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Market Networks and Corporate Behaviorl
Wayne E. Baker
University of Chicago
I Initial funding was provided by the Harvard Business School (HBS) in the form of a
fellowship held by the author. I am grateful to HBS for sustained support to pursue
independent research. I thank the Graduate School of Business, University of
Chicago, where most of the analysis and writing took place, for continuing support.
Preliminary findings were originally documented in my "Organization-Market Inter-
face: Corporations' Relations with Investment Banks," HBS Working Paper no. 87-
043 (April 1987). Some findings were also reported (with my permission) in chapter 4 of
Eccles and Crane (1988). Versions of the paper were presented at the annual meetings
of the American Sociological Association (1988) and the Academy of Management
(1989). I am indebted to Mitchel Abolafia, Robert Faulkner, Ray Friedman, Mark
Granovetter, Edward Laumann, Jane Mather, Mark Shanley, Andrew Van de Ven,
and Harrison White for extensive comments on earlier drafts; to Dean Foster, Edward
George, Ananth Iyer, Peter E. Rossi, and Abbie Smith for technical advice; and to
Chu Zhang for research assistance. The paper benefited tremendously from the com-
ments of the reviewers and from comments received in Gary Becker and James Cole-
man's seminar on rational models in the social sciences.
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American Journal of Sociology
590
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Market Networks
591
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American Journal of Sociology
power. Firms may wield their transactions in ways that compel banks to
compete for the business, for example, bidding down spreads, improving
pricing advice, and increasing distribution effort (see App. A). The cen-
tral problem for corporations is how to manage their relations with in-
vestment banks to reduce dependence and exploit power advantages. The
observed configuration of market ties is the revealed result of efforts to
do so.
As a theoretical orientation, I adapt the resource dependence perspec-
tive, in which "intercorporate relations can be understood as a product of
patterns of interorganizational dependence and constraint" (Pfeffer
1987a, p. 40).4 The resource dependence approach has rarely been ap-
plied directly to market relations and never to market ties at the firm-to-
firm level. The usual foci are co-optive or absorptive devices and political
activity (Pfeffer 1987a). With the adaptation of the resource-dependence
view to understand how firms manage market ties, a theoretical contribu-
tion of this study is the extension of the perspective to the subject of
market relations. Another contribution is consideration of the concurrent
use of multiple strategies (what I call "tandem strategies"). For example, I
investigate how director interlocks as co-optive devices influence the con-
figuration of market relations.
Like many sociological theories, the driving force in the resource de-
pendence perspective is power, where organizations strive to reduce in-
terdependence "regardless of considerations of profit or efficiency for the
most part" (Pfeffer 1987a, p. 27). In contrast, the driving force in econom-
ics is efficiency, with emphasis on providing incentives for efficient trans-
actions (as in, e.g., agency theory) and economizing on transaction costs
(see, e.g., Williamson 1985). Power and efficiency are often seen as theo-
retical opposites, but they are empirically intertwined, and their distinc-
tions are not so great (Pfeffer 1987a; Eccles and White 1988). Indeed, in
the context of investment banking, power and efficiency motives can
drive a firm to take the same action. Corporate finance managers (CFMs)
told me that they moved from reliance on a single bank to reduce depen-
592
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Market Networks
dence but also reported that the addition of banks cuts costs by creating
competition.5 Given that power and efficiency produce similar behaviors
(such as using multiple banks), it is inappropriate to consider them as
competing hypotheses; instead, observed market relations may be under-
stood as the joint effect of efforts to reduce dependence and increase
efficiency (e.g., cut costs).
This presentation is organized as follows: In Section I, I develop a
framework for the analysis of interorganizational market relations. Data
and methods are described in Section II. Findings are presented and
discussed in Section III. The conclusion is Section IV. Appendix A briefly
describes the functions of investment banks and pricing mechanics for
new issues.
I. THEORETICAL FRAMEWORK
5The positive relationship of competition and cost reduction is consistent with studies
of the corporate bond market in which increasing the number of bidders on new issues
was found to decrease interest costs (Ederington 1978; Sorensen 1979).
593
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American Journal of Sociology
6 Related but more distant concepts include "implicit understandings" between mem-
bers of a distribution channel (Shugan 1985) and "implicit contracts" between workers
and employers (Rosen 1985).
7It is not possible to analyze historical trends, however, because of the unfortunate
lack of systematic longitudinal data on investment-bank usage.
