5 per cent following the commencement of the trade war,” says Wu Jing, Associate Professor in the Department of Decisions, Operations and Technology at the Chinese University of Hong Kong (CUHK) Business School.

“These results suggest that rather than being replacements for Chinese suppliers with equivalent end-to-end supply chain capabilities, US suppliers in Vietnam and Mexico may instead be intermediaries who retain a strong reliance on Chinese inputs.”

Along with Vernon Hsu, Choh-Ming Li Professor of Operations Management at the same department and his PhD student Peng Boya, Professor Wu investigated the dynamics of indirect supply chain connections in response to the US-China trade war in a recent research titled The paradox of de-risking: Global supply chain rerouting in response to the US-China trade war.

The increased indirect exposure to China

Researchers observed that suppliers for US companies still rely on inputs from China, illustrating the impact of the US-China trade war on indirect supply chain dependencies. “Despite the apparent trade diversion, China’s well-established supply chains continue to exert a significant influence on US global supply chains, even in the presence of trade barriers,” says Professor Wu.

To get to this conclusion, the team developed a novel measure to assess the indirect exposure to China for American importers. This measure considers two key components: the share of US imports from Vietnam and Mexico, and Vietnam and Mexico’s dependence on inputs from China. Although American companies can import from other markets to replace China, both Vietnam and Mexico have emerged as primary beneficiaries of the recent global supply chain reallocation trends, with strategic locations of sharing borders with the conflicting parties.

The researchers examined publicly listed manufacturing firms in the US that engaged in imports from China between 2013 and 2017 before the trade war,  and also from either Vietnam between 2018 and 2022, or Mexico between 2016 and 2022. They collected the transaction-level global shipping data from Panjiva, as well as firms’ financial statements and broader economic indicators from Compustat and Orbis.

The results showed that US imports from Vietnam and Mexico and both countries’ imports from China increased following the trade war. Specifically, there has been a substantial increase in the imports of inputs from China among Vietnamese suppliers, surpassing the rise in US imports from Vietnam. However, the increase in the US imports from Mexican suppliers slightly exceeds the increase in Mexican imports from China.

Vietnam: A bridge to downstream goods

Both Vietnam and Mexico stand as viable alternatives for US companies seeking new suppliers, but what sets these two nations apart? Delving deeper into this question, Professor Wu and his team thoroughly analysed the channels influencing product rerouting through either Vietnam or Mexico.

Their investigation unveiled the crucial roles of geography and product characteristics in shaping supply chains. Product characteristics refer to whether products are upstream or downstream and the degree of China’s comparative advantage in their production. Upstream products are raw materials, components, and intermediate goods used in early supply chain stages to create downstream products or finished goods ready for sale.

The results indicated that more downstream goods and products for which China has a greater comparative advantage experience a more significant increase in indirect exposure via Vietnam, particularly in the textile, footwear, and electrical industries.

“China leverages Vietnam as a bridge to continue exporting products that are more downstream—products that typically involve more labour-intensive final assembly and for which it retains a significant comparative advantage,” Professor Wu says. “Vietnam’s proximity to China and comparable cost-effective production capabilities facilitate its smooth integration into Chinese supply chains.”

For instance, the researchers found that Nike witnessed a 153 per cent increase in indirect exposure to China through Vietnam for textile and footwear products after the trade war, but the company seldom imports from Mexico.

Mexico’s advantage in upstream products

Upstream products, particularly in the chemicals, plastics or rubbers, metals, and machinery industries, showed a notable increase in indirect exposure through Mexico. “These upstream products are typically imported into the US to be further integrated into products that are higher-value-added, which require greater supply chain responsiveness for which Mexico’s close proximity to the US is a major advantage,” Professor Wu explains.

Professor Wu further notes that their empirical evidence supports the strategies adopted by American firms in response to the trade disputes.

