Network governance — coordination characterized by informal social systems rather than by bureaucratic structures within firms and formal contractual relationships between them is increasingly used to coordinate complex products or services in uncertain and competitive environments (Piore & Sable, 1984; Powell, 1990; Ring & Van de Ven, 1992; Snow, Miles & Coleman, 1992). Network governance has been observed in industries such as semiconductors (Saxenian, 1990), biotechnology (Barley, Freeman & Hybels, 1992), film (Faulkner & Anderson, 1987), music (Peterson & Berger, 1971), financial services (Eccles & Crane, 1988; Podolny, 1993, 1994), fashion (Uzzi, 1996a, 1996b), and Italian textiles (Lazerson, 1995; Mariotti & Cainarca, 1986). Although network governance is widely acknowledged and seen as producing important economic benefits, "…the mechanisms that produce these benefits are vaguely specified and empirically still incipient (Uzzi, 1996a: 677)." This vague specification takes the form of a lack of clarity on what network governance is, when it is likely to occur, and how it helps firms (and non-profit agencies) resolve problems of adapting, coordinating, and safeguarding exchanges.

A synthesis of transaction cost economics (TCE) and social network theory can resolve this vague specification of network governance in multiple ways. TCE provides a "relentlessly comparative" framework for assessing alternative governance forms (Williamson, 1994). It allows us to go beyond descriptive observations of where network governance has occurred and identify the conditions that predict where network governance is likely to emerge. Prior work within the TCE framework has shown that relational contracting is the basis for an alternative governance form between markets and hierarchies (Eccles, 1981; Jarillo, 1988; Mariotti & Cainarca, 1986). These studies, while important, rarely define network governance and do little to show how network governance resolves fundamental problems of adapting, coordinating, and safeguarding exchanges. In addition, since these studies most often focus on exchange dyads rather than the network’s overall structure or architecture, they cannot adequately show how the network structure influences exchanges.

A synthesis of TCE and social network theory also advances our understanding of transaction costs and governance. Although the social context — referred to as structural embeddedness — surrounding economic exchange has been recognized as critical since Granovetter’s (1985) widely cited critique, it has not been integrated into the TCE framework. "Embeddedness refers to the fact that economic action and outcomes...are affected by actors’ dyadic (pairwise) relations and by the structure of the overall network of relations" (Granovetter, 1992: 33). As Williamson (1994: 85) acknowledges, "network relations are given short shrift" partly because of TCE’s preoccupation with dyadic relations. We integrate social context into the TCE perspective by explaining how social mechanisms influence the costs of transacting exchanges. Specifically, we show that exchange conditions characterized by needs for high adaptation, high coordination, and high safeguarding influence the emergence of structural embeddedness. We also show how structural embeddedness provides the foundation for social mechanisms such as restricted access, macrocultures, collective sanctions, and reputations to coordinate and safeguard exchanges in network governance. We move beyond recent work on embeddedness by explaining how structural embeddedness arises and provides a foundation for social mechanisms to coordinate and safeguard exchanges. Finally, we show how social mechanisms interact to create an exchange system where coordination and cooperation among autonomous parties for customized exchanges is not only possible but probable.

By integrating TCE and social network theory, we provide a simple yet coherent framework for identifying the conditions under which network governance is likely to emerge, and the social mechanisms that allow network governance to simultaneously coordinate and safeguard customized exchanges in rapidly changing markets.

We organize the paper as follows. First, we review the literature defining network governance and provide our own definition. Second, we identify conditions for network governance and explore why networks are employed rather than markets or hierarchies. Third, we explain how structural embeddedness arises out of exchange conditions and provides the foundation for social mechanisms used in network governance. In addition, we specify how key social mechanisms enhance coordination and reduce behavioral uncertainty among exchange parties. These social mechanisms in network governance reduce transaction costs to gain comparative advantage over markets and hierarchies. This enables network governance to emerge and thrive. Finally, we suggest future directions for research on network governance.