Replacing contracts with handshakes: A study of social networks of entrepreneurs in the weaving sector

Abstract

Informal institutions like kinship based networks play a crucial role in business activity. The flow of information in such networks, based on trust and reciprocity helps in creating an environment where opportunism is curtailed and relational based governance mechanism prevails. This paper studies, whether such factors play a role as an alternative governance mechanism for contracts as opposed to the formal institutions or not. The effectiveness of such network factors hinges on the network structure, and therefore network density and network size are taken as independent variables. Though network density was positively and significantly related to the use of social networks for management of breach of contracts, network size was negatively related to management of breach of contracts. Network size and network density were positively related to ex-post transaction costs of dispute resolutions however, they were not statistically significant.