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For example, 3M saw a 20 per cent increase in indirect exposure through Mexico for chemicals, plastics and rubber products and a 47 per cent increase for machinery products. Power management company Eaton’s indirect exposure via Mexico increased by 123 per cent for chemicals, plastics and rubber products, and by 94 per cent for metals products. Both companies have limited interaction with Vietnam.

Reviewing reliance beyond primary suppliers

The study underscores the necessity for reassessing global supply chain risks and dependencies. “It is important to consider sub-tier supply network structures in managing supply chain risks,” says Professor Wu. To fortify supply chains, he recommends that companies review dependencies beyond primary suppliers and proactively assess their supply network’s exposure to key markets.

Moreover, while the US-China trade war has posed challenges for Chinese firms, the researchers note that companies can still capitalise on the third-party countries’ markets as China’s role in the global supply chain remains difficult to fully replace. “Our findings suggest that suppliers in Vietnam and Mexico cannot fully substitute China in an end-to-end capacity and continue to rely on Chinese inputs, resulting in the maintenance of indirect connections between the US and China,” Professor Wu concludes.

The post Supply chains find new routes amid trade war first appeared on China Business Knowledge.

By Putro Harnowo, Senior Content Manager, China Business Knowledge @ CUHK

The world has become so connected that cross-border collaboration is essential in today’s businesses. Take a look at the global chip shortage in the past few years, which has proven how the global value chain has become a dominant feature of the economy. This crisis highlights the need for multinational companies to enhance collaboration with original equipment manufacturers (OEMs) to secure their value chains.

Such a relationship is particularly prevalent in large-scale projects involving massive quantities of specific parts or goods. Using parts made by OEMs has been a traditional practice among world-leading carmakers. Nowadays, notable chipmakers such as Foxconn, TSMC, and Huawei are recognised for producing parts for smartphones and computers.

Although OEMs play a huge role in modern industries, only a few can stand out and successfully upgrade themselves. As international trade becomes more competitive, major brands or the lead firms strategically strive to maintain their dominance. The relationships often become imbalanced as OEMs find themselves vulnerable due to their reliance on their lead firms.

“Lead firms possess robust global coordination resources that can support OEMs with sales channels and financial resources,” says Ma Xufei, Professor at the Department of Management of The Chinese University of Hong Kong (CUHK) Business School.

“Lead firms prioritise cost competitiveness and assembly efficiency in selecting OEMs, thereby enabling the OEM to curtail investment in technological innovation to manage the cost structure and mitigate its potential threat to sustain cooperation.”

Shedding light on this disparity, Professor Ma, along with Deng Ziliang of the Renmin University of China and Zhu Ziyan of Sun Yat-sen University, explored the relationship between the two parties and found the root cause: the dependence on the lead firms weakens OEMs’ technological upgrading.

“The asymmetric ownership of technological and branding assets is the fundamental cause of lead firm and OEM power imbalance,” says Professor Ma. “To break the dependence on lead firms, OEMs can strengthen their bargaining leverage by enhancing their innovation capacities, finding alternative partners, cooperating with other OEMs to share resources and knowledge, and securing governmental support and protection to achieve more sustainable growth in the global value chain.”

How to rise above dependencies

In a study titled Transactional dependence and technological upgrading in global value chains, Professor Ma and the team collected data on a large longitudinal sample of Chinese OEMs from 2007 to 2014 from various government agencies in China, including the General Administration of Customs, the National Bureau of Statistics, and the Ministry of Science and Technology.

The researchers excluded foreign-invested and state-owned OEMs to ensure that firms in the sample were not manufacturing subsidiaries of multinationals and to rule out government interventions. The final data contains disaggregated information from 968 OEMs, including their research and development along with patent applications.

The analyses showed that the ability of OEMs to perform technological upgrading is reduced when they rely heavily on original equipment manufacturing for revenue. As a result, attempting to reduce this reliance and rebalance the power dynamics with lead firms may not be a practical option. This finding is consistent with power-dependence theory, which suggests that firms with less bargaining power are less likely to invest in innovation and upgrading.

