Scand. J. Mgmt,Vol. 12, No. 2, pp.

189-205, 1996
Copyright © 1996 Elsevier Science Ltd
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OPPORTUNISM, ORGANIZATIONAL ECONOMICS AND

THE N E T W O R KAPPROACH

N I C O L A I J. FOSS

Institute of lndustrial Economics and Strategy, Copenhagen Business School, Denmark

CARSTEN A. K O C H

Department of Management, Odense Universi~, Denmark

(First received September 1993; accepted in revised form October 1994)

Abstract -- This article discusses the concept of opportunism, familiar from Williamsonian transaction cost
economics, and its role in business studies. Various arguments for the importance and centrality of the concept
are presented. The transaction cost framework is compared to the Swedish network approach. Specifically,
opportunistic behavior seems to be implicitly present in the claims of network theory. The overall conclusion
is that many network arguments are not in substantial conflict with transaction cost economics. And by joining
forces, the approaches may provide a more comprehensive and dynamic theory of economic relationships. A
number of new arguments are brought to bear on these issues. Copyright © 1996 Elsevier Science Ltd

Key words: Transaction cost economics, network approach, opportunistic behavior.

Though the wicked were fewer in number than the righteous, yet because we cannot distinguish
them, there is a necessity of suspecting, heeding, anticipating, subjugating, self-depending, ever
incident to the most honest and fair-conditioned (Thomas Hobbes, De Cive).

1. INTRODUCTION

During the last decade organizational economics -- particularly Oliver E. Williamson's

transaction cost economics (Williamson, 1985)* -- has penetrated increasingly into management
science, making an impact on marketing (Anderson and Schmidtlein, 1984), strategy (Reve,
1990), and organizational theory (Miller, 1992). An increasing part of the curriculum
traditionally taught in business schools is now influenced or potentially influenced by
organizational economics. What is remarkable from a sociology of science perspective about this
development is the fervor - - on the part of both foes and friends -- that has accompanied the
spread of organizational economics in much of the academic community.t Although the field of

*For a technical overview of the streams in organizational economics which differ from Williamsonian transaction cost
economics, see Holmstrom and Tirole (1989). Our use of the term "organizational economics" is less inclusive than that
which is found in Barney and Ouchi (1988); for example, we exclude evolutionary economics.
tSee in particular the exchange between Perrow (1981) and Williamson and Ouchi (1981 a and b).

189
190 NICOLAIJ. FOSSandCARSTENA. KOCH

organizational theory is very heterogeneous -- a circumstance that should arguably foster

tolerance and pluralism -- no other approach seems to have been met with such criticism or such
intense opposition (Barney, 1990, p. 383).
In very broad outline the criticism of organizational economics has been that the approach is
given to methodological individualist excesses (Donaldson, 1990), that it puts a low premium on
empirical studies (Robins, 1987), neglects power considerations and instead over-emphasizes
efficiency (Perrow, 1981), relies on functionalist explanation (Dow, 1987) and works with an
under-socialized conception of agency that gives self-interest seeking a too prominent
explanatory role (Granovetter, 1985; Bradach and Eccles, 1989). Such a critique amounts to
essentially the same as have been levelled at "economic imperialists" by traditional sociology (cf.
Fields, 1984; Vanberg, 1988; Williamson, 1992). And the central component found most
reprehensible by contemporary critics of organizational economics is undoubtedly the
assumption of opportunistic behavior;* an assumption that is held to reflect precisely the under-
socialized concept of agency that characterizes traditional economic theory.
Although organizational economics has not (yet?) had an impact on Nordic thinking in busi-
ness studies comparable to its impact on the American academic community, various criticisms
have already been levelled at it by Nordic researchers. Proponents of the Swedish network
approach have been particularly outspoken in their critique of organizational economics.t One
of the purposes of this article is to expose their view to a critical assessment. Since Williamson's
work represents the kind of organizational economics best known to researchers in business
studies and since his has, accordingly, been the most frequently criticized contribution, reference
to "organizational economics" will almost only imply reference to Williamson.
We begin by clarifying the explanatory role of opportunism in section 2, discussing the lim-
its and content of the concept. We also present some intuitive arguments, leading to the propo-
sition that opportunism should be used "in an unapologetic way" (to borrow an expression from
Williamson (1992)). That is, the opportunism assumption may be justified despite the fact that
it embodies more cynicism about persons' behavior patterns than the simple evidence warrants.
In section 3, we present what is often suggested by its proponents as a genuine alternative to
transaction cost economics, namely the Swedish network approach. The proponents of the net-
work approach have often adopted a very critical stance towards the concept of opportunism.
"Trust" has been claimed as a more theoretically reasonable and descriptively correct
assumption.
In sections 3 and 4 we argue that in the kind of world envisaged by the network approach,
characterized by the ubiquitousness of trust, it would be difficult or impossible to treat analyt-
ically a number of phenomena that are in fact present in this approach. These phenomena can
only be rationalized under the assumption of opportunism. In conclusion, section 5 briefly
argues that organizational economics promises to become a central organizing influence on
management science, and that this should involve an appreciation of the concept of
opportunism.

