Getting the Best Deal: The Governance Benefits of Social Networks in Commercial Loans

This study investigated whether social embeddedness affects governance costs in loan contracts among midmarket banks and firms‹a lucrative yet understudied financial market. Drawing on social embeddedness theory, this paper makes the argument that embedding commercial transactions in social attachments and networks facilitates exchange by initiating self-organizing governance arrangements that operate through expectations of trust and reciprocity and access to private knowledge. At the level of the bank-firm tie, one would expect increased embeddedness to enhance government benefits. At the network level, the expectation is that networks composed of a complementary mix of embedded and arm's-length ties would produce optimal governance. Based on methods that triangulated theory, original fieldwork, and statistical analysis, the statistical results supported these arguments and showed that embeddedness creates governance by reducing the need for costly formal governance benefits and by motivating exchange partners to mutually share gains through Pareto improved loan contracts.