“Without technical resources, OEMs find it difficult to find new partners, and are restricted to constantly relying on lead firms, ultimately forming a vicious cycle,” Professor Ma adds.

“Lead firms prioritise cost competitiveness and assembly efficiency in selecting OEMs, thereby enabling the OEM to curtail investment in technological innovation to manage the cost structure and mitigate its potential threat to sustain cooperation.”

Professor Ma Xufei

The researchers also found that several technology-related strategies can moderate this dependence. Specifically, OEMs that possess advanced technological capabilities, collaborate in technology-intensive industries, or operate in regions with robust intellectual property protection are more likely to engage in technological upgrading activities, even when they are highly dependent on lead firms.

“Possessing an abundance of technical resources can help OEMs be more flexible and autonomous in technological upgrades and reduce their reliance on lead firms,” says Professor Ma. “OEMs can also choose to collaborate in technology-intensive industries, so the lead firms would tend to be more active in cultivating and improving the technical capacity of OEMs. This can be achieved by redesigning management systems, improving plant layout, and training employees.”

The impact of transactional dependence was found to be stronger for OEMs that are located in places with weaker institutional environments. This suggests that institutional factors, such as the quality of governance and the strength of intellectual property protection, can play an important role in shaping the relationship between power-asymmetric transactional dependence and technological upgrading.

“OEMs can choose to upgrade their technology in regions with strong intellectual property protection,” he adds. “A stronger protection of intellectual property will reduce the risk of technology infringement, making OEMs’ local research and development activities more legitimate and without arousing suspicion and motivation for retaliation from leading companies. In this way, OEMs can upgrade technology more securely.”

Levelling the playing field

Given the varying degrees of power inequality between OEMs and lead firms, Professor Ma further explains five different types of governance in the global value chain. Market governance is a purely transaction-based relationship, and producers can make products with minimal input from buyers. At the other end of the spectrum, hierarchy governance is an equity-based relationship, where lead firms develop and manufacture products in-house. Modular, relational, and captive governance are mixed governance between both mentioned above, where OEMs lack technical capabilities and focus solely on ensuring cost-effectiveness.

“Different types of global value chain governance have different impacts on the relationship, where power imbalance is the core difference,” he says.

Most OEMs employ a combination of multiple governances in dynamic settings, migrating from one type to another. OEMs’ technological upgrading can be seen as an “avoidance” strategy to reduce their dependence on lead firms and alleviate power imbalances. Therefore, the ideal global value chain governance may depend on the specific context, as well as the power dynamics and technological capabilities of the firms involved.

“In the era of de-globalisation and post-pandemic, the global value chains must be restructured,” says Professor Ma. “Contract instability drives the lead firms to switch to new partners while putting enormous pressure on OEMs to maintain cost advantages.”

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Moreover, policymakers can play a role in promoting more balanced power relations by implementing policies that support the development of local technological capabilities and encourage collaboration between firms.

Although the study’s sample was mainly concentrated on OEMs in China’s electronic industry, Professor Ma is confident that the findings can be extrapolated to other industries and places. “Asymmetric dependencies and power relationships in global value chain exist across numerous industries,” he says. “Whether in manufacturing, services or digital platforms, suppliers often rely on lead firms for assembly, processing or other services.”

Therefore, it is reasonable to say that suppliers in industries that have a similar power imbalance and dependence relationship with lead firms may also face similar issues. However, Professor Ma notes that industry-specific factors and contexts need to be taken into account when applying the findings. Variances exist among diverse industries, and these differences may influence the outcomes.

“Further research can delve into the power relationships in other industries and consider industry-specific technical conditions and market environments,” he adds. “Moreover, the issue will be more pertinent in developing countries and emerging economies.”

