Do Social Connections Mitigate Hold-up and Facilitate Cooperation? Evidence from Supply Chain Relationships

We show that prior social connections can mitigate hold-up in bilateral relationships and encourage relation-specific investment and cooperation when contracts are incomplete. We examine vertical relationships and show that relation-specific innovative activities by suppliers increase with the existence and strength of prior social connections between the suppliers' managers and board members and those of their customers. To establish causality, we exploit connection breaches due to manager/director retirements or deaths and find that innovation drops for affected suppliers after the departure of socially connected individuals relative to unaffected suppliers. Our work sheds light on how social connections can shape firm boundaries.

Automated summary

Prior social connections can help mitigate hold-up and encourage relation-specific investment and cooperation in bilateral relationships with incomplete contracts. Our study shows that the existence and strength of prior social connections between suppliers and customers can lead to increased relation-specific innovative activities by suppliers. Additionally, when socially connected individuals leave the organization, there is a drop in innovation for affected suppliers compared to unaffected suppliers, highlighting the importance of social connections in shaping firm boundaries.