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Trust and the Economic Theory of the Firm

Trust and the Economic Theory of the Firm
Jackson Nickerson
Timothy Gubler
Kurt Dirks
Olin Business School
Washington University in St. Louis
During the past two decades the literatures in strategic management and
organizational theory have exploded with papers studying the impact of trust on exchange
relationships, be they dyadic or within a network.
Scholars have investigated how trust
can be built (Gulati 1995; Nooteboom 1996; Lorenz 1999; Zaheer, McEvily, and Perrone
1998; Lewicki, Tomlinson, and Gillespie 2006), how it is maintained and used (Barney and
Hansen 1994; Nooteboom, Berger, and Noorderhaven 1997; Zaheer, McEvily, and Perrone
1998; Dirks, Lewicki, and Zaheer 2009; Gillespie and Dietz 2009), the ways in which trust is
damaged (Robinson 1996; Zaheer, McEvily, and Perrone 1998), and the implications on the
relationship when it is lost (Bies and Tripp 1996; Dirks and Ferrin 2001). Most of the
research adopts units of analysis that reflect interpersonal relationships. For example,
scholars in organizational behavior mostly explore how trust operates within groups or
between superiors and subordinates (Dirks and Ferrin 2001; Ferrin, Dirks, and Shah 2006).
Some scholars have explored the role of trust in the structuring and performance of
interorganizational exchanges (Chiles and McMackin 1996; Nooteboom 1996; Nooteboom,
Berger, and Noorderhaven 1997; Gulati and Nickerson 2008), including the role of
interpersonal trust in interorganizational trust (e.g. Zaheer, McEvily, and Perrone 1998).
Other scholars have investigated the extent to which pre-existing trust influences the
choice of a firm’s decision to make, buy, or ally and the extent to which a particular
governance choice encourages the emergence of trust during the exchange relationship
A recent search in Strategic Management Journal and Organization Science revealed 1933 total articles
written on the topic of trust, 1482 of these articles published in the last twenty years.
(Williamson 1996; Malhotra and Murnighan 2002; Ferrin and Dirks 2003; Gulati and
Nickerson 2008).
While much progress has been made in understanding the role of trust in exchange
relationships, an area of unrealized potential involves the role of trust in the economic
theory of the firm
. The economic theory of the firm is a central tent pole for strategic
management and organization theory. It attempts to understand the purpose of the firm,
why and where its boundaries are formed, how it selects its members, how it organizes and
shapes the behavior of its members, and how all of these decisions translate into
organizational performance outcomes (Williamson 1975; Klein, Crawford, and Alchian
1978; Williamson 1985). The discriminating alignment hypothesis that informs much of
the economic theory of the firm holds that exchanges, which differ in their characteristics,
are aligned with governance structures (e.g. market, hybrid, or hierarchy), which differ in
their costs and competencies, in a discriminating way (Williamson 1991). While scholars
have shown that trust can act as a shift parameter and raise the switchover level from
market to hybrid to hierarchy by reducing exchange hazards (Chiles and McMackin 1996;
Gulati and Nickerson 2008), less is known about how the structural competencies inherent
“Williamson states that “trust is important and businessmen rely on it much more extensively than is
commonly realized” (Williamson 1975, 108). However, Williamson does not integrate trust into the TCE
model and argues that trust is not needed to explain economic organizations, instead relying on risk and
calculative economic reasoning (Williamson 1993, 486). Moreover, Williamson argues that trust should be
reserved almost exclusively for personal relationships (1993, 483). In this chapter we develop a compatible
but different perspective compared to Williamson that takes into account the intertemporal management of
trust and expectations. Our theory identifies important ex post features of governance forms for building and
managing trust and hence expectations. We argue that these ex post features should be considered and
folded back into ex ante governance choice considerations because they affect the level of trust actually
achieved, which in turn shapes ex post risk in a path dependent way. By doing so, we acknowledge, like
Williamson, that a calculative ex ante approach for assessing expectations and risk is warranted but that
actual creation and management of trust can vary over a considerable range. Ex post management of trust
shapes the level of risk as the exchange unfolds. In essence, we believe that this paper unpacks governance
features not articulated in Williamson’s initial ex ante calculus of governance choice.
in the differing governance structures impact the organization’s ability to build and
maintain trust with exchange partners. This relationship is a hitherto underexplored yet
key element to the economic theory of the firm.
In this chapter we seek to explore the extent to which the institutional archetypes of
markets, hybrids, and hierarchies vary in their capacity to support the building and
maintenance of trust. Previous work relating trust to governance choice has focused on the
benefits of trust in exchanges including lower transaction costs, increased knowledge
sharing, and increased coordination (Zaheer, McEvily, and Perrone 1998; Dyer and Chu
2003) and how trust subsequently can influence governance choice (Chiles and McMackin
1996; Gulati and Nickerson 2008). Other work also has highlighted how trust can lead to
exchanges built more on relationships or social structure (Uzzi 1997; Dyer and Singh
1998). Relatively few studies have looked, however, at how the inherent structural
characteristics of each governance mode endogenously impact, both positively and
negatively, the building of trust and its maintenance. We assert that a complete theory of
the firm needs to understand this key relationship and provide insight into how it
influences firm performance.
A vast amount of research highlights how markets, hybrids, and hierarchies differ in
the structure and relative strength of their incentives, administrative controls, and conflict
resolution methods including access to external contract law. Moreover, much theory has
been proposed as to how these characteristics differentially affect the behavior and
outcomes of exchanges (Williamson 1975; Klein, Crawford, and Alchian 1978; Williamson
1985; Grossman and Hart 1986; Hart and Moore 1990; Williamson 1991). We suggest that
this analysis is particularly well suited as a starting point in understanding how trust is
differentially affected in each governance form by the structure and strength of each of
these factors.
Our chapter reviews the literature on trust in the context of the economic theory of
the firm. We provide a definition of trust and outline three mechanisms through which
trust can be built. We then briefly review key fundamentals to the economic theory of the
firm from the transaction cost economics perspective and review the literature that
connects this theory to the building and use of trust in organizations. Lastly, we review the
recent literature on the maintenance of trust, for which repairing trust is the central issue,
and outline three processes of trust repair, highlighting aspects of repair that can be
influenced by governance structure. We conclude that the role of trust in the economic
theory of the firm remains preliminary, partial, and piecemeal and overlooks our key
question of how differing governance alternatives endogenously affect the building and
maintenance of trust in exchange relationships.
With this background in hand, we launch an exploration of how the inherent
differences in governance alternatives can influence each build and repair mechanism. We
find that trust is endogenously impacted both positively and negatively in different ways by
markets, hybrids, and hierarchies and that this difference can yield varying performance
outcomes. Furthermore, we find that managers have a key role to play in which the role
and its potential implications depends on the managerial resources available given the
governance mode. That said our exploration is not a theory building exercise. Instead, our
intent is to understand the potential for developing theory and to identify key elements of a
possible theory to incorporate trust more fully into the economic theory of the firm. If
successful, we anticipate future research will develop the theory not only with respect to
the economic theory of the firm but also with respect to how leaders can better manage the
building and maintenanceincluding the repairof trust.
We finish our exploration by emphasizing three apparent paradoxes regarding trust
and the choice of governance. While the paradoxes provide counterpoints to our
exploration of trust in the context of the economic theory of the firm, our review suggests a
potential path to resolve them. Managers, we argue, potentially play a pivotal role and are
commonly overlooked in the economic theory of the firm. Incorporating the managerial
role and notions of adept versus inept decisions and behaviors into the theory may help to
resolve the paradoxes. We then conclude.
