Interorganizational-trust; the choice of make, buy, or ally; and the performance of interorganizational relationships in the us auto industry

Ranjay Gulati Kellogg School of Management

Northwestern University 2001 Sheridan Rd

Evanston, IL 60208 r-gulati@kellogg.northwestern.edu

Jack A. Nickerson* John M. Olin School of Business

Washington University in St. Louis Campus Box 1133

One Brookings Drive St. Louis, MO 63130-4899

nickerson@wuolin.wustl.edu

*The authors would like to thank Paul Lawrence for his assistance in survey design and data collection. We also thank Lyda Bigelow, Kurt Dirks, Jim Wade, Aks Zaheer, and Todd Zenger for their comments on earlier drafts. All errors remain our own.

Interorganizational-trust; the choice of make, buy, or ally; and the performance of interorganizational relationships in the us auto industry

Abstract

This paper investigates the implications of interorganizational-trust for the performance

of exchange relationships and considers the role of varying antecedents of trust on this

performance. It develops a theory of the relationship between exchange performance and two

distinct sources of interorganizational-trust—trust arising out of past interactions or the

institutional environment that existed prior to the focal exchange, which we call exogenous trust,

and trust that is intrinsic to the choice of governance, which we call endogenous trust. The

central focus of this paper is to consider in detail the role that exogenous interorganizational-trust

plays in both directly enhancing exchange performance and indirectly enhancing exchange

performance by facilitating the use of less costly modes of governance. Drawing on a sample of

222 sourcing arrangements for components from two assemblers in the automobile industry, we

evaluate our hypotheses using a novel three-stage switching regression model. We find broad

support for our theory that exogenous interorganizational-trust enhances performance both

directly and indirectly through governance choice.

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Interorganizational-trust; the choice of make, buy, or ally; and the performance of interorganizational relationships in the us auto industry

The effects of interorganizational-trust on the outcome of exchange relationships between

organizations has been of considerable interest to organizational scholars. Prior studies have

found that the existence of interorganizational-trust can enhance the performance of such

relationships in the face of labor turnover and interpersonal difficulties (Dodgson 1993),

facilitate joint action in interorganizational exchanges (Zaheer and Venkatraman 1995), enhance

market performance of cross-border marketing partnerships (Aulakh et al. 1996), reduce the need

for hierarchical controls in alliances (Gulati 1995), and lower costs of negotiation and conflict

while improving performance of interfirm exchanges (Zaheer et al. 1998). Collectively, these

studies demonstrate that the presence of interorganizational-trust corresponds to a reduced

transaction costs along with greater information exchange, problem solving and joint

commitment, which, in turn, presumably enhance exchange performance.

While extant research has investigated the implications of a generalized notion of

interorganizational-trust, there is limited understanding of how varying antecedents of trust lead

to differing performance benefits. Explanations in the literature tend to cluster around two

sources of trust: the first encompasses the structure of governance arrangements and the second

set includes pre-existing conditions that encompass past interactions or the institutional

environment. In the first set of these antecedents, scholars have suggested that

interorganizational-trust can arise from the formal governance arrangements that in turn

constrain and shape partner behavior (Dyer, 1997). These specific arrangements can in turn

reduce the likelihood of opportunistic behavior and hence generate trust. If governance

arrangements themselves were the only source of interorganizational-trust, trust would be

intrinsic to governance and attention on the relationship between trust and performance would be

1

misplaced since the key relationship would be between governance and performance. Thus,

instead, effort should be redirected toward developing more nuanced understanding of the choice

of governance mechanisms and the resulting performance implications (Zaheer and Venkatraman

1995).

Interorganizational-trust, however, may also result from a second set of antecedents that

exist prior to firms entering a given exchange that result from previous interactions or that derive

from the institutional environment, which constrains behavior. Past interactions presumably

provides firms with information that allows them to select those exchange partners who in the

past have demonstrated lower propensity to engage in opportunistic behavior while avoiding

those partners who demonstrate higher propensities (Gulati 1995). Such selection shapes

expectations about partner behavior and lessens concerns about opportunistic behavior.

Furthermore, such conditions also encourage collaborative social processes (Zucker 1987) and

interactions (Blau 1964) that are foundations of trust (Uzzi, 1997). Alternatively, the larger

institutional context including industry culture, norms, laws, embeddedness and the like (e.g.,

Zucker 1987; Fukuyama, 1995) may constrain the range of potential behavior by creating

pressures for conformity to cooperate. Such environments constrain opportunistic behavior and

thereby engender interorganizational-trust.

If these two different antecedents of interorganizational-trust reduce concerns about

opportunistic behavior how do they combine to affect exchange performance? Some have

argued that the antecedent conditions for trust resulting from past interactions and the

institutional environment directly affect the choice of governance (e.g., Bromiley and Cummings

1995, Gulati 1995). This implies in some sense that trust arising from antecedent conditions

resulting from past interactions and the institutional context can substitute, at least to some

2

degree, for more formal mechanisms of governance. Alternatively, the antecedents of

interorganizational-trust could be viewed as complementing governance by providing an

additional means by which to reduce the likelihood of opportunistic behavior thereby enhancing

exchange performance. While scholars have alluded to either the substitutive or complementary

nature of these two antecedents of trust, few studies have investigated the relationship between

interorganizational-trust and their combined effect on performance. In other words, while prior

research has drawn attention to the direct benefits of interorganizational-trust, it has tended to

neglect some additional indirect benefits of such trust that may arise from its impact on the

choice of governance structure.

In this study, we seek to address this important lacuna by considering not only the direct benefits

of exogenous trust on the performance of exchange relationships but also the indirect benefits of

exogenous trust through its impact on governance choice. This paper develops a theory of the

relationship between exchange performance and two distinct antecedents of interorganizational-

trust—trust arising out of pre-existing conditions and trust arising from governance

arrangements. We use the term “exogenous” trust to describe interorganizational-trust that

derives from past interactions or the institutional environment because trust is pre-existing to the

focal exchange. We use the term “endogenous” trust to describe trust that emerges from the

adoption of specific governance arrangements in an exchange because it is the governance

structure that generates the trust. In other words, we maintain that endogenous trust is intrinsic

to the governance structure since governance provides the basis for trust by creating a set of

incentives, administrative controls, and a means for resolving disputes that impact the extent to

which the behavior of partners is likely to be predictable in the partnership. It is also likely that

3

each distinct formal governance structure engenders certain kinds of social processes that impact

the extent of trust likely to emerge.

The terms endogenous and exogenous are useful because they draw distinctions about not

only different mechanisms generating trust but also the sequential v. contemporaneous features

of these mechanisms. Since we assume that endogenous trust is intrinsic to governance, our

focus will be on the relationship between exogenous trust, governance, and exchange

performance. Specifically, we first argue that exogenous interorganizational-trust directly

impacts performance of exchange relationships by lowering the concern for opportunistic

behavior when asset specificity associated with the exchange is greater than zero. Thus,

interorganizational-trust directly improves exchange performance by lowering the cost of

governance no matter which governance mode is selected. Second, we argue that this benefit

from exogenous trust accumulates most for the buy mode of governance and least for make. The

net result is that with exogenous trust moral hazards decline and, all else equal, the preferred

mode of governance shifts from make, to ally, to buy as trust deepens. Such a shift further

enhances exchange performance by allowing a less costly governance mode, say buy, to

substitute for a more expensive mode like ally. Thus, exogenous interorganizational-trust

impacts the performance of exchange relationships both directly, by complementing each

governance mode to improve exchange performance, and indirectly, by enabling a less

hierarchical mode of governance to substitute for a more hierarchical one.

An important contribution of this study is a careful consideration of how exogenous

interorganizational-trust both directly affects exchange performance and indirectly affects

exchange performance through governance mode choice. While prior research has drawn

attention to either the direct or indirect benefits of interorganizational-trust, it has tended to

4

neglect the way in which trust affects both simultaneously. In this study, we seek to address this

important lacuna by considering not only the direct benefits of exogenous trust but also the

indirect benefits of exogenous trust through its impact on governance choice. Thus, an important

contribution of this study is a careful consideration of how exogenous interorganizational-trust

both directly affects exchange performance and indirectly affects exchange performance through

governance mode choice.

Another distinct contribution of our study is our extension of the possible choice of

governance arrangements by firms from the traditional make or buy choice to encompass a third

choice which we describe as ally or hybrid. In light of the proliferation of research on the

emergence of hybrid arrangements to facilitate exchange, it is a glaring omission that most

empirical studies still consider the choice of governance as a dichotomous one between make or

buy (for recent exceptions see Dyer, 1997, Zaheer and Venkatraman, 1994). In our discussion of

both endogenous and exogenous trust, we consider the choice of governance as trichotomous

between make, ally, and buy.

We examine our propositions with the help of a three-stage switching regression model

and a sample of 222 sourcing arrangements for components from two assemblers in the

automobile industry. Our data allows us to evaluate the effect of exogenous interorganizational-

trust on the choice of three discrete modes of governance: components bought from the market

using short-term contracts (buy), through long-term contracts (what we refer to as ally), and from

other divisions with the firm (which is a form of make). Further, controlling for the choice of

governance, we estimate the effects of governance choice and exogenous interorganizational

trust on performance. Analysis of our data provides broad support for our hypotheses linking

interorganizational-trust to the performance of exchange relationships.

5

Theory and hypotheses

Interorganizational-trust

Trust is a complex topic that has received much attention from a wide array of

disciplinary lenses. This diversity of perspectives has lead to a confusing assortment of

theoretical constructs. In recent years the inherently interpersonal notion of trust has been

extended to organizations with new ways of considering the occurrence and implications of

interorganizational-trust. Comparing, contrasting, and rationalizing these differing constructs is

beyond the scope of our paper. Instead, we rely upon and build on the conceptualization of

interorganizational-trust proffered by Zaheer et al. (1998), which builds on Anderson and Weitz

(1989), Anderson and Narus (1990), and Bromiley and Cummings (1995). They define trust

(p.143) as “the expectation that an actor (1) can be relied on to fulfill obligations, (2) will behave

in a predictable manner, and (3) will act and negotiate fairly when the possibility for

opportunism is present.” Zaheer et al. claim that their conceptualization is advantageous because

it is based on reliability, predictability, and fairness, which together capture some of the

complexity of trust. Their definition also recognizes the distinction between dispositional and

relational trust, where the former reflects an individual trait and the latter pertains specifically to

the trust within a dyad.

