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Trust and Corporate Performance


Sandra Rothenberger
Innsbruck University School of Management
Unit for Strategic Management & Leadership
Universitaetsstrasse 15
6020 Innsbruck
Tel. ++43-512-507-7183
Fax ++43-512-507-2968
Florian Schmid
Roland Berger Strategy Consultants
Arabellastr. 33
81926 Munich
Tel. +49-89-9230-8973
Fax +49-89-9230-8264

The impact and relevance of intangible strategic assets in economic transactions and on
financial performance has been the center of various empirical studies. These studies however
have so far failed to close what appears to be a gap in empirical research between trust and
knowledge intensity and trust and corporate financial performance. Zaheer et al. (1998) were
the first to link inter-organizational trust with performance; however they exclusively focused
on supplier-buyer relationships with performance being determined using satisfaction
measures. Due to this lack in empirical research, the primary goal of this study was to
investigate the relationships between inter-organizational trust and corporate financial
performance outcomes measured as return on assets (ROA). A new model to measure the
impact of inter-organizational trust on financial performance was proposed and tested
indicating that trust not only enhances information-sharing and thus knowledge intensity but
also has an impact on financial performance (ROA).

Key words - Trust, Knowledge intensity, Performance, Return on Assets (ROA), Structural
Equation Modeling (SEM)

Studies concerning trust in economic transactions have been conducted by various researchers
(Nooteboom et al., 1997; Williamson, 1994; Wilson & Kennedy, 1999; Zaheer &
Venkatraman, 1995, Zucker, 1986). The question that needs to be answered is whether trust
really pays off in hard economic benefits, or whether it only brings marginal economic
benefits into economic exchange relationships? While the theory side on this issue is well

developed, empirical research is lacking with the exception of some case-study evidence
provided by Dore (1983), Lorenz (1988) and Fukuyama (1995).
These studies, however, have so far failed to close what appears to be a gap in empirical
research between inter-organizational trust, knowledge intensity and corporate financial
performance. Zaheer et al. (1998) were the first to link inter-organizational trust with
performance, however exclusively focusing on supplier-buyer relationships with performance
being measured using satisfaction measures.

Theoretical foundation and research hypothesis

Akerlof (1970) original analysis of the US car industry was among the first to suggest that
trust might be an important factor to transactions. He argued that buyers of used cars could
hardly make any statement about the quality of a car unless they bought it and drove it for a
time. The seller of the car in most cases has a good idea about the quality of the car, there are
however no easy means of diffusing this information in a believable way. The buyer knows
that the seller will describe the quality of the car as good no matter what the actual status of
the car, and that the seller will make a large profit if he manages to sell a bad or lemon car
as a reliable car. Due to this risk, a buyer will be unwilling to purchase a used car at a high
price, and if sellers cannot sell any used car at a high price, they have only incentives to sell
lemons. Other factors absent, only lemon cars will be traded at low prices, which has a
negative outcome for both sellers and buyers even though it is based on individual rational
behavior. This analysis however is limited to the extent that it does not consider the
possibility of iterative transactions, in which an actor can limit ones transactions to those
partners that are known or have proven to be trustworthy.

