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Market Networks and Corporate Behavior

Author(s): Wayne E. Baker

Source: American Journal of Sociology, Vol. 96, No. 3 (Nov., 1990), pp. 589-625
Published by: The University of Chicago Press
Stable URL: http://www.jstor.org/stable/2781065
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Market Networks and Corporate Behaviorl
Wayne E. Baker
University of Chicago

Data on market relations between a large population of corpora-

tions and investment banks are used to study the organization-
market interface-the pattern of direct market ties between a firm
and its banks. Forms of interfaces range from a long-term, exclusive
tie (the relationship interface) to many short-lived, episodic ties (the
transaction interface), with hybrid forms between the two poles.
Contrary to widespread belief, the article finds that strong relation-
ships still exist. Transaction interfaces are rare. Most firms use
hybrid interfaces. A firm's interface is conceptualized as the inten-
tional result of its efforts to reduce dependence and exploit power
advantages. Observed interfaces are shown to be related system-
atically to various power-dependence concepts, including resource
intensity (number of transactions and dollar amounts raised), criti-
cality (the availability of resource alternatives), power asymmetry
between a firm and its main bank, organization size, standardiza-
tion of exchange, and the use of tandem strategies (director inter-

How do business organizations manage market relations? How do they

mobilize and marshal the social capital (Coleman 1988) inherent in the
structures of relations between and among firms?

I Initial funding was provided by the Harvard Business School (HBS) in the form of a
fellowship held by the author. I am grateful to HBS for sustained support to pursue
independent research. I thank the Graduate School of Business, University of
Chicago, where most of the analysis and writing took place, for continuing support.
Preliminary findings were originally documented in my "Organization-Market Inter-
face: Corporations' Relations with Investment Banks," HBS Working Paper no. 87-
043 (April 1987). Some findings were also reported (with my permission) in chapter 4 of
Eccles and Crane (1988). Versions of the paper were presented at the annual meetings
of the American Sociological Association (1988) and the Academy of Management
(1989). I am indebted to Mitchel Abolafia, Robert Faulkner, Ray Friedman, Mark
Granovetter, Edward Laumann, Jane Mather, Mark Shanley, Andrew Van de Ven,
and Harrison White for extensive comments on earlier drafts; to Dean Foster, Edward
George, Ananth Iyer, Peter E. Rossi, and Abbie Smith for technical advice; and to
Chu Zhang for research assistance. The paper benefited tremendously from the com-
ments of the reviewers and from comments received in Gary Becker and James Cole-
man's seminar on rational models in the social sciences.

? 1990 by The University of Chicago. All rights reserved.


AJS Volume 96 Number 3 (November 1990): 589-625 589

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American Journal of Sociology

Market ties, created by the exchange of goods, services, and money,

are the predominant type of linkage between business firms. Despite the
importance of market ties, however, most research on interorganizational
relations has focused on (1) nonmarket relations, especially those involv-
ing nonprofit organizations, where market exchange is absent, periph-
eral, or unimportant or (2) tactics used to circumvent, supersede, co-opt,
suspend, or eliminate market ties, such as mergers, director interlocks,
and political action. The dearth of research in economic and organiza-
tional sociology on interorganizational market relations has been noted by
many sociologists (e.g., Granovetter 1985; Perrow 1986, p. 240; Pfeffer
1987a, 1987b; Whetten 1987).2
The purpose of this study is to advance the sociological understanding
of interorganizational relations by focusing explicitly on market relations
between firms. To do so, I analyze the patterns and determinants of
market ties between a large population of corporations and their invest-
ment banks during a five-year period. These ties are studied as concrete
exemplars of interorganizational market relations, but they are important
in their own right. First, investment banks are gatekeepers to a critical
resource-capital. Capital is a unique commodity (it is exchanged for
itself), and it plays a central role in capitalist societies (Mintz and
Schwartz 1985; Baker 1987a; Simmel 1978). The importance of capital is
underscored by Fligstein's (1987) finding that the finance function has
become the dominant location of intraorganizational power in the con-
temporary corporation. Second, these market relations provide an un-
usual opportunity to analyze interorganizational behavior that is not
specific to the particular industry in which the focal corporations are
located. Because capital is a universal good (it has low "asset-specificity,"
to use Williamson's [1985] term), it is possible to observe how firms from
diverse industries interact with the same (financial) environment. Third,
investment banks are powerful corporate actors, especially given recent
trends, such as the disintermediation of commercial banks (diversion of
deposits to investments with higher interest rates) and investment banks'
leading role in the wave of mergers and acquisitions.
Corporations have a repertory of tactics that can be employed to man-
age market relations. Several of these are highlighted in various theoreti-
cal perspectives. Agency theory, for example, focuses narrowly on the

2 Previous sociological studies of markets focused on interpersonal rather than inter-

organizational markets, such as stock and commodity exchanges (e.g., Abolafia 1984;
Abolafia and Kilduff 1988; Baker 1984a, 1984b) and the freelance Hollywood labor
markets (Faulkner 1983; Faulkner and Anderson 1987). The only large-scale study of
interorganizational markets examined economic ties at the interindustry level (see,
e.g., Burt 1983, 1988) instead of the interfirm level studied here.


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Market Networks

proper construction of contracts to bring the agent's interests in line with

the principal's (e.g., Barnea, Haugen, and Senbet 1985; Baron and
Holmstrom 1980). Frequent renegotiation of contracts can reduce moral
hazard (Heimer 1985). Hierarchy (intraorganizational ties) can replace
market exchange (interorganizational ties), as theorized in transaction
cost economics (Williamson 1981, 1985). Resource dependency theory
suggests the use of director interlocks, mergers, joint ventures, and polit-
ical activity (e.g., Pfeffer 1987a). Generally, economic exchange can be
sustained by embedding economic ties in structures of social relations
(Granovetter 1985). When social embedding is not possible and trust
relationships are impersonal, exchange relations can be socially controlled
by the "guardians of trust"-fiduciary norms, policing mechanisms, so-
cial control specialists, and others (Shapiro 1987).
Such tactics are important, but corporations also use another critical
and fundamental control mechanism: the direct manipulation of the num-
ber and intensity of market ties with other organizations. In the invest-
ment banking context, for example, many tactics and control mechanisms
are evident. Each transaction is expressed in a short-term contract, and a
new contract is negotiated for each deal. Some firms perform investment
banking functions themselves, avoiding market relations, and some over-
lay market ties with director interlocks. The Securities and Exchange
Commission (SEC) and Federal Reserve are well-known guardians of
trust in the securities and banking industry. But firms also manage their
market ties directly, selecting the configuration of relations that (they
believe) will yield desired results. In the view developed here, market
relations are considered to be socially structured, like any other type of
interorganizational relations, rather than some undifferentiated, atom-
istic mass, as often implied in economics and sociology.
The central argument is that corporations structure their market rela-
tions with investment banks to reduce dependence and exploit power
advantages. The general source of corporate dependence is reliance on
investment banks for access to critical resources, such as capital and
market information. The main source of power for investment banks is
control of access to investors.3 They obtain power by exploiting a market
inefficiency-the difficulty users and providers of capital have getting
together (cf. Marsden 1982). But investment banks are subject to a key
dependency of their own: they rely on corporations for a critical input-
financial transactions to process. Their reliance is a source of corporate

3 "Investors" is defined broadly to include individual investors, institutional investors,

such as pension funds and insurance companies, and groups or firms involved in
mergers and acquisitions.


