Embeddedness in the Making of Financial Capital: How Social Relations and Networks Benefit
Firms Seeking Financing
Author(s): Brian Uzzi
Source: American Sociological Review, Vol. 64, No. 4 (Aug., 1999), pp. 481-505
Published by: American Sociological Association
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EMBEDDEDNESS IN THE MAKING OF FINANCIAL CAPITAL:
HOW SOCIAL RELATIONS AND NETWORKS BENEFIT
FIRMS SEEKING FINANCING*
Brian Uzzi
Northwestern University
I investigate how social embeddedness affects an organization’s acquisition
and cost offinancial capital in middle-market banking-a lucrative but understudied financial sector Using existing theory and original fieldwork, I
develop a framework to explain how embeddedness can influence which
firms get capital and at what cost. I then statistically examine my claims
using national data on small-business lending. At the level of dyadic ties, I
find that firms that embed their commercial transactions with their lender in
social attachments receive lower interest rates on loans. At the network level,
firms are more likely to get loans and to receive lower interest rates on loans
if their network of bank ties has a mix of embedded ties and arm’s-length
ties. These network effects arise because embedded ties motivate network
partners to share private resources, while arm’s-length ties facilitate access
to public information on market prices and loan opportunities so that the
benefits of different types of ties are optimized within one network. I conclude with a discussion of how the value produced by a network is at a premium when it creates a bridge that links the public information of markets
with the private resources of relationships.
XWjhich
firms get capital and at what
cost? The answer can determine the
life chances of firms, the growth of economies, and how markets stratify firms and persons through the rationing and pricing of
credit. In financial theory, any firm with a
positive economic net present value should
obtain credit at a competitive price (Petersen
and Rajan 1994). Sociological theory does
not necessarily reject this axiom, yet argues
that banking transactions are embedded in
social relations that uniquely shape credit ac*
Direct all correspondence to Brian Uzzi,
Kellogg GraduateSchool of Management, Northwestern University, Evanston, IL (uzzi@nwu.
edu). I thank John Wolken at the Federal Reserve
Bank, James Baron, Wayne Baker, Willie Ocasio,
Ryon Lancaster, Nan Lin, Mitch Petersen, Holly
Raider, Mike Sacks, James G. Gillespie, the bank
CEOs and Relationship Managers that contributed their insights to this research, and Northwestern University’s Institute for Policy Research
and the Kellogg Graduate School of Management’s Banking Resource Center for their research support.
cess and costs in ways that are inadequately
incorporated into financial theory (Baker
1990; Mintz and Schwartz 1985; Mizruchi
and Stearns 1994b; Podolny 1993; Uzzi and
Gillespie 1999). Bankers and entrepreneurs
echo this observation and complain that financial models often do not appreciate the
value of bank-client relationships. This suggests that there is a growing demand for sociological theory on finance (Abolafia 1997;
Arrow 1998; Haunschild 1994; Mizruchi and
Stearns 1994b).
Most sociological research on lending has
not focused on the availability and pricing of
capital. Rather, classical writings take a
philosophical approach to analyzing money
economies, and most contemporary work
concentrates on how bank-firm ties, coarsely
defined as the incidence of a director interlock, affect the politics and level of a firm’s
borrowing (Baker 1990; Mintz and Schwartz
1985; Mizruchi and Stearns 1994a). These
approaches, while productive for certain
problems, leave unexplored how the embeddedness of commercial transactions in social
American Sociological Review, 1999, Vol. 64 (August:481-505)
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All use subject to JSTOR Terms and Conditions
481
482
AMERICAN SOCIOLOGICAL REVIEW
attachments and networks affects personal
and corporate financial dealings (DiMaggio
and Louch 1998; Uzzi 1997). Finance research similarly concludes that while bankfirm ties are more critical to lending markets
than classical theory suggests, inconsistencies in financial theory also signify a need
for more research on how social relationships and networks affect who gets capital
and at what cost (Arrow 1998; Petersen and
Rajan 1994).