Our focus is on interorganizational-trust and not on the trust one individual has in another

individual. Indeed, Zaheer et al. (1998) use institutional theory to argue that institutionalizing

processes (e.g., Zucker 1987) institutionalize interpersonal trust so that expectations of trust

about a particular partner firm become a norm within a focal firm. Similarly, even though labor

may turnover, institutionalizing processes will socialize new boundary spanners with the norms

of the firm, which include expectations about partner firm behavior. We utilize Zaheer et al.’s

6

definition of interorganizational-trust, which, in essence, is the extent of trust placed in the

partner organization by the member of a focal organization.

Components of Interorganizational-trust

We propose that there are two distinct components of interorganizational-trust:

endogenous trust and exogenous trust. We define endogenous interorganizational-trust as trust

that emerges from the governance arrangements in which an exchange between two

organizations is embedded. Treating the antecedents of the governance structure as exogenous,

this view indicates the extent of trust that arises between two organizations is intrinsic to the

governance arrangements they use to formalize their exchange.1 In our context, endogenous trust

is intrinsic to the governance arrangements chosen by virtue of the fact that the governance

structure creates a set of incentives and engenders social processes that in turn impacts the

predictability of both partner’s behavior and thus the likely level of trust. We refer to this form

of trust as endogenous trust because interorganizational-trust here arises through the choice of

governance structure, which is endogenous in our framework. In our framework, while

endogenous trust affects performance, it is the choice of governance structure that delivers the

level of endogenous trust, which causes is to concentrate our efforts on examining the

relationship between governance choice and performance. Thus, our focus will be on

governance choice and on what we refer to as exogenous interorganizational-trust and its effect

on governance choice and exchange performance.

1 This definition of trust arising out of the formal governance structure used is akin to what Williamson (1993) describes as “calculative trust” (although an apparent contradiction in terms), which arises when an actor assesses the potential for alternative behaviors from an exchange partner and makes a calculated judgment to trust the other based on those assessments (1993, 256-261). Calculative trust reflects the idea of a “farsighted” approach to contracting in which actors not only assess the risk of opportunistic behavior, but also consider cost-effective safeguards, like mutual hostages, credible commitments, and other governance instruments, to shape and constrain behavior and to support more efficient exchange. As a result, trust arises out of the formal structure used.

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We define exogenous interorganizational-trust as trust derived from past experience or

from the broader institutional context. It is labeled exogenous because trust is pre-existing to the

focal exchange and the governance structure used to formalize the exchange. Past interactions

generate exogenous trust by shaping expectations of subsequent behavior. For instance, over

many years a firm may avoid those exchange partners who have demonstrated a propensity for

opportunistic behavior while retaining those who have displayed low propensities in such

behavior. In this way, selection may lead to knowledge about a partner’s “type” and an

expectation of behavior that is superior to that provided by a random draw from potential

unknown suppliers. In addition to selection dynamics, past interactions also engender social

processes (Zucker 1987) and interaction patterns (Blau 1964) that scholars have identified as

providing important foundations of trust (Uzzi, 1997).

The institutional context is also exogenous to a focal exchange and it represents another

antecedent of trust. Institutional contexts in which firms are embedded in a web of social

relationships, culture, norms, laws, or customs can lead to punishment for those who don’t

conform to norms of behavior (Fukuyama, 1995). In such institutional contexts, opportunistic

behavior may be less likely (for examples from the Italian districts, see Lazerson 1988; Weiss

1984). Thus, the institutional context may effect general expectations about anticipated behavior

and in turn engender interorganizational-trust.

The principle emphasis of prior research on interorganizational-trust has been on

illustrating the implications of exogenous interorganizational-trust on behavior and performance

in interorganizational relationships. These implications arise directly as a result of information

made available to exchange partners from their past experience or from the institutional context

within which exchanges are embedded. Building on these ideas, researchers have suggested that

8

expectations shaped by prior exchanges and the institutional environment in which the exchange

is embedded should be taken as exogenous factors that have a direct impact on the performance

of exchange relationships.

Our central claim is that exogenous interorganizational-trust affects both directly and

indirectly the expected ex post costs of governing the exchange.2 Exogenous trust has a direct

effect because it reduces the cost of governance thereby enhancing exchange performance.

Exogenous trust also has an indirect effect because it affects the relative costs of the choice of

governance among buy, ally and make differentially, which has important implications for the

choice of governance. With this indirect effect, exogenous trust facilitates the substitution of a

less expensive governance structure for a more expensive one on the margin, thereby further

lowering the cost of governance and enhancing exchange performance.

Direct and Indirect Effect of Exogenous Interorganizational-trust on Performance

Before proceeding with development of our theory, we introduce Figure 1, which is an

adaptation Williamson’s reduced-form discussion of governance choices. Transaction cost

economics was largely developed around the dichotomy of make v. buy and practically all

empirical work is restricted to examination of dichotomous choices. More recently Williamson

(1991) expanded the theory to encompass the choices of market, hybrid, and hierarchy, which

equate with our more conventional labels of buy, ally, and make used in organizational theory

today. We utilize this expansion to develop our theory.

Let B(k:θ), A(k:θ), and M(k:θ) represent reduced-form expressions of the expected

governance costs associated with buy, ally, and make modes of governance, as a function of

2 Our theory expressly assumes that interorganizational-trust can exist between different organizations within a firm such as between divisions. Our view differs from Chiles and McMackin (1996) who implicitly assert that trust affects only market modes of organization.

9

asset specificity (k) and a vector of shift parameters (θ).3 Governance cost is a class of

transaction costs and refers to the costs of drafting, negotiating, and safeguarding an agreement

between two or more actors and as well as ex post costs of contracting. Williamson (1985, 21)

describes expected ex post governance costs that arise once the governance structure is chosen as

including: (1) the “maladaptation costs” incurred when bilateral parties are not able to respond

quickly and easily to problems stemming from disagreements and self-interested bargaining,

which arise during the exchange (see also, Williamson, 1996, 107); (2) the “haggling costs”

incurred when exchange partners attempt to realign the exchange should it have drifted our of

alignment because of the occurrence of unanticipated events, (3) the set up and running costs

associated with the governance structures to which disputes that arise during the exchange are

referred (e.g., management costs to monitor and resolve disputes, administrative controls that

establish rules and procedures for resolving disputes, etc.); and (4) the bonding costs affecting

secure commitments, such as mutual investments to signal financial commitment to the exchange

and muted incentives.

Such ex post costs, and governance costs more generally, have a critical impact on

exchange performance since exchange performance declines in direct response to increases in

governance costs, all else held equal. Williamson asserts that the shape of the governance cost

curves are such that B(0) < A(0) < M(0) and that ∂B/ ∂k > ∂A/∂k > ∂M/∂k > 0, which implies

that buying in the market is the least costly mode of organization for low levels of asset

specificity, making internal production the least costly mode of organization for high levels of

asset specificity, and allying is the least costly mode of organization for moderate levels of asset

3 We set aside these shift parameters for the moment but will return to them below when we discuss exogenous interorganizational-trust.

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specificity. The intersections of the curves B and A, denoted by k1, and the curves A and M,

denoted by k2, identify the “critical values” of asset specificity where the transaction-cost

economizing governance choice changes from one mode to another.

<Insert Figure 1 about here>

Direct Effect. Exogenous interorganizational-trust’s direct effect on exchange

performance comes from the attenuation of the corresponding expectation of opportunistic

behavior by an exchange partner for a given organization. Past interactions and the institutional

context can mitigate concerns of opportunism that, if present, leads to high ex post governance

costs and correspondingly low exchange performance. We propose that exogenous

interorganizational-trust is only beneficial when possible opportunistic behavior by one partner

could impose costs on the other partner, which arises only when investments are co-specialized

(i.e., asset specificity > 0). This logic equates to Bradach and Eccles (1989:104) assertion that

“the risk of opportunism must be present for trust to operate.” As asset specificity deepens so

too does the cost of opportunistic behavior as well as the benefits from mechanisms that reduce

the likelihood of such behavior. For this reason, exogenous interorganizational-trust (and the

mechanisms that generated it) offers little expected benefit for low-levels of asset specificity but

offers increasing expected benefit as asset specificity deepens. The net result is that we postulate

exogenous-interorganizational-trust reduces the level of expected opportunistic behavior and

hence reduces expected governance costs, which thereby increases exchange performance.

However, this benefit arises only when asset specificity is present and increases as asset

specificity deepens.

In terms of Figure 1, this means that exogenous interorganizational-trust has no affect on

the vertical axis intercepts for the expected governance costs curves of buy, ally, and make, but

11

does change the slope of the curves by making them flatter. It makes them flatter because with

exogenous interorganizational-trust you experience benefits such as fewer disputes along with

greater collaboration, which in turn leads to lower costs for governing the exchange and higher

exchange performance. This flattening of the slope of the governance cost curves equates to

lowering the expected cost of governance for each mode thereby directly improving exchange

performance.

Indirect Effect. We propose that exogenous interorganizational-trust not only affects

the exchange performance directly by lowering governance costs but also indirectly through its

influence on the choice of governance structure, which in turn enhances exchange performance

by facilitating a less expensive governance mode to substitute for a more expensive one. While

exogenous interorganizational-trust lowers governance costs for buy, ally, and make, we argue

below that it has a differential effect on buy, ally, and make, which can lead managers to choose

a governance mode that is different from the one they would choose if no exogenous trust was

present. We propose that for any positive level of asset specificity, exogenous

interorganizational-trust reduces expected ex post governance costs by reducing expected

opportunistic behavior differentially across the three discrete choices of make, buy, and ally.

This in turn impacts the choice of governance made by managers and leads them to select less

costly modes of governance, which in turn enhances exchange performance. Thus, if exogenous

trust has a greater governance cost lowering affect on buy than on ally, then for some levels of

asset specificity, increasing levels of exogenous trust will increasing allow managers to choose

buy, the less expensive form of governance, in place of ally. Similarly, if exogenous trust has a

greater governance cost lowering affect on ally than on make then, for at least some levels of

12

asset specificity, increasing levels of exogenous trust will increasingly cause managers to

substitute the less expensive ally form of governance for make.

To see the logic behind why this substitution of one governance mode for another takes

place, consider the four categories of ex post governance costs identified above and how

exogenous trust affects these costs for each discrete choice of make, buy, and ally. First,

expected maladaptation costs that result from exchange partners not being able to adapt quickly

due to self-interested bargaining, will decline with increasing levels of exogenous

interorganizational-trust since it is expected either that the institutional environment constrains

behavior or that exchange partners have a low propensity to engage in opportunistic behavior.

