Does familiarity breed trust? The implications of repeated ties for contractual choice in alliances. (Special Research Forum: Intra- and Interorganizational Cooperation) Relevancy: 100; ( Academy of Management Journal ) Gulati, Ranjay; 02-01-1995 Size: 66K Reading Level: 11.
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Joskow, P. 1985. Contract duration and relationship-specific
investments: Empirical evidence from coal markets. American Economic
Review, 77: 168-185.
Kanter, R. M., & Myers, P. 1989, Inter-organizational bonds and
intra- orgonizational behavior: How alliances and partnerships change the
organizations forming them. Paper presented at the First Annual Meeting of
the Society for the Advancement of Socio-Economics, Cambridge, MA.
Kogut, B. 1988. A study of the life cycle of joint ventures, In F. K.
Contractor & P. Lorange (Eds.), Cooperative strategies in
international In the last two decades, a number of environmental shifts
have led to new opportunities for interfirm cooperation - the
globalization of markets, the convergence of and rapid shifts in
technologies, the rise of Japan and Europe as technologically advanced
economies, and regulatory changes within the United States. Perhaps the
most significant manifestation of this rise in interorganizational
cooperation has been the dramatic increase in interfirm strategic
alliances. Such alliances encompass a variety of agreements whereby two or
more firms agree to pool their resources to pursue specific market
opportunities. These agreements include joint ventures, joint R&D
agreements, technology exchange, direct investment, licensing, and a host
of other arrangements. Many empirical studies have documented the dramatic
growth of such alliances in numerous industrial sectors, the multitude of
reasons why firms have entered into such partnerships, and the wide
variety of contractual arrangements firms use to formalize their alliances
(Contractor & Lorange, 1988; Harrigan, 1986, 1989; Hergert &
Morris, 1988; Hladik, 1985).
Economists and management theorists have become concerned in recent
years with the contractual, or governance, structures used in alliances
and most have adopted a theoretical stance informed by transaction cost
economics (cf. Hennart, 1988; Pisano, 1989; Pisano, Russo, & Teece,
1988). Transaction cost theorists argue that anticipated transaction costs
determine the type of contract used in an alliance. Transaction costs,
which typically arise out of concerns about opportunistic behavior on the
part of one or more of a set of partners, include the costs of negotiating
and writing contingent contracts, monitoring contractual performance,
enforcing contractual promises, and addressing breaches of contractual
promises (Joskow, 1985: 36).
Much of the prior empirical research on transaction cost economics has
examined the choice companies make between vertical integration and
arm's-length market transactions, also called the make-or-buy decision
(Balakrishnan & Wernerfelt, 1986; Masten, 1984; Monteverde &
Teece, 1982; Walker & Weber, 1984). In these instances, treating each
transaction as discrete is justifiable since the repeated making of ties
between the same two partners is rare. However, two firms may enter
multiple strategic alliances with each other over several years. Empirical
studies on the governance of alliances have unfortunately continued in the
transaction cost economics tradition, treating each alliance as
independent and considering the activities it includes as singularly
reflecting the transaction costs associated with it. The approach taken is
thus static; it ignores the possibility of repeated alliances and the
emergent processes resulting from prior interactions between partners that
may alter their calculus when they are choosing contracts in alliances
(Ring & Van de Ven, 1992; Zajac & Olsen, 1993).
By ignoring the fact that firms may enter multiple alliances with each
other over time, empirical work informed by transaction cost economics
precludes the possibility that an important economic and social context
may alter the formal structure of those alliances and the transaction
costs associated with them. This omission is significant because
experience can engender trust among partners, and trust can limit the
transaction costs associated with their future alliances (Granovetter,
1985, 1992; Marsden, 1981). Early theorizing within transaction cost
economics highlighted such facets (Commons, 1970; Williamson, 1975), but
subsequent researchers in this stream have not systematically examined
This article draws on both transaction cost economics and sociological
theory to examine the factors that explain the choice of governance
structure in individual alliances. The social context of alliances, viewed
here as emerging over time, can only be observed by examining firms'
relationships over time. Thus, I tested predictions with comprehensive
data on alliances formed between 1970 and 1989 in the biopharmaceutical,
new materials, and automotive economic sectors by American, European, and
Japanese firms. I defined an alliance as any independently initiated
interfirm link that involves exchange, sharing, or co-development. This
definition, which excludes one-time marketing promotions, transient
distribution agreements, technology purchase agreements, and state-
supported R&D programs such as SEMATECH, a semiconductor industry
consortium, the Microelectronics Computer Corporation, and ESPIRIT, a
European Community - supported subsidy program, is consistent with many
prior empirical approaches to the study of alliances (Harrigan, 1986;
Hergert & Morris, 1988; Hladik, 1985; Parkhe, 1993).
TRANSACTION COSTS AND THE GOVERNANCE OF ALLIANCES
According to transaction cost economics, in a world without transaction
costs all activities would be carried out as exchanges between units, and
it is due to the failure of markets, or arenas of exchange, to allow for
many exchanges without prohibitively high governance costs that
organizations come to exist (Williamson, 1985, 1991). In other words,
hierarchical organization is considered a response to market failure.
Transaction cost economics is not only concerned with the emergence of
organizations per se to manage transaction costs, but also with how the
choice of organizational form may vary according to the specific types of
exchange activities encompassed. Thus, a second-order question examined
is, how can existing exchange relations be structured to economize on
transaction costs? In this context, the application of transaction cost
economics to the formation of alliances is most apparent. Since alliances
blend elements of the two extremes of market and hierarchy, it follows
that firms would enter such arrangements when the transaction costs
associated with an exchange are intermediate and not high enough to
justify vertical integration (Bradach & Eccles, 1989; Eccles, 1981;
A similar logic can be applied to draw even liner distinctions about
the type of contract used in those intermediate instances in which
transaction cost considerations mandate alliances. The contract used for
an alliance will be closer to either the market or the hierarchy extreme,
depending on the magnitude of the transaction costs: the greater the
transaction costs, the more hierarchical the contract (Pisano, 1989;
Pisano et al., 1988). The possibility of opportunistic behavior by a
partner generates the most salient transaction costs in the alliance
context. Additional costs result from making alliance- specific
investments and from any uncertainty associated with the partnership
The specific governance structure of alliances is important for a
number of reasons. First, a contract is an important mechanism by which
firms protect themselves from a partner's opportunism. Evidence suggests
that firms entering alliances are potentially vulnerable to the
opportunistic behavior of their partners (Business Week, 1986; Doz, Hamel,
& Prahalad, 1989; Kogut, 1988, 1989; Reich & Mankin, 1986). In the
face of the hazards associated with alliances, the contracts used reflect
the risks the partners see (Ring & Van de Ven, 1992).
