NetSuite follows the Hierarchy in assigning a Supervisor to an employee. As a rule, employee's subordinates or their subordinates cannot be his supervisor. Only the employees on the upper management/hierarchy will be available on the dropdown list on the Supervisor field on employee record.
Below is an example of the scenario:
Employee A is the supervisor of Employee B.
If Employee B's subordinates are Employee AA, Employee AB and Employee AC, Employee B and her subordinates Employee AA, AB and AC will no longer appear as an option when selecting Employee A's supervisor.