Embeddedness Posicional e Relacional

Strategic Organization
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Should you bank on your network? Relational and positional embeddedness in

the making of financial capital
Andrew V. Shipilov
Strategic Organization 2005; 3; 279
DOI: 10.1177/1476127005055793
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STRATEGIC ORGANIZATION Vol 3(3): 279–309
DOI: 10.1177/1476127005055793
Copyright ©2005 Sage Publications (London,Thousand Oaks, CA and New Delhi)
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Should you bank on your network?

Relational and positional embeddedness
in the making of financial capital
Andrew V. Shipilov INSEAD, France
Abstract
This study explores the mechanisms through which relational embeddedness affects the
performance of banks in syndication networks formed in the Canadian investment banking
industry. I argue that banks have a choice between building embedded network ties that
are overlaid with social context and arm’s-length ties that facilitate individual competition.
Contrary to the arguments advanced in previous studies, I propose that maintaining a mix
of arm’s-length and embedded relationships represents a disadvantageous network strat-
egy. Such strategy not only simultaneously exposes investment banks to competition from
their peers, relying primarily upon embedded or arm’s-length ties, but also sends confusing
signals about banks’ networking behavior. I also propose that the link between relational
embeddedness and performance is moderated by banks’ positional embeddedness,
reflected in their status, and find that banks of higher status extract greater benefits from
maintaining embedded ties, as compared with banks of lower status.
Key words • embeddedness • investment banking • networks • status
The notion that the structure of a firm’s ties to partners is consequential to the
firm’s performance is now a commonly accepted postulate in the field of strategy
and organization (Gulati et al., 2002; Owen-Smith and Powell, 2004). Patterns
of a firm’s structural embeddedness have clear consequences for its survival
(Baum et al., 2000), market share (Rowley and Baum, 2004) and innovation
output (Podolny et al., 1996). Less clear, however, is the field’s understanding of
the exact nature of mechanisms translating a firm’s network position into its
performance outcomes, as firms competing in different industries seem to
extract different benefits from following the same patterns of structural em-
beddedness (Ahuja, 2000). The key to understanding these mechanisms is to
systematically analyze the types of relationships that firms maintain with their
partners (Baker and Faulkner, 2002) and to examine how these ties help firms
improve performance in different industry contexts (Rowley et al., 2000).
Uzzi (1996, 1997, 1999) proposes that ties among firms and their partners
can be viewed as either embedded or arm’s-length. Embedded ties represent
279

280 S T R AT E G I C O R G A N I Z AT I O N 3 ( 3 )
relationships overlaid with social context and associated with trust between
partners. In contrast, arm’s-length ties are characterized by short-term profit
orientation and sporadic transactions, similar to the elements of atomistic com-
petition described by some economists (Wilson, 1989). Firms connected to their
partners through embedded or arm’s-length ties are likely to experience benefits
and liabilities specific to the relational strategy they have adopted. Firms that
rely upon arm’s-length ties enjoy flexibility and access to diverse information in
their networks, while firms that rely upon embedded ties can capitalize on trust,
reciprocal fine-grained information exchange and joint problem-solving
arrangements with their partners. However, embedded ties can become liab-
ilities either when a firm’s partners exit the market, or when external shocks to
an industry render previous social relationships obsolete. Furthermore, an over-
reliance upon embedded ties could potentially result in a firm’s isolation from
the rest of a network.
Uzzi (1997, 1999) argues that firms benefit from maintaining a mix of
arm’s-length and embedded relationships, because this provides them with the
advantages of both strategies. However, there has been little research conducted
to corroborate Uzzi’s hypotheses in different settings. As Ahuja (2000) suggests,
benefits of particular network structures will vary according to the context in
which firms are competing, as the nature of competition in different industries
materially affects the mechanisms that translate firm embeddedness into perfor-
mance. As will be argued in this article, in the Canadian investment banking
industry, banks forming syndication relationships to underwrite public offerings
can suffer from maintaining a mix of embedded and arm’s-length ties. At one
end of the spectrum, banks following a mixed relational strategy will be exposed
to competition for deals from arm’s-length banks; at the other end, such banks
will also be competing with banks following an embedded strategy. Such simul-
taneous competition is likely to severely limit the number of deals available to
underwriters following the mixed strategy, and result in these banks being
crowded out of their markets. Furthermore, by following a mixed relational
strategy, banks are sending conflicting signals about the true nature of their
networking behavior, which is likely to confuse their prospective partners and
make the latter unwilling to cooperate. The crowding-out effects and uncertain
signals about banks’ networking behavior may well contribute to the reduction
of performance among banks following the mixed relational strategy, contrary to
what Uzzi (1999) found in his study of relationships formed between entrepre-
neurs and commercial banks.
While the type of ties (i.e. embedded or arm’s-length) through which firms
directly connect to their partners is an indicator of their relational embedded-
ness, the position of firms within an overall industry structure characterizes their
positional embeddedness (Gulati and Gargiulo, 1999; Podolny, 2001). Most of
Uzzi’s (1997, 1999) arguments appear to suggest that all firms in an industry
will be similarly affected by the liabilities of embeddedness. This article, how-
ever, advances an argument that the benefits and limitations of network ties

S H I P I L OV : S H O U L D YO U B A N K O N YO U R N E T WO R K ? 281
depend on a firm’s position (status) within its industry, with higher status
helping firms to avoid the liabilities of embeddedness and increasing the
benefits that firms can reap from maintaining embedded ties.
Many previous studies on the issues surrounding network embeddedness
have been cross-sectional in nature, which have prevented researchers from
empirically separating a firm’s network ties and network positions from their
consequences. To obtain comprehensive insights into the association between
network position and performance, researchers need to depart from the tradi-
tional static view of networks and rely on dynamic models that capture changes
in network structures and firm performance over extended periods. Data on
syndicate formation among Canadian investment banks between 1952 and
1990 provide a rich resource for testing hypotheses in the present study, con-
tributing to the small but growing number of dynamic network analyses
(Walker et al., 1997; Gulati and Gargiulo, 1999; Ahuja, 2000; Podolny, 2001;
Baum et al., 2003; Owen-Smith and Powell, 2004).
Components of relational embeddedness
Embeddedness can be broadly defined as the contingency of economic action

with respect to cognition, culture, political institutions and social structure
(Zukin and DiMaggio, 1990: 15–23). The first three contingencies are the
products of actors’ mental processes, shared collective understandings and
struggle for power in a society, respectively. The final element, structural
embeddedness, is the product of ongoing social relationships, which consists of
at least two components, namely positional and relational embeddedness. While
relational embeddedness commonly comprises the effects of direct ties between
actors on their behavior (Uzzi, 1996; Gulati and Gargiulo, 1999), positional
embeddedness is an outcome of the actors’ location within the social structure as
a whole (Gulati and Gargiulo, 1999; Podolny, 2001). Direct ties between actors
can be characterized as either embedded or arm’s-length (Uzzi, 1996).
Embedded ties represent relationships that are overlaid with social context and
mutual obligations among parties. Firms with embedded ties are heavily depen-
dent upon the small group of allies to whom they are connected through
exchanges of social obligations and trust, creating so-called ‘identity-based net-
works’ (Hite and Hesterly, 2001). In turn, arm’s-length ties are characterized by
Uzzi (1999) as ‘lean and sporadic transactions without any prolonged human or
social contact between the parties’. These ties consist of short-term relation-
ships, and are similar to market-mediated transactions traditionally described
by some economists (Williamson, 1991; Wilson, 1989). Networks composed of
such firms are sometimes referred to as ‘calculative networks’ (Hite and
Hesterly, 2001), reflecting the self-interested orientation of their members.
Both embedded and arm’s-length ties can provide firms with important
benefits, while exposing them to potentially dangerous liabilities. As Uzzi