Second, a contractual agreement serves as a framework within which
cooperation between partners proceeds. Although alliance partners may not
follow their initial contract to the letter, it provides a set of
normative guidelines: "The major importance of a legal contract is to
provide a framework ... a framework highly adjustable, a framework which
almost never accurately indicates real working relations, but which
affords a rough indication around which such relations vary, an occasional
guide in case of doubt, and a norm of ultimate appeal when the relations
cease in fact to work" (Llewellyn, 1931: 736-737).
Third, the recent availability of an array of innovative contractual
arrangements opens up the possibility of new interfirm cooperative
agreements. The dramatic increase in the use of arm's-length contracts,
which don't involve shared ownership, is particularly noteworthy in this
Equity and Nonequity Alliances
Transaction cost economists have classified the governance structures
of alliances in terms of their use of equity ownership (Pisano, 1989;
Pisano et al., 1988). Equity alliances, as defined by transaction cost
economists, take one of two forms (Pisano, 1989). They can either be
organized as an equity joint venture, which involves the creation of a new
and independent jointly owned entity, or they can come about when one of
the partners takes a minority equity position in the other partner or
partners. Transaction cost economists justify treating equity joint
ventures and minority equity investments as a single category on the
grounds that "a direct equity investment by one firm into another
essentially creates an equity joint venture between one firm's existing
shareholders and the new corporate investor" (Pisano, 1989: 111). In both
types, the effective shared equity stakes of the firms vary case by case.
The important point is that beyond a certain threshold, the shared
ownership structure effectively deters opportunistic behavior.
Equity-based ventures are considered hierarchical to the extent that
they more closely replicate some of the features associated with
organizational hierarchies than do other alliances. An example of an
equity joint venture is CFM International (CFMI), whose partners are the
French jet engine manufacturer Societe Nationale d'Etude et de Constuction
de Moteurs d'Aviation (SNECMA) and General Electric. This 50-50 venture,
formed in 1971 to produce jet engines for small commercial aircraft, has
been eminently successful. According to the original agreement, the
partners were to share both ownership and work equally. As is typical of
equity joint ventures, CFMI is an entity with its own headquarters, chief
executive officer (CEO), board of directors, and staff, members of which
come from both companies (Enright, 1992).
Nonequity arrangements in contrast, don't involve the sharing or
exchange of equity, nor do they usually entail the creation of a new
organizational entity. In the absence of any shared ownership structure,
nonequity alliances are more akin to arm's-length market exchanges on the
continuum of market to hierarchy. Organization members of the partner
firms work together directly from their own organizational confines.
Nonequity alliances include unidirectional agreements, such as licensing,
second- sourcing, and distribution agreements, and bidirectional
agreements such as joint contracts and technology exchange agreements.
Examples of such alliances are some of the partnerships Cadence
Technologies, a leader in electronic design automation, has entered over
the years with their leading customers, such as Harris, Toshiba, National
Semiconductor, Ericksson, Intel, Phillips, IBM, Mitsubishi, Kawasaki
Steel, and SGS-Thompson. Within such partnerships, the customers share
Cadence' s development costs for new products that are especially useful
for the former's own purposes. They provide Cadence with financial
resources and may maintain engineering staff at Cadence to assist in the
ongoing development efforts. Equity is exchanged, and no new
organizational entities are created to oversee the partnerships.
From a transaction cost economics standpoint, quasi-market ties like
nonequity alliances are the default mode for organizing alliances, and the
use of equity must be explained. The explanation offered is that firms use
equity alliances when the transaction costs associated with an exchange
are too high to justify a quasi-market, nonequity alliance. Researchers
have identified two sets of governance properties through which equity
alliances effectively alleviate transaction costs (Pisano et al., 1988).
The first are the properties of a "mutual hostage" situation in which
shared equity helps align the interests of all the partners. Not only are
the partners required to make ex ante commitments to an equity alliance,
but also, their concern for their investment reduces the possibility of
their behaving opportunistically over the course of the alliance
(Williamson, 1975). In the case of alliances that involve sharing or
developing new technologies over which property rights are difficult to
enforce, equity ownership also provides an effective means for allocating
such resources. For instance, at CFMI, both partners benefit from the
increasing value of their equity in the venture. Issues of the ownership
of intellectual property developed in the venture are sidestepped as the
property belongs to the venture itself.
The second set of properties are those of the administrative hierarchy
that not only oversees the day-to-day functioning of an alliance, but also
addresses contingencies as they arise. In equity joint ventures, a
hierarchy of managers serves this function; in the case of direct equity
investments, hierarchical supervision is created when the investing
partners participate in the board of directors of the partner that
received the investment. For instance, the top management team of the
joint venture CFMI includes a CEO, a chief financial officer (CFO), and
two vice presidents. Traditionally, the CEO and one vice president have
come from SNECMA and the CFO and the other vice president from General
Electric. The board of directors, which includes top managers from both
partners, ratifies important decisions. This participation is the
mechanism by which partners exercise their residual rights of control
(Grossman & Hart, 1986).
The benefits of equity alliances must be weighed against their
disadvantages. Equity alliances can not only take a long time to negotiate
and organize, but can also involve very high exit costs. Furthermore,
significant administrative costs can be associated with the hierarchical
supervision they encompass.