Literature Review
While many definitions of trust exist, we adopt a multidisciplinary definition that
describes interactions both within and between firms as put forth by Rousseau, Sitkin,
Burt, and Camerer (1998). Trust is defined as a “psychological state comprising the
intention to accept vulnerability based upon positive expectations of the intentions or
behavior of another(1998: 395)
. It is important to highlight that trust is based on
Another oft-used definition of trust is the expectation that one organization will not act opportunistically
against another, especially when the latter is vulnerable (Bradach and Eccles 1989). These definitions
highlight that trust often goes beyond calculative self-interest even to the point where exchange partners are
“willing to forego guarantees based on coercion or self-interest” (Williamson 1993; Nooteboom 1996;
Nooteboom, Berger, and Noorderhaven 1997, 313). While our definition of trust acknowledges that it is based
on an expectation of behavior and that past behavior provides important information, we largely remain
agnostic about the cognitive processes by which the expectation is formed. Consequently, and largely
because of space limitations, we will not specifically highlight or contrast the impact of differing types of trust
such as institution-based or generalized trust (e.g. Zucker 1986; Burchell and Wilkinson 1997; Child and
Möllering 2003). This is not to say that trust functions the same in each governance form or that trust is built
and maintained in identical ways across forms. On the contrary, we believe that the differing organizational
expectations about the future intentions or behavior of an exchange partner. These
expectations have two main foundations: trust stemming from the relationship between
exchange partners, either dyadic or in larger groups, and trust stemming from the
exchange structure or some other outside party. While both are important and related, we
largely focus on trust that is built and maintained by the exchange structure itself with
support from management. That said, we do highlight the linkage between the twohow
exchange structures can influence the building and maintaining of trust between exchange
Extant literature emphasizes three main ways through which trust is built both at
the micro and macro levels. The first is through direct interaction between parties.
Interaction allows each party to cultivate a relationship built on experience. Thus,
exchange partners observe each other’s behavior and draw inferences upon which
expectations of future behavior and trustworthiness are built (Lorenz 1999). Expectation
building can occur between individuals (Ferrin, Dirks, and Shah 2006), between individuals
and an organization (Robinson 1996), or between organizations (Gulati 1995; Zaheer,
McEvily, and Perrone 1998; Lorenz 1999). Uncertainty is reduced over time as parties
forms vary in their capacity to access tools to build and maintain trust. Our main objective in this paper is to
highlight some of these tools while leaving the work of linking types of trust to future theoretical work. By
not restricting our analysis we expand the consideration set, realizing that economic actors or institutions
may be able to shape expectations.
It is important to emphasize that trust should not be confounded with compliance. In our definition we
allow the possibility for trust between exchange partners to be influenced by some outside third party, such
as a manager, arbitrators, or the law. This broadening emphasizes that trust between exchange partners can
be augmented, and in some cases substituted, by trust in third parties. While it may be the case that the type,
overall level, and potential level of trust may be different in these cases, access to third parties provides an
important mechanism that influences trust creation and maintenance. For instance, a manager between two
hostile divisions may play the role as a third party of ensuring that each party lives up to its end of the
bargain. While these two divisions may have minimal trust between the two of them without the manager,
the addition of the manager, and the trust each has in the manager, allows them to function as if they had a
high level of trust between themselves in isolation.
continue to interact and become more familiar with each other (Gulati 1995). Thus
expectation building is a dynamic learning process wherein organizations are constantly
updating perceptions of their counterparts and determining whether or not they can
increase their level of trust.
The second way trust is built relies on the existence of a social structure in which
exchange dyads are embedded. Social structure can transmit information about pre-
existing trustworthiness and allows for reputation effects (Uzzi 1997; Ferrin, Dirks, and
Shah 2006). Reputation effects increase incentive for trustworthy behavior to occur
because otherwise a loss of reputation could expand beyond the focal relationship. Parties
make inferences about trustworthiness both from the direct information they receive as
well as from indirect information supplied by the social structure. Some mechanisms that
lead to the creation of social structure are interorganizational asset connectedness, partner
scarcity, resource indivisibility and co-evolution of capabilities, and a socially complex and
difficult to imitate institutional environment (i.e. country specific environment) (Dyer and
Singh 1998).
The last way trust is built is through formal structural factors. Formal structures
provide differential incentives, administrative controls, conflict resolution methods, and
access to contract law that can influence trust positively or negatively. While formal
governance structures have been shown to decrease exchange hazards (Klein, Crawford,
and Alchian 1978; Williamson 1985) and promote cooperation (Bromiley and Cummings
1995; Zaheer, McEvily, and Perrone 1998), they also may inhibit the building of trust
between exchange partners directly through the problem of attribution. Attribution occurs
when exchange partners attribute good behavior to structure instead of the other party,
which results in little residual trust when the formal structure is removed (Malhotra and
Murnighan 2002; Ferrin and Dirks 2003). It is precisely in formal governance structures,
however, that trust is assumed to be of most benefit to the firm in reducing transaction
costs and promoting cooperation. We therefore believe that integrating trust into the
economic theory of the firm is needed to expose new insights into the extent to which each
alternative structure supports and discourages the building and maintenance of trust.
The theory of the firm seeks ultimately to explain the organization of firms in a
world in which potentially costly vulnerability creates exchange hazards. These hazards
stem from the fact that agents are self-interested, sometimes with guile, and can act
opportunistically, especially as their circumstances change (Klein, Crawford, and Alchian
1978; Williamson 1979). Coase asserts that formal organizations arise precisely for this
reasonto provide a mechanism for minimizing transaction hazards when the cost of
transacting through a market is high (1937). Hazards to exchange largely result from the
combination of three factors: asset specificity, frequency, and uncertainty (Williamson
1985). The discriminating alignment hypothesis that informs much of the economic theory
of the firm holds that exchanges, which differ in their characteristics, can be aligned with
governance structures, which differ in their costs and competencies, in a discriminating
way (Williamson 1991). To emerge and thrive, a governance structure must address the
problems of adapting, coordinating, and safeguarding exchanges more efficiently than
alternative governance structures (Williamson 1991).
Previous work has shown that trust and formal governance structures can function
as partial substitutes. Many studies show that relational exchanges based on trust can
substitute for complex contracts or vertical integration (e.g. Granovetter 1985; Bradach
and Eccles 1989; Gulati 1995; Uzzi 1997; Bernheim and Whinston 1998; Dyer and Singh
1998; Adler 2001). Substitution comes from that fact that trust can allow for higher levels
of cooperation (Barney and Hansen 1994; Bromiley and Cummings 1995; Zaheer, McEvily,
and Perrone 1998; Dyer and Chu 2003) and function as a more effective and less costly
self-enforcement mechanism than some formal governance structures (Hill 1990; Chiles
and McMackin 1996; Uzzi 1997; Gulati and Nickerson 2008). These findings follow
Arrow’s observation that “trust is an important lubricant of the social system” that adds
efficiency to many economic exchanges (1974). While the lubricant does not eliminate all
frictions and replace governance structures in their entirety, trust can either act as a “shift
parameter” that lowers the cost of each governance mode (Chiles and McMackin 1996;
Gulati and Nickerson 2008), or can lead to a relational governance structure that uses trust
and other informal safeguards to facilitate efficient exchange (e.g. Uzzi 1997; Dyer and
Singh 1998). In either case, governance is less costly and more efficient because of trust.
The obverse and less common view, which is that structure (or trust in structure) can at
times partially substitute for trust that occurs directly between exchange partners, is
where this paper seeks to make a contribution.
Trust and formal governance structures also can function as complements.
Following North’s assertion (1990) that “formal rules can complement and increase the
effectiveness of informal constraints,” scholars have found that higher levels of relational
governance (via trust) are often coupled with customized complex contracts (e.g. Poppo
and Zenger 2002) and that formal structure can enhance the level of trust among
collaborators (Lorenz 1999; Coletti, Sedatole, and Towry 2005). Some scholars have even
argued that formal governance is essential for trust to be beneficial to exchange
performance (Lazzarini, Miller, and Zenger 2004). One key way trust can function as a
complement is by allowing firms to both avoid conflict and to resolve it more quickly when
it arises (e.g. Uzzi 1997; Dyer and Singh 1998; Gulati and Nickerson 2008). Gulati and
Nickerson find that trust enhances exchange performance across all governance modes, the
benefits being greatest for markets, followed by hybrids and then hierarchies (2008).
