TRUST AND ALLIANCE FORMATION

12 Trust is often treated as a precondition for successful collaboration in the literature (e.g., Lane and Bachmann, 1998; Cullen, Johnson and Sakano, 2000). As argued by Ring (1997), trust is an enabling condition, which facilitates the formation of ongoing networks. Others argue that a certain minimum level of interfirm trust is indispensable for any strategic alliance to be formed and to function (Das and Teng, 1998). However, the question remains as to how management builds initial trust in the alliance formation phase.

13 Trust improves and accelerates exchanges, as economic actors have access to more information about the predictability of other’s behaviors so as to be able to identify reliable partners in the search and partner selection (formation) phase. Moreover, trust can modify partners’ intentions about future exchanges when it is based on direct experiences with previous business relationships with a partner. The desire and willingness to expend resources in the development of trust and long-term relationships is closely linked to a firm’s prior experiences with that partner and the extent to which positive or negative expectancies have been fulfilled (Larson, 1992). Trust earned from prior engagement serves as evidence to justify subsequent risky steps beyond the accumulated evidence (Das and Teng, 1998). That is, faced with a situation in which one can be taken advantage of, a natural response is to restrict one’s transactions to those who have shown themselves to be trustworthy. This is consistent with Ariño, de la Torre and Ring (2001), who found prior experiences to be a critical determinant of future levels of relational quality. These direct experiences are likely to influence the parties’ views of each other’s capabilities and trustworthiness in the face of internal or external challenges (Lewicki and Bunker, 1996). It follows that if trust in business relationships initially develops on a calculative basis (Shapiro, Sheppard, and Cheraskin, 1992), as parties try to determine the nature of their interdependence, prior experience is likely to minimize uncertainty (and increase predictability), thus impacting the evolution of trust.

14 In lack of prior experience with a particular partner, the next logical step is to rely on the reputation of that firm, which is a direct consequence of prior relational behavior (Granovetter, 1985). According to Granovetter (1985: 490-491, emphasis in original): « The widespread preference for transacting with individuals with known reputation implies that few are actually content to rely on either generalized morality or institutional arrangements to guard against trouble. [Instead] social relations, rather than institutionalized arrangements or generalized morality, are mainly responsible for the production of trust in economic life ». Research suggests that most firms are embedded in a social network of prior alliances through which they are connected with one another either directly or indirectly (Kogut, Shan and Walker, 1993). The concept of structural embeddedness focuses on the informational role of the position an organization occupies in the overall structure of the network (Uzzi, 1996; Gulati, 1998). Thus, the type of network in which a firm is embedded defines the opportunities potentially available; its relative position in this structure and the types of interfirm ties it maintains defines its access to those opportunities (Uzzi, 1996). Within such a dense social network, reputational considerations play an important role in a firm’s potential for future alliances, because these social affiliations determine the firm’s perceived status and serve as a source of legitimacy. This is especially true for firms entering new markets or industries or collaborating across organizational and national boundaries, where affiliation with a known firm might signal quality and trustworthiness and thereby serve as a foundation for a favorable evaluation by a potential partner. An example is the establishment of foreign trade councils by many countries to support international trade, which help firms obtain valuable information about potential partner firms. For instance, whereas the business license of a focal firm can provide information about its legal capacity, registered capital, and business scope, foreign trade councils can usually provide invaluable reputational information regarding local (consumer) perceptions of the focal firm, its competitive position, and its relationship to local authorities.