The post Can component manufacturers outgrow themselves? first appeared on China Business Knowledge.

By Jaymee Ng, Principal Writer, China Business Knowledge@CUHK

The days of running businesses solely for profit are long gone. Businesses, large or small, must make considerable efforts to be socially responsible and eco-friendly. A past survey shows that 91 percent of global consumers expect businesses to address social and environmental issues, and 90 percent of them would boycott a company if it were engaged in irresponsible business practices. In other words, corporate social responsibility (CSR) is not only a buzzword, but vital for businesses to be successful nowadays. However, it is not always easy to tell whether a company is really doing good or just faking it, and as a recent research study looks at depth, some firms would voluntarily publish their supply chain relationships with “green” suppliers to to present a CSR image that fails to represent the whole truth.

Titled Corporate Social Responsibility in Supply Chain: Green or Greenwashing?, this research study is the first to examine greenwashing behaviour of firms by looking at the voluntary disclosure of their suppliers. It was co-conducted by Wu Jing, Assistant Professor in the Department of Decision Sciences and Managerial Economics at The Chinese University of Hong Kong (CUHK) Business School, Shi Yilin, an incoming PhD student at the CUHK Business School, and Prof. Zhang Yu at Peking University. The researchers found greenwashing to be common in the more than 40 countries who are the world’s major economies. The team looked at around 7,600 public manufacturing firms globally and observed over 12,000 unique firm-supplier-year relationships from 2003 to 2017.

“It is just not enough for firms to show the ‘green’ image of themselves to the world to demonstrate their efforts in CSR. Our results show that firms now selectively reveal their ‘green’ suppliers to win customer trust,” Prof. Wu says.

“If the ‘bright’ side to CSR is a world where firms are seeking to lower their carbon footprint, then what our study shows is the ‘dark’ side and how smaller and weaker firms are using it to greenwash their public image.”

Prof. Wu Jing

To gauge greenwashing behaviour, the researchers first calculated a score for each of the companies in the sample based on their environmental performance. They found consistent evidence that a suppliers’ environment score is positively related to how likely their partner firm would disclose its supply chain relationship. Specifically, a one-standard-deviation increase in a supplier’s environment score would lead to a 4.2 percent higher chance of being disclosed by their customer firm. In addition, firms tend to not reveal their less eco-friendly suppliers.

To rule out the alternative explanation that firms may have chosen to disclose their relationship with a certain set of suppliers based on other favourable characteristics and that these suppliers also happen to possess strong CSR credentials, the researchers tested if firms displayed greenwashing behaviour more when their local weather was abnormally hotter, an indicator of global warming.

“For example, people google more about global warming in extremely hot days and even retail investors would sell stocks of firms that produce more carbon emissions and buy stocks of more eco-friendly firms,” Prof. Wu explains. “The same goes for our study. We think that if firms greenwash because they are concerned about their CSR image, then such behaviour would be more prominent in extreme weather conditions.”

Just as theorised, Prof. Wu and his co-authors found that firms are significantly more likely to fake good CSR image by greenwashing in extremely hot weather. “We also find that when other environmental concerns trigger people’s attention to climate warming, such as wildfire outbreaks, local firms are also more likely to greenwash their images,” Prof. Wu adds.

Who Does Greenwashing?

In terms of firm size and market share, the study found that small firms and those with less market share and usually lower CSR scores are more likely to greenwash in presenting a good CSR image. This is because unlike large firms, small firms may not have the resources to invest in substantial CSR efforts and they may need to leverage the power of their supplier’s images. For firms facing intensive competition, faking a green image without making real CSR efforts can be a convenient strategy. When small firms are under competitive pressure, a good CSR image may help them to stand out from their rivals.

Firms that are more concerned about their public image and reputation are also more likely to conduct greenwashing. In particular, firms that spend significantly more on advertising are found to be more aggressive in supply chain greenwashing, as the strategic disclosure of their “green” suppliers would help build a better CSR image.