While there is evidence that formal structure and trust can be either substitutes or
complements for each other, it remains ambiguous how formal structures influence the
building of trust. For instance, work on relational governance and social structures
explores how frequent interactions between dependent exchange partners in a formal
governance structure can lead to a separate governance mechanism that uses trust and
other informal safeguards to facilitate efficient exchange. Increasing trust allows
cooperation between a pair or network of firms and allows them to jointly own and utilize
critical resources that span firm boundaries and that may be embedded in interfirm
routines and processes (Uzzi 1997; Dyer and Singh 1998). Gulati observed such a pattern
in alliances, finding that many alliances begin with the use of formal governance
mechanisms and then progressively move towards more informal ones, mainly as a result
of increased trust (1995). Recent work also has argued, however, that formal governance
structures are unable to build and support high levels of trust because of either a problem
of attribution (Malhotra and Murnighan 2002) or from formal structures “crowding out”
intrinsic motivation (such as trust) with external interventions (e.g. Titmuss 1970; Frey
and Oberholzer-Gee 1997; Uzzi 1997). Some scholars have even argued that formal
contracts can potentially encourage opportunistic behavior and undermine trust by
signaling distrust to exchange partners (Macaulay 1963; Ghoshal and Moran 1996). These
competing theories highlight the need for increased attention to how formal structure
influences the building of trust.
While the building of trust has received much attention by researchers, only
recently has increasing focus been placed on how trust is maintained and repaired between
organizations. Exchange relationships can begin with a high level of trust (Kim et al. 2004).
Trivially, trust is maintained as each party performs in a way that will not damage positive
expectations. Trust, however, can be damaged. Damage through incidents that violate
expectations causes positive expectations to be replaced by negative ones, motivating firms
to restrict exposing to future vulnerability (Robinson 1996; Lewicki, McAllister, and Bies
1998). Breach of trust in these settings can result in reduced willingness for workers to
share information and cooperate (Dirks and Ferrin 2001) and may even result in acts of
retaliation (Bies and Tripp 1996). Trust can take months or years to build, while a single
incident may violate expectations and severely damage trust. Furthermore, while research
suggests that trust can be repaired (Dirks, Lewicki, and Zaheer 2009), how conflict and
negative events are resolved are crucial to the future health of the relationship (Driver et al.
The current trust repair literature
emphasizes three main goals: trust repair,
restoring positive exchange, and reducing negative affect (Dirks, Lewicki, and Zaheer
For a review on the trust repair literature see (Dirks, Lewicki, and Zaheer 2009).
2009). Three processes allow for the accomplishment of these goals: an attributional
process, a social equilibrium process, and a structural process (Dirks, Lewicki, and Zaheer
. The attributional process builds on attribution theory (Heider 1958) and
emphasizes that to repair trust, the offended party must perceive that the transgression
does not reflect the true nature of the violator, or that the true nature of the violator has
changed (Dirks, Lewicki, and Zaheer 2009). While time and continued expectation building
through exchange with “good” behavior serves to slowly restore positive expectations,
believable apologies and accounts (Kim et al. 2004; 2006; Tomlinson and Mayer 2009) and
credible substantive actions to demonstrate trustworthiness (Gillespie and Dietz 2009),
such as voluntarily introducing monitoring systems and sanctions (Nakayachi and Watabe
2005), can change perceptions thereby repairing trust more rapidly in these instances.
Managers also may play a key role by influencing perceptions and assigning blame.
The social equilibrium process refers to repairing the social and interpersonal
aspects of the relationship by resolving a disequilibrium that results when transgressions
impact the social order of the relationship (Goffman 1967) and impact the social norms
(i.e., resolving disputes in good faith, norms of reciprocity, fairness, etc.) that once provided
an economically beneficial self-enforcement mechanism to govern the exchange
(Granovetter 1985; Uzzi 1997). Goffman argues that relationship repair does not occur in a
vacuum. Transgressions call into question the prevailing norms that once governed the
relationship and consequently result in reduced willingness for exchange partners to
interact in the future (1967). Ren and Gray posit that effective repair must reaffirm the
These three processes are expected to differentially related to the goals of repairing trust, restoring positive
exchange, and reducing negative affect. The attributional process is most strongly associated with trust
repair, although the other processes may also have an effect.
norms governing interaction at two levels: the individual level and the dyadic level. Repair
at the individual level removes negative emotions associated with the transgression and
replaces them with a feeling of satisfaction with the restorative actions taken. Repair at the
dyadic level entails restoring the social order by recommitting to the norms that govern the
relationship and expressing a desire for continued interaction (Ren and Gray 2009). Repair
hinges on the reestablishment of social order by restoring the standing of the parties as
well as the norms that govern them through various restorative actions (Goffman 1967;
Ren and Gray 2009). Such actions may include penance, punishment, and apologies
(Bottom et al. 2002; Reb et al. 2006; Ren and Gray 2009). Restorative actions allow
exchange partners to “settle the accounts” and to reestablish positive expectations through
continued interaction.
The third process used in trust repair is structural in nature. Structural processes
involve changing the context within which relationships are situated and consist of
changing the structure, incentives, and systems to shape behavior in such a way as to
discourage future transgressions and restore positive expectations (Sitkin and Roth 1993;
Dirks, Lewicki, and Zaheer 2009). Changes to incentives may include adopting lower-
powered incentives that dull the connection between pay and performance, or through
crafting incentives that encourage cooperation such as compensating or promoting based
on group performance. The introduction of financial penalties for the observation of
particular behaviors also changes incentives. An example of changing the structure is
through managers changing job descriptions to influence the role actors play in the
exchange. While repair through formal structures has been shown by some scholars to
inhibit trust repair by placing a barrier between parties that results in increased distance,
formality, and rules (e.g. Granovetter 1985; Zucker 1986; Shapiro 1987), other scholars
have argued that structural remedies can be effective in repairing trust when violations are
specific to a particular task or context (Sitkin and Roth 1993). We argue that more
attention is needed in order to better understand how structural factors and third parties
such as managers influence the maintenance and repair of organizational trust.
Upon reviewing the literature it is apparent to us that the extant literature provides
at best a fragmented and partial theory of trust and the economic theory of the firm. While
there is a broad literature focusing on how trust impacts governance, the benefits to trust
in exchanges, and the mechanisms that build and maintain trust in general, less is known
about how the internal workings of governance structures impact the building and
maintaining of trustor how trust is endogenously impacted by governance structures.
Furthermore, existing studies present at best mixed results. In the sections that follow we
outline some fundamental elements that provide the groundwork for the further
integration of trust and the economic theory of the firm.
The Need for Trust in the Economic Theory of the Firm
We follow the standard assumption of TCE and assume that agents may act
opportunistically and are boundedly rational. Increased incentive and opportunity, which
implies probability of opportunistic behavior, follows mainly from three attributes of
exchanges: asset specificity, uncertainty, and frequency. Of the three, asset specificity,
measured in terms of the difference in an assets current value compared to value in its
next best use, is the most impactful (Williamson 1985). Asset specificity arises when
exchanges require significant relation-specific investments in physical and/or human
capital. Asset specific investments transform the exchange from one in which relationship
is irrelevant to one wherein maintenance of the relation is of paramount importance
(Williamson 1991). Continued exchange and preventing hold-up is essential to capture the
value created by these specialized investments (Klein, Crawford, and Alchian 1978).