(1997) points out, personal relationships within arm’s-length networks are cool
and atomistic. Arm’s-length firms choose partners primarily based on the com-
parison of either prices or the quality of partners’ products with those offered by
other market participants. Accordingly, arm’s-length ties help firms improve
performance, because they allow them to disperse their business across many
competitors, conduct an industry-wide search for information and avoid small-
numbers bargaining situations that can entrap them in inefficient relationships
(Hirchman, 1970). Previous research has shown, for example, that a large net-
work of arm’s-length ties to lenders expands the borrowers’ pool of potential
loan offers and their ability to play lenders against one another (Eccles and
Crane, 1988).
Since arm’s-length ties are usually established with multiple firms, they
result in an increase in the absolute number of indirect relationships between a
focal firm and its partners’ partners. Organizations tied to a common partner can
utilize mutually advantageous information from that contact (Baker, 1990).
This information allows firms to determine whether they could benefit from
establishing a direct relationship between each other. The mere fact that firm ‘A’
is cooperating with firm ‘B’ can be viewed by B’s partners as a signal of A ful-
filling the same quality standards as they do. Such mutual quality certification
by the existence of a common partner would then facilitate future cooperation
between firm A and other partners of firm B. Thus, through an increase in the
number of indirect relationships, arm’s-length ties expand future partnering
opportunities for the focal firm (Gulati and Gargiulo, 1999). Furthermore,
arm’s-length ties provide firms with a considerable degree of flexibility in choos-
ing their partners and in adapting to environmental changes. When a firm’s
existing partners no longer have the resources or capabilities sufficient to meet
its needs, the firm maintaining arm’s-length networks can easily abrogate its
existing relationships and build new ones with different partners. Since arm’s-
length ties do not presuppose reciprocity, abandoned partners will be unlikely to
see such actions as violating mutual commitments and will be willing to
work with the focal firm sometime in the future. If an embedded firm abrogates
existing ties with its long-time partners, however, such actions are likely to be
viewed as violating mutual commitments, which, in turn, will make future
cooperation between these firms highly improbable.
While arm’s-length ties provide important competitive benefits, they lack
the cooperative properties of embedded ties. For example, social constraints
associated with embedded networks can facilitate large relationship-specific
investments that help maximize benefits resulting from collaboration (Walker
et al., 1997). As Uzzi (1996, 1997) points out, the major benefits of embedded
ties include the emergence of trust, fine-grained information transfer and joint
problem-solving arrangements between the partners. First, familiarity with
long-term partners helps forge bonds of trust that greatly facilitate cooperation
(Gulati, 1995). One outcome of governance by trust is that it promotes access to
privileged and difficult-to-price resources that are impossible to exchange

through arm’s-length ties. Another outcome of trust is that it enables firms to

save on contracting costs, because partners believe that any payoffs resulting
from cooperation will be divided equitably among them, and all favors will be
reciprocated in due course. Second, embedded relationships induce knowledge
exchange that is more proprietary and tacit than price and quality data traded in
arm’s-length ties. Exchange through embedded ties includes such sensi-
tive components as knowledge on profit margins, proprietary knowledge, know-
how, failed solutions and strategic blueprints (Uzzi, 1996). Third, joint
problem-solving arrangements that result from embedded ties enable actors to
quickly work out problems emerging in their relationships. While arm’s-length
ties presuppose a termination of contracts in the event of dissatisfaction with the
partner, embedded ties involve direct communication between the parties in
order to resolve misunderstandings and increase mutual benefits gained from
cooperation. Such communication enables partners to find non-traditional solu-
tions to problems and to innovate (Uzzi, 1996), ultimately making embedded
ties more durable as compared with arm’s-length relationships.
Despite their apparent advantages over arm’s-length ties, embedded ties
have unique limitations of their own. The conditions under which embedded-
ness can become a liability include the loss of investment in social relationships
because of the unforeseen exit of a firm’s partners, disruption of the market
caused by external shocks and firms’ isolation from the rest of the network
because of overembeddedness. First, within networks dominated by embedded
ties, the ease of cooperation with familiar partners and the uncertainty associated
with the formation of new ties both increase the costs of investing in relation-
ships with new partners (Gargiulo and Benassi, 2000). For a firm enjoying sta-
ble, prolonged relationships with its allies, their abrupt exit from the market as
a result, for example, of periods of mismanagement, will have adverse conse-
quences, as the focal firm will lack the resources and capabilities required for
making a transition to replacement partners (Romo and Schwartz, 1995).
Second, embedded ties can lose their value as institutional changes or environ-
mental shocks render previous social ties obsolete. This can place firms that have
invested heavily in their networks at a high risk of failure, because the social
relationships that created and supported the embeddedness-based competitive
advantage no longer exist. Third, embeddedness could become an important
liability when all firms in a network come to be connected through embedded
ties. Over time, as a small group of partners of an embedded firm becomes inter-
connected as a result of referrals received from this firm (Gulati and Gargiulo,
1999), the firm’s local network will close (Burt, 1992). Such structures will have
high levels of reproducibility, as norms of cooperation and reciprocity inherent
in closed networks will force partners to continue cooperating with one another,
even in situations where such cooperation no longer yields mutual benefits
(Gargiulo and Benassi, 2000). In closed, overembedded networks, the same
strong bonds that ensure cooperation will also prevent novel ideas and perspec-
tives from reaching the actors, thus isolating them from environmental

demands, and ultimately leading to obsolescence of these actors’ competitive

capabilities (Uzzi, 1997).
Arm’s-length and embedded ties in the investment banking industry
In the equity underwriting side of the investment banking industry, banks

exchange standardized, easy-to-price resources in the form of financial capital
available from many different suppliers. At the same time, this industry is rela-
tionship-oriented, with the most common form of cooperation being the forma-
tion of underwriting syndicates. The primary objective of these arrangements is
to spread the risks associated with purchasing newly issued securities
across multiple financial institutions. In Canada, banks take one of two roles in
underwriting syndicates, either a lead manager or a rank-and-file syndicate
underwriter. The bank in a position of a lead manager serves as the primary
point of contact between the issuer and other syndicate participants. It is
responsible for assembling the syndicates by inviting other banks to commit
their capital (Li and Berta, 2002). Other syndicate members provide capital to
the issues, and their involvement is more passive than that of lead banks.
Since capital provided by syndicate members is readily available from mul-
tiple suppliers, lead managers can use non-economic factors for determining
the composition of syndicates. For example, lead managers can invite only
those banks to participate in their syndicates that can reciprocate such invita-
tions in the future. With underwriting fees generally constant across the
investment banking industry (with a standard underwriting spread of 7% as
the norm, according to Dunbar, 2000), competition among firms is based on
market share (volume), the growth of which is achieved by increased access to
underwriting opportunities. Information regarding potential underwriting
deals and investor interests is, as pointed out by Rowley and Baum (2004),
‘essential to successful investment banking, and novel information, sooner
rather than later, is a vital source of competitive advantage’. Banks can obtain
such information through two distinct mechanisms. They can either conduct
industry-wide searches, using their arm’s-length ties, or tap into a local net-
work of contacts belonging to their embedded partners. Arm’s-length searches
allow firms to join syndicates with virtually any bank, as long as the focal bank
has enough capital to commit to different deals. However, having chosen the
deals from a wide number of options available, arm’s-length banks do not
expect to receive preferential treatment from their partners. At the other
extreme, there are banks that obtain access to deals through their network of
embedded ties. While embedded relationships potentially provide firms with a
limited number of deal-making opportunities only, participation in such syn-
dicates guarantees favorable treatment from other syndicate members. Since
this treatment requires reciprocation in the future, investment banks become
locked in a series of exchanges overlaid with social context, trust and mutual
obligations.

Uzzi (1997, 1999) suggests an alternative way of competing within indus-

try networks, a so-called ‘mixed portfolio strategy’. This strategy involves main-
taining a combination of arm’s-length and embedded ties. This approach
provides firms with some degree of flexibility inherent in arm’s-length ties and
allows them to enjoy the benefits of embedded relationships. Uzzi (1999) finds
that entrepreneurs lower their borrowing costs when they maintain both
embedded and arm’s-length ties to commercial banks. However, there are
potentially serious challenges facing investment banks that adopt such an
approach. Investment banking networks exist in the environments where firms
compete in a zero-sum game, for example, to gain market share or underwriting
revenues. In the vertical networks, formed between consumers and suppliers of
capital, consumers’ ability to obtain a better deal on the resources provided by
suppliers is, ceteris paribus, independent of the ability of other consumers to
obtain these resources at the lower price. In contrast, in horizontal networks,
exemplified by public offering syndication among investment banks, an increase
in the benefit (market share, underwriting revenues) of one bank means a reduc-
tion of this benefit available to another. In such environments, banks relying
upon distinct networking strategies would be competing for deals against other
banks relying upon the same networking strategies as well as with banks that
are following mixed networking strategies. Arm’s-length banks would compete
by conducting industry-wide searches for prospective deals by using the breadth
of their reach to multiple network partners. In so doing, they compete with
other arm’s-length banks as well as with the arm’s-length share of relational
portfolio of banks that are using a mixed strategy. In turn, banks primarily
relying upon embedded ties conduct local searches for deals in their immediate
network neighborhood. Such banks would compete with other embedded banks
and with embedded ties owned by banks following a mixed strategy. As both
embedded and arm’s-length market participants appropriate the deals that
might have been completed by firms following a mixed relational strategy, these
dynamics would ultimately lower the latter firms’ access to underwriting oppor-
tunities, and consequently their market share.
A further detriment to the successful performance of firms with a mixed
relational strategy stems from their inability to project a consistent image for
their networking strategy. As Barron (2004) and McKendrick et al. (2003)
point out, organizational images or identities are important competitive charac-
teristics of individual firms, and failure to adhere to such identities, or the
uncertainty surrounding one’s identity, could lead to detrimental performance
consequences. When there is confusion about a firm’s identity, reflected, for
example, in the complexity or uncertainty associated with a firm’s strategy,
others would be inclined to react negatively to this uncertainty. Deephouse
(1999) provides a useful summary of negative consequences that a firm’s
prospective partners are likely to inflict upon this firm as a result of uncertainty
surrounding its strategies. First, if a potential partner cannot comprehend a
firm’s strategies, it will not be willing to provide this firm with any of its

