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Pollock, T. and Porac, J. and Wade, J. B. (2004) 'Constructing deal networks : brokers as network 'architects'in the U.S. IPO market and other examples.', Academy of management review., 29 (1). pp. 50-72.

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CONSTRUCTING DEAL NETWORKS: BROKERSAS NETWORK “ARCHITECTS” IN THE U.S. IPO

MARKET AND OTHER EXAMPLES

TIMOTHY G. POLLOCKUniversity of Maryland

JOSEPH F. PORACNew York University

JAMES B. WADEUniversity of Wisconsin–Madison

We introduce the concept of the network architect to extend theory explaining howbrokers create and manage structural holes in mediated markets. We argue that abroker’s social resources and dependence on the market, along with exogenous dealconditions, influence the broker’s motivations and willingness to make tradeoffsbetween long-term and short-term considerations when constructing deal networks.We develop our model and propositions in the context of the U.S. initial publicofferings market and then generalize these arguments to other market contexts.

Over the last twenty years, scholars have be-come interested in how markets are sociallyconstructed. Researchers have focused on theroles that cognition (e.g., Porac, Thomas, & Baden-Fuller, 1989; Porac, Thomas, Wilson, Paton, &Kanfer, 1995), institutional forces (e.g., Abolafia,1996; Fligstein, 1996; Leblebici & Salancik, 1982),and social structure (e.g., Burt, 1992; Granovet-ter, 1985; Kenis & Knoke, 2002; Rao, Davis, &Ward, 2000; Uzzi, 1996; White, 1981) play in shap-ing market behavior. Within this literature,scholars have given transaction networks a con-siderable amount of attention (e.g., Baker, 1984;Granovetter, 1985; Larson, 1992; Uzzi, 1996; White,1981). Their research has increased our under-standing of how stable ongoing networks im-pact market outcomes, such as firm survival,terms of trade, and the exchange of information.

At the same time, however, researchers havepaid little attention to the fundamental questionof how a market network is actually constructedfor the purpose of carrying out one or moretransactions (Salancik, 1995). Salancik arguesthat a network theory of organizations shouldpropose how networks of interactions achieve

collective and individual interests and how theinclusion or exclusion of different actors influ-ences network functioning. Similarly, Portes andSensenbrenner suggest that a theory of net-works requires that “we must better specify howsocial structure constrains, supports or derailsindividual goal seeking behavior” (1993: 1325).Within the literature on market networks, therehas been little research and theory on theseissues.

Burt’s (1992) notion of structural holes in net-work organization provides an important start-ing point for conceptualizing the strategic use ofnetwork building to advance a given set of in-terests. According to Burt, relational networksoften contain missing links that can be consid-ered holes in the flow of information. A struc-tural hole between two parties exists when theparties do not attend to each other and, thus, donot exchange information in the course of socialinteraction. Burt suggests that the existence ofstructural holes creates opportunities for thirdparties to mediate the flow of informationamong disconnected actors. Burt (2000) revieweda large amount of recent evidence showing thatmarket advantages, such as increased profits,survival, and innovation, accrue both to the so-called informational brokers who bridge struc-tural holes and to the individuals, groups, ororganizations that they bring together in the

We thank Mason Carpenter, Anne Miner, former associateeditor P. Devereaux Jennings, and three anonymous AMRreviewers for their helpful comments on previous versions ofthis manuscript.

� Academy of Management Review2004, Vol. 29, No. 1, 50–72.

50

course of their brokering activities. Burt’s reviewhighlights, in a convincing manner, the impor-tant role that structural holes—and the brokerswho span them—play in market networks.

The informational role of the broker in marketnetworks is perhaps most apparent in mediatedmarkets, such as real estate transactions andthe buying and selling of financial securities. Inall such markets, buyers and sellers interactwith each other through an intermediary marketmaker whose formal role is to bridge the buyer-seller informational interface (e.g., Abolafia,1996; Baker, 1984; Finlay & Coverdill, 2000; Halp-ern, 1996; Khurana, 2002). Transaction intermedi-aries such as brokers, underwriters, and agentsarise in markets where the search costs associ-ated with identifying potential transaction part-ners are high, where opportunism can easily runrampant, and where buyers often require steepprice discounts to compensate for the risks theymust absorb by participating in a deal (Abola-fia, 1996). Brokers help to manage these risksand, in return, capture a percentage of theresources that are exchanged in the form ofcommissions, brokerage fees, retainers, or eventhe opportunity to participate in a transactionthemselves.

As Finlay and Coverdill (2000) note, however,while research on structural holes provides asolid foundation for theorizing about brokers,market mediators are more than bridging con-duits that facilitate the flow of information be-tween buyers and sellers through their advan-taged network position. Not all structural holesare equivalent and equally attractive. They varyin a number of ways, and it is the job of thebroker to respond to these variations by “pack-aging” viable configurations of network actors.Moreover, brokers often strategically createstructural holes through the selective accumula-tion and exploitation of social resources. Thus,brokers are network “architects” who activelydesign, build, and maintain transactional net-works through their own strategic and profit-driven activities. These activities extend thebrokering role beyond a purely structural posi-tion and transform it into a complex and multi-dimensional market function (e.g., Finlay &Coverdill, 2000; Khurana, 2002).

Despite its theoretical and economic signifi-cance, this proactive and constitutive aspect ofbrokering has not been theorized adequately.Aside from the literature on structural holes,

existing studies of brokering consist mainly ofdescriptive accounts of broker activities in veryspecific market contexts, such as securities trad-ing (e.g., Abolafia, 1996), employee recruiting(Finlay & Coverdill, 2000; Khurana, 2002), realestate (Halpern, 1996), leisure travel (Reimer,1990), and cocoa exporting (Southall, 1978).These descriptive accounts have illustrated howthe brokering role is complicated by and embed-ded within the idiosyncrasies of each marketsituation. The scholarly challenge is to developtheory that accommodates these idiosyncrasies,while still providing general principles for un-derstanding the proactive and network-buildingrole of brokers in meditated markets.

We suggest that three key factors are impor-tant in determining how the role of network ar-chitect plays out during the brokering process:(1) the stock of social resources the broker hasaccumulated from previously successful trans-actions that can be brought to bear on a currenttransaction, (2) the broker’s dependence on thefocal market as a source of profits, and (3) thevarious exogenous conditions in which a dealtakes place. These three factors are interdepen-dent, but each is vital in controlling the motiva-tions of the broker in a mediated transaction.The exogenous conditions of the deal, includingsuch factors as the current economic climate,availability of alternatives, and the quality ofthe assets offered for exchange, impact the ini-tial favorability of the deal and, thus, influencehow easy or difficult it is for the broker to recruitbuyers and sellers into the transaction network.A broker’s accumulated social resources affectthe broker’s motivational leverage in persuad-ing, enticing, and/or cajoling buyers and sellersto consummate a deal. Finally, a broker’s de-pendence on the focal market as a source ofprofits influences the broker’s risk profile andrelative focus on short- versus long-term trad-ing considerations.

Our primary purpose in this paper is to extendtheory on brokering by explicating the joint in-fluence of these three factors on how brokersconfigure transactional networks in mediatedmarkets. Because the conditions of brokeringare so closely tied to specific market situations,it is difficult to theorize about brokering in theabstract. To help concretize our arguments, wesituate our discussion within the context of theU.S. market for initial public offerings (IPOs), animportant mediated market that controls the al-

2004 51Pollock, Porac, and Wade

location of billions of dollars each year. In themarket for IPOs, the network structure of trans-actions changes from deal to deal, and the roleof the broker, or network architect, is played bythe lead investment bank underwriting each of-fering. Our key claim is that deal conditions,underwriter social resources, and underwriterdependence on the IPO market come togetherwithin individual stock offerings to shape howthe lead underwriter adjusts the attributes of thetransactional network that takes a companypublic. These latter network characteristics thenhelp to determine important outcomes of thedeal—specifically, the initial price of the sharesoffered for sale and their allocation amonginvestors.

A secondary purpose of this article is to ex-plore how social and economic motivations mu-tually shape the structure and functioning ofmarket networks. These two categories of moti-vations are sometimes positioned in the litera-ture as representing opposing logics of actionthat are mutually exclusive. However, the micro-processes of IPO brokering make it clear thateconomic and social motivations are inter-twined in complex and interdependent ways.Brokers are effective when they strike an accept-able balance between the economic interests ofbuyers and sellers and their own profit objec-tives. Because preferences are often hard to de-cipher ex ante, and because there are inherentconflicts involved in most strictly distributivecontexts, the task of brokering is neither easynor programmable.