Second, the reduced expectation of opportunistic behavior also reduces expected haggling costs

since more exogenous interorganizational-trust implies less expected opportunistic bargaining—

the source of haggling costs. By reducing these two facets of governance costs, the presence of

exogenous trust thus mitigates concerns of opportunism and in turn impacts their choice of

governance between make, buy, and ally by encouraging the use of less hierarchical

arrangements

We expect that the two facets of governance cost cost reductions discussed above

accumulate similarly for the discrete choices of buy, ally, and make. However, such a parallel

development is not necessarily true for the remaining two categories of costs—set up and

running costs of governance structures for dispute resolution and the bonding costs affecting

secure commitments. We propose that exogenous interorganizational-trust does indeed affect

these latter two categories of governance costs differentially for buy, ally and make, which, on

the margin, facilitates buy substituting for ally and ally substituting for make. These

13

substitutions, as we discuss below, lower the cost for setting up and running the exchange, which

increases exchange performance.

For the third category of costs associated with dispute resolution it is insightful to

consider the work of Zaheer et al. (1998) who show that trust enables a broader search for

solutions and lowers conflict and negotiation costs. Nonetheless, it offers no dispute resolution

mechanism and thus cannot provide any structural safeguard against opportunistic behavior

(remember, trust reduces but does not eliminate the likelihood of opportunism). Thus, while

exogenous trust can lower ex post governance costs, it cannot substitute for those aspects of

governance to which disputes are referred, the third category of ex post governance costs. This

means that exogenous trust does not and cannot substitute for dispute resolution mechanisms

associated with ally and make. Thus, ally and buy still must incur the set up and running cost of

dispute resolution, which limits the cost-reducing benefit of exogenous trust for these modes,

whereas buy provides no such mechanisms, does not incur these costs, and more fully realizes

the cost reducing benefits of exogenous trust.

Furthermore, trust also is an imperfect substitute for the fourth category of ex post

governance cost—tangible commitments that act to bond two exchange partners. Commitments

involving real expenditures would represent real losses should the exchange be severed whereas

the loss of trust in such an event represents the only loss of expected future cost savings. The

former represents an incentive that cannot be perfectly duplicated by the latter. Exogenous trust

does not and cannot offer the additional incentive of forfeiting tangible commitments since it is

not tangible. Yet, the potential forfeiture of tangible commitments arguably is a more certain

and immediate penalty than the less certain and less immediate potential of harming a

relationship should trust be violated. This difference in penalties suggests that the forfeiture of

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tangible commitments represents an incentive that shapes behavior and cannot be duplicated by

exogenous trust.

All of this is not to say that as an imperfect substitute there is no marginal rate of

substitution of trust for governance. Indeed, as Bromiley and Cummings (1995) argue, trust may

substitute for some aspects of governance instruments; but this substitution is not complete and is

on the margin. Thus, since such tangible commitments are present only in ally and make forms

of governance, these two modes incur the costs of establishing such commitments whereas buy

does not. Here again, the cost reducing effect of exogenous interorganizational-trust is limited

for ally and make whereas buy more fully realizes the cost reducing benefits of exogenous trust.

These arguments indicate that exogenous trust lowers the likelihood of conflict and,

hence, ex post governance costs but does not substitute for underlying conflict resolution

mechanisms and tangible commitments and their associated costs. Since the governance mode

of buy is low cost to set up and has no resolution mechanisms and tangible commitments

associated with it, exogenous trust’s cost-reducing effect on the ex post costs of governance is

great. Exogenous trust can have only a lesser cost-reducing effect on the ex post governance

costs of ally since the governance mode incurs set up and running costs associated with moderate

levels of conflict resolution and tangible commitments. Thus, these safeguarding features of ally

entail ex post governance costs for their maintenance and use, for which exogenous trust cannot

substitute. In others words, exogenous trust lowers governance costs more for buy than ally for

any positive level of asset specificity. Furthermore, exogenous trust’s cost-reducing effect on the

ex post governance costs of make is less than for ally because make provides conflict resolution

mechanisms and tangible commitments that are more costly to set up and run than for ally. For

instance, a conflict resolution mechanism might be specified contractually in an ally form of

15

governance where as a make form of governance requires a management structure that can

adjudicate conflicts. Exogenous interorganizational-trust does not substitute for these costs and

thus has less of an effect of lowering overall ex post governance costs for make than for ally or

buy. Thus, exogenous trust has a greater cost reducing affect on ally than for make.

Our discussion of exogenous trust’s affect on the set up and running costs associated with

governance and the bonding costs affecting secure commitments implies that exogenous

interorganizational-trust lowers the cost of governance where the cost lowering effect is greatest

for buy and least for make. Exogenous trust offers no safeguard for resolving conflict nor does it

provide tangible commitments, which in turn shape behavior and thus proves a poor substitute

for ally and an even poorer substitute for make. Buy, on the other hand, is a governance

structure that does into rely on these instruments and thus fully benefits from the lower expected

levels of opportunistic behavior that exogenous trust provides. Based on this reasoning, we

conclude that exogenous interorganizational-trust facilitates market exchanges because markets

include neither specialized governance instruments for resolving disputes nor bonding for

protecting buyers and sellers. Thus, the full benefit of exogenous interorganizational-trust for

lowering governance costs can be realized in market exchanges. In contrast, we conclude that

exchanges which take place under non-market governance like, for example, between two

divisions of a single firm also known as the make option, have to put in place administrative

controls, muted incentives, and fiat whose combined purpose is to attenuate opportunistic

behavior and resolve disputes, should they arise. This implies that exogenous

interorganizational-trust is a poorer substitute for make than for ally for the same reasons

outlined above and thus lowers governance costs less so than for buy, ceteris paribus.

16

If exogenous interorganizational-trust differentially affects the governance costs of buy,

ally, and make then it implies a pattern of substitution of one governance mode for another. For

instance, if exogenous trust causes the governance cost of buy to decline more than ally (for

every level of asset specificity) then the “critical value” of asset specificity, which indicates

where buy and ally have equivalent governance costs, increases. In other words, with the

presence of exogenous interorganizational-trust, buy can be chosen where otherwise ally would

be chosen, for at least some values of asset specificity. Similarly, if exogenous trust causes the

governance cost of ally to decline more than make then ally can be chosen where otherwise make

would be chosen, for at least some values of asset specificity. The net result is that not only does

a lowering of governance costs due to exogenous trust enhance exchange performance, but also

exchange performance is additionally enhanced by the substitution of a lower cost governance

mode for a higher cost one.

These conclusions can be seen more easily by illustrating them with the governance cost

curves B(k:θ), A(k:θ), and M(k:θ) shown in Figure 2. Assume that positive exogenous

interorganizational-trust is a shift parameter (γ) such that θ = γ > 0. Our first argument suggests

that the expected governance cost curve intercepts are unchanged by exogenous

interorganizational-trust: i.e., B(0) = B(0, γ); A(0) = A(0, γ); and M(0) = M(0, γ). Our second

argument suggests that the slope of each governance cost curve flattens for k > 0 when γ > 0 such

that,

0,0k0),k(M),k(A),k(B >γ>∀<γ∂

γ∂<γ∂

γ∂<γ∂

γ∂ .

17

Also, higher levels of γ are anticipated to have diminishing marginal returns since

interorganizational-trust cannot in the limit eliminate the possibility of opportunistic behavior.

Thus,

00),k(M),k(A),k(B2

2

2

2

2

2

>γ∀>γ∂

γ∂>γ∂

γ∂>γ∂

γ∂

<Insert Figure 2 about here>

We can see the effect of these conditions graphically in Figure 2. Figure 2 illustrates that

exogenous interorganizational-trust shifts the reduced form equations from B(k, 0), A(k, 0), and

M(k, 0) to B(k, γ), A(k, γ), and M(k, γ). One effect of exogenous interorganizational-trust on

governance costs is clear in Figure 2: the higher the level of exogenous trust the lower the

governance costs regardless of which mode is chosen. Lowering expected governance cost,

holding asset specificity constant, has a direct affect on lowering governance costs which

translates into a positive affect on the economic performance of an exchange: the higher the level

of exogenous interorganizational-trust the lower the expected governance costs and hence the

higher the economic performance, ceteris paribus.4 Thus, the presence of exogenous

interorganizational-trust increases performance by lowering governance costs whether buy, ally,

or make is the chosen governance mode. Hence, we predict:

H1A: The higher the level of exogenous interorganizational-trust the higher the economic performance of the exchange organized as buy, ceteris paribus.

H1B: The higher the level of exogenous interorganizational-trust the higher the economic

performance of the exchange organized as ally, ceteris paribus. H1C: The higher the level of exogenous interorganizational-trust the higher the economic

performance of the exchange organized as make, ceteris paribus.

4 It is possible that lower expected governance costs because of exogenous interorganizational-trust could lead to increases on the margin in asset specific investments. We would expect that such a substitution is not likely unless there are significant expected gains.

18

By virtue of exogenous interorganizational-trust having a greater expected effect on

transaction costs as asset specificity increases and having its greatest expected effect on buy and

least effect on make, the two critical values of asset specificity shift to k1γ from k1 and to k2

γ

from k2. The higher the level of exogenous interorganizational-trust the further k1γ and k2

γ shift

to the right. These shifts change the efficient choice of governance mode from make to ally to

buy as exogenous interorganizational-trust increases, which indirectly enhances exchange

performance by allowing a less expensive governance mode to substitute for a more expensive

on. Conversely, increasing levels of negative organizational-trust, or mistrust, would shift

organizing mode choice in the opposite direction. Of course, such mistrust invites dropping the

partner and selecting a different partner.

While exogenous trust yields this indirect effect on performance, it has a direct effect on

governance choice. The higher the level of exogenous interorganizational- trust more likely

firms will choose a governance mode that is less hierarchical than one would predict without

such trust. Thus, we predict:

H2A: The preferred organizing mode of an exchange shifts from ally to buy as the level of exogenous interorganizational-trust increases, ceteris paribus.

H2B: The preferred organizing mode of an exchange shifts from make to ally as the level of

exogenous interorganizational-trust increases, ceteris paribus.

Method

Sample and Data Collection

We utilize of a survey on supplier exchanges undertaken in 1995. The survey data were

collected by questionnaire filled out by lead buyers of a variety of component areas at the Ford

Motor Co. and at the Chrysler Corp. The unit of analysis for this study is each component

exchange, with each survey respondent providing data on the component itself and then on the

19

two largest suppliers (or one, if only one existed) for a particular component. Our unit of

analysis differs from several other studies of organizational choice in the auto industry because

of its focus on individual transactions. In contrast, Masten et al. (1989) and Monteverde and

Teece (1982) use the commodity as the unit of analysis, which can encompass several

transactions with potentially different attributes for each transaction, and thus fail to examine

transaction-level data as we do in this study.