The notion of trust in economic transactions has attracted substantial thought in the recent
academic research (Barney and Hansen, 1994; Mayer et al., 1995, Zaheer et al., 1998). Trust
is defined as one partys confidence that the other party in the exchange relationship will not
exploit its vulnerabilities (Barney and Hansen, 1994; Sako, 1991; Zaheer et al., 1998). Mayer
et al. (1995) explain the emergence of trust in an exchange relationship in situations where
one party is known to make good-faith efforts, to make fair adjustments to a contract in case
market conditions change, and does not take advantage of the transaction partner even in
cases when the opportunity to do so is given (Mayer et al. 1995). Trust however is a
phenomenon that can only be observed on the micro-level, not on the organizational level. It
is based in individuals and can be placed by individuals in other individuals or group of
individuals within other organizations. Following this line of argumentation, Zaheer et al.
(1998) concluded that trust between organizations is based on the amount of trust,
organizational members hold collectively towards the partner firm (Zaheer et al. 1998).
Trust in exchange relationships has been proposed to be an economic asset of significant
value because it is supposed to lower transaction costs and to allow for greater flexibility in
responses to changing market conditions (Barney & Hansen, 1994), as well as to lead to
superior information sharing that improves coordination and joint efforts to minimize
inefficiencies (Aoki, 1988; Nishiguchi, 1994). Some researchers even claim that the
efficiency of a countrys national economy is positively related to a high-trust institutional
environment (Fukuyama, 1995; North, 1990). This claim has amplified interest in the crucial
function of trust in economic transaction. In spite of the fact that the theoretical literature on
the potential economic value of trust is well developed, empirical proof with a few exceptions
(Fukuyama, 1995) is absent. Barney and Hansen (1994) have argued that trustworthiness
reduces transaction costs in exchange relationships and can potentially serve as a source of
competitive advantage; however empirical research supporting this hypothesis is to the
knowledge of the authors with a few exceptions (i.e. Dyer & Chu, 2003) lacking.

Trust is capable of reducing transaction costs in a number of ways. The ex ante transaction
costs can be reduced by high levels of trust, since the partners do not have to specify a large
amount of possible scenarios resulting from environmental factors in their contract, but have
faith in the partner that they can agree on a solution that is acceptable to both partners.
Consequently, trust helps reducing the needs and costs for the transacting parties to invest
heavily in ex ante bargaining. Ex post transaction costs can be minimized by trust between
partners for two main reasons. First, partners having high trust between each other will spend
less time and resources monitoring the partner in order to see whether she is fulfilling her part
of the agreement (Dyer & Chu, 2003). Second, high trust also reduces the time and resources
partners have to invest in order to negotiate changes to the contract due to changes in
environmental contingencies, since each party will expect the other party to be acting in good
faith (Uzzi, 1997).
If theory is correct that trust lowers transaction costs and increases information sharing, then
higher levels of trust between business partners should lower their total costs, thus providing a
boost to financial outcomes. Companies capable of economizing on transaction costs will
experience superior performance (North, 1990; Williamson, 1991b). This would be
particularly true if transaction costs are as high a share of total costs as predicted by Butler et
al. (1997) and North (1990). Concluding both theory and previous research studies, it can be
argued that higher levels of inter-organizational trust lower transaction costs and enhance
information-sharing, thus increasing corporate financial performance outcomes.
Though hypothesis I and II can be defined as the following:
H1: The higher the level of inter-organizational trust between business partners,
the higher their financial performance outcomes.

H2: The higher inter-organizational trust, the higher is the enhancement of
information-sharing and thus knowledge intensity.

Figure 1 Construct for testing hypothesis I and II

Research instrument, theoretical construct and variables

In regards to the issue of designing the survey instrument, the use of constructs has played an
important role in strategic management research. Constructs or scales are defined as latent
variables that cannot be measured directly. In any research concerning qualitative ROA
performance measurement, there is no device that can precisely produce measurement
through a single metric unit. Therefore researchers usually employ two or more measures to
gauge a construct or scale. Working with constructs or scales of measurement, however, is a
complex task, moving from development to final validation. Since the primary objective of
this research is to examine the relationship between trust and corporate performance, we
attempted to use pre-tested items from past empirical studies to ensure their validity and
reliability (Prajogo and Sohal 2006; Tata et al. 1990).

The recent performance measurement literature suggests that organizations should put more
emphasis on non-financial measures qualitative performance measures - in their
performance measurement systems that organizations must use new performance
measurement approaches such as trust, knowledge intensity and that measures should be
aligned with contextual factors such as reputation and environmental structure (Gosselin
As the focus of this research lies on the analysis of the relationship between trust and
knowledge intensity and trust and corporate performance, the following dependent and
independent variables will be explained and used for the theoretical construct:

Dependent Variables corporate performance (ROA)