Much research suggests that, under condi-tions of market uncertainty, social variablessuch as actor status and familiarity provide use-ful information to market participants and lubri-cate exchange processes that could otherwisebog down in claims, counterclaims, and protec-tive maneuvering (e.g., Geertz, 1978; Haunschild,1994; Podolny, 1994; Powell, 1985; Uzzi, 1997). Me-diated markets in general and the IPO marketspecifically are, thus, excellent venues for theo-rizing about how economic and social processescome together in the consummation of particu-lar deals.

To accomplish these objectives, we first de-scribe the general structure of IPO deal net-works. Not all elements of these networks arecontrolled by the lead underwriter, and manyparticipants act as background constraints thatonly indirectly influence an underwriter’s bro-

kering activities. We label the portion of a dealnetwork that is constructed by the lead under-writer the deal network kernel, and we enumer-ate the actors who are typically included within it.

We follow this discussion with the develop-ment of propositions explaining how under-writer dependence and underwriter social re-sources influence key attributes of deal networkkernels under “typical” or “average” deal condi-tions. We then elaborate this argument by con-sidering how positive and negative variationsaway from typical deal conditions are reflectedin adjustments to deal kernels. This is followedby propositions that link the characteristics ofIPO kernels to variations in an offering’s priceand share allocations.

After describing these relationships in the IPOmarket, we then generalize our approach by dis-cussing how each of these factors is importantin the brokering processes of other mediatedmarkets. In this way, we use the IPO market asa bridge linking the concepts of social re-sources, dependence, and deal conditions tobrokering processes within mediated markets ingeneral. We finish by suggesting potentiallyfruitful directions for future research on broker-ing in mediated markets.

THE IPO DEAL NETWORK KERNEL

The IPO market is an often studied mediatedmarket, and previous researchers have exploredthe role of various parties in shaping IPO out-comes. In addition to the underwriter (Carter &Manaster, 1990; Megginson & Weiss, 1995;Michaely & Shaw, 1994; Stuart, Hoang, & Hybels,1999), researchers have examined the impact ofauditors (Balvers, McDonald, & Miller, 1988;Beatty, 1989), venture capitalists (Brav &Gompers, 1997; Gompers, 1996; Lerner, 1994), andalliance partners (Higgins & Gulati, 2003; Stuartet al., 1999) on IPO valuation and performance.In all of these studies, researchers have reliedprimarily on signaling theory (Spence, 1974) toexamine how the reputation of different partici-pants in the IPO process can reduce informationasymmetries between the offering firm and in-vestors, and thus increase the price investorsare willing to pay for an IPO stock.

A potentially more fruitful approach is to viewIPOs as transient deal networks in which cer-tain parties are brought together for a limited

52 JanuaryAcademy of Management Review

period of time to take a company public.1 With afew exceptions (e.g., Hanley & Wilhelm, 1995;Higgins & Gulati, 2003; Wolfe, Cooperman, &Ferris, 1994), scholars have not addressed howdeal networks are actually constructed, andthere has been little research on the brokeringprocess through which the lead underwritermanages a transaction. The lead underwriterfills a critical role in an IPO deal network byrecruiting investors and other underwriters toparticipate in the offering. It is this portion of thetotal IPO deal network that is directly within theunderwriter’s sphere of influence and that formsthe core—the kernel—of an IPO deal network.Figure 1 depicts a hypothetical IPO deal net-work, and the shaded area represents the dealnetwork kernel.

The lead underwriter is linked directly tosome, but not all, of the investors participatingin an offering. The vast majority of offerings aresyndicated, which means that other investmentbanks are recruited to help distribute shares.The lead underwriter, thus, is also linked toother underwriters, who are connected to addi-tional investors who similarly participate in theoffering. Syndicates are used to reduce the risk

and cost of an offering by distributing sharesover several investment banks. Although manyunderwriters today can absorb the cost and riskof IPOs, syndicates are still used to broaden thedistribution of shares, ensure client access toshares of IPOs led by other banks, and allow thelead underwriter to take advantage of differ-ences in the social resources of other banks soas to manage the outcomes of the offeringmore effectively.

Other actors outside the kernel, such as audi-tors, venture capitalists, and board members,are also important, but their relationships to theoffering firm typically exist prior to retaining thelead underwriter. Although some of these non-kernel actors may influence the outcomes of anoffering independent of the underwriter, theyare not directly involved in the construction ofthe deal network kernel itself.

In addition, although individual investorsform a small part of the investor network in atypical IPO, institutional investors purchase theoverwhelming majority of IPO shares (Hanley &Wilhelm, 1995). Individual investor participationin multiple offerings is more ad hoc and has lessimpact than institutional investor participation.For these reasons, we focus only on an under-writer’s recruitment of institutional investorsinto the network kernel, and we do not consider

1 The appendix provides a detailed description of the pro-cess of taking a company public.

FIGURE 1The IPO Deal Network


the roles that these other actors play in the IPOprocess.

By including or excluding investors and syn-dicate members with different sets of character-istics, the lead underwriter can alter the config-uration of a network kernel and, with it, thecourse of a transaction. Prior research on mar-kets (e.g., Baker, 1984, 1990; Carter & Dark, 1993;Carter & Manaster, 1990; Fombrun, 1996; Uzzi,1996, 1999) suggests that four characteristics ofdeal network kernels are particularly importantin shaping IPO outcomes: (1) the size of the net-work kernel, as defined by the number of inves-tors recruited to participate in the deal; (2) theproportion of investors who have close and re-peated ties to the lead underwriter or syndicatemembers; (3) the proportion of investors with along-term investment horizon who are willing toretain a company’s stock in the face of short-term performance downturns; and (4) the heter-ogeneity of the underwriting syndicate withrespect to the syndicate members’ social re-sources in the IPO market.

Each of these network attributes, singly and incombination, provides a lead underwriter with aseries of tradeoffs in designing IPO network ker-nels. Large kernels, for example, are effective inspreading the risk of an offering across manyinvestors and syndicate members, and they canalso be used to build new relationships withinvestors and/or banks with whom the under-writer has had little prior experience. However,large kernels are harder to construct and man-age, thus increasing transaction costs, as wellas the possibility of buyer opportunism and/orstock price volatility.

In like fashion, kernels consisting of manyinvestors who have close ties to the lead under-writer provide a measure of controllability to theunderwriter, who can leverage past obligationsto influence a current transaction. However,overreliance on past trading relationships in-creases information redundancy in the kernel,as well as the underwriter’s dependence on asmall set of regular customers. Understandingand managing tradeoffs such as these are im-portant components of the lead underwriter’scompetence in taking companies public.

The specific choices that an underwritermakes determine the fate of a new offering byinfluencing the price the company receives forits shares and how the shares are allocatedamong investors. The initial pricing of the stock

determines the amount of capital the companyreceives from the offering to finance its contin-ued growth and development. This price, as wellas the price fluctuations that occur once thestock begins trading on the open market, alsosends powerful signals to investors, customers,suppliers, and business partners about thestrength and viability of the company (Ben-veniste & Spindt, 1989; Ibbotson & Ritter, 1995;Welch, 1989).

The allocation of shares is important, becausethe concentration of shares in the hands of fewor many investors affects both investor influ-ence over the firm and the ongoing stability ofthe stock price. Stock price volatility is an im-portant signal to stakeholders, and indepen-dence from investors influences the company’srelative focus on long-term and short-term per-formance (Bushee, 1998; Carter & Dark, 1993;Krigman, Shaw, & Womack, 1999). Given theirimpact on IPO outcomes, it is thus necessary tounpack the choices underwriters make in con-structing deal network kernels and to detail thefactors that influence these choices. It is to thistask that we now turn.

CONSTRUCTING AN IPO DEALNETWORK KERNEL

Since both IPO buyers and sellers are clients,the underwriter has a fiduciary responsibility torepresent their opposing needs equally, al-though the underwriter retains broad discretionin determining how these needs are met. Theunderwriter’s own motivations are important inthis regard. As Figure 2 illustrates, the under-writer is faced with a tension between long-termand short-term considerations. Like buyers andsellers, the underwriter has a profit motive andseeks to reap higher commissions from an offer-ing. Underwriting fees are a direct function ofthe selling price. However, underwriters alsowant to build and maintain a strong reputationand good relationships with the investor com-munity so as not to impair their ability to suc-cessfully place offerings in the future (Abolafia,1996). Thus, underwriters have long-term self-protective as well as short-term profit motivations.