The same pros and cons must be assessed for nonequity alliances. They
can be negotiated rapidly and require only limited investments from each
partner. For instance, the partners at Cadence Technologies can withdraw
their investments at short notice if necessary, and Cadence can put
together such alliances with other partners relatively quickly. But
partners are vulnerable to each other's opportunistic behavior, and one
may find it difficult to persuade the other to make significant
alliance-specific investments (Joskow, 1985). A further difficulty may
arise in alliances formed to share or develop new technologies; here,
significant disagreements on the allocation of property rights may arise.
Even when there is agreement, it may be difficult to transfer tacit
knowledge across loosely connected firms (Badaracco, 1990; Hennart,
1988).(1) Furthermore, such agreements entail a fair amount of management
effort, albeit of a different nature than that required in equity
Following prior research on the governance of alliances, I chose to
focus on the dichotomy between equity and nonequity alliances. My central
concern was to examine the factors that explain the use of equity in
alliances. I looked at equity for numerous reasons. First, its use is a
prominent feature that offers a means to distinguish most alliances, Most
other classifications are not based on such a readily measured feature, so
alliances cannot easily be placed on their proposed scales. Second, the
use of equity is an important measure by which partners, especially
first-time ones, address their concerns about malfeasance in alliances. My
previous fieldwork at firms entering alliances corroborates this practice
(Gulati, 1993). Third, prior research by transaction cost economists on
these issues has focused on the use of equity, so looking at the dichotomy
between equity and nonequity alliances allows the present findings to be
compared to those of prior research.
R&D alliances. Firms enter alliances for a wide variety of
reasons.(2) A primary basis from which transaction cost economics has
examined the costs associated with alliances has been the activities
encompassed by the agreement, for instance, the presence of R&D. Prior
research suggests that transactions involving the sharing, exchange, or
co- development of knowledge can be somewhat problematic because of the
peculiar character of knowledge as a commodity (Arrow, 1974). Many of
these problems result from parties' inability to accurately assess the
value of the commodity being exchanged as well as from concerns about
opportunism resulting from poor monitoring possibilities in such exchanges
(Balakrishnan & Koza, 1993). The difficulty of transferring R&D
know-how across organizations compounds these problems (Badaracco, 1990;
Hennart, 1988). In sum, alliances with an R&D component are likely to
have higher transaction costs than those that don't involve joint
Transaction cost theorists claim that alliances encompassing R&D
will most likely be organized as equity-based partnerships because of the
significant transaction cost burden. Shared equity can align the interests
of partners and limit opportunistic behavior by focusing attention on
their equity stake in the alliance. Furthermore, such alliances are
usually accompanied by an independent administrative structure, which
fosters information flow and provides for ongoing coordination.
In a study of the telecommunications industry, Pisano, Russo, and Teece
(1988) explicitly tested the impact of transaction costs on the nature of
alliances. They predicted that the greater the hazards associated with an
alliance, the more likely it will be equity based, and their findings
supported these predictions. Pisano (1989) observed similar results in the
biotechnology sector. In both cases, high transaction costs were measured
as the presence of an R&D component in the alliance. In a study of
U.S.-Japanese alliances, Osborn and Baughn (1990) followed a similar
reasoning and also showed that alliances encompassing joint R&D were
more likely to be equity based. Thus,
Hypothesis 1: Alliances are more likely to be equity based if they have
a shared R&D component.
Unlike transaction costs analyses, the current work treated this
hypothesis as a starting point rather than an end point.
THE ROLE OF INTERFIRM TRUST IN ALLIANCES
In recent years, numerous researchers have been critical of transaction
cost economics' treatment of each transaction between companies as an
independent event (Doz & Prahalad, 1991; Ring & Van de Ven, 1992).
This assumption is particularly inappropriate where firms repeatedly enter
transactions with each other. Why and how are repeat alliances likely to
differ from one-time alliances in governance structure? An important cause
and consequence of such repeat alliances among firms is the emergence of
interfirm trust, which obliges partners to behave loyally and can play an
important role in their choice of governance structure for future
alliances with each other. The term trust has widely varying connotations
(for excellent reviews on the topic, see Barber , Gambetta ,
and Luhmann ). In this context, I conceived of trust as "a type of
expectation that alleviates the fear that one's exchange partner will act
opportunistically" (Bradach & Eccles, 1989: 104). This definition is
akin to Simmel' s notion of mutual "faithfulness" in social relationships
(Simmel, 1978: 379). Gambetta gave this cogent definition of such forms of
Trust . . . is a particular level of the subjective probability with
which an agent assesses that another agent or group of agents will perform
a particular action both before he can monitor such action . . . and in a
context in which it affects his own action. When we say we trust someone
or that someone is trustworthy, we implicitly mean that the probability
that he will perform an action that it beneficial or at least not
detrimental to us is high enough for us to consider engaging in some form
of cooperation with him (1988: 217).