15 Once the partner is selected, the basis for initial trust needs to be built. Open and honest communication at the outset of any relationship is important and in terms of forming a complex business relationship even more so. Communication can be described as the glue that holds together a channel of exchange. In this sense, communication can be broadly defined as « the formal as well as the informal sharing of meaningful and timely information between firms » (Anderson and Narus, 1990: 44). Communication fosters trust by assisting in resolving disputes and aligning perceptions and expectations (Etgar, 1979) and it would be impossible to theorize about trust in collaboration without paying due attention to communication. As argued by Lane and Beamish (1990), high quality communication leads to trust and openness and essentially to higher performance. Consistently, Nielsen (forthcoming) argues for the existence of a dyadic embeddedness construct, which serves as a mediator between trust and synergies of learning (innovativeness), pointing to the multi-directional and dynamic role of trust. Formation of an alliance involves a search and identification process in order to find the right partner, where differences and complementarities need to be recognized and articulated. Different perspectives and expectations do not necessarily lead to conflict and subsequent poor performance, however, the probability of this occurring is, all other things being equal, higher when there is a lack of transparency between the parties involved. Communication and proactive information exchange as well as willingness to make adaptations according to the partnership is likely to build initial trust (Webb, 1991; Das and Teng, 1998).

16 From a research perspective, a multi-dimensional operationalization of trust at both the interpersonal and interorganizational level is needed, as the level of institutional flexibility in terms of policies and procedures for knowledge exchange, risk taking, and goal adjustment needs to be combined with cognitive and affect-based measures of interpersonal interaction. Moreover, a multi-directional approach is needed in order to account for the simultaneous cause-effect roles of trust.

TRUST AND IMPLEMENTATION

17 In the implementation phase of the alliance, key issues for firms include, among other things, defining transaction rules, certifying exchange elements, and creating mechanisms to support decisions. In short, this phase is concerned with the governance of the alliance relationship.

18 A large part of research on choice of governance form in alliances has been based on the distinction between equity and non-equity arrangements (Pisano, 1989; Osborn and Baughn, 1990). Equity alliances involve, by definition, common ownership, and are typically organized as joint ventures. In the market-hierarchy continuum of organizational forms, equity joint ventures most closely replicate the characteristics normally associated with hierarchies, as they entail the creation of a separate administrative structure with formal coordination and control mechanisms. Non-equity alliances, on the contrary, are contractual agreements that lack shared ownership or dedicated administrative structures. Hence, equity arrangements are seen as governance forms fundamentally different from non-equity alliances, which are more akin to arm’s length market exchanges (Contractor and Lorange, 1988). Research concerning the choice between equity and non-equity contracts has traditionally focused on the level of control typical of different governance forms (Das and Teng, 1998). Part of this literature assumes that, because equity alliances provide more control over partner behavior than non-equity alliances, non-equity arrangements require a higher level of trust than equity arrangements to effectively manage the uncertainty surrounding the alliance partner’s behavior. According to this view, through the familiarity developed in past alliances, partners build enough confidence in each other to give up the hierarchical control offered by equity forms of governance in favor of the trust-based flexibility of non-equity alliances (Gulati, 1995). However, the notion that, in the absence of trust, equity arrangements protect collaborators from undesirable partner behavior more effectively than non-equity arrangements is questionable. In fact, equity and non-equity arrangements offer different sets of advantages and disadvantages in controlling partner behavior, with neither governance form dominating the other in this respect. Specifically, equity alliances are believed to provide partners with more control by creating a “mutual hostage” situation that helps align the interests of all partners, since partners’ concern for their investment reduces the probability that they will behave opportunistically (Williamson, 1993). However, it can be argued that the mutual hostage condition protects partners from each other while exposing them to a different type of risk. For instance, firms operating in the same markets may attempt to use an alliance to gain as much as possible from their partners while sharing as little as possible (protectiveness) of their knowledge and resources (Hamel, 1991). In such a context, by facilitating the unintended transfer of tacit knowledge across tightly connected organizations (Hennart, 1988), joint ventures can provide a partner with greater opportunities for free-riding than non-equity alliances. In general, because they entail the establishment of an ad hoc organizational entity, equity alliances require a higher level of alliance-specific investment than non-equity alliances (Das and Teng, 1998), and thus a higher degree of mutual dependence and connectedness between partners (Osborn and Baughn, 1990). Thus, in spite of the commitment they induce (and because of it), equity investments increase the difficulty and cost of exit, thus intensifying the vulnerability to undesirable partner behavior. For these reasons, equity alliances may require a higher level of confidence (trust) in a partner than non-equity arrangements (Das and Teng, 1998), however, this relationship may be contingent upon the nature of the collaboration (i.e., marketing of low-tech products versus R&D agreement of high-tech products).