Our key argument is that specific tradeoffsbetween an underwriter’s long- and short-termmotivations in a given deal will be a function ofthe social resources the underwriter has avail-able for managing the deal, the underwriter’s


dependence on this market, and the favorabilityof the deal conditions. These tradeoffs are thenmanifested in specific design choices made bythe underwriter in constructing a deal networkkernel.

Social Resources, Market Dependence, andDeal Conditions: Basic Definitions

Social resources. In prior research scholarshave identified two social resources that areparticularly valuable to actors for managingtheir position in a network: (1) actors’ general-ized reputations as reliable and competent net-work members (Benjamin & Podolny, 1999; Bro-miley, 1993; Fombrun, 1996; Weigelt & Camerer,1988; Wilson, 1985) and (2) the relationships thatactors have accumulated over time with othernetwork members via past interactions (Baker,1984; Granovetter, 1985; Larson, 1992; Uzzi, 1996).2

With respect to reputation, the public reputa-tion of investment banks has long played animportant role in stabilizing transactions wheninvestment uncertainty is high. Prior to the Se-curities Acts of 1933 and 1934, a successful secu-rities offering of any significant size requiredthe participation of a highly reputable under-writer (Chernow, 1997; Hayes, 1970). Since otherinformation on the prospects of a company go-ing public was generally unavailable, the will-ingness of the bank to risk its reputation was animportant signal about the quality of the offer-ing. Despite today’s greater availability of fi-nancial information, recent research suggeststhat an investment bank’s reputation still influ-ences its ability to generate underwriting busi-ness and place offerings successfully (Carter &Dark, 1993; Eccles & Crane, 1988; Podolny, 1994;Stuart et al., 1999; Wolfe et al., 1994).

With respect to network ties, the number ofembedded relationships the underwriter has todraw on is another important market-makingsocial resource. Research suggests that marketrelationships vary along a continuum, fromthose that are instrumental and “arm’s length”to those that are “embedded” in dense socialinteractions that promote trust and cooperation

2 We recognize that underwriters possess other resourcesbeyond their reputations and networks of relationships. Theamount of financial capital they possess, for example, canbe another powerful resource in market-making activities.However, the vast majority of IPOs are “firm commitment”offerings (i.e., the bank agrees to buy the entire offering fromthe company at the initial price, thereby absorbing any riskthat the offering will not be fully subscribed); therefore, aslong as the underwriter has the resources necessary to pur-chase the offering, its capital does not play a significant rolein the portion of the process we discuss in this article. Inaddition, since the majority of offerings are syndicated, thelead underwriter generally does not bear the cost of pur-

chasing the shares alone. The capital strength of the under-writer is more important when considering the role the un-derwriter plays in supporting the stock in the secondarymarket (e.g., Ellis, Michaely, & O’Hara, 2000), but these ac-tivities are beyond the scope of our discussion.

FIGURE 2Factors Impacting Underwriter Motivations


(Granovetter, 1985). The degree to which rela-tionships are either embedded or arm’s lengthseems to depend on the frequency (e.g., Baker,1984; Granovetter, 1985; White, 1981) and concen-tration (e.g., Baker, 1990; Larson, 1992; Uzzi, 1996)of past and current transactions between theactors involved. The greater the frequency andthe larger the proportion of transactions that areconcentrated within a set of actors, the moresocially embedded the transactional relation-ships are. Evidence suggests that embedded re-lationships decrease opportunistic behavior(Uzzi, 1996, 1997), facilitate information transfer(Larson, 1992; Uzzi, 1996), influence the acquisi-tion and use of power (Baker, 1990), reduce costs(Uzzi, 1999), build trust between the transactionpartners (Uzzi, 1997), and reduce market volatil-ity (Baker, 1984).

These reputational and relational resourcescan partially substitute for one another. Re-peated interactions over multiple transactionsprovide valuable information about an actor’scompetence and trustworthiness as a transac-tion partner (Uzzi, 1996; Wilson, 1985). However,participants in a transaction do not always haveprior experience working with one another. Anactor’s generalized reputation can serve as avaluable proxy for prior experience and reducesome of the uncertainties about the transaction(Bromiley, 1993; Fombrun, 1996).

If a bank has a strong reputation, an investormay be more willing to participate in the bank’soffering and to accept claims the bank makesabout the quality of the company, even if theinvestor has not transacted with the bank previ-ously. In opposite fashion, if a bank does notenjoy a strong reputation in the IPO market butdoes have embedded ties with investors, per-haps through other types of deals, it can draw onthese relationships to promote a particularstock.

These substitutabilities aside, higher com-bined levels of an underwriter’s social resourcesafford the underwriter greater flexibility in man-aging the characteristics of investors and syndi-cate members within the deal network kernel.Whether underwriters choose to exploit thisflexibility is another matter.

Market dependence. Prior research has shownthat the number of different financial markets inwhich a bank participates can be useful in un-derstanding variations in bank behavior (Eccles& Crane, 1988). As resource dependence theory

suggests, greater or lesser dependence on a par-ticular resource in a bank’s task environmenthas important implications for how the bankmanages those resources (e.g., Baker, 1990; Pfef-fer & Salancik, 1978). To the extent that a bank isfinancially dependent on the IPO market, it willbe more sensitive to conditions that could causelong-term damage to the integrity of the offeringprocess. It will also be more concerned withcultivating and expanding the social resourcesit has developed in the context of this market soas to become a more powerful player and, if notreduce its own dependence, increase the depen-dence of others on it.

The largest and most well-known investmentbanks, such as Morgan Stanley, GoldmanSachs, and Credit Suisse First Boston, are ac-tively involved in a variety of markets, and IPOsrepresent only a small proportion of their reve-nues, even though they underwrite IPOs on aregular basis. Because their social resourcesand profits are generated in a wide range offinancial markets, these banks are less depen-dent on IPO brokering than smaller banks thatspecialize in taking companies public. This lat-ter group of underwriters includes such firms asAlex. Brown & Sons, Hambrecht & Quist, andMontgomery Securities.3 These banks derive alarger percentage of their profits from IPOs andhave generated substantial social resourcesthat are quite specific to their IPO underwritingactivities. Finally, a third group of banks fo-cuses on other types of financial transactions orserves primarily as retail stock brokers. Thesebanks participate in the IPO market as leadunderwriters the least frequently. Examples in-clude A.G. Edwards, Piper Jaffray, and Pennsyl-vania Merchant’s Group. Because such banks donot derive a substantial proportion of their so-cial resources and revenues from the IPO mar-ket, they are less dependent than both the largeand more specialized banks on IPO underwriting.

Deal conditions. An underwriter does not havecomplete freedom to broker IPO outcomes. Even

3 During the course of developing this article, several ofthe banks used as examples were acquired by larger enti-ties and, in some cases, shut down after the IPO marketcrash in 2001–2002. We continue to offer these banks asexamples because their names are still widely recognized inthe IPO market context, and because any empirical researchon the IPO market still needs to take these banks—and theircharacteristics as we have described them—into account.


though the brokering process is an attempt tobalance interests across the deal network, eachoffering has exogenously determined character-istics that independently influence the final out-comes of a deal and make it easier or moredifficult to sell the stock. These conditions im-pact the underwriter’s brokering activities sig-nificantly. Under favorable deal conditions, theunderwriter occupies an advantaged gate-keeper position, rationing a scarce and high-demand commodity to a large pool of willinginvestors. Under unfavorable deal conditions,however, the underwriter serves as an enthusi-astic recruiter, convincing wary investors that itis worthwhile for them to participate in a trans-action that may have certain undesirable prop-erties. Two aspects of deal conditions that areespecially important are the quality of the firmbeing taken public and the general market con-ditions present at the time of the IPO.

With respect to firm quality, current researchon IPOs suggests that factors such as the in-volvement of a reputable venture capitalist (Jain& Kini, 2000), the presence of prominent boardmembers (Stuart et al., 1999), and well-devel-oped organizational practices for managing thefirm’s human capital (Welbourne & Andrews,1996) enhance the value and quality of a newoffering. Other factors such as an innovativeproduct, an experienced management team, anda history of profitability also influence the de-sirability of an offering in the eyes of investors(Gutterman, 1991).