The sampling frame for this study consisted of all commodities that go into the assembly

of an automobile and thus offers an advance over those automotive studies that are far more

restrictive in the sample of exchanges (e.g., Walker and Weber 1987). Drawing on a previous

study of the automobile sector (Monteverde and Teece, 1982) and discussions with informants in

the automobile industry, we used a list of 120 components that go into most automobiles. The

comprehensiveness of this list was verified with several executives in the industry and also

against component lists used by the firms to monitor their own parts’ quality. For each

commodity, senior managers at the two automobile assemblers supplied the names of buyers

with oversight for the sourcing of that commodity. Additionally, the controller’s office in each

company verified expert status for each survey respondent.

In-depth interviews with managers at both Ford and Chrysler preceded the design of the

questionnaire and influenced many of the items included. Fieldwork was conducted as follows.

Permission for the study was sought from senior managers at both Ford and Chrysler. Following

approval, a total of 37 interviews (16 at Chrysler, 21 at Ford) were conducted. Fieldwork

involved speaking with managers responsible for both external and internal sourcing. This

included individuals in purchasing, quality control, platform management, and engineering

operations. The initial interviews were exploratory and open-ended but focused on the

20

characteristics of each individual’s particular commodity, the type of sourcing arrangement used,

its relative performance, and the pros and cons of alternative sourcing arrangements for that

commodity.

The survey instrument was pre-tested with several groups of executives and also by

senior managers at the participating companies to remove ambiguities and examine the face

validity of the measures. Three groups of five executives at the two companies went through the

survey together to identify questions that were unclear or subject to multiple interpretations,

revealed sensitive information, were difficult to answer, or were subject to social desirability

bias. Detailed feedback from these groups was incorporated and additional input was sought on

the revised instrument from key informants in each company and incorporated the additional

changes.

The cover letter to respondents indicated that he or she had been identified as an expert

on the acquisition of a specific commodity and asked for return of the survey blank and a

nomination of an expert if this were not the case. The approach of contacting the most

knowledgeable informant is consistent with prior research in other contexts (e.g., Venkatraman

and Grant, 1986; Heide and John, 1990; Walker and Poppo, 1991). This approach differs from

other studies of governance choice in the automotive industry where either one individual

(Masten et al., 1989) or a small team (Monteverde and Teece, 1982) filled out surveys for all

components instead of the most knowledgeable informant.

Survey implementation took the following steps to ensure a good response rate (Fowler,

1993). First, an attractive, professionally printed questionnaire with clear instructions was

developed. Second, requests for participation specified that senior management had endorsed the

project, which was part of an ongoing study jointly conducted by researchers at two prominent

21

business schools. Third, a cover letter stated that respondents would receive a synopsis of the

key findings of the study. Fourth, several follow-ups were conducted with non-respondents

including a reminder letter sent after 21 days and a telephone call after 42 days. Sixty-four

buyers responded from Ford, and 67 buyers responded from Chrysler, representing response

rates of 53 percent and 56 percent, respectively, and a total response rate of 55 percent.

We examined non-response bias by comparing the characteristics of the commodities for

which responses were received against those for which no response was received. We looked at

two key characteristics of commodities identified in prior research—type of sourcing and

engineering complexity. We relied on Monteverde and Teece’s (1982) ratings of the primary

types of sourcing of all commodities in automobiles and ratings of their engineering complexity

as a basis for this comparison. We used the Kolmogorov-Smirnov two-sample test to assess the

possibility of differences in the distribution of respondents and non-respondents across these two

variables (Siegel and Castellan, 1988). This test looks at a host of differences, including central

tendency, skewness, and dispersion. The results of this test indicate that the respondents and

non-respondents came from the same population and that sample selection bias is not an issue

with these data.

Empirical Approach and Measures

Our empirical approach had three elements. First, we examined the extent to which our

construct for interorganizational-trust captured exogenous versus endogenous trust. Thus, our

first dependant variable is interorganizational-trust, TRUST. Second, we examined the effect of

exogenous interorganizational-trust, controlling for the level of asset specificity, on governance

mode choice. The type of governance mode—buy, ally, and make—is our second dependent

variable. Because we use cross-sectional data, there exists the potential for endogeneity between

22

our construct for interorganizational-trust and governance choice (i.e., the governance choice

may affect the level of endogenous interorganizational-trust). To control for this possibility, we

constructed the predicted level of interorganizational-trust, P_TRUST, by using those

antecedents that are likely to generate exogenous interorganizational-trust to identify our

estimate. We develop this measure because it allows us to econometrically identify exogenous

interorganizational-trust from a construct that is comprised of both. We used this predicted level

of exogenous interorganizational-trust to investigate hypothesis 1. Finally, we examined to what

extent governance mode choice and exogenous interorganizational-trust affected exchange

performance. Exchange performance is our third dependent variable (actually, we employ two

different measures of performance), which allows us to investigate hypothesis 2.

Dependent Variables

Our first dependent variable measures interorganizational-trust. We use five items that

are nearly identical to those employed by Zaheer et al. (1998) to identify interorganizational-

trust. Our five questions were: (1) the supplier has always been even handed in its negotiation

with your company; (2) this supplier may use opportunities that arise to profit at your expense;

(3) based on past experience, you cannot with complete confidence rely on this supplier to keep

promises made to you; (4) you are hesitant to transact with this supplier when specifications are

vague; and (5) you trust this supplier to treat you fairly. Each question is based on a 7-point

Likert scale ranging from strongly disagree to strongly agree. We evaluated reliability of our

dependent variable by estimating Cronbach’s alpha (Nunnally, 1978) for the battery of five

items, which yielded a scale reliability coefficient of 0.835. This value indicated a high level of

reliability and led us to use the resulting scale, which we labeled TRUST, as our measure of

interorganizational-trust. It is important to note that this battery of questions was designed to

23

capture the total level of interorganizational-trust. It does not distinguish trust that emerges from

different antecedents. Thus, this construct measures total interorganizational-trust, which can

include both endogenous trust and exogenous trust. We later use our empirical methodology to

distinguish between different antecedents of trust by econometrically identifying the component

of trust that is exogenous.

Our second dependent variable identifies how the component exchange is organized.

Extensive interviews with buyers and executives lead us to conclude that there were essentially

three discrete types of organizational arrangements, perhaps with variations within type but a

gulf between types. We classify as MAKE those exchanges organized hierarchically with an in-

house supplier agreement where the purchasing arrangement was with an internal division of

their company. We classify as ALLY those exchanges organized as a hybrid with external

suppliers where the purchasing arrangement is characterized by relatively longer-term or open-

ended contracts. Finally, we classify as BUY those exchanges organized as a market with

external suppliers where the purchasing arrangement is characterized by relatively shorter-term

contracts and competitive bidding. Respondents were asked to identify whether each exchange

was organized predominately as MAKE, ALLY, or BUY, according to these definitions. Hence,

our study investigates the choice among three distinct organizing modes whereas most prior

studies investigate only make v. buy. Of the 222 exchanges with complete information, 24 were

organized as MAKE, 126 were organized as ALLY, and 72 were organized as BUY. MODE is

our ordered categorical variable set equal to 0 if the exchange is organized at a BUY, 1 if the

exchange is an ALLY, and 2 if the exchange is organized as a MAKE. Our mode choice

variable is more consistent with the transaction as the unit of analysis than some prior studies of

auto industry exchange organization that used the percentage of the company’s component needs

24

produced by the assembler (i.e., Masten et al. 1989) or that classified the organizing mode as

vertical integration only if 80% or more of the component needs were produced by the assembler

(i.e., Monteverde and Teece 1982).

Our third dependent variable measures exchange performance. We were unable to

directly measure economic exchange performance because it is difficult to measure and is

considered to be sensitive company information. So instead, the survey contained thirteen

questions used to investigate the buyer’s opinion of satisfaction with the supplier compared to

the best alternative supplier for the commodity. These questions were based on a survey of the

literature and on fieldwork and pretests. All questions employed a 7-point Likert scale. The first

ten questions reflected the respondent’s opinion about the attractiveness of the supplier compared

to the best alternative supplier for the commodity in question—1 indicating much less attractive

than alternative and 7 indicating much more attractive than alternative. These dimensions are:

price competitive, support and services, flexibility in production, product quality, product

innovations, overall performance, average passed target-price ratio, average passed price change

rate, average defect rate, and improvement in average defect rate (see Table 1 for definitions for

the latter four terms). The next question asked “during the past year how often were there

significant disagreements between your business unit and the supplier?” to which the respondent

was asked to reply with a 1 indicating very rarely and 7 indicating very frequently. Finally, the

last two questions asked how easy are negotiations between your business unit and the supplier

over sharing the burden of cost when your business units requests engineering changes, and

when the supplier’s raw material costs increase. The respondent was asked to reply with a 1

indicating fairly easy and 7 indicating are very difficult.

25

Rather than specify a performance construct based on a subset of these questions, we

chose instead to undertake a factor analysis to identify relevant performance dimensions. We

analyzed our thirteen performance measures using exploratory factor analysis with varimax

rotation, which is appropriate for measuring unobservable theoretical constructs using reflective

indicators (Carmines and Zeller, 1979; Zeller and Carmines, 1980). The vast majority of

variance loaded onto a single factor, which had an eigenvalue of 6.149 and accounted for 75% of

the variation in our data. Only the first two factors yielded eigenvalues greater than one: the

second factor had an eigenvalue of 1.425, explaining no more than 18% of the of variation in our

data; and the third factor had an eigenvalue of 0.710 and explained less than 9% of the of

variation in our data. Table 1 displays factor loadings for these three factors. Using a loading

coefficient greater than or equal to 0.50 and identifying the factor for which each variable loads

maximally and uniquely (Dillion and Goldstein 1984, 69), we concluded that the first 10 of our

variables load onto the first factor.

The remaining three variables uniquely load on to the second factor. Interestingly, these

items were used by Zaheer et al. (1998) to represent conflict and negotiation costs that mediate

overall performance. However, neither construct was found to be statistically significant in their

study. We evaluated reliability by estimating Cronbach’s alpha for the battery of 10 items,

which yielded a scale reliability coefficient of 0.93, and the battery of three items, which yielded

a scale reliability coefficient of 0.78. These values indicate a high level of reliability and led us

to use the resulting scales as measures of performance. The former scale is labeled

PERFORMANCE and is our primary performance variable because of the high proportion of

variance captured by the eigenvector. We also investigated the latter scale, which we labeled

CONFLICT, since it explains some variance and the items were used by Zaher et al. (1998). A

26

high score for PERFORMANCE indicates high exchange performance whereas a high score for

CONFLICT indicates high exchange conflict.

