Mitigating moral hazard in entrepreneurial networks: examining structural and relational social capital in East Africa.
Within the family business literature, researchers are recognizing the importance of examining family firm heterogeneity, developing numerous streams to examine the variation. One topic of focus is the cultural and geographic differences among family firms (e.g., Birley, 2001; Khavul, Bruton, & Wood, 2009; Mehrotra, Morck, Shim, & Wiwattanakantang, 2011; Sharma & Manikutty, 2005). Following this line of research and employing an investigation of entrepreneurial firms in Uganda, the study by Khayesi, George, and Antonakis (2014) examines the influence of sociocultural factors (network structures dominated by family and kin) on an entrepreneur's resource accumulation in developing countries.
The work by Khayesi et al. (2014) contributes to the literature by suggesting that entrepreneurs in Uganda should include more nonfamily members in their focal networks. They argue that by including more nonfamily members, entrepreneurs are able to minimize the cost of raising resources because, in contrast to many Western contexts, entrepreneurs in their sample often experience strong social obligations or demands to share financial resources with network members regardless of any financial contribution made by that member. More specifically, Khayesi et al. find that the relationship between the structural dimension of an entrepreneur's social capital (i.e., size of network) and the cost/benefit of employing kinship networks for resource assembly (i.e., dollar cost of network maintenance and search vs. dollar amount raised) is moderated by the degree of shared identity an entrepreneur perceives within the focal network. While these findings offer valuable insight into understanding the influence of one contextual factor on entrepreneurial resources, it is important to further the contextual examination of resource accumulation by asking whether the relational dimension of social capital further specifies the extent to which family-related moral hazards proliferate and examining what strategic responses can be taken to mitigate the dysfunctional outcomes associated with a kinship network while also helping to secure value capture and creation.
In answer to these questions, our extension of the model by Khayesi et al. (2014) offers several refinements: (1) extending the conceptualization of structural social capital to one that more clearly represents Granovetter's (1973) important tie strength via ease of monitoring/sanctioning of participant behavior; (2) considering the relational dimension of social capital proposed by Nahapiet and Ghoshal (1998); (3) using structural and relational social capital to outline network configurations that demonstrate the varying degrees of moral hazard likelihood; and (4) detailing mechanisms for altering the negative outcomes associated with kinship networks in Uganda. Thus, while the work by Khayesi et al. supports their conclusion that, when seeking financial resources, entrepreneurs are likely to incur greater costs of accumulation when they rely on kinship networks, we argue that a better understanding of the structural dimension of social capital, via tie strength and the relational content of those network connections, serves to illuminate the circumstances that push these familial bonds toward dysfunction. Such an extension, we believe, also points the way for entrepreneurs looking to leverage kinship where possible and minimize its risk when necessary.
The Relational Content of Network Ties
Much of the early debate in strategic management centered on the question of why firms develop and whether the driving forces behind organizational survival lie largely within the firm's control (e.g., resource-based view and strategic choice theory) or rest mostly outside the firm and its managers' charge (e.g., institutional theory, population ecology). Over time, these debates have tempered and become more sophisticated with broad agreement that firms are influenced by both internal and external considerations. Among these drivers are transaction costs and the dependencies that push development of markets and hierarchies (Williamson, 1975). Working from rational choice theories of organization (e.g., Coleman, 1986; Hechter, 1987; Williamson) implicit in the approach by Khayesi et al. (2014), we focus on two indicators of the costs associated with entrepreneurial networks: the ease with which member behaviors can be monitored by exchange partners and the degree of dependence involved in network relationships.