The researchers also found that more profit-hungry firms are likely to engage in supply chain greenwashing. According to the study, firms seeking to chase a higher return on assets (ROA) tend to hide their “brown” or less environmentally-friendly suppliers to avoid being punished for having a low CSR affiliation. The same is true for firms that are owned more by institutional investors. A firm with a good CSR image is a profitable asset in investors’ portfolios, and therefore firms might want to maintain a positive image for institutional investors. On the other hand, some institutional investors might not care about greenwashing at all as long as it brings in profits.

The study highlights that if a supplier has more institutional ownership, then a firm using this supplier is more likely to selectively disclose the relationship based on the latter’s environmental performance. This is because a relationship with a supplier with good CSR credentials and large institutional ownership will receive more public attention, which would benefit the firm using this supplier in terms of publicity and recognition.

“If the ‘bright’ side to CSR is a world where firms are seeking to lower their carbon footprint, then what our study shows is the ‘dark’ side and how smaller and weaker firms are using it to greenwash their public image,” Prof. Wu says.

Short-term Benefit

Showing off a “green” image is not the only benefit that the firms can get out of greenwashing. The researchers found that sales in firms that disclose their suppliers with good environment ratings increased when compared with sales of the firms that disclose their “brown” suppliers. However, such an improvement in sales was short-lived. Similarly, disclosing “green” suppliers could have a positive effect on a firm’s ROA, but the effect would diminish in the long term.

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Why is that? Prof. Wu explains that the public can be slow in familiarising themselves with the manufacturing process of products or the details of supply chains, so it is easy for firms to lure people with their seemingly “green” efforts in the supply chain. But, in the long run, the general public would realise that what the firms did was a mere publicity stunt. Therefore, the boosted sales and ROA would not last.

“Everyone wants to drive a Tesla, but not all of them know how the cars are made and where the parts come from. If a manufacturer tells the public that they only work with eco-friendly suppliers, then people might just fall for it,” Prof. Wu says. “Just like how retail customers are now increasingly sceptical of so-called ‘green’ products, the public would become sophisticated enough to tell whether the firms are dedicating real efforts in protecting the planet. It just takes time.”

Real-world Implications

Prof. Wu and his co-authors point out that there is a way to put a damper on firms’ greenwashing behaviour. In examining environment-related disclosure regulations around the world launched between 2003 and 2016, they found that supply chain greenwashing typically reduces after CSR reporting and disclosure regulations are tightened.

The researchers also say that since, more often than not, environmental legislation tends to focus on the green credentials of a company’s own production and operations and pay less attention to its suppliers, it can be easy for firms to hide environmentally polluting production processes in complex supply chains.

To enhance the effectiveness of regulations, they suggest countries expand their scope in requiring the disclosure of suppliers. This way, firms would not be able to only disclose the “green” suppliers and hide the bad ones. Policymakers should also consider improving the transparency of supply chains in the current regulatory framework and they should always beware of firms’ strategic and selective disclosure to boost a “green” image.

For managers, the researchers advise them to bear in mind that higher profits, either in the form of sales or ROA, brought about by greenwashing practices only last for a very short term. When people find out that a firm engaged in greenwashing their CSR efforts and with no actual interest in being socially responsible, then the short-term gains would likely disappear.

“For investors, they should make an effort to detect when strategic disclosure of ‘green’ suppliers purely for CSR image purposes is happening, and realise that only truly greener supply chains can improve firms’ capital market valuation in the long term,” Prof. Wu comments. “The public can also get in on the action and help out by monitoring any suspicious supply chain greenwashing behaviour.”

The post How to Spot and Avoid Greenwashing in Supply Chains first appeared on China Business Knowledge.