The second factor, increases in uncertainty, in conjunction with asset specificity,
results in a more complex contracting environment and leads to a heightened threat of
opportunism through the need to adjust contracts ex post in response to unforeseeable
changes. Third, recurrent transactions, especially in conjunction with asset specificity and
uncertainty, not only affords the opportunity for cost-saving benefits through relation-
specific investments and cooperation but also places pressure on an exchange through
increasing the amount of contact, coordination, and adaptation required to continue the
exchange relationship (Williamson 1991). We assume frequency and repeated ties as
being driven primarily by asset specificity and its resulting co-dependency. Thus, for the
purpose of pushing the theory forward we assume, all else being equal, that the higher
levels of co-dependency which leads to the choice of hybrids over markets and hierarchy
over hybrids also leads to increased needs for coordination and necessitates increased
contact, which results in increased frequency and in the number of repeated ties.
Firms can reduce exchange hazards in two ways. The first and perhaps more costly
alternative is through adoption of a formal governance structure. For instance, the
likelihood of opportunistic behavior can decrease as a firm increases administrative
controls, utilizes low powered incentives, offers career paths, and adopts specialized
monitoring by vertically integrating the exchange. The second way is through basing the
exchange on a relationship of trust. Trust can respond positively to these hazards by
allowing for more efficient ex post contracting (Gulati 1995; Uzzi 1997; Poppo and Zenger
2002), increased cooperation (Bromiley and Cummings 1995; Zaheer, McEvily, and
Perrone 1998), and for the use of less-costly governance structures to govern these
idiosyncratic exchange relationships (Bradach and Eccles 1989; Gulati 1995; Chiles and
McMackin 1996; Gulati and Nickerson 2008). Were relationship-based trust perfect there
would be no threat of opportunism and each of these exchange hazards would be
insignificant. However, as risk of opportunism is assumed present, trust based on
relationships can at best substitute for formal structure, with potential cost-saving benefits.
The key theoretical question then is to what extent formal structures influence, positively
or negatively, the building and maintenance of trust.
Governance Structures and Support of Trust
Our exploration in this section seeks to understand the potential for developing
theory and to identify key elements of a possible theory to incorporate trust more fully into
the economic theory of the firm. The following analysis proposes that the alternative
governance structures of markets, hybrids, and hierarchies display different capacities for
building and maintaining trust. Moreover, these capacities are not “automatically”
exercised by structural choice alone. Instead, we argue that utilizing at least some of these
capacities requires managerial intervention, which is feasible and more efficacious in some
organizational alternatives than others. Adept managers can help build and maintain trust
while inept managers can inhibit its development and undermine it. It is critical to note
that even though more formal organizational forms enjoy more mechanisms to build trust
and processes to repair trust, these advantages may not automatically lead to increased
trust between exchange partners when compared to less formal organizational forms
which enjoy lower levels of asset specificity. For instance, even though hierarchies have
access to increased mechanisms and processes to support the building and maintenance of
trust compared to hybrids, the overall level of trust in hybrids could be higher. Thus
support of trust should not be confused with the resulting outcome or level of trust.
We focus our analysis in two ways. First we outline the key differences between
governance alternatives based on three attributes: internal incentives intensity,
administrative controls, and conflict resolution mechanisms. When formality of the
governance structure increases, internal incentive intensity decreases and the influence of
administrative controls and access to internal conflict resolution increases. Moreover,
changes in governance structure dictate the contract law and social structure that supports
the exchange. For instance, markets are characterized by classical contract law and little
social structure. It organizes and governs exchanges under the bounds set by the law.
Hierarchies, on the other hand, rely on forbearance, social norms, and the adeptness of
managers to govern exchanges. Differences in contract law and social structure also impact
the employee relationships and allow managers different tools to influence the exchange
relationship. For example, hierarchies allow managers to move employees or reassign
them to different jobs in order to influence the exchange relationship. Market exchanges
enjoy no such option. Understanding these differences in governance alternatives and
managerial oversight provides a basis for understanding exchange relationships in each
structure and, consequently, each structure’s ability to support trust.
The second way we focus our analysis is through assessing how the attributes of
governance structures affect the three mechanisms for building trust and the three
processes of trust repair previously outlined in the literature review. Trust is built through
direct interaction, interaction within a social structure, and through formal structural
factors. Trust is maintained and potentially repaired through an attributional process, a
process that restores social equilibrium, and through a structural process. The inherent
attributes of governance structures impact each of these building and repair mechanisms
in different ways. For instance, because of the lack of internal conflict resolution methods
and administrative controls in markets trust repair relies mainly on appeal to the law.
Legal recourse, however, provides little benefit to trust repair as it does not resolve the
attribution problem, restore social equilibrium, or place structural safeguards in place to
reduce future opportunism. Hierarchies, on the other hand, have access to administrative
controls and conflict resolution mechanisms that allow managers to influence and even
manipulate social mechanisms in order to restore trust. For example, managers may take
the blame for an action between parties that damages trust (an attributional repair
process) thereby restoring positive expectations between the two partners. The following
analysis seeks to better understand the linkage between these governance attributes and
the mechanisms that build and maintain trust.
Market’s Ability to Build and Maintain Trust
Markets have little need for trust and have few mechanisms to support its building
and maintenance. Low asset specificity, near perfect information, standardized goods,
strong property rights, and the functioning of an efficient price mechanism allows
exchanges where, “Faceless buyers and sellers…meet in the marketplace for an instant to
exchange standardized goods at equilibrium prices” (Ben-Porath 1980). The strength of
markets lies in its ability to execute routine tasks efficiently (Ghoshal and Moran 1996).
Moreover, minimal needs for co-specialization allow dealings to take place at an “arms-
length,and thus relationships beyond the focal exchange are rare (Williamson 1979).
Exchange efficiency is found through agents acting in self-interested ways largely without
regard to the welfare of others (Smith 1776). Furthermore, the presence of many outside
options coupled with high-powered incentives leads to relatively little cooperation or
coordination. Administrative controls in market structures are weak, supplanted instead
by binding legal rules that rely mainly on government or the court system to enforce and
only guard against explicit illegal behavior. Conflict resolution is similarly solved
externally through classical contract law (legal recourse), or through replacing the
exchange relationship altogether.
While pure markets that satisfy all these conditions are rare, this polar case
provides the base from which to understand the relative strengths and weaknesses of
markets in comparison to hybrids and hierarchies. Pure markets that satisfy these
conditions have little need for trust and similarly possess few mechanisms to build and
maintain it. As pure markets break down, for instance from the introduction of asset
specificity or mutual dependence, the need for trust increases, creating additional pressure
for organizations to adopt a more formal organizational structure.
Markets and building trust. To better understand the extent to which trust can be
built in markets, we review the three principal mechanisms through which trust is built:
direct interaction, embeddedness, and structural supports.
Direct interaction. Market structures largely rely on the mechanism of direct
interaction to build trust between individuals. Exchange partners are chosen based on
price and initial positive expectations. Expectation building then occurs as partners
interact and update their expectations based on behavior. Future interaction and the
building of future trust depend on trust built through previous experience. Expectation
building through experience alone can be a slow process because market exchanges are
usually less repetitive and are often infrequent. It is also an imperfect process,
compounded by the fact that expectations, aside from those explicitly illegal, are often
either unclear or not formally stated and shared. Consequently, exchange partners may
find evaluating their performance, relative to expectations, difficult because few
expectations may exist. While market exchanges carry relatively few expectations
(Williamson 1979; Ben-Porath 1980), they also do not inherently possess many signals of
commitment, which contributes to slow and imperfect expectation building.
Embeddedness. Embeddedness in a social structure facilitates little building of trust
in markets. Weak ties between individuals in a community develop slowly when
interactions are not frequent. If the initial condition in the community is the absence of
embeddedness, then building trust through an interaction mechanism can be slow and
result in little trust (Williamson 1985; Good 1988; Gulati 1995). Investments in co-
specialized assets generate a type of embeddedness as the exchange partners come to rely
on one another. Yet, as the need for co-specialization and consequently the possibility of
loss of economic value is low in market settings, exchange partners have little need to
depend on embeddedness for reputation, which can be shared throughout an embedded
community. Instead partners expect “sharp in by clear agreement [and] sharp out by clear
performance” (MacNeil 1974). Low co-specialization also results in little need for
adaptation and consequently less benefit to embedded relationships.