The use of an accounting-based financial measure was necessary due to the fact that marketbased performance measures such as Tobins q are not available for any company in this
sample. Using return on assets (ROA) as a dependent variable would have resulted in
redundancy problems since firm size in this research is also determined through annual sales.
As the applied dataset consists of a very homogeneous group of firms - they all are operating
in the same home market, and in industries following similar patterns, thus resulting in rather
similar objective environmental conditions in terms of legislation, regulation, public
institutions and the political environment the ROA was selected as a dependent variable.
Competition is high due to low entry barriers into the European markets, however high exit
barriers due to high assets specificity. Heavy investments in machinery and equipment are
necessary to maintain ones competitive edge and the efficient use of productive assets is
essential. Even minor variations in resource productivity can result in major changes in a
firms competitive positioning. Additionally the ROA as a dependent variable allows for a
comparison of the results gathered through this study with the ones resulting from similar

research in other geographic settings and last but not least constitutes an easy to derive
variable, which can be easily calculated from the profit and loss account and the balance

Independent variable - knowledge intensity

Knowledge intensity was used as an independent variable for this research as it indicates
whether the production process of a firm requires high technical and knowledge intensive
skills. So far, no generally accepted method to measure KI has been developed (Autio et al.,
1999). Objective indicators like R&D expenditures as well as patents face accuracy problems
(Spender & Grant, 1996), since R&D expenditures can be observed to be high when sales are
low (Eisenhardt & Schoonhoven, 1990). On top of that, since especially small companies do
in most cases not have a distinct R&D department, the cash flows into this field are often hard
to assess. The number of patents held is more likely to reflect the strategic positioning rather
than innovation or knowledge intensity (Eisenhardt & Schoonhoven, 1990). As a result of
this, the assessment of managers is often the preferred method of measuring KI, especially in
small companies (Eisenhardt & Schoonhoven, 1990). Thus, using 7-point Likert scales, we
measured knowledge intensity via executives ratings of four statements on the extent to
which KI characterized the company.

Independent Variables inter-organizational trust

Rempel and Holmes (1986) were the first to develop a reliable measure for interorganizational trust, which was adapted by Zaheer et al. (1988) in their research paper. Even
though Zaheer et al. (1998) yielded good results with their measure, this research did not
follow their approach for several reasons. First of all, Rempel and Holmes (1986) only take a
limited number of measures into account known to affect the construct of inter-organizational
trust. Theoretical research on trust has come up with a variety of new approaches on how to

build up trust, which were not considered in the measure developed in 1986. These include
for instance a transaction partners reputation, which was shown to have direct impact on
trust-building (Podolny, 1994; Podolny and Philips, 1996). Rempel and Holmes (1986) as
well as Zaheer et al. (1998) also omit such factors like technical trust as well as the business
partners reliance on legal binding contracts from their measure.
Due to these researches, knowledge intensity and inter-organizational trust were measured
developing a new construct using eight closed questions. Responses were on a 7-point Likert
scale with anchors ranging from strongly agree (1) to strongly disagree (7).


performance variable was computed as the ratio of net income to total assets which include
current assets, net property, plant and equipment, and other non-current assets as identified by
the company reported during each fiscal year.








In contact with business partners you have never had the

feeling of being misled


The longer a business relationship with a business partner lasts, the better and faster
the understanding with him/her


You remain cautious to new business partners until they prove that they
are trustworthy


You cover everything watertight in contracts


Specialized knowledge and technology required for your production process is easily
available in the market


The Economic Value Added during the production process is high


Special knowledge required for the production process is equally divided among different
members in the organization


Much time has been spent acquiring the procedures necessary for the demands of your

Table 1 Eight questions used to determine inter-organizational trust and knowledge intensity

Figure 2 The hypothetical structural relationship of inter-organizational trust, knowledge

intensity and the return on assets (ROA)