594
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595
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American Journal of Sociology
TABLE 1
FORD GM
Share Share
Bank (S) Bank (%)
NOTE.-For Ford, 15 other unspecified banks each held a share less than .5%; total number of banks
= 25, number of deals = 81. For GM, eight other unspecified banks each held a share less than .5%;
number of banks = 2 7, number of deals = 1 19. "Direct" indicates a deal made without the participation
of a bank.
596
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Market Networks
9 Goldman Sachs, e.g., helped Ford Motor Company through its troubled times in the
1980s. Such practices also occur in other service industries. When Mattel neared
bankruptcy in the 1970s, Ogilvy & Mather, its longtime advertising agency, paid
Mattel's television and magazine advertising bills (Pendleton 1988).
597
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American Journal of Sociology
10 If investment banks have become powerless, then interface choice would be largely
irrelevant: corporations could simply rely on competitive forces to produce proper
bank behavior.
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20 - Pure Transaction d
15 -
a e n r of l .Hypergeometric (random)
5 -
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
Number of deals
volume of business (number of deals). (As defined in Sec. II, one lead
bank is used on any transaction.) The pure relationship interface is the
lower bound on empirical interfaces, represented by the horizontal line in
figure 1. In contrast, a firm with a pure transaction strategy uses a new
lead bank on every deal. This theoretical upper bound is represented
by the upward-sloping line in figure 1. If hybrid interfaces predomi-
nate, then the empirical relationship of number of lead banks and vol-
ume of business should fall between the two theoretical boundaries. Cor-
respondingly, the popularity of hybrids should be observed in measures
of central tendency for the universe of firms, such that 1 < b < d, where
b = the average number of lead banks and d = the average number
of deals.
Firms enjoy considerable leeway in the configurations used to imple-
ment the general hybrid strategy. Each firm's configuration is expected to
be influenced by its level of dependence and power. Dependence and
power can be conceptualized in many ways (e.g., Pfeffer and Salancik
1978; Aldrich 1979). Table 2 presents six main concepts, with associated
measures and operationalizations, expected to be related to the configura-
tion of interfaces-number of banks used in total, strength of the main
relationship, and so on (interface measures are defined in Sec. II below).
Intensity refers to the amount of contact between a corporation and
investment banks; it includes the amount of resources (total dollar
599
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American Journal of Sociology
TABLE 2
Intensity:
Amount of resources ....... Log (total dollar value of financing deals 1981-85)
Frequency of interaction ... Total number of deals 1981-85
Low volume .............. Dummy (1 = single deal 1981-85; 0 = otherwise)
Criticality:
Internal sources of funds Average annual free cash flow 1981-85, adjusted for
inflation
Debt capacity ............. Debt/equity ratio (1985) (Equity = market value);
Long-term debt/equity ratio (1985)
Asymmetry:
Power balance (ratio) ...... Log (total number of deals for firm 1981-85/
total number of deals by firm's main bank for all
1,530 firms)
Standardization:
Similarity of deals ......... Herfindahl index of concentration (H)
Tandem strategies:
Social embeddedness ...... Director-interlock dummy (1 = investment bank
on board; 0 = otherwise)
Organization size .......... Log (market value 1985; market value = number
of shares outstanding x price per share)
Organization growth ....... Change in market value 1981-85 [(T2-T1)IT2,
where Ti = 1981, T2 = 1985]
Third-party influence:
Attractiveness to investors
("pull-through") ......... E/P ratio (five-year average)
" Power perspectives are applied at various levels (dyadic, organization set, action set,
network), but specific concepts, such as intensity, are often discussed in the context of
dyads only (e.g., the frequency of interaction between two organizations) (Aldrich
1979, pp. 265-79). Since my analytic focus on the organization set is wider than the
dyad, I apply power concepts, except for asymmetry, at the intermediate level.
600
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12 Free cash flow represents the firm's cash surplus (deficit) from operations before
financing activities. Free cash flow is defined as funds generated from operations (cash
flow) plus after-tax interest expense, less required net investment in working capital,
less investment in property, plant, and equipment, less other investment expenditures.
Free cash flow is considered more reliable than other earnings measures, as it is less
subject to accounting methods.
601
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American Journal of Sociology
ties, I expect that the debt/equity ratio will be positively associated with a
more transactional interface, holding other factors constant. (I report the
debt/equity ratio but also use a more precise measure, the ratio of long-
term debt to equity, which is preferred because investment banks tend to
arrange long-term debt while commercial banks provide short-term
debt.)