Structural supports. Structural supports in markets also only weakly support the
building of trust. Markets exchanges rely on high-powered incentives, which directly allow
actors to increase their individual return through an increase of effort (Williamson 1985).
Such incentives, coupled with the low cost of switching exchange partners, means few
opportunities to be opportunistic, decreased motivation to cooperate, and weak employee
career concerns (Williamson 1985; Williamson 1991). The structure of markets is based
on classical contracting, or the court system. While the law protects against illegal activity,
it leaves other aspects of the exchange, such as incentive intensity, untouched. Thus the
law is limited in mitigating “legal” opportunism. Lastly, supports for monitoring effort and
factor inputs are weak in markets; monitoring typically is restricted to output. Overall the
structural factors of markets fail to decrease opportunism and engender cooperation. They
do little to structurally support the building of trust.
Markets and maintaining trust. Like the building of trust, market structures have
few mechanisms to maintain and repair trust. Trust is maintained in markets as partners
choose to act in non-opportunistic ways, especially when their exchange partner is
vulnerable. In markets such behaviors include performing in a reliable, predictable, and
fair way (Zaheer, McEvily, and Perrone 1998) within the bounds of the law. While research
has shown that these exchanges can begin with a fairly high level of pre-existing trust, any
breach of expectations can have a large negative impact on trust. We next review the
extent to which markets support the three main processes for trust repair: the
attributional, social equilibrium, and structural repair processes.
While embeddedness may develop slowly over time in markets, especially as co-specialization and
frequency increase, our focus is primarily on markets initial condition of little embeddedness.
Attributional repair process. Markets provide some support for the attributional
repair process, but it is slow and imperfect. Trust is naturally repaired if exchange
partners continue to interact and the offending party proves that their nature has changed.
However, as market exchanges are usually infrequent and expectations are not well
defined, reparation through ongoing interaction can be a slow and imperfect process.
Markets also allow for apologies and accounts to be given such that the offending party
offers an explanation regarding their actions and asks forgiveness. However, given the low
level of co-specialization in markets, many partners may find it easier to replace the
offending exchange partner altogether instead of providing the opportunity to repair trust.
Social equilibrium repair process. The social equilibrium process of trust repair is
similarly limited in markets because of the low level of embeddedness. Markets initially
possess few social norms and legal recourse is unable to reestablish or recommit exchange
partners to social norms should they be broken. While markets allow for restorative
actions such as apologies and punishment, there is little incentive to recommit to norms as
little economic value can be created because of low levels of co-specialization. Restoring
the social equilibrium may simply be more costly than switching exchange partners.
Structural repair process. Markets provide little support for trust repair through
the structural repair process. Markets rely on classical contracting (classical legal
recourse) to resolve disputes. Outside enforcement via the courts is rigid, the terms
precise, and decisions legally binding. Even when contracts are incomplete the courts lack
flexibility in how they respond to conflict in the exchange. The lack of internal conflict
resolution mechanisms prohibits markets from changing the exchange structure, terms, or
incentives in order to restore positive expectations. Instead exchange partners must either
rely on legal recourse or choose to replace the exchange partner altogether.
In summary, markets possess few mechanisms that support the building and
maintenance of trust. Furthermore, the mechanisms that markets do possess are limited in
their speed of building and maintaining trust. Individuals similarly have little ability to
influence the building and maintenance of trust in market structures.
Hybrids Ability to Build and Maintain Trust
Hybrids, in contrast to markets, have greater need for trust and have more
mechanisms to support its building and maintenance. The greater need for trust stems
from the desire to support adaptation in the presence of co-specialized investments
between exchange partners. Asset specificity, uncertainty, and frequency in the presence
of asset specificity lead to economic exchange hazards, which are mitigated through
complex contracting and benefited by trust and cooperation.
Complex contracts may take the form of alliances, joint ventures, franchising, or
simply through a well-specified long-term exchange contract. Hybrid forms of governance
are characterized by moderate incentive intensity, administrative controls specified in the
contract, internal conflict resolution mechanisms specific in the contract, and the use of
contract law even though the complexity of hybrid contracts leaves gaps in their
completeness, which opens disputes to uncertain legal interpretations (Williamson 1991).
With this definitional background in place, we turn our attention to assessing hybrid
governance structures for their ability to build and maintain trust.
Hybrids and building trust. Hybrids support the building of trust between
organizations as well as individuals through direct interaction, embeddedness in a social
structure, and through increased structural supports that are not found in markets.
Furthermore, they allow for greater and faster building of trust compared to markets.
Direct interaction. Like markets, expectations are built through exchange
experience. Hybrids, however, offer several additional mechanisms for forming
expectations that are unavailable in markets. First, exchanges mediated by a contract are
usually more frequent than those found in markets because of co-specialization and the
increase of repeated network ties, allowing for more positive experience to be built in a
given timeframe (Gulati 1995). All else being equal trust can build at greater speed in
hybrids. Second, contracts define expectations explicitly and thus offer a measuring stick
for actors with which to evaluate their behavior. Evaluation enables adjustments to be
made that can strengthen positive expectations of trust, which allows partners to contract
more efficiently (Mayer and Argyres 2004) and build trust more quickly as they continue to
interact. Third, the act of contracting signals an exchange partner’s commitment to work
things out in a relationship (Poppo and Zenger 2002), which further shapes expectations.
In combination, the aforementioned mechanisms available in hybrids offer superior
support and speed for building expectations of trust compared to markets.
Embeddedness. Hybrids facilitate the building of trust through embeddedness in
social structures in a more significant way than do markets. Where the initial condition in
markets lacked embeddedness, the initial condition in hybrids entails two or more
organizations, with already-established deep and broad intra-organizational networks,
becoming connected through individuals directly participating in the hybrid relationship.
Pre-existing network connections allow reputations from both organizations to be quickly
communicated through the newly connected networks (e.g. Macaulay 1963).
Co-specialization, which is the underpinning of hybrids, affects the initial condition
of embeddedness within each organization. Trading partners in hybrids often make joint
idiosyncratic investments that embed them in a relationship as such investments introduce
switching costs and thereby limit alternative exchange partners. The resulting bi-lateral
dependence calls for more flexibility in adapting to and resolving disputes when
unforeseen situations arise. Embeddedness facilitates adaptation through reciprocal favors
and adherence to social norms without having to appeal to the economic structure alone
(Uzzi 1997). Reputation also becomes increasingly important to both organizations and
individuals as negative behavior can impact exchanges beyond the focal one. When an
organization does not behave according to the contract, for instance, negative expectations
can be passed on to all other potential trading partners, possibly resulting in loss of future
exchange. Similarly, individuals that damage a trusting relation and are terminated in one
firm may find decreased future employment opportunities because of their negative
reputation within the network (e.g. Macaulay 1963).