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American Journal of Sociology

power. Firms may wield their transactions in ways that compel banks to
compete for the business, for example, bidding down spreads, improving
pricing advice, and increasing distribution effort (see App. A). The cen-
tral problem for corporations is how to manage their relations with in-
vestment banks to reduce dependence and exploit power advantages. The
observed configuration of market ties is the revealed result of efforts to
do so.
As a theoretical orientation, I adapt the resource dependence perspec-
tive, in which "intercorporate relations can be understood as a product of
patterns of interorganizational dependence and constraint" (Pfeffer
1987a, p. 40).4 The resource dependence approach has rarely been ap-
plied directly to market relations and never to market ties at the firm-to-
firm level. The usual foci are co-optive or absorptive devices and political
activity (Pfeffer 1987a). With the adaptation of the resource-dependence
view to understand how firms manage market ties, a theoretical contribu-
tion of this study is the extension of the perspective to the subject of
market relations. Another contribution is consideration of the concurrent
use of multiple strategies (what I call "tandem strategies"). For example, I
investigate how director interlocks as co-optive devices influence the con-
figuration of market relations.
Like many sociological theories, the driving force in the resource de-
pendence perspective is power, where organizations strive to reduce in-
terdependence "regardless of considerations of profit or efficiency for the
most part" (Pfeffer 1987a, p. 27). In contrast, the driving force in econom-
ics is efficiency, with emphasis on providing incentives for efficient trans-
actions (as in, e.g., agency theory) and economizing on transaction costs
(see, e.g., Williamson 1985). Power and efficiency are often seen as theo-
retical opposites, but they are empirically intertwined, and their distinc-
tions are not so great (Pfeffer 1987a; Eccles and White 1988). Indeed, in
the context of investment banking, power and efficiency motives can
drive a firm to take the same action. Corporate finance managers (CFMs)
told me that they moved from reliance on a single bank to reduce depen-

4 It is unclear that extant sociological theories of financial institutions, such as the

influential finance hegemony theory (Mintz and Schwartz 1985), apply here. Such
theories are based on lending relationships-debtor-creditor ties between nonfinancial
firms and two types of lenders: commercial banks and insurance companies. The
function of investment banks is fundamentally different (see App. A). In addition, the
analytic focus is not actual market ties (as here) but director interlocks. Interlocks are
used as surrogates for market ties (see, e.g., Gogel and Koenig 1981) even though there
is virtually no systematic evidence that director-interlocked firms actually do business
with each other. (As I show here, interlocks with investment banks have only a modest
economic base [see, also, Baker 1987b].)


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Market Networks

dence but also reported that the addition of banks cuts costs by creating
competition.5 Given that power and efficiency produce similar behaviors
(such as using multiple banks), it is inappropriate to consider them as
competing hypotheses; instead, observed market relations may be under-
stood as the joint effect of efforts to reduce dependence and increase
efficiency (e.g., cut costs).
This presentation is organized as follows: In Section I, I develop a
framework for the analysis of interorganizational market relations. Data
and methods are described in Section II. Findings are presented and
discussed in Section III. The conclusion is Section IV. Appendix A briefly
describes the functions of investment banks and pricing mechanics for
new issues.


Interorganizational relations can be conceptualized at various levels,

ranging from the dyad (see, e.g., Palmer, Friedland, and Singh 1986;
Hayes, Spence, and Marks 1983) to the network (see, e.g., Burt 1983;
Baker 1986; Van de Ven, Walker, and Liston 1979). For the purposes of
this study, the dyadic level is too micro because the typical firm uses
multiple banks, employing a strategy that takes multiple ties into ac-
count. Multiple ties cannot be validly decomposed into independent "bi-
lateral monopolies" (Williamson 1985). The network level is too macro
because the market as a whole is beyond the control of any one firm.
Thus, I focus on the intermediate level of the organization set (Evan 1966)
and investigate the organization-market interface-the pattern of ties
between a focal corporation and its set of investment banks.

Three Types of Organization-Market Interfaces

Because most research on interorganizational relations is based on non-

market ties, it is necessary to theorize about market relations. William-
son's (1985) polar concepts of hierarchy and market provide a convenient
starting point since they have empirical referents in investment banking.
Hierarchy and market are comparable to what is colloquially known as
the "relationship" and "transaction" orientations, respectively. Most real
organizational forms fall between the ideal types of market and hierarchy
and mix the two (Granovetter 1985; Perrow 1986; Stinchcombe 1985).

5The positive relationship of competition and cost reduction is consistent with studies
of the corporate bond market in which increasing the number of bidders on new issues
was found to decrease interest costs (Ederington 1978; Sorensen 1979).


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American Journal of Sociology

This suggests an intermediate form of interface, a "hybrid" of relationship

and transaction strategies.
Relationship interface.-A long-term relationship is the type of market
tie closest to hierarchy. Indeed, interfirm contracts can be so strong that
they act as functional substitutes for hierarchy (Stinchcombe 1985). Many
relationships are long lasting but informal, noncontractual, tacit commit-
ments to continue doing business (Macaulay 1963; Durkheim 1933).6
Noncontractual relationships are possible for many reasons, including
effective nonlegal mechanisms such as business norms (Heimer 1985;
Shapiro 1987), relationship-specific investments (see, e.g., Williamson
1985), social embeddedness (Granovetter 1985), reputation (see, e.g.,
Barnea et al. 1985), cost-benefit calculations (Telser 1980; Klein and
Leffler 1981), and the prospect of continuing interaction (see, e.g., Axel-
rod 1984).
Informal sole-source relationships with investment banks were very
common in the past. Each firm had a long-term exclusive tie with a single
bank, known variously as its "principal banker" or "traditional banker"
(Carosso 1970; Hayes et al. 1983). The principal-banker model was estab-
lished in the post-Civil War decade and persisted until contemporary
times (Carosso 1970). It was the modal strategy in the 1970s, especially
for ties involving large investment banks, although there is evidence of
some switching in that decade (Hayes et al. 1983, pp. 55-58). Many
CFMs told me that it was the dominant ideology before 1980.
It is commonly believed that corporations have moved away from the
historic principal-banker model.7 During the period studied here (1981-
85), it was often heard among Wall Street bankers that "relationships are
dead" and contemporary corporations were now very transactional, an
opinion also popular among some academics (e.g., Crum and Meer-
schwam 1986). This trend is consistent with sociological analyses of the
declining importance and power of investment banks (e.g., Mintz and
Schwartz 1985, pp. 66-68; Mizruchi 1982). Historically, investment
banks were so powerful that they could capture all of a firm's business,
resulting in the widespread appearance of the principal-banker model. As
the power of investment banks diminished, firms could begin establishing
ties with multiple banks, becoming more transactional. In contrast to
these views, however, I argue below that investment banks are still pow-
erful, that firms must manage market ties to offset bank power, and that

6 Related but more distant concepts include "implicit understandings" between mem-
bers of a distribution channel (Shugan 1985) and "implicit contracts" between workers
and employers (Rosen 1985).
7It is not possible to analyze historical trends, however, because of the unfortunate
lack of systematic longitudinal data on investment-bank usage.


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Market Networks

firms have not become as transactional as commonly believed, even

though the pure principal-banker model has been largely abandoned.
Transaction interface.-A transaction interface is implied by the com-
petitive market of neoclassical economics; it is the image commonly
evoked in sociological and economic references to "the market." In an
ideal-typical market, a firm is indifferent in its choice of suppliers: each
supplier is the same as the next, and all offer the same (competitive) price.
Such markets, Hirschman (1982, p. 1473) describes, "function without
any prolonged human or social contact between parties.... The various
operators that contract together need not enter into recurrent or continu-
ing relationships as a result of which they would get to know each other
well." Market ties in a transactional world are short-lived, episodic, and
The expected pattern of exchange relations in a competitive market is
not addressed in neoclassical economics, as I have noted elsewhere (Baker
1984a, p. 785). The market is typically described as "atomistic"-
relations are considered unimportant if they are considered at all. Simi-
larly, Granovetter (1985) faults the new institutional economics (see, e.g.,
Williamson 1985) for its atomistic (nonrelational) image of the market.8
Nevertheless, a structural image may be inferred from the atomistic ideal:
micronetworks in a competitive market tend to be expansive, resulting in
a dense undifferentiated macronetwork (Baker 1984a, pp. 783-85). In
investment banking, the transaction strategy is the closest empirical ap-
proximation to an expansive image. A transaction-oriented firm uses
many banks, forcing them to compete vigorously for its business. In the
extreme, a firm uses a new bank (or set of banks) for each transaction.
Hybrid interface. -Real organizational forms fall between the pure
market and pure hierarchy poles. Various studies have documented the
mixed forms closer to hierarchy, in which observed forms mimic or serve
as functional substitutes for intraorganizational relations (e.g., Bradach
and Eccles 1989; Eccles 1981; Powell 1987; Miles and Snow 1986; Stinch-
combe 1985). Much less is known about the mixed forms closer to the
market pole, in which interorganizational relations exhibit a combination
of market and hierarchical characteristics yet preserve essential market
features, such as ongoing competition among rival suppliers.
A hybrid interface combines hierarchical and market characteristics. It
results from a two-tier strategy that blends a relationship orientation with
a transaction orientation. For example, a firm may maintain a long-term
tie with one main supplier and use rival suppliers on a transactional basis,

8 Williamson's (1985) focus is the use of "market" (interorganizational ties) versus

"hierarchy" (intraorganizational ties) as alternative ways to organize economic transac-
tions. He is silent, however, on the issue of market structure addressed here.