Can there be trust between two organizations that are simply
agglomerations of individuals. Intuitively, trust is an interpersonal
phenomenon. Some sociologists have argued that although expectations of
trust do ultimately reside within individuals, it is possible to think of
interfirm trust in economic transactions (Zucker, 1986). At the
organizational level, observers point to numerous examples of
"preferential, stable, obligated, bilateral trading relationships" to
illustrate that firms develop close bonds with other firms through
recurrent interactions (Sabel, 1991). Recent historical accounts of
industrial districts such as the modern woolens center at Prato, Italy,
the injection molding center in Oyannax, France, the cutlery industry in
Sheffield, England, and the nineteenth-century Swiss watch-making region
(Piore & Sabel, 1984; Sabel, 1991; Sabel & Zeitlin, 1985; Weiss,
1984, 1988) support this argument. Similar accounts have been made of
subcontracting relations in the Japanese textile industry (Dore, 1983),
the French engineering industry (Lorenz, 1988), the American construction
industry (Eccles, 1981), and the Italian textile industry (Johnston &
Lawrence, 1988). A variety of terms have been used to describe this
phenomenon: Williamson (1985) described it as both "relational
contracting" and "obligational contracting"; Eccles (1961) as "quasi-firm
arrangements"; Johnston and Lawrence (1988) as "value-added partnerships";
Dore (1983) as "obligated relational contracting"; and Zucker (1986) as
"process- based trust." Underlying all these accounts is a single notion:
interfirm trust is incrementally built as firms repeatedly interact (Good,
The idea of trust emerging from prior contact is based on the premise
that through ongoing interaction, firms learn about each other and develop
trust around norms of equity, or "knowledge-based trust" (Shapiro,
Sheppard, & Cheraskin, 1992). There are strong cognitive and emotional
bases for such trust, which are perhaps most visible among individual
organization members (Lewis & Weigert, 1985). Macaulay, in a seminal
essay, observed how close personal ties emerged between individuals in
organizations that contracted with each other; these personal
relationships in turn "exert pressures for conformity to expectations"
(Macaulay, 1963: 63). Palay (1985) similarly found that the relationships
between rail-freight carriers and auto shippers were overlaid with close
personal connections among members of those organizations. He described
how these overlapping relationships were an important factor in their use
of informal contracts in a situation that would otherwise have demanded a
detailed, formal contract because of high transaction costs. Kanter and
Myers (1989) pointed out that interpersonal ties across organizations with
alliances increase over time. Similarly, Ring and Van de Ven (1989)
pointed to the important role of informal, personal connections across
organizations in determining the governance structures used to organize
How is trust between firms likely to alter their choice of contracts in
subsequent alliances? Perhaps the biggest concern of firms entering
alliances is the predictability of their partners' behavior. A detailed
contract is one mechanism for making behavior predictable, and another is
trust. Where there is trust, people may not choose to rely upon detailed
contracts to ensure predictability. Indeed, as Macaulay observed:
"Detailed negotiated contracts can get in the way of creating good
exchange relationships between business units" (1963: 64).
Entertaining the possibility of trust between alliance partners
emerging from prior ties clearly alters assessments of the transaction
costs associated with specific alliances. Trust counteracts fear of
opportunistic behavior and as a result, is likely to limit the transaction
costs associated with an exchange. This process in turn should affect the
governance structure of the alliance. In other words, trust can substitute
for hierarchical contracts in many exchanges and serve as an alternative
control mechanism (Bradach & Eccles, 1989).
It is important to distinguish knowledge-based trust just discussed
from deterrence-based trust, which also plays a role in repeat alliances
(Ring & Van de Ven, 1989; Shapiro et al., 1992). The latter emphasizes
utilitarian considerations that may also lead to believing that a partner
will behave in a trustworthy manner. Specifically, trust can arise when
untrustworthy behavior by a partner can lead to costly sanctions that
exceed any potential benefits that opportunistic behavior may provide.
Some potential sanctions are loss of repeat business with the same
partner, loss of other points of interaction between the two firms, and
loss of reputation (Granovetter, 1985; Macaulay, 1963; Maitland, Bryson,
& Van de Ven, 1985: 63). Thus, on strictly utilitarian grounds it is
to the firm's benefit to behave in a trustworthy manner.(3)
How significant might the role of such deterrent sanctions be in the
case of interfirm alliances? Recent research on alliances suggests that
most firms are embedded in a social network of prior alliances through
which they are connected with one another either directly or indirectly
(Kogut, Shan, & Walker, 1993; Powell & Brantley, 1993). Within
such a dense social network, reputational considerations should play an
important role in each firm's potential for future alliances. Furthermore,
as this article shows, many firms do engage in repeat alliances with each
other, suggesting that there are always prospects for future partnerships
among presently allied firms.
Trust itself can be difficult to observe and measure. It has a taken-
for-granted character since it is so closely linked to fundamental social
norms and customs. Following prior research, I chose to use a factor that
likely produces trust as its proxy (Zucker, 1986) - prior alliances
between firms. This substitution is based on the intuition that two firms
with prior alliances are likely to trust each other more than other firms
with whom they have had no alliances (Ring & Van de Ven, 1989).(4)
Other theorists have made similar claims about the role of repeat
alliances. In a survey-based empirical study, Parkhe (1993) observed that
the presence of a prior history of cooperation between two firms limited
their perception of expected opportunistic behavior in new alliances and
as a result lowered the level of contractual safeguards employed in those
alliances. Drawing on an inductive field study at seven pairs of firms in
alliances, Larson (1992) observed that firms not only rely extensively
upon mechanisms of social control, as opposed to formal contracts, in the
formation and maintenance of alliances, but that such relational factors
become increasingly important as the relationships between firms develop
The operational proposition examined here is that firms are less likely
to use equity in repeated alliances than in a first-time alliance since
interfirm trust based on prior alliances reduces the imperative to use
equity. Actors are thus willing to take what Williamson (1993) calls
"calculative risks" because of their confident expectation that their
counterparts will act responsibly. Thus:
Hypothesis 2: The greater the number of previous alliances between the
partners in an alliance, the less likely the alliance is to be equity
A further question remains as to whether the character of the previous
alliances affects the type of new alliance used. It could be that two
firms will prefer a nonequity alliance only when they already have an
equity alliance in place. According to such a logic, an equity alliance
creates a hostage situation by requiring ex ante commitments by the
partners and engendering partners' concern for the value of their
investments. Once two firms share one hostage it obviates the need for
additional hostages. This is similar to what Williamson (1983) described
as "credible commitments." A singular focus on this hostage- taking
character is, however, overly narrow. As highlighted earlier, prior equity
alliances are more than simple hostages. They entail close interactions
between the partners over prolonged periods of time, all of which can
enhance trust through mutual awareness. As a senior manager whom I
interviewed at a computer software firm said,
Our technology partnerships are organized as detailed equity-based
contracts. . . . These in turn have led to numerous repeated alliances
with the same set of firms. . . . In our subsequent alliances we don' t
bother to write detailed contracts. That would not only be tedious but
also an insult to our relationship, Sometimes we give our lawyers only a
few days to write up the contract, and that too after the project may
already have begun.
Such behavior could be a result of having a hostage in the form of an
equity alliance already in place. However, informants also reported that
the logic behind their use of loose contracts was not so much the existing
equity alliance, but their familiarity with their partners and judgment
that they were trustworthy (Gulati, 1993).