Structural supports. Hybrids contain additional structural factors, compared to
markets, that support the building of trust. Hybrids sacrifice some internal incentive
Macaulay gives an example of how this may occur. He notes that salesmen "often know purchasing agents
well. The same two individuals may have dealt with each other from five to 25 years. Each has something to
give the other. Salesmen have gossip about competitors, shortages and price increases to give purchasing
agents who treat them well" (1963, p. 63). On the other hand, when sellers do not satisfy their customers they
"become the subject of discussion in the gossip exchanged by purchasing agents and salesmen, at meetings of
purchasing agents' associations and trade associations or even at country clubs or social gatherings…” (p. 64).
intensity compared to markets in return for administrative controls and internal conflict
resolution mechanisms. Lower incentive intensity decreases the payoff an individual
receives from their own effort and can motivate increased cooperation and stronger career
concerns (Williamson 1991). The structure of hybrids relies on contracts built on excuse
doctrine (Williamson 1991). While courts serve as the final appeal, Macauley observed
that "businessmen often prefer to rely on 'a man's word' in a brief letter, a handshake, or
'common honesty and decency'-even where the transaction involves exposure to serious
risks" (1963: 58). Excuse doctrine relieves parties from strict outside enforcement and
provides cooperation by allowing exchange partners to adjust the structure and terms of
the contract internally. Successful internal cooperation can even lead to heavy reliance on
trust and result in more open-ended contracts that are socially, but not legally, binding
(Jones, Hesterly, and Borgatti 1997). Hybrids also provide monitoring advantages
compared to markets because they provide agreed upon focal points in contract evaluation
and can facilitate specialized monitoring and increased information-sharing (Dyer and
Singh 1998). Thus it becomes easier for an exchange partner to observe behavior and form
well-informed expectations about future reliability. If exchange partners behave according
to expectations, monitoring will increase trust by conveying positive information.
Conversely, monitoring can act as a catalyst for contracts to be adjusted to support the
building of trust should negative information be received. Overall, hybrids contain many
additional structural factors compared to markets that support the building of trust.
Hybrids and maintaining trust. Hybrids offer support for maintaining trust in ways
unavailable in markets. Indeed, unlike markets, hybrid structures support all three
processes of trust repair. Below we explore attributional repair, social equilibrium repair,
and structural repair processes available in hybrids for maintaining trust.
Attributional repair process. Hybrids provide more support and speed than
markets for trust repair through attributional repair processes. Similar to markets, trust
can be repaired in hybrids as exchange partners continue to interact and prove their
change of nature. Yet hybrids offer an advantage over markets as exchanges and
interactions are usually more frequent, providing potential for greater repair speed.
Moreover, contracts define expectations and provide a framework upon which partners
may focus and model their behavior, which facilitates demonstrably correcting the
behavior that initially damaged the relationship.
While hybrids support trust repair through apologies and accounts similar to
markets, contracting also provides two major benefits to the attributional repair process
not found in markets. First, hybrids can shift attribution from the organization to
employees. Over time and through contracting individual expectations move beyond
individual actors and form about the behavior of a partner organization. When such
expectations form, organizations have the opportunity to maintain and even build trust by
attributing any breach of trust to an individual’s motivation and behavior. Such attribution
can be made credible by punishingif not terminatingthe offending employee. Second,
contracts provide a credible method for offending partners to bind themselves to
substantive actions to demonstrate trustworthiness. For instance, violators may
voluntarily propose to implement a new monitoring system or to impose sanctions
(Nakayachi and Watabe 2005). Such actions, which may be directly written into the
contract and are thus more credible than in markets, can repair damaged perceptions by
showing that the nature of the exchange partner has changed.
Social equilibrium repair process. Unlike markets, social equilibrium processes of
trust repair are supported in hybrids because they involve higher levels of co-specialization
and increased embeddedness in the exchange relationship. Co-specialization results in
increased dependence on self-enforcing agreements (based on social norms) as self-
enforcing agreements allow for greater value creation initiatives. For example, even when
contracts are incomplete, dependent exchange partners may be willing to make relation-
specific investments because of credible assurances, based on social norms, that they will
be compensated for their investment (Dyer and Singh 1998). When trust is damaged,
exchange partners may be unwilling to make such investments as the norms that
previously governed the exchange are called into question. Hybrids provide two
mechanisms to “settle the accounts” to repair social equilibrium. The first is through
punishment via the contract. Offending parties may voluntarily submit to sanctions or less-
favorable contract terms as a means of proving their penance and resolving negative
emotions in the offended partner. Second, the offending party may provide explanations
and apologize for their actions while expressing their recommitment to the norms that
previously governed the relationship. Higher levels of co-specialization in hybrids allow
more credibility in such claims as each partner has a vested interest in the relationship
Structural repair process. Hybrids provide more support than markets for trust
repair through structural repair processes. Hybrids rely on a neoclassical contracting
regimeexcuse doctrinewhich relieves parties from strict enforcement and provides a
more flexible contracting mechanism (Williamson 1991). While outside enforcement is
still available through legal recourse, excuse doctrine allows disputes to be resolved
internally. Contracts allow partners to change the context within which the exchange is
situated, through actions such as renegotiation and rewriting the contract, to change the
terms and incentives in order to restore positive expectations and discourage future
transgressions. For instance, exchange partners may choose to implement equity alliances
and either form a new independent jointly owned entity or take a minority equity stake in
the other exchange partners firm (Pisano 1989). While contracting for such alliances may
take longer and require higher cost compared to non-equity alliances, they can mitigate
opportunistic behavior (Williamson 1979) and potentially change the context of the
exchange to allow for trust repair.
In summary, hybrids possess more mechanisms than markets to support the
building and maintaining of trust. Furthermore, the mechanisms in hybrids allow for
greater building and maintaining speed compared to markets. While hybrids have access
to additional mechanisms, the use of such mechanisms depends on adept management of
the contract by exchange partners.
Hierarchy’s Ability to Build and Maintain Trust
Hierarchies have a high need for trust and support the most mechanisms for its
building and maintenance. Hierarchical governance is characterized by weak incentive
intensity, strong internal administrative controls, strong internal conflict resolution
mechanisms, and weak contract law (Williamson 1991). While greater asset specificity and
frequency increase exchange hazards beyond that experienced in hybrid structures,
hierarchies also enjoy monitoring advantages as exchanges take place within the structure
of the firm. When exchange hazards are significant, managers may craft well-specified
complex contracts to govern the exchange. Under high levels of uncertainty, however, it
quickly becomes too costly to contract for all unforeseeable circumstances. In these
situations, firms can find efficiency through vertically integrating (Klein, Crawford, and
Alchian 1978; Williamson 1979). Integration allows for cooperation, coordination, and
flexibility. Low-powered incentives can encourage employee coordination and high-
powered administrative controls allow managers to influence, manage, and even
manipulate exchange relationships. Access to fiat and internal conflict resolution
mechanisms come at a loss of external contract law. Thus exchanges rely solely on internal
mechanisms and the firm becomes its own court of ultimate appeal (Williamson 1991).
Trust is essential for efficient exchanges in hierarchies, largely as a result of the highly
dependent nature of the exchange as well as the lack of outside options.
While integration can decrease exchange hazards under high levels of asset
specificity it is important to note that it is not unusual for integrated exchange partners,
such as business units, to experience low levels of trust. Integrated exchange partners
often face differing incentives and consequently vie for political power or an additional
share of limited resources. Moreover, problems of asymmetric information may lead to
inefficiencies as one exchange partner seeks to “game the system” for their own personal
benefit (e.g. Pierce 2012). These issues are particularly significant as the time horizon
shortens. However, the added tools available for trust building and maintenance in
hierarchies allow the exchange relationship to be organized and managed in order to
minimize such difficulties in the long run. This highlights both an important managerial
role as well as the importance of adept management in hierarchies.
Hierarchies and building trust. Hierarchies support the building of trust between
individuals in an organization through direct interaction, embeddedness in a social
structure, and through increased structural supports not found in hybrids. Furthermore,
when managed correctly, these mechanisms allow for greater building speed compared to
Direct interaction. Because of heightened levels of asset specificity and co-
dependency, direct interaction between parties in hierarchies is usually more frequent
than in hybrids, allowing for more experience in a given timeframe and thus greater speed
in building trust through interaction. In addition, hierarchies differ from hybrids by
enabling managers to influence and shape the exchange relationship in important ways.