I examine how bank-borrower relationships and networks affect a firm’s acquisition
and cost of capital using a social embeddedness approach (Granovetter 1985). The social embeddedness approach aims to explain
why economic transactions become embedded in social relations that differentially affect the allocation and valuation of resources. Social embeddedness is defined as
the degree to which commercial transactions
take place through social relations and networks of relations that use exchange protocols associated with social, noncommercial
attachments to govern business dealings
(Marsden 1981; Uzzi 1997). I argue that embedding commercial transactions in social
attachments benefits firms that are seeking
financing by promoting distinctive governance mechanisms and the transferof private
information-factors that motivate banks
and firms to find integrative solutions to financing problems beyond those possible
through market relations, which possess different benefits.
In developing my arguments, I analyze
how both social relationships and networks
affect lending. At the level of relationships, I
draw on research that examines how properties of embedded ties and arm’s-length ties
promote different kinds of access and governance benefits in market exchanges. At the
level of the network, I elaborate on the finding that networks incorporatinga mix of embedded ties and market ties provide premium
benefits because they enable a firm to synthesize the advantages of partneringvia embedded ties with the advantages of brokerage
offered by arm’s-length ties. I argue that
firms are more likely to secure loans and receive lower interest rates if they are tied to
their lenders through embedded ties and if
their networks of bank ties have a mix of embedded ties and arm’s-length ties.
My study aims to enhance sociological
theory on finance in several ways. First, I examine the setting of interest rates, the touchstone market mechanism by which value is
created, thereby extending sociological research on markets to price formation
(Fligstein 1996; Podolny 1993). Second,
since financial capital is a substitutablecommodity and banks can write nearly complete
contracts by holding collateral, this study reveals how social embeddedness operates in
the presence of market "efficiency" conditions thought to supplant it (Carruthers
1996). Third, I focus on what bankers dub
"the midmarket"-a sector of the economy
that has been neglected in research yet deserves closer analysis (Fama 1985). The
midmarket is composed of firms with fewer
than 500 employees or less than $500 million in annual sales and is bountiful in its social and economic effects. The midmarket
accounts for more than one-half of the U.S.
gross domestic product (GDP), has twice the
innovations per employee as large firms, and
since 1970 has created two-thirds of the jobs
in the United States. In the 1980s, it emerged
as a seedbed. for entrepreneurship and a
source of 16 million of the 20 million new
jobs created in that decade.
Before proceeding, it is worth noting the
unique qualitative and quantitative materials
used in this analysis. Because the effect of
embeddedness in financial markets is contested and remains "in need of greater theoretical specification" (Smelser and Swedberg
1994:18), I strengthen my analysis using a
triangulationof theory, fieldwork, and statistical analysis (King, Keohane, and Verba
1994). I use original field data on bank-borrower ties to help explicate and illustrate the
mechanisms by which embeddedness produces outcomes and actors construct markets. I then use a national random sample of
2,400 companies to test the validity and
generalizability of my theory.
THEORY
The social embeddedness framework is one
of several sociological accounts for how social structure affects financial markets
(Granovetter 1985; Portes and Sensenbrenner 1993; Romo and Schwartz 1995, Uzzi
1996, 1997). Research has focused on the
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EMBEDDEDNESS IN THE MAKING OF FINANCIAL CAPITAL
483
types of social relations and social networks efit. Embedded ties promote these outcomes
that exist and their economic effects. Follow- through the transfer of private resources and
ing this literature, I treat social embed- self-enforcing governance (Portes and
dedness as a variable and focus on how the Sensenbrenner 1993; Uzzi 1997). Private requality of relationships and the configuration sources and private information are distincof ties in a network influence a firm’s ability tive in that they identify where an actor’s exto obtain loans and to lower the cost of bor- pertise and dependencies reside. They might
rowing.