An implication of using our qualitative measures for exchange performance and conflict

is that we cannot directly measure transaction costs. Thus, we only can make comparative and

not absolute assessments of performance. With respect to PERFORMANCE, we expect that

BUY will have the highest exchange performance for low levels of asset specificity, ALLY, will

have the highest exchange performance for moderate levels of asset specificity, and MAKE will

have the highest exchange performance for high levels of asset specificity. Also,

PERFORMANCE is predicted to increase with asset specificity across all three governance

modes. CONFLICT should be lower for those exchanges where ally and make were chosen

since governance arrangements are purportedly chosen to limit and resolve conflict. In contrast,

so such arrangements are associated with buy, which would suggest that conflict should be

higher for buy than if exchange partners had either ally or make.

Covariates

Our first set of covariates helped us identify the extent to which our interorganizational-

trust construct is associated with factors that would indicate trust was exogenous to the current

exchange. Exogenous interorganizational-trust, which is associated with past interactions, is

between the buying organization and supplying organization—a relationship that transcends trust

between individual buyers. Zaheer et al. (1998) argue that expectations held by others in an

organization can be transmitted to a boundary spanner through an institutionalization process but

also that boundary spanners expectations can be transmitted to others in the organization through

the same process. These expectations develop over time (Ring and Van de Ven 1992) at an

organizational level. While expectations can arise during a focal exchange, the temporal

27

dimension of expectation formation suggests that much of the expectations are formed before

entering a focal exchange. Thus, the amount of time over which organizations have exchanged

is relevant to the level of exogenous interorganizational-trust. COMP_HIST is the logarithm of

the number of years the assembler has purchased the component from the supplier. We also

include ORG_HIST, which is the logarithm of the number of years the assembler has purchased

any component from the supplier. Presumably, buyers are likely to re-contract with suppliers

who have performed well and that such performance will engender exogenous

interorganizational-trust. Indeed, organizational dyads have engaged in prior transactions in

almost all cases for which we have data (198 out of 222). Ongoing selection of suppliers by

buyers would suggest that those dyads with a long history of exchanges are more likely to

possess exogenous interorganizational-trust, ceteris paribus.

In accordance with the logic above, the institutionalization process whereby an employee

receives the expectations held by others in the organization is also an antecedent of exogenous

trust. Since buyers filled out our survey, a relevant measure of this institutionalization process is

the amount of time the buyer has been employed by the assembler. BUYER_TENURE is the

logarithm of the number of years that the assembler’s buyer has been with the company. A

related measure is the amount of time a buyer has exchanged with a particular buyer.

BUYER_HIST is the logarithm of the number of years that the assembler’s buyer has personally

dealt with supplier. Whereas any affect on the level of interorganizational-trust by the former

measure is likely to be associated with exogenous trust, any affect by the latter may contain both

endogenous and exogenous depending on the length of time the buyer as worked with the

supplying organization under the current transaction. We do not include contract duration in our

estimate of exogenous interorganizational-trust for several reasons: we do not know for how

28

long the contract was in force; contract duration is likely to be endogenous with asset specificity

and mode choice, which would greatly increase the complexity of our empirical model should

we include it; and contract duration is unlikely to be reliably reported for exchange between

divisions of the same firm.

Our second set of covariates relate to the degree to which firms make co-specialized

investments—the level of asset specificity in the exchange. These covariates are likely to affect

the level of endogenous interorganizational-trust, since they are attributes of the exchange, as

well as factors that effect governance choice and performance. Our survey provides three items

intended to qualitatively assess the degree of asset specificity. The variable SUPPLIER_K is the

buyer’s response, using a 7-point Likert scale ranging from strongly disagree to strongly agree,

to the question “This supplier has made significant investments in terms of equipment, facilities,

and engineering designed specifically to meet the buyer’s supply requirement for the

commodity.” SUPPLIER_K captures specific investment made by the supplier in support of the

exchange. In the context of the auto industry, interviewees suggested that specific investments,

when called for, typically are made by the supplying organization.

Of course, the buyer also could make specific investments. The variable BUYER_K is

the buyer’s response, using a 7-point Likert scale ranging from strongly disagrees to strongly

agree, to the question “Your company has made significant investments in tooling and equipment

that are specific to your relationship with the supplier.” Hence, BUYER_K captures specific

investment by the buyer. We do not create a single measure by combining these two items

because BUYER_K may signal a credible commitment in response to supplier specific

investments, which may create an exchange of hostages to mitigate hazards (Williamson 1993).

29

Although less precise, we also posit as an alternative measure of asset specificity: the

extent to which a component is used narrowly, in one trim line, or broadly, across all platforms,

by the assembler. Components used across multiple platforms are likely to be standardized

whereas components used in a single trim line are more likely to require some degree of co-

specialization. To conserve degrees of freedom in our analysis, BREADTH is coded as an

ordered categorical measure of the extent to which a commodity type is used company wide,

more than one platform, one platform, one model, or in one trim line—higher levels correspond

to higher degrees of co-specialization.

If the level of asset specificity is related to interorganizational-trust in an exchange, it

should be related to the level of endogenous trust, not exogenous trust, because the level of asset

specificity, like endogenous trust, is part of the fundamental transformation (Williamson 1985)

of the focal exchange. Hence, should our construct for interorganizational-trust in actuality

represent exogenous trust, we expect that our three proxies for asset specificity will not be

related to interorganizational-trust. Following TCE’s economizing hypothesis, asset specificity

should be positively related to the choice of increasingly hierarchical governance modes.

Control Variables

To insure the robustness of our results and to identify our regression models we include

several control variables. We include a control dummy variable, FORD, to identify assembler

specific effects. Chrysler is our omitted assembler.

We control for the effect of the size of the transaction may have either on the emergence

of interorganizational-trust on organizational choice. REV_COMPONENT and

REV_OVERALL are categorical measures of the annual dollar value of purchases from a

supplier for the focal exchange and from all exchanges between the buyer and supplier,

30

respectively. The qualitative categories are less than $10 MM, $50 MM, or $100 MM or more

than $100 MM. However, to conserve degrees of freedom in our analysis, we code these as a

collapsed variable using whole numbers ranging from 1 for the lowest category to 4 for the

highest category for each variable. We assume that the size of a transaction does affect

organizing mode choice but does not affect performance.5 The greater the transaction size in

terms of revenue the more economical it is for a firm to incur the fixed cost of setting up and

running an ALLY or MAKE form of organization. Hence, we expect size to act as a shift

parameter such that the organizational form chosen will shift from BUY, to ALLY, to MAKE as

the size of the exchange increases.

Table 2 displays summary statistics and correlation coefficients for each of our variables.

No correlation is sufficiently great to pose estimation problems.

Analysis

We employed a reduced-form three-stage treatment model to assess organizational choice

and performance (e.g., Hamilton and Nickerson 2002). It is likely that interorganizational-trust,

choice of organizational form, and performance are endogenous—i.e., each is likely to be a

function of the other because of our use of cross-sectional data. Failure to account for

endogeneity may have serious consequences. For example, unobserved heterogeneity may affect

the level of interorganizational-trust, choice of organizational form, and performance. If this is

the case, then simple OLS estimation of interorganizational-trust on organizational form, or

interorganizational-trust in a given organizational form on performance will reflect, in part, this

5Riordan and Williamson (1985) argue that size does affect governance choice. However, this does not imply that size should affect the type of qualitative performance measure used in our study. Also, size was used as a control for in an estimation of performance in at least one prior study of TCE and performance (Poppo and Zenger 1998); although, it was not significant. Thus, we use REV_COMPONENT and REV_OVERALL as instruments for identifying our governance choice equation.

31

unobserved heterogeneity rather than the direct impact of trust or organizational choice. Such

endogeneity problems would lead to an underestimation of the effect of interorganizational-trust

or asset specificity on organization choice and/or the effect of trust and organization choice on

performance. Our estimation method explicitly accounted for these potential biases by using a

three-stage treatment model. First, we implemented an OLS model where the level of

interorganizational-trust is a function of all of our explanatory and control variables. Our first

stage model took the form:

(1) TRUSTi = α0 + α1*FORD + α2*REV_COMPONENT + α3*REV_OVERALL + α4*SUPPLIER_K + α5*BUYER_K + α6*BREADTH + α7*BUYER_TENURE + α8* BUYER_HIST + α9*COMP_HIST + α10*ORG_HIST + ε1i where ε1i is a random error term. For econometric reasons, all variables and instruments used in

Eqs.(2) and (3) below are included in Eq (1). Also, since responses by each survey respondent

for more than one supplier could be correlated, we controlled for such correlation by allowing

responses by a single respondent to be correlated across different exchanges, which is

implemented by a clustering option in software packages like STATA. Clustering affects the

estimated standard errors and the variance-covariance matrix of the estimators but does not effect

the estimated coefficients.

The second stage of our model employed an ordered Probit to model the choice of BUY,

ALLY, or MAKE. Our second stage model took the form:

(2) MODE*i = β0 + β1*FORD + β2*REV_COMPONENT + β3*REV_OVERALL +

β4*SUPPLIER_K + β5*BUYER_K + β6*BREADTH + β7*P_TRUST + ε2i where ε2i is a random error term and MODEi = 0 if MODE*

i ≤ µ1, MODEi = 1 if µ1 < MODE*i

≤ µ2, and MODEi = 0 if MODE*i > µ2. We use P_TRUST, which is the level of

interorganizational-trust predicted by Eq. (1), instead of TRUST. Doing so allows us to account

32

for possible endogeneity between the level of interorganizational-trust and the governance mode

choice. We omit our four length-of-relationship variables to econometrically identify Eq.(2)

because we assumed that they affect the level of exogenous interorganizational-trust but do not

otherwise effect organizational choice or performance. Without omitting these variables,

P_TRUST and the covariates would be co-linear. Again, we allowed clustering on the

respondent to control for correlation across a buyer’s assessment of different suppliers.