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American Journal of Sociology

or it may maintain a top tier of multiple long-term relationships while still

using other transactional suppliers. Ford Motor Company and General
Motors (GM) illustrate two (of many) ways to implement a hybrid strat-
egy. As shown in table 1, GM split 67% of its business among three banks
(First Boston, Morgan Stanley, and Salomon Brothers), but it also used
24 other banks on a transactional basis. Ford is much more relationship
oriented, giving almost 70% of its business to one bank (Goldman Sachs)
but using 24 other banks as well.

Expectations and Hypotheses

The three interface strategies-relationship, transaction, and hybrid-

are alternative solutions to the problem of managing market relations.
Each has certain advantages and disadvantages. A relationship interface




Share Share
Bank (S) Bank (%)

Goldman Sachs .......... ........ 69.23 First Boston .............. 2 7.2 7

Merrill Lynch ............ ........ 10.05 Morgan Stanley ........... 27.24
Deutsche Bank ................... 3.58 Salomon Bros . ............ 12.18
Salomon Bros. ........... ........ 2.65 Merrill Lynch ............. 9.27
Commerzbank ................... 2.30 Direct .................... 5.04
Swiss Bank ...................... 1.41 Hambros ................. 2.52
Union Bank of Switzerland ........ 1.41 Chemical ................. 1.68
Direct ........................... 1.41 Orion Royal Bank ......... 1.68
Bank Paribas ............ ........ 1.23 Societe Generale ........... 1.68
Daiwa .......................... .82 Nomura Securities ......... 1.43
Orion Royal Bank ........ ........ .56 Deutsche Bank ............ 1.17
Paine Webber ............. 1.12
First Michigan ............ 1.01
Continental Illinois ........ .84
Morgan Genfell ........... .84
Stern Bros . ............... .84
Bank America ............ .56
Bateman ................. .50
Bradford ................. .50
Dain Bosworth ............ .50

NOTE.-For Ford, 15 other unspecified banks each held a share less than .5%; total number of banks
= 25, number of deals = 81. For GM, eight other unspecified banks each held a share less than .5%;
number of banks = 2 7, number of deals = 1 19. "Direct" indicates a deal made without the participation
of a bank.


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Market Networks

can reduce opportunism, offer downside insurance,9 and provide better

service through continuity and inside knowledge. A relationship interface
has limitations, however, such as the lack of price competition among
rival banks and restricted information flow because of lack of access to
other banks' information networks. A relationship can deter other banks
from interacting with the company. For example, a treasurer lamented to
me that "the other investment banks tell me, 'You're tied in with [two
banks]. We don't want to tell you our ideas; you'll turn them over to
[them].' They don't want to educate the competition."
A transaction interface avoids some of the problems incurred with a
relationship interface. A transaction interface reduces dependence on a
sole source. By using many banks, a firm can induce banks to act more
competitively, yielding efficiency benefits (e.g., lower prices) and getting
access to multiple information networks. However, a transaction strategy
is subject to several limitations of its own. Because of a lack of loyalty on
either side and the potential for opportunism, it is not well suited to
activities that require or create confidential information (such as the for-
mulation of a hostile takeover defense). A transaction strategy can have
unintended negative consequences. For example, as CFMs become more
and more transactional, (former) relationship bankers may provide a
"suicide bid" (see App. A) in a desperate effort to win a deal. If the deal is
priced too "close to the market" (see App. A), however, it will receive a
lukewarm reception by investors and float around unsold for many days,
sullying the firm's reputation as an issuer of "quality" securities (i.e.,
issues that investors snap up).
A hybrid interface secures the benefits of a relationship strategy and a
transactional strategy while limiting exposure to their disadvantages.
Firms that use hybrid strategies, such as Ford and GM, maintain infor-
mal long-term ties with one or a few investment banks, allocating a large
share of their business to them and thereby obtaining relationship bene-
fits, such as loyalty (low opportunism), continuity of resource supply, and
quality of service. By using other banks on a transactional basis, they
avoid sole-source dependence, obtain efficiency (price) benefits from com-
petition, and increase the flow of information. In addition, with the im-
plicit threat of loss of business, they can ensure that relationship banks
continue to act in the firm's interests. As one chief financial officer (CFO)
told me, "I've always believed that competition breeds better solutions.
[Our second bank] is there to keep the primary banker honest." Even

9 Goldman Sachs, e.g., helped Ford Motor Company through its troubled times in the
1980s. Such practices also occur in other service industries. When Mattel neared
bankruptcy in the 1970s, Ogilvy & Mather, its longtime advertising agency, paid
Mattel's television and magazine advertising bills (Pendleton 1988).


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American Journal of Sociology

though a hybrid strategy appears to be a good compromise, it is not

appropriate in all situations. For instance, a firm's volume of business
(e.g., number of deals) may be so low that it cannot spread its business
among many banks.
Which interfaces should be expected? If the common belief that firms
have become very transactional is valid, and the power of investment
banks has declined as drastically as some assert (e.g., Sweezy 1982), then
I would expect to observe few relationship interfaces and many transac-
tion interfaces. 10 However, although there has been a relative decline in
the power of investment banks, I believe the case is overstated, especially
given the resurgence of investment banks in the period studied (1981-85)
(see, e.g., Bianco 1986). For example, during this period, commercial
banks suffered from financial disintermediation, a shift that benefited
investment banks. Further, investment banks became the leading force in
mergers and acquisitions, aided by the legitimation of the hostile-take-
over technique (Hirsch 1986). The investment banking industry still oc-
cupies a favorable structural position. Burt (1983) argues that firms in an
industry enjoy "structural autonomy" (the ability to control prices) to the
extent that their industry is concentrated, it is supplied by small firms
from many industries, and it sells to many small competitive firms across
many industries (cf. Porter 1980). Burt's structural definition implies that
investment banks are still powerful. The industry exhibits moderately
high concentration; for example, the top four investment banks under-
wrote 56% of all corporate securities issued in the United States in 1986;
19 banks underwrote 96% of the total (Institutional Investor 1987, p.
178). Investment banks' customers (issuers) and suppliers (investors) are
diverse and numerous, including firms of all sizes from all industries as
well as local, state, and national agencies and governments. Thus, invest-
ment banks still possess considerable power, and firms cannot rely solely
on abstract competitive forces-they must actively manage market ties to
offset bank power and achieve their objectives.
In contrast to the conventional view that firms have become very trans-
actional, I expect that most observed interfaces will be hybrids. Hybrids
offer a good way to reduce dependence and exploit power advantages
while retaining important relationship benefits. The expected prevalence
of hybrid strategies can be evaluated by comparing real interfaces with
the theoretical baselines suggested by the relationship and transaction
strategies. Since a firm with a pure relationship strategy grants all of its
business to a single bank, only one "lead" bank is used regardless of

10 If investment banks have become powerless, then interface choice would be largely
irrelevant: corporations could simply rely on competitive forces to produce proper
bank behavior.