By Jaymee Ng, Principal Writer, China Business Knowledge @ CUHK

The unprecedented COVID-19 pandemic has posed severe challenges for the global economy and supply chains have been in the eye of the storm. Amid heightened geopolitical tensions, some countries are considering moving supply chains out of China. However, as a recent research study by The Chinese University of Hong Kong (CUHK) reveals, cutting ties with China might not help firms to mitigate risks.

“In many parts of the world, there’s been concern that global supply chains were over-reliant on China, now widely regarded as ‘the world’s factory’”, says Jing Wu, Assistant Professor in the Department of Decision Sciences and Managerial Economics at CUHK Business School and one of the authors for a new study.

“Having supply chain relations with other regions when the pandemic hit China didn’t mitigate credit risk at a time when credit risk for firms with ties to Chinese supply chain partners was increasing.”

Prof. Jing Wu

Such efforts include reported talks in August between Japan, India and Australia to establish a trilateral effort, named the Supply Chain Resilience Initiative, to build stronger supply chains and to reduce dependence on China. Earlier in the year, Japan also earmarked US$2 billion to help its companies shift production out of China and back onto its shores. Across the Pacific, both the Trump administration as well as Democratic Presidential nominee Joe Biden have signaled that post-election they would seek to end the U.S.’ reliance on Chinese manufacturing.

“We live in an increasingly interconnected world, so much so that having supply chain relations with other regions when the pandemic hit China didn’t mitigate credit risk at a time when credit risk for firms with ties to Chinese supply chain partners was increasing,” says Prof. Wu in discussing the results of his latest study The Impact of COVID-19 on Supply Chain Credit Risk

“When the pandemic spread to the rest of the world and recovery started in China, having supply chain linkages to China was beneficial for the companies as the rest of the world was going through economic shutdowns or slowdowns.” he says.

The research was conducted by Prof. Wu in collaboration with Prof. Senay Agca at George Washington University, Prof. John Birge at University of Chicago and CUHK Business School PhD student Zi’ang Wang. The researchers examined how supply chain activity reflects into credit risk during different phases of the COVID-19 pandemic.

They specifically looked into spreads on credit default swaps, or CDS — a type of financial instruments which allows credit risks to be hedged, and its relation to U.S.-China supply chain links. The study mainly reviewed CDS data in two phases of COVID-19: when the Chinese economy shut down between January 31 to February 29 and when the Chinese economy reopened between March 1 to April 6.

“By exploring two phases of the pandemic, we find that supply chain disruptions and resumptions substantially affected the credit risk of U.S. firms during the pandemic. Credit risk increases with supply chain disruptions due to economic shutdowns and decreases when supply chain activity resumes when the economy opens,” says Prof. Wu. The effects were economically significant, increasing CDS spreads by around 6 percent to 7 percent during disruptions and improving credit risk by 16 percent 29 percent when supply chain activity resumes during the reopening of the economy.

The study also points out that the resumption of supply chain activity in China seems to have a more pronounced effect on improving credit risk than during supply chain disruptions when the pandemic spread in China.

Household Demand Factor

Prof. Wu and his collaborators then looked into specific industries to find out which sectors were more vulnerable to supply chain disruptions. They found that sectors that are more closely related to household demand, such as electronics and consumer goods, did not benefit as much as other sectors when supply chain activity was improved during phase two of COVID-19 in China. The resumption of supply chain activity in China did not reduce the credit risk for these sectors due to low household demand in the U.S.

According to the study, sectors such as oil and gas and manufacturing were more directly affected by disruptions and the resumption of supply chain activity. The CDS spreads for these sectors increased during periods of disruptions and decreased with resumptions.
t had Chinese customers. When the Chinese economy re-opened in phase two, increasing household demand in China, the CDS spreads of the consumer goods sector reduced considerably for the U.S. firms with links to Chinese customers.

“Since this is the period when the U.S. economy shut down, having access to Chinese markets was beneficial for U.S. firms with Chinese customers, particularly for those in the consumer goods sector,” Prof. Wu explains. Among other sectors, firms in the oil and gas industry that work with Chinese customers also have reduced credit risk when the Chinese economy reopened.