*More "antiseptic"(Williamson, 1992) terms for closelyrelated phenomenaare "moralhazardand "adverseselection,"

terms that figure most prominently in agency theory. See Masten (1988) for a comprehensive discussion of the
differences betweenopportunismand moralhazard/adverseselection.
tArguably, the strongestNordiccritic of organizationaleconomicsand the assumptionof opportunismhas been Bengt-
/~ke Lundvall. Lundvall (1993) is representativeof this writer's stance. We do not discuss Lundvall's critique here,
primarilybecausehe is not directly associatedwith the Swedish network approach.
 THE NETWORK APPROACH 191

Although a large part of this article consists of a critical examination of the network approach
from an organizational economics perspective, this does not imply any belief on our part that
organizational economics can completely replace network approaches. Network approaches are
more than organizational economics in disguise. For example, the processes of change that are
crucial to many network researchers are inadequately theorized in organizational economics.
Here, the two approaches are clearly complementary, as is recognized in some parts of the
network literature (Johanson and Mattsson, 1987, pp. 47-48). This indicates the possibility of
joining forces, so that we may end up with a more comprehensive, dynamic theory of economic
relationships. In its normative guise such a theory would certainly not neglect the reality of oppor-
tunism; however, it would put a high premium on the building of the opportunism-reducing rela-
tionships so much emphasized in the network literature.
There is, we think, a methodological lesson in this. It will readily be agreed that business
economics, management science, organization studies, etc., are fields characterized by much
heterogeneity. There is in general little dialogue between various disciplines and subdisciplines,
so that important learning and knowledge-sharing economies are not realized.* As the philoso-
pher of science, Larry Laudan (1977), convincingly argues, scientific disciplines progress when
it can be demonstrated that seemingly irreconcilable approaches are fully or to some extent
complementary. Although we think that the network approach has some weak spots and that some
network arguments are reducible to transaction cost arguments, we also recognize and briefly
discuss the relation of complementarity between organizational economics and the network
approach. Accepting Laudan's argument, we believe that the following pages may take our
understanding of the way organizational economics relates to the network approach somewhat
further.

2. THE CONCEPT OF OPPORTUNISM

2.1 Meaning and function

We shall take organizational economics in its Williamsonian transaction cost version to
constitute a coherent set of theories -- a "research program" -- bound together by a set of
behavioral assumptions (cf. Knudsen, 1991, chapter 23). The two central behavioral assumptions
are bounded rationality -- which we shall take to be unproblematic in this article -- and
opportunism. Following Williamson, we shall understand opportunism to be:

self-interest seeking with guile. This includes but is scarcely limited to more blatant forms, such as
lying, stealing and cheating. More generally, opportunism refers to the incomplete or distorted
disclosure of information, especially to calculated efforts to mislead, distort, disguise, obfuscate, or
otherwise confuse (Williamson, 1985, p. 47).

*This has been the situation at least since the beginning of the 1960s when behavioralist thought made a tremendous
impact on business economics, separating the discipline into economistic disciplines and "soft," behaviorally oriented
ones. It is precisely this schism that transaction cost economics can repair, since it is an analytically precise approach
with a large problem-solving capacity, and it possesses elements from both the "soft," behavioral side (such as bounded
rationality) and the "harder" economistic side (such as the focus on efficiency).
192 NICOLAI J. FOSS and CARSTEN A. KOCH

Interpreting this statement, we should always be aware that:

Although it is a central behavioral assumption, it is not essential that all economic agents behave in
this way. What is crucial is that some agents behave in this fashion and that it is costly to sort out
those who are opportunistic from those who are not (Williamson and Ouchi, 1981a, p. 351).

We will now look briefly at the general analytical role of opportunism; some more subtle
points will be addressed later, in connection with a discussion of the Swedish network approach.
But first note that the assumption of opportunistic behavior, as defined in the latter part of the
above quotations, would be true even if only one opportunistic actor existed. Strictly speaking,
then, to claim that the assumption of opportunistic behavior is false implies that there cannot be
even one opportunistic actor. This seems to us to be an awkward position, and we do not think
that network theorists believe there are literally no opportunists at all. The assumption, as it is
used here, implies that the two following requirements are simultaneously met:* (i) a non-
negligible proportion of the actors involved in economic transactions have inclinations toward
opportunistic behavior, and (ii) that the opportunistic actors cannot be easily distinguished from
the non-opportunists; in Hobbes' terms, "the wicked" cannot easily be distinguished from "the
righteous."
Apart from opportunism, one of the central dimensions in Williamson's theory is the degree
of asset-specificity. In the case of non-specific assets, exchange is simply regulated by the
ability of any of the contract partners to turn to alternative partners. But the realizing of scale-
economies, for example, may require the deployment of resources for building specialized
capital equipment. For reasons of capability and/or incentives a finn may wish to have a
supplier undertake the relevant investment. Once the investment has been made, and resources
have been sunk in the building-up of dedicated capital assets -- human, physical or organiza-
tional - - only imperfect market alternatives exist, and the parties are effectively locked into a
bilateral monopoly situation. Given specificity, the assets earn a rent that may give rise to
distributive battles, so-called "hold-ups."t Furthermore, the larger the rents, the larger will be
the amount of resources invested in the tussle for rents. Though described in e x p o s t distribu-
tional terms, there is also an e x a n t e allocative aspect to the situation, since mutual e x a n t e fear
of rent-seeking behavior may cause an inefficient level of investment in specific assets
(Grossman and Hart, 1986). Given a sufficiently high level of asset-specificity, efficiency dic-
tates vertical integration; this will economize on e x p o s t transaction costs as well as harmonize
investment incentives.
A number of reservations are in order here. In the above we have deliberately left out a
number of details - - for example, on central concepts such as frequency, uncertainty, etc. -- and
only focused on the most familiar kind of transactional failure. However, using similar reason-
ing, it is possible to trace the origin of a number of (existing) contractual forms and economic
institutions in general by varying parameters such as uncertainty, frequency or asset-specificity,
and investigating what governance structure best economizes on transaction costs, for example
by providing adequate incentives.