An alternative to the above scenario is that two firms will prefer a
nonequity alliance even when they only have a prior nonequity tie that may
be easy to dissolve but also enhances mutual awareness.(5) This effect is
likely to be less significant than that arising from the presence of prior
equity alliances, which not only create shared hostages but may lead to
closer interaction among partners. Thus,
Hypothesis 3a: The greater the number of previous equity alliances
between the partners in an alliance, the less likely an alliance is to be
Hypothesis 3b: The greater the number of previous nonequity alliances
between the partners in an alliance, the less likely the alliance is to be
Looking beyond the history of alliances between given firms, I also
expected firms to trust domestic partners more than international
partners, not only because more and better information is available about
domestic firms, but also because the reputational consequences of
opportunistic behavior are greater in a domestic context (Gerlach, 1990).
"Character-based trust," whereby firms trust others that are socially
similar to themselves, may also be an issue (Zucker, 1986). Given such
trust, I expected firms to be more willing to engage in loose,
quasi-market alliances with domestic partners than with international
Hypothesis 4: Alliances are more likely to be equity based if they are
among firms of different nations.
Alliances can be between two or more partners. Research on group
behavior suggests that beyond a certain threshold, an increase in the
number of participants in any group can lead to dysfunctional behavior
within the group and to a decline in its ability to perform assigned tasks
(Hackman, 1987; Steiner, 1972). Within alliances, the presence of more
than two partners heightens the possibility of stalemates and conflicts.
Inasmuch as multilateral alliances pose larger organizational problems
than bilateral alliances, I expected them to more likely be equity
Hypothesis 5: Alliances are more likely to be equity based if they are
among more than two firms.
The unit of analysis here was the transaction. My data set included
information on all publicly announced alliances in the period 1970- 89 in
the biopharmaceuticals, new materials, and automotive economic sectors.
The biopharmaceutical sector includes applications in therapeutics,
vaccines, and diagnostics. The new materials sector includes metals,
ceramics, polymers, and composites. The automotive sector includes both
manufacturers of finished automobiles and their suppliers.
More than half the data came from the Cooperative Agreements and
Technology Indicators (CATI) database, collected by researchers at the
Maastricht Economic Research Institute on Innovation and Technology
(MERIT) at the University of Limburg. Unlike data on alliances drawn
solely from announcements in popular business periodicals like the Wall
Street Journal, the CATI data were collected by examining technical
journals, books, and business periodicals for various sectors. I collected
the remainder of the alliance data used here from numerous sources,
including industry reports, industry-specific articles reporting
alliances, and materials from industry consultants. For the automotive
industry, the sources I consulted included Automotive News, Ward's
Automotive Reports, U.S. Auto Industry Report, Motor Industry of Japan,
and the Japanese Auto Manufacturers Forum; for the biopharmaceutical
sector, Bioscan, Ernst & Young Reports, and the Biotechnology
Directory; for the new materials sector, Office of Technology Assessment
reports and Organization for Economic Cooperation and Development reports;
and for all sectors, Predicast's F & S Index of Corporate
The goal of the data collection was to comprehensively cover all
alliances formed within the selected industries. I placed no restrictions
on the sizes of the partners in the alliances, including both large and
small firms. Only alliances that had actually been formed were recorded.
The complete data set includes information on over 2,400 alliances formed
by American, European, and Japanese firms. To my knowledge, it is the most
comprehensive data set on alliances within each of the focal sectors, both
in terms of the length of time included and the depth of
The data segment acquired from MERIT coded information on the form of
an alliance (equity based or not) and the activities it encompassed. This
was based upon precise criteria used to draw assessments from the public
announcement of the alliance. In coding the remainder of the data that I
collected, I was consistent with the coding scheme outlined by MERIT.
Furthermore, I assessed the reliability of the coding criteria by asking
two academic experts on strategic alliances to code a random sample of 25
alliances using the information I had collected. There was complete
coincidence in their coding and my own.
An alliance was labeled as including R&D only if a public
announcement clearly stated that the agreement encompassed joint product
development or basic R&D. Similarly, an alliance was coded as equity
based when a public announcement said that an equity joint venture had
been created or that a firm had taken a substantive minority position in
another with the intent of pursuing joint projects.
Fortunately, most public announcements of alliances report detailed
information on their governance structures, activities, and goals. When
activities or governance structure were ambiguous, I tried to identify
additional public records that more clearly stated the goals of a
partnership. For over 30 percent of the alliance records that I collected,
I consulted multiple sources.
The period of this study, 1970-89, was a potential source of bias, but
there were strong reasons for choosing it. First, the growth of alliances
in these years was unprecedentedly high (Anderson, 1990; Hagedoorn &
Schakenraad, 1990), but little previous research on alliances has
encompassed longitudinal data covering such an extensive time period.
Inasmuch as the growth of alliances in this period represents current
trends in alliances, the present findings should continue to be relevant
to the contemporary formation of alliances.
A second possible limitation of the sampling design was that the data
encompass only three industries. I exercised caution in interpreting
results obtained with the pooled sample of data from all three industries,
including dummy variables for each sector. Furthermore, I reestimated the
models for each sector separately to ensure that the postulated effects
held within each industry. Although these industries represent a broad
spectrum in terms of stage of maturity, a legitimate remaining concern is
that the findings reported here may be idiosyncratic to the industries
The dependent variable, mode of alliance, was coded "1" if an alliance
involved the use of equity and "0" if it did not. The fundamental
characteristic that distinguishes equity alliances from nonequity
alliances is that equity sharing creates shared ownership and is, beyond a
minimum threshold, effective in reducing exposure to opportunistic
Table 1 describes the variables included in the analysis and summarizes
arguments made in this article in the predicted signs.
For consistency with prior empirical research, I defined high
transaction costs as the presence of an R&D component in an alliance
(1 = R&D present, 0 = no R&D). R&D alliances included those
that encompassed basic R&D, product development, or elements of both.
Non-R&D alliances typically were those that involved joint production
Hypothesis 2 concerns the relationship between the type of alliance
[TABULAR DATA OMITTED] between given partners and the history of alliances
between them. The variable repeated ties recorded the number of prior
alliances two firms had had since 1970 (0 = first-time alliance). I also
calculated the variables repeated equity ties and repeated nonequity ties,
respectively indicating the number of prior equity and nonequity alliances
between two parties. These variables also took a zero value for a
first-time alliance of the given type.
