the transaction cost advantage of guanxi-based business practices

The Transaction CostAdvantage of Guanxi-Based

Business PracticesStephen S. Standifird R. Scott Marshall

The purpose of this paper is to provide a theoretical explanation of the perpetuation of China’sguanxi-based business practices. As a complement to the social embeddedness- and resource-basedexplanations, we seek to demonstrate the perseverance and relevance ofguanxi in terms of thetransaction cost advantages it offers. Specifically, we argue thatguanxi-based business practices offercertain transaction cost advantages over existing structural alternatives identified in transaction costtheory. Where theguanxinetwork is well developed, the transaction cost advantages ofguanxi-basedexchange are sufficient to warrant the integration ofguanxi- and market-based exchange mechanisms.

I n the third quarter of 1996, Chinasurpassed Japan as the country with

the largest U.S. trade imbalance. OnJuly 1, 1997, China regained controlover Hong Kong and in the processgained control over the world’s eighthlargest stock exchange (Barnathan,1996) and the world’s most profitableexchange over the last 20 years (T.Rowe Price, 1996).

China’s increased assertion in theworld market demands more attention

be given to the unique aspects of con-ducting business in China. One specificaspect that has received attention re-cently is the practice ofguanxi. In short,guanxiinvolves cultivating personal re-lationships through the exchange of fa-vors and gifts for the purpose of obtain-ing goods and services, developingnetworks of mutual dependence, andcreating a sense of obligation and in-debtedness (Yang, 1994).

The purpose of this paper is to pro-vide a theoretical explanation of theperpetuation ofguanxi-based businesspractices. Specifically, our primary the-sis is thatguanxi-based business prac-tices offer certain transaction cost ad-vantages over existing structuralalternatives identified in transactioncost theory. Subordinate to this argu-

Stephen S. Standifird, College of Business andEconomics, Western Washington University,Bellingham, WA 98225-9077, USA. Tel: 360-650-7440; Fax: 360-650-4844; E-mail: [email protected]. Scott Marshall, Lundquist College of Business,University of Oregon, Eugene, OR 97403-1208,USA. Tel: 541-346-1343; Fax: 541-346-3341E-mail: [email protected]

Guanxi-Based Business Practices21

ment is the position that the significanceof guanxi will not diminish, as someresearchers have suggested (Nee, 1992;Xin & Pearce, 1994; Luo & Chen, 1996)even with the transformation to a moremarket-based economy. The enduringstrength ofguanxilies in the conductingof moderately asset specific activitiessuch as long-term supplier relations forindustrial machinery. These types of ex-changes will continue to be performedvia the guanxi network whereas lessasset specific functions, such as equip-ment leasing, will be performed throughmarket-based exchange.

Granovetter (1985) posits that institu-tional structures such asguanximaintaincontinuity due to their deep embedded-ness in particular cultures. Supportive tothis argument, Solinger (1989) revealedhow transactions, in the Chinese provi-dence Wuhan, were founded on long-standing economic relationships betweenindividuals within the organizations stud-ied. Further, Tsang (1998) asserts thatguanxican provide individuals and firmswith an imperfectly imitable resource thatprovides a distinct competitive advantageover others in modern day China. As acomplement to, rather than an argumentagainst, the social embeddedness- andresource-based explanations, we seek todemonstrate the perseverance and rele-vance ofguanxi in terms of the transac-tion cost advantages it offers.

We begin with a detailed discussionof whatguanxi is and more specificallywhatguanxiis not. We then outline thecurrent theoretical explication of trans-action cost economics. Next, we presenttransaction cost economics as an argu-ment favoring the continuation ofguanxi-based exchange. Finally, we dis-

cuss implications for both research andpractice.

AN OVERVIEW OF GUANXI-BASED

BUSINESS PRACTICES

Guanxi Defined

Contrary to common perception,guanxi is more than the exchanging ofgifts in order to procure favorable busi-ness exchange. As Luo & Chen (1996:298–299) point out, “many Westernbusiness people are often in danger ofoveremphasizing the gift-giving andwining-and-dining components of aguanxi relationship, thereby comingdangerously close to crass bribery or tobeing perceived as ‘meat and winefriends,’ which is a Chinese metaphorfor mistrust.” Guanxi is first and fore-most about the cultivation of long-termpersonal relationships. In these terms,guanxi does not appear to be unique,and in fact it exists to some extent inevery human society. Chinese society isdistinct becauseguanxi is ubiquitousand plays a central role in daily socialand business life.

Guanxi may viewed as “friendshipwith implications of continued ex-change of favors” (Pye, 1992).Guanxiis established when one party doessomething (often more symbolic thansubstantive) for another party therebydeveloping an unpaid obligation. Thisunpaid obligation orrenqing is the firststep in a series of exchanges, whichultimately lead to the formation of aguanxi-based relationship. Thus, the in-strumental value ofguanxi is the recip-rocal obligations of the parties involved

22 Journal of World Business / 35(1) / 2000

with respect to the acquisition of re-sources. As noted by Joseph Denaro,general manager of Xerox of Shanghai,“(Xerox) has the best dealer network inthe country. It is based on a lot offriendships that have been developedover time. We have 42–43% of themarket share in this country. We arenumber one in this country because ofour dealers” (Batson, 1994: 95).

Becauseguanxi is transferable fromperson to person, the development ofindividual links ultimately leads to anetwork of relationships. Once em-broiled in a network, one maintains faceor mianziby reciprocating favor for fa-vor. Face is a key element in the devel-opment and maintenance ofguanxi. Theconcept of face, although highly ab-stract, is treated by the Chinese assomething that can be quantified andmeasured (Ho, 1976). How much facean individual has depends partly ontheir guanxinetwork. Failure to followthe rules of reciprocity and equity in aguanxi-based relationship results in lossof face and the identification as beinguntrustworthy (Luo & Chen, 1996). Theeffects are quite different than the lossof reputation. With the damaging ofreputation, future exchange partners be-come cautious and are more likely toerect safeguards before engaging in anexchange relationship. With the loss offace, the possibility of any future ex-change within theguanxi network isthreatened.