First, managers shape expectations between exchange partners. This includes both
defining expectations as well as tempering unrealistic expectations. Second, managers
engage in measurement. Engaging in measurement allows managers to interpret actions
taken by each exchange partner and influence the expectation building process. For
example, if party A does not behave according to expectations, party B may form negative
expectations about party A. Managers, however, can convince party B that party A was not
behaving opportunistically but in effect doing the best it could given the situation. Thus
party B may instead form positive expectations and trust can continue to be built. Lastly,
managers can shape commitment between exchange partners. For instance, managers may
require exchange partners to signal commitment to each other by either incurring some
sunk cost (i.e. making a relation-specific investment) or being subject to some punishment
if they fail to cooperate. Managers also may choose to reward exchange partners based on
how the exchange performs. These actions can influence the amount of commitment in
exchange relationships. Overall hierarchies support expectation building, when managed
adeptly, through direct interaction better than hybrids and allow for greater building
Embeddedness. Hierarchies facilitate the building of trust through embeddedness
in a social structure in a more significant way than hybrids. More frequent exchanges and a
tighter integrated community built on cooperation and coordination allow strong ties to be
developed faster between partners than in hybrids. Highly recurrent exchanges also
support additional norms such as norms of reciprocity and the keeping of social accounts.
Similar to hybrids, the initial condition in hierarchies is embedded, resulting from the high
need for co-specialization. Even more co-specialization in hierarchies, however, leads to
higher switching costs and fewer alternative exchange partners compared to hybrids.
Heightened dependence results in more need for flexibility in adapting exchanges and
resolving disputes when unforeseen situations arise. Embeddedness in hierarchies
provides structure to handle such exchanges by forming a single large community with a
culture based on norms of cooperation and adaptation. Moreover, reputation is more
important in hierarchies than hybrids as negative behavior can impact reputation within
the entire community. Strong ties and a small community provide information about the
trustworthiness of parties that is easily transferred within the firm. The added
embeddedness in hierarchies and the stronger reputation effects support more trust
building and greater building speed than hybrids.
Structural supports. Hierarchies contain additional formal structural factors
compared to hybrids that further support the building of trust. Hierarchies rely on low-
powered incentives compared to hybrids and heightened administrative controls.
Decreased incentive intensity means that employees are unable to immediately directly
impact their compensation through their own efforts. Instead they have heightened
motivation to cooperate and stronger career concerns. The structure of hierarchies is
based on forbearance (Williamson 1991). Forbearance is a stronger internal contract law
than hybrid’s excuse doctrine and requires disputes to be resolved internally. While the
employee relation may still have some access to legal recourse, exchanges between parties
within a firm fall under the jurisdiction of management and have no access to legal
recourse. Thus, exchanges are ultimately overseen by managers who have access to fiat.
These managers identify where trust is needed and adapt the incentives, particularly
career paths, and exchange structure to support it. For instance, managers may choose, up
to a point, to encourage competition or reward exchange partners for cooperation. Making
adjustments in hierarchies is less costly than hybrids because they do not require costly
negotiation and recontracting. Lastly, hierarchies have monitoring advantages compared
to hybrids. Transparency between exchange partners is greater as they both reside in the
same firm. Furthermore, exchanges are overseen by managers who have direct access to
information about each exchange partner’s situation. Increased monitoring provides
added motivation for exchange partners to cooperate. It also allows managers to quickly
identify and modify exchanges in order to support the building of trust. Overall,
hierarchies contain many additional structural factors compared to hybrids that support
the building of trust.
Hierarchies and maintaining trust. Hierarchies support a higher level of trust
maintenance compared to hybrids when managed effectively. As managers set
expectations and policies, engage in measurement, and shape commitment, trust can be
effectively maintained. When damaged, trust repair can be difficult in hierarchies as repair
involves restoring trust in the system, which entails recalibrating the system
. Moreover,
the compositional dimension of integration and the knowledge flows within the firm often
necessitate repairing trust among many individuals (Dirks, Lewicki, and Zaheer 2009;
Gillespie and Dietz 2009). Hierarchies, however, possess access to a greater range of
options in repairing trust because of high-powered administrative controls.
Attributional repair process. Hierarchies provide more support and greater speed
than hybrids for trust repair through the attributional process. Similar to markets and
hybrids, trust can be repaired in hierarchies as exchange partners continue to interact with
good behavior. Hierarchies provide additional advantages as exchanges and interactions
usually are more frequent than in hybrids. Moreover, managerial oversight and increased
information sharing from co-specialization allow for expectations to be defined and
communicated clearly. Thus exchange partners are better able to efficiently identify and
remedy behavior that damages positive expectations.
Access to managers (i.e. fiat) provides key benefits to attributional trust repair in
hierarchies compared to hybrids. Similar to hybrids, exchange partners are able to offer
apologies and accounts and terminate offending employees to restore credibility in
exchanges. Different from hybrids, managers have access to three additional tools to repair
Gillespie and Dietz (2009) put forth four primary internal components that define the organizational
system: Leadership and management practice, culture and climate, strategy, and structure, policies, and
trust. First, not only do hierarchies allow managers to terminate employees, but the
employment relation also allows them to move employees to a different job or to change
the job description altogether. Where in hybrids managers could only influence one side of
the employment relation, hierarchies allow managers to influence both sides. Managers
are therefore able to guide attribution by controlling who participates in the exchange
relationship as well as the role they play. Second, managers may shape attribution
between parties. For example, managers may choose to accept blame when trust is harmed
which, if effective, could restore the violator’s credibility. Third, managers may shape
measurement and influence the perceptions of exchange partners. Managers may use their
authority and credibility to reliably blame some other source for lack of performance. Thus
instead of exchange partners blaming each other, managers can help attribute behavior to a
third source.
Overall, the increased frequency of the exchange and the tools at the
manager’s disposal provide, if exercised, additional supports compared to hybrids for
attributional trust repair.
Social equilibrium repair process. Social equilibrium processes of trust repair are
supported more in hierarchies than hybrids because co-specialization and embeddedness
of the exchange relationship are greater than in hybrids. Hierarchies possess mechanisms
through which managers can influence the social equilibrium repair process. First,
managers can use administrative controls to punish offending parties. Punishment may
include moving employees to new jobs or locations, changing employee job descriptions, or
even termination. Such movements, in essence, introduce a new partner into the exchange,
It is important to note that many of these tools at the manager’s disposal may be limited by information
flows within the firm. The social structure may allow actors to receive information before managers are able
to mediate it. Thus adept managers must move quickly and decisively to repair through attribution before
the problem spreads too widely.
which can act to reset norms. Second, managers may use the powerful levers at their
disposal to encourage offending parties to apologize and make reparations to compensate
the offended party for their loss. Third, managers can encourage exchange partners to
recommit to norms by communicating their expectations. Managers constantly send
signals to employees about what behavior is expected and will be rewarded. These signals
include whether or not untrustworthy or unethical behavior might be tolerated or even
tacitly encouraged in the firm (Dickson et al. 2001). These restorative actions may
recommit exchange partners to norms and allow for continued future exchange.
Structural repair process. Hierarchies provide more support for trust repair
through the structural process than hybrids. Exchanges in hierarchies are built on
forbearance, which removes outside enforcement of the exchange and requires that
disputes must be solved internally using administrative controls (Williamson 1991).
Administrative controls allow managers some freedom in adjusting incentives, structure,
and terms of the exchange to motivate actors towards either competition or cooperation.
For instance, managers may choose to encourage cooperation by promoting individuals
who are team players or by compensating based on group performance. They also can
introduce financial penalties for the observation of undesired opportunistic behavior. An
example of changing the structure is through managers changing job descriptions to
influence the role actors play in the exchange. Adept managers seek to influence structures
and incentive systems to motivate efficient exchange, and skillfully identify how the terms,
incentives, and structure can be changed in order to repair trust and discourage future
opportunistic behavior.
