Abstract: There is a growing body of literature suggesting that personal relationships are important factors in market exchange, but little has been done to empirically examine the impact of networks of such relations on individual business's performance and growth. This paper investigates the impact of networking activity on profit reinvestment through the role of social networks in assisting businesses to enforce their contracts. Using an original dataset from Serbia and Montenegro, the paper shows that networking activity is strongly and consistently associated with greater profit reinvestment. Businesses that rely the most on networks for dispute resolution, reinvest approximately 80% more of their profits compared to businesses that use networks only minimally. Moreover, businesses whose executives claim to spend 40 hours per week maintaining contacts, reinvested approximately 300% more of their profits than businesses that devoted no time to maintaining their business contacts. These effects of networking activity are observed independent of the businesses' reliance on courts as a formal venue for contract enforcement. The paper concludes that networks are a powerful alternative, informal strategy for contract enforcement and that managerial ties directly contribute to business investment and thus performance.
Abstract: The transition reforms and introduction of open markets in post-communist Eastern Europe were expected to dissipate the role of informal (non-market) exchange facilitated by networks of social relations, and increase the role of impersonal exchange supported by the rule of law and formal mechanisms for contract enforcement. However, seventeen years after communism’s collapse, exchange based on personal trust and the principle of reciprocity still plays an important role in these economies. The relationship between personal exchange and economic activity in the context of transition has not been researched to date. This chapter examines the role of social networks in facilitating business transactions on the basis of in-person interviews with managers and owners of small and medium size enterprises. The framework of transaction costs is employed to understand the individual manager’s decision whether to transact within his or her social network or in the impersonal market. Contrasting the total costs of transacting in each of the exchange settings shows that social networks sometimes offer a cost-saving alternative to the impersonal market but that their predominant use is associated with significant social costs. Individually efficient strategies thus produce less than efficient social outcomes. Suboptimal outcomes can persist when personalized exchange prevents changes to formal institutions designed to lower incentives for the use of social networks.