Firm and Supply Chain Characteristics

In terms of firm characteristics, the researchers found that firms that were investment-grade, with more cash and more growth opportunities were less affected by supply chain disruptions during the pandemic. In addition, firms with high leverage were more vulnerable to supply chain disruptions but also benefited more when activity resumed.

“Investment-grade firms are further away from the default boundary and therefore have the ability to withstand adverse developments. Firms with more cash holdings also have more buffer in such situations. In addition, growth opportunities appear to allow firms to shift to other businesses when production or customer demand changes during the pandemic,” Prof. Wu explains.

Firms that operate in highly concentrated industries, where a small number of firms made up for a high proportion of production, were affected more by supplier disruption but less from customer disruption, as these firms have a lower risk of losing market share. This contrasted with firms in sectors where products were similar and competition fierce. As firms were more substitutable, they were more vulnerable to supply chain dynamics. Firms with more capital could also better adjust to supply chain driven changes and thus they were less affected during supply chain disruptions.

Furthermore, companies with longer supply chains suffered from amplified credit risk as these relations are harder to substitute. Upstream sectors were less affected from reduced demand in China as it might be easier for these firms to find substitute markets. According to the study, these firms also recovered faster when supply chain activity resumed. On the other hand, when firms were more central in the supply chain network, their credit risk was less affected by disruptions in any particular individual supply chains.

The study complements the current discussion about the impact of COVID-19 supply chain disruption on firm credit risk and it is also the first to consider supply chain disruptions with household demand within the context of supply chains.

“We bring evidence of how supply chain disruptions affect firms as economies move to different phases of the pandemic. These results have implications for other forms of regional production or consumption disruptions and the impact of global supply chains on propagating or mitigating such shocks.”

The post Why Pulling Supply Chains Out of China is the Wrong Answer first appeared on China Business Knowledge.

By Raymond Ma, Managing Editor, China Business Knowledge @ CUHK

COVID-19 has turned the business world upside down. That being said, some businesses are doing better than others. For example, the average U.S. manufacturing firm saw stock prices fall by 29% over the first quarter with a standard deviation of 24%. But who are these companies and what makes them more immune to the economic contagion which has spread in the wake of the virus’ path around the world?

That is the question that a group of researchers, including Wensi Xie, Assistant Professor at the Department of Finance at The Chinese University of Hong Kong Business School, have sought to examine in a study entitled Corporate Immunity to the COVID-19 Pandemic.

After examining weekly stock returns for over 6,000 firms across almost 60 economies during the first quarter of 2020, the study found (perhaps not surprisingly) that the share prices of companies with stronger financial conditions before the virus struck this year – in the form of higher cash balances, lower debt levels and healthier profits – were less affected by COVID-19. This better immunity to the virus also applied to businesses that were less exposed to the crippling economic effects of the coronavirus from paralysed global supply chains and lower foreign customer demand.

“Firms with more cash, less debt, and larger profits experienced better stock price performance than otherwise similar firms.”

Prof. Wensi Xie

The more interesting finding of the study, which was also authored by Prof. Ross Levine of the University of California, Berkeley, and Prof. Chen Lin and Wenzhi Ding at the University of Hong Kong, was that this outperformance extended to the stocks of companies that engaged in more corporate social responsibility (CSR) activities, those whose corporate executives were less entrenched in their roles, and those with a higher level of ownership that were non-financial corporations.

The findings come as unemployment continues to rise with established businesses declaring bankruptcy left and right. Many of those that are still surviving are expected to report (or have already announced) steep losses for the quarter. Much uncertainty hangs in the air for the subsequent quarters.

Deeper Pockets

Among its main findings, the study shows that a firm with one standard deviation lower in its pre-2020 cash-to-asset ratio would experience an almost 6 percent (of the average weekly stock return) additional drop in its share price. Likewise, a firm with one standard deviation higher leverage pre-2020 saw its share prices fall by 10 percent more than average.