*This follows Koch (1994).

tToo much has probably been made out of the dramatic quality of hold-ups; much more important is arguablythe more
covert and subtle "post-agreementjockeying" of (1) attempts to evade performanceobligations (pure moral hazard), and
(2) subtle efforts to force through a de jure change in the distribution of rents through insisting on strict complianceon
quality standards, reading the contract "literally", etc. (genuine rent-seeking) (see Masten, 1988,pp. 186-187).
 THE NETWORK APPROACH 193

Furthermore, transaction cost economics does not predict that any situation involving high
levels of asset-specificity will lead -- with some absurd necessity -- to opportunistic attempts to
appropriate rents, or, equally absurdly, that firms are in general well-advised to behave
opportunistically. For example, the parties may exchange "hostages" (Williamson, 1983), or the
relation may be such that non-opportunistic behavior is self-enforcing (Klein, 1985; Rubin,
1990).* And the prime managerial recommendation from transaction cost economics is indeed
consistently to seek out credible commitments from other transactors. Note that this is perfectly
consistent with the emphasis on relation-building in the network literature.

2.2 What can and what cannot be said with and without opportunism
It seems to be a generally agreed opinion among philosophers of science today that "you can
only beat a theory with a better theory" (for example, Lakatos, 1978). But what does it mean for
one theory to be "better" than another? Meanings that can be ascribed to "being better" are: (1)
having a greater problem-solving capacity; (2) conforming more closely to (conventionalist)
criteria such as parsimony, precision, etc.; (3) having greater predictive success.
These criteria may sometimes be in conflict, so that one has to weight them for an overall
evaluation and comparison. Predictive performance (point 3) is not considered the litmus-test of
scientific respectability as it was, say, two decades ago. More emphasis is now put on successful
problem-solving and the identification of underlying mechanisms. In more hierarchical sciences,
such as economics, there is typically a high premium on conforming closely to criteria such as
precision, parsimony, etc., often at the cost of a lack of realism. We feel that organizational
economics has honored the criteria of problem-solving capability (point 1) particularly well,
while at the same time offering a relatively precise and unambiguous approach. We will briefly
indicate the extent of the problem-solving capacity of organizational economics, leaving the
specific comparative issue for a later treatment.
Arguably, the major strength of organizational economics is that it is the only social scientific
approach that has successfully addressed the issue of why different forms of economic organi-
zation even exist in the first place. Other approaches have tried to do this, but in our opinion not
successfully. For example, the Marxist attempt to explain the rationale of the firm in power terms
has been generally unsuccessful. In other words, it is not possible today to explain economic orga-
nization outside organizational economics, only to take its existence as given. The paradigmatic
case of problem-solving capacity in organizational economics has usually been considered ver-
tical integration, but the approach has increasingly manifested a strongly unfolding process,
whereby phenomenon after phenomenon has been considered. Thus, the internal organization of
firms, diversification, franchising, the company town, corporate finance, joint ventures, etc., have
been addressed, constituting an intricate and elaborate morphology of economic organization
(point 1 above). It would seem, then, that as far as problem-solving capacity is concerned, the
approach is quite a powerful one. Note that all the problem-solving successes of organizational
economics have been obtained with the use of a theoretical apparatus that has employed the
assumption of opportunism.t All of this has taken place within a relatively unified and rigorous
approach (point 2 above), addressing distinct phenomena with the same theoretical tools and

*Because, for example, the length of the relation is indeterminate, so that the "hot potato"-problem does not arise (e.g.
if the length is determinate and A can, with certainty, be expected to behave opportunistically in the end period, it will
not pay B not to behave opportunistically in the initial period).
tOne of us (Foss, 1993a and b) has argued, however, that some aspects of economic organization are explicable in
economic terms which avoid the use of opportunism. But these are very limited stories.
194 NICOLAI J. FOSS and CARSTEN A. KOCH

central assumptions. Furthermore, some quite impressive empirical work has emerged, such as
Armour and Teece's (1978) test of the M-form hypothesis, Masten's (1984) study of procure-
ment decisions in the aerospace industry, and Anderson and Schmidtlein's (1984) test of organi-
zational economics in the context of whether firms decide to hire their own sales-force or rather
rely on independent agents.
Arguments such as the above may not appeal to some critics. For example, it may be argued
that it is not necessary to consider the above criteria; instead, one should consider the descriptive
realism of fundamental assumptions. We do have some reservations concerning an unconditional
requirement for "realism of assumptions" as a means for evaluating theories, partly because it is
not always simple or non-trivial to define what is implied by it.* As far as the assumption of
opportunistic behavior is concerned, however, it is relatively straightforward what is meant by it
being realistic or not.
As noted by Johanson and Mattsson (1987), the assumption of opportunistic behavior in trans-
action cost economics is the major difference between organizational economics and the network
approach. An evaluation of the strengths of these approaches should therefore include an analy-
sis of the realism or not of opportunistic behavior. We shall argue later that a number of obser-
vations made by sociologists and proponents of the network approach make little sense if the
assumption of opportunistic behavior is not fulfilled, that is to say, if it is not descriptively real-
istic. So, although we question an unconditional demand for realistic assumptions as a criterion
of evaluation, we believe that for most reasonable interpretations of the term "realistic," transac-
tion cost economics is superior to network theory on this count.