An important clarification is necessary at this point. Three
alternative scenarios are possible in the history of alliances between two
firms. The two could have entered (1) only nonequity alliances in the
past, or (2) only equity alliances, or (3) both equity and nonequity
alliances. To which category should the third scenario be assigned? Since
Hypothesis 3a predicts the role of prior equity ties, in the presence or
absence of other nonequity ties, repeated equity includes both the
situation in which there are only prior equity alliances and that in which
there have been mixed alliances. Hypotheses 3b, on the other hand, focuses
on the effect of prior nonequity alliances in the absence of any other
ties. Hence, repeated nonequity ties does not include situations with
I included a dummy variable indicating whether an alliance was domestic
or international (1 = partners of differing nationalities, 0 = partners of
the same nationality).
To capture any effects that arose from the number of partners in an
alliance, I computed that number. Since the alliances in the sample were
either bilateral or trilateral, this variable was recoded as a dummy
variable with a value of "1" if an alliance was multilateral and a value
of "0" if an alliance was bilateral.
A "logit" model was used to assess the effects of the independent
variables on the likelihood of an alliance being equity based (Aldrich
& Nelson, 1984). The general specification of the model used was as
follows: log[P([M.sub.i] = 1)/(1 - P([M.sub.i] = 1)] = [A.sub.o] +
B1([X.sub.i]), where P([M.sub.i] = 1)) is the probability that alliance i
is equity based and [X.sub.i] is the vector of independent variables. A
variable's positive coefficient indicates its propensity to promote equity
I included two control variables to represent the three sectors
studied. One dummy variable was coded "1" if an alliance was in the new
materials sector, "0" otherwise, and the second was coded "1" if the
alliance was in the automotive sector and "0" otherwise. The default
sector was biopharmaceuticals.
A control variable assessing the relationship of equity alliance
formation to the percentage of equity alliances announced in an industry
was also included. I counted the number of alliances announced in an
industry in the year prior and computed the percentage of those that were
equity based. In a limited way, this variable tested the institutionalist
claim that firms mimic [TABULAR DATA OMITTED] the contracts other firms in
their industry use. This variable can also be interpreted as capturing the
net effect of the various macroeconomic factors within an industry that
may influence the formation of equity alliances (Amburgey & Miner,
Finally, I included a dummy variable for each year to capture temporal
effects and also control for any temporal autocorrelation.
Table 2 presents descriptive statistics and correlations for all
variables. The data presented in this table point to the diversity of
alliances included in the pooled sample, in which over 500 of the
approximately 2,400 alliances were repeat links between firms.
The correlations show a few problems of multicollinearity. Notably,
repeated equity ties is highly correlated with repeated ties (r [greater
than] .70); the high correlation is no surprise since repeated equity ties
is a nested subset of repeated ties. Because of the collinearity, I
introduced these variables separately in the logit analysis.
Table 3 presents the logistic regression estimates. The first column
reports the base model including all the control variables. The
coefficients for the sector variables were significant (p [less than] .01)
in all cases. Although this finding suggests intrinsic industry
differences in the likelihood that equity-based alliances will be used
(the constant terms for each of the industries differ), it does not reveal
whether or not the main effects hypothesized differ across the three
industries. More specifically, the positive signs indicate that both the
automotive and new materials sectors were more likely to have equity-based
alliances than the biopharmaceutical sector, once independent variables
included in each model were controlled. I later estimated unrestricted
models for each of the industries (these results are not presented here).
The signs of the coefficients indicated that the postulated directions of
the main effects were indeed observed in each sector.
My original estimations included a dummy variable for each year. For
simplicity of presentation, I reestimated the models using a single
variable, year, which ranges in value from 1 to 19, indicating each year.
No differences in results for the other independent variables were
observed in these two sets of estimates, and the results are mixed for
year, which is significant in some models and not in others.
The positive and significant coefficient (p [less than] .01) for the
percentage of equity-based alliances announced in an industry in a given
year suggests that this variable positively affects the use of equity
alliances by firms in the industry in the subsequent year. This finding
holds true in the remaining models as well and suggests that the form of
contracts used in alliances may be linked to an industry' s propensity to
use equity alliances.
The second column in Table 3 shows results with the measure of
transaction costs introduced into the model. The results are consistent
with Hypothesis 1: alliances involving R&D are more likely to be
equity based than are non-R&D alliances, a relationship indicated by
the positive coefficients [TABULAR DATA OMITTED] of the variable R&D
component (p [less than] .01). This finding remains true in later models
The third column shows results with the three measures of trust: the
number of prior alliances by the same pair of firms, whether they were
domestic or international, and the number of partners involved. Results
suggest that the repetition of ties is a significant determinant of mode
of alliance (p [less than] .01). Specifically, the negative coefficient of
the dummy variable repeated ties supports Hypothesis 2 and indicates that
the larger the number of prior alliances between partners, the less likely
their current alliance is to be equity based, even when the presence of an
R&D component is controlled for. The positive and significant
coefficient for international alliance supports Hypothesis 4, which
predicts that such alliances are more likely to be equity based than
domestic alliances. No support is found for Hypothesis 5, however, which
predicts that the use of equity is more likely in multilateral than in
bilateral alliances. These results remain true in subsequent
Models 4 and 5 were estimated using the measures of prior equity and
nonequity alliances. The variable for repeated alliances was omitted
because of multicollinearity concerns. In both models, results suggest
that the number of prior equity-based ties between two firms reduces the
likelihood that a current alliance between them will be equity based, thus
supporting Hypothesis 3a.
Results do not support Hypothesis 3b, which postulates that even in the
absence of prior equity ties, the larger the number of nonequity alliances
between two firms, the less likely their future alliance is to be equity
based. However, the number of alliances that actually fit this pattern was
extremely small (N = 23). Thus, the insignificant finding may be the
result of my having too few observations.
Looking at the overall fit of each of the models indicated by their - 2
log likelihoods and associated chi-squares, I observed that the
introduction of R&D in model 2 significantly improved the fit of the
base model. Another significant improvement occurred in models 3 and 4,
with the introduction of the variables for repeated, international, and
multilateral alliances and that for repeated equity ties.