In summary, hierarchies possess more mechanisms that support the building and
maintaining of trust than markets. Furthermore, the mechanisms in hierarchies allow for
greater building and repair speed compared to hybrids. While hierarchies have access to
additional mechanisms, managers are largely responsible for their efficient use. Simply
put, adept managers can support high levels of trust; inept managers can destroy it.
Paradoxes and the Importance of Managers for Building and Maintaining Trust
While we argue that hybrids and hierarchies support mechanisms that can build and
maintain higher levels of trust than markets, and are often chosen for their ability to do so,
research has highlighted the potential for three paradoxes that argue for opposite
outcomesformal structure may inhibit the creation of relationship-based trust instead of
building and maintaining it.
Three paradoxes may limit or reverse relationship-based trust through hybrids and
hierarchy. The first paradox involves an attributional problem that occurs when exchange
partners attribute good” behavior to the structure of the relationship instead of to the
individual (Malhotra and Murnighan 2002; Ferrin and Dirks 2003). Attributing desirable
behaviors and trust only to structure implies individual relationship-based trust would not
exist should the structure be removed or changed.
The second paradox arises should formal governance structures “crowd out”
intrinsic motivations for trust with external structural interventions (Titmuss 1970; Frey
and Oberholzer-Gee 1997; Uzzi 1997). Should crowding out occur then exchange partners
would have to move psychologically from an exchange based on intrinsic motivations to
one that must rely on formal structure, which could lead exchange partners to behave in
ways that may “game the system.”
The third paradox suggests that in particular instances formal structure could
potentially encourage opportunistic behavior and undermine trust should formal structure
signal distrust to exchange partners (Macaulay 1963; Ghoshal and Moran 1996). Partners
consequently may assume that the reason they are interacting through a formal
governance structure is because their exchange partner is inherently untrustworthy.
These paradoxes all predict that formal governance structures may undermine and
eliminate relationship-based trust.
Resolving the paradoxes with respect to our exploration is beyond the scope of our
paper. Nonetheless, both our exploration and the paradoxes point us in a similar direction:
that managers play a central role at least in hybrids and hierarchy in building and
maintaining trust. Managers not only shape contracts and organizational structure, they
also hold conversations and communicate with exchange partners and employees; play an
important role in setting expectations, encouraging and managing embeddedness, and
establishing the formal structure of and running of governance structures; and play a
central role in attributional, social equilibrium, and structural repair processes. In other
words, managers and their behavior are a necessary part of understanding the building and
maintenance of trust and may provide an explanation for when the paradoxes arise.
Formal structure may undermine and preclude certain types of trust if the actions of
managers do not display complementarity. Put simply, inept management can destroy
trust even in the best of formal governance structures. If so, then future research on the
described paradoxes needs to adopt a more nuanced view of trust building and
maintaining, one that involves both the structural dimensions of governance and those who
manage exchanges and people.
In this chapter we explored the extent to which the institutional archetypes of
markets, hybrids, and hierarchies vary in their capacity to support the building and
maintenance of trust. While a broad literature focuses on how trust impacts governance,
the benefits to trust in exchanges, and the mechanisms that build and maintain trust in
general, less is known about how the internal workings of governance structures impact
the building and maintaining of trustor how trust is endogenously impacted by
governance structures. We propose that integrating trust into the economic theory of the
firm can provide insights into the relationship between trust, governance structures, and
exchange performance. This chapter seeks to provide a foundation and lay out essential
elements where upon future theory may be built to integrate trust more fully into the
economic theory of the firm.
Our exploration identifies inherent differences in governance structures that
influence each building mechanism and repair process. Furthermore, we find that the
speed of building and repair is impacted differently by governance structure. Overall, we
find that market structures provide little support for building and maintaining trust. In
comparison hybrid structures provide a variety of supports for building and maintaining
trust. And, hierarchies offer an even greater variety of supports. While hybrids and
hierarchies have access to a greater array of supports to affect trust, we find that the
efficacy and use of these mechanisms is dependent upon managers. Moreover, while adept
managers can support high levels of trust; inept managers can destroy it. In the initial
governance decision such considerations are important. When high levels of trust are
needed or desired between exchange partners it may be beneficial for a firm to align its
governance structure accordingly in order to take advantage of managerial or structural
resources used to build and maintain trust.
We propose that future efforts should build on our exploration to develop theory
that provides testable implications and integrates trust into the theory of the firm. Such a
theory should explain how trust is endogenously impacted by each governance structure
and the resulting implications this may have on firm performance. Moreover, a complete
theory must address the role of managers in the building and maintenanceincluding the
repairof trust. We assert that a fruitful area of future research concerns explication of
exactly what managers can do (and not do) to build and maintain trust within and between
organizations. A further understanding of the managerial role may provide insight into the
resolution of the three paradoxes outlined earlier and lead to a more robust theory of the
In conclusion, we emphasize that to resolve the difficult questions put forth in this
chapter and to develop a complete theory of trust and the economic theory of the firm
necessarily requires an interdisciplinary approach. Yet as trust impacts and can provide
benefits to the firm and its employees at all levels of analysis, we propose that developing a
more complete theory of trust in the context of the economic theory of the firm is a useful
and necessary undertaking.
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Full-text available
A phenomenon of the last 20 years has been the rapid rise of the network form of governance. This governance form has received significant scholarly attention, but, to date, no comprehensive theory for it has been advanced, and no sufficiently detailed and theoretically consistent definition has appeared. Our objective in this article is to provide a theory that explains under what conditions network governance, rigorously defined, has comparative advantage and is therefore likely to emerge and thrive. Our theory integrates transaction cost economics and social network theories, and, in broad strokes, asserts that the network form of governance is a response to exchange conditions of asset specificity, demand uncertainty, task complexity, and frequency. These exchange conditions drive firms toward structurally embedding their transactions, which enables firms to use social mechanisms for coordinating and safeguarding exchanges. When all of these conditions are in place, the network governance form has advantages over both hierarchy and market solutions in simultaneously adapting, coordinating, and safeguarding exchanges.
This review article focuses on the three control mechanisms that govern economic transactions between actors: price, authority, and trust. In contrast to conventional approaches that view market and hierarchy as mutually exclusive control mechanisms (or as poles of a continuum), we argue that price, authority, and trust are independent and can be combined in a variety of ways. For instance, price and authority are often played off each other within firms, while trust and price are sometimes intertwined to control transactions between firms. We also identify a type of organization largely ignored in the literature: the plural form. In the plural form, organizations simultaneously operate distinct control mechanisms for the same function. For example, organizations operate franchises and company-owned units under the same trademark, and companies sometimes make and buy the same part. To understand this form, the analytic focus must move from individual transactions to the broader architecture of control mechanisms
How can relationships be repaired after being damaged? There is a small but growing body of work on the topic from a number of different disciplinary perspectives using different theoretical lenses and at different levels of analysis. We begin by examining the existing streams of work on relationship repair and organizing them into a conceptual framework. We then consider four questions that probe assumptions or overlooked issues in existing research with the intent of moving toward a more comprehensive conceptual foundation.
We examine the repair of one party's trust in another via repairing trustworthiness (Mayer, Davis, & Schoorman, 1995). Based on Weiner's (1986) causal attribution theory, we posit that causal attributions (i.e., locus of causality, controllability, and stability) for the cause of a negative outcome in a trusting relationship explain when trustworthiness is in need of repair and how trustworthiness may be repaired by the trustee's efforts. We also discuss the role of specific emotional reactions of the truster in this process.
Transaction cost theorists have generally neglected to consider the implications that the invisible hand of the market mechanism can have for the risk of opportunism. In the long run, the invisible hand deletes actors whose behaviors are habitually opportunistic. Consequently, as markets move toward the state of competitive equilibrium, the risk of opportunism will be low, even for transactions supported by specific asset investments. Therefore, in many contexts the transaction cost rationale for internalization has been overstated.