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Market Networks

Number of lead banks


20 - Pure Transaction d

15 -

a e n r of l .Hypergeometric (random)

5 -

bank is used on any transaction.) ThepPure Relationship

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
Number of deals

FIG. .a Number of lead banks by number of deals. Actual = observed

average number
lowe bon of lead banks.
on empirical inefcs rersne by th horizontalll l lin in

volume of business (number of deals). (As defined in Sec. II, one lead
bank is used on any transaction.) The pure relationship interface is the
lower bound on empirical interfaces, represented by the horizontal line in
figure 1. In contrast, a firm with a pure transaction strategy uses a new
lead bank on every deal. This theoretical upper bound is represented
by the upward-sloping line in figure 1. If hybrid interfaces predomi-
nate, then the empirical relationship of number of lead banks and vol-
ume of business should fall between the two theoretical boundaries. Cor-
respondingly, the popularity of hybrids should be observed in measures
of central tendency for the universe of firms, such that 1 < b < d, where
b = the average number of lead banks and d = the average number
of deals.
Firms enjoy considerable leeway in the configurations used to imple-
ment the general hybrid strategy. Each firm's configuration is expected to
be influenced by its level of dependence and power. Dependence and
power can be conceptualized in many ways (e.g., Pfeffer and Salancik
1978; Aldrich 1979). Table 2 presents six main concepts, with associated
measures and operationalizations, expected to be related to the configura-
tion of interfaces-number of banks used in total, strength of the main
relationship, and so on (interface measures are defined in Sec. II below).
Intensity refers to the amount of contact between a corporation and
investment banks; it includes the amount of resources (total dollar


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Concept and Measure Operationalization

Amount of resources ....... Log (total dollar value of financing deals 1981-85)
Frequency of interaction ... Total number of deals 1981-85
Low volume .............. Dummy (1 = single deal 1981-85; 0 = otherwise)
Internal sources of funds Average annual free cash flow 1981-85, adjusted for
Debt capacity ............. Debt/equity ratio (1985) (Equity = market value);
Long-term debt/equity ratio (1985)
Power balance (ratio) ...... Log (total number of deals for firm 1981-85/
total number of deals by firm's main bank for all
1,530 firms)
Similarity of deals ......... Herfindahl index of concentration (H)
Tandem strategies:
Social embeddedness ...... Director-interlock dummy (1 = investment bank
on board; 0 = otherwise)
Organization size .......... Log (market value 1985; market value = number
of shares outstanding x price per share)
Organization growth ....... Change in market value 1981-85 [(T2-T1)IT2,
where Ti = 1981, T2 = 1985]
Third-party influence:
Attractiveness to investors
("pull-through") ......... E/P ratio (five-year average)

amount raised) and the frequency of interaction (number of deals)."I In-

tensity represents corporate power because it indicates control of critical
bank inputs. A firm can exploit power advantages derived from its re-
source endowment to reduce sole-source dependence and to lower costs
by making banks compete. I hypothesize that total dollars raised and
number of deals will each be associated with a more transactional inter-
face, such as more banks used and a smaller share of business given to the
firm's main bank (ceteris paribus).
Infrequent financers-firms with an extremely low number of deals-
are a special case. Although volume of business is a source of corporate
power, an infrequent financer has a very limited resource endowment. I

" Power perspectives are applied at various levels (dyadic, organization set, action set,
network), but specific concepts, such as intensity, are often discussed in the context of
dyads only (e.g., the frequency of interaction between two organizations) (Aldrich
1979, pp. 265-79). Since my analytic focus on the organization set is wider than the
dyad, I apply power concepts, except for asymmetry, at the intermediate level.


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Market Networks

suspect that low volume so diminishes power that a firm conducting a

single transaction lacks any power advantage. Banks might not be willing
to compete vigorously for business when they know (or suspect) that the
possibility of repeated transactions is negligible. Banks might also view
low volume as an occasion to act opportunistically. They might, for
example, misrepresent investor interest in a new issue, underpricing it to
make distribution easy (see App. A). As game theorists emphasize, con-
tinuing interaction is what makes cooperation possible; single transac-
tions invite opportunism (see, e.g., Axelrod 1984). To account for low-
volume effects, I include a dummy variable for single-deal firms (1
= single deal; 0 = otherwise).
Criticality refers to the availability of alternatives. Generally, an or-
ganization with alternatives for a resource is less dependent on any partic-
ular supplier of the resource. A firm with ample sources of internal funds,
for example, can postpone external financing and be less dependent on
banks for access to capital. Because the availability of alternatives makes
the firm less dependent, it has less need to become more transactional to
reduce resource dependence. I hypothesize, therefore, that greater free
cash flow will be associated with a more relationship-oriented interface,
holding other factors constant. 12 This means, for example, that, on aver-
age, firms raising the same amount of funds with the same number of
transactions will develop different interfaces if their internal funds are
Criticality also refers to debt capacity, measured as the ratio of debt to
equity in a firm's capital structure. The lower the proportion of debt, the
more capacity the firm has to use debt financing in addition to equity
financing; the higher the proportion of debt, the fewer financing alterna-
tives are available (such a firm might be forced into equity financing with
its attendant loss of control). Thus, I interpret the debt/equity ratio as an
index of potential alternative financing opportunities, where a higher
ratio indicates higher dependence (fewer alternatives). Prior sociological
research proposes a similar interpretation. Director-interlock studies use
the debt/equity ratio as a measure of solvency, where high ratios indicate
high dependence. The debt/equity ratio and the number of director inter-
locks are correlated (Dooley 1969; Pfeffer 1987a), which is customarily
interpreted to mean that dependent firms attempt to overcome depen-
dence by establishing nonmarket ties. If the same holds true for market

12 Free cash flow represents the firm's cash surplus (deficit) from operations before
financing activities. Free cash flow is defined as funds generated from operations (cash
flow) plus after-tax interest expense, less required net investment in working capital,
less investment in property, plant, and equipment, less other investment expenditures.
Free cash flow is considered more reliable than other earnings measures, as it is less
subject to accounting methods.


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American Journal of Sociology

ties, I expect that the debt/equity ratio will be positively associated with a
more transactional interface, holding other factors constant. (I report the
debt/equity ratio but also use a more precise measure, the ratio of long-
term debt to equity, which is preferred because investment banks tend to
arrange long-term debt while commercial banks provide short-term
Asymmetry exists when an exchange is not equally important to both
organizations (Pfeffer and Salancik 1978, p. 53). I measure asymmetry by
examining the balance of (potential) power in a firm's main relationship,
that is, between a firm and the bank that receives the largest share of the
firm's business (e.g., between Ford and Goldman Sachs). The balance
measure indicates the power of the firm relative to the power of its main
bank, operationalized as the ratio of the total number of transactions a
firm does (regardless of banks used) to the total number of transactions
the firm's main bank does for the entire population of firms. When a firm
has more relative power in its main relationship (high ratio) it can act
more transactionally; when a firm has less relative power (low ratio) it is
less able to do so, and the bank is more able to induce the corporation to
restrict the size of its organization set. Therefore, I hypothesize that the
power ratio will be positively associated with a more transactional inter-
face, holding other factors constant.
Standardization refers to the similarity of units of resources in ex-
changes (see, e.g., Aldrich 1979, p. 227). Here, standardization refers to
similarity of type of financial transaction. It is operationalized as H, the
Herfindahl index of concentration (or homogeneity), over all product cat-
egories (defined in Sec. II below). When a firm's transactions are very
similar (high H), I expect that fewer banks will be used because of the
efficiency of working with the same supplir. When a variety of deals are
done (low H), I expect more banks will be used, partly because a single
bank may not be able to conduct all types of deals. 13
Tandem strategies refers to the concurrent use of multiple strategies to
reduce dependence and exploit power advantages. Various strategies can
be used with (or in place of) the direct management of market ties. I
analyze the use of one of the main tactics considered in sociological re-
search on interorganizational relations: director interlocks as co-optive
devices. Because director interlocks can stabilize the flow of critical re-
sources (see, e.g., Burt 1983; Palmer et al. 1986; Pfeffer and Salancik

13 It is also possible, as one reviewer suggested, that the nature of a deal (which might
involve confidential information or the need for quick execution) influences interface
choice. Unfortunately, the data available (see Sec. II) do not contain information that
allows one to assess this possibility directly. As an indirect examination, separate
analyses were conducted for two different types of deals (corporate securities only vs.
mergers and acquisitions only). These produced results similar to those presented here.