Asymmetry exists when an exchange is not equally important to both
organizations (Pfeffer and Salancik 1978, p. 53). I measure asymmetry by
examining the balance of (potential) power in a firm's main relationship,
that is, between a firm and the bank that receives the largest share of the
firm's business (e.g., between Ford and Goldman Sachs). The balance
measure indicates the power of the firm relative to the power of its main
bank, operationalized as the ratio of the total number of transactions a
firm does (regardless of banks used) to the total number of transactions
the firm's main bank does for the entire population of firms. When a firm
has more relative power in its main relationship (high ratio) it can act
more transactionally; when a firm has less relative power (low ratio) it is
less able to do so, and the bank is more able to induce the corporation to
restrict the size of its organization set. Therefore, I hypothesize that the
power ratio will be positively associated with a more transactional inter-
face, holding other factors constant.
Standardization refers to the similarity of units of resources in ex-
changes (see, e.g., Aldrich 1979, p. 227). Here, standardization refers to
similarity of type of financial transaction. It is operationalized as H, the
Herfindahl index of concentration (or homogeneity), over all product cat-
egories (defined in Sec. II below). When a firm's transactions are very
similar (high H), I expect that fewer banks will be used because of the
efficiency of working with the same supplir. When a variety of deals are
done (low H), I expect more banks will be used, partly because a single
bank may not be able to conduct all types of deals. 13
Tandem strategies refers to the concurrent use of multiple strategies to
reduce dependence and exploit power advantages. Various strategies can
be used with (or in place of) the direct management of market ties. I
analyze the use of one of the main tactics considered in sociological re-
search on interorganizational relations: director interlocks as co-optive
devices. Because director interlocks can stabilize the flow of critical re-
sources (see, e.g., Burt 1983; Palmer et al. 1986; Pfeffer and Salancik
13 It is also possible, as one reviewer suggested, that the nature of a deal (which might
involve confidential information or the need for quick execution) influences interface
choice. Unfortunately, the data available (see Sec. II) do not contain information that
allows one to assess this possibility directly. As an indirect examination, separate
analyses were conducted for two different types of deals (corporate securities only vs.
mergers and acquisitions only). These produced results similar to those presented here.
602
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1978), firms with investment bankers on their boards should have less
need to become transactional to reduce dependence or exploit power
advantages than firms without such co-optive ties. To evaluate this sub-
stitution effect, I include the presence of a director interlock as an inde-
pendent dummy variable, assessing the extent to which interlocks in-
fluence the configuration of market relations. I hypothesize that firms
with interlocks will exhibit more relationship-oriented interfaces than
firms without interlocks, all other factors held constant. I further hy-
pothesize that a firm with an investment banker on its board will tend to
give more business to the banker on its board than to any other bank. (An
alternative explanation, leading to the same hypothesis, is that banks use
interlocks to capture business.) The hypothesis that director interlocks
overlay market ties is a core assumption in the interorganizational per-
spective on director interlocks (see, e.g., Burt 1983; Palmer et al. 1986;
Pennings 1980) that has never been systematically tested.
Organization size is open to many interpretations. Consistent with the
resource dependence interpretation (Pfeffer and Salancik 1978, pp. 131-
39), I view size as a conscious strategy for managing the environment.
Size enhances survival; it is a buffer against immediate environmental
pressures and a cushion against failure. If size is a tandem strategy used
to reduce dependence, then I expect that size will be associated with a
more relationship-oriented interface, holding other factors constant. Al-
ternatively, because bigger firms have bigger corporate finance staffs and
greater in-house capabilities (Hayes et al. 1983), size may be associated
with a more transactional interface because large firms are able to man-
age more bank ties.
Organizational growth is also open to many interpretations. Like size, I
interpret growth as an intentional strategy that enables an organization to
reduce environmental dependence. If growth is a tandem strategy, then I
expect that it will be associated with a more relationship-oriented inter-
face, all other factors held constant.
Third-party influence refers to the "pull-through" effect of investors for
new issues of corporate securities. If investors believe a firm is sound,
then it is easier to issue new securities. Investor pull-through effect is a
source of corporate power because it reduces dependence on the banks'
distribution efforts (see App. A) and makes the firm an attractive cus-
tomer. To assess this effect, I use the inverse of the well-known price/
earnings, or P/E, ratio, a general measure of investors' or security ana-
lysts' assessment of external economic factors, growth prospects, financial
strengths, capital structure, and other factors. (The inverse, or E/P ratio,
is customarily used to avoid occasional problems of small denominators.)
