The Missing Links: Formation and Decay of Economic Networks

4. The Formation of Inter-Organizational Networks

Chapter 4 The Formation of Inter-Organizational Networks Toby Stuart In this chapter I will offer a literature review and some thoughts on processes that may systematically account for the formation networks among economic actors. After reviewing why sociologists (and, increasingly, economists) see networks as essential to the functioning of markets, and then review much of the work that has been done in economic sociology on the formation of networks and a smaller portion of the research on the subject in economics and applied mathematics. Although I describe research on networks at both the organizational and the individual level, I focus on the organization level. In the interest of brevity, I emphasize horizontal relationships among organizations, rather than vertical (that is, buyersupplier ) transactions. What, exactly, is meant by “horizontal inter-organizational networks ”? To fix ideas, imagine a venture capital firm that has identified a promising young company that it wishes to finance. Further, suppose that the venture capitalist chooses to form a syndicate—a small group composed of other high-risk investors—to finance the startup company. Although not all venture investments are made in syndicates, the majority of them are. In the context of the venture capital industry, the question of where inter-organizational networks come from translates into a question about the mechanisms that guide venture capital firms in the search for and selection of syndicate partners. To give another example that has been the site of much empirical research, consider the case of a pharmaceutical firm that has a promising drug candidate but lacks sufficient internal capacity to launch a worldwide marketing campaign. What regularities guide its selection of a marketing partner? Both of these examples are about the formation of horizontal inter-organizational networks. Why examine the question of what determines the formation of particular transactions, or of patterns of connections, in inter-organizational networks? The most straightforward answer is that we believe we know that the shapes of networks—the particular structures of relations in place—is consequential for important outcomes experienced by the actors in networks. Research on social and economic networks has thrived during the last few decades, but the overwhelming thrust of the empirical literature has been to document the consequences of occupancy of different locations in established networks on outcomes of all types. In the economic sociology and organization theory literature—the area in which the author works—there are literally hundreds of studies that examine “network effects.” For instance, in the tradition of Mark S. Granovetter (1973), a number of studies consider the role of networks in the job search process (see Fernandez, Castilla, and Moore 2000) and in the process of securing promotions inside firms (Podolny and Baron 1997). Extending classic work on the diffusion of innovations (Coleman , Katz, and Menzel 1966; Burt 1987), a large number of studies have assessed the influence of interfirm networks on explaining patterns of adoption of practices and processes (Mizruchi 1992). Building from network-based conceptions of market structure, a third thrust of the literature has been to show that firm positions influence performance outcomes, ranging from sales growth (Podolny, Stuart, and Hannan 1996; Ingram and Roberts 2000) to market valuation (Stuart, Hoang, and Hybels 1999) to innovation rates (Ahuja 2000). Can we be certain that the findings from this body of work are valid? It is possible to take issue with any one of these studies on empirical grounds. In particular, the vast majority of published work treats measures of network position as exogenous to the outcome 80 The Missing Links variable under examination and in many cases does little adequately to account for plausible unobserved correlates of particular network positions. As is discussed at some length in chapter 6 in this volume, by Ray E. Reagans, Ezra Zuckerman, and Bill McEvily (and is implied in chapter 3, by Rachel Kranton and Deborah Minehart, and chapter 8, by James E. Rauch and Joel Watson), the endogeneity of network position may be particularly problematic in studies seeking to document the effects of networks on actors’ performance (see Durlauf and Fafchamps 2004 for an introduction to the issues). The reason why unadjusted empirical estimates of network effects may be confounded is simple. If actors are aware that benefits accrue to those who possess certain network configurations, they have an incentive to elbow in to certain regions of a social structure. Conversely , if actors differ in their ability to create or benefit from...