Abstract Downstream customer firms’ bargaining power can lead to suboptimal diversification in upstream suppliers’ innovation when customers cannot commit to a long-term relationship. After the revelation of financial fraud by a major customer, suppliers surprisingly outperform a control group in terms of sales growth, Tobin’s q, and survival likelihood over a 10-year period. Our results suggest that, before a fraud revelation, supplier managers’ short decision horizons and aversion to short-term risk enable influential customers to demand relation-specific innovation, leading to suboptimal diversification. When customer importance weakens, suppliers engage in riskier and novel innovation, thereby stimulating sales growth. (JEL G14, G3, L14, L24)
Banerjee et al. (Tue,) studied this question.