As noted, our first extension of the work by Khayesi et al. (2014) involves adding to their conceptualization of social capital structure by focusing on Granovetter's (1973) fundamental network construct: tie strength. This aspect of Nahapiet and Ghoshal's (1998) structural dimension is the proximity and frequency of interaction among the nodes of a network. Expanding beyond network size in this way allows for a clearer assessment of the impact network structure can have on exchange partners' abilities to monitor and sanction errant behaviors while providing an indirect gauge of dependency. As an indicator of this structural feature, we suggest classifying entrepreneurial networks as either external (market network structure with, ceteris paribus, weaker ties) or internal (firm network structure with, ceteris paribus, stronger ties). We also propose to examine the relational content of network ties in terms of the degree to which network partners are dependent on one another for desired outcomes. We suggest that as dependency increases, network members are more likely to avoid behaviors that might seriously jeopardize access to those outcomes and instead develop increasing levels of trust, obligation, and identification (Arregle, Hitt, Sirmon, & Very, 2007; Nahapiet & Ghoshal; Pearson, Carr, & Shaw, 2008). Such dependency developments strengthen ties and allow for greater ease of monitoring because information about behavior is more easily gathered via increasing intimacy. In Table 1, we labeled this factor for evaluating moral hazard in entrepreneurial networks dependence (high relational obligation, trust, and identification) and independence (low relational obligation, trust, and identification). These two social capital dimensions (structural and relational) thus form a four-cell typology of the network relations a Ugandan entrepreneur may encounter as well as the propensity for moral hazard to be found as a result of varying degrees of dependence and monitoring ability.
The family unit in Eastern African is expansive, including parents, siblings, cousins, aunts/uncles, and other relatives. For Ugandan entrepreneurs, family members may not have a direct affiliation with the firm, yet they may pose a moral hazard by attempting to expropriate resources, thus minimizing value captured by the firm. As Khayesi et al. (2014) note, the cost of raising resources outweighs the quantity of resources raised and has a negative performance effect related to family-specific moral hazards (Khavul et al., 2009). Therefore, we offer propositions detailing strategic repositioning efforts intended to reduce expropriation by kin and enhance overall firm performance.
As members demand resources, and due to their location outside the firm, monitoring and sanctioning such behaviors become more difficult. This family-dominated external network (quadrant I) supports resource mobilization; however, such a configuration is subject to opportunism and agency costs (Stewart, 1990, 2003). In an effort to minimize the propensity for moral hazard, Khayesi et al. (2014) have suggested integrating nonfamily members into the network with the idea that cultural obligations will be minimized among nonfamily members. Within this new nonfamily-dominated external network (quadrant II), the likelihood of moral hazard is decreased by the greater independence of relational ties and the decreased presence of sociocultural expectations. A reduced incidence of moral hazard by virtue of formalized investor contracts enhances the firm's ability to capture a higher level of value; however, because member goals are not likely to be closely aligned with firm goals, only moderate value is created when members are externally located. Therefore, we suggest that such a reconfiguration will have a beneficial influence on firm performance compared to a family-dominated external network.
Proposition 1: A configurational transition from a family-dominated external network (quadrant I) to a nonfamily-dominated external network (quadrant II) will reduce moral hazard and positively influence firm performance by increasing relational independence of the external network.
An alternative to external network relations are those developed within the firm. If a nonfamily-dominated network exists within the boundaries of the firm (quadrant III), both value creation and capture is high given that monitoring and sanctioning occur more easily inside the firm via formalized firm processes and minimized sociocultural obligations. Within this type of network, family-related moral hazard is lower and value capture is enhanced when pressure to expropriate resources for family members, who are now incorporated into a network of proportionally fewer kin, is decreased (similar to the outcome noted in quadrant II). Including nonfamily members into the internal firm network creates additional allies who act as countervailing forces against expropriation. As a result of more allies safeguarding resource expropriation, the overall alignment of firm-employee goals is enhanced, which reduces the bifurcation bias noted by Verbeke and Kano (2012). Thus, the internalization of the network provides additional means for oversight, and the manifestation of allies minimizes resource expropriation, thereby supporting a higher level of value creation and capture.
Proposition 2: A configurational transition from a family-dominated external network (quadrant I) to a nonfamily-dominated firm network (quadrant III) will reduce moral hazard and positively influence firm performance by increasing relational independence and internalizing the firm network.