As suggested above,guanxi is dy-namic and certain socialguanxiis trans-ferable. Thus, if person A wants tomake a request of person C with whomA has no guanxi, A may seek out amember of his or herguanxi network,

person B, who hasguanxi with C.Given B provides A the introduction toC, a guanxi relationship may be estab-lished between A and C (Tsang, 1998).The transferability ofguanxi is exem-plified by the statement of Chon-Phung,general manager of Hewlett-PackardSouth Asia. Chon-Phung (1999: 9) sug-gests that “a person who brings a buyerand seller together is more than a mid-dleman – he vouches for the reputationof the one he introduces. Thus, strang-ers doing business become strangers nomore.” According to Victor Fund,Chairman of the Hong Kong investmentbank Prudential Asia, “If you are beingconsidered for a new partnership, a per-sonal reference from a respected mem-ber of the Chinese business communityis worth more than any amount ofmoney you could throw on the table”(Kraar, 1994: 92).

Importantly, transference ofguanxidoes not occur easily or quickly andperson B likely would take great care inintroducing someone to his or her ownguanxinetwork. As suggested by KwekLeng Joo, a senior executive with theHong Leong Group in Hong Kong,“Who I know in China and whether Ihave some network there is exclusiveinformation. I hardly make it knowneven to my closest friends” (Kraar,1994: 108). This cautious approach tonetwork inclusion comes from concernsof potential damage to existingguanxirelationships as well as the potential ofinfusing competition for the same re-sources.

Loss of face results in the degrada-tion and possible dissolution of theguanxi relationship. Becauseguanxiserves as a lubricant for exchange, the


loss ofguanxican result in the loss ofexchange opportunity with a specificnetwork participant. The loss of ex-change opportunity with one networkparticipant can easily result in the of-fending party’s banishment from thenetwork altogether. The mere threat ofnetwork ostracism serves as a strongincentive for commitment to the indi-vidual exchange relationship.

Many have attempted to depict prac-tices such asguanxi as trust-based ex-change (e.g., Hill, 1995). However,trust appears to play little role in aguanxiwhereas assurance appears to becritical. According to Yamagishi &Yamagishi (1994:132), trust is “an ex-pectation of goodwill and benign intent.Assurance, on the other hand, is definedhere as an expectation of benign behav-ior for reasons other than goodwill ofthe partner. Trust is based on the infer-ence of the interaction partner’s per-sonal traits and intentions, whereas as-surance is based on the knowledge ofthe incentive structure surrounding therelationship.” Stated differently, trustexists where one party believes theother party will not act opportunisticallyregardless of external variables or fu-ture interactions. Assurance existswhere one party believes the other partywill not act opportunistically specifi-cally due to external constraints and theexpectation of future exchange.

Research by Fock and Woo (1998)illustrates the differentiation betweenassurance and trust inguanxinetworks.They find that relatively more sophisti-cated foreign managers in China arecompetent and skillful at manipulatingthe exchange of favors/benefits, infor-mation, and social activities with their

Chinese business counterparts. Execu-tives with significant experience inChina perceive “exchange of favor” and“mutual cooperation” as essential tomaintaining guanxi networks. Thus,these executives manage business rela-tionships based on the knowledge of theincentive structure surrounding the re-lationships (i.e., assurance) rather thanrelying on inferences of the personalintegrity of the individual (i.e., trust).Less experienced foreign managers per-ceive guanxi in a more “Western”interpretation—trust based on a per-sonal relationship.

The loss of face associated with op-portunistic behavior spreads quicklythrough theguanxi wang(guanxi net-work). Opportunistic behavior with oneexchange partner can easily be inter-preted as opportunistic behavior withthe entire network. Opportunistic be-havior becomes an attractive optionwhen the expected pay out from oppor-tunistic behavior outweighs the ex-pected costs. In aguanxi network, thecost of opportunism is the potential lossof exchange opportunities with allmembers of the network. The larger andmore richly connected theguanxi net-work, the greater the assurance that anindividual exchange partner within thenetwork will not risk the potential net-work ostracism that could result fromopportunistic behavior. The mere threatof network expulsion provides in-creased assurance that one’s exchangepartner will not act opportunistically,thereby replacing the need for trust inthe exchange relationship.

The importance of maintaining faceis well illustrated in the example ofMotorola. Motorola spent many years


cultivating relationships with Chinesebureaucrats. Former CEO RobertGalvin took his first trip to China inOctober 1986, and since that time, Mo-torola identified and befriended threegenerations of potential top leaders. In1989, Motorola was set to build its firstfactories in Tianjin. The TiananmenSquare massacre lead the U.S. govern-ment to sever diplomatic relations withChina. A corresponding withdrawal byMotorola of its commitment to build inChina would have caused the numerousChinese bureaucrats working with Mo-torola to lose face. In order to re-enterthe Chinese market, Motorola wouldhave had to start completely anew re-building theguanxinetwork it so care-fully nurtured. Although Motorola de-layed construction of the factories fortwo years, it never withdrew its com-mitment to do so. According to Maney(1997: 3), “in the realm ofguanxi,China never has forgotten Motorola’sloyalty.” By 1997, Motorola’s invest-ment in China was $1.3 billion, doublethe next largest U.S. investor, AtlanticRichfield (Maney, 1997).

A TRANSACTION COST PERSPECTIVE

Theoretical Overview

Transaction costs are the “costs ofrunning the system” and include suchex ante costs as drafting and negotiatingcontracts and such ex post costs as mon-itoring and enforcing agreements. Atransaction cost analysis (TCA) ap-proach uses differences in transactioncosts to explain the advantages associ-ated with certain governance structures.

The firm and the market are identifiedas the primary structural alternatives fororganizing economic activity. Tables 1and 2 present definitions and explana-tions of the key concepts and underly-ing assumptions of TCA as well as il-lustrative examples.

Coase (1937) proposes that undercertain conditions, the costs of conduct-ing economic exchange in a market mayexceed the costs of organizing the ex-change within a firm. The magnitude ofmarket-based transaction costs as com-pared to the transaction costs of inter-nalization via the firm determinewhether a function will be performedwithin the firm or through market-basedexchange. Where the transaction costsof exchanging through the market arerelatively low, a firm is more likely tobuy supplies from others than producethe supplies internally. Conversely,where the transaction costs of exchang-ing through the market are relativelyhigh, a firm is more likely to producesupplies internally.

Two key assumptions of transactioncost analysis are bounded rationality(Simon, 1947) and opportunism (Wil-liamson, 1975; 1985). Bounded ratio-nality implies that human actors as wellas firms are incapable of perfect con-tracting. As such, certain environmentaland behavioral uncertainties inevitablyarise. Ex ante environmental uncer-tainty is characterized by an inability tospecify the exact conditions of the ex-change to take place in the future. Thisform of uncertainty leads to a gover-nance problem of adaptation, where thescreening of potential partners and ne-gotiating of contracts insufficiently cov-ers all possible contingencies that may


arise in the future. Direct transactionscosts in this case might include commu-nication, negotiation and coordinationcosts. Opportunity transaction costs in-clude maladaptation or failure to adaptto unforeseen exigencies.