2.3 A very strong interpretation of opportunistic behavior

In this section we shall present some hard-nosed Hobbesian arguments for the analytical
necessity of opportunism.t The analysis is more uncompromising than Williamson's, for
example, since it implies that realized opportunism may under certain circumstances become a
general mode of behavior. Williamson is content to note that since we "cannot distinguish them,"
it is warranted to treat many people as potential opportunists, but not to treat them as having really
committed opportunistic acts or to behave opportunistically ourselves.
An overall argument for opportunism -- with which Williamson would probably agree -- is
that if we want to discover how economic institutions are able to turn conflict into cooperation,
we cannot -- purely as a matter of explanatory logic -- assume that people are naturally coop-
erative and honest. To some extent, however, this is what some of the critics of opportunism do:
it is taken for granted that economic organization is "embedded" in multifarious relations of trust
(which, in their turn, are not really explained), so that economic institutions".., do not produce
trust but instead are a functional substitute for it" (Granovetter, 1985, p. 489). In this view, it is
" . . . social relations, rather than institutional arrangements [which] are mainly responsible for the
production of trust in economic life" (ibid, p. 491).

*Much criticism has been levelled at Friedman's famous claim that the realism of assumptions is unimportant (Friedman,
1953). Friedman's reasoning, which has -- we believe rightly -- been judged as too extreme, has obscured the very real
topic of how to evaluate scientific explanations. Some reviewers seem to believe that, because the arguments offered by
Friedman against the demand for descriptive realism of assumptions are fallacious or at least, flawed, then descriptive
realism of assumptions is to be considered a requirement that should be fulfilled. But the latter position does not, of
course, follow from the former.
tGranovetter (1985, p. 494) noted "the Hobbesian flavor of Williamson's argument." Our arguments draw on the
arguments for employing the Homo Oeconomicus assumption in constitutional analysis presented in Brennan and
Buchanan (1985).
 THE NETWORK APPROACH 195

Matrix 1

bl b2

al (4,4) (-20,5)
A
a2 (5,-20) (0.0)

In some situations it may not be unreasonable to make the analytical assumption that every-
body will act opportunistically. The argument may be interpreted as a sort of Gresham's Law of
Behavior -- once a critical mass of opportunistic actors are present, bad behavior drives out good
behavior. This can be given various interpretations (here we follow Brennan and Buchanan, 1985,
pp. 61-62). Consider an initial situation in which there are both altruists and opportunists (and
abstract from repeated games and hostages). Suppose that the agents -- here A and B -- are linked
together in their interactions in a way that can be described by the following prisoners' dilemma-
matrix (where the numbers in the cells represent money values), Matrix 1. For example, A and B
can be envisaged as deciding whether or not to invest in transaction specific assets.
In this setting, wealth-maximization produces the suboptimal outcome, so that the agents end
up in the south-east cell. What is notable about the specified pay-offs is that the gain to each
player for the selection of strategy 2 is much smaller when the other player chooses strategy 1
than when he chooses strategy 2. For instance, A playing strategy 2 rather than strategy 1 only
gains one unit if B plays strategy 1, but 20 if B plays strategy 2. Assume now that A derives plea-
sure in proportion (say, one-tenth) to B's pay-offs. One implication is that A can be expected not
to harm B in their dealings (within certain limits), since A's utility depends positively upon B's
wealth. Assuming that A is risk neutral, Matrix 2 portrays A's (and only A's) pay-offs evaluated
in utility rather than monetary terms.

Matrix 2

bl b2

al (4.4, (-19.5,
A
a2 (3, (0,
196 NICOLAI J. FOSS and CARSTEN A. KOCH

What will A do? Obviously, there is no dominant strategy for A now; his best move depends
on what B does. If A knows that B is reciprocally altruistic, the socially optimal outcome results
(the north-west cell). If A knows that B is an opportunist the socially non-optimal outcome will
result, despite A ' s altruistic inclinations. But will A generally know whether B is "wicked" or
"righteous"? The Hobbesian and Williamsonian view is that he does not. Let us assume that A
chooses his strategy in order to maximize expected wealth. He will then have to have more than
93.3% confidence that the specific person he plays against will choose the altruist strategy, b l ,
in order to cooperate.* This example demonstrates that some degree of altruism will not
necessarily alter actual behavior significantly.
It should be remembered, however, that our example illustrates the case where there is only
one possible way of protecting oneself from opportunistic actions from others, namely to act
opportunistically oneself. Very often the best strategy, when faced with the possibility of
coming up against opportunistic action and provided that one is "vulnerable" to it, will not be to
act opportunistically oneself. Instead, contractual arrangements capable of protecting against
such behavior should be insisted upon, or some form of compensation should be demanded for
the risk exposure involved.
The implication of the above analysis is that altruism is not necessarily a rare bird, but rather
a delicate flower which can only bloom if certain institutions exist. In other words, economic
organization - - or constitutions - - should be designed with Homo Opportunisticus in mind:

In constraining any system of government and fixing the several checks and controls of the constitu-
tion, every man ought to be considered a knave and to have no other end, in all his actions, than
private interest (David Hume, Essays).