Research and sample design
To measure the causal relationship of inter-organizational trust on knowledge intensity and on
corporate performance, the sample consists of small and medium sized unlisted industrial
enterprises headquartered in Germany. This industry sector is characterized by both intense
national and international competition, resulting in an ever increasing pressure to innovate,
cut costs and exploit market opportunities as they arise. The operating companies chosen for
the sample in this industry cluster rely heavily on long-lasting business relations to their key
suppliers and customers and the means of competition are mainly innovation and efficiency
maximization through the use of superior production technologies.
The empirical data was obtained by sending out questionnaires to 3,978 German industrial
SME. A total of 705 questionnaires were returned and as many of them contained large
amounts of missing data, especially with regard to the section investigating trust, technical

knowledge, industry volatility and financial performance, the final response rate accounted
14,2% (= 565 questionnaires).
A standardized questionnaire with closed-response questions using 7-point-rating scales
(1=strongly agree 7=strongly disagree) was developed. Based on the definitions of the
constructs, the variables were generated by the literature (Rempel and Holmes 1986) and the
research team to measure the constructs. These variables were then presented to the other
experts of the research department. The team members discussed the variables, added
variables where necessary, reworded variables and deleted variables to improve the
questionnaire. The questionnaire was then pre-tested and administered to the companies.
Data Analysis
The selected data analysis method involved two major steps: the data reduction process using
an explorative factor analysis and the structural relationship analysis using structural equation
modelling (SEM) method with AMOS 5.0. The data reduction process aimed to reduce the
number of variables and parameters in the research model to a manageable number in terms of
the ratio between sample size and parameters estimated in the research model (Hair et al.
1998). The structural relationship analysis was used to examine the factor interorganizational trust as well as examining the relationship among trust and the relation to the
dependent performance variable ROA.
Data reduction process
In order to bring the eight variables into two composite construct the data reduction and
correlation process was conducted. Four variables represented the inter-organizational trust
and four variables the knowledge intensity construct. These two construct were subjected to
validity and reliability tests before a single score could be calculated to represent each

Confirmatory factor analysis (CFA) using AMOS 5.0 was employed for examining construct
validity of each scale by assessing how well the individual item measured the scale. During
the process, no items were deleted due to poor loading to their respective latent variables. The
value of Goodness-of-Fit Indices (GFI) of the two constructs cannot be computed because
only two to four items were left per construct that will result in a zero degree of freedom.
However, AMOS 5.0 still could estimate the parameters of the scale, and the result supports
robustness of the construct. The path coefficient of each item in differentiation scale is
significant (p<0.05) and reasonably high (0.8), hence, establishing the convergent validity of
the scale.
Standardized Regression

Level of Significance
(*** p<0.001, ** p<0.01, * p<0.05, n.s.=
not significant)

Watertight contracts
inter-organizational trust



Cautious to new business

inter-organizational trust
Long lasting relationships
inter-organizational trust





Contact with business

inter-organizational trust
Return on assets
inter-organizational trust





Technology knowledge
knowledge intensity



Specific knowledge
knowledge intensity



Acquiring procedures
knowledge intensity



High EVA knowledge




Inter-organizational trust
knowledge intensity



Table 2 Path coefficient: standardized regression weights and level of significance

As such, exploratory factor analysis - using SPSS 13.0 - was used instead to proof the validity
of the scale. Despite its weaknesses, this method is commonly employed in many empirical
studies. By using principal component analysis and varimax rotation, all items were extracted
into factors based on the eigenvalue greater than 1, and the final result indicates a strong
construct with variance exceeding 60% for every factor.
Data reliability
The reliability of the construct was tested calculating item-to-item-correlations and Cronbach
Alpha. The results show that the Cronbachs alpha measure for the construct well exceed the
recommended critical point of 0.7 (Nunnally 1978) hence, establishing their reliability. The
final result of construct validity and reliability tests of the construct is reported in Table 3.
Inter-organizational trust was measured with four items: watertight contracts, remain
cautious, long lasting relationships and contact with business partners and knowledge
intensity was also measured with four items technological availability, divided
knowledge, procedures for customers and high EVA. Both constructs showed a
Cronbachs alpha with = .768 (trust) and = .720 (knowledge) and therefore exceeded the
recommended critical point of 0.7 (Nunnally 1978).

The purified scales were then used to test the causal relationship between the impacts of interorganizational trust on corporate performance and knowledge intensity using structural
equation modelling with AMOS 5.0.