The third stage of our model implemented a switching regression model (Madalla 1983,

Idson and Feaster 1990) to assess the performance delivered by each organizing mode. Hence,

we have one estimated equation for each governance mode and included the inverse Mills ratio

for each organizational mode based on our results from Eq.(2). The inverse Mills ratio is an

appropriate correction for sample selection bias that may arise from the self-selection of

organizational modes (Hamilton and Nickerson 2002, Masten 1996). Our third stage model had

three equations that took the form:

(3) PERFORMANCEij = γj0 + γj1*FORD + γj2*SUPPLIER_K + γj3*BUYER_K + γj4*BREADTH + γj5*P_TRUST + γj6*MILLS_RATIOj + εji

where j = [BUY, ALLY, MAKE], MILLS_RATIOj is the inverse Mills ratio for organizing

mode j, and εji is a random error term. The switching regression model allowed us not only to

evaluate the performance delivered by each organization mode but also to quantify the effect of

inappropriately matching exchange conditions to organizing mode (Maddala, 1983). We omit

from Eq.(3) the controls REV_COMPONENT and REV_OVERALL in order to econometrically

identify our ordered Probit because we assumed that the size of the transaction had no direct

effect on performance. Without omitting these variables, our estimate of predicted mode choice

would be identified only by the non-linearity of the ordered Probit. We again allowed for

33

clustering on the respondent to control for correlation across a buyer’s assessment of different

suppliers. We also estimated model (3) with CONFLICT as our dependent variable such that:

(3a) CONFLICTij = γj0 + γj1*FORD + γj2*SUPPLIER_K + γj3*BUYER_K + γj4*BREADTH + γj5*P_TRUST + γj6*MILLS_RATIOj + εji

Results

Table 3 displays the set of nested models through which we analyzed our model of

TRUST. Model 1 includes the dummy variable controlling for the assembler and our two

controls for revenue. No coefficient is significant and the model had little explanatory power.

Model 2, which adds our three measures of asset specificity, had an R2 of 0.059 and offered a

statistically significant improvement over Model 1 (p<0.05). Only the coefficients for

SUPPLIER_K (t<0.05) and BUYER_K (t<0.10) and our constant are statistically significant in

Model 2. The signs of these coefficients suggest that interorganizational-trust increases with

asset specific investments by the supplier and diminishes with specific investments made by the

buyer. However, this statistical significance does not remain when our four length-of-

relationship variables are added in Model 3.

Model 3 increases the R2 to 0.130 and offers a statistically significant improvement over

Model 2 (p<0.01). Only the coefficients for BUYER_TENURE and ORG_HIST are significant

in Model 3. BUYER_TENURE is positive and highly significant (t<0.01), which indicates that

interorganizational-trust increases the longer a buyer works for an assembler. This positive

relationship is consistent with the idea that it takes time for the institutionalization process to

transmit an organization’s set of expectations about which other organizations to trust to a new

employee. The coefficient for ORG_HIST is significant (t<0.05) but negative, which suggests

that the longer the assembler has bought any component from the supplier the lower the level of

34

interorganizational-trust. The finding may be due to the fact that the mean age of internal

suppliers (34 years), which we might expect to have the lowest level of interorganizational-trust

due to internal politics and influence activities, is much greater than the mean age for external

suppliers (18 years). Neither the length of time over which a buyer had procured a component

from a particular supplier, the length of time a supplier had supplied the focal component to the

assembler, or any other coefficient was significant.

While these findings do not examine any specific theoretical prediction, they are useful,

as will be seen later, for evaluating the extent to which our interorganizational-trust construct

captures endogenous or exogenous trust. While not conclusive, these parameter estimates

suggest that TRUST captures exogenous interorganizational-trust, driven by institutionalization

and slow to form expectations, and not interorganizational-trust that is endogenous to

governance choice. Notably, none of the asset specificity measures are significant, which further

suggests that our measure of interorganizational-trust has little to do with the attributes of the

current exchange.

Models 4, 5, and 6, in Table 3, present results from our ordered Probit analysis of

governance choice. Model 4 includes the dummy variable controlling for the assembler and our

two revenue controls. It offers little explanatory power. Model 5 adds our asset specificity

proxies and offers a Psuedo R2 of 0.072 and is a significant improvement (p<0.05) over Model 4.

Finally, Model 6 adds the predicted level of interorganizational-trust. It increases the Psuedo R2

to 0.091 offers a significant improvement over Model 5 (p<0.01).

Coefficients are generally consistent over these three nested models so we focus our

attention on Model 6. The coefficient for REV_OVERALL is significant (t<0.01) and positive,

which indicates that the likelihood of choosing a more hierarchical organizational form increases

35

with the sum of revenue from all the exchanges between the buyer and seller. This finding

suggests that there may be interdependencies across transactions in a dyadic exchange that

influences organizational choice (Argyres and Libeskind 1999). The coefficient for

SUPPLIER_K is positive and significant (t<0.01), which indicates that organization choice is

more likely to change from BUY, to ALLY, to MAKE as the supplier’s asset specific investment

deepens. BREADTH is significant (t<0.01) and positive, which implies that the more narrowly a

component is used the more likely organization choice will shift from BUY, to ALLY, to

MAKE. Both of these findings support TCE’s prediction that transaction attributes are matched

in a transaction-cost economizing way to governance structures. BUYER_K is insignificant

which suggests that buyer specific investments have little influence on governance choice.

Our predicted level of exogenous interorganizational-trust is significant (t<0.01) and

negative. The negative sign indicates that the greater the level of exogenous interorganizational-

trust the less likely the exchange will be organized hierarchically. Thus, consistent with

hypotheses 2A and 2B, we find that as the level of interorganizational-trust increases it shifts the

likelihood of organizational choice from hierarchy to markets.

Before discussing the third stage of our model, we note that the marginal effects of the

regressors on the probabilities in an ordered Probit do not equal regressor coefficients and

depend on µ1 and µ2. The marginal effects for any particular regressor, Xi, are calculated by:

[ ]

i2i

MAKE

i21i

ALLY

i1i

BUY

)X(X

P

)X()X(X

P

)X(X

P

ββ−µφ=∂

∂

ββ−µφ−β−µφ=∂

∂

ββ−µφ−=∂

∂

36

Thus, the marginal effect varies with the value of Xi. We focus our attention on assessing

the marginal effects SUPPLIER_K, BREADTH, and P_TRUST. This allows us to compare the

effects of asset specificity and exogenous interorganizational-trust on governance choice. Table

4 reports the marginal probabilities at the mean value, 20th percentile, and 80th percentile for each

covariate holding all other covariates at their mean, which allows us to compare the relative

effects of each of these three regressors. As expected, higher levels of SUPPLIER_K or

BREADTH increase the marginal probability that MAKE will be chosen and decrease the

marginal probability the either BUY or ALLY is chosen. Conversely, higher levels of P_TRUST

decrease the likelihood that MAKE will be chosen and increase the likelihood that either ALLY

or BUY will be chosen. Perhaps the most interesting finding from Table 4 is that marginal

effects are greater for our proxy of exogenous interorganizational-trust than for either measure of

asset specificity. Indeed, this finding suggests that managing such trust deserves much attention

if the choice of organizational form has substantial cost implications, as we assert in our theory.

We conclude that exogenous interorganizational-trust has a substantial and important effect on

the choice of organizational form when compared to the marginal affect of asset specificity.

Thus, consistent with hypotheses 2A and 2B, higher levels of exogenous interorganizational-trust

shift the organizing mode from ally to buy and from make to ally, respectively.

Table 5 reports results for our switching regression model of performance. Models 7, 8

and 9 report nested regressions analyzing exchange performance in the 72 exchanges organized

as BUY. Models 7 and 8 are not statistically significant thus we focus our attention on Model 9,

which yields an R2 of 0.106 and offers a statistically significant improvement (p<0.05) over

Model 8. Only one coefficient is statistically significant in Model 9: the coefficient for

P_TRUST is significant (t<0.05) and positive. Thus, consistent with hypothesis 1A, exchange

37

performance increases with the level of exogenous interorganizational-trust in those exchanges

organized as BUY. Also, specific investments by the buyer confer no performance benefits

when asset specificity is low, which is the case for those for exchanges organized as BUY.

Models 10, 11, and 12 report nested regressions for analyzing exchange performance in

the 126 exchanges organized as ALLY. We note that no coefficient is significant in Model 10

and the model provides little explanatory power. Model 11, which incorporates our three asset

specificity measures, provides an R2 of 0.243 and is a statistically significant improvement over

Model 10. The coefficient for SUPPLIER_ K is positive and highly significant (t<0.01),

indicating that performance improves as specific investments by the supplier increases. Our

inverse Mills ratio for ALLY is significant (t<0.01) and negative, which suggests selection bias

is an appropriate concern, which provides support for the methodology we use to correct for such

selection. Also, our constant is highly significant and negative. Model 12, which incorporates

P_TRUST, increases our R2 to 0.243 but offers no statistically significant improvement over

Model 11. In model 12 only the coefficients for SUPPLIER_ K and the constant remain

significant, albeit at reduced levels of significance. The coefficient for P_TRUST is positive but

insignificant. The changes in coefficient estimates prompted us to examine correlation

coefficients for each of our variables for only those observations organized as ALLY. No

problematic correlations were found.

These findings have several implications. First, exogenous interorganizational-trust may

affect the organizing mode but does not lead directly to performance benefits in ALLY forms of

organization as it is currently measured. This finding leads us to reject hypothesis 1B for ALLY.

Second, asset specific investments by the buyer do not appear to affect performance in ALLY

forms of organization. However, perceptions of exchange performance do increase with supplier

38

asset specificity. This increase could be due to economic benefits from deeper levels of asset

specificity or they could be due to the crafting of governance features not directly measured in

our current analysis. Buyers could rely on commitments other than making asset specific

investments to shape governance and endogenous interorganizational-trust. Indeed, our

discussions with executives and buyers indicated that while ALLY is discretely different from

BUY and MAKE, there nonetheless were a wide variety of hybrid arrangements not

discriminated by our analysis that were lumped into the ALLY mode. By lumping these

different hybrid arrangements in to one mode category we may have inadvertently increased our

standard error, which might explain the lack of statistical insignificance for both the coefficients

of the Mills ratio and exogenous interorganizational-trust in our ALLY equation. In this case,

signs of the coefficient estimates, which are in the direction predicted, take on more significance

in examining our theory.

Models 13, 14, and 15, report nested regressions for analyzing the level of performance

in the 24 exchanges organized as MAKE. No coefficients are significant in Model 13, which

includes our assembler dummy, inverse Mills ratio, and a constant. Model 14, which

incorporates our asset specificity variables, is a significant improvement (p<0.01) over Model 13

and substantially increases R2 to 0.571. The coefficient for SUPPLIER_K is significant (t<0.01)

and positive, which indicates that performance increases as specific investments by other

divisions deepens. Also, the coefficient for BREADTH is positive and significant (t < 0.01)

indicating that the more narrowly a component is used by the assembler the higher the level of

performance. Both the inverse Mills ratio and the constant are significant, although the former is

positive and the latter negative.