“Firms with more cash, less debt, and larger profits experienced better stock price performance than otherwise similar firms,” says Prof. Xie.

Amid the disruption in global supply chains caused by the coronavirus outbreak, with shutdowns causing delays in the production of goods and lowering customer demand, the study found companies with suppliers and customers in countries more affected by COVID-19 experienced larger stock price declines.

A one standard deviation increase in a firm’s exposure to COVID-19-hit suppliers and customers led to stock price declines of 5 percent and 11 percent, respectively, the study shows.

The research also differentiated companies by their CSR performance before 2020. A company with a high CSR score (in the 75th percentile) was estimated to have seen their stock returns fall by 2 percentage points less than a company with a low CSR score (25th percentile).

Prof. Xie says past research has found that CSR activities; such as creating safe and health workplaces, engaging in ethical business practices and providing enduring and reliable services to customers; build trust and loyalty with stakeholders. This in turn boosts their willingness to support a company’s operations, especially in a difficult economic climate.

Next, the study found that in responding to the COVID-19 pandemic, markets penalised companies with more entrenched executives. Looking at firm-level differences in the adoption of anti-takeover provisions, which give the existing leadership ways to fend off threats to their control of the firm from hostile bids, the study found a statistically significant negative interaction with COVID-19 stock movements.

“In assessing how companies respond to the pandemic, markets valued flexibility, and that included mergers and acquisitions, leadership changes, and governance structures that limit tunnelling,” says Prof. Xie. Tunnelling refers to practices whereby major shareholders or company management directs the firm’s assets or future business for personal gain, which is more likely to happen during periods of great uncertainty and tumult.

Comparing a company scoring in the 25th percentile in terms of its use of anti-takeover provisions against another company in the 75th percentile, the study found that the market reacted 24% more for company with more anti-takeover provisions. However, it found no evidence that the stock price reactions to COVID-19 vary systematically with a company’s board structure or executive compensation.

Hedge Fund Ownership Takes a Beating

Finally, the study found that the stock prices of companies fell by a smaller magnitude on average when they were owned by blockholders (that hold no less than 5% of a firm’s shares) that were non-financial corporations. It found that companies with a one-standard-deviation increase in corporate ownership saw their share prices fall by 1.5 percentage points less over two months.

One explanation, according to the research, is that markets price in the beneficial nature when companies are owned by corporate shareholders with a long-term strategic interest, rather than financial shareholders who are focused on turning a quick profit.

“If a firm has a large, strategic corporate investor as a major block shareholder, then the market might expect this blockholder to provide support for this firm during the crisis, dampening the impact of COVID-19 on the firm,” says Prof. Xie.

This was the opposite case when a big chunk of a firm was owned by hedge funds, with a one-standard-deviation increase in hedge fund ownership leading to an additional 1.2 percentage point decline over two months.

Prof. Xie says prices of stocks with heavy hedge fund ownership fell much more in response to COVID-19. This was coherent with the view that the quantitative trading strategies employed by hedge funds, and their reliance on leverage, can contribute to sharp price movements in response to adverse shocks.

On top of analyses of firm characteristics, the study also looked at how markets reacted in different countries. It found that the stock prices of companies in rich countries performed better than those of their poorer counterparts, reflecting the ability of wealthier economies to better marshal the resources needed to fight the pandemic.

Reflecting greater risks faced by older people against the coronavirus, stock prices in countries with bigger proportion of people over the age of 65 fell more sharply than those in countries with younger populations. Consistent with the notion that markets viewed economies with more powerful states as better able to respond to the pandemic, countries with civil and socialist legal traditions experienced smaller stock price declines than those with a common law tradition.

The post COVID-19: Which Companies Are More Immune? first appeared on China Business Knowledge.