Social Capital and the Boundary of the Firm: Evidence from Relationship-Specific Investments

This study investigates the role of social capital in mitigating hold-up problems along the supply chain. We hypothesize that social capital, as captured by the strength of cooperative norms and the density of social networks, constrains opportunistic behavior and improves cooperation in mutual relationships. Consistent with the hypothesis, we find that supplier firms are more willing to make relationship-specific investments (proxied by their citations to customers’ patents) when transacting with customers headquartered in high social capital areas. This effect is more pronounced when the potential for expropriation by the customer is greatest: when the supplier has a weak bargaining position, faces high asset specificity, or the customer is in poor financial condition. Additional analyses indicate that suppliers with high social capital customers generate more non-tradable patents, share greater technological overlaps, and demonstrate stronger R&D comovement with their customers. Furthermore, high social capital firms are less vertically integrated and are more likely to form trading relationships with each other. We also find that trading relationships with high social capital customers last longer, and those customers are less likely to pass on negative shocks to their suppliers, further supporting the argument that customers’ social capital alleviates the hold-up concern of their supplier firms.