resources, and may ultimately refuse outright to form a relationship with it.
Second, if a partner, nonetheless, has decided to make available its resources to a
firm with an uncertain strategy, the former may grant less favorable contract
terms of resource provision to this firm, as compared with terms offered to the
firm’s peers that follow a more clearly defined strategy. Finally, when providing
a mixed strategy firm with their resources, partners could demand higher pre-
miums as compared with those demanded from the firms that follow clear
strategies. In support of the arguments about the negative consequences of
maintaining an unclear strategy, Zuckerman (1999) shows that investment
banks, whose diversification strategy does not conform to the expectations of
analysts, are likely to receive a less favorable coverage. Furthermore, Padgett and
Ansell (1993) demonstrate that one of the key reasons for the Medici family’s
rise in power was a clear and differentiated network strategy that linked them to
distinctive groups within Florentine society. In turn, the key disadvantage
of their competitors was rooted in the uncertainty that surrounded their net-
work position. McKendrick et al. (2003) demonstrate that the existence of a
focused strategy positively influences the survival of new organizational forms,
whereas the absence of a focused strategy will detrimentally affect the survival of
these forms.
In the investment banking industry, because of the generic nature of capital
that banks bring to the IPO syndication, banks’ past networking behaviors serve
as important differentiating factors in their partners’ decisions to form relation-
ships, for example, by extending invitations to jointly participate in new syndi-
cates. Banks can observe partnering strategies of prospective allies using public
information, such as tombstone advertisements. Both embedded and arm’s-
length banks exhibit clear network behaviors in that they follow explicitly
defined relational strategies. By clearly understanding these strategies, pros-
pective partners can anticipate the benefits which they are bound to obtain, if
they forge relationships with either arm’s-length or embedded banks. Banks pri-
marily building embedded networks are expected to possess and maintain pref-
erential relationships with a small group of selected partners, whereas banks
primarily relying upon arm’s-length relationships are expected to have access to
a wide array of transactions with multiple partners in their relational portfolio.
When prospective partners choose to invite an embedded bank to join their syn-
dicate, they expect, in the future, to be included in the embedded bank’s circle
of exclusive partners, which guarantees reciprocation of underwriting opportu-
nity. Embedded banks reward their past partners by inviting them to participate
in syndicates involving few underwriters, which guarantees higher volumes of
underwriting fees per public offering. In turn, banks contemplating the forma-
tion of relationships with an arm’s-length partner expect to gain access to a wide
number of future deals through the referrals that this partner’s expansive
network is likely to generate. In contrast, benefits that can be extracted from
forming a tie with a firm that is following a mixed relational strategy are
unclear, as prospective partners do not know which particular benefits, in terms

of access to future deal opportunities, they would receive from collaborating

with this bank. Facing this uncertainty, prospective partners would be less
likely to initiate relationships with a bank following a mixed strategy, ulti-
mately reducing the pool of potential deals in which mixed-strategy banks
could participate.
In summary, the market position of banks following a mixed relational
strategy would be eroded by competitors building either primarily arm’s-length
or primarily embedded ties. At the same time, unclear signals about the benefits
of tie formation with a mixed network strategy bank would create disincentives
for prospective partners’ cooperation. Taken together, these arguments suggest
the following hypothesis.
HYPOTHESIS 1 An investment bank maintaining a mix of arm’s-length
and embedded ties will underperform a bank maintaining primarily
embedded or arm’s-length ties.
Status and relational embeddedness
The link between a firm’s relational strategy and its performance can be moder-
ated by its position in the overall industry structure, namely its positional
embeddedness (Gulati and Gargiulo, 1999). A firm’s position in the industry is
often conceptualized in terms of centrality or status (Bonacich, 1987; Podolny
1993, 1994, 2001). Podolny (1993: 830–1) defines status as a signal of the per-
ceived quality of a firm in relation to the perceived quality of its competitors. In
the environment of imperfect information and uncertainty about the quality of
a firm’s products and services, a firm’s connectedness with other high-status
firms through the means of network ties is often viewed as a signal that indi-
cates the superior quality of the firm’s own output. High-status firms enjoy sub-
stantial benefits as compared with those enjoyed by their lower-status
counterparts. First, higher-status firms save on advertising costs. More cus-
tomers simply flock to these firms without them actively seeking customers out,
and often, a higher-status firm receives ‘free advertising’ that lower-status firms
are unable to obtain (Podolny, 1993). Second, being associated with a high-
status firm is also likely to enhance one’s own status (Podolny, 1994); thus not
only customers but also potential partners are attracted to this firm. Since a
high-status firm can foresee that others will reap important benefits from associ-
ating with it, such a firm can negotiate for a larger share of payoffs that result
from this collaboration. Third, since employees are willing to accept lower mon-
etary compensation in exchange for being associated with a higher-quality
workplace (Frank, 1985; Podolny, 1993), high-status firms are able to attract
better people at lower costs.
As Podolny (1993, 1994) points out, industries are subject to strict status
hierarchies, with high-status firms forming relationships with other high-status

partners, and low-status firms forming relationships with low-status partners.

When a high-status firm forms a tie with a lower-status partner, the status of the
former is likely to diminish. Cooperation between firms of similar status is aided
by the similarity in the quality of resources that each partner is likely to commit
to a relationship (Chung et al., 2000). When both partners are of equal status,
they both commit a similar quality of resources to their relationship, which
facilitates the functioning of the social exchange. When there is a difference in
status between the partners, the partner of higher status could contribute to the
relationship resources of lower quality than it is capable of contributing, which
would ultimately damage the cooperation between the parties. Recognizing the
negative consequences of cooperating with a lower-status partner, firms of high
status avoid forming relationships with lower-status allies and, consequently,
the existence of status homophily in firms’ partnering decisions is a general
finding in the strategy and organization literature (Podolny, 1994; Chung et al.,
2000; Shipilov et al., 2006).
Firms of higher status are more likely to benefit from maintaining embed-
ded ties as compared with firms of lower status. While embedded ties expose
firms to a number of risks, such as: heightened impact of their partners’ abrupt
failure; institutional or environmental changes rendering old ties obsolete;
increased threat of isolation (overembeddedness), high status lowers the impact
that these adverse events could have on firm performance. First, partners of
high-status firms are less likely to abruptly exit the market because of their indi-
vidual failures. According to the status homophily principle (Podolny, 1994),
partners of high-status firms are likely to be of high status themselves. Their
high status implies that firms’ partners are enjoying a very favorable cost-
revenue profile and visibility. As noted above, the costs of higher-status firms
will be lower than those incurred by their lower-status counterparts, thanks to
the lesser expenditure on advertising and labor that high-status firms enjoy as a
result of their increased visibility. At the same time, higher-status firms are able
to charge more for their products, because they are perceived to be of higher
quality than those produced by the rest of the competition (Podolny, 1994). The
extremely favorable difference between the costs and revenues of high-status
firms translates into higher slack resources in their possession. The buffer of
slack resources available to a high-status firm could help it survive long periods
of mismanagement, before it actually becomes at risk of exiting the market.
Even when exit is inevitable, due to continuing poor management of a high-
status firm, such a firm’s visibility will guarantee the scrutiny of outsiders,
and its partners will receive advanced notice of it being at risk of failure, thus
alerting them to reconfigure their network ties in order to compensate for its
eventual loss.
Second, powerful, high-status incumbent organizations are usually well
positioned to resist and survive changes (Fligstein, 1996), including those that
could destroy existing social relationships. Such changes could come from two
sources: institutional rationalization of the markets by governments or industry