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Market Networks

1978), firms with investment bankers on their boards should have less
need to become transactional to reduce dependence or exploit power
advantages than firms without such co-optive ties. To evaluate this sub-
stitution effect, I include the presence of a director interlock as an inde-
pendent dummy variable, assessing the extent to which interlocks in-
fluence the configuration of market relations. I hypothesize that firms
with interlocks will exhibit more relationship-oriented interfaces than
firms without interlocks, all other factors held constant. I further hy-
pothesize that a firm with an investment banker on its board will tend to
give more business to the banker on its board than to any other bank. (An
alternative explanation, leading to the same hypothesis, is that banks use
interlocks to capture business.) The hypothesis that director interlocks
overlay market ties is a core assumption in the interorganizational per-
spective on director interlocks (see, e.g., Burt 1983; Palmer et al. 1986;
Pennings 1980) that has never been systematically tested.
Organization size is open to many interpretations. Consistent with the
resource dependence interpretation (Pfeffer and Salancik 1978, pp. 131-
39), I view size as a conscious strategy for managing the environment.
Size enhances survival; it is a buffer against immediate environmental
pressures and a cushion against failure. If size is a tandem strategy used
to reduce dependence, then I expect that size will be associated with a
more relationship-oriented interface, holding other factors constant. Al-
ternatively, because bigger firms have bigger corporate finance staffs and
greater in-house capabilities (Hayes et al. 1983), size may be associated
with a more transactional interface because large firms are able to man-
age more bank ties.
Organizational growth is also open to many interpretations. Like size, I
interpret growth as an intentional strategy that enables an organization to
reduce environmental dependence. If growth is a tandem strategy, then I
expect that it will be associated with a more relationship-oriented inter-
face, all other factors held constant.
Third-party influence refers to the "pull-through" effect of investors for
new issues of corporate securities. If investors believe a firm is sound,
then it is easier to issue new securities. Investor pull-through effect is a
source of corporate power because it reduces dependence on the banks'
distribution efforts (see App. A) and makes the firm an attractive cus-
tomer. To assess this effect, I use the inverse of the well-known price/
earnings, or P/E, ratio, a general measure of investors' or security ana-
lysts' assessment of external economic factors, growth prospects, financial
strengths, capital structure, and other factors. (The inverse, or E/P ratio,
is customarily used to avoid occasional problems of small denominators.)
The E/P ratio is interpreted many ways. As a measure of the stock price
investors are willing to pay for current (and expected) earnings, I inter-


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American Journal of Sociology

pret low E/P ratios as positive evaluations of a firm (more power) and
high E/P ratios as negative evaluations (less power). I hypothesize that
the E/P ratio will be negatively associated with more transactional inter-
faces, indicating that firms with positive investor evaluations will be
more transactional than firms with negative investor evaluations, all
other factors held constant.


Multiple methods were used. Field data were generated from interviews
with CFMs in 20 corporations covering 13 major industries and ranging
in size from roughly $1 billion to $95 billion in market value in 1985.
These CFMs included the CFO, senior vice-president of finance, trea-
surer, assistant treasurers, cash managers, senior executives in business
development (i.e., mergers and acquisitions), and, in a few cases, the
chief executive officer (CEO). Access was obtained to all relevant CFMs
in most firms, although it was limited to one or two key CFMs in a few.
Data on market ties between firms and investment banks from 1981 to
1985 were obtained from Securities Data Company (SDC). These data
include (1) taxable debt and equity issued in the United States (debt,
common stock, and preferred stock), (2) corporate-backed tax-exempt
municipal issues, (3) public Eurobonds, and (4) mergers and acquisitions.
Analyses were conducted for all four categories combined and for selected
subsets. The results based on the combined data and on major subsets
were similar, so only the combined results are reported.
Data on company attributes were obtained from Standard and Poor's
Annual Industrial Compustat Datafile. Data on director interlocks with
investment banks were determined directly from corporate annual re-
ports and/or various SEC filings for 1985 and 1981 (most interlocks per-
sisted through the five-year period).
Hypotheses were tested on the population of all companies with a 1985
market value of at least $50 million that were publicly traded on the New
York, American, and over-the-counter (OTC) stock exchanges. Of the
1,963 firms with a 1985 market value of $50 million or more, 433 firms
did not conduct transactions covered by the SDC data and were excluded
from study.
The organization-market interface is operationalized as the pattern of
bank ties during the 1981-85 period, measured as: (1) total number of
banks used; (2) total number of banks used in a "lead" capacity; (3) total
number of banks used in a "comanager" capacity only (calculated as [1] -
[2]); (4) the one-bank ratio (the percentage of business given to the most
often used bank), which represents the strength of the firm's main bank
relationship; and (5) the Herfindahl index of concentration (H). A


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Market Networks

minimum of one bank is used on a transaction, but the use of multiple

banks is common. When a firm issues common stock, for example, one
bank is always used as the lead, but multiple comanagers are typically
added. The lead role is more important because the lead originates and
manages the deal, underwrites and distributes the largest share of the
issue, and earns the largest share of fees (see App. A). A comanager does
not originate deals and typically underwrites and distributes a smaller
share. Investment banks may also be used in a minor third role as syndi-
cate members (not included in SDC data).
The H index is a measure of concentration used in industrial organiza-
tion economics (Scherer 1980). It is calculated as H = sum (s2), where s
= banki's fraction (or share) of the firm's business. Squared shares are
summed over all banks. (For example, on the basis of data in table 1,
Ford's H = .49 and GM's H = .18.) Thus, H obtains its maximum of 1.0
when one bank gets 100% of a firm's business (pure relationship inter-
face). It decreases as the number of banks used increases and business is
allocated more evenly among them. This H is closely related to the Gibbs-
Martin index of heterogeneity, which is calculated as H' = 1 - sum
where p = the fraction of the population in group or category i (Blau and
Schwartz 1984, p. 17).
Credit must be allocated among multiple banks used on the same deal.
I use the allocation method preferred by analysts in the investment bank-
ing industry-the bonus credit method-which gives credit to every
bank but grants extra credit to the lead in recognition of its primary role.
Appendix B contains an illustration of the method and calculation of
interface measures for a hypothetical firm. As shown, I do not define
"credit" as principal dollar amount (e.g., face amount of a bond) because,
as CFMs warned in the field interviews, doing so can misrepresent bank
relationships. For example, five deals for $10 million each indicate a
much different situation than one deal for $50 million, even though the
dollar totals are equal. Five deals represent five "trips to the market" and
five opportunities to change lead banks. A bank used as lead five times
has a much stronger relationship than a bank used as lead once, regard-
less of dollar amounts. 14 Because it is more relevant to count the number
of times a bank is chosen to participate, I ignore dollar amounts and
count deals instead. 15

14 A secondary reason is that dollar amounts are missing on most mergers and acquisi-
tions deals. (The incidence of missing amounts on financings is low enough to be
ignored.) Fee data, however, are missing for most transactions of all types, preventing
any valid and reliable analysis of spreads, costs, etc.
15 Note, however, that rankings of banks (known as "league tables" or "manager
rankings") based on dollar amounts or number of deals yield very similar results (see,
e.g., Institutional Investor 1987, p. 178).


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American Journal of Sociology



Variable All Firms (N = 1,530) Multideal Firms* (N = 1,091)

Number of deals ........ ....... 6.00 (10.28) 8.02 (11.58)

Number of banks in total ........ 3.42 (3.54) 4.23 (3.88)
Number of banks in lead role .... 2.42 (2.18) 2.99 (2.35)
One-bank ratio ......... ........ .68 (.25) .59 (.23)
H ............................ .60 (.29) .50 (.25)

NOTE.-Values are means, with SDs in parentheses.

*Firms that conduct two or more transactions.


Overall Patterns

Most firms develop hybrid interfaces. As expected, on average, the num-

ber of banks used is substantially lower than the number of transactions
but greater than the relationship baseline. As shown in table 3, the popu-
lation of 1,530 firms conducted an average of 6.00 transactions but used
an average of 2.42 banks as lead and 3.42 banks in total. Similarly,
multitransaction firms (those doing two or more deals) conducted an aver-
age of 8.02 transactions but used an average of 4.23 banks in total and
2.99 banks as lead. The prevalence of hybrid interfaces is illustrated
vividly in figure 1 above, which arrays number of lead banks by number
of transactions. As expected, the average number of lead banks used is
always greater than the pure relationship baseline and less than the pure
transaction baseline.
It is very unlikely that the observed relationship of number of deals and
number of banks is the result of chance rather than the deliberate manip-
ulation of market relations. The relationship of deals and lead banks
expected under the assumption of random selection from a finite popula-
tion of 20 investment banks is represented by the hypergeometric line in
figure 1.16 As shown, the actual average number of lead banks used is
located below the random baseline, indicating that the simple "naive"
decision rule of random choice is not a plausible explanation of interface

16 This sampling problem is mathematically equivalent to the hypergeometric distribu-

tion. Note that E(b) = (ndb)l(nd + b - 1), where E(b) is the expected number of
distinct banks used given random assignment of d deals to a finite population of b
banks, with a maximum of n banks used per deal. Banks are "replaced" after each
"draw" so a bank may be drawn more than once, but it can only be counted once. The
hypergeometric distribution assumes sampling without replacement; counting distinct
banks is equivalent. Sampling without replacement is a simpler problem. The relation-
ship between E(b) and d is linear, with n as the slope.


