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Dealing with the Paradox of Embeddedness: The Role of Contracts and Trust in Facilitating Movement Out of Committed Relationships

Ibmec São Paulo, R. Quatá 300, São Paulo, SP Brazil 04546
Department of Political Science, Washington University, St. Louis, Missouri 63130
John M. Olin School of Business, Washington University, St. Louis, Missouri 63130
sergiogl1{at}isp.edu.br
gjmiller{at}artsci.wustl.edu
zenger{at}wustl.edu

When there are constantly new, valuable opportunities to transact with alternative partners—a situation we refer to as exchange value uncertainty—long-term or committed transactions among the same individuals are discouraged. However, when opportunism creates exchange hazards, which escalate in nonrecurring transactions, individuals will be reluctant to take full advantage of the gains from switching to more valuable partners, thereby leading to "overembedded" exchanges. Instead of embracing new, valuable exchanges with strangers whose propensity to cooperate is uncertain, individuals may prefer to preserve recurring ties with familiar actors. Two mechanisms may encourage movement out of committed relationships in those conditions. First, formal contracts should serve as a safeguard to market participants, in the sense that they limit potential losses due to opportunistic behavior. Second, trust in general others (as opposed to trust in familiar people) reduces participants' perception of hazards in market exchanges, and hence promotes transactions among strangers. By increasing the propensity to initiate new exchanges, general trust also diminishes the role of contracts in causing movement out of committed relationships. In this paper, we present experimental evidence largely consistent with this theory of the interplay between formal and informal mechanisms in the determination of social mobility.

Key Words: networks; embeddedness; contracts; trust