include, for example, unpublished capabiliRelationships vary between arm’s-length ties in products, the need to source a particuand embedded (Baker 1990; Lie 1997; lar material, the strategic blueprints for an
Powell 1990; Uzzi 1996, 1997). Arm’s- executive succession, investment plans,
length ties are characterized by lean and failed solutions, the rollout date of a new
sporadic transactions and "function without product, or critical resource dependencies. In
any prolonged human or social contact be- essence, private information differs from
tween parties . .. [who] need not enter into public market information, such as financial
recurrent or continuing relations as a result statements or job listings, in that it is not "inof which they would get to know each other formation for the asking," but information
well" (Hirschman 1982:1473). Weber that must be voluntarily transferredin an ex(1946) characterized them as lacking social change. In fact, because private knowledge
distinction and having an expressive nature can be misappropriated,it is commonly inthat "knows nothing of honor" (p. 192). The accessible through arm’s-length ties and is
main proposition related to arm’s-length ties shared only within a set of trustworthy exis that they determine the degree to which change partners.
an actor can access heterogeneous informaThe transfer of private knowledge protion in a market, even if that information is motes value creation in exchanges by revealpublicly available through advertising or ing to exchange partners the unique possipublicity, because actors use network ties to bilities they possess for matching their comsearch for opportunities and investments. petencies and resources. In contrast, public
For example, Granovetter (1973) found that information such as ask-and-bid prices can
job-seekers tend to search for and learn be a source of value creation, but is less so
about new job openings through acquaintan- in competitive markets because it is less reces, even when the jobs were publicly ad- stricted and unique than private knowledge
vertised. Davis (1991) found that firms and resources. Hence, the solutions prompted
adopted "poison pills" chiefly through inter- by the transfer of private knowledge are
lock ties, despite the takeover defense’s valuable not only because they are distincpublic notoriety and marketing by many le- tive, but also because they are hard for comgal firms. Burt (1992) developed this petitors without private knowledge to imiformulation’s most trenchant propositions. tate. Consistent with this argument, Eccles
He argued that the strategic expansion of and Crane (1988) found that investment
networks through the use of arm’s-length bankers were able to customize deals and
ties offers the highest possible returns to create innovative risk-reducing financial infirms and persons by linking them to di- struments for their clients when they posverse pools of market information, which sessed information and resources beyond
they broker among less informed actors who what firms made publicly available. Mark
reside in cloistered networks of relations Twain Bancshares, a lucrative midmarket
that hinder their autonomy.
bank, gained recognition by using private inIn contrast, there is less theory and empiri- formation to tailor their bank products and
cal justification for expecting that socially loan structures to the distinctive and often
embedded ties generate exchange benefits in confidential capabilities of their customers
markets. Recent research on interfirm net- (Baker 1994).
works suggests that embedding economic exThe embedding of commercial transacchanges in social attachments can both cre- tions in social attachments promotes the
ate unique value and motivate exchange part- benefits discussed above by enacting expecners to share the value for their mutual ben- tations of trust and reciprocal obligation that
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484
AMERICAN SOCIOLOGICAL REVIEW
actors espouse as the right and proper protocols for governing exchange with persons
they come to know well (Blau 1964;
DiMaggio and Louch 1998; Portes and
Sensenbrenner 1993).1 These expectations
reduce fears of misappropriation because
transactors anticipate that others will not
voluntarily engage in opportunistic behavior. Instead, exchange partners share the belief that these motives, coupled with access
to private information, can enlarge the pool
of potentially beneficial transactions that
are not available through market means.