Although banks try to underwrite the best-quality companies they can, company quality issometimes equivocal. For example, a bank maydiscover unanticipated problems with a com-pany once it has already agreed to underwritethe offering. Or competitors may introduce anew product that threatens an IPO firm’s pros-pects once the offering has begun. A bank alsomay agree to underwrite a less attractive offer-ing if doing so leads to a future benefit. Forexample, a bank might agree to underwrite theIPO of a weaker company funded by a particularventure capitalist to increase the probabilitythat the bank will attract future offerings ofhigher quality from the same financier.

Over and above the factors that determinefirm quality, particular industries—and even theIPO market in general—can quickly go in andout of favor with investors (Ibbotson & Jaffe,1975; Ritter, 1984). When conditions are favor-

able, researchers have shown that companiesare taken public at higher valuations, and com-panies of more uncertain quality are brought tomarket more easily (Ritter, 1984). When marketscool, however, many IPOs are postponed orwithdrawn, and only the strongest offerings arepursued. Recent examples of such changes inmarket conditions can be found in the downturnbetween July and October of 1998 and the crashin the internet IPO segment that began in April2000. In both cases, otherwise robust IPO mar-kets came to a screeching halt when marketconditions and investor preferences shifted.Even promising companies can have poorlyperforming IPOs if market conditions changeunexpectedly.

An underwriter’s social resources and depen-dence on the IPO market, as well as the favor-ability of deal conditions, all impact the designof the deal network kernel. Figure 3 summarizesthe key causal influences in network kernel de-sign. An underwriter manages the constructionof the deal network kernel by pursuing a partic-ular combination of kernel size, proportions oflong-term and embedded investors, and hetero-geneity of the underwriter syndicate. The leadunderwriter then recruits investors with the de-sired characteristics, as well as underwritersyndicate members who have access to theseparticular types of investors. By including orexcluding investors with different sets of char-acteristics, the underwriter shapes the deal net-work kernel and, with it, influences the valua-tion of the offering and the allocation of shares.We now turn to developing propositions thataccount for variations in kernel design andtransaction outcomes.

The Impact of Social Resources on DealNetwork Design4

Who holds a company’s stock and how longthey hold it influence the success of an IPO.Successful offerings are those that do not result

4 It is not surprising that underwriters possessing thegreatest amounts of social resources will have more embed-ded ties in their deal networks, on average, than underwrit-ers with fewer social resources. We therefore do not developpropositions about this relationship in this section but,rather, view the relationship as a background assumption.We do, however, develop propositions about embedded tieswhen discussing market dependence and deal conditions.


in wild gyrations in stock price but, rather, leadto steady price increases over time (Gutterman,1991; Krigman et al., 1999). In order to achievethis outcome, it is important for underwriters tosell shares of stock to investors who will holdthe stock rather than “flip” it to capture a short-term gain. Krigman et al. (1999) found that IPOswith low flipping rates enjoyed abnormal re-turns of 1.5 percent a month for the first sixmonths of trading. Heavy trading increasesstock price volatility and, thus, increases its per-ceived investment risk. This risk, in turn, canlimit a company’s ability to raise additionalcapital through a subsequent offering (Ben-veniste, Erdal, & Wilhelm, 1998; Welch, 1989).Although some short-term investors are neces-sary to ensure the liquidity and price apprecia-tion of an offering, placing stock in the hands oflong-term investors is an important brokeringstrategy for increasing market perceptions ofthe quality of both the IPO and its underwriter.

Long-term investors are valuable and scarcecustomers, however, and not all underwritershave equal access to them. Underwriters withlarger stocks of social resources enjoy greateraccess to long-term investors, because theirprior dealings in the IPO market afford themmany opportunities for developing close rela-

tionships with such investors. In addition, theirgeneralized positive reputation as underwritersacts as a signal for the long-term viability of anoffering.

The signaling effect of underwriter reputationhas been shown to be especially important inrecruiting long-term investors (Gulati & Higgins,2003). Carter and Dark (1993), for example, ob-served that highly reputable underwriters ledofferings with less short-term flipping. One caninfer from this result that the highly reputableunderwriters in their sample were more able torecruit long-term investors into their deal net-work kernels. We therefore suggest the follow-ing proposition.

Proposition 1: The greater the socialresources of the lead underwriter, thehigher the proportion of long-term in-vestors included in a deal networkkernel.

The underwriting syndicate is another mech-anism that the lead underwriter uses to managethe types of investors included in the deal net-work kernel. The key motivation for using a syn-dicate of other banks is to broaden the distribu-tion of shares to ensure a mix of long-term andshort-term investors, as well as investors with

FIGURE 3Underwriter Interests and the Construction of the IPO Deal Network Kernel


ties of varying strength to the underwriters.Completely homogenous networks are usuallypoor design choices because, at one extreme,they constrain market liquidity and, at the otherextreme, generate excessive pricing volatility.Establishing relationships with varied investorstakes time and resources, however, and even themost reputable and largest banks do not havecomplete coverage of the market. This makesunderwriting syndicates useful in constructingthe deal network kernel. Different kinds of in-vestments banks have different portfolios of cli-ents, and by including a range of investmentbanks in a deal kernel, the lead underwriter canadjust the characteristics of the kernel in waysappropriate for a given deal.

At the same time, underwriters vary in theirability to recruit syndicate members, and anasymmetry exists in this regard between bankswith high and low social resources. While allunderwriters will be able to recruit syndicatemembers with low social resources, banks withhigher social resources have more degrees offreedom in syndicate construction. Lead under-writers prefer to include at least some banks ofsimilar or higher social resources in their syndi-cates. Podolny (1994), for example, found thatdeals in the bond market involving high-statusbanks reduce uncertainties, enhance the leadunderwriter’s own reputation, and providegreater access to desirable offerings. Thus, un-derwriters can benefit both socially and finan-cially by including banks with substantial so-cial resources in their deal networks.

Underwriters with limited social resourceswould also prefer to include such banks in theirdeal networks for these same reasons. They areunlikely to do so, however, because their posi-tion at the periphery of the IPO market con-strains their ability to recruit high-status banks.The underwriting syndicates for banks with lowsocial resources will therefore consist primarilyof other similarly resource-constrained banks.

Proposition 2: The greater the socialresources of the lead underwriter, thegreater the social resource heteroge-neity of the underwriting syndicate.

The Impact of Market Dependence on DealNetwork Design

An underwriter’s dependence on the IPO mar-ket as a source of profits influences its willing-

ness to exploit investors in this market for short-term gains. An important consideration for theunderwriter is whether to include investors in adeal network with whom it has done substantialbusiness in the past or to include new investorswith whom it has only an arm’s length relation-ship (Granovetter, 1985). Even though there are anumber of benefits associated with constructinghighly embedded deal network kernels (e.g.,Baker, 1984; Uzzi, 1996, 1997), such networks canalso make it difficult to gather new informationfrom the environment (Burt, 1992; Uzzi, 1996,1999). In addition, working exclusively and re-peatedly with the same investors increases anunderwriter’s dependence on those investorsand weakens the underwriter’s ability to nego-tiate effectively (Baker, 1990; Pfeffer & Salancik,1978). Finally, because of the positive expecta-tions that surround embedded relationships,any negative outcomes from a deal may be am-plified and communicated throughout the mar-ket, thus detracting from a bank’s reputation asa reliable and trustworthy intermediary be-tween buyers and sellers.

An underwriter’s dependence on the IPO mar-ket impacts the tradeoffs it makes regardingthese concerns. Since dependent underwritersdo not possess the diverse range of profitsources that a presence in multiple markets pro-vides, they will be more risk averse when itcomes to constructing their IPO deal networkkernels. It is to the dependent bank’s advantageto have greater variety in the types of relation-ships composing its IPO deal networks and to bemore aggressive in recruiting new institutionalinvestors into its deals, even though doing soincreases the risk that arm’s length investorswill act opportunistically.

In prior research on strategic alliances, Row-ley, Behrens, and Krackhardt (2000) found thatstrong ties are beneficial to performance whenthe environment demands a high degree of ex-ploitation, whereas weak ties are beneficial forexploration purposes. Extrapolating this reason-ing to the IPO context suggests that dependentunderwriters who feel greater pressure to en-gage in exploration for new network resourcesinclude a greater proportion of arm’s length tiesin their deal networks than less dependent un-derwriters, who are content to make use of theircurrent network resources. In order to minimizethe risks associated with having a higher pro-portion of arm’s length ties in the deal network,


dependent underwriters also construct largerdeal networks in terms of both investors andsyndicate members so that they reduce theirexposure to opportunistic behavior by any oneinvestor (Baker, 1990).