Behavioral uncertainties linked tobounded rationality arise both ex anteand ex post to any agreement. Ascer-taining the true character of a potentialpartner prior to any agreement is nearlyimpossible, regardless of the depth ofdue diligence. Following the signing ofa contract, it can be costly to monitorand verify the performance of one’spartner. Thus, the governance problemof performance evaluation arises as cer-tain monitoring and contract enforcingmechanisms are put in place to ensurecompliance with agreed upon obliga-tions. Direct ex ante transaction costs

arising from behavioral uncertainty in-clude the costs of screening and select-ing partners. Direct ex post transactioncosts are related to the processes put inplace to measure a partner’s perfor-mance. Opportunity transaction costsinclude the failure to identify the appro-priate (best) partner (ex ante) and thepossible productivity losses accruingfrom adjustment efforts (ex post).1

Opportunism is the assumption that,given the occasion, decision-makersmay seek “with guile” to serve theirown interests (Williamson, 1985), andthat it is difficult to know a priori who istrustworthy and who is not (Barney,1990).2 Opportunism leads to the gov-ernance problem of asset specificity.Asset specificity exists where certainbusiness relationships maintain a highdegree of unique, dedicated assets that

Table 1The Basic Components of the Transaction Costs Analysis Framework

Transaction Costs: The “costs of running the system” including such ex ante costs as draftingand negotiating agreements and such ex post costs as monitoring andenforcing agreements.

Governance Structures

Market versus Hierarchy: Markets(where transactions are conducted between firms, e.g. manufacturerand wholelsaler) andHierarchies(where transactions are conductedwithin a firm, e.g. vertically integrated supply chains) are compared fortheir relative efficiency in sustaining recurrent trading relationship.(Williamson 1978)

Assumptions Regarding Human Nature

(1) Bounded Rationality Decision-makers intend to be rational, but are constrained by their limitedinformation processing and communication abilities.

(2) Opportunism Given the opportunity, decision-makers may unscrupulously seek to servetheir self-interests, and it is difficult to determine a priori who istrustworthy and who is not.

Problematic when an interfirm relationship is suported by specific assets(degree of asset specificity) whose values are limited outside the focalrelationship.


are not transferable outside the partner-ship. Thus, firms may be inclined toestablish mechanisms for safeguardinginvestments in the focal relationship. Amutual hostage situation may arise inwhich both partners make idiosyncraticinvestments into the relationship to dis-courage opportunistic behaviors. The

cost of crafting safeguards representsdirect transaction costs. Failure to in-vest in productive assets represents anopportunity transaction cost of assetspecificity.

Where asset specificity is low, mar-kets provide increased discipline andinformation through market-based pric-

Table 2Sources, Types, and Examples of Transaction Costs

(Adapted fromRindfleisch and Heide (1997))

ASSETSPECIFICITY

ENVIRONMENTALUNCERTAINTY

BEHAVIORALUNCERTAINTY

SOURCES OFTRANSACTIONCOSTS

Nature ofGovernanceProblem

Safeguarding Adaptation Performance Evaluation

Arises when a decision-maker deploysspecificassetsto an exchangeand fears its partnermay opportunisticallyexploit theseinvestments.

Arises when a decision-maker, limited bybounded rationality, hasdifficulty modifyingagreements in the faceof environmentaluncertainty.

Arises when a decision-maker, limited bybounded rationality, hasdifficulty assessing thecontractual complianceof its exchange partnerin the face ofbehavioral uncertainty.

TYPES OFTRANSACTIONCOSTS

Direct Costs Costs of craftingsafeguards.

Communication,negotiation, andcoordination costs.

Screening and selection ofpartner costs (ex ante).

Measurement and moni-toring costs (ex post).

Opportunity Costs Failure to invest inproductive assets.

Maladaptation; Failure toadapt.

Failure to identify appro-priate partners (ex ante).

Productivity lossesthrough effort adjust-ments (ex post).

EXAMPLES A manufacturer of atrademarked brand willincur transactional costsin its attempt to set upexclusive internationaldistribution channels toprotect the image valueof its trademark.

Negotiating agreements ina foreigh culturegenerally incurs highertransactional costs dueto unfamiliarity with thelegal system, businessprocedures and culturaltraditions.

A firm seeking a potentialforeign joint venturepartner will incur trans-actional costs whenhiring an outside com-pany to perform duediligence on potentialpartners in the selectedforeign market.


ing mechanisms. The clarity of infor-mation and the reduced dependency onindividual exchange partners providedby competitive markets eliminates theneed for safeguards against opportunis-tic behavior. However, as asset speci-ficity increases, the potential for oppor-tunistic behavior rises because marketcompetition no longer serves as a re-straint. Internalization of an activitycurbs opportunistic behavior by 1) re-ducing incentives to suboptimize, 2) al-lowing for the invocation of fiat (au-thority), and 3) increasing the ability toaccess information to resolve disputes.Internalization through the use of hier-archy occurs at the point at which thecombined savings associated withmarket-based production and transac-tion become zero.

Transaction costs within the organi-zation are not assumed to be insignifi-cant as is sometimes indicated in cri-tiques of TCA (e.g., Perrow, 1981;1990). Grossman and Hart (1986) arguethat integration of two firms shifts, butdoes not eliminate, incentives for op-portunistic behavior. We do not claimthat transaction costs are reduced tozero under full integration, only thatthe contractor-contracteerelationshipmaintains higher transaction costs undersituations of high asset specificity thanthe employer-employeerelationshipsdue to the need for on-going discussionsof the allocation of residual rights ofcontrol.3 That is, transaction costswithin the organization are assumed tobe significantly lower than markettransaction costs at high levels of assetspecificity. Even assuming constantproduction costs, increased markettransaction costs (as compared to inter-

nal transaction costs) associated with in-creased asset specificity would eventuallydictate the internalization of an activity.

The above discussion assumes twostructural alternatives: internalizationvia hierarchy or market-based exchange.Williamson (1991) suggests a third al-ternative in which relational contractsare used to fill the gap between the polarextremes of markets and hierarchies.This third alternative, the hybrid form,relies on contractual safeguards and in-creased information disclosure to re-duce opportunistic behavior. At moder-ate levels of asset specificity, the hybridform incurs fewer transaction costs thanmarket-based exchange by reducing in-centives to act opportunistically.