2.3.1 A variation on the theme. There is a particular and unpleasant way in which "favor-
able assumptions" about the human character of o n e ' s fellow men could be self-defeating, at
least if the assumption is used as a guide to actual behavior. A s s u m e that an economic actor
decided to act on the assumption that nobody would engage in opportunistic actions against
him. He might believe that this is justified because only a small proportion o f the potential con-
tract partners are given to opportunistic behavior. A s s u m e further that he is in fact v u l n e r a b l e t
to opportunistic actions, and that his potential contract partners stand to gain if they act oppor-
tunistically. Ceteris paribus, the potential contract partners with opportunistic intentions would
offer what looked like superior contractual terms, because they stand to realize greater gains
than the honest ones. Presumably, if information about the contract terms offered by this
believer in good faith were to become generally known, he would end up making deals with
opportunistic actors only. So, although only a certain proportion o f the economic actors were
opportunistic, all those making what appeared to him, ex ante, to be the better deals, would turn
out to be opportunists.

*Given the assumptions of the text, A's expected utility from choosing strategy al, E{U(al)}, will be p'4.4 +
(l - p)*(-19,5) = 23.9p - 19.5, where p is the probability that B will choose strategy bl. The expected utility from
choosing a2, E{U(a2)}, isp*3 + (1 -p)*0 = 3p. For A to be indifferent as between al and a2, E{U(al)} must be equal
to E{U(a2)}, so that 23.9 p - 19.5 = 3p. Solving forp, we getp = 19.5/20.9, approximatelyp = 0.933. Ifp > 19.5/20.9.
A will maximize his utility by choosing al ; ifp < 19.5/20.9, he will maximize his utility by choosing a2, i.e., by choosing
the non-cooperative strategy,
tCf. Koch (1994) for the concept of vulnerability and its importance in transaction cost economics.
 THE NETWORK APPROACH 197

2.4 Types of trust, risk and opportunism

Many of the recent explanations of the emergence of trust have started out from precisely the
kind of interactions depicted in section 2.3, the prisoners' dilemma-game.* But whereas the
argument above basically had a rational, design-oriented point of view, recent literature has
emphasized the potentially beneficial effects of selection forces operating among different
boundedly rational modes of behavior over time. And whereas the reasoning above assumed that
some agents had genuinely non-opportunistic dispositions, recent game-theoretical work
demonstrates how stable behavioral norms may develop even in settings where everybody is a
pure opportunist.
Central to all these stories is that the returns from being honest must outweigh the returns
from being dishonest, which may be the case when repeated interactions are indeterminate in
length (there is always a positive probability that the game will be played again), and given some
assumptions regarding certain other things, such as time preferences. The equilibria of such
repeated games -- an infinite number of which may exist (the so-called folk-theorem) -- are
then interpreted as norms of behavior, specifically as relations of trust between independent con-
tractors or organizational cultures within firms (Kreps, 1990), among the relevant players. Out
of pure self-interest specific agents may build up reputations for being trustworthy.
Most reasoning of this type has assumed two or relatively few fixed players, so that -- inter-
preted in an inter-firm context -- it is really at its strongest, so far, in the case of stable relations
between few contractors. Recent theoretical attempts have been made, though, to extend the
basic setting to sequences of traders playing against each other (e.g., Milgrom, North, and
Weingast, 1990),# and these results can be taken as loose, preliminary evidence for the future
possibility of constructing a theory of broad societal norms applying in a multiperson setting.
Furtherraore, they bear the seeds of a deeper understanding of relations of embeddedness
(Granovetter, 1985), i.e., the existence of meta-norms which co-regulate specific relations. In
such an interpretation, the taken-for-grantedness of such meta-norms is connected with the inter-
nalization of the behavioral regularities originally arising from prisoners' dilemma-like situa-
tions, so that these come to form part of the surrounding culture. The original game situation
and the sanctions of repeated plays are forgotten; conforming to norms is thus largely a matter
of tacit rule-following. Consequently, we should really distinguish between privately rational
reciprocity enforced by private play and the idea of a norm proper. It is something resembling
this Williamson (1992) is suggesting when he protest against the close identification of trust and
risk found in many contemporary contributions (for example, in Dasgupta, 1988), so that trust
becomes "calculative trust." Trust, proper, in Williamson's interpretation, is much closer to
what we have called a "meta-norm" above: it is largely non-instrumental and is not calculated
to promote self-interest. And this trust proper is not what usually characterizes business
relationships.

*The relevant literature is enormous, but among the most prominent work is the celebrated theoretical contribution of
"the gang of four" (Kreps, Milgrom, Roberts, and Wilson, 1982), and the empirical work of Axelrod (1984). Mention
should also be made of Kreps (1990). Other relevant game-forms are "the hawk-dove" game and the "chicken" game.
tFor some reservations, see Williamson (1991).
198 NICOLAI J. FOSS and CARSTEN A. KOCH

3. THE NETWORK APPROACH

3.1. Background
The ideas behind the industrial network approaches are related to the social network approach
in sociology, albeit with some differences. The most important of these is that in the industrial
network approach it is not only the actors and their exchange relations that are important: the
activities/resources, and the various dependencies* between them also have to be included in the
analysis (Johanson and Mattsson, 1987, pp. 37-38; H~kansson and Johanson, 1993, pp. 35-36).
In the sociological network approach, on the other hand, the actors and their exchange relations
are truly important, while dependencies are seen as being largely symbolic in character (ibid).
A number of related ideas appear under the umbrella of the industrial network approach. First,
there is the central notion that a large part of business relations -- especially long-lasting and
"important" relations -- should be analyzed as industrial networks. This is done by supplement-
ing the traditional technical-economic and legal--economic analysis with a perspective on
exchange relations inspired by the more traditional sociological network analysis. Second, there
is the view that networks are governance structures on a par, for example, with hierarchy and
market in the WiUiamsonian sense (H~kansson and Johanson, 1993, pp. 44--49). Third, networks
are seen as pervasive social institutions. Thorelli (1986) puts this as follows:

The point taken here is that the entire economy may be viewed as a network of organizations with a
vast hierarchy of sub-ordinate, criss-crossing networks (ibid, p. 38).