Proposition 3: The greater the lead un-derwriter’s financial dependence onthe IPO market, the lower the propor-tion of embedded ties in a deal net-work kernel.

Proposition 4: The greater the lead un-derwriter’s financial dependence onthe IPO market, the greater the size ofa deal network kernel.

Taken together, these two propositions can beused to derive an important implication of un-derwriter dependence on deal network kernels.Large and diversified banks such as GoldmanSachs and Credit Suisse First Boston are in-volved in a wide variety of financial marketsand tend to lead IPOs selectively (Beatty & Rit-ter, 1986; Wolfe et al., 1994). Propositions 3 and 4suggest that these banks approach the IPO mar-ket with less concern for expanding their rela-tional base and spend less time recruiting newinvestors into their deals than more dependentspecialist underwriters, such as Hambrecht &Quist and Alex. Brown & Sons. Consequently,the deal network kernels of large and diversi-fied banks will generally be more compact thanspecialist kernels, and include a higher percent-age of investors with whom the banks have de-veloped long-standing relationships. Paradoxi-cally, then, our arguments imply that whilelarger and diversified underwriters are less de-pendent than specialists on the IPO market as asource of profits, they become more dependenton a smaller set of investors to place their IPOs.

This paradox between global and local de-pendence is a double-edged sword for IPO bro-kering processes. As noted above, compact andembedded networks have consequences thatvary in their desirability. A small portfolio ofclose and regular investors provides a ready-made outlet for the diversified underwriter in-terested in creating a favorable market for anoffering. However, strongly embedded networkkernels propagate expectations and opportuni-ties for reciprocity that can lead underwritersand investors to lose their bargaining objectiv-ity over time and, in the extreme, to stretch in-

stitutional rules that have been enacted to en-sure fair play and impartiality. They also creategreater potential for opportunistic behaviors bythe underwriter as the embedded investors be-come more dependent on the bank. This mayexplain why some large and diversified banksengaged in self-serving behaviors such as so-called tying arrangements and investor kick-backs of profits from IPOs during the late 1990s,and why specialized banks were less likely tofollow suit (Labate & Luce, 2001; SEC vs. CreditSuisse First Boston, 2002).

Both large underwriters and specialists pos-sess the substantial social resources necessaryto engage in these activities. However, our ar-guments suggest that, because of their depen-dence on the IPO market, specialists are lesslikely to risk their social capital by engaging inpotentially exploitive behaviors that enhancetheir short-term profits, even when market con-ditions make this sort of behavior possible.

The Impact of Deal Conditions on DealNetwork Design

Propositions 1 through 4 describe IPO dealnetworks for “average” firm and market condi-tions. However, variations in either firm qualityor market favorability significantly influencethe difficulty of building a deal network kernel.They also influence the underwriter’s motiva-tion to protect and grow its social resources(Bromiley, 1993; Wilson, 1985). For both of thesereasons, deal conditions are an important exog-enous influence on a lead underwriter’s broker-ing activities, making it more or less likely thatthe underwriter recruits embedded transactionpartners, long-term investors, and differentkinds of syndicate members as participants.

When IPO deal conditions are favorable, anoffering is an opportunity to expand an under-writer’s social resources through allocations ofshares to desirable long-term investors withwhom the underwriter has not transacted in thepast. Given the likelihood that an attractive of-fering will perform well over the long term, anunderwriter generates goodwill with new long-term investors, thus making it more likely thatthe investor will participate in the underwriter’sfuture deals. At the same time, these positiveeffects enhance the underwriter’s reputation(Hayes, 1970; Wilson, 1985). Finally, IPOs that areattractive to investors are also going to be at-


tractive to other underwriters who would like togain access to the offering for their own clients.The lead underwriter will therefore use the op-portunity afforded by favorable deal conditionsto recruit more underwriters with substantialsocial resources into their deal networks. Doingso not only enhances the performance of theoffering but also creates obligations that canprovide the underwriter with access to theshares of attractive IPOs led by the other banks.Thus, highly favorable conditions lead to largerdeal network kernels with larger proportions oflong-term investors, smaller proportions of em-bedded ties with investors, and less underwritersyndicate heterogeneity.

Brokering dynamics are substantially differ-ent for unfavorable deal conditions, althoughthe resulting deal network size and embedded-ness are similar to those observed in highlyfavorable deal conditions. Underwriters per-ceive unfavorable deal conditions as a threat totheir market-making resources. Rather then re-cruit long-term investors with whom they haveembedded relationships, underwriters are morelikely to involve short-term and arm’s lengthinvestors who are of less interest to them asfuture transaction partners. Since these inves-tors are not part of their ongoing deal networks,underwriters are less concerned about any dam-age to the relationship from a poorly performingIPO.

At the same time, short-term, arm’s length in-vestors are risky and potentially volatile in theirtrading behavior. Lead underwriters expand thesize of the deal network to minimize this risk byincreasing the number of short-term investorsand by including more banks with fewer socialresources in the underwriting syndicate. Theabove reasoning suggests a number of interac-tive causal relationships.

Proposition 5: Lead underwriters willconstruct larger deal network kernelswhen deal conditions are highly fa-vorable or highly unfavorable, com-pared to average deal conditions.

Proposition 6: Lead underwriters willinclude a higher proportion of inves-tors with whom they have arm’slength relationships in their deal net-work kernels when deal conditionsare highly favorable or highly unfa-

vorable, compared to average dealconditions.

Proposition 7: Lead underwriters willinclude a higher proportion of long-term investors in their deal networkkernels when deal conditions arehighly favorable, and a higher propor-tion of short-term investors when dealconditions are highly unfavorable,compared to average deal conditions.

Proposition 8: Lead underwriters willdecrease underwriter syndicate heter-ogeneity when deal conditions arehighly favorable, and will increasesyndicate heterogeneity when dealconditions are highly unfavorable,compared to average deal conditions.

While the above effects are general tenden-cies evident across a variety of deal conditions,they do not apply to all lead underwritersequally. In fact, the influence of deal conditionson IPO deal network kernels is complicated by abank’s social resources and market dependence,and banks can be arrayed along these two di-mensions by their sensitivity to deal conditions.This differential sensitivity is important be-cause it influences a bank’s tendency to adjustnetwork kernel properties in response to varia-tions in deal quality. This is clearest in the caseof banks such as Pennsylvania MerchantsGroup and Whale Securities who possess lim-ited social resources in the IPO market and whoact as lead underwriters for IPOs only infre-quently. Because these banks have fewer socialresources at risk when a deal goes awry, andbecause they are not highly dependent on IPOsas a source of profits, they are less responsivethan other banks to deal conditions. Conse-quently, the deal network kernels constructedby these banks exhibit less systematic varia-tion across deal conditions than those con-structed by either large diversified or specialistunderwriters.

Similarly, large diversified banks are less de-pendent on the IPO market than specialists, andthey rely on a smaller portfolio of regular inves-tors to place their offerings. Thus, the deal net-work kernels constructed by large diversifiedbanks will typically exhibit less variance fromdeal to deal than those constructed by specialists.


In short, different combinations of market de-pendence and social resources serve to amplifyor dampen sensitivity to deal conditions. Be-cause of their unique combination of high mar-ket dependence and substantial social re-sources, specialist underwriters are most likelyto use their degrees of freedom to adjust kerneldesigns in response to the quality of an offering.

IPO Transaction Outcomes

Two transaction outcomes are most affectedby the structure of an IPO deal network kernel:(1) the initial “primary market” price set for thestock by the underwriter and the IPO firm and (2)the initial allocation of shares among investors.Once an IPO stock begins “secondary market”trading on a national exchange, the associatedperformance outcomes, such as underpricing,trading volume, and stock price volatility, areinfluenced by a variety of exogenous factorsthat are outside the direct influence of the leadunderwriter. A lead underwriter’s ability to im-pact secondary market outcomes is largely afunction of the initial conditions it establishes inthe primary market.