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Market Networks

strategy. (This naive rule is also inconsistent with CFMs' accounts of

their behavior, and it does not explain the persistence or abandonment of
the principal-banker model.) In sum, corporations have not moved as far
toward a transactional strategy as some believe (e.g., Crum and Meer-
schwam 1986); typical organization-market interfaces are hybrids that
fall between the historic principal-banker (pure relationship) model and
the theoretical random model.
Extreme transaction interfaces are rare. All but nine of the 1,530 firms
granted more than 50% of their business to their three top banks. The
most transactional firm of all-Citicorp-conducted the largest number
of deals (146) and used more banks in total (32) and more banks as lead
(22) than any other firm. Nonetheless, like most firms, Citicorp imple-
mented a hybrid strategy, even though it could have been much more
transactional. 17 The infrequency of extreme transaction interfaces under-
scores a common theme in the field interviews: CFMs consider the intense
competition fostered by a transaction strategy to be undesirable and dys-
functional. If too much competition is created, for example, banks may
price a deal so close to the market (see App. A) that it is not well received
by investors. Instead of getting the best possible price, many CFMs said
they would rather see the deal move smoothly in the market. As one said,
"We can't afford to have a deal out there floating around. We need the
deal done." Another said, "Having a smooth underwriting is more impor-
tant than saving an eighth."'18
Pure relationship interfaces are more common than expected. About
30% of all firms gave 100% of their investment banking business to a
single bank. These firms always used the same bank across deals and
never used multiple banks on any single deal. One firm, for example,
used one bank exclusively on 14 different deals. The typical single-bank
firm, however, tends to do relatively few deals, just 1.63 transactions on
average (SD = 1.34).
Strong ties are common, even though 70% of firms did not use a pure
relationship interface. Even though multiple banks tend to be used, a
single investment bank is favored: CFMs allocated an average of 68% of

17 Citicorp is not an outlier in a statistical or theoretical sense. It is an influential point,

but it is located right where it should be, on the basis of the theoretical relationship of
deals and banks. Further, it is supported by the presence of nearby points. Deletion of
Citicorp (and other frequent financers) from the regression models does not have a
noticeable effect. Thus, the outlier problems analyzed by Wu (1985) are not present
18 Bloch (1986, p. 171) argues that it is in the corporate CFO's interest to underprice a
new issue because "the sale of an issue at a better-than-anticipated price will not
generate as much credit for him as a failed issue will raise doubts about his abilities
and promotability" (emphasis in original).


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American Journal of Sociology

their business to their most frequently used bank (table 3). Despite Wall
Street's lament that customer loyalty is dead, many firms maintain strong
ties with investment banks. These ties vary in strength, however, accord-
ing to a firm's level of power and dependence, as discussed below.

Power-Dependence Relations and Interface Structure

If organization-market interfaces are the results of CFMs' attempts to

reduce dependence and exploit power advantages, then observed inter-
faces should vary systematically with measures of power relations be-
tween corporations and investment banks, including intensity, criticality,
asymmetry, standardization of exchange, use of tandem strategies, and
third-party (investor) influence (table 2). The relations of these measures
and interface structure are evident in the ordinary least squares (OLS)
regression models in table 4.19 These models include all independent
variables and, because of listwise deletion of cases with missing data,
represent an 832-firm subset of the 1,530 population. Table 5 presents
reduced OLS regression models for all five interface measures; they ex-
clude independent variables that contained excessive missing values and
forced the exclusion of many cases. Almost all excluded variables were
not significantly related to interface patterns (P > .05; a significance level
of .05 is used for interpretation of regression results). After briefly discuss-
ing the full models, I focus on interpreting the reduced models.
Full regression models. -Power-dependence concepts explain a consid-
erable percentage of the variation in market interfaces for the subset of
firms (table 4). The measures explain about 65% (adjusted R2) of the
variation in total number of banks used (model 1), 61% of the variation in
number of banks used as lead (model 2),20 and 47% of the variation in the

19 When dependent variables are counts, the use of Poisson regression might be more
appropriate than ordinary least squares (OLS), as one reviewer reminded me. Both
approaches, however, produced very similar conclusions. For example, consider the
following simple models for number of lead banks (N) regressed on the key indepen-
dent variable, the inverse of the square root of deals (D), for multideal firms. The OLS
method takes the general form y = a + Bx, and the Poisson takes y = exB' . The OLS
model is N = 7.66 - 9.5 7(D). The Poisson model is N = e[2.56 - 3.2 1(D)]. It can be
shown that B = Bly. Dividing the OLS constant and coefficient by the average of N
(2.99) shows that, on the average, the two models produce similar results. (The Poisson
program was adapted from a Minitab algorithm kindly supplied by Peter E. Rossi.)
Another approach involves using OLS but taking the square root of the dependent
variable, which tends to stabilize the variance in counted data. This alternative also
produced similar results. Given these similarities and my intent to describe (rather
than predict) patterns, OLS is acceptable.
20 All models for the number of lead banks are restricted to the subpopulation of firms
conducting two or more deals (N = 1,091) because a single-deal firm, by definition,
uses only one lead bank.


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Market Networks

strength of the main bank relationship (model 3). All measures of resource
intensity are significantly related, as hypothesized, to the number of
banks used in total. The number of deals, but not dollar amount, is
significantly related to number of lead banks. All measures of intensity
are related as expected to the strength of the main tie, except total dollars
raised for multideal firms.2'
In the subset of firms, just one measure of criticality, average free cash
flow, is significantly related to the number of banks used in total and as
lead, but the direction is the opposite of expectations: on the average,
firms tend to use more banks when they have greater sources of internal
funds, all other factors held constant. None of the measures of criticality
is significantly related to the strength of the main tie. Asymmetry-the
balance of power between a firm and its main bank-is related as ex-
pected to the number of banks used in total and as lead, and to the
strength of the main relationship: firms that are powerful relative to their
main bank are more transactional. However, as can be inferred by the
interaction term, single-deal firms lose power advantages.22
Standardization of exchange is related as expected to the strength of the
main tie, but not to the number of banks used in total or as lead. Firms
that do similar deals tend to favor their main bank. This could indicate
the convenience or efficiency of working with one bank, but some CFMs
said that they used the need to conduct "different" deals as an excuse to
build ties to banks other than the main bank. If so, then similarity repre-
sents dependence, and the positive association with strength of the main
tie indicates difficulties in weakening this strong tie when a firm's deals
are homogeneous.
Organization size is significantly related to interface structure in the
subset of firms, but the direction is not consistent with the interpretation
of size as a tandem strategy. The finding that larger firms use more banks
and grant less business to their main bank, all other factors held constant,
is consistent with the alternative explanation that larger firms, with larger
corporate staffs, are able to manage more bank ties. Organizational
growth is not significantly related to interface patterns.
The presence of director interlocks is related as expected to the number

21 Note that the one-bank ratio and the H are bounded dependent variables, which
could violate the normality assumption for the error distribution. I have retained these
measures because very few predicted values fall outside the 0-1 range, transformed
measures defy substantive interpretation and lack theoretical meaning, and my intent
is to describe rather than predict.
22 The dummy interaction terms are interpreted in the customary manner. If, e.g., the
power-ratio variable and its interaction with the dummy are both significant, the
coefficients are added to interpret the relationship of the power balance for single-deal


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American Journal of Sociology

of banks used in the lead role and to the strength of the main tie. (The
effect of interlocks for one-deal firms is not different from that for mul-
tideal firms.) Finally, third-party (investor) influence is not significantly
related to any of the three interface measures.
Reduced regression models. -The reduced models explain a large pro-
portion of the variation in organization-market interfaces in the popula-
tion of the 1,530 firms (table 5). Note, however, that only 28% of the
variation in number of banks used as comanagers can be explained by the
various power-dependence measures (model 3). Several key variables-
number of deals, power ratio, and board interlocks-are not significantly
related to number of comanagers. This suggests that CFMs do not man-
age dependence or exploit power advantages by manipulating comanager
ties; rather, they focus efforts on number of lead banks and the strength of
the main bank relationship. The similarity of coefficients for the one-bank
ratio (model 4) and the H index (model 5) indicates that the latter is driven
primarily by the strength of the main tie. Indeed, the two measures are
highly correlated (r = .97).
Intensity (deals and dollars) is related as hypothesized to the number of
banks used in total and as lead (models 1 and 2). Intensity is similarly
related to the strength of the main bank relationship (model 4). Surpris-
ingly, however, the strength of the main tie is not significantly associated
with dollars raised for multideal firms. These overall patterns are consis-
tent with the argument that deals and dollars are resource endowments
from which firms derive power advantages. Firms that do more deals, all
other factors held constant, are more transactional; similarly, firms that
raise more funds, holding other factors constant, are more transactional.
The interaction terms, however, show that power advantages derived
from deals and dollars are lost for single-transaction firms.
Both number of deals and dollars raised provide opportunities to use
more banks and induce competition. Corporations establish additional
bank ties and weaken the main bank relationship to compel banks to act
more competitively. Power advantages are used to obtain efficiency bene-
fits. Although the traditional resource dependence argument maintains
that organizations act to reduce dependence regardless of profit or
efficiency (Pfeffer 1987a), in the case of corporate relations with invest-
ment banks, power and efficiency go hand in hand.
The use of power advantages can be readily seen in the allocational
tactics used by CFMs. For example, CFMs include banks on deals as a
means of payment for analyses and studies that are not individually
compensated.23 As an assistant treasurer said, "We think of who has done