According to latter interpretation, stakeholder theory may be seen as a special case of network
theory (ibid, p. 44), and even "Industrial organization t h e o r y . . , in a sense may be viewed as a
case of attenuated network theory" (ibid).

3.2. The Swedish network approach

Many researchers describe their own contributions as involving networks and network theory.
Several schools can be distinguished. When we refer below to research in networks, we are
referring primarily to the research in marketing networks developed in Sweden, especially at the
Department of Business Administration at the University of Uppsala.~" Prominent proponents
include professors HLkan H~kansson, Jan Johanson, and Lars-Gunnar Mattsson. The approach
was originally developed with marketing research in mind (Johanson and Mattsson, 1993),
although it is no longer solely tied to marketing. It is related in particular to the first and second
points outlined in section 3.1 above.
As noted by Johanson and Mattsson (1993, p. 3): "Much work is needed before the network
approach can be considered a coherent theory." In line with this view, it seems to us that a con-
siderable part of what counts as the theoretical part of this literature can be regarded as a kind of
"stylized facts," statements summarizing the results of the many empirical studies that have been
conducted, but without a satisfactory explanation of the occurrence or importance. We do not
attempt to provide such a coherent theory, although we believe -- probably in opposition to some
researchers in the field -- that such a theory is really needed. We shall argue that this theory can-
not dispense with opportunistic behavior.

*In short, the goodsproduced,the economicresources available, and the productionfunctions (whether well-behaved
or givento X-inefficiencyd la Leibenstein, 1981).
~Cf. Johanson and Mattsson (1987); H~lkanssonand Snehota (1989, pp. 190-192);Johansonand Mattsson (1993) for
this research tradition.
 THE NETWORK APPROACH 1~)9

3.3. Fundamentals of the Swedish network approach

The typical and interesting kind of interaction that is envisaged as taking place between the
firms in the network consists of informal contacts between actors enjoying close interpersonal
relations. It is also assumed that power and its distribution among the actors in the network are
important (Thorelli, 1986). Underlying the distribution of power between actors are the relations
of dependence between the participants. As Johanson and Mattsson (1987, p. 36) have put it: "A
basic assumption in the network m o d e l . . . [is] that the individual firm is dependent on resources
controlled by other firms." This assumption of dependency could be regarded as wholly uncon-
troversial -- as a general condition of co-existence under any division of labor -- unless
precisely what is meant by "dependence" is specified, as well as the kind of behavior such
dependence may generate. This seems to imply the existence of a potential hold-up problem for
any single firm, since most of the firms participating in the network presumably have incurred
substantial transaction-specific sunk costs.
On the subject of self-interest seeking, Johanson and Mattsson (1987, p. 44) declare:

We do not regard opportunism as a basic characteristic of the actors. As in social network theory, its
correlate trust is an important concept in the network approach.

But it is still assumed that the participating firms pursue their own interests, so that competi-
tion occurs alongside cooperation in the network (Hhkansson and Johanson, 1993, pp. 39, 44;
H~tkansson and Snehota, 1989, p. 191): In order to reconcile these observations, we shall take
non-opportunistic self-interest seeking as characterizing actual behavior in a network. In such
circumstances legally enforceable contracts can be dispensed with. Instead, loose (verbal)
agreements, i.e. agreed conditions of exchange that are unenforceable by the legal system, can
presumably be relied upon instead.
But what is meant by refusing to see opportunism " . . . as a basic characteristic of the actors"?
We suggest that this phrase should be interpreted as meaning either (a) that actors participating
in networks are somehow "transformed" into non-opportunists, or (b) that actors are basically
non-opportunists, in the sense that conditions (i) and (ii) (see section 2.1) are not fulfilled. We
take (b) to be the most likely position held by Johanson and Mattsson and other network
theorists, and we consequently disregard (a). In the following sections we will discuss the
assumption of opportunistic behavior.

4. PROPERTIES OF A WORLD OF NON-OPPORTUNIST

SELF-INTEREST SEEKING*

4.1. The absence of opportunistic behavior

The best way of examining the validity of the assumption of opportunistic behavior is to
assume that it is false, and then to examine the consequences of this. But what precisely is meant
by the absence of opportunistic behavior? Obviously, it is not the same as the absence of self-
interest seeking.

*Section 4 is largely based on Koch (1994).

200 NICOLAIJ. FOSSand CARSTENA. KOCH

The difference between the "normal" assumption in economics of self-interest seeking, and
the assumption of opportunistic behavior, concerns the means whereby the actors pursue their
self-interest. Both models assume self-interest seeking prior to the making of agreements or con-
tracts. Considerations of fairness do not enter into either of them; for example, monopolists
charge prices above marginal costs, if they believe it to be in their best interest to do so. However,
given non-opportunistic self-interest seeking, actors will keep their promises, will disclose their
intentions, reveal their preferences, etc. The latter assumption would produce the three following
conclusions:

A. Loose agreements would be as safe as legally enforceable contracts. Consequently, actors would
not be expected to prefer one type of agreement or contract to another.
B. If considerations relating to "outsiders" are ignored, the sole purpose of making a written
contract would be that it should serve as a reminder of obligations.
C. Any investment in "trust relations" or in "building trust" would be a waste of resources, since
there would be no reason to destruct anybody.*

Note that the absence of opportunistic behavior is a sufficient condition for all of the three
conclusions to be true. If just one of them is not, then the condition of "non-opportunism" must
be false and the assumption of opportunistic behavior is true. In the following section, we discuss
A toC.