In presenting the model depicted in Figure 3,it is not our intent to imply that the four charac-teristics of the deal network kernel we discussare the only factors that influence initial sharepricing and allocation decisions. The size andasset base of the company, its record of profit-ability, the availability of alternative offerings,and so forth also have a direct impact on theseoutcomes. Within the constraints imposed bythese other factors, however, we argue that vari-ations in the characteristics of the deal networkkernel will shape IPO transaction outcomes inpredictable ways. While all four characteristicsare important, in this section we focus specifi-cally on the impact of embedded and long-terminvestors in the deal network. We do not developpropositions about the impact of deal networkkernel size, because its impact on the IPO (i.e.,the larger the deal network kernel, the lower theconcentration of shares is likely to be) is theo-retically unremarkable. We also do not developspecific propositions about the relationship be-tween underwriting syndicate heterogeneityand transaction outcomes, because we havesuggested that the underwriting syndicate isused as a mechanism to manage the proportionsof long-term and embedded investors in the deal

network. The impact of syndicate heterogeneityon IPO transaction outcomes, thus, is mediatedby these other deal network characteristics.

Research directly examining the relationshipbetween investor embeddedness with under-writers and IPO valuation is sparse, althoughrecently scholars have suggested that investorswho participate regularly in an underwriter’sdeal networks (Hanley & Wilhelm, 1995), andwho provide the underwriter with informationduring the price-setting process (Cornelli &Goldreich, 2001), benefit from underwriter shareallocation decisions. The trust and informationsharing that exist between embedded under-writers and investors reduce investor uncertain-ties and increase their willingness to pay morefor the stock. Underwriters can prevail on inves-tors with whom they have embedded relation-ships to pay a slightly higher price for the stockas a “favor” to the bank, with the implicit under-standing that the favor will be reciprocated vialarger allocations of more desirable offerings inthe future.

Even though all investors receiving initial al-locations pay the same price for a stock, Welch(1992) has shown that once a few investors par-ticipate in an offering at a particular price, otherinvestors will do so as well, creating a cascadeeffect in the market. Thus, if a deal networkincludes a larger proportion of embedded net-work ties, the underwriter can use embeddedrelationships with investors to prime the marketand fully subscribe a less attractive offering at ahigher price.

This sort of pricing reciprocity is not likelywhen an offering is oversubscribed. An offeringis oversubscribed when there are more requestsfor shares than there are shares available. Inhighly anticipated offerings, especially duringhot markets, requests for shares may be severaltimes greater than the number of shares avail-able (Cornelli & Goldreich, 2001). Adjustingprices downward for high-demand offerings tobenefit embedded transaction partners placesan underwriter in direct conflict with the inter-ests of the sellers. Also, since all buyers mustpay the same price for an offering, underwritersdo not have the same flexibility to reward par-ticipation via price adjustments as they do viashare allocations. As a consequence, when anIPO is oversubscribed, reciprocal behaviors onthe part of the investment bank must take theform of share allocations rather than pricing


adjustments (Benveniste & Spindt, 1989; Cornelli& Goldreich, 2001). Embedded relationships withinvestors are therefore likely to have little effecton pricing for oversubscribed offerings.

Proposition 9: Increasing the propor-tion of embedded investors in a dealnetwork kernel increases the valua-tion of lower-demand offerings buthas no effect on the valuation of high-demand offerings.

As noted previously, underwriters prefer toplace a significant proportion of the shares in anoffering with investors who possess long-termtime horizons and who can be relied on not toflip the stock (Carter & Dark, 1993; Krigman etal., 1999). This objective can be accomplished byrecruiting institutional investors who possessthe desired investment perspective and time ho-rizon and/or by recruiting investors with whomthe underwriter has an embedded relationship.Because they can be expected to hold theirshares, underwriters will grant long-term andembedded investors larger share allocations. Ifan underwriter has lower proportions of embed-ded and long-term investors in its deal network,it will disperse shares more widely by givingsmaller allocations to each investor so that op-portunistic flipping of the stock by any one in-vestor will have less of an impact on the vola-tility of the stock’s price.

Proposition 10: The greater the propor-tion of embedded investors and long-term investors in the deal network, themore concentrated the allocation ofshares is likely to be.

When considered together with Propositions 1through 8, these last two propositions suggestthat large diversified underwriters will generatethe highest prices and most concentrated shareallocations for their IPOs. Smaller and more spe-cialized underwriters will price their offeringsmore conservatively and allocate shares morebroadly than the diversified banks because ofthe concerns borne out of their greater depen-dency on the market; their IPOs should also pro-vide the greatest variation in pricing and shareallocation from deal to deal because of theirsensitivity to deal conditions. The IPOs led bymore peripheral banks will have the lowestprices and share allocation concentrations; theyalso will reflect the most consistency in deal

network design from deal to deal, because theyare the least likely to be affected by variationsin deal conditions and have the least ability torespond to changes in deal conditions.

THE PROCESS OF MANAGING STRUCTURALHOLES: GENERALIZING TO OTHER MARKETS

The IPO brokering processes we describedabove have their roots in Burt’s (1992) suggestionthat brokers bridge structural holes in transac-tion networks. The theory of structural holes pro-vides an important basis for conceptualizing therole of brokers in market dynamics. At the sametime, we argued that the theory focuses primar-ily on the opportunities created by bridgingholes in an existing social structure and, thus,does not fully account for how brokers activelycreate and manage structural holes or for therole that broker interests and motivations playin this process (Finlay & Coverdill, 2000). Broker-ing is a complex and multidimensional activity,and information transmission is only one com-ponent of the broker’s role in consummating adeal.

A structural analysis of brokers thus requiressupplemental theorizing about the brokeringprocess. Our conceptualization highlights theproactive and network-building role of brokersin mediated markets. Indeed, our model makesit clear that the role of brokers in mediated mar-kets is a constitutive one and that it is difficult toseparate the characteristics of deal networksfrom the choices that brokers are making in re-sponse to a variety of social and economicforces operating at the time of a transaction.Although we have used the applied context ofthe U.S. IPO market to illustrate how brokersdesign, build, and manage transaction net-works, our arguments are generally applicableto any number of markets in which transactionsare mediated by a third party.

Studies of mediated markets can be foundscattered throughout a variety of literature insociology, anthropology, and management. Ta-ble 1 presents selected studies from this litera-ture. Each mediated market is shaped by a par-ticular purpose, an institutional context, and aset of governance procedures that create aunique venue for brokering activities. For exam-ple, the desirability of recruiting investors withlong-term investment horizons as a way of sta-bilizing the market for an IPO seems particu-


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larly bound up with the idiosyncrasies of thestock market. Similarly, the nuances of syndi-cate design seem especially dependent on theexistence of specific types of underwriters, suchas large and diversified investment banks, spe-cialist banks, and peripheral dealers.

Nevertheless, whether it is the cocoa marketin Ghana (Southall, 1978), the Canadian tourismmarket (Reimer, 1990), the market for employeetalent (Finlay & Coverdill, 2000), the residentialreal estate market (Halpern, 1996), the New Yorkstock exchange (Abolafia, 1996), or purchases ofagricultural technology (McIntosh & Zey-Ferrell,1986), our model of the brokering process sum-marized in Figure 3 suggests that the networkarchitect’s situation can be described as a set ofbackground forces that influence the broker’smotivations and capabilities as a market medi-ator, a set of deal network attributes over whichthe broker can exert at least some control, and aset of transaction outcomes that are partiallydetermined by the broker’s network designchoices. As described in Table 1, within theboundaries of a broker’s situation, the broker’saccumulated social resources, the broker’s de-pendence on the market as a source of profits,and the exogenous properties of the deal, suchas the desirability of the assets being ex-changed, are important in influencing how thebroker goes about building and managing agiven transaction network. Abstracting from ourIPO propositions, we can derive three generali-zations about the influence of these variables onbrokering processes.

First, a broker’s ability to balance the compet-ing interests of participants in a deal network isheavily bound up with the social resources thatthe broker has accumulated via past transac-tions. Previous theorizing about the role of socialcapital in market exchange (e.g., Baker, 1990;Uzzi, 1997, 1999) has emphasized how social re-sources lubricate existing exchange relation-ships by facilitating the transmission of infor-mation among transaction partners. Whileinformation exchange is also an important con-sideration in market mediation, our model ofbrokering supplements the existing literature bysuggesting that social resources are importantin market making as well. Generally speaking,the greater a broker’s social resources, the moreflexibility the broker has in building and man-aging a given deal network.

By deploying social resources to adjust themix of participants in a deal, a broker exertscontrol over transaction outcomes. Greater so-cial resources afford the broker more choices inrecruiting deal participants and, thus, assist thebroker in striking appropriate tradeoffs amongparticipant objectives. At the same time, whentaken to the extreme, social resources can alsoinduce the broker to lose bargaining objectivityand to favor some market participants over oth-ers. Collusive behavior in mediated marketssometimes occurs outside of accepted tradingpractices and can be detrimental to the integrityof the market as a whole. Such collusion is an-other “dark side” of embedded social relation-ships that has not been given much attention inthe existing literature.