The entrepreneur may also increase the relational dependency of family within the firm network as a means of reducing the likelihood of moral hazard. Increased relational dependency creates a family-dominated internal network (quadrant IV) wherein the likelihood of moral hazard is reduced because of greater relational dependency among family members (especially for noneconomic outcomes) and the increased ability to monitor and sanction individual members. Quadrant IV networks reflect the dependencies and outcomes often associated with family firms (see, e.g., Arregle et al., 2007; Pearson et al., 2008). Given closer proximity, frequency of interactions, and stronger relational ties, monitoring and sanctioning actions in these networks can occur more easily. Further, the inclusion of family members into the internal firm network more closely aligns firm and family member goals, thereby creating family allies who have a shared value commitment of firm success. However, while the relational dependence and goal alignment among family members reduce the likelihood of moral hazard to some extent, short-term needs may cause members to resort to resource expropriation. This configuration, thus, is not likely to negate entirely the temptations to engage in moral hazard; nonetheless, the ease of monitoring and sanctioning coupled with the closer alignment of member and firm goals (e.g., transgenerational intent) minimizes moral hazard. Therefore, the amount of value captured by the firm is moderate in this internal-dependent configuration, and because members operate within the boundary, the level of value creation is higher given greater member contributions to the firm. Compared with a family-dominated external network, the family-dominated (coalition) network is likely to have a higher level of performance given enhanced goal alignment and increased monitoring ability.
Proposition 3: A configurational transition from a family-dominated external network (quadrant I) to a family-dominated (coalition) firm network (quadrant IV) will reduce moral hazard and positively influence firm performance by internalizing the family-dominated network.
Mechanisms to Mitigate Moral Hazard
Oliver (1991) suggests firms that are pushed to conform to strong pressures at the institutional level may respond in a number of ways to lessen or circumvent those forces; we propose that Ugandan entrepreneurs, faced with their own demands for conformity from family members, may employ similar strategic responses. While Oliver examines the response of the firm and groups of firms to institutional pressures, we adapt her framework to outline pragmatic, short-term responses to an entrepreneur's family-related moral hazards. Specifically, we propose that the Ugandan entrepreneur may engage a strategic response to minimize the moral hazard in an attempt to maximize value creation and capture for the firm. Based on Oliver's work, we classify the range of strategic responses as acquiescence, accommodation, defiance, and manipulation.
If the entrepreneur chooses to comply with the sociocultural pressure and expropriates resources to family members external to the firm, the entrepreneur engages the strategic response of acquiescence. In this response, the entrepreneur does not seek to alter the family-dominated external network (quadrant I), and the likelihood of family-related moral hazard remains high. Khayesi et al. (2014) and Khavul et al. (2009) suggest that one way entrepreneurs may reduce moral hazard is to integrate nonfamily members (community ties) into the network. To do so, the Ugandan entrepreneur attempts to minimize the influence of sociocultural norms via integration of nonfamily members. We classify this action as accommodation (subsuming Oliver's avoidance and compromise strategies) and suggest that it may be employed to alter the family-dominated external network into a nonfamily-dominated external network (quadrant II) as specified in proposition 1.
For the entrepreneurial network to transition away from a family-dominated external network where the potential for moral hazard is high, the entrepreneur can employ a strategic response whereby family members are separated from the external network and integrated into the firm as "traditional" employees, thus creating a nonfamily-dominated firm network (quadrant III). This strategy, labeled as defiance and as referenced in proposition 2, reduces the relational social capital of kin by disembedding members from the family network and setting them into a formal firm network where behaviors are more easily monitored. A final means for minimizing the moral hazard among family members is a transition from the family-dominated external network to the family-dominated (coalition) firm network (quadrant IV) as suggested in proposition 3. Oliver (1991) suggests that this strategy can be used to manipulate societal level norms; however, in the context of East Africa, we suggest that the entrepreneur is most directly concerned with strategic responses offering short-term, immediate payback. Applying this strategy at the network level, the entrepreneur may seek to minimize moral hazard and increase value capture through pursuit of the manipulation strategy whereby family members are fully incorporated into the firm as owners and part of the dominant coalition. As a whole, the mechanisms discussed here offer the East African entrepreneur a set of useful approaches for reducing moral hazard while enhancing value creation and capture for the firm.
Khayesi et al. (2014) offer valuable insight into how sociocultural norms influence resource accumulation and suggest the entrepreneur minimize such influences by incorporating nonfamily members into the focal network. We extended their work by expanding their approach to structural social capital and integrating relational capital to examine dependence and independence in entrepreneurial networks. We outlined the extent to which family moral hazards exist within four network types and offered mechanisms for altering moral hazard. For entrepreneurs in Uganda, or other high-dependency environments, reconfiguring the entrepreneurial network is a useful approach for reducing the moral hazard associated with family-dominated external networks. Such recommendations, however, are not exclusive to East Africa and are likely to be generalizable to similar contexts wherein entrepreneurs experience high levels of obligation to support family dependents.