newcomers, and environmental shocks that are due to external processes beyond
the control of market participants. When such changes are orchestrated by
governments or industry newcomers that are hostile to the incumbents, the
challengers still need to take into account the existing industry structure and
the influence of powerful firms. For a change to be successful and relatively
painless, challengers need to co-opt core industry members and prevent them
from opposing reforms. This can be achieved by executing institutional reforms
in such a manner that existing investments made by powerful firms can be
restructured to fit the new institutional climate. Such investments not only
include physical assets or firm capabilities, but they also comprise relational ties
between the firms. In contrast, investments made by peripheral incumbent
firms would seldom be taken into account, as their opposition to change can be
easily overcome. When a radical change is caused by some external shock, for
example an oil crisis, high-status firms, too, are better able to weather its conse-
quences. Slack resources that high-status firms have accumulated as a result of
enjoying higher revenues and lower costs would help them to survive the nega-
tive consequences of environmental shakeouts. The prestige and visibility of
high-status firms could also translate into their greater legitimacy in the eyes of
outside stakeholders, such as governments, which could be relied upon for emer-
gency assistance when dire need arises. Lower-status firms, in contrast, have
high costs and lower revenues, and would thus accumulate thinner buffers of
slack resources and would thus be easily wiped out because of an environmental
shock. Also, such firms would not be able to count on much outside support
from governments, and these firms’ failures might not be even noticed by
outside observers.
In Canadian investment banking, between 1952 and 1990, the primary
source of shocks affecting the industry came from its external environment.
During this period, the industry faced three clearly defined difficult periods: the
oil shock in the early 1970s (1970–5), the brief recession of 1982–3, caused by
fiscal restraint, and the 1987 financial crisis. The last two events did not result
in prolonged recessions, and their impact on the underwriting network was not
as dramatic as the impact of the oil shock in the 1970s. As compared with 1969,
by 1970, the number of new issues fell by 50 percent and stayed at that level
until the recovery in 1976. As a result of this unusually long period of economic
hardship, many banks lost a lot of money in the syndication business, and even-
tually became absorbed by their partners (for a more detailed review of network
evolution in the Canadian investment banking industry, see Baum et al., 2004).
Figure 1 illustrates the changes that took place in the networks of Canadian
investment banks between 1970 and 1974. Ties between banks represent their
joint participation in public offerings, while the size of the circles is proportion-
ate to banks’ status. The comparison between panels A and B shows that all
seven banks which occupied high-status positions in 1970 – A. E. Ames (#3),
Dominion Securities (# 214), Greenshields Co. (# 307), McLeod, Young, Weir
(# 466), Nesbitt Thompson (# 515), Pitifeld and Co. (# 561) and Wood, Gundy

Figure 1 Networks of Canadian public offerings underwriters
(# 727) – survived the oil shock and still competed for business in 1974. Thus,
embedded ties that partners had formed with these banks were, indeed, less
likely to lose value as compared with similar ties formed with more peripheral
underwriters.

Finally, overembeddedness, associated with a lack of new information flow-

ing into firms’ networks, is also unlikely to be a problem for firms with higher
status. First, peripheral firms in the industry are actively seeking involvement
with high-status actors. For a lower-status firm, one way of attracting the atten-
tion of high-status partners is to offer them access to information or know-how
that can be jointly exploited. In this case, high-status firms do not need to con-
duct industry-wide searches for novel information themselves, as they can rely
upon their partners to bring this information to their attention. In the invest-
ment banking industry, for example, lower-status underwriters frequently invite
higher-status banks to join their syndicates, providing the latter with business
opportunities and fees otherwise not available in their embedded networks.
Second, the best and the brightest employees in the industry would rather work
for high-status than for lower-status organizations (Frank, 1985). These people
bring with them not only their knowledge, but also the information and capa-
bilities embedded in their own personal networks. Thus, higher-status banks are
likely to have access to wide and diverse contact networks of the best employees
in their industry, which could be used for conducting industry-wide searches for
deal-making opportunities when necessary.
While higher status lowers the risks of firms’ maintaining embedded ties to
their partners, it also increases the benefits that such ties will provide to the
firms. One of the key advantages of maintaining embedded ties is the fine-
grained information that partners exchange within the confines of their social
relationship (Uzzi, 1996). In the absence of trust between the partners (as would
be the case if they maintained arm’s-length networks), such information
exchange would simply not be possible. Since partners of a high-status firm are
of high status themselves, they would be exposed to extremely valuable sources
of information, as organizational status is often associated with firm centrality in
the industry-level networks of information and communication flows (Gulati,
1999). As Figure 1 illustrates, high-status banks tend to be the most central
firms in the network of underwriters. Extremely valuable information that they
can make available to partners, as a result of their own privileged position in a
communications network, could contain advance warnings about new techno-
logical developments, forthcoming government regulations altering the nature
of competition in the industry, highly promising deal-making opportunities,
insider knowledge on specific transactions and the like. A high-status bank
can capitalize on such information received from its network partners by, for
example, gaining access to the most lucrative deals, which would positively con-
tribute to its performance.
In summary, higher status provides important advantages for investment
banks, and in so doing, increases the benefits and lowers the risks that banks
could face when maintaining embedded ties. High-status banks enjoy lower
costs and higher revenues, allowing them to develop a buffer of slack resources
that would shield them from adverse consequences of their individual mis-
management or of the broader environmental shakeouts, ultimately lowering

their risk of market exit. High-status banks can also avoid risks of isolation from
the rest of the industry and secure preferential access to the most lucrative
underwriting deals through their embedded ties. Thus, one can suggest the
following hypothesis.
HYPOTHESIS 2 The relationship between an investment bank’s rela-
tional strategies and performance is moderated by the bank’s status, with a
higher-status bank reaping greater performance improvements from pos-
sessing embedded ties than a lower-status bank would.
Data, analysis and results
The above hypotheses were tested using the data on syndicates formed by
investment banks involved in underwriting public offerings in Canada. Life-
history information on all offerings placed by the banks between 1952 and 1990
on all Canadian stock exchanges (Vancouver, Alberta, Winnipeg, Montreal and
Toronto) was coded from The Record of New Issues, which is published yearly by
the Financial Data Group in Toronto. Environmental control variables were col-
lected from the Toronto Stock Exchange (TSE) annual reports as well as from the
Canadian Sociometric Information and Management Database.
Inter-organizational networks were defined based on banks’ membership in
underwriting syndicates. The data were organized into the series of symmetric
sociomatrices (Rt ). Since syndicates could be created up to six months or more
prior to the date of an offering (Podolny, 1993), these matrices reflected rela-
tionships not within individual years, but represented the sum of relationships
in two-year periods, for example 1952–3 or 1989–90. A particular entry, Xij, in
a matrix, Rt , corresponded to the sum of the number of times a bank in row i
co-advised with a bank in column j during period t.
Dependent variable
The present study uses the market share of banks as an indicator of their per-
formance. This measure has been extensively used in prior studies of the invest-
ment banking industry, conducted by scholars of corporate finance (Beatty and
Ritter, 1986; Maginson and Weiss, 1991). The use of this measure is based
upon an observation that banks’ success results, in part, from their ability to
provide issuing firms and investors with market insights. This ability is con-
tingent upon banks’ involvement in many deals with many investors and
issuers (Podolny, 1993). As such, market share is an important benchmark in
investment banking, since it provides an objective basis for judging the expo-
sure of financial institutions to multiple transactions (Eccles and Crane, 1988).
Furthermore, because underwriting fees and margins are relatively constant
across the industry (a standard underwriting margin (spread) of 7 percent is the

norm (Chen and Ritter, 2000; Dunbar, 2000), banks’ profit increases are
derived primarily from the increases in their market share/volume (Baum et al.,
2003).
To measure market share at time t, the dollar value (inflation adjusted) of
each public offering was allocated among the members of a syndicate. For deals
involving a lead manager only (i.e. with no syndicate), a bank was assigned 100
percent of the offering’s dollar value. For deals involving multiple banks, a lead
bank was assigned 50 percent of the underwriting value, and the remaining
value was split equally among rank-and-file syndicate members (Baum et al.,
2003). Then, the sum of all deal values involving the focal bank was divided by
the total value of public offerings placed in Canada during a particular period.
Alternative specifications of banks’ market share were also computed (e.g. by
equally splitting the value of deals among all syndicate members, assigning
25% or 75% of the syndicate’s value to the lead manager); however, the correla-
tion between different specifications of market share was close to 1 (r = 0.98).
Independent variables
To distinguish between arm’s-length and embedded networks, Uzzi (1996) pro-