The E/P ratio is interpreted many ways. As a measure of the stock price
investors are willing to pay for current (and expected) earnings, I inter-
603
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American Journal of Sociology
pret low E/P ratios as positive evaluations of a firm (more power) and
high E/P ratios as negative evaluations (less power). I hypothesize that
the E/P ratio will be negatively associated with more transactional inter-
faces, indicating that firms with positive investor evaluations will be
more transactional than firms with negative investor evaluations, all
other factors held constant.
Multiple methods were used. Field data were generated from interviews
with CFMs in 20 corporations covering 13 major industries and ranging
in size from roughly $1 billion to $95 billion in market value in 1985.
These CFMs included the CFO, senior vice-president of finance, trea-
surer, assistant treasurers, cash managers, senior executives in business
development (i.e., mergers and acquisitions), and, in a few cases, the
chief executive officer (CEO). Access was obtained to all relevant CFMs
in most firms, although it was limited to one or two key CFMs in a few.
Data on market ties between firms and investment banks from 1981 to
1985 were obtained from Securities Data Company (SDC). These data
include (1) taxable debt and equity issued in the United States (debt,
common stock, and preferred stock), (2) corporate-backed tax-exempt
municipal issues, (3) public Eurobonds, and (4) mergers and acquisitions.
Analyses were conducted for all four categories combined and for selected
subsets. The results based on the combined data and on major subsets
were similar, so only the combined results are reported.
Data on company attributes were obtained from Standard and Poor's
Annual Industrial Compustat Datafile. Data on director interlocks with
investment banks were determined directly from corporate annual re-
ports and/or various SEC filings for 1985 and 1981 (most interlocks per-
sisted through the five-year period).
Hypotheses were tested on the population of all companies with a 1985
market value of at least $50 million that were publicly traded on the New
York, American, and over-the-counter (OTC) stock exchanges. Of the
1,963 firms with a 1985 market value of $50 million or more, 433 firms
did not conduct transactions covered by the SDC data and were excluded
from study.
The organization-market interface is operationalized as the pattern of
bank ties during the 1981-85 period, measured as: (1) total number of
banks used; (2) total number of banks used in a "lead" capacity; (3) total
number of banks used in a "comanager" capacity only (calculated as [1] -
[2]); (4) the one-bank ratio (the percentage of business given to the most
often used bank), which represents the strength of the firm's main bank
relationship; and (5) the Herfindahl index of concentration (H). A
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14 A secondary reason is that dollar amounts are missing on most mergers and acquisi-
tions deals. (The incidence of missing amounts on financings is low enough to be
ignored.) Fee data, however, are missing for most transactions of all types, preventing
any valid and reliable analysis of spreads, costs, etc.
15 Note, however, that rankings of banks (known as "league tables" or "manager
rankings") based on dollar amounts or number of deals yield very similar results (see,
e.g., Institutional Investor 1987, p. 178).
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American Journal of Sociology
TABLE 3
Overall Patterns
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607
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American Journal of Sociology
their business to their most frequently used bank (table 3). Despite Wall
Street's lament that customer loyalty is dead, many firms maintain strong
ties with investment banks. These ties vary in strength, however, accord-
ing to a firm's level of power and dependence, as discussed below.
19 When dependent variables are counts, the use of Poisson regression might be more
appropriate than ordinary least squares (OLS), as one reviewer reminded me. Both
approaches, however, produced very similar conclusions. For example, consider the
following simple models for number of lead banks (N) regressed on the key indepen-
dent variable, the inverse of the square root of deals (D), for multideal firms. The OLS
method takes the general form y = a + Bx, and the Poisson takes y = exB' . The OLS
model is N = 7.66 - 9.5 7(D). The Poisson model is N = e[2.56 - 3.2 1(D)]. It can be
shown that B = Bly. Dividing the OLS constant and coefficient by the average of N
(2.99) shows that, on the average, the two models produce similar results. (The Poisson
program was adapted from a Minitab algorithm kindly supplied by Peter E. Rossi.)
Another approach involves using OLS but taking the square root of the dependent
variable, which tends to stabilize the variance in counted data. This alternative also
produced similar results. Given these similarities and my intent to describe (rather
than predict) patterns, OLS is acceptable.
20 All models for the number of lead banks are restricted to the subpopulation of firms
conducting two or more deals (N = 1,091) because a single-deal firm, by definition,
uses only one lead bank.