19 Some scholars view trust as a specific type of control mechanism that governs economic transactions. Accordingly, it is argued that social knowledge can be viewed as a social control mechanism that can substitute certain formal control mechanisms, such as majority equity ownership in joint ventures (Sohn, 1994). Social knowledge (i.e., the ability to understand and predict other’s behavior) is not the same as trust; however, one could argue that trust is a substitute for hierarchical control in organizations (e.g., Zaheer and Venkatraman, 1995). That is, trust is not in and by itself a control mechanism, but it might be viewed as a reason not to use objective controls. Ring and Van de Ven (1994) support this argument in their discussion of the relationship between formal legal contract (control) and psychological contract (trust) in interfirm cooperation. Empirically, Gulati and Singh (1998) find support for their hypothesis that alliances in which there is less trust between partners are more likely to be organized with more hierarchical governance structures than are those in which there is greater trust. Hence, relational norms, such as trust, are often viewed as substitutes for complex, explicit contracts or vertical integration (Granovetter, 1985; Bradach and Eccles, 1989). Indeed, some contend that formal contracts may even undermine a firm’s capacity to develop relational governance as it signals distrust of your exchange partner and undermines trust, thereby encouraging, rather than discouraging, opportunistic behavior (Ghoshal and Moran, 1996). From this perspective, relational governance is regarded a substitute for formal contracts and, in the presence of relational governance, formal contracts are at best an unnecessary expense and at worst counter-productive (Poppo and Zenger, 2002). According to Poppo and Zenger (2002), however, formal contracts and relational contracts complement each other rather than act as substitutes, since well-specified contracts promote more cooperative, long-term, trusting exchange relationships.

20 Managerially, this paradox translates into the question of how to optimally mix formal and relational governance. Clearly, far from all contingencies can be worked into a formal contract, hence it seems that the role of trust may be, in conjunction with formal governance, to mitigate risk. Indeed, most definitions of trust regard risk as an integral part of trust (Das and Teng, 1998). It seems evident, then, that the nature of the contractual agreement is contingent upon the level of trust developed in the initial stages of alliance formation, which in turn is contingent upon the motives (for instance exploitation versus exploration) behind the alliance and the perceived risk associated with the investment in the relationship. Goal congruence and collaborative know-how (see Simonin, 1997; 2000) provide the basis for assessing the extent of formal contracting needed in a given situation. Practices like owning stock (e.g., stock swaps), transferring employees, having guest engineers, and using flexible legal contracts create a high degree of goal congruence and mutual trust (Dyer and Ouchi, 1993). Building on prior research suggesting that alliances go through several stages of evolution, Simonin (2000; 2002) identified five separate dimensions of his collaborative know-how construct via factor analysis. The five underlying factors pertaining to the assessed level of corporate expertise with aspects of 1/managing and monitoring, 2/negotiation, 3/search and selection, 4/knowledge and skills transfer, and 5/exiting relate directly to the moderating role of trust. As noted by several authors (e.g., Brouthers, Brouthers, and Harris 1997), changes in the environment, business climate, venture objectives, and the commitment of partner firms warrant modifications to the original agreement, hence, the configuration of relational and formal contracts should be considered an ongoing ordeal.

21 Operationally, trust must be captured primarily at the (inter) organizational level as a moderator of the degree of goal congruency and collaborative capabilities on the degree of sanctions and specificity of contracts (control). Moreover, trust may also have indirect, mediating effects on governance choice and performance. For instance, Rajan, van Eupen and Jaspers (1997) linked the effects of trust to intrafirm team-working and organizational learning. According to Ring and Van de Ven (1992), under conditions of high trust, developed in a longstanding relationship, both implicit and proprietary knowledge considered confidential is made available to the exchange partner. Sako (1998) suggested that such easy exchange of information, in turn, makes exchange partners more open to each other and thus inclines them to explore new opportunities of collaboration, such as exploitation of new technology. Hence, relational governance (trust) may mediate the relationship between antecedent variables of formal governance and control.