poses the measure of the First Order Network Coupling (FONC), which reflects
the extent to which individual banks’ networks are concentrated on a single
partner. A slightly modified version of this measure can be computed as follows.
Nm
FONCit = ∑ (P * W )
j=1
ij ij
2 (1)
where Nm equals the number of partners that bank i has connections to in

period t; Pij is the percentage of the total number of deals made by bank i
involving bank j and Wij is the percentage of total dollar volume of deals that
bank i made involving bank j. This formula differs from Uzzi’s definition of the
FONC in one important respect, namely that it reflects not only the extent to
which a bank’s ties are focused on individual partners (Pij), but also the degree to
which this bank’s resource flows are concentrated on these partners (Wij).
Essentially, this measure captures not only the quantity, but also the quality of
relationships between a bank and its allies. The FONC approaches 1.0 as the
focal bank concentrates its transactions in a few embedded relationships, and
approaches 0.0 as the bank disperses its transactions among a large number
of partners in an arm’s-length network. The medium level of this index (0.5)
indicates that the bank is following a mixed relational strategy. As Uzzi (1996)
indicates, such a measure has a strong face validity among subjects involved in
managing relational networks, and has precedents in the literature (Baker,
1990). One potential shortcoming of this measure is that it does not capture the
identities of firms’ partners, as it leaves open a possibility that firms could con-
centrate their relationships among few partners, which are being rotated every

year. However, as numerous studies have demonstrated, there is an extremely

high level of reproducibility in networks, particularly among strong (embedded)
relationships (Gulati, 1995; Gulati and Gargiulo, 1999; Baum et al., 2004), vir-
tually guaranteeing that intense relationships with partners in the past are likely
to continue with the same partners in the future. Thus, it is very unlikely that
firms would constantly change the partners in their embedded networks.
Bonacich’s (1987) eigenvector centrality was used to measure the status of
banks in industry networks. This indicator can formally be defined as:
∞
st(a,B) = ∑ aB R
k=0
k k+11.
t (2)
In this expression, a is a scaling coefficient, B is a weighting parameter that can

range between zero and the absolute value of the inverse of the value of the maxi-
mum eigenvalue of the sociomatrix, Rt, 1 is a column vector, where each element
has the value ‘1’, and st is also a column vector, where element Si,t denotes the
status of an investment bank i. Given this specification, an investment bank’s
status is a function of the number and the status of the banks with which it forms
underwriting syndicates. In turn, the status of these partners is the function of
the number and the status of their syndicate partners, and so on. The B para-
meter is set equal to the reciprocal of the maximum eigenvalue. The distribution
of status is skewed, indicating that there are many more low-status than high-
status banks. This skewed distribution is consistent with the status ordering
observed in other studies of the investment banking industry (Podolny, 1993,
2001). The status index for each bank was computed by calculating its eigen-
vector centrality using the symmetric sociomatrix of relationships among
underwriters. The measure was normalized, dividing it by the maximum differ-
ence in each two-year network, to facilitate comparisons over time. While this
approach is potentially less precise than one based on asymmetric tombstone
rankings (Podolny, 1993), it is consistent with past, network-based measure-
ment of status in investment and commercial banking (Jensen, 2003).
Control variables
Many other variables could influence banks’ performance, which warrants the
inclusion of firm-level, industry-level and time-specific covariates in the regres-
sion models. For example, a firm-level variable, Firm Lead Manager
Specialization, was defined as the number of a bank’s lead manager roles divided
by the total number of deals in which the bank has participated in each period.
This variable was designed to capture the extent to which a bank and its
partners were specialized in organizing investment syndicates. Banks scoring
one (the maximum) on this measure specialize in the lead-manager role; those
scoring close to zero, primarily co-underwrite the syndicates in which they have
participated (Baum et al., 2003). Furthermore, a variable capturing the special-

ization of the focal bank’s partners, Partner Lead Manager Specialization, was
computed by averaging Firm Lead Manager Specialization for all the partners of
the focal bank. These variables were computed using a non-symmetric version of
sociomatrices in which a particular entry, Xij, corresponded to the number of
times a bank in row i invited a bank in column j to participate in a syndicate led
by bank i during period t.
Network literature suggests that the existence of ties between a firm’s part-
ners and these partners’ ability to collectively influence this firm’s behavior can
both have a profound effect on a firm’s performance (Burt, 1992; Podolny, 2001;
Rowley and Baum, 2004). Network Constraint (Burt, 1992: 54–5) was used to
capture interconnectedness among a bank’s partners and their influence upon
this bank. The higher this measure, the more a bank is considered dependent
upon a single partner, which, in turn, can project a powerful influence upon this
bank. The lower the measure, the more independent is the bank from any of its
partners. No network analysis is complete without controlling for the density of
ties surrounding the focal firm. Local Density was computed by calculating the
total number of interconnected ties that a bank’s partners had, and then
dividing this value by the number of ties that could possibly exist in this bank’s
local network (Rowley et al., 2000). The key difference between Constraint and
Local Density is that the former measure reflects the dependence of a firm on a
single partner in its local network, whereas the latter measure reflects the depen-
dence of a firm on its local network as a whole.
Among environmental factors, Overall Density was computed by dividing
the total count of all actual ties in the investment banking industry by the
number of possible ties in this network. In this ratio, the denominator is com-
puted as (n(n-1)), where n is the number of all banks in an industry (Wasserman
and Faust, 1994). Furthermore, over time fluctuations of demand for invest-
ment banking services can potentially affect both the type and the number of
partnering opportunities available to individual banks. Thus, variable
Uncertainty was computed, first, by calculating the natural logarithms of the
values of public offerings in every two-year period. Second, each value
of the transformed series was regressed on the previous period’s value and its
square, using quadratic specifications to take into account the accelerating
growth of transaction volumes. Finally, the standardized residuals from this
time-series analysis were used as the measure of Uncertainty (Hannan and
Freeman, 1989).
To account for the availability of resources in the industry, a control for the
logged Total Value of Public Offerings was also used in the models.
Furthermore, it is also widely known that financial markets are highly sensitive
to the fluctuations of interest rates (Beatty and Ritter, 1986; Ritter, 1991), thus,
a Prime Interest Rate variable was also included. Lastly, decade dummy vari-
ables (1950s, 1960s, 1970s and 1980s) were created to account for additional
unobserved time-specific shifts in the performance of banks.

Analysis and results
Means, standard deviations and correlations for all variables are reported in
Table 1. Although the correlations are generally small in magnitude, those
between the linear and the quadratic specifications of the FONC, as well as
those between current and lagged market share are quite large. Such levels of
multicollinearity among explanatory variables could result in less precise para-
meter estimates, that is, larger standard errors for correlated variables.
Fortunately, this multicollinearity is not likely to bias parameter estimates, and
its effects are substantially reduced by large sample sizes (Kennedy, 1992).
The regression coefficients were estimated using the following model:
Ln(M.S.(t))i = a * Ln(M.S.(t–1))i1b * Xi(t–1) 1 ε (3)
where M.S. (Market Share) represented a time-varying measure of performance.

Using the logarithm, instead of the actual measure, reflects the fact that equal
changes in the market share mean more for a smaller firm than they do for a
larger one. In the equation above, a is an adjustment parameter that indicates
how current performance depends on prior performance, and b is a vector of
parameters for the effects of independent and control variables. The inclusion
of a bank’s performance in the previous period (Market Share t–1) to predict the
current period’s dependent variable helps account for the possibility that
the empirical models of banks’ performance suffer from specification bias due to
unobserved heterogeneity (Jacobson, 1990).
This model was estimated on a pooled time-series dataset, with each bank
contributing a panel based on the number of years it was active on the market.
For example, if a bank had four years of data, it would contribute four observa-
tions to the analysis. Altogether, the dataset comprised 1446 bank-years after
taking into account the lagged dependent variable. Pooling repeated observa-
tions on the same firms is likely to violate the assumption of independence from
observation to observation, which is likely to result in the models’ residuals
being autocorrelated. First order autocorrelation occurs when disturbances in
one period are correlated with those in the previous period, which produces
incorrect variance estimates, rendering OLS estimates inefficient (Judge et al.,
1985). Instead, fixed-effects GLS estimation was used to produce the unbiased
estimates of the effects that theoretical and control variables had on banks’ per-
formance.
A U-shaped relationship between the FONC and Market Share was neces-
sary to render support for Hypothesis 1, namely:
bFONC , 0; bFONC2 . 0. (4)
Furthermore, a positive sign for the interaction between status and the linear
term of the FONC was expected to yield support for Hypothesis 2, namely:

Table 1 Descriptive statistics and correlations a b
Mean SD 1 2 3 4 5 6 7 8 9 10 11 12 13
1 Market Share (t)d –7.32 3.10 1.00

2 Market Share (t–1)d –6.89 2.96 0.89 1.00
3 First Order Network Couplingc 0.40 0.44 –0.16 –0.43 1.00

4 First Order Network Coupling2 0.36 0.46 –0.18 –0.43 0.98 1.00
S H I P I L OV : S H O U L D YO U B A N K O N YO U R N E T WO R K ?
5 Status 5.48 14.07 0.40 0.43 -–0.23 –0.24 1.00
6 Prime Interest Rate 7.47 3.11 –0.11 –0.11 –0.10 –0.09 –0.3 1.00
7 Firm Lead Manager Specialization 0.39 0.38 0.18 0.19 –0.28 –0.29 0.18 0.01 1.00
8 Partners’ Lead Manager Specialization 0.38 0.37 0.22 0.23 –0.34 –0.34 0.23 0.05 0.87 1.00
9 Network Constraint 0.46 0.38 –0.02 –0.02 –0.09 –0.12 –0.08 0.01 –0.36 –0.40 1.00
10 Local Density 0.03 0.06 0.45 0.46 –0.43 –0.41 0.67 –0.02 0.15 0.24 –0.06 1.00
11 Uncertainty –0.02 0.44 –0.01 –0.05 –0.05 –0.01 0.01 0.14 0.06 0.08 –0.02 0.02 1.00
12 IPO Market Valued 0.21 0.76 –0.11 –0.13 –0.13 –0.01 –0.02 0.06 –0.04 –0.05 0.04 –0.04 0.20 1.00
13 Overall Network Density 0.04 0.04 –0.11 –0.13 –0.13 –0.11 –0.01 0.59 0.02 0.06 0.02 –0.03 0.11 0.19 1.00
Notes
a n = 1446 firm-years
b For correlations greater than 0.06, p<0.05.
c First Order Network Coupling.
d Logged value
297
bFONC * status . 0. (5)
The estimates of factors influencing the performance of investment banks are

reported in Table 2. These coefficients indicate how a change in the independent
variable during the previous period affects changes in the market share of banks
in the current period.
Table 2 Regression Modelsa
Model 1 Model 2 Model 3
Market Share(t–1)b 0.691*** 0.700*** 0.699***

(0.028) (0.029) (0.029)
First Order Network Coupling 0.313** –0.709x –1.157*
(0.133) (0.522) (0.559)
First Order Network Coupling2 0.972** 1.295**
(0.480) (0.501)
Status × First Order Network Coupling 0.027*
(0.012)
Status 0.008*** 0.007*** 0.004x
(0.002) (0.002) (0.003)
Firm Lead Manager Specialization 0.177 0.170 0.189
(0.213) (0.213) (0.213)
Partners’ Lead Manager Specialization –0.221 –0.193 –0.205
(0.198) (0.198) (0.198)
Network Constraint 0.203 0.263 0.307+
(0.181) (0.182) (0.183)
Local Network Density 0.975 0.802 1.053
(0.896) (0.898) (0.904)
Overall Network Density –0.544 –0.979 –0.658
(1.74) (1.755) (1.758)
Uncertainty 0.166** 0.167** 0.170**
(0.074) (0.080) (0.074)
IPO Market Valueb –0.038 –0.035 –0.030
(0.043) (0.043) (0.043)
Prime Interest Rate 0.038+ 0.037+ 0.037
(0.022) (0.022) (0.022)
Period 2 (1960–9)c –0.148 –0.142 –0.131
(0.120) (0.120) (0.119)
Period 3 (1970–9) –0.316+ –0.344+ –0.329+
(0.191) (0.191) (0.022)
Period 4 (1980–9) –0.343 –0.335 –0.335
(0.258 (0.258) (0.257)
D.f. 14 15 16
R2 0.8293 0.8301 0.8306
F –– 6.73** 4.23*
Notes
aStandard errors are in parenthesis.
b Logged value.
c Period 1 (1952–9) was omitted.Two–tailed tests: +p<0.1; *p<0.05; **p<0.01; ***p<0.001;
One-tailed tests: x p<0.1.

Model 1 represents a baseline containing control variables, such as FONC,

status, Lead Manager Specialization of the focal firm and that of its partners, the
firm’s Network Constraint, Overall and Local Network Density, Uncertainty,
Total Value of Public Offerings, Prime Interest Rate and period dummies. The
Market Share of a bank in the previous period (Market Share(t–1)) appears to be
the best predictor of its market share in the next period. Status is positively asso-
ciated with the increases in a firm’s market share. The linear estimate of the
FONC is also significant and positive. Furthermore, Uncertainty in Model 1 is
positive and significant, suggesting that banks are generally able to increase
their market share in unstable environments. Finally, increases in the Prime
Interest Rate are positively related to increases in the market share of
investment banks.
Substantial improvement in fit was achieved in Model 2, when adding the
squared term of the FONC to Model 1 (FModel 2 vs Model 1 = 6.73, p<0.01).
Similarly, when adding an interaction between banks’ status and the FONC to
Model 2, significant improvement in fit was achieved (FModel 3 vs Model 2 = 4.23,
p<0.05). In the full Model 3, as expected, the linear term of the FONC
was negative (bFONC < 0) and the quadratic term was positive (bFONC2 > 0),
with interaction between the FONC and status positive and significant
(bFONC * status > 0). These findings provide strong support for both Hypothesis 1
and Hypothesis 2, suggesting that banks following a mixed relational strategy
perform worse than their competitors that are building either primarily em-
bedded or arm’s-length relationships. Also, the results suggest that status,
indeed, moderates the relationship between a firm’s relational strategy and
performance, with higher status firms being better able to extract performance
benefits from maintaining embedded ties.
Coupled with the regression analysis’s results, some correlations among the-
oretical and control variables reported in Table 1 are worth noting. For example,
there is a negative correlation (r = –0.23, p>0.001) between the measures of
relational and positional embeddedness, namely status and the FONC. This
relationship signals that, on average, a higher proportion of embedded ties in a
bank’s network is associated with lower status, as the fewer the ties that the
banks maintain, the more difficult it is for them to establish relationships with
high-status partners. Given the support for Hypothesis 2, the negative cor-
relation between FONC and status suggests that there are only a few banks in
the network that are actually able to take advantage of occupying high-status
position while maintaining embedded ties, as most high-status banks follow a
less optimal strategy by building expansive, arm’s-length networks.
Banks’ status in period t and market share in period t+1 are positively and
significantly correlated (r = 0.40, p>0.001), and, as indicated in Table 2, status
in period (t) has a positive causal effect on banks’ market share in period (t+1).
Such relationships are consistent with prior findings of Podolny (1993), which
showed firms enjoying superior performance because of increased visibility and
perceived quality that are associated with their higher status. In the investment

banking industry, issues underwritten by high-status banks are more likely to

attract investor visibility, to be perceived of being of high quality and enjoy
higher levels of trading. Such positive factors can ultimately contribute to the
improvement in these issues’ performance (Beatty and Ritter, 1986). Therefore,
individual issuers are more willing to retain high-status banks as their lead man-
agers, and, similarly, lead managers are more willing to invite high-status banks
to join their syndication teams to send signals to investors about the quality of
the issue that is being placed on the market. Such favorable dynamics contribute
to the increase in deal-making opportunities available to high-status banks,
which positively influences their market share.
Banks’ Local Network Density has a much higher correlation with their
Market Share (r = 0.45, p>0.001) than does the FONC (r = – 0.16, p>0.001),
suggesting that higher levels of interconnectedness within a firm’s partner net-
work have a greater impact on its performance than does the number of part-
ners. As argued above, banks can improve performance by referring
underwriting deals to one another, and a high level of partner interconnected-
ness appears to help them develop rules and norms of cooperation which increase
the likelihood of deal reciprocation. The lack of findings for the main effect of
Local Network Density on firm performance in the regression results could be
attributed to the substantial correlation between status and Local Network
Density (r = 0.67, p>0.001). To isolate the main effect of network density in the
supplementary analysis, status was removed from Model 1, which resulted in
the finding of a significant positive coefficient of Local Network Density
(p>0.1). To check whether these dynamics were not a signal of negative influ-
ences attributable to multicollinearity, Variance Inflation Factors (VIF) were
computed for each model reported in Table 2. These statistics all fell within an
acceptable range (VIF Model 1 = 3.53; VIF Model 2 = 6.99; VIF Model 3 =
7.12), suggesting that correlation among theoretical and control variables did
not provide biased regression results (Studenmund, 1992).
Finally, there is a negative and significant relationship between the 1970s
period dummy (1970–9) and banks’ performance. This relationship is not sur-
prising given the dynamics illustrated by Figure 1, which showed a dramatic
decline in the underwriting opportunities for investment banks because of the
oil shock. The regression results show that this shock had a negative influence
on all banks; however, as Figure 1 illustrates, high-status investment banks
were more likely to survive this external influence as compared with lower-
status underwriters.
Discussion and conclusion
This study has examined mechanisms through which structural embeddedness