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strength of the main bank relationship (model 3). All measures of resource
intensity are significantly related, as hypothesized, to the number of
banks used in total. The number of deals, but not dollar amount, is
significantly related to number of lead banks. All measures of intensity
are related as expected to the strength of the main tie, except total dollars
raised for multideal firms.2'
In the subset of firms, just one measure of criticality, average free cash
flow, is significantly related to the number of banks used in total and as
lead, but the direction is the opposite of expectations: on the average,
firms tend to use more banks when they have greater sources of internal
funds, all other factors held constant. None of the measures of criticality
is significantly related to the strength of the main tie. Asymmetry-the
balance of power between a firm and its main bank-is related as ex-
pected to the number of banks used in total and as lead, and to the
strength of the main relationship: firms that are powerful relative to their
main bank are more transactional. However, as can be inferred by the
interaction term, single-deal firms lose power advantages.22
Standardization of exchange is related as expected to the strength of the
main tie, but not to the number of banks used in total or as lead. Firms
that do similar deals tend to favor their main bank. This could indicate
the convenience or efficiency of working with one bank, but some CFMs
said that they used the need to conduct "different" deals as an excuse to
build ties to banks other than the main bank. If so, then similarity repre-
sents dependence, and the positive association with strength of the main
tie indicates difficulties in weakening this strong tie when a firm's deals
are homogeneous.
Organization size is significantly related to interface structure in the
subset of firms, but the direction is not consistent with the interpretation
of size as a tandem strategy. The finding that larger firms use more banks
and grant less business to their main bank, all other factors held constant,
is consistent with the alternative explanation that larger firms, with larger
corporate staffs, are able to manage more bank ties. Organizational
growth is not significantly related to interface patterns.
The presence of director interlocks is related as expected to the number
21 Note that the one-bank ratio and the H are bounded dependent variables, which
could violate the normality assumption for the error distribution. I have retained these
measures because very few predicted values fall outside the 0-1 range, transformed
measures defy substantive interpretation and lack theoretical meaning, and my intent
is to describe rather than predict.
22 The dummy interaction terms are interpreted in the customary manner. If, e.g., the
power-ratio variable and its interaction with the dummy are both significant, the
coefficients are added to interpret the relationship of the power balance for single-deal
firms.
609
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American Journal of Sociology
of banks used in the lead role and to the strength of the main tie. (The
effect of interlocks for one-deal firms is not different from that for mul-
tideal firms.) Finally, third-party (investor) influence is not significantly
related to any of the three interface measures.
Reduced regression models. -The reduced models explain a large pro-
portion of the variation in organization-market interfaces in the popula-
tion of the 1,530 firms (table 5). Note, however, that only 28% of the
variation in number of banks used as comanagers can be explained by the
various power-dependence measures (model 3). Several key variables-
number of deals, power ratio, and board interlocks-are not significantly
related to number of comanagers. This suggests that CFMs do not man-
age dependence or exploit power advantages by manipulating comanager
ties; rather, they focus efforts on number of lead banks and the strength of
the main bank relationship. The similarity of coefficients for the one-bank
ratio (model 4) and the H index (model 5) indicates that the latter is driven
primarily by the strength of the main tie. Indeed, the two measures are
highly correlated (r = .97).
Intensity (deals and dollars) is related as hypothesized to the number of
banks used in total and as lead (models 1 and 2). Intensity is similarly
related to the strength of the main bank relationship (model 4). Surpris-
ingly, however, the strength of the main tie is not significantly associated
with dollars raised for multideal firms. These overall patterns are consis-
tent with the argument that deals and dollars are resource endowments
from which firms derive power advantages. Firms that do more deals, all
other factors held constant, are more transactional; similarly, firms that
raise more funds, holding other factors constant, are more transactional.
The interaction terms, however, show that power advantages derived
from deals and dollars are lost for single-transaction firms.
Both number of deals and dollars raised provide opportunities to use
more banks and induce competition. Corporations establish additional
bank ties and weaken the main bank relationship to compel banks to act
more competitively. Power advantages are used to obtain efficiency bene-
fits. Although the traditional resource dependence argument maintains
that organizations act to reduce dependence regardless of profit or
efficiency (Pfeffer 1987a), in the case of corporate relations with invest-
ment banks, power and efficiency go hand in hand.
