The myth of formal control and trust : a context-based analysis

Abstract

Formal control and trust are two typical governance mechanisms that safeguard business transactions from both economic and social perspectives. As to the joint effects of these two control mechanisms, the extant literature demonstrates parallel conclusions. Indeed, a portion of relevant literature proves that formal control and trust could be applied simultaneously to secure transactions, whereas other research argues that these two control mechanisms can actually be substituted for each other. According to social embeddedness theory, firms’ governance strategies are influenced by their relational quality within a particular relationship; hence differentiating inter-firm relationships based on relational tie strength that firms bear within a particular relationship helps determine appropriate control strategies that the firms may pursue. The current study applies social embeddedness theory and differentiates the strong tie relationship from the weak tie relationship; it also describes two scenarios in which formal control and trust are employed differently. It is found that distinctive formal control/trust joint effects in different relational ties lead to consequential transactional differences. On the basis of empirical tests, it is concluded that the joint effects of formal control and trust on governing transactions depends on the relational tie that the focal partners share. Specifically, formal control and trust complement each other in weak tie relations, while they are substituted for one another in strong tie relations. This study not only discovers situations leading to parallel conclusions about the relationship between formal control and trust, but also provides a novel perspective in judging inter-firm governance issues. Key words: Trust, Formal control, Opportunism, Governance mechanism