Table 4 presents the classification tables corresponding to each of the
models in Table 3. These tables succinctly highlight the association
between the predicted and observed responses for each model. All five
models perform better than a random proportional chance model, which would
have a "hit rate" of [p.sup.2] + [(1 - p).sup.2], where p is the
probability of an event's having occurred (Bayus & Gupta, 1992). On
the basis of the observed proportion of events, I estimated p to be .65
(1,568/2,395). Thus, the classification accuracy for a random model is
54.25 percent. The percentage of correctly classified cases in the five
models reported ranges from 65.7 to 67.7 percent, a rate clearly superior
to the random model. The models also perform better than a simple model
with only the intercept (which would predict all nonevents), albeit not by
a large percentage difference. Although this pattern suggests a
significant improvement over a random proportional chance model, it also
indicates that I may have overlooked additional relevant
The relative magnitudes of raw logit coefficients are not directly
interpretable since they refer to the increase in logarithmic odds
resulting from a unit increase in a variable. In Table 5 I present
elasticities for the key variables entered in two models shown in Table 3
(Ben-Akiva & Lerman, 1985; Fernandez & McAdam, 1988; Peterson,
1985).(7) Elasticities indicate the percentage change in the probability
of a hypothesized event for a one-unit change in an explanatory
The results in Table 5 must be interpreted with caution since each
variable has a different underlying measurement scale. In particular, for
R&D, a unit change indicates that non-R&D alliances possibly had
an R&D component. For repeated alliances, a unit change indicates the
existence of one more prior alliance. Thus, Table 5 shows that if two
firms had entered an R&D alliance instead of a non-R&D alliance,
their likelihood of forming an equity joint venture would have increased
by about 38 percent. If two firms entering an alliance had one more prior
alliance of any kind, model 3 suggests that their likelihood of forming an
equity joint venture would have declined by 14.13 percent. Model 5
suggests that one more prior equity alliance reduced the likelihood of
forming an equity alliance by 13.70 percent. Similarly, the marginal
effects of international and multilateral alliances are also
The results of models 1 through 5 (Table 3) provide strong evidence for
most of the present hypotheses. They show (1) that R&D-based alliances
are more likely to be equity based than non-R&D alliances, (2) that
the larger the number of prior alliances between two firms, the less
likely are their subsequent alliances to be equity based, (3) that the
larger the number of prior equity alliances across two firms, the less
likely their subsequent alliances are to be equity based, and (4) that
international alliances are more likely to be equity based than domestic
alliances. No support, however, emerged for the claim that prior nonequity
alliances alone reduce use of equity in new alliances. Also, the number of
partners in an alliance does not seem to affect the form of governance
Taken together, the results suggest that firms select contractual forms
for their alliances on the basis of not only the activities they include
(R&D), but also the existence and frequency of prior ties with a
partner. What emerges from this account is an image of alliance formation
in which cautious contracting gives way to looser practices as partner
firms build confidence in each other. In other words, familiarity between
organizations through prior alliances does indeed breed trust.
In an important review of the transaction cost economics literature,
Bradach and Eccles (1989) argued that three primary control mechanisms
govern economic transactions between firms: price, authority, and trust.
They observed that, in equity alliances, firms rely upon a mix of price
and authority - price because of concern for the value of their equity,
and authority because of the hierarchy created. Such an approach, however,
looks at alliances in a static context, treating each transaction as
independent, without taking into account how the relationships can evolve
over time. Observing interfirm alliances over time suggests that repeated
ties between firms engender trust that is manifested in the form of the
contracts used to organize subsequent alliances. Firms appear to some
degree to substitute trust for contractual safeguards in their repeated
alliances. Thus, trust is also an important component of the control
mechanisms used within alliances.
The creation of trust is most visible between partners that already
have an equity alliance in place. My earlier discussion of some of the
processes underlying interorganizational behavior suggests that prior
equity ties are not simply mutual hostages that enhance each firm's
ability to penalize partners that behave opportunistically, but also
conduits for the exchange of information between partners that allow them
to build knowledge-based trust in each other. The finding here that only
having prior equity alliances led to looser contracts could very well
indicate that equity alliances foster closer interaction between partners
than do nonequity alliances.
The results reported here do not show that prior nonequity alliances
alter the choice of subsequent contracts. Such alliances may represent
purely knowledge-based trust but, as pointed out earlier, this argument is
somewhat tenuous. It is difficult to draw any significant conclusions from
this finding because of the extremely small number of observations of such
Although the findings reported here enhance understanding of governance
structure in alliances, they have broad implications for transaction cost
economics as well. Building on the original insights of Coase (1937), this
theory has reified the transaction as the unit of analysis, treating each
transaction as an independent event. It has ignored the work of Commons
(1970), Coase's contemporary, who also placed importance on transactions
as the appropriate unit of analysis but offered a more process-oriented
and temporally informed view of transactions (cf. Van de Ven, 1993). Other
researchers have offered similar exhortations (cf. Zajac & Olsen,
1993), but organizational researchers have yet to take them up. The
current work, a step in this direction, suggests that transaction cost
economics must explicitly incorporate the role of prior ties in its
analytical framework. In particular, if the theory' s emphasis on the
transaction as the appropriate unit of analysis is to remain viable, the
interdependencies that result from prior transactions should be
Within the broad market-versus-hierarchy argument, my focus has been on
those cases in which firms have decided to form an alliance and face the
issue of the type of governance to be used. Within this narrow domain, not
only the complexity of activities within the alliance moderates firm
behavior - the social context resulting from past alliances also affects
the contractual form an alliance takes. Similarly, transaction costs as
traditionally defined are unlikely to singularly determine decisions about
the use of markets, alliances, or hierarchical integration, and social
context should play an important role (Granovetter, 1985).
The findings of this study have several practical consequences for
interfirm alliance activity and, more broadly, for interfirm cooperation.