TRUST AND PERFORMANCE

22 As the alliance relationship evolves and matures the focus shifts toward the problem of assessing performance and divvying up the profit (or loss). Despite the apparent importance and frequency of strategic partnerships, many of these report only limited success (Adler, Brahm, and Graham, 1992, Beamish and Delios, 1997). The literature suggests that one of the most critical factors determining alliance performance is the degree of trust between the partners (e.g., Madhok, 1995; Inkpen and Beamish, 1997). Trust has been shown to increase cooperation, improve flexibility, lowering the cost of coordinating activities, and increasing the level of knowledge transfer and potential for learning. According to Sherman (1992: 78) « the biggest stumbling block to the success of alliances is the lack of trust ». Among the few empirical studies dealing explicitly with antecedents of trust in conjunction with alliance performance is Aulakh, Kotabe, and Sahay (1996), who addressed behavioral issues in cross-border marketing partnerships. The findings that initiating and fostering norms of continuity, flexibility, and information exchange between the firms are positively related to trust illustrates the importance of trust building ex post. The study did not, however, establish a direct significant relationship between trust and performance. Similarly, Dyer and Chu’s (2000) study of supplier-automaker relationships in the US, Japan, and Korea found strong support for process-based determinants of trust for all countries but did not link it to performance. Lane, Salk, and Lyles (2001), however, found trust to be positively associated with international joint-venture performance but, unexpectedly, not learning, perhaps a testimony to the difficulty of operationalizing both trust and learning. Most researchers and practitioners can agree that trust promotes voluntary, non-obligating exchanges of assets and services between actors. Consequently, a significant outcome of trust is that it facilitates tighter social relationships and hence reduces uncertainty in transactions. However, despite the seemingly obvious benefits of trust, debate on its value in organizational exchange continues to persist. Williamson (1993) contends that exchange relations are calculative and explains trust in terms of efficiency and credibility. Others concur that trust is ephemeral and may have little bearing on economic exchange (e.g., Barney and Hansen, 1994). Individuals may engage in trusting actions with an intention to develop close, collaborative relationships, but if the organizations are not supportive of these actions, interorganizational benefits may never be achieved (Barney and Hansen 1994).

23 In this phase, management is concerned with accurate evaluation of performance, for instance via quality control or enhancements in organizational effectiveness (subjective measures) in addition to more traditional measures of financial performance (objective measures), in order to verify the exact match between the partner’s performance and the mutual agreement (specified in the terms and conditions of the contract). Trust plays a pivotal role in the evaluation of performance as it dramatically reduces the potential for conflict and instability resulting from incomplete, ambiguous formal contracts. Managers should seek to agree upon and specify the exact terms of performance evaluation of the collaborative venture early on during the contract negotiations, as these may have an influence on both partner selection and the type of governance form chosen. For instance, if the motivation behind the cooperation is exploration, such as the case of many R&D agreements, the type of partner and desired trust levels (perhaps based on prior relationships and/or reputation) may lead to a looser governance structure based on flexible relational governance, where performance is measured as a combination of subjective (i.e., innovation and level of learning) and objective (i.e., number of patents filed and profits from commercialization) elements. Although open to interpretation and negotiation, managers in this case should clearly stipulate in the contracts both how innovation and learning is evaluated and profits shared as well as who owns the rights to any patents resulting from the alliance.

24 Trust is often considered a dichotomous variable, where one is either trustworthy or not, however, recent research suggests that different levels and degrees of trust might exist or even co-exist. Some authors even point to the existence of optimal trust, which is a match between trust and interdependence levels (Wicks, Berman and Jones, 1999). As argued above, both interpersonal and (inter) organizational types of trust play a role in developing and measuring performance in collaborative relationships. Consequently, both aspects of trust should be included in determining performance outcomes of these relationships, for instance, by considering the simultaneous role of trust in reducing costs associated with instability and conflict and the influence of trust on individual—and team-based—performance. Both dimensions should be evaluated based on their direct and indirect contribution to both objective and subjective performance measures in the short, medium, and long-term.