While we have focused on the structural and relational dimensions of social capital, family firm members also possess an overarching, shared understanding of the firm's vision, goals, and purpose. Future research should thus examine cognitive social capital and its role in entrepreneurial networks as well as the manner in which it may lead family-related networks to create value for the firm. In a related vein, study of the extent to which other sociocultural forces may engender positive or negative consequences for entrepreneurial efforts would be useful. Additionally, the type of resources an entrepreneur pursues may have significant consequences for the study of social capital in family networks. For example, the work by Khayesi et al. (2014), as well as our commentary, has focused on financial resources; however, studies may also investigate whether similar hazards exist when intangible resources are involved.
In all, we argue that not only is the examination of social capital valuable to the future development of entrepreneurship (Gedajlovic, Honig, Moore, Payne, & Wright, 2013), but as highlighted in the study by the Khayesi et al. (2014), and as we have attempted to emphasize, the benefit to further examining social capital in family firms is vast and holds potential for further articulating family firm heterogeneity across cultures and geographic locations.
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Joshua J. Daspit is assistant professor of management in the Department of Management and Information Systems, College of Business, Mississippi State University, Mississippi State, MS 39762-9581, USA.
Rebecca G. Long is professor of management in the Department of Management and Information Systems, College of Business, Mississippi State University, Mississippi State, MS 39762-9581, USA.
A previous version of this commentary was presented at the 2013 Theories of Family Enterprise Conference. The authors are grateful to the conference organizers and participants for comments received. Furthermore, the authors appreciate the recommendations provided by the special issue coeditor, Lloyd Steier, and two anonymous reviewers. We also appreciate the feedback received from Jim Chrisman on earlier versions of the commentary and support received from the Center of Family Enterprise Research at Mississippi State University.
Please send correspondence to: Joshua J. Daspit, tel.: 662-325-3928; e-mail: Josh.Daspit@msstate.edu, and to Rebecca G. Long at RLong@business.msstate.edu.
Table 1 Structural and Relational Social Capital Network Configurations and Strategic Responses for Mitigating Moral Hazard Through Network Transition Structural social capital Relational Dependence social External (market) capital Family-dominated external network * Members demand compensation via financial share * Promotes increased costs * Monitoring/sanctioning difficult * High potential of family-related moral hazard * Minimum firm value creation given low family member oversight and involvement in external network * Minimum firm value capture given weak alignment of family members with firm goals Quadrant I Independence Quadrant II Nonfamily-dominated external network * Members compensated as investors based on contract * Promotes reduced and stabilized costs * Monitoring/sanctioning moderate and done by contractual processes * Minimal potential of family-related moral hazard * Moderate firm value creation given external location of network * High firm value capture given lower threat of family expropriation owing to nonfamily dominance Structural social capital Relational Dependence social Internal (hierarchy) Family-dominated (coalition) capital firm network * Members compensated via noneconomic outcomes based on familial covenant and salary/wages * Promotes minimized costs * Monitoring easier due to proximity, frequent interaction, and strong ties * Moderate potential of family-related moral hazard * High firm value creation given more formal oversight and family involvement in internal network * Moderate firm value capture given lower resource expropriation; family members act as allies to safeguard resources given goal alignment Quadrant IV Independence Quadrant III Nonfamily-dominated firm network * Members compensated as employees based on contract * Promotes reduced and stabilized costs * Monitoring/sanctioning moderate and done by formal firm processes * Minimal potential of family-related moral hazard * High firm value creation given more formal oversight and member involvement in internal network * High firm value capture given lower threat of family expropriation owing family and nonfamily members act as allies to safeguard resources given goal alignment Note: The name of the strategic response appropriate for each corresponding network transition is noted within the respective arrow. The acquiescence strategy is not graphically displayed given its strategy of no action.
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|Author:||Daspit, Joshua J.; Long, Rebecca G.|
|Publication:||Entrepreneurship: Theory and Practice|
|Date:||Nov 1, 2014|
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