23 It is a common practice in the industry for investment banks to conduct a variety of

analyses for which they are not directly compensated. Bankers may do so as a market-


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Market Networks

work for us, and try to make it up." A CFO related a similar practice: "If
they're doing lots of nontransaction stuff, I'll make sure they're [included]
in a deal. That doesn't mean I'll pay more for it. [But] I'm not so calloused
[sic] that I'd just ignore the thing, because relationships help us too."
The nonlinearity of deals and interface patterns indicates that power
advantages accrue disproportionately in relation to number of "trips to
the market" (deals).24 Competitive benefits are obtained as soon as a firm
moves from a pure relationship interface, but they decline as the firm
becomes more and more transactional. Returns to diversification of mar-
ket ties come early. Indeed, a firm can lose power by attempting to use too
many banks. If it spreads business too thinly, the firm will become an
unprofitable account for the banks, which will stop vying for its business.
Further, if the firm violates the norm of reciprocity by failing to assign
enough business to its relationship bank(s), the quality and benefits of
these ties will deteriorate. As one CFO put it, "There's no really good
argument against competition, but you have to have sufficient volume.
You have to have enough volume to justify [two banks, in this firm's
case]. " And another said, "There's no value to adding a fourth
[relationship] bank. The economics would be diluted from the investment
banks' point of view." Thus, to obtain the benefits of competitive behav-
ior while preserving its long-term relationships, a firm must "balance" ties
with banks, as the interorganizational principle of reciprocity suggests
(Laumann and Marsden 1982, p. 332).
Criticality- -the availability of resource alternatives-is significantly
related as hypothesized to number of banks used in total, as lead, and as
comanagers, but not to the strength of the main tie. Firms with less debt
capacity (higher long-term debt/equity ratios) have fewer financing op-
portunities and attempt to overcome this dependence by establishing
more bank ties, all other factors held constant. Single-deal firms, how-
ever, are unable to add ties to reduce dependence, as indicated by the
interaction term.
The asymmetry of power between a firm and its main investment bank
is related as expected to number of banks used in total, as lead, and to the
strength of the main tie, all other factors held constant. The greater the
relative power of a firm, the more CFMs are able to exploit power advan-
tages by using more banks and weakening the strength of its main tie,

ing tactic, hoping to win future business, or as part of the tacit obligations inherent in a
24 A nonlinear measure of deals was suggested by the scatterplots. Note that random
selection from a finite population of banks (equivalent to the hypergeometric distribu-
tion) also yields a curvilinear relationship of deals and number of banks. However, as
shown in fig. 1, the observed nonlinear relationship falls substantially below the
hypergeometric, suggesting that the naive rule of random selection is implausible.


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American Journal of Sociology

yielding more independence and efficiency gains from intensified competi-

Tandem strategies are expected to be used as substitutes for the direct
management of market ties. Organization size, however, does not appear
to function as a tandem strategy; instead, larger firms are associated with
more transactional interfaces because of greater management capabili-
ties. The interaction terms reveal that the ability (or need) to manage
bank ties diminishes when firms only conduct a single deal.
Director interlocks do appear to be used as tandem strategies. The
presence of an interlock with an investment bank is negatively associated
with number of banks used in total and as lead, and positively associated
with the strength of the main relationship. Thus, the 267 firms with
investment bankers on their boards appear to already reduce (some) de-
pendence with nonmarket co-optive ties and therefore have less need to
manipulate market interfaces. The use of interlocks to reduce dependence
is consistent with the interorganizational perspective on interlocks as well
as with Granovetter's (1985) embeddedness argument. In addition to in-
terlocks, CFMs reported various and numerous nonmarket ties between
corporations and banks, such as elite family ties and ties created in the
course of doing business, by career movements, by participation in pro-
fessional associations and business roundtables, and by common under-
graduate and graduate schools (cf. Mintz and Schwartz 1985; Useem
1982). The CFMs reported using these social ties in many ways. The ties
may lie dormant until special information must be communicated. They
are used as entry points for marketing calls or sourcing for information.
They are also used to ensure satisfactory performance (or the rectification
of unsatisfactory performance) of both principals and agents. For ex-
ample, when one firm I interviewed was contemplating doing a deal with
a bank it had not worked with before, it used social networks to reduce
uncertainty and ensure satisfactory performance. Because the bank had a
reputation for opportunism and the bank's offer was exceptionally good
(possibly "too good to be true"), CFMs felt the need for extra protective
measures. As agency theory would predict, CFMs devised a formal con-
tract with special guarantees to shift the risk of a poor market reception to
the bank. But the firm also overlaid its contract with social relationships.
The firm's CEO, who had an extensive network of social and business ties
with the financial community, contacted his social acquaintance, the
bank's CEO, to make sure that the terms of the deal were legitimate and
the bank would stand behind them. The deal went through successfully.
Interlocked firms are more relationship oriented than firms without
such ties, but there is wide variation in the extent to which director ties
actually overlay market ties, with many interlocks lacking an economic
base altogether (see table 6). Of the 75 investment banks with corporate


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Market Networks



Number of Percentage
Investment Bank Board Interlocks as Main Bank

Johnson Lane ................................ 1 100

Seidler Arnett ................................ 1 100
Drexel Burnham Lambert ...................... 17 94
L. F. Rothschild et al . ............ 6 83
Kidder Peabody .............................. 11 82
First Boston Corp ............... 9 78
Lazard Freres ................................ 13 77
Bear Stearns ................................. 4 75
Moseley Hallgarten ........................... 3 67
Prudential Bache ............................. 6 67
Wertheim .................................... 8 63
Dillon Read .................................. 5 60
Goldman Sachs ............................... 25 60
Paine Webber ................................ 9 56
Shearson Lehman Brothers ..................... 30 53
Morgan Stanley ........................4 50
Merrill Lynch ................................ 9 44
Smith Barney et al. ........................... 3 33
Thomson McKinnon .......................... 3 33
E. F. Hutton . ................................ 6 17
William Blair ................................ 6 17
Hambrecht & Quist ........................... 3 0
Rotan Mosle ................................. 3 0
Wheat First .................................. 1 0
51 others .................................... 84 0

NOTE.-Main Bank = most frequently used bank.

board ties, only eight are the main banks (capturing more than 50% of a
firm's business) for at least three-quarters of their boards. Only 16 capture
a main share of business from at least half of their boards. Fifty-four
banks are not the lead for any firms on whose boards they sit. Indeed,
43% of the firms do not give any business whatsoever to their banker-
Variation in the extent to which interlocks overlay market ties appears
to be related to the balance of power between firms and banks (Baker
1987b). For example, Drexel Burnham Lambert, the fourth largest in-
vestment bank in 1986, worked with small and highly leveraged corpora-
tions. It was the main bank for 16 of the 17 boards on which it sat, and it
captured 90% or more of the business of 8 of the 16. In contrast, the
prestigious and powerful "special bracket" banks tend to work with simi-