Moreover, because the protocols of embedded ties are borrowed from the protocols of
social attachments, which are learned from
pre-existing structures, they are serviceable
in business dealings not just as "good faith
conformity" norms, but as clear expectations for a "meeting of the minds" (Macneil
forthcoming). Potentially this can save on
the costs of organizing other governance arrangements, freeing resources for future
productive prospects (Fukuyama 1995). In
this way, embedding transactions in social
ties does not foreordain cooperative outcomes. Rather,it provides an essential priming mechanism that promotes initial offers
of trust and reciprocity that, if accepted and
returned, solidify through reciprocal investments and self-enforcement. In contrast, the
expectation of avaricious actions that is anticipated in arm’s-length ties is likely to
prompt distrust, even if action is credible,
except for discrete cases in which economic
incentives are aligned or third parties enforce fairness (Kollock 1994).2
Extending the above argumentsto lending
relationships suggests that the availability
and costs of a firm’s capital should vary
with the degree to which its commercial
transactions with a bank are embedded in
social attachments. Embedded ties furnish
governance and access to private information benefits that can channel resources and
motivate attempts at integrative solutions to
lending problems that are not available
through market ties. Building on these arguments for how embeddedness affects dyadic
exchange also suggests that an actor’s network of ties is pertinent to the financing
process. Previous research has argued that a
large network of arm’s-length ties to banks
expands the firm’s pool of potential loan offers and the firm’s ability to play banks off
against one another (Baker 1990; Eccles and
Crane 1988). While I agree in part with this
logic, my analysis of lending suggests that
"shopping the market"for potential offers is
an incomplete picture of the lending process. Firms secure loans and lower their
borrowing costs by shopping the market for
what’s available and through collaborative
problem-solving over terms with specific
lenders. This suggests that firms embedded
in networks that enable them to gather information about the range of loan deals
available in a market and to access the pri2 While
I The literature on attachments distinguishes
between ties between persons and ties between
organizations (Baker, Faulkner and Fisher 1998;
Blau 1964; Levinthal and Fichman 1988;
Seabright, Levinthal, and Fichman 1992) and
views social attachments as personal ties (which
constitute ties between the individuals’ firms,
even if the reverse does not hold). A social attachment is an affiliation of shared interests and
fidelity that develops when behavior that is culturally associated with familiar and noncommercial transactions is enacted as part of the commercial exchange (Jacobucci and Ostrom 1996). In
this study, such social behaviors include wedding
invitations, parties, dining, sports competitions,
shows, or other social events that both friends and
businesspersons can and do commonly enact
through time and that are valued in that persons
share these behaviors in proprietary ways with
select others.
my objective is to propose and investigate these processes ratherthan to assert their validity, much social psychological research on decision-making supports these processes. Montgomery (1998) showed how transactors who assume the identity of "friend"are likely to cooperate, while transactors who assume the identity of
"businessperson"are unlikely to cooperate (even
if commitments are credible) because there is no
priming mechanism for trust. The logic of appropriateness, first identified by March (1994), suggests that decision-makers choose actions by asking, "Who am I and what is the appropriate action for my role?" ratherthan basing these actions
on situation-free personal preferences. Cognitive
dissonance research also finds that attitudes and
interests are aligned with role behavior (Kunda
1990:484). This suggests that motives to create
and share value are supported by psychological
processes that are set in motion by embedding
processes.
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EMBEDDEDNESS IN THE MAKING OF FINANCIAL CAPITAL
485
vate resources of particular lenders gain The Social Embeddedness of Lending
premium benefits from social structure be- Relationships
cause their ability to "broker and partner"
The fieldwork revealed that bankers segment
on loan deals is enhanced.
the market into three strata: new corporate,
midmarket, and entry-level firms. Table 2
ETHNOGRAPHIC FIELDWORK
summarizes the segments, lending practices,
I conducted field research to help formulate and bank-firmrelationships in these markets.
my embeddedness framework. Given the While important distinctions exist between
scarcity of research on midmarket banking, the new corporate segment and the other two
field research furnished an empirical basis segments, RMs rarely distinguish between
for describing the pertinentactors, resources, midmarket and entry-market clients and
and relationships. It also enabled a more re- typically maintain ties to both types of firms
fined analysis of bank-borrower ties than in their portfolios. Thus, I treat midmarket
would have been possible using coarser and entry-marketfirms similarly in my fieldmethodological tools, although the small work and control for possible differences
sample size moderatedgeneralizability. Field due to organizational size in my statistical
research also permitted a triangulation of analysis.