The importance of social resources for broker-ing activities is certainly evident in the litera-ture on mediated markets. Broker reputation, theability to develop embedded ties, and the bro-ker’s role as a crucial conduit of resources be-tween one group and another are recurrentthemes in the literature.

For example, in their study of corporate head-hunters, Finlay and Coverdill focus on the “id-iosyncratic and personalized characteristics ofthe exchange relationship—the degree of loy-alty, trust and dependence between the head-hunter and client” (2000: 378) and the significantrole that these factors play in determining howand where headhunters focus their efforts. Fin-lay and Coverdill suggest that a headhunter’sreputation and ability to gain repeat businessare keys to his or her success in creating andfilling structural holes between clients and po-tential job candidates.

Halpern (1996) describes how friendshipsamong real estate agents influenced their be-havior during real estate transactions. Shefound evidence suggesting that when theagents representing the buyer and seller werefriends, the transaction was closed more quicklyand the transaction process was viewed as amore positive experience. Halpern also foundthat building a reputation as an honest andcompetent agent was a long-term interest oftenoutweighing an agent’s shorter-term interests inincreasing the commissions from a sale.

Southall’s (1978) study of middlemen in theGhana cocoa industry is a rich description of thecomplicated subnetworks of cocoa dealers ofvarying status. Major dealers used these con-


nections, as well as their ties to producers andEuropean merchants, not only to bridge struc-tural holes but to keep these holes open evenwhen the merchants attempted to circumventthe brokers and reduce their power.

Reimer (1990) discusses the importance of touroperator ties to the service providers at vacationdestinations, and McIntosh and Zey-Ferrell(1986) highlight the role that reputation and ex-perience in the agricultural market played inshaping bankers’ recommendations and loandecisions supporting the purchase of new agri-cultural technologies by farmers.

Second, a broker’s motivational orientation to-ward a deal is largely controlled by the broker’sdependence on that market as a source of finan-cial or nonfinancial resources. Generally speak-ing, the greater a broker’s dependence on a par-ticular market for resources, the more likely thebroker will balance short-term and long-termconsiderations in the consummation of a deal.We have suggested that nondependent brokersare more short-term oriented, less concernedwith expanding their social resources withinthat market, and potentially more exploitative ofthe market when short-term profit opportunitiesarise. In contrast, dependent brokers use eachdeal not only to extract short-term profits butalso to expand the social resources that willenhance their brokering flexibility in the future.

Southall (1978), for example, notes that differ-ent cocoa brokers varied in their involvement inbrokering as a line of business. Some brokerswere farmers who engaged in part-time cocoatrading on a very limited scale, whereas otherbrokers were larger operators with nationalscope. Part-time brokers had very locally em-bedded relationships and tended to sell theirproducts to larger brokers who sold exclusivelyto European merchants. Southall’s descriptionimplies that the part-time brokers were muchless dependent on brokering for their liveli-hoods and, thus, engaged in little activity toexpand their relationships beyond their localcommunity.

In another example of varying dependence,Halpern (1996) describes how realtors who weremore established in their market had more atstake in maintaining their broker position. As aresult, established brokers demonstrated con-cern for preserving and enhancing their socialrelationships. Halpern notes that experiencedrealtors focused more on building and leverag-

ing friendships with other agents than neweragents, who instead placed a greater emphasison mastering the technical aspects of real estatetransactions. Halpern quotes one experiencedbroker: “There’s no need to be highly technicallyskilled. There’s always someone during a trans-action that knows what they’re doing—the otheragent, a broker. The people part is more impor-tant” (Halpern, 1996: 1536).

Research also suggests that the concept ofmarket dependence can be expanded fruitfullyto include not only the broker’s dependence on aset of buyers and sellers but also the depen-dence of the buyers and sellers on the broker. Insome markets, dependence on the broker is rel-atively low, because alternative brokers areavailable and broker competition can be orches-trated (Finlay & Coverdill, 2000; Reimer, 1990). Inothers, dependence on brokers for information orresources is relatively high (Abolafia, 1996;Halpern, 1996; McIntosh & Zey-Ferrell, 1986;Southall, 1978), thus placing brokers in the posi-tion of managing this dependence for their ownadvantage.

Southall (1978) provides a fascinating accountof buyer and seller dependence in his discus-sion of the actions taken by cocoa brokers topreserve their profits. When cocoa producershalted sales in 1930 in response to concertedefforts by merchants to lower prices, brokerssuccessfully worked on behalf of the merchantsto end the stoppage, because it threatened theirown ability to earn profits. However, the samebrokers actively supported a later producerholdup in 1937–1938. In the period between thetwo holdups, the merchants’ dependence on bro-kers had grown, along with the commissionsthey paid to the brokers for their services. Themerchants tried, unsuccessfully, to reduce costsby using their monopoly buying power to forcereductions in the excessive commissions paid tobrokers. Southall notes that “the difference be-tween the earlier failure and the latter success[of the production holdups] can be largely ex-plained by the role of the brokers” (Southall,1978: 206).

Abolafia’s (1996) description of the actions ofmarket-making specialists on the New YorkStock Exchange (NYSE) during the 1930s furtherillustrates how brokers sometimes leverage par-ticipant dependencies for their own benefit.Concerned with the growing power of special-ists in the governance of the NYSE and its po-


tential for abuse, then SEC chairman William O.Douglas met with exchange leaders in 1938 todiscuss greater regulation of NYSE activities.When Douglas suggested separating the spe-cialists’ agent and dealer5 functions—an issueof great importance to the specialists—the ex-change president responded, “That’s fine. We’renot opening on Monday” (Abolafia, 1996: 110).

It is interesting to note that as others’ depen-dence on the brokers increased and the brokersbecame more powerful, the brokers acted in anincreasingly opportunistic fashion to bolstertheir own profits without considering the long-term consequences of their actions on the mar-ket. This pattern is similar to the behaviors ofsome large and diversified underwriters dis-cussed previously. It also illustrates the context-dependent nature of self-interest and how socialcontext can shift an actor’s focus between long-term and short-term concerns (e.g., Abolafia,1996).

Third, exogenous deal conditions provide aslate of important contextual factors to which abroker must be sensitive and respond accord-ingly by adjusting the characteristics of the dealnetwork kernel in appropriate ways. Halpern(1996), for example, found that in “looser” mar-kets realtors tended to be less competitive andfocused more on using friendship contacts thanin “tighter” markets, where housing was scarceand demand was high. Finlay and Coverdill(2000) found that deal conditions influencedwhether headhunters engaged in “reciprocalopportunism” by poaching employees from oneclient company and placing them with another.Deal conditions were also found to impact head-hunters’ decisions regarding whether to acceptan assignment, and how much effort to expendon the search. Moreover, if a headhunter had aparticularly competent and desirable candi-date— known as a “most placeable candi-date”—the headhunter would make unsolicitedmarketing calls on companies that had not ex-plicitly engaged the headhunter but with whomhe or she wished to establish a new relationship.

Not all brokers are equally sensitive to dealconditions, however, either because they lackthe motivation to adjust deal kernels in re-sponse to deal conditions or because they do nothave the ability to do so. Generally speaking,the greater a broker’s social resources and de-pendence on the market, the more likely thebroker will adjust deal network characteristicsin response to changes in the favorability of dealconditions. This generalization is an importantsupplement to a purely structural analysis ofbrokering, because it suggests that brokers areoften placed in the position of having to pack-age particular configurations of participants inresponse to deal conditions— configurationsthat are dependent on a broker’s motivationsand abilities to generate interest in the transac-tion. Brokers play a constitutive role in mediatedmarkets, and, as a consequence, such marketscannot be fully understood without consideringthe unique contributions and characteristics ofthe brokers who design and manage them.