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American Journal of Sociology

larly prestigious and powerful companies.25 As a result, their director

interlocks are not associated with economic benefits rivaling Drexel's.
Goldman Sachs, Merrill Lynch, and Morgan Stanley, for example, are
the top banks for, at most, 60% of their corporate boards.
The observed effect of interlocks on interfaces lends some support to
the interorganizational perspective on interlocks: these ties are used as
part of a strategy to ensure the flow of critical resources. The fact that
interlocked firms tend to be more relationship oriented is consistent with
the argument that interlocks are used to ensure and enhance the flow of
information (see, e.g., Stearns and Mizruchi 1986). Interlocked firms
have preferential access to advice, information about market conditions,
new products, investor attitudes, and so on, and have less need to in-
crease the number of bank ties to increase the flow of information. The
field interviews corroborated the quantitative evidence of the informa-
tional benefits of interlocks. However, there is only partial support for the
long-untested assumption that director interlocks overlay economic ties.26
Interlocks strongly embed market exchange in some cases, but generally
interlocked firms do not tend to favor the investment banks on their
boards. This finding holds even when the relative market shares of the
banks are controlled: on average, interlocked firms give business to their
board-represented banks less often than expected by chance alone (Baker


Market relations-like most interorganizational relations-are socially

structured. Contrary to the usual view of market relations as an undif-
ferentiated mass or as epiphenomena, this study shows that real market
ties are the result of deliberate management. They are products of inten-
tional efforts to reduce dependence and exploit power in interorganiza-
tional relations. Corporations directly manipulate the number and inten-
sity of market ties to pursue the objectives of independence, uncertainty

25 "Special bracket" indicates the top position in the relative standings of investment
banks. It is symbolized in the so-called tombstone ads that appear in the financial
press, indicating the members of an underwriting syndicate. The ads divide firms into
hierarchical categories or "brackets." Membership in the special bracket is based
primarily on market share; members are Goldman Sachs, First Boston, Merrill Lynch,
Morgan Stanley, and Salomon Brothers. Salomon does not sit on corporate boards as a
matter of company policy.
26 Two broken-tie studies include limited consideration of firm-level market ties
(Stearns and Mizruchi 1986; Palmer et al. 1986). In contrast with these studies, I
examine the strength of economic ties rather than their presence or absence (i.e., as a
dichotomous variable), control for the market position of the banks, and consider
different types of market ties (Baker 1987b).


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Market Networks

reduction, and efficiency. Observed interfaces are related systematically

to key measures of power and dependence, especially the amount of
resources and frequency of interaction (intensity), the availability of re-
source alternatives (criticality), organization size (management capabil-
ity), the presence of director interlocks (tandem strategies), and the firm's
power relative to the power of its main bank (asymmetry).
By demonstrating that market relations are socially structured, the
study brings the topic of market relations into the purview of research on
interorganizational relations. It advances the emerging sociological view
of markets as social structures (e.g., Baker 1984a, 1987a; Burt 1983;
Etzioni 1988; Faulkner 1983; White 1981) in several ways. First, in
sociology and economics, market structure is often considered (with valu-
able results) as a determinant of organizational behavior (Scherer 1980;
Aldrich and Marsden 1988). The study suggests that the reverse-
corporate behavior as a determinant of market structure-offers insights
into the patterns and dynamics of markets. The next step is to combine
both sides into a dynamic model of market processes that allows for the
emergence of novel and unexpected structural forms (see, e.g., Baker and
Faulkner 1990) as well as the self-reproduction of stable structures (see,
e.g., White 1981).
Second, the study describes and explains specific practices used to
marshal and mobilize the social capital in markets. Social capital is a
resource that actors derive from specific social structures and then use to
pursue their interests; it is created by changes in the relations among
actors (Coleman 1988, pp. S100-S101). By deliberately manipulating
market interfaces, CFMs create and extract the social capital that inheres
in the social structure of relations between the corporate and financial
Third, the study supports the argument that the direct management of
market relations should be included in sociological analyses of interor-
ganizational relations among firms. Most work focuses on nonmarket
mechanisms used to manage environmental dependence, like social em-
beddedness, director interlocks, mergers, joint ventures, and political
activity. A principal finding is that the direct management of market ties
alone can accomplish similar ends: firms can solve classic principal-agent
problems, reduce dependence, and lower costs-even if they do not
embed market exchange in social relations or engage in the use of other
nonmarket tactics.
Finally, the study gives impetus to continued sociological research on
markets by showing that power plays a critical role in real interorganiza-
tional market relations. Corporations do not rely on nebulous "competi-
tive forces" but adroitly manage their market ties to counterbalance bank
power and create competition among banks. Competition does not arise


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American Journal of Sociology

spontaneously in imperfectly competitive markets-it can only be in-

duced by the purposive use of power. The efficiency benefits of competi-
tion are obtained because power and efficiency motives are compatible,
jointly driving CFMs in the same direction. Given the interwoven nature
of power and efficiency, a major implication is the need for further syn-
thesis and application of sociological and economic perspectives (see, e.g.,
Baker and Iyer 1989).


The Functions of Investment Banks

Investment banks are intermediaries that enable buyers and sellers to

exchange assets. They are best known for their prominent role as under-
writers of new securities and as advisers and players in mergers and
acquisitions, but they engage in other activities as well (see Carosso 1970;
Hayes et al. 1983; Auerbach and Hayes 1986; Bloch 1986; and Eccles and
Crane 1988). Traditional underwriting includes (1) origination and man-
agement, when the bank works with a firm to price a new security, time
the issue, and assemble the team of banks for distribution; (2) underwrit-
ing, which refers to the risk the bank assumes when it buys the security
from the firm at a fixed price and the resale price to investors is uncertain;
and (3) distribution, the actual selling activities.
Commercial banks and investment banks differ fundamentally. The
Glass-Steagall Act of 1933 separated the functions of commercial and
investment banking (see, e.g., Burk 1985). Commercial banks take de-
posits and lend funds but are barred from underwriting new public issues
of corporate securities. Investment banks are barred from taking depos-
its; irregularly they do lend funds, such as bridge loans (interim financing
to assist mergers and acquisitions).
Bloch (1986, p. 128) presents a useful illustration of pricing for an issue
of common stock (the original source is Childs [1976]):

(a) Market price of stock just before announcement $100.00

(b) Decline in price because of preoffering pressure $1.00
(c) Market price on day offering price is set $99.00
(d) Amount by which offering price is set under market $.50
(e) Offering price $98.50
(f) Underwriter's compensation ("spread") $4.50
(g) Price paid to company by underwriters $94.00
(h) Corporate expenses $.50
(i) Net proceeds to company $93.50

The pricing advice provided by investment banks is represented by line


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Market Networks

e above. The bank would like to set a low offering price to reduce distri-
bution effort, but the firm, trying to maximize net proceeds (line i), wants
a high offering price. In this example, the issue is "underpriced" by $.50
per share (line d).
The offering price (line e) usually reflects the decline in market value
(line b) that occurs when a new issue is announced (Asquith and Mullins
1986a, 1986b). The gross spread (linef) is the difference between the price
at which the bank buys the security from the issuer and the price at which
the bank offers it to investors. It includes the management fee (compensa-
tion to the lead manager for costs and risks), the underwriting fee (com-
pensation for underwriting risk), and the selling concession (discounts to
brokers selling the issue).
Price competition among banks involves pricing advice (line e) and
gross spread (linef). A bank can hold its compensation (spread) constant
but compete by offering to sell the issue "close to the market" (i.e., in-
crease line e). This increases distribution effort. If the offering price is too
close to the market price, the bank could have difficulty selling the issue.
A "suicide bid" is a price so close to the market that the bank's costs
exceed its compensation. A bank can give the same pricing advice but
compete by lowering its compensation. This should not affect distribution
effort, but it would lower profit margins.


Illustration of Bonus Allocation Method and Interface Measures


Transactions Conducted by the Same Firm

Transaction 1. Bank X is lead; banks Y and Z are comanagers.

Transaction 2. Bank Y is lead; bank X is the only comanager.
Transaction 3. Bank X is the lead (no comanagers).

Allocation of Credit

A single share of a transaction equals 1/ (n + 1), where n is the number of

banks. The lead gets two shares; each comanager gets one share.

Interface Measures

Number of banks in total = 3;

Number of banks as lead = 2;
Number of banks as comanagers only = 1;
One-bank ratio = .61;
H = .612 + .302 + .082 = .47.


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American Journal of Sociology




Bank X Bank Y Bank Z Total

Transaction 1 .............. . 50 .25 .25 1.00

Transaction 2 .............. . 33 .66 . . . 1.00
Transaction 3 .............. 1.00 .. . ... 1.00
Totals .1.83 .91 .25 3.00
Share of all transactions ... 1.83/3 .91/3 .25/3
Percentage share ......... .61 .31 .083


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