Model fit
First, the overall fit of the observed data to the model was tested. The first test yielded a chisquare value of x/df = 7.252 (df = 23, p = .000; cmin = 166.790), implying that the model
was not adequate. However, literature suggests that chi-square is only recommended with
moderate samples (Hu and Bentler 1999), e.g. 100 to 200 (Tabachnik and Fidell 1996), as
with larger sample sizes in the actual study we have a sample of 565 -, trivial differences
become significant. Our measurement model showing a CFI value of .939 well exceeds the
lower bound of .9 and therefore can be considered as an indicator for a very good model fit.
Also the Tucker-Lewis index (TLI), which is less susceptible to non-normality of data (West
et al. 1995) and sample size (Marsh and Balla 1988), yields a corroborating value for good
model fit of .904. In summary, the hypothesized model can be regarded as fitting for the
sample data.
In the next step, reliability of the measures was tested calculating the composite reliability
(CR) of the constructs and the average variance extracted (AVE) (Fornell and Larcker 1981),
resulting in the following values:


Cronbachs alpha

Construct reliability

Average variance

inter-organizational trust




knowledge intensity




Table 3 Reliability of constructs

Regression Paths
This part of the analysis is focused on comparing the direct path coefficients between the
dependent performance variable ROA and the impact of the independent variables interorganizational trust and on knowledge intensity (Figure 3). As the structure equation model
displays the results of the analysis it is evident that the direct path between ROA/ interorganizational trust and inter-organizational trust/ knowledge intensity is highly significant,
meaning that there is a certain proportion of variance between the variables. Interorganizational trust has a strong impact on the dependent performance variable ROA (= .91,
p=.000, R = .24). Thus, the hypothesis: The higher the level of inter-organizational trust
between business partners, the higher their financial performance outcomes. is supported.
Inter-organizational trust has a good impact on knowledge intensity (= .52, p=.000, R = .44)
and therefore hypothesis II: The higher inter-organizational trust, the higher is the
enhancement of information-sharing and thus knowledge intensity. is supported.

Figure 3 Trust on Corporate Performance and knowledge intensity model (SEM)

Discussion and future research

The results show that manufacturing firms continue to use financial performance measures.
Despite the recommendations from experts and academics, the proportion of firms that
implement a balanced scorecard or integrated performance measurement systems is low.
Furthermore, organizations that use these approaches are not employing more extensively
non-financial measures than those which are applying traditional performance measurement
approaches. This research project also shows that there are some significant relationships
between the types of measures and contextual factors like strategy, decentralization and
environmental uncertainty. This research finally demonstrates clearly that there is a need to
develop a theory that explains how firms can use their performance measurement system to
enhance their performance. This paper provides information on performance measures used
by organizations and their association with organizational determinants (Gosselin 2005).
Longitudinal research as well as research across multiple industry settings could shed more
light on both the validity of the causal links we suggested as well as the generalizability of
these finding in differing industry conditions. The results shown in this research indicate a
need for studies further investigating the link between trust, knowledge and performance
empirically. Particularly longitudinal designs are required for establishing both the nature and
direction of the associations between trust and company performance. These research studies
should pay more attention to the measurement of trust, identify its different dimensions and
provide a more complex picture of the benefits companies are likely to gain from pursuing
initiatives to establish and develop trust relationships with business partners. On top of that,
the links between all aspects of trust on financial performance on one side and trust on
knowledge intensity on the other deserve a closer examination in future research.

A new model to measure inter-organizational trust on knowledge intensity and interorganizational trust on the performance measure ROA was proposed and tested in this
research study. The causal model provides strong support for the validity of this construct.
This research is among the first one to suggest that inter-organizational trust does not only
enhance knowledge intensity, but that this relationship might work both ways. We believe
these contributions to be important, especially given the tendency to conceptualize resource
differences in static terms. To the best knowledge of the authors, this research is also among
the first to show that there is a negative relationship between knowledge intensity and
perceived environmental uncertainty. This finding provides strong support for the argument
made by Milliken (1990) that executives in resource-rich organizations perceive the
organizations less threatening than decision-makers in resource-poor organizations.

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