affected Canadian investment banks between 1952 and 1990. In the investment
industry, access to underwriting deals is the key to improved performance, and

banks can secure such access by relying upon two distinct relational strategies:
building either arm’s-length or embedded ties to their partners. Uzzi (1999)
suggests an alternative strategy for improving firm performance, by calling for
the development of a mixed relational strategy, followers of which maintain
both embedded and arm’s-length ties in their networks. The results in the pres-
ent study question whether performance improvements, which firms can obtain
by following a mixed strategy, hold across different industry settings. While
Uzzi (1999) did find the positive effects of mixed strategy, the present analysis
has found quite the opposite: that is, firms being at a disadvantage when main-
taining a mix of arm’s-length and embedded ties. The present study has also
shown that the benefits of maintaining embedded ties are dependent upon a
firm’s position in the overall network structure. Specifically, the analyses pro-
vided evidence that firms occupying privileged network positions, as reflected
in their high status, were likely to extract greater benefits from maintaining
embedded ties than were more peripheral firms.
The discrepancies in the results related to the outcomes of mixed relational
strategy in two different settings – horizontal relationships amongst investment
banks and vertical relationships amongst entrepreneurs and their commer-
cial banks (Uzzi, 1999) – can be explained by looking at the different nature of
competition that translates a firm’s network position into performance in these
two industries. In the investment banking industry, banks compete in the zero-
sum game; wherein one bank’s gain in underwriting opportunities represents
the loss for another. Banks following a mixed relational strategy are crowded out
from the market by their competitors that are following clearly defined strate-
gies. Deals available to the banks following a mixed strategy become few in
number, as some of them go to arm’s-length competitors and others to the
embedded competition, and ultimately the market share of mixed banks
dwindles. A further difference between the investment banking and commercial
banking settings is the importance of clearly defined strategies in firms’ part-
nering behaviors in the investment banking industry. Banks secure participation
in a large number of underwriting deals through partnering arrangements with
other investment banks. However, before inviting a bank to join its under-
writing syndicate, a prospective partner must have a clear idea of the benefits
that could be reaped from this invitation. A lead bank may be counting on rec-
iprocation of its invitation to co-underwrite substantial proportions of new
issues led by its partner (as would be the case when collaborating with em-
bedded banks) or expecting access to the wide number of smaller underwriting
opportunities spread through the partner’s own vast network (as would be the
case when collaborating with arm’s-length banks). In contrast, banks following
a mixed relational strategy fail to send consistent signals to their prospective
partners about the benefits that could be reaped from collaborating with them,
thus depriving themselves of a large number of opportunities to participate in
syndicates led by others.

The crowding-out in the investment banking industry effects are similar in

nature to those prevalent in the Manhattan hotel industry analyzed by Baum
and Mezias (1992). Hotels’ competition for their customers is also a zero-sum
game in which extreme competitive strategies are more effective than their com-
bination. In Manhattan, mid-priced hotels have faced severe competition from
both highly priced, luxury hotels as well as from cheap, budget accommodation
providers. Hotels following a mid-range pricing strategy have failed to project
a consistent image to their customers as they have catered neither to budget-
conscious travelers nor to individuals seeking luxury accommodation. Thus
‘stuck in the middle’ (Porter, 1980), mid-price hotels were driven out of the
market by their competition.
In Uzzi’s (1999) study of vertical network linking entrepreneurs and com-
mercial banks supplying capital, the successfulness of relational strategies used
by the consumers of capital is determined by the reduction in their costs of bor-
rowing. Unlike in the investment banking network or in the hotel business, the
fact that a consumer of capital that is maintaining primarily arm’s-length ties to
suppliers (commercial banks) gains a lower interest rate, has no bearing on the
interest rate secured by the consumer following a mixed relational strategy.
Similarly, if a consumer that maintains a primarily embedded network gains a
lower interest rate, it would have no impact on the interest rate obtained by the
consumer’s following a mixed strategy. Thus, in that environment, an entrepre-
neur following mixed strategy would not be threatened by entrepreneurs using
distinct networking strategies.
The examination of a mixed relational strategy’s viability in a setting that is
different from Uzzi’s (1999) constitutes the first contribution of the current
paper to the literature on inter-firm networks. Research on the contingent
nature of network strategies is currently well under way, with scholars focusing,
for example, on the boundary conditions of information and resource brokerage
strategies that exploit structural holes (disconnections) among a firm’s partners.
For instance, Rowley et al. (2000) showed that being embedded in networks
rich in structural holes provides advantages to firms in turbulent environments,
as sparse networks expose them to diverse partnering opportunities that facili-
tate flexibility and adaptation. In contrast, more stable environments favor firms
embedded in dense networks lacking structural holes, because such networks
help firms to enjoy the economies of scale critical in mature industries. Ahuja
(2000) demonstrated that biotechnology firms embedded in dense networks
lacking structural holes were more likely to be trusted by their partners, which
leads to the heightened levels of cooperation among them, consequently result-
ing in higher levels of collaboration among dense network members. In con-
trast, Rowley and Baum (2004) showed that investment banks improved their
performance as a result of spanning multiple structural holes among partners,
because such disconnections expose banks to diverse deal-making opportuni-
ties, enhancing their market share. The key lesson to be learned from the
present study, coupled with prior work on the contingent nature of networking

strategies, is that the successfulness of a firm’s network strategy, be that

exploiting structural holes in its network or maintaining a mix of arm’s-length
and embedded ties in its relational portfolio, is highly context-specific, and
there exists no single prescription for maintaining a firm’s relationship to its
partners that is going to universally boost the firm’s performance across all
industry contexts.
Another contribution of this study to the understanding of the mechanics
underlying the relationship between firm network strategies and performance is
its focus on a moderating effect that the firm’s status exerts on the relationship
between the structure of the firm’s direct ties to its partners – its relational
embeddedness – and its performance. While prior studies (Podolny, 1993,
1994; Gulati, 1999) have looked at the direct influence of status or centrality on
firms’ performance, the current study suggests that differences in status also
affect performance in an indirect way, by reducing the liabilities of embedded-
ness and increasing the payoffs that firms can obtain from maintaining em-
bedded ties. This happens in a number of ways. First, the likelihood of a
high-status firm’s ties losing their value as a result of its key partners’ failure is
minimal, as partners of high-status firms are likely to be of high status them-
selves, and having accumulated slack resources as a result of maintaining low
costs and earning higher revenues, they have a low probability of exiting the
market. Second, the likelihood of a high-status firm’s ties losing their value
because of an institutional change or environmental shakeout is also low. Finally,
any embedded cluster of high-status firms is not likely to become isolated and
lack access to outside information. Instead, thanks to their privileged position in
the industry network, high-status partners of high-status firms will have access
to extremely valuable information, such as intelligence about upcoming lucra-
tive deal-making opportunities. Such information would not be circulated out-
side the small circle of high-status partners interconnected through embedded
relationships, and the ability of high-status firms to capitalize on their privi-
leged access to such information would improve these firms’ performance.
While this study has suggested that higher-status firms can avoid the lia-
bilities of embeddedness and reap performance improvement benefits from their
embedded relationships, some questions remain unresolved. For example, on the
surface, the present findings seem to contradict the results of Li and Berta
(2002), which demonstrate that higher-status US investment banks tend to
build expansive networks with multiple partners, whereas lower-status banks
build networks with a limited number of partners only. This apparent contra-
diction is eliminated when comparing research questions addressed by these two
studies. While Li and Berta’s (2002) inquiry was designed to test the determi-
nants of alliance formation in the investment banking industry, it was not
designed to test the performance implications of particular alliance-building
strategies, which, in turn, comprises the focus of the present investigation.
Furthermore, the correlation analysis, reported in the section entitled Data,
analysis and results above, shows that in the present setting, there is a negative