39

Model 15, which incorporates P_TRUST, is a significant improvement (p<0.05) and

increases R2 to 0.541. The introduction of P_TRUST leads to several substantive changes in our

estimates. Most notably, the coefficients for SUPPLIER_K and BREADTH are smaller in

magnitude but remain significant. The coefficient for BUYER_K is positive and weakly

significant. These results indicate that the benefits of supplier investments in asset specificity are

greater for MAKE than for ALLY and that buyer investments as well as BREADTH generate

significant performance benefits under MAKE whereas no such benefits accrue under ALLY.

The coefficient for P_TRUST is insignificant, which suggests that exchange performance is not

significantly enhanced with when exogenous interorganizational-trust is present and therefore we

reject hypothesis 1C. The inverse Mills ratio is positive, which in this case indicates that the

assemblers would face lower performance if the exchange was organized other than through

make. The constant is negative and significant (t<0.01), albeit with a lower magnitude that in

Model 14.

We re-estimated our switching regression model with CONFLICT, instead of

PERFORMANCE, as the dependent variable. Only 216 observations were available for this

estimation. Models 16 through 24 report coefficient estimates in Table 6. Since CONFLICT

accounted for a small variance in our factor analysis and because most coefficient estimates are

insignificant, we focus only on consistently significant findings. First, the negative and

significant coefficient estimates for FORD in models 19 through 21 indicate that Ford’s alliances

experience less conflict that those involving Chrysler. Second, the Mill’s ratio for BUY and

MAKE are negative and display at least some level of significance. The former indicates that

exchanges organized as BUY experience more conflict than if they would have been organized

differently whereas the latter indicates that exchanges organized as MAKE experience less

40

conflict than if organized otherwise. The findings suggest that assemblers select MAKE to avoid

conflicts and that conflicts cannot be avoided in the BUY mode. The Mill’s ratio for ALLY is

not significant which suggests that buyers and suppliers do not select ally to achieve lower levels

of conflict.

Discussion and Conclusion

Our empirical analysis of exchange performance of component sourcing in the U.S. auto

industry provides broad support for our theory. Controlling for the endogeneity of trust and

governance choice, we found empirical support for the indirect effect of exogenous trust, in

which increasing exogenous trust increases the probability that less hierarchical modes of

governance are substituted for more hierarchical modes (i.e., a shift form make to ally and from

ally to buy as exogenous trust deepens). Thus, exogenous trust does facilitate the substitution of

a less expensive mode of governance for a more expensive one. Interestingly, our analysis

indicates that on the margin, exogenous trust has an effect greater (and countervailing) than that

of asset specificity. We also found support for the direct effect of exogenous trust on exchange

performance. That is, exogenous trust directly increases exchange performance. However,

although all coefficients had the correct sign, the effect was only significant for the buy mode of

organization. This finding suggests that the direct effect of exogenous trust is not uniform across

buy, ally and make as we had argued in our theory. Instead, any direct effects may be greatly

attenuated for ally and make. Moreover, this finding suggests the much of exogenous trust’s

impact on performance may be through its indirect effect instead of its direct effect.

Our findings also support the claims put forward in transaction cost economics. As asset

specificity deepens we found that the governance mode switched from buy to ally to make. In

particular, we found that specific investments by suppliers are critical predictors of governance

41

choice. They also clearly affect exchange performance for ally and buy as performance

increases with the level of supplier specific investment in ally and make. Unfortunately, we have

no measure of economic or transaction costs, which makes evaluating the performance

implications of transaction costs predictions impossible since we have no direct way to connect

transaction costs to our performance measure. Also, we found that the less commodity type is

used company wide, which is an indicator of specific investment, is a predictor of governance

and affected performance for make. These findings lend strong support for TCE’s main

predictions.

Our paper advances the literature on trust by theoretically unpacking the antecedents of

interorganizational-trust and its direct and indirect effect on performance. Building on prior

research on interorganizational-trust, our paper is predicated on the notion that

interorganizational-trust is usefully classified into two types based on its antecedents. One type,

which we refer to as endogenous interorganizational-trust, arises during an exchange as a result

of the chosen form of governance. A second type, which we referred to as exogenous

interorganizational-trust, emerges from past exchanges with a trading partner and the

institutional environment. Focusing on this latter source of trust, we argued that exogenous

interorganizational-trust affects exchange performance directly and indirectly. Exogenous

interorganizational-trust directly enhances exchange performance, at least for the BUY mode of

organization, by reducing expected opportunistic behavior. Exogenous interorganizational-trust

enhances exchange performance indirectly by facilitating the use of a less hierarchical and less

expensive governance mode than otherwise. This effect allows for a less costly form of

governance to be used even though exchange hazards, which would demand a more costly form

of governance with the presence of exogenous trust, may be present. Distinguishing exogenous

42

trust from endogenous trust and theorizing about how the latter both directly and indirectly affect

exchange performance unpacks effects that were previously confounded both theoretically and

empirically.

Our theory challenges some of the extant literature on the relationship between trust and

performance by focusing attention away from endogenous interorganizational-trust and toward

governance and exogenous interorganizational-trust. While endogenous interorganizational-trust

may be a useful metric for evaluating the effect of governance choice, our theory suggests that

attention to the relationship between endogenous trust and performance may be misplaced.

While endogenous trust surely enhances performance, our theory argues that it is the governance

mode that delivers such trust, which suggest research on trust should focus on the relationship

between governance choice and performance. Research on the relationship between governance

choice and performance needs to go beyond the now classic discrete choice framework to

explore the relationship between variations in governance and performance within a single

organizing mode. Little research outside of the contract and franchise literature has explored

such relationships. Also, since exogenous trust is economically meaningful, it is an important

and appropriate focal point for managers and researchers alike. While the literature on trust has

made progress in unpacking the antecedents of exogenous trust, few studies detail the process by

which such trust arises and how it impacts organizational choice and performance. This lack of

study, at a minimum, invites further empirical efforts in a variety of contexts.

This paper introduced a novel empirical methodology not typically employed in research

on trust. Endogeneity has not been much of a concern in many empirical investigations on trust.

Yet, it is likely that trust is indeed endogenous to a variety of antecedents, which suggests that

endogeneity should always be a concern when choosing an empirical methodology. This paper

43

provides an illustration of one method to control for endogeneity. Nonetheless, future studies

can improve upon our study in a number of useful and important ways. At a minimum, future

research needs to develop improved proxies for identifying exogenous interorganizational-trust

to facilitate the discrimination between exogenous and endogenous sources of trust. Better

proxies for transaction costs need to be developed so that the effects of between exogenous and

endogenous interorganizational-trust on performance can be more clearly identified.

Additionally, identification of different types of hybrid modes organization may inform why

exogenous interorganizational trust had little impact on perceived performance.

In addition to research on trust, our paper also is important for transaction cost economics

and the growing body of research on hybrid forms. Our analysis provided one of the first

empirical assessments of a trichotomous choice between markets, hybrids, and hierarchy. This

trichotomous choice model is a particularly important result because of the rise of and growing

interest in hybrid modes of organization over the past decade (Dyer, 1997; Zaheer and

Venkatraman, 1994). Our results for the first time provide an empirical examination of ally

modes for governance with buy and make. It is also interesting to note that although the

automobile industry is the empirical context for many empirical transaction cost economics

studies, none has the breath of observations and microanalytic detail of our study. For instance,

even though transaction cost economics is predicated on the transaction as the unit of analysis,

most other studies use instead more aggregated units of analysis such as all the transactions of a

particular component (e.g., Masten et al. 1989). Alternatively, those automotive that have used

the transaction as the unit of analysis have far fewer observations (e.g., Walker and Weber

1987). Thus, our analysis of the automobile industry should be superior to other TCE studies

because of the depth and detail of our data.

44

Interorganizational-trust indeed is an important concept and, as this research, as well as

others, has pointed out, has theoretical and managerial implications. We believe that the key to

helping managers understand how to beneficially create and utilize trust is understanding the

direct and indirect affects of trust on exchange performance in various contexts. The findings in

our study suggest the benefits to developing exogenous interorganizational-trust are potentially

great. However, exogenous trust is built over the long run and may involve identifying those

suppliers (and buyers) that are less opportunistic than others unless the institutional environment

provides and alternative means for limiting opportunistic behavior. Moreover, in our study the

realization of benefits from trust is largely achieved indirectly through the choice of governance.

Thus, simply possessing exogenous trust is not enough to realize substantial performance

benefits. Substantial performance benefits from exogenous trust accrue only when they translate

into the use of less expensive governance modes.

45

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48

49

Table 1: Factor Loadings for Performance Constructs

Factor 1 Factor 2 Factor 3 Opinion of supplier compared to the best alternative supplier for this commodity

1 Price competitive 0.620 -0.127 0.356 2 Support and services 0.764 0.096 0.019 3 Flexibility in production 0.795 0.092 0.112 4 Product quality 0.817 0.174 -0.261 5 Product innovations 0.738 0.074 -0.114 6 Overall performance 0.904 0.134 -0.019 7 Average past target ratio1 0.698 -0.064 0.368 8 Average past price change rate2 0.678 -0.107 0.399 9 Average defect rate3 0.793 0.167 -0.321

10 Improvement in average defect rate4 0.828 0.128 -0.206 11 Frequency of significant dissagreements5 -0.398 0.487 0.158 12 Ease of negotiation over sharing cost-engineering changes6 -0.260 0.731 0.111 13 Ease of negotiation over sharing cost-material cost increases7 -0.173 0.711 0.109

Eigenvalue 6.149 1.425 0.710 Proportion of Variance eigenvector explains 0.753 0.175 0.087

Loadings > 0.3 are significant at p < 0.05. 1 Target-price ratio = (actual part price at market introduction)/(target price your company set when it selected the supplier for the part). 2 Price change rate = average annual rate of price change after the market introduction (excluding the price change when the part’s design was changed due to engineering changes in specification). 3 Defect rate = (number of defective parts)/(number of parts received). 4 Improvement in defect rate = average annual rate of defect change after market introduction. 5 “During the past year how often were there significant disagreements between your business unit and this supplier.” 6 “How easy are negotiations between your business unit and the supplier over sharing the burden of cost (not exactly covered by the contract) when your business unit requests engineering changes.” 7 “How easy our negotiations between your business unit and the supplier over sharing the burden of cost (not exactly covered by the contract) when the supplier’s raw material costs increased.”