At low levels of asset specificity, thethreat of opportunism is minimal, mak-ing markets the most transaction cost-efficient structural alternative. As assetspecificity increases, the cost of oppor-tunism increases dictating the need forincreased structural protection. The hy-brid form reduces opportunistic behav-ior as compared to markets but main-tains some aspects of market discipline.Thus, the hybrid form emerges as themost cost-efficient transaction at mod-erate levels of asset specificity. Highlevels of asset specificity result in highcosts of opportunistic behavior. Hierar-chies are superior in their ability to re-duce the threat of opportunism. Conse-quently, hierarchies emerge as mosttransaction cost efficient at the highestlevels of asset specificity.

Qualifications to Existing Theory

Transaction cost economics has beencriticized for failing to recognize the


importance of institutional environ-ments (Robins, 1987). Williamson’s(1991) discussion of the hybrid form isa direct response to such criticisms.Still, predictions concerning the hybridform all revolve around the existenceof contract law (Williamson, 1991)and the hybrid structure is viewed asan exception to general practice(Granovetter, 1985). Contract law is as-sumed to characterize institutionalstructures. The lack of contract law isassumed to represent a lack of institu-tional structure (Nee, 1992; Xin &Pearce, 1994). Given TCA’s preoccupa-tion with contract law, structural alter-natives such asguanxi-based exchangehave received insufficient attention.

Institutional structures represent hu-manly devised constraint systems de-signed to facilitate economic and socialexchange (North, 1990). Two condi-tions appear critical in identifying aconstraint as institutional. First, a con-straint must attain a sense of culturalpersistence (Zucker, 1991). Second, aconstraint must transcend interpersonalrelationships (Zucker, 1986).

The historical roots ofguanxi extendsome 2000 years. Codified societal rulesand values specified by Confucius duringthe sixth century B.C. provide the frame-work for guanxi-based practices. The factthat the same basic tenets specified byConfucius during the sixth century B.C.still dominateguanxi-based exchange inthe twentieth century A.D. affirmsguanxi’scultural persistence.

The transferability ofguanxi allowsguanxi-based exchange to transcend therealm of interpersonal relationship. Theloss of face with any individual in theguanxinetwork can result in the loss of

face with the entireguanxi network.This loss of face can result in the of-fending party’s banishment from allnetwork exchange. The core ofguanxi-based exchange begins with the individ-ual relationship. However, the loss offace with the individual can result insystem wide pecuniary effects. Thesesystem wide effects which transcend theinterpersonal relationship are indicativeof an institutional constraint.

Cultural persistence combined withthe systemic pecuniary aspect ofguanxi-based exchange suggests thatany serious discussion of China’s eco-nomic environment must include a dis-cussion of guanxi as an institutionalconstraint. Unlike the hybrid form,guanxi-based exchange is not based onthe presumption of contract law. Yet,the guanxi-based transactional arrange-ment appears to have significant latentstrengths by allowing for the reconsti-tution of transactions to meet new op-portunities and changing circumstances(Boisot and Child, 1996). Therefore, theguanxinetwork orguanxi wangmust beincluded as an independent structuralalternative if we are to truly understandthe transaction cost implications ofguanxi-based business practices.

Ouchi (1980) suggests that clans rep-resent yet another alternative gover-nance structure to markets and bureau-cracies. Specifically, he suggests thatthe normative and informational re-quirements of various governance struc-tures differ and that each offers transac-tion costs advantages based on thedegree of and the means for attaininggoal congruence between transactingparties. Whereas markets are foundedon the basis of reciprocity directed by


price-setting mechanisms, and bureau-cracies rely on reciprocity and legiti-mate authority guided by explicit rules,the clan structure relies on reciprocity,legitimate authority and common so-cialized values and beliefs steeped inlong held traditions.

We differentiateguanxifrom Ouchi’sclan structure by positing thatguanxifunctions based on common traditionalsocial agreements and reciprocity, sim-ilar to clans, but that legitimate author-ity is implicit and dynamic, that is, morein line with the market structure. Thus,guanxi is similar to the hybrid formsuggested by Williamson, in which re-lational contracting is supported by thehistorically based and future-orientatedperspectives of partners. Further, theguanxi network provides a measure ofdiscipline in how obligations are madeand paid. This supposition suggests thatlegitimate authority inguanxiis endog-enous to the relationship, and continu-ally evolves based on the nature of ob-ligations between partners.

The Transaction Cost Advantages ofGuanxi-Based Exchange

A detailed comparison of structuraltransaction costs can now be pre-sented treating guanxi-based ex-change as a structural alternative tomarkets, hierarchies, and the hybridform. The advantages of the variousstructural alternatives are found in theway each deals with uncertainties cre-ated by bounded rationality and op-portunistic behavior. The transactioncost advantage ofguanxi-based ex-change specifically lies in the wayguanxi deals with governance prob-

lems associated with bounded ratio-nality and opportunism.

Bounded rationality and the resultinginability to construct comprehensivecontracts is an important component ofTCA. In nonintegrated situations, closerelationships (Heide & John, 1990) mayenjoy commonalties in knowledge andmodes of communication (Conner &Prahalad, 1996) that permit more effi-cient adaptation than does market gov-ernance. Knowledge of individual faceor mianzi is transmitted through theguanxinetwork. This increased transferof knowledge appears to reducebounded rationality by providing broadinformation concerning an individual’scharacter as an exchange partner. How-ever, the specificity of knowledge trans-ferred is sufficient to warrant only adeclaration of the reduction, not elimi-nation, of uncertainty.

The assumption of bounded ratio-nality suggests that we are incapableof perfect contracting due to unfore-seen future contingencies. The broadinformation provided byguanxi ad-dresses some of the problems relatedto the governance problem of adapta-tion. Specifically, the operational pro-cess ofguanxi development (i.e., thetransferability of guanxi) permits afairly sophisticated, although implicit,means for screening potential part-ners. The flexible and socially-basednature of guanxi also permits mem-bers of aguanxinetwork to deal withunforeseen contingencies arising afteragreements are reached. Because thespirit of contract takes precedenceover the letter of contract inguanxi-based relationships, the problems as-sociated with ex post adaptation are


substantially reduced. Thus,guanxipossesses the capacity to reduce trans-action costs associatedwith environ-mental uncertainties, such as communi-cating, negotiating and coordinatingtransactions, as well as maladaptationand/or a failure to adapt.