4.2. The consequences of the absence of opportunistic behavior further examined

4.2.1. A: the preferred form of contract. In his classic 1963 study Macauley noted that busi-
nessmen quite often rely not upon written contracts to regulate transactions, but on informal
agreements. In many other transactions, however, formal contracts are used. For example, few
people would consider buying or selling a house without a written contract. Furthermore, at least
in business settings, these contracts often involve considerable expenses. Ignore, for the remain-
der of this section, the notion of written contracts as "reminders," i.e. as devices made only in
order to store information about what was agreed, with no legal effect whatsoever. In other words,
we assume that contracts fulfill a different role from that of merely economizing on information
costs, or, rather of economizing on human memory storage capacity (which is, undoubtedly, an
important function of some contracts).
In this setting (and given the qualification just made), the dismissal of opportunistic behavior
means declaring that all activities related to contract drafting represent a waste of resources. For
example, no action intended to secure the intelligibility of the contract for outsiders, such as
lawyers, judges or (potential) litigators would be taken. We do not think that this is generally war-
ranted. We do admit, of course, that the foregoing is not quite true, simply because some actors
may prefer one contractual form to another, just as some actors prefer apples to peanuts. But it
would be inexplicable to the same extent as such preferences are inexplicable, or, at least, con-
sidered as being outside the explanatory realm of economics proper.
One might of course hypothesize that an argument based on preferences which are biased
towards special contractual forms suffices as the only explanation for the choice of contract form.
But a few moments of reflection on the implications of assuming that this hypothesis holds will
reveal its basic flaw. If this taste/distaste relationship was the sole explanation of the appearance

*Although they express themselves somewhatdifferently, we believe this to be consistent with the position outlined in
Bradach and Eccles (1989, p. 104).
 THE NETWORK APPROACH 201

of different forms of contracts, no correlation would be expected between, for instance, the
importance of a specific transaction and the contractual form relied upon to regulate it. The trans-
actions concerning the construction of a bridge and the purchase of an ice cream would, ceteris
paribus, with equal likelihood be regulated by written or unwritten contracts. More generally,
there would be only one variable with an expected correlation with the form of contractual
regulation of a transaction, namely the preferences of the participants. This seems to us to be an
absurd proposition.

4.2.2. B: the rationale for choosing written rather than unwritten contracts. Remember that
economizing on information costs may provide a rationale for written rather than unwritten (e.g.
purely verbal) contracts, if the possibility of memory deficiencies is allowed for. This would be
particularly relevant in complicated agreements, such as contingent claims contracting. If there
is a positive correlation between the importance of a relationship, and how complicated an agree-
ment has to be made, then there will be a positive correlation between the importance of the rela-
tion and the likelihood that the agreement will be "stored" in a written contract. But we have no
immediate way of estimating the importance of this correlation. This is unfortunate, because it
hampers empirical testing of proposition A. We must therefore consider the existence of other
counter-intuitive consequences of the "lack" of opportunistic behavior in the above interpreta-
tion that are not given to this correlation.
In fact there are such counter-intuitive consequences: in the absence of opportunistic behav-
ior, there would be no need for legal expertise to protect the participants from formulating a con-
tract in a way that exposes one of them to "unfair" conditions. Since legal expertise is costly, it
would not be used in order to protect the participants against each other, but only to ensure that
their contract was legal vis-gt-vis third parties. Again, we do not think that the latter is an accu-
rate description of reality. Legal expertise is a traded service, and we do not find it appropriate to
rely on ad hoc claims on the nature of the preference structure when accounting for its quite wide-
spread use.* Another consequence is that, in the absence of opportunistic behavior, there would
be no need to sign contracts. Since actors will stick to their word in a non-opportunistic world, a
signature or a verbal guarantee would be of equal value. This does not seem to us to be generally
true.

4.2.3. C: investment in trust. Point C was that, in the absence of opportunism, any investment
in "trust relations" or in "building trust" would be a waste of resources, since there would be no
reason to distrust anybody. We think that this argument is so self-evident as to warrant no further
comments on its logical validity. We will be concerned instead with the compatibility between
this argument and traditional networks literature.
Network theorists frequently refer to the assumption of opportunistic behavior as too "grim"
an assumption about human behavior. Consider, once more, the quotation from Johanson and
Mattsson (1987, p. 44):

We do not regard opportunism as a basic characteristic of the actors. As in social network theory, its
correlate trust is an important concept in the network approach.

*Which is not to say, of course, that it is always used wisely, or in the "proper" amount. In our complicated world.
bounded rationality is, loosely speaking, enough to guarantee that it will not always be.
202 NICOLAI J. FOSS and CARSTEN A. KOCH

Unfortunately, the authors do not provide a definition of trust. But they seem to be using the
term more or less in accordance with the definition provided by Bradach and Eccles (1989, p.
104), where trust is described as " . . . a type of expectation that alleviates the fear that one's
exchange partner will act opportunistically." Note that this general conception is perfectly con-
sistent with the kind of "calculative trust" discussed earlier. As noted, we take (b) in section 3.4
to be the position most likely held by Johanson and Mattsson and other network theorists. But
consider the words of social exchange sociologist Peter M. Blau,* quoted by Johanson and
Mattsson (1987, p. 37):

Social exchange relations evolve as a slow process, starting with minor transactions in which little
trust is required because little risk is involved and in which both partners can prove their trust-
worthiness, enabling them to expand their relation and engage in major transactions.