Table 3: Interorganizational-trust and Organizational Choice

Interorganizational-trust Organizational Choice Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

-1.081 ** (0.348)

BUYER_TENURE 0.197 ** (0.064)

BUYER_HIST 0.033 (0.086)

COMP_HIST 0.044 (0.101)

ORG_HIST -0.225 * (0.105)

CONSTANT 0.002 -0.628 * -0.419 (0.204) (0.308) (0.380)

µ1 0.455 1.575 2.287 (0.331) (0.530) (0.578)

µ2 2.246 3.425 4.183 (0.351) (0.555) (0.605)

R2 0.003 0.059 0.130 F-Test 3.080 * 3.6 ** Psuedo R2 0.001 0.072 0.091 χ2 10.070 * 9.640 **

FORD 0.077 0.096 -0.004 -0.200 -0.152 -0.054 (0.127) (0.131) (0.136) (0.175) (0.179) (0.186)

REV_COMPONENT -0.018 -0.009 -0.049 -0.011 0.002 -0.008 (0.079) (0.075) (0.069) (0.095) (0.093) (0.094)

REV_OVERALL 0.002 0.002 0.064 0.332 ** 0.310 ** 0.321 ** (0.081) (0.080) (0.077) (0.098) (0.099) (0.100)

SUPPLIER_K 0.126 * 0.086 0.135 + 0.275 ** (0.063) (0.064) (0.077) (0.091)

BUYER_K -0.062 + -0.051 -0.003 -0.071 (0.036) (0.033) (0.051) (0.058)

BREADTH 0.069 0.068 0.158 * 0.235 ** (0.055) (0.052) (0.064) (0.069)

P_TRUST

50

Tab

le 2

: Su

mm

ary

stat

istic

s and

Cor

rela

tions

(N=2

16)

1

23

45

67

89

1011

1213

141

TRU

ST

2

GO

V_M

OD

E -0

.086

3

PER

FOR

MA

NC

E 0.

636

-0.0

96

4C

ON

FLIC

T 0.

490

0.03

30.

369

5FO

RD

0.

052

-0.0

780.

134

0.13

7 6

REV

_CO

MPO

NEN

T-0

.044

0.17

3-0

.103

-0.0

72-0

.095

7R

EV_O

VER

ALL

-0

.027

0.26

9-0

.077

-0.0

87-0

.002

0.66

1 8

BU

YER

_TEN

UR

E0.

262

-0.0

590.

227

0.07

70.

288

0.09

90.

114

9B

UY

ER_H

IST

0.10

00.

157

0.08

30.

055

0.07

20.

016

-0.0

030.

196

10 C

OM

P_H

IST

-0.0

880.

253

-0.1

23-0

.114

-0.1

170.

268

0.25

20.

061

-0.0

0411

OR

G_H

IST

-0.1

350.

277

-0.2

08-0

.138

-0.0

040.

197

0.40

50.

102

0.01

30.

595

12 B

REA

DTH

0.

088

0.23

1-0

.035

0.06

3-0

.222

0.05

30.

089

-0.0

310.

037

0.01

1 0.

055

13 S

UPP

LIER

_K

0.17

60.

133

0.27

50.

077

0.13

10.

012

0.04

60.

233

0.17

4-0

.071

-0.0

160.

049

14 B

UY

ER_K

-0

.068

0.07

30.

040

0.05

50.

073

0.14

20.

198

-0.0

090.

044

0.02

80.

056

0.07

00.

250

Mea

n0.

001

1.78

4-0

.012

0.00

00.

509

2.57

73.

207

2.36

50.

532

2.48

12.

946

2.47

75.

698

4.70

7

Std.

Dev

.

0.77

60.

622

0.

766

0.83

10.

501

1.

077

1.00

3

0.92

70.

576

0.84

40.

714

1.36

11.

139

1.74

9

Min

-2.6

191

-2.7

92-1

.994

01

1-1

.100

-1.7

92-1

.833

01

21

M

ax1.

541

31.

926

2.10

41

44

3.71

41.

179

4.31

84.

318

57

7ρ

< 0.

133

corr

espo

nds t

o p<

0.05

51

Tab

le 5

: Sw

itchi

ng R

egre

ssio

n M

odel

of P

ER

FOR

MA

NC

E (N

= 2

22)

Buy

Ally

Mak

e

Mod

el 7

M

odel

8

Mod

el 9

M

odel

10

Mod

el 1

1 M

odel

12

Mod

el 1

3 M

odel

14

Mod

el 1

5 FO

RD

0.06

9

0.12

80.

074

0.19

20.

041

0.

012

0.

321

0.25

8

0.21

9

(0.2

31)

(0.2

27)

(0.2

21)

(0.1

56)

(0.1

52)

(0.1

52)

(0.5

45)

(0

.349

)

(0

.437

)(0

.457

)

Mill

s rat

io-A

LLY

-0

.274

-0.6

76**

-0

.486

*(0

.214

)(0

.246

) (0

.263

)

Mill

s rat

io-M

AK

E

0.13

11.

621

**1.

118

**(0

.470

)(0

.361

) (0

.318

)

CO

NST

AN

T

-0

.165

-0.5

990.

108

-0.1

19-2

.048

**

-1.5

26+

-0.7

29-8

.667

**

-6.8

98 *

*(0

.442

)(0

.482

)(0

.598

)(0

.122

)(0

.543

) (0

.644

)(0

.722

)(1

.384

) (1

.627

)

R2

0.00

4

0.

047

0.10

60.

037

0.23

40.

243

0.03

40.

571

0.54

1F-

stat

0.

800

4.

610

*

4.93

0 **

1.

910

9.37

0 **

2.

590

(0.4

14)

(0.4

35)

SUPP

LIER

_K

-0.0

03

-0.1

78

0.31

9 **

0.

243

*

0.65

6 **

0.

457

*

(0.1

13)

(0.1

28)

(0.0

85)

(0.0

96)

(0.2

18)

(0.2

30)

BU

YER

_K

0.

078

0.10

9-0

.013

0.01

30.

076

0.15

2 +

(0

.064

)(0

.062

)(0

.042

)(0

.046

)(0

.078

)(0

.090

)

BR

EAD

TH

0.

086

-0.0

560.

048

-0.0

080.

453

**0.

332

**

(0

.103

)(0

.117

)(0

.059

)(0

.073

)(0

.107

) (0

.092

)

P_TR

UST

1.

200

*0.

429

0.82

7

(0

.559

)(0

.310

)(0

.514

)

Mill

s rat

io-B

UY

-0.1

300.

001

-0.4

38

52

53

Tab

le 6

: Sw

itchi

ng R

egre

ssio

n M

odel

of C

ON

FLIC

T (N

= 2

16)

Buy

Ally

Mak

e

Mod

el 1

6 M

odel

17

Mod

el 1

8 M

odel

19

Mod

el 2

0 M

odel

21

Mod

el 2

2 M

odel

23

Mod

el 2

4 FO

RD

0.

019

0.

03

0.07

7 -0

.438

*

-0.4

16 *

-0

.397

+ -0

.471

-0

.528

-0.5

17

(0

.250

)

(0

.249

)(0

.247

)(0

.183

) (0

.193

) (0

.213

)(0

.450

)(0

.500

)(0

.548

)

SUPP

LIER

_K

-0.0

24

0.06

6

-0.0

66

-0.0

48

-0

.214

-0

.055

(0

.088

)(0

.102

)(0

.102

)(0

.111

)(0

.277

)(0

.384

)

BU

YER

_K

-0.0

55

-0.0

700.

014

0.

002

0.13

70.

035

(0

.065

)(0

.065

)(0

.050

)(0

.055

)(0

.222

)(0

.276

)

BR

EAD

TH

-0

.258

**

-0.1

87-0

.027

0.01

8-0

.273

-0

.246

(0.0

96)

(0.1

16)

(0.0

82)

(0.0

87)

(0.1

65)

(0.1

61)

P_TR

UST

-0

.823

-0.1

35

-1.0

33

(0.5

62)

(0.3

36)

(1

.581

)

Mill

s rat

io-B

UY

-0

.099

-0

.725

+ -0

.701

+

(0.3

48)

(0

.430

)(0

.414

)

Mill

s rat

io-A

LLY

0.

028

0.16

2

0.17

1

(0.3

09)

(0.4

29)

(0.4

29)

Mill

s rat

io-M

AK

E

-0.8

29-1

.594

* -1

.784

*(0

.908

)(0

.763

) (0

.838

)

CO

NST

AN

T -0

.155

-0.1

90

-0.4

05

0.28

9 +

0.70

6

0.62

5

1.21

4 3.

713

+ 3.

493

(0

.405

)(0

.345

)(0

.512

)(0

.147

) (0

.715

)(0

.712

)(1

.494

)(2

.086

) (2

.223

)

R2

0.00

4

0.

121

0.15

70.

068

0.07

40.

076

0.09

20.

149

0.18

5F-

stat

4.

18*

2.14

0.93

0.

68

0.

38

0.52

Gov

erna

nce

Cos

t

0

k 1

k

2

k

Ass

et S

peci

ficity

Figu

re 1

: G

over

nanc

e C

osts

as a

Fun

ctio

n of

Ass

et S

peci

ficity

B(k

) A

(k)

M(k

)

Buy

Ally

Mak

e

54

Gov

erna

nce

C

ost

0k 1

kγ1

k 2kγ

2k

Ass

et S

peci

ficity

Figu

re 2

: G

over

nanc

e C

osts

as a

Fun

ctio

n of

Ass

et S

peci

ficity

B(k

,0)

A(k

,0)

M(k

,0)

B(k

,γ)

A(k

,γ) M

(k,γ

)

55

Table 4: Marginal Effect of Regressors*

Marginal Effects on Probability BUY ALLY MAKE

SUPPLIER_K at 20th percentile -0.105 0.073 0.032SUPPLIER_K at mean -0.097 0.055 0.042SUPPLIER_K at 80th percentile -0.075 0.011 0.065

BREADTH at 20th percentile -0.093 0.072 0.021BREADTH at mean -0.082 0.047 0.036BREADTH at 80th percentile -0.064 0.009 0.055

P_TRUST at 20th percentile 0.319 -0.088 -0.231P_TRUST at mean 0.379 -0.214 -0.165P_TRUST at 80th percentile -0.306 -0.112* All covariates except focal one set to mean.

0.418

56

57