Davies et al.’s (1995) survey of HongKong Chinese executives regarding theimportance ofguanxi relationships ad-dresses the role ofguanxi in reducingtransaction costs associated with environ-mental uncertainties. They found that thebusinessmen believed that once goodguanxihad been established, a number ofbenefits would follow. These benefits in-cluded the smooth running of routinebusiness operations, greater access to in-formation about government policies, andquicker receipt of administrative approv-als. Xin and Pearce (1994) found a similareffect when observing that private com-pany executives made more extensive useof guanxi, and maintained deeper busi-ness connections as a way of reducingenvironmental uncertainty than did themore institutionally secure state-ownedcompany executives. Bjorkman andKock’s (1995) interviews of foreign andChinese marketing managers active injoint activities revealed that Westerncompanies had very limited access to in-formation regarding who might be poten-tial customers and where they were lo-cated. The key to unlocking the flow ofthis information to the Western compa-nies appears to lie in possessingguanxinetworks.

Wal-Mart’s successful entry intoChina illustrates the way in which theguanxi network can be used to reducethe transaction costs associated with en-vironmental uncertainties. To facilitate

initial entry, Wal-Mart teamed up withthe Charoen Pokphand Group of Thai-land (Kraar, 1994). At the time of theinitial venture, Wal-Mart had no opera-tional experience outside the WesternHemisphere. Conversely, the CharoenPokphand Group had significant expe-rience in China, with 55 ventures inoperation at the time of the initial jointventure with Wal-Mart. As suggestedby Don Shinkle (Kraar, 1994: 102),Wal-Mart’s vice president for corporateaffairs, “There’s not a heck of a lot thatwe know about retailing in China, so wefound an outstanding teacher.” In addi-tion to the information intrinsic to theCharoen Pokphand Group, Wal-Martwas able to make use of the extrinsicinformation associated with the Cha-roen Pokphand Group’s well-developedguanxinetwork.

Proposition One

Transaction costs caused by environ-mental uncertainties related to boundedrationality will be lower in situations inwhich guanxi wang(guanxinetwork) iswell developed than in situations in whichthe guanxinetwork is less developed.

Guanxialso reduces transaction costsassociated with behavioral uncertaintiesthat arise on account of bounded ratio-nality. Because of the interlocked na-ture of a guanxi network, a failure touphold obligations is destructive to allmembers. Thus, aguanxi network al-lows a member to ascertain, with a fairdegree of confidence, the true characterof potential partners ex ante to anytransaction. In other words, the transac-tion costs derived from screening and


selecting partners are reduced becauseof the latent strength of theguanxinet-work. In addition, the alacrity of infor-mation flow within theguanxinetworkprovides rapid feedback, directly andindirectly, on the performance of a part-ner. Thus, to a lesser degree than in thecase of ex ante screening, but no lesscertainly, ex post transaction costs ofmeasurement are reduced. Finally, thetightly woven information network pro-vided by guanxi reduces opportunitytransaction costs related to failure toidentify the appropriate partner.

The experience of AST Research inChina illustrates the ability ofguanxi-based exchange to reduce the transac-tion costs associated with behavioraluncertainties. As of 1994, AST was fifthin market share among computer mak-ers in the U.S., but was first in Chinabecause of early entry and mature rela-tionships (Pitta, 1994). AST cofoundersAlbert Wong and Thomas Yuen (bothChinese) leveraged their ancestral heri-tage to overcome the Chinese mistrustof foreigners. AST moved early andaggressively to establish links with gov-ernment agencies. According to Rich-ard Fade, VP of Far Eastern operationsfor Microsoft, AST has “. . . the distri-bution, . . . the relationships, . . . andthe market share” (Pitta, 1994: 12).AST established a joint venture manu-facturing operation with state-ownedTianjin Economic-Technological AreaBusiness Development Corporation.Through the networks it had estab-lished, AST also identified a capableand trustworthy state-owned distributor,Legend Technology. Costs associatedwith finding and examining potentialpartners (i.e., costs associated with be-

havioral uncertainties) were relativelylow for AST because of the establishedrelationships between Wong and Yuenand key government and business offi-cials.

Proposition Two

Transaction costs caused by behav-ioral uncertainties related to boundedrationality will be lower in situations inwhich theguanxinetwork is well devel-oped than in situations in which theguanxinetwork is less developed.

Guanxi-based exchange providessome assurance of exchange partner be-havior. Specifically, the pecuniarythreat of network ostracism associatedwith opportunistic behavior leads to areduction of opportunism where theguanxinetwork is well developed. Theloss of face with a single exchange part-ner is transmitted throughout theguanxinetwork. Opportunistic behavior withone exchange partner can be easily in-terpreted as opportunistic behavior withthe entire network. Opportunistic be-havior can be an attractive option if thepay out from opportunistic behavioroutweighs potential costs. In aguanxinetwork, the cost of opportunism is thepotential loss of exchange opportunitieswith all members of theguanxi net-work. Therefore, the more developedthe guanxinetwork, the greater the as-surance that the individual exchangepartner within the network will not actopportunistically due to the potentialcosts of network ostracism. The level ofdevelopment is taken here as the levelof network membership and the scopeof network activities. The mere threat of


expulsion from the well-developedguanxi network provides increased as-surance that one’s exchange partner willnot act opportunistically.

Luo and Chen (1996) examined anumber of key business variables interms of their importance in businessactivities in China. They found thatcredit granting was highly correlatedwith guanxi relationships. In China,where theguanxi network is deliber-ately nurtured and the preservation ofamity is of the utmost importance, sell-ers will make every effort to avoid em-barrassing customers who confront tem-porary cash shortages. Credit isextended as a way for both the sellerand buyer to maintain an amicable re-lationship. The probability that thosereceiving credit will act opportunisti-cally towards those extending credit isattenuated by the socially-constructedface preservation mechanism associatedwith the well-developedguanxinetworks.

Proposition Three

Opportunistic behavior will be lessprevalent in situations in which theguanxinetwork is well developed thanin situations in which theguanxi net-work is less developed.

Guanxi-based exchange offers theadvantage of reduced opportunisticbehavior. However, the threat of oppor-tunistic behavior diminishes as assetspecificity decreases. Where asset spec-ificity is low, markets provide increaseddiscipline and information through mar-ket pricing mechanisms. The clarity ofinformation provided in competitivemarkets eliminates the need for safe-

guards against opportunistic behavior.Future exchange contingencies can beresolved by referring to market pricing.The ability to rely on market pricingreduces the overall cost of transacting.Therefore, at low levels of asset speci-ficity, markets outperform all otherstructural alternatives includingguanxi-based exchange.

