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Article Excerpt
It stands to reason that when businesses trust each other the costs associated with transactions between them will be lower since safeguards are not needed. Lower transaction costs should enhance profit. But does trust have these results in a transitional economy like China's, one with many state-owned businesses and with significant differences between rural and urban economies? A survey of almost 3,000 firms in 31 Chinese cities located throughout China finds that trust does lower transaction costs, but developing trust is another matter. Trust did not correlate positively with profitability. Details of these results should be of great interest to any firm seeking to do business in China or invest in that country.
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Introduction
Agency theory and transaction cost economics (TCE) assume that people are opportunistic in seeking self-interest (Beccerra and Gupta, 1999). Behavioral scientists view trust as a key ingredient of social capital. Reputation and trustworthiness can become a source of competitive advantage (Barney and Hensen, 1995). Hence, institutions may reduce transaction costs by creating trust, specifically the costs of cooperation and specialization (Hill, 1995). However, the institutional environment in the emergent market including China is less stable (Scott, 2001) and less conducive to mutually beneficial economic exchange between economic actors (North, 1994), so transaction costs are generally higher (Khanna and Rivkin, 2001; Peng, 2003). In addition, a poorly specified property rights undermines trust among transacting partners, and high transaction costs lead to firm inefficiency (Fussell, et al. 2006). Therefore, the competing hypothesis is that institutional conditions in emerging economies do not yet support lower-cost transactions.
Some level of trust is necessary for individuals and society to function adequately and effectively. What is the role of trust in curbing opportunistic behaviors? What is the economic payoff in maintaining trust and high credit rating? There is no consistent evidence that formal monitoring mechanisms and relational trust complement or substitute for each other (Poppo and Zenger, 2002). This study examines the role of trustworthiness in reducing transaction costs and improving firm performance. The impact of information flow, environmental uncertainty, and trust on firm transaction costs and profit were investigated. In particular, the present study integrates the transaction cost question with the institutional perspective and argues that firm performance depends on the entrepreneur's propensity to trust and on the credit rating of the firm. The results help to advance our understanding of these relationships among social context variables, trust, and firm performance. In addition, it aims to test whether or not the relationship between trust and performance outcomes is robust in the emergent institutional environment.
The assumption of current economic exchange is based on individualistic behavior of exchange partners seeking self-interest and maximum profit. Social and economic factors exert significant influence on transactions in different cultural settings. Social pressure, the moral obligations inherent in the social norms, may also constrain opportunistic behavior in a more collectivistic and relationship-oriented society like China's (Lui and Ngo, 2004). The China context is critical to understanding trust. In the Chinese society, relations depend strongly on trust, but ironically, trust is difficult to build beyond circles of kinship or closely knit social networks. China provides a unique setting for studying trust among entrepreneurs. It is worthwhile to explore the cultural characteristics of Chinese trusting behaviors in the world's largest transitional economy.
Theoretical Perspectives for Understanding Trust in Society
Trust-embedded economic theories The literature on trust-building focuses largely on economics (Williamson, 1991), social psychology (Lewicki and Bunker, 1996; MacAllister, 1995), and several other disciplines. Economic exchange is contractual in nature with obligations of the parties clearly defined. Social exchange is based on trust with less concern for direct and immediate compensation; obligations are diffused and not precisely-defined. These two perspectives may not necessary exclude each other. Jones, Hesterly, and Borgater's study (1997) integrated social context into transaction cost economics (TCE) by explaining how social mechanism influences the costs of transactions. Both agency theory and TCE can reasonably explain trusting behaviors (Chiles and McMackin, 1996). Actually, these economic and social factors complement each other.
Agency theory describes economic exchange relationships between two parties that aim to reduce the degree of opportunism by the partners (Eisenhardt, 1989). Both parties attempt to structure the relationship to protect their own interests. The principal partner delegates certain tasks to the agent and bears the risks of the agent's not behaving in the best interests of the principal. The objective of the agency theory is to take some action to minimize the costs. TCE assumes people are opportunistic, so it is important to prevent opportunities for benefiting at the cost of others. The goals of the two parties conflict, and it is difficult or expensive for the principal to monitor the agent's performance and opportunities to take excessive advantage (Klaes, 2000). Both parties strive to maximize individual interests and seek to minimize risks associated with the relationship. Thus, it is important to create an environment of trust that reduces the possibility of selfish opportunistic behavior by the agents (Bromiley and Cummings, 1995).
TCE posits using contractual and governing mechanisms to regulate behaviors and safeguard against opportunism. Business enterprises choose governance structures that economize transaction costs associated with establishing, monitoring, evaluating, and enforcing agreed-upon exchanges (Klaes, 2000). Obviously, the resource, effort, and attention invested in a relationship cannot be recovered if the relationship is terminated (social capital loss), and legalistic remedies are often ineffective. Since the relationship investment has no outside value, a high level of trust is needed to reduce transaction costs, potential relationship termination costs, and opportunistic reactions (Williamson, 1991).
Both agency theory and TCE project a gloomy view...
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