The study highlights a number of efficiency benefits that follow from
creating trust in cooperative relationships. First, drafting detailed
contracts can be costly and time consuming. Business Week (1986) reported
that executives can spend as much as 23 percent of their time developing
alliance plans and 19 percent of their time drafting legal documents.
Trust between partners can reduce such costs. As Arrow (1974) claimed,
trust is perhaps the most efficient mechanism for governing economic
transactions. Trust may also expand the realm of feasible alliances and
allow firms to enter partnerships that may otherwise have been deemed
impossible, even with detailed equity contracts. Furthermore, detailed
contracts can stifle a partnership's adaptability to shifting
Another efficiency-related benefit for firms in trusting relationships
is reduced search costs. An important concern for firms seeking new
alliances is the availability of trustworthy partners, and considerable
effort can be devoted to identifying them (Nohria, 1993). Firms placed in
a social network of trusting relationships can significantly reduce their
search for new partners when they decide to ally with an entity they
already trust (Gulati, 1993).
Limitations and Future Research
An important dimension omitted in this discussion is how organizational
factors guide contractual choices. Each partners' size, technological
sophistication, resource constraints, and prior experience with alliances
can play a role, as can a host of other factors. Osborn and Baughn (1990)
pointed to the size of partners as an important determinant of the
governance structure of alliances.
Another possible line of inquiry would be a liner-grained analysis of
contractual forms of alliances. For equity alliances, this analysis could
entail examining what explains the distribution of ownership, or more
broadly, the distinctions between asymmetrically and symmetrically owned
partnerships. For nonequity alliances, researchers could look in more
detail at the various forms included within this category, arrayed on a
scale running from informal to formal, and some of the factors that
explain the specific form used.
Following prior empirical research by transaction cost theorists, I
used the presence of R&D in an alliance as a proxy for transaction
costs. There is considerable room for improvement in measuring these
costs. Such improvement would not only allow a more accurate assessment of
the multifaceted role of transaction costs in alliances, but would also
test how appropriate R&D has been as a measure of transaction
Yet another arena for future research could be examining the social
context in which alliances take place in more depth. My focus has been on
direct ties between firms established through prior alliances. It would be
interesting to assess the role of a broader social context, encompassing
other forms of interfirm connections besides alliances, defined by both
direct and indirect ties.
Finally, an important area for future research would be to identify,
measure, and empirically assess the role of trust in the formation,
governance, and ultimate success of interfirm alliances. I relied on the
history of prior ties as the factor most likely to produce trust, but a
vast gap in understanding the many dimensions of trust and their operation
within alliances remains.
The suggested analyses offer exciting research opportunities, but
require the collection of data beyond those available for this research.
Examining organizational factors guiding contractual choices would require
detailed data on the firms participating in the alliances studied.
Similarly, a richer analysis of the contractual forms themselves would
entail collecting detailed data on the contracts used and, in the case of
equity alliances, the distribution of equity shares. Disentangling
transaction costs in alliances and assessing their various components
would require detailed information on the transactions themselves and the
specific circumstances of each of the partners. An examination of the
effects of the overall social structure would entail collecting
information on various additional ties among organizations. Assessing
interfirm trust and its various dimensions would most likely entail a
detailed survey administered to managers in firms participating in
alliances. Given the comprehensiveness with which this study covered
alliance announcements and the resultant large number of alliances
included (2,417), detailed data collection on firms and contracts was not
possible. These further issues are, however, important, and they present
some of the most exciting opportunities for future research on interfirm
The most basic conclusion that follows from this study is that
contracts chosen in alliances do not depend wholly upon the activities
included within the partnership and their associated transaction costs.
Rather, such choices also depend on the trust that emerges between
organizations over time through repeated ties. My findings suggest that
neither transaction costs nor social factors should dominate discussion of
alliances and that in the final analysis, any explanation should encompass
1 Tacit knowledge here refers to knowledge that cannot be made fully
explicit and typically resides in patterns of relationships, norms,
information flows, ways of making decisions, and other organizational
2 Systematic empirical studies have examined some of the economic and
technological factors underlying the formation of alliances (Mariti &
Smiley, 1983). Some of the typical motivations examined include sharing
uncertainty, sharing costs, access to complementary technologies, learning
new tacit technologies, reducing innovation period, monitoring
environmental changes, entering foreign markets, and expanding product
range (Hagedoorn & Schakenraad, 1990).
3 In recent years there has been some debate on whether behavior with
utilitarian motivations can really be described as trust (Uzzi. 1993;
Williamson, 1993). For my purposes, interfirm trust encompasses such
utilitarian behavior, and I choose not to engage in this debate.
4 Firms can be connected with other firms through a wide array of
social and economic relationships. These include supplier relationships,
trade association memberships, interlocking directorates, relationships
amongst individual employees, and alliances. All these can be important
sources of information that leads to trust. Indeed, prior research has
shown that a variety of interorganizational contacts serve as conduits for
both technological and social information about organizational activities
(Baker, 1990; Davis, 1991). Because of limitations in the scope of this
study, I focused on a single source of social connections among firms,
5 Of course, nonequity alliances, even if they can be easily dissolved,
can be very important strategically and thus can still serve as important
6 The number of alliances examined here far exceeds the numbers
examined in previous studies: Nohria and Garcia-Pont (1991) reported 96
automotive sector alliances for the period 1980-89 versus the 493 reported
here; and Pisano (1989) reported 195 biopharmaceuticals alliances, versus
the 781 reported here.
7 I computed these elasticity scores by looking across all individual
records as opposed to simply setting mean values for each independent
variable and then looking at percentage shifts.
8 In a competing perspective regarding prior nonequity alliances,
commitment between organizations would be viewed as incrementally
escalating. In this view, firms may first "test the water" with each other
through loosely organized small-scale projects and subsequently expand the
scopes of their partnerships by entering equity alliances with each other.
In this case, the existence of a prior nonequity alliance would make it
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COPYRIGHT 1995 Academy of Management
Gulati, Ranjay, Does familiarity breed trust? The implications of repeated ties for contractual choice in alliances. (Special Research Forum: Intra- and Interorganizational Cooperation). Vol. 38, Academy of Management Journal, 02-01-1995, pp 85(28).
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