The experience of General Motors inits joint venture with state-owned JinbeiAutomotive illustrates the dominance ofmarkets in low asset specificity circum-stances. GM set up a $97.5 million jointventure with Jinbei in 1992, the lattertaking a 70% equity stake (Murray,1994). Part of GM’s incentive for estab-lishing the joint venture was to accessbusiness channels more easily accessedby the state-owned firm. As Jinbei tran-sitioned from state-owned to privatestatus, low asset specific inputs such asplant and equipment leasing werepriced by the basic market principles ofsupply and demand despite Jinbei’sguanxi connections thereby reducingthe transaction cost advantages of thestrategic alliance.

Proposition Four

Transactions low in asset specificitywill be conducted using market-basedexchange no matter how well-developed the guanxi network.

As asset specificity increases, mar-kets fail in their ability to provide safe-guards through accurate pricing (Coase,1937). The hybrid form suggested byWilliamson (1991) serves as an inter-mediary between markets and hierar-chies and is most efficient at moderate


levels of asset specificity. The increasedefficiency of the hybrid form over themarket occurs due to the hybrid’s abil-ity to reduce opportunistic behavior.Opportunistic behavior is reducedthrough the use of long term contractssupported by contract law and increasedinformation disclosure.

The assumption of bounded rationalitysuggests that we are incapable of com-plete contracting. Therefore, the hybridform is limited in its ability to discourageopportunistic behavior. The hybrid formassumes a well-developed system of con-tract law through which formal disputescan be resolved. However, increased doc-umentation and the cost of litigation bothdetract for the transaction cost advantageof the hybrid form.

Guanxi-based exchange also has theadvantage of reducing threats of oppor-tunism. However, the magnitude of re-duction is a function of the networkdevelopment, not contract law. Unlikethe hybrid form, theguanxi networkdoes not require extensive documenta-tion or litigation. The primary transac-tion cost associated withguanxi-basedexchange is the cultivation of personalrelations.

Entrance into aguanxi network re-quires the cultivation of an individualrelationship. The level of cultivationnecessary is independent of network de-velopment. Once this initial relationshipis established, additional relationshipswithin the network can be established atminimal cost due toguanxi’s transfer-ability. The transaction costs associatedwith membership in a well-developedguanxinetwork are only marginally dif-ferent than the transaction costs associ-ated with membership in a less devel-

oped network. However, the threat ofopportunistic behavior decreases signif-icantly as theguanxinetwork increasesin size and scope. The reduced threat ofopportunism comes from two sources:(1) the reluctance to sacrifice the sunkinvestments in an existingguanxi rela-tionship, and (2) the near impossibilityof reentering aguanxi relationship thathas been severed (Yau, 1988). There-fore, the transaction cost advantage ofguanxi-based exchange increases withincreased network development.

Once sufficiently developed, the in-creased ability to reduce opportunismcombined with fairly constant mainte-nance costs make the well developedguanxi network a superior alternativeto the hybrid form. The less developedguanxinetwork incurs similar mainte-nance costs as compared to the well-developed network but does not sharethe same reduced threat of opportun-ism. Therefore, the inability to signif-icantly reduce opportunism combinedwith fairly constant maintenance costsmake the less developedguanxi net-work an inferior alternative to the hy-brid form.

A well-developedguanxinetwork inChina can assist the manager carry outat least three moderately asset specificvalue chain activities. First,guanxipro-vides an avenue for building salesthrough long term accounts payable.Luo and Chen (1996) found that, inbusiness dealing underscored byguanxi, both buyers and sellers benefit.The seller benefits by providing favor-able credit terms with extended pay-ment periods resulting in concordantsales growth. The buyer benefits frommore favorable cash flow circumstances


and increase operational flexibility.This form of buyer-seller relationshipwould depend on contractual arrange-ments in the absence ofguanxi, but inthe presence ofguanxi it is conductedthrough the obligatory reciprocity in-herent inguanxinetworks.

Second, companies interested inselling industrial and consumer goodsreliant on personal selling will greatlybenefit from strongguanxi relation-ships. Particularly in the early stage ofactivity in China, theguanxiof a Chi-nese partner can assist with sales con-tracts and distribution access (Shawand Meier, 1994). In services such asinsurance and banking,guanxi rela-tionships provide important sources ofcommercial security. Chubb Insur-ance, an American insurance pro-vider, treats networking as a form ofprotection against environmental un-certainty (Economist, March 29,1997, p. 24). With no clear forecast ofwhen, and if, rules and regulations inthe Chinese insurance industry willemerge, maintainingguanxinetworksprovides Chubb Insurance with asense of security through reliable re-lationships with current commercialclients.

Third, a firm needs to nurtureguanxirelationships to keep abreast of changesin relevant policy, to garner the neces-sary licenses, permits, and approvals,and to have access to government pro-curement contract offerings. Koll, anAmerican real estate services company,relies heavily on the long-establishedguanxiconnections of its partner, Cha-roen Pokphand Group (Singapore), tomanage its $300 million shopping mallproject in Pudong. By piggybacking on

the relationships that CP has with gov-ernment officials in Shanghai, buildingpermits and other requisite licenseswere placed on the bureaucratic fasttrack (Yatsko, 1997). The bureaucracyaccess provided byguanxi can play apart in everything from import licenseapplications, to securing electricity forproduction operations, to approval ofbillboard advertisements.

Each of these value chain activities,credit policy, relationship-related sales,and management of policy issues, ismoderate in asset specificity. In a West-ern context, such activities would beconducted through long-term contrac-tual arrangements, that is, the hybridform. However, in China these activi-ties are largely dependent onguanxinetworks and can be used to advantageby Western firms motivated to developsuch networks.

Proposition Five

Where theguanxi wang(guanxinet-work) is well developed, transactionsmoderate in asset specificity will beconducted using theguanxi wang(guanxinetwork).

Proposition Six

Where theguanxi wang(guanxinet-work) is not well developed, transac-tions moderate in asset specificity willbe conducted using the hybrid form.

