Institutional environment, transaction costs, and the theory of interfirm guanxi

Journal of the Academy of Business and Economics, April, 2003 by Yongliang Han

ABSTRACT

Taking a new institutionalist and transaction costs approach, we argue that in such special institutional environments as China, where transactions are highly uncertain, opportunism is widespread, property rights-based contract laws are not well developed and enforced, and capital and managerial resources are scarce, economic exchanges conducted in both markets and hierarchies may entail high transaction costs. Therefore if intermediate forms are less costly, they will be chosen as an alternative way of organizing exchanges. Interfirm guanxi, the trust-based particularistic ties between the key personnel of independent firms to pursue mutual interest of firms, is the primary or at least supplementary governance mechanism of intermediate forms. Interfirm guanxi is backed by a series of special enforcement instruments, such as goodwill, reputation, and codes of ethics, etc. Therefore whether the intermediate forms have a transaction cost advantage is determined by the efficacy of interfirm guanxi, which is a function of economic calculus of gains and losses from cooperation, goal and product complementarity, information symmetry, and the efficiency of transmitting reputation across networks. We then identify several characteristics of interfirm guanxi: trust-based particularistic ties; reciprocity; long-term orientation; adaptability and incentive intensity, etc. Interfirm guanxi as a product of institutional environment evolves with institutional change. We conclude this paper with some suggestions for future research.

1. INTRODUCTION

In recent years, guanxi has attracted increasing attention from both popular press and academic circle. Such articles as "The Relentless Pursuit of Guanxi" and "Get Guanxi Out of Washington" frequently have appeared on influential magazines and newspapers. Meanwhile, sociologists and management scholars have tried to find out the origin, functions, and operational mechanisms of guanxi in Chinese business society (e.g., Redding 1990; Xin and Pearce 1996; Yang 1994; Yeung and Tung 1996). Among these pioneering works, only a few of them (e.g., Xin and Pearce 1996) have tried to specify the settings, ground their theory on empirical test and hence extract concrete results. Most of the other works deal with guanxi in an abstract and unspecified way. So there is still much room to improve our understanding of this important phenomenon.

In spite of its increasing importance and popularity, guanxi has been a complex and even elusive concept. Yang (1994) states that guanxi "means literally 'a relationship' between objects, forces, or persons. When it is used to refer to relationships between people, not only can it be applied to husband-wife, kinship and friendship relations, it can also have the sense of 'social connections,' dyadic relationships that are based implicitly (rather than explicitly) on mutual interest and benefit." However, it is the "social connections" aspect of guanxi that has attracted the interest of most scholars. For example, Yeung and Tung (1996) define guanxi as "the establishment of a connection between two independent individuals to enable a bilateral flow of personal or social transactions." Consistent with this definition, in this paper we will concentrate on the "social connections" aspect and further narrow guanxi down to interfirm level. By interfirm guanxi we refer to the trust-based particularistic ties between the key personnel of independent firms to pursue mutual interest of firms. What differentiates interfirm guanxi from purely interpersonal guanxi is that interfirm guanxi is basically used to pursue mutual interest and benefit of firms, not only individuals.

Previous literature has tried to explain the origin of interorganizational guanxi in Chinese business society. Some scholars simply attribute its origin to cultural factors such as Confucianism or collectivism (Redding 1990; Yeung and Tung 1996). Xin and Pearce (1996) clearly argue that guanxi is the product of a specific institutional environment. They suggest that Chinese private-company executives operating without the structural protection of governmental support develop guanxi as a substitute for the formal institutional protection government offers their counterparts--state-owned and collective-hybrid organizations. However, we still lack a concrete and comprehensive theory of interfirm guanxi. This paper intends to take a new institutionalist approach to explicating the attributes and functions of interfirm guanxi and explaining its origin from and evolution with the institutional environment. Our arguments are straightforward: Interfirm guanxi is rooted in specific institutional environment; it serves as a governance mechanism of intermediate forms to economize on transaction costs and is enforced by a series of special institutional mechanisms; Institutional change is a crucial determinant of the evolution of interfirm guanxi. The reminder of this paper starts with a discussion of the emergence of interfirm guanxi. We will explain the existence of barriers to both markets and hierarchies in the Chinese economy and how it induces development of interfirm guanxi as a governance mechanism for intermediate forms. In the following section we discuss the characteristics of interfirm guanxi in detail. Then we explore the relationship between institutional change and evolution of interfirm guanxi, which is followed by concluding remarks and future research directions.