In other words, in the "early" part of a potentially long-term exchange relationship, actors
expose themselves to risk, and then move on to mutually proving their trustworthiness so that the
full value of their relation can be realized. Johanson and Mattsson claim that the same takes place
in networks (ibid, p. 37). Since at least one of the actors could break out of the relationship with
a short-term advantage (otherwise, no risk would be involved for the other), it is not unfair to
consider the resource outlays as investment in building up trust. But what such considerations
basically amount to is a claim that social relations develop from initial situations characterized
by risk and potential opportunism to become situations in which opportunism has been strongly
mitigated by investments in trust. In other words, we seem to have encountered two propositions
that are flatly contradictory: (P1) Actors are assumed to be basically non-opportunists; (P2) Trust,
and investments in trust, are prevalent.
The consequence of these considerations is that many scholars, including network theorists,
have, implicitly, argued in favor of the assumption of opportunistic behavior, since they report
that many activities are undertaken in order to build or maintain trust. When Johanson and
Mattsson (1987) quote Blau and invoke his authority in support of the notion that trust relations
develop gradually to safeguard against contractual risk, they are implicitly invoking an argument
based on opportunism. The reasoning presented by Johanson, Mattsson and Blau indicates
precisely that actors suspect their transaction partners will act opportunistically, and that they
only expose themselves to considerable risk once their transaction partners have proved that they
acted in a non-opportunistic fashion on some previous occasion. Briefly, it is our view that the
quotation can be used to support the view that economic actors make "experiments," not that eco-
nomic actors are not given to opportunistic behavior. And, indeed, if these "experiments" did not
turn out badly once in a while, they would probably be abandoned altogether.

4.3. Summing up
Thus we find the implications of assuming that economic actors are not given to opportunis-
tic behavior to be strongly at variance with the most reasonable interpretations of the social world.
It is not possible to put forward simultaneously the propositions (1) that actors are inherently non-
opportunistic, and (2) that trust relations do exist, are important and are non-trivial. They are
inconsistent propositions. The conclusion must be, then, that opportunistic behavior does exist,
and thus constitutes a realistic assumption. We also know, from demonstrated scientific practice,
that it is not too difficult to be analytically tractable. Following the above argument, that the

*It is perhaps an odd choice to use Blau in attacking opportunism. B l a u ' s man is a much less benign being than
Williamson's.
 THE NETWORK APPROACH 203

explanation of economic institutions is designed to - - and, indeed, hardly rationalizable by other

theoretical means -- further economic transactions by protecting the participants, it should be
accepted as a necessary analytical assumption.

5. C O N C L U D I N G COMMENTS

In this article we have come out strongly in favor of the assumption of opportunism and more
implicitly in favor of organizational economics. The argument that we have repeatedly used is
the essentially simple one that in the absence of opportunism, it is not possible to make sense of
a number of existing institutions, such as firms, various contractual forms a n d trust relations.
As was noted by Johanson and Mattsson (1993, p. 3), there is still no coherent theory of networks
(here we refer exclusively to the "Swedish" approach; cf. section 3.2). It might, therefore, be asked
whether the insights of the network approach are merely transaction cost arguments in disguise, or
whether this approach promises to become a t h e o r e t i c a l rival. For approaches to become rivals they
have to address the same phenomena with different assumptions and using different analytical tools.
In our opinion, the answer to this question is both "yes" and "no." For some phenomena, such as
the r a t i o n a l e of trust-based inter-firm relations, network arguments are not in any fundamental con-
flict with organizational economics, and can even be argued to be wholly interpretable in terms of
transaction cost economics. If this last interpretation is adopted, we are led to the conclusion that
network analysis is not a serious competitor to transaction cost economics.
This conclusion is not altogether warranted, however, since the two approaches are not char-
acterized by a full congruency of their explananda. In general, network analysis is much more
oriented towards dynamic issues than transaction cost economics, which is arguably to some
extent a reflection of its more informal nature. This is where there is room for dialogue. First,
the network approach has provided much empirical grist to the transaction cost mill. Second, not
all network arguments and assumptions -- such as the emphasis on dynamics -- lend themselves
directly to transaction cost interpretations. On the other hand, the network approach has not
addressed the existential issues associated with various kinds of economic organization, includ-
ing trust relations. This clearly points towards a relation of complementarity between insights
from the two approaches. In so far as this complementarity can be fruitfully developed, we may
ultimately achieve a more comprehensive and dynamic framework for analyzing inter-firm rela-
tions. Thus our ultimate conclusion is that what we see as the spirit of the network arguments is
either clearly reconcilable with transaction cost economics or is complementary to it. For exam-
ple, to the extent that the network approach asks "why is there, sometimes, not integration even
though asset specific investments are called for?," both the question and the trust-centered answer
are reconcilable with organizational economics and the assumption of opportunism.

Acknowledgements -- We have benefited from the comments of Bo Eriksen and B¢rge Obel, Department of
Management, Odense University, and Richard M. Burton, Fuqua Business School, Duke University. Nancy Adler
commented extensively on the language applied. However,all remaining errors are our responsibility.

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