The relationship specified in proposi-tions five and six is illustrated in Fig. 1.At a constant level of asset specificity,the transaction costs associated with thehybrid form remain constant regardlessof network size and scope. The transac-


tion costs associated with theguanxinetwork decrease as network size andscope increase. Point A represents thepoint at which the difference betweentransaction costs of theguanxinetworkand transaction costs of the hybrid formequals zero. Point B represents the levelof network development above whichthe guanxinetwork incurs lower trans-action costs that the hybrid form. Trans-actions moderate in asset specificitywill be conducted using theguanxinet-work where the existingguanxinetworkis of size and scope B or greater.

Hierarchies are superior to the hybridform in their ability to (1) reduce theneed for documentation, (2) reduce thecost of arbitration, (3) gain access toinformation, (4) resolve disputes inter-nally, and (5) invoke additional incen-tives such as career advancement andprofit sharing (Williamson, 1991).Guanxinetworks do not incur the costsof documentation or arbitration associ-ated with the hybrid form. As a result,the well-developedguanxinetwork can

handle an increased level of asset spec-ificity as compared to the hybrid form.However, theguanxi network is notable to access information, resolve dis-putes internally, or invoke additionalincentives as can be done in hierarchies.Thus, hierarchies are superior at reduc-ing transaction costs as compared to theguanxi network at high levels of assetspecificity.

Recent investments by Motorola andSamsung Electronics support this sup-position. Both companies recently de-cided to establish semiconductor manu-facturing plants in China, Motorola’svalued at $360 million and Samsung’sat $140 million (Science Center Inter-national, Ltd., 1996). Semiconductormanufacturing is an inherently highlyasset specific operation, where highlytrained personnel and advanced, propri-etary processing and product technolo-gies are uniquely committed to the taskof semiconductor production. Motorolawas the first foreign firm to insist onfull-ownership for a manufacturing op-eration (Maney, 1997). Thus, even inthe midst of China’sguanxi social/business system, Western firms are opt-ing for fully integrated (or, wholly-owned) operations where idiosyncraticinvestments are kept strictly in-house.

Proposition Seven

Transactions high in asset specificitywill be conducted using hierarchies nomatter how well developed theguanxiwang (guanxinetwork).

In short,guanxi-based exchange is aviable structural alternative with dis-tinct advantages over markets, hierar-

FIGURE 1Transaction Costs of theGuanxi

Network and Hybrid Form AssumingVarying Network Development and

Constant Asset Specificity


chies, and the hybrid form. Markets andhierarchies still emerge as superior atthe extremes of asset specificity. How-ever, the well-developedguanxi net-work serves as a functional substitutefor the hybrid form at moderate levelsof asset specificity.

IMPLICATIONS FOR RESEARCH

The transaction cost advantage ofguanxi-based exchange depends on theguanxi network’s ability to reduce op-portunistic behavior. The ability to re-duce opportunistic behavior is a func-tion of network development. Keyvariables in determining a network’slevel of development include networksize and scope. Size is broadly definedat the number of network participantsand could be measured either in abso-lute terms (e.g., roughly 10 participants)or in terms of shared market dominance(e.g., 20% of the overall market partic-ipants). Network scope includes thebreath of activities covered by a specificnetwork and could be measured by thevariety of tasks completed by networkparticipants. A large network in termsof scope would cover such diverse tasksas general finance and metal fabricationwhile a more restricted network wouldfocus on a narrow band of related ac-tivities. Explicating more exact mea-sures of network development would bethe first task of any empirical investiga-tion concerning the transaction cost ad-vantages ofguanxi-based business prac-tices.

A combination of increased member-ship size and scope of activity is pre-sumed to reduce the threat of opportun-

ism by increasing the penalty ofnetwork ostracism. The way in whichthese two variables interact to curb op-portunism is not explicitly discussed inthis analysis. Further insight concerningthe potential resilience ofguanxi-basedbusiness practices can be gain by expli-cating the ways in which size and scopeinteract to restrain opportunistic behav-ior. The exact level of developmentnecessary to reduce opportunism to thepoint where theguanxinetwork outper-forms the hybrid form (point B in Fig.1) is a question of empirical research.The range of asset specificity overwhich theguanxinetwork outperformsmarkets and hierarchies also depends onthe level of network development andcan be best determined through empir-ical investigation.

The transaction cost analysis outlineabove assumes a self-interested individ-ualistic predisposition of certain ex-change partners. The transaction costadvantage ofguanxi-based practices asdiscussed in this paper relates to theability of network participants to penal-ize individualistic opportunistic behav-ior through network ostracism. Socialpressures independent of business trans-actions may also serve to reduce oppor-tunistic behavior in a more collectivisticsociety such as China (Chen, Chen, &Meindl, 1998). Therefore, the tendencytowards collective behavior could serveto further increase the transaction costadvantage ofguanxi-based practices.The purpose of this paper is to show thetransaction cost advantages ofguanxi-based exchange independent of the in-dividualistic or collectivistic assump-tions. Still, greater insight into thepotential advantages ofguanxi-based


exchange could be ascertained by fur-ther investigating the ability of collec-tivistic predispositions to reduce oppor-tunistic behavior.

The above discussion is restricted toa transaction cost explanation ofguanxi’s continuity. An alternative ex-planation involves the cultural embed-dedness ofguanxi-based business prac-tices. A cultural embeddedness argumentsuggests thatguanxi-based exchangehas been taken for granted as necessaryand appropriate (Zucker, 1986). With acultural embeddedness argument, thepractice ofguanxiis seen as being fullyinstitutionalized exhibiting a sense ofpersistence beyond what would be ex-pected based on the technical aspect ofthe task at hand (Davis, Diekmann, &Tinsley, 1994).

Cultural embeddedness may, in fact,explain some portion ofguanxi’s per-sistence. Further research is needed toclarify the possible contribution of thecultural embeddedness argument. Theprimary contribution of this discussionis to show that the steadfast nature ofguanxi-based business practices can beexplained regardless of cultural embed-dedness effects. Our intention is to dis-close the utility of transaction costsanalysis in elucidating the transactionalbenefits of the distinctly cultural andhistorical phenomenon ofguanxi. In do-ing so, greater conceptual clarity isadded to the transaction cost analysisargument by demonstrating how socialand economic factors influence the de-sign and implementation of transactionsin different cultural settings. An argu-ment suggesting persistence based oncultural embeddedness would onlyserve to reinforce the prediction of con-

tinuity suggested by the transactioncost-based explanation discussed.