FUTURE RESEARCH DIRECTIONS

Adopting a network perspective offers a pow-erful lens for exploring how social resources aredeployed in market transactions. Many impor-tant contributions have been made by scholarswho have explored how network structures in-fluence market functioning and outcomes (e.g.,Baker, 1984; Burt, 1992; Granovetter, 1985; Uzzi,1996; White, 1981). This article extends this liter-ature by focusing on how transaction networksare actually constructed in order to facilitate theobjectives of the network architect in mediatedmarkets, and how various attributes of deal net-works influence transaction outcomes. Our dis-cussion illustrates the complex ways that socialresources and dependence interact with the mo-tivations of key actors, environmental condi-tions, and transaction-specific characteristics toshape the way transaction networks are builtand managed. Moreover, we have drawn theo-retical concepts and empirical support from themanagement, finance, and sociological litera-ture and have attempted to integrate, ratherthan counterpose, their implications.

One of the benefits of theorizing market con-struction processes in the context of IPOs is thewealth of publicly available data about an of-fering (Marino, Castaldi, & Dollinger, 1989).Methods and measures for capturing the repu-

5 Specialists can act both as “dealers,” trading shares fortheir own account, and “agents,” buying and selling sharesfor others. Serving these dual roles creates a potential con-flict of interest whereby the specialists use informationabout the other orders to self-deal and “front run” customers’orders, buying or selling shares for their own accounts be-fore fulfilling customers’ requests.


tation of key participants in the process are welldeveloped (e.g., Bushee, 1998; Carter, Dark, &Singh, 1998; Podolny, 1994), and it is possible toconstruct network measures from several sec-ondary sources, such as SEC disclosures of in-stitutional investor holdings, IPO prospectuses,and offering tombstones. In-depth qualitativestudies, both of companies going through theIPO process and investment banks as they un-derwrite offerings, can also yield important in-sights that cannot be captured through the useof archival data alone (e.g., Eccles & Crane, 1988;Malone, 1991).

However, the arguments presented in this ar-ticle also can be extended in important ways byconducting comparative studies that cross mar-ket boundaries. As we noted previously, medi-ated markets vary in idiosyncratic ways, and theinteraction of broker social resources, marketdependence, and deal conditions is likely toplay out in subtly different ways, depending onthe market context. Three market characteristicsseem to be especially important in shapingthese interactions: (1) the extent and nature ofthe institutional governance structures presentin a particular market (Abolafia, 1996), (2) theopportunities for social enforcement of trust(Portes & Sensenbrenner, 1993), and (3) the exis-tence of competition among multiple networkarchitects (Finlay & Coverdill, 2000). Compara-tive studies examining how these three factorsshape brokering processes in different marketsseem to be especially desirable.

Formal regulatory institutions (e.g., govern-mental agencies, industry associations andboards of conduct, etc.) often have a significantimpact on the way brokers design and managedeal networks. While the IPO market is regu-lated by the SEC and the national exchanges onwhich IPO stocks are listed, other markets, suchas the bond trading market (Abolafia, 1996), aremore self-regulating. Still others, such as theemployee placement market, are not subject tomuch regulation of any kind (Finlay & Coverdill,2000). On the one hand, Abolafia (1996) suggeststhat brokers in more regulated markets may besomewhat less apt to engage in self-serving andopportunistic behaviors than brokers in unregu-lated markets, implying that different gover-nance structures create different perceivedtradeoffs between short-term and long-termbenefits and costs. On the other hand, formalmarket regulations might simply create new

possibilities and incentives for broker opportun-ism. Future theorizing and research examiningthe linkages between market regulatory institu-tions and broker behavior would be useful.

Even when formal institutional structures areweak, trust can be promoted and opportunismcurtailed through social sanctions—what Portesand Sensenbrenner (1993) call enforceable trust.When market transactions take place withinclose-knit social groups, such as Dominican andCuban neighborhoods (Portes & Sensenbrenner,1993), rotating credit societies in Asian commu-nities (Geertz, 1962), or Jewish diamond mer-chants in New York (Coleman, 1988), the threat ofsocial ostracism from the community is gener-ally sufficient to curb opportunistic behavior.Brokers serving as network architects in thesedense social contexts are likely to face differentsets of motivations and concerns, and differentbrokering tradeoffs, than network architects inless tightly bound social environments. Furtherresearch exploring the role of enforceable trustand relational density in brokering processeswould be desirable.

Finally, competition among brokers often cre-ates dynamics that make it easier or more diffi-cult for brokers to control their deal networkkernels. Competition does not play a significantrole in the IPO market, since competition to beselected as the lead underwriter occurs prior tothe construction of the deal network kernel. AsFinlay and Coverdill (2000) point out, however,not all mediated markets operate in this fashion.In the employee placement market, for example,the client firm will usually contact multipleheadhunters for an engagement and encouragethem to compete throughout the placement pro-cess. Explicating how competition among bro-kers impacts deal network construction couldalso be a fruitful direction for future theorizingand empirical research.

Following these research leads should go along way toward fleshing out a generalized the-ory of brokering processes. Comparative re-search on mediated markets will permit the si-multaneous appreciation of the idiosyncrasiesof each market context, while also calling atten-tion to the interaction of the key underlying vari-ables of broker social resources, market depen-dence, and deal conditions in shaping thetradeoffs made by brokers when designing andmanaging deal networks. We believe that ourchoice to focus on the details of the IPO market


in conjunction with generalizations that apply toother mediated markets is a useful first step inthis direction. Our hope is that our combinedapproach encourages additional comparativeendeavors by scholars interested in understand-ing the social construction of markets.

APPENDIX: THE PROCESS OF TAKING ACOMPANY PUBLIC

Within an IPO deal network, the offeringfirm’s auditor, attorneys, and underwriter pro-vide the first line of fiduciary assurance that allmaterial information affecting the performanceof the company in the near future has been in-cluded in the prospectus. The SEC provides thesecond line of fiduciary assurance by verifyingthe information included in the prospectus priorto granting the company the right to issue stock.Other key participants in the network are earlyinvestors in the company and the institutionaland individual investors who purchase the stockat the initial share price.

The first step in going public is drafting theregistration statement to be filed with the SEC(Husick & Arrington, 1998). Drafting a registra-tion statement is a group activity combining theefforts of the company’s executives, the under-writers, both outside counsels, and the auditors(Husick & Arrington, 1998). In conjunction withthe SEC filing, a “red herring” prospectus isprepared for distribution to potential investors.The red herring prospectus includes all relevantinformation about the offering except the initialprice of the stock and the number of shares to beoffered. Filing with the SEC also triggers thefirm’s “quiet period,” which expires twenty-fivedays after the effective date of the offering (Hu-sick & Arrington, 1998). During this period, thecompany is not permitted to grant interviews orto otherwise promote the company in any way. Ifthe SEC feels that the company is promoting itsstock during the quiet period, it may object toor even postpone the offering. The company ispermitted, however, to conduct “road shows”around the country, in which the underwritersand top management team meet with investors,analysts, and potential members of the under-writing syndicate. The company is prohibited inthese meetings from presenting information notincluded in the prospectus, but it may clarify

issues raised in the prospectus and respond toaudience questions.

It is during the registration period that theunderwriter must determine the offering price ofthe stock (Benveniste & Spindt, 1989). The under-writer first contacts various institutional inves-tors and determines the number of shares theseinvestors are willing to purchase at variousprice levels. The underwriter then uses this in-formation to assess how the market initially val-ues the company and to identify potential inves-tors. Once the SEC is satisfied that all relevantinformation about the company has been pre-sented in a clear and accurate way, the com-pany is permitted to file a final pricing amend-ment that includes the stock’s price, the numberof shares to be sold, the underwriter’s commis-sion, and the effective date on which the com-pany has the right to offer its stock to the public.The company signs the underwriting agreementwith its investment bank twenty-four hours be-fore the effective date and sets the offering priceof the stock. The company’s stock is offered tothe public shortly after the IPO goes effective.

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Timothy G. Pollock is an assistant professor in the R. H. Smith School of Business,University of Maryland. He received his Ph.D. from the University of Illinois at Urbana-Champaign. His research explores the roles reputation, networks, legitimacy, andpower play in shaping corporate governance activities, strategic choice, and the IPOmarket.

Joseph F. Porac is a professor of management at New York University’s Stern Schoolof Business. He received his Ph.D. from the University of Rochester and has previouslybeen on the faculties of the University of Illinois and Emory University. He studies thecognitive bases of organizations and markets.


James B. Wade is an associate professor in the School of Business at the University ofWisconsin–Madison. He received his Ph.D. in organizational behavior from the Uni-versity of California at Berkeley. His research interests include organizational ecologyand top management team issues.


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Durham Research Online - COnnecting REpositories · 2017. 12. 14. · location of billions of dollars each year. In the market for IPOs, the network structure of trans-actions changes