relationship between banks’ status and the extent to which their local networks
are dominated by embedded ties, results that are actually consistent with those
obtained by Li and Berta (2002). The results of these two studies combined sug-
gest an interesting possibility that investment banks, at some point in time,
become locked in potentially suboptimal strategies. As high-status banks are
building expansive networks, they may not be aware that in the long run such
strategies could actually be less advantageous than confining themselves to a
small group of trusted, high-status allies, whose cooperation could be much
more valuable than that of multiple partners. This intriguing possibility calls
for further studies that would simultaneously examine both the likelihood of
firms’ choosing particular network strategies and the implications of such
choices for firms’ performance.
The negative effect of a 1970s period dummy variable suggests an interest-
ing possibility that is worth exploring in the future. Thornton and Ocasio
(1999) use the concept of institutional logics to illustrate the shifts in executive
succession patterns that occurred between 1958 and 1990 in the higher-
education publishing industry. Institutional logic is defined as a socially con-
structed, historical pattern of material practices, assumptions, values, beliefs and
rules, by which individuals produce and reproduce their material subsistence
(Thornton and Ocasio, 1999: 804). Environmental shocks, particularly such
profound events as the 1970s oil crisis, could well affect the institutional logics
that underlie the functioning of companies and markets. Future research should
explore whether, following this period of 1970s depression in the Canadian
investment banking industry, the nature of competition dramatically changed
and investment banks started to use different logics in selecting their partners.
Moreover, as we are currently entering a new period of volatile oil prices, are we
likely to witness changes in institutional logics underlying the operations of
capital markets? If so, how will such changes influence the effects of positional
and relational embeddedness on the performance of individual underwriters?
One limitation of this study, which is common to most current research on
networks, is its focus on a single type of relationship that links firms in a social
structure. Other than underwriting IPOs, investment banks are also involved in
a number of other collaborative activities, including giving advice on M&A
deals to their partners or syndicating non-publicly traded debt. In addition,
investment bankers are frequently changing jobs, connecting the organizations
that they have worked for in the past by virtue of their personal relationships.
Despite the wealth of studies in the field of inter-organizational networks, we
still do not know how a firm’s position in one social network could influence its
position in another network. With respect to a firm’s performance, can it lever-
age its high-status position in one network to gain access to resources and
opportunities available in other networks, ultimately improving its performance
even further? Can a firm use the network of its alumni to enhance its status in
new markets and industries? The present study is mute on these points.

In addition to status, other variables could moderate the relationship

between a firm’s relational embeddedness and its performance. For example,
large size might afford firms sufficient resources to battle competition from
firms following both arm’s-length and embedded strategies, and avoid being
squeezed out of the market. In this article, since most of the banks, during the
observation period, were privately held, it was not possible to measure their size
by, for example, looking at the financial assets at their disposal. However, one
ought to expect some association between a bank’s size, its status and its market
share. As a bank gains high status, an increase in its revenues and a reduction in
its costs are likely to increase the assets in the bank’s possession, ultimately
increasing the bank’s size. The relationship between size and market share is less
clear. A bank needs to have a high asset base in order to underwrite multiple
public offerings which would lead to an increase in its market share. However,
a bank that is following inappropriate network strategies could have a low mar-
ket share, despite having plenty of financial assets, as poor networking would
shut this bank off from access to deals led by other banks. Thus, a bank can be
of a large size, but at the same time be poorly performing with respect to its
market share. These complex relationships should be examined in future
research projects.
Finally, the feasibility of high-status firms confining themselves to a small
subset of high-status partners suggests a possibility that inter-organizational
networks could, over time, become dominated by powerful cliques, that is,
groups of high-status firms occupying privileged positions at the core of the
industry. In contrast to business groups characterized by common ownership
and shared management (Lincoln et al., 1992; Khanna and Palepu, 2000),
cliques spawned by alliances and other forms of collaboration have narrower
goals and lack common ownership or shared management. Indeed, the study of
Rowley et al. (2005) has examined this question in some detail and found that
cliques were common among Canadian investment banks. Membership of such
cliques helped improve banks’ performance, particularly when they belonged to
the cliques dominated by small groups of high-status underwriters. In contrast,
when banks were not members of such cliques, their performance was substan-
tially lower. In fact, the differences in performance are stunning, when com-
paring the values of underwriting deals of banks that remained embedded
within the cliques with those that exited them. Results of this comparison,
reported in Rowley et al. (2005), showed that clique members’ underwriting
volumes were 12 times greater than those of non-clique members. The evidence
that cliques do exist in the investment banking industry, and that these cliques
are dominated by tightly interconnected high-status investment banks, is not
unique to Canadian capital markets. Similar cliquey patterns of industry struc-
ture have been found in other settings, such as in the study of the American cor-
porate elite (Davis et al., 2003) or health-care institutions (Provan and
Sebastian, 1998); however, the evidence of the impact that internal organization
of such cliques has on their members’ performance is still limited.

In summary, the current study takes an explicitly contingent view of the

outcomes that firms can obtain from their structural embeddedness. In so doing,
the study makes two contributions to the literature on inter-organizational net-
works. First, it demonstrates that the benefits of following mixed relational
strategies are context-specific and that in the investment banking industry,
firms maintaining both embedded and arm’s-length ties underperform their
competitors that primarily rely on either of these relational strategies. Second,
this study examines an interaction between relational and positional embedded-
ness, with status augmenting benefits that firms can reap from maintaining
embedded ties. It is by exploring these and other possible contingencies affect-
ing the costs and benefits of network positions, that we can obtain a fuller
understanding of the mechanisms that translate a firm’s network position into
performance improvement.
Acknowledgement
The author would like to thank Joel Baum, Terry Amburgey, Stan Li, Martin Gargiulo and Wade
Danis for their advice and encouragement. SO! Editor Dev Jennings and three anonymous
reviewers have greatly helped to improve this article.
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Andrew Shipilov is Assistant Professor of Strategy at INSEAD, France. His current research
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Huggy Rao; ‘Where Do Small Worlds Come From?’ (Industrial and Corporate Change, 2003)
with Joel Baum and Tim Rowley; and ‘From Cradle to Grave:Value Generation and Partnering
Uncertainty as Antecedents of Social Relationships’ Formation and Decay’ (in Joel Baum, ed.,
Advances in Strategic Management, 2006) with Barak Aharonson and Tim Rowley. Address:
INSEAD, Boulevard de Constance, 77305 Fontainebleau Cedex, France. [email: shipilov@
insead.edu]


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Strategic Organization

Should you bank on your network? Relational and positional embeddedness in

The online version of this article can be found at:

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Citations (this article cites 42 articles hosted on the

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Should you bank on your network?

Key words • embeddedness • investment banking • networks • status

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Components of relational embeddedness

Embeddedness can be broadly defined as the contingency of economic action

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through arm’s-length ties. Another outcome of trust is that it enables firms to

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demands, and ultimately leading to obsolescence of these actors’ competitive

Arm’s-length and embedded ties in the investment banking industry

In the equity underwriting side of the investment banking industry, banks

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Uzzi (1997, 1999) suggests an alternative way of competing within indus-

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of access to future deal opportunities, they would receive from collaborating

Status and relational embeddedness

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partners, and low-status firms forming relationships with low-status partners.

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Figure 1 Networks of Canadian public offerings underwriters

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Finally, overembeddedness, associated with a lack of new information flow-

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Data, analysis and results

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To distinguish between arm’s-length and embedded networks, Uzzi (1996) pro-

where Nm equals the number of partners that bank i has connections to in

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year. However, as numerous studies have demonstrated, there is an extremely

In this expression, a is a scaling coefficient, B is a weighting parameter that can

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Analysis and results

Ln(M.S.(t))i = a * Ln(M.S.(t–1))i1b * Xi(t–1) 1 ε (3)

where M.S. (Market Share) represented a time-varying measure of performance.

bFONC , 0; bFONC2 . 0. (4)

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1 Market Share (t)d –7.32 3.10 1.00

3 First Order Network Couplingc 0.40 0.44 –0.16 –0.43 1.00

bFONC * status . 0. (5)

The estimates of factors influencing the performance of investment banks are

Table 2 Regression Modelsa

Model 1 Model 2 Model 3

Market Share(t–1)b 0.691*** 0.700*** 0.699***

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Model 1 represents a baseline containing control variables, such as FONC,

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banking industry, issues underwritten by high-status banks are more likely to

Discussion and conclusion

This study has examined mechanisms through which structural embeddedness

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The crowding-out in the investment banking industry effects are similar in

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Market Share(t–1)b 0.691* 0.700* 0.699***