Accounting-Based Monitoring: Evidence from Supply Chain Contracts

Abstract

I investigate the role of accounting-based monitoring provisions in material supply agreements filed with the SEC from 2000 to 2023. I find that 60.5% of contracts contain at least one such provision, and monitoring is asymmetrically allocated, with the customer monitoring the supplier in 70.4% of cases. Customers impose more monitoring when contracts use cost-plus pricing and when suppliers have stronger public reporting quality, while suppliers monitor customers when customers are financially weaker. After contract initiation, monitored suppliers exhibit higher subsequent sales and improvements in their own reporting quality, while customers that impose monitoring on suppliers exhibit lower operating-cost ratios, lower cash holdings, and higher sales growth. These effects concentrate in firms with poor baseline reporting quality of the monitored party. Under cost-plus contracts these benefits accrue to the customer through lower operating costs, while under fixed-price contracts they accrue to the supplier through both lower costs and higher sales, consistent with the idea that cost-plus pricing mechanically passes verified cost savings back to the customer, whereas fixed-price contracting leaves the residual with the supplier.