IMPLICATIONS FOR MANAGEMENT

The overriding managerial implication ofthe proceeding analysis is the recognitionof guanxi’scontinued influence on busi-ness transactions amid China’s market re-forms. The failure to appropriately assessthe perseverance ofguanxi-based busi-ness practices can have a devastating ef-fect on managers attempting to enter theChinese market. Each business interac-tion must be treated not as an independentevent but as a building block for futureexchange. The failure to do so could re-sult in network ostracism even wheremarket dynamics are well established.Conversely,guanxihas significant poten-tial to facilitate the building of interfirmand firm–government relationships inChina’s increasingly market-oriented en-vironment. Thus, Western firms investinginto China may benefit more from seek-ing long-term partnerships through thegradual development ofguanxinetworksthan from relying strictly on the morefamiliar contract-based agreements.

Specific managerial implications canbe considered in terms of a sequence ofinvolvement in the Chinese market. Atthe Initial Entry stage, it is suggestedthat a foreign firm enter slowly by wayof established distribution channels ifpossible. Find a Chinese national oroverseas Chinese to act as yourinter-face personin order to establish con-tacts with relevant government andbusiness organizations. Provide ‘gifts’to distribution partners, including win-ing and dining, items with company


logo, and so forth, but do not considerthese as end-alls in building the rela-tionship.Guanxican have limiting im-plications at this stage. Given a firm hassuccessfully set up distribution of itsproduct and it satisfied with sales, fur-ther commitment to the market may bepursued in the Engagement stage.

In order to continue to buildguanxi,it is suggested that the firm provideclear signals to the business partners ofthe greater level of commitment. Thiscommitment may be communicated byestablishing (1) a subsidiary office, (2)assembly operations, and/or (3) local(Chinese) sources of supplies (raw ma-terials, component parts). Additionally,greater personal involvement shouldtake place through face-to-face meet-ings with your interface person, higher-level company executives, Chinesegovernment officials, and other busi-ness partners. At this point, the firm’sexecutives should be aware of the pos-sibility that their activities may be con-strained in terms of access to the marketand government agencies by the singleinterface person and his or her existingguanxi network. Therefore, never passup an opportunity to meet new peopleand start establishing one’s ownguanxiwithout causing your interface person tolose face.

At some point, a manager may wantto consider full commitment. At thisjuncture, it is suggested that a foreignmanager work with a Chinese partneridentified earlier to establish a full-scalemanufacturing operation. Control is notas critical as access. In other words, donot seek a greater equity control at theexpense of greater knowledge of themarket, access to additional channels of

distribution and the goodwill of one’sgovernment and business partners. Fi-nally, a manager should continue tonurture his or her existingguanxi rela-tionships by engaging in such activitiesas bringing government officials andbusiness partners for training and visitsto the company’s domestic (e.g., U.S.)headquarters (an activity that could oc-cur earlier in the process depending onthe aggressiveness of the firm’s marketentry strategy).

In general, the development of aguanxi network reduces costs associ-ated with searching for partners, andnegotiating contracts. Managers shouldmaintain a long-term horizon with theshort-term objectives focused on nurtur-ing the development of a network.Short-term transaction costs associatedwith development of the network maybe equal or even exceed costs associ-ated with the more familiar Westernsearch mechanisms. But, long-termtransaction costs reduction will comefrom your ability to rely on your part-ner, your partner’s flexibility in face ofunforeseen contingencies, and the abil-ity to continually build a largerguanxinetwork at relatively lower costs. Thus,foreign executives should not focus somuch on the formalities of traditionalWestern search for partners (formalbusiness plan, etc.), but on the integrityand abilities inferred through relation-ships.

This is not to suggest that the man-ager should forgo the use of contractsaltogether. Relying strictly onguanxi-based exchange creates its own sourceof organizational inefficiencies. For ex-ample, over reliance on relational ex-change can impede outside monitoring


efforts and decrease the organization’sability to response to specific circum-stances of opportunistic behavior.Clearly, some level of contractual safe-guard is appropriate. On the other hand,over-reliance on contractual agreementsreduces the organization’s ability to ad-just to unforeseen contingencies. In-stead, the individual manager shouldstrive to attain a balance. Contractualarrangements should be seen as a start-ing point, incorporating a relativelyhigh degree of flexibility through rela-tional exchange established via theguanxinetwork.

CONCLUSION

From a transaction cost perspective,guanxi-based business practices offercertain advantages over existing struc-tural alternatives. The transaction costadvantage ofguanxi can only be seenwhen guanxi-based exchange is recog-nized as a distinct structural alternativeindependent of contract law. Where theguanxinetwork orguanxi wangis welldeveloped, the transaction cost advan-tages of reduced environmental and be-havioral uncertainties and opportunisticbehavior are enough to warrant the in-tegration ofguanxi- and market-basedexchange.

Guanxi-based business practices willnot diminish in importance to the extentpreviously predicted. Instead,guanxi-based exchange will remain as a viablestructural alternative with distinct ad-vantages over markets, hierarchies, andthe hybrid form. Markets and hierar-chies may emerge as superior at theextremes of asset specificity. However,

the well-developedguanxinetwork willcontinue to serve as a functional substi-tute for the hybrid form at moderatelevels of asset specificity.

From a managerial perspective, thisimplies a continued influence on busi-ness transactions amid China’s marketreforms. The failure to appropriately as-sess the perseverance ofguanxi-basedbusiness practices can have a devastat-ing effect on a company’s ability tosuccessfully operate in the Chinesemarket. Conversely, firms willing torecognize and embrace the importanceof theguanxinetwork should see trans-actional cost advantages unattainable bythose who fail to develop such networks.

Acknowledgments: An earlier ver-sion of this paper was presented at the1997 Academy of Management meetingin Boston, MA. We would like to thankDan Moshavi, Rick Mowday, and thetwo anonymous reviewers for their in-sightful comments on previous versionsof this manuscript.

NOTES

1. TCA’s original framework supposes an interac-tion effect between environmental uncertaintyand asset specificity (Rindfleisch & Heide,1997). For conceptual clarity, this paper willaddress both of these issues separately.

2. The assumption of opportunism has receivedconsiderable criticism (e.g., Perrow, 1981; Hill,1990; Donaldson, 1995; Ghosal & Moran, 1996).However, as Williamson has pointed out on sev-eral occasions (1985, 1994, 1996; Williamson &Ouchi, 1981), it is not critical that everyone beopportunistic. The threat of opportunism (espe-cially in impersonal markets) is sufficient to war-rant the implementation of structural safeguards.

3. We would like to thank an anonymous reviewerfor bringing Grossman and Hart’s (1986) articleto our attention.


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