theory, ethnography, and statistical analysis
Consistent with previous research, I found
on lending.3
that in the new corporatesegment, public and
I conducted field research at 11 midmarket certified financial statements provide banks
banks in the Chicago area, a highly competi- with ready access to pertinent information
tive banking market. Table 1 describes the about a firm’s creditworthiness (Mizruchi
demographic and organizational back- and Stearns 1994b). Similarly, firms use their
grounds of my 26 interviewees and their 11 large treasury departments to identify the
banks. My sample of interviewees typified lowest cost loans or to gain bargaining posithe racial, gender, and educational profiles of tion vis-a’-vis banks by borrowing directly
bankers, who are largely white, male, and from money markets.4Thus, lending ties becollege-educated. I principally interviewed tween big firms and banks are transactional,
"Relationship Managers" (hereafter RMs), with banks chasing customers who treat
the bank personnel who make lending deci- loans and banks as commodities (Davis and
sions and interface with clients. I also inter- Mizruchi 1999).
viewed two bank CEOs and two bad-debt
The social structureof the midmarket difcollectors (who deal with fraudulent clients) fers from the new corporate segment in ways
to understand and cross-examine the view- that have important theoretical and substanpoints of other types of lending officers. I tive implications. Firms experience ambigufocused on RMs because they make the judg- ity in evaluating banks because they lack soments about a client’s loan eligibility and phisticated financial expertise and are too
consequently can reveal how social and net- small to borrow from money markets. Thus,
work ties affect their lending decisions. I they depend on banks for financial advice
also reviewed Federal Reserve Bank Opin- and credit, yet they lack the clout and finanion Surveys on lending to corroborateRMs’ cial wherewithal to ensure a bank’s probity,
accounts. Appendix A describes these increasing their reluctance to share private
sources and the fieldwork methodology in information with the bank’s RMs. For exgreater detail.
ample, one RM observed,
If it’s companymoneyit mightbe in the right
pocket, if it’s personalmoney it might be in
I Lendingdecisionsaremadein two stages.In
theirleft pocket,but it’s all in the samepairof
to
stage one, a bankdecideswhether offer a loan
to an applicant. Loan denial reflects cases in
4 Moneymarkets capitaldirectlyto firmsat
sell
which the bankwill not raise the interestrateto
makeup for a bad creditrisk. In stage two, the the same rate as banks.LondonInterBank
Offer
for
bankdecideswhatcost of creditto chargeappli- Rate is the currentmoney marketstandard
cants who were deemed creditworthyin stage lendingratesandreflectsthe interestratepaidon
market.
one.
depositsamongbanksin the Eurodollar
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486
AMERICAN SOCIOLOGICAL REVIEW
Table 1. Characteristics of Interviewees in the Field Research: Relationship Managers (RMs) at Chicago Banks, 1988
RM’s Profile
Bank
Depositsa
(in $1,000s)
Bank
RM’s
Sex /Race
Numberof
Years in
Industry
Numberof Interview
Firmsin
Time
Portfolio (in Minutes)
Entry-Level
125,475
178,825
17
2
40+
8
3
35
4
21
9
50
17
6
17
60
30
120
120
120
60
45
Male/white
Male/black
Female/white
Male/white
15
3
6
20
50
12
26
54
45
50
30
45
Male/white
Female/white
Male/white
Female/white
5
19
7
9
13
15
35
50
60
45
30
Male/white
Male/white
19
9
50
25
75
50
Male/white
25
27
120
7
Male/white
Male/white
1st Midwest Bank
104,181
Male/white
Female/white
Male/white
Male/white
Male/white
Male/white
Male/white
Male/white
First Bank of
Evanston
1st NationalBank
of La Grange
5
15
8
19
30
70
Male/white
Female/white
Male/white
Male/white
7
9
12
12
21
18
14
25
60
55
45
50
Male/white
25
50
35
Midmarket
Bank One-Chicago 1,156,874
Cole Taylor
BankAmerica
1,327,893
3,887,571
AmericanNational 4,357,509
Bank
NorthernTrust
6,301,607
60
Midmarket and New Corporate
HarrisBank
8,653,638
LaSalle National
9,761,356
Bank
1st NationalBank 17,961,480
of Chicago
Note: A total of 26 RMs were interviewedat 11 differentChicago banks. Interviewswere conductedon
site between February1 and May 1, 1988. Interviewtime totalled 26 hours.
a
Bank deposits…