The use of power advantages can be readily seen in the allocational
tactics used by CFMs. For example, CFMs include banks on deals as a
means of payment for analyses and studies that are not individually
compensated.23 As an assistant treasurer said, "We think of who has done
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work for us, and try to make it up." A CFO related a similar practice: "If
they're doing lots of nontransaction stuff, I'll make sure they're [included]
in a deal. That doesn't mean I'll pay more for it. [But] I'm not so calloused
[sic] that I'd just ignore the thing, because relationships help us too."
The nonlinearity of deals and interface patterns indicates that power
advantages accrue disproportionately in relation to number of "trips to
the market" (deals).24 Competitive benefits are obtained as soon as a firm
moves from a pure relationship interface, but they decline as the firm
becomes more and more transactional. Returns to diversification of mar-
ket ties come early. Indeed, a firm can lose power by attempting to use too
many banks. If it spreads business too thinly, the firm will become an
unprofitable account for the banks, which will stop vying for its business.
Further, if the firm violates the norm of reciprocity by failing to assign
enough business to its relationship bank(s), the quality and benefits of
these ties will deteriorate. As one CFO put it, "There's no really good
argument against competition, but you have to have sufficient volume.
You have to have enough volume to justify [two banks, in this firm's
case]. " And another said, "There's no value to adding a fourth
[relationship] bank. The economics would be diluted from the investment
banks' point of view." Thus, to obtain the benefits of competitive behav-
ior while preserving its long-term relationships, a firm must "balance" ties
with banks, as the interorganizational principle of reciprocity suggests
(Laumann and Marsden 1982, p. 332).
Criticality- -the availability of resource alternatives-is significantly
related as hypothesized to number of banks used in total, as lead, and as
comanagers, but not to the strength of the main tie. Firms with less debt
capacity (higher long-term debt/equity ratios) have fewer financing op-
portunities and attempt to overcome this dependence by establishing
more bank ties, all other factors held constant. Single-deal firms, how-
ever, are unable to add ties to reduce dependence, as indicated by the
interaction term.
The asymmetry of power between a firm and its main investment bank
is related as expected to number of banks used in total, as lead, and to the
strength of the main tie, all other factors held constant. The greater the
relative power of a firm, the more CFMs are able to exploit power advan-
tages by using more banks and weakening the strength of its main tie,
ing tactic, hoping to win future business, or as part of the tacit obligations inherent in a
relationship.
24 A nonlinear measure of deals was suggested by the scatterplots. Note that random
selection from a finite population of banks (equivalent to the hypergeometric distribu-
tion) also yields a curvilinear relationship of deals and number of banks. However, as
shown in fig. 1, the observed nonlinear relationship falls substantially below the
hypergeometric, suggesting that the naive rule of random selection is implausible.
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TABLE 6
Number of Percentage
Investment Bank Board Interlocks as Main Bank
board ties, only eight are the main banks (capturing more than 50% of a
firm's business) for at least three-quarters of their boards. Only 16 capture
a main share of business from at least half of their boards. Fifty-four
banks are not the lead for any firms on whose boards they sit. Indeed,
43% of the firms do not give any business whatsoever to their banker-
directors.
Variation in the extent to which interlocks overlay market ties appears
to be related to the balance of power between firms and banks (Baker
1987b). For example, Drexel Burnham Lambert, the fourth largest in-
vestment bank in 1986, worked with small and highly leveraged corpora-
tions. It was the main bank for 16 of the 17 boards on which it sat, and it
captured 90% or more of the business of 8 of the 16. In contrast, the
prestigious and powerful "special bracket" banks tend to work with simi-
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IV. CONCLUSION
25 "Special bracket" indicates the top position in the relative standings of investment
banks. It is symbolized in the so-called tombstone ads that appear in the financial
press, indicating the members of an underwriting syndicate. The ads divide firms into
hierarchical categories or "brackets." Membership in the special bracket is based
primarily on market share; members are Goldman Sachs, First Boston, Merrill Lynch,
Morgan Stanley, and Salomon Brothers. Salomon does not sit on corporate boards as a
matter of company policy.
26 Two broken-tie studies include limited consideration of firm-level market ties
(Stearns and Mizruchi 1986; Palmer et al. 1986). In contrast with these studies, I
examine the strength of economic ties rather than their presence or absence (i.e., as a
dichotomous variable), control for the market position of the banks, and consider
different types of market ties (Baker 1987b).
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APPENDIX A
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e above. The bank would like to set a low offering price to reduce distri-
bution effort, but the firm, trying to maximize net proceeds (line i), wants
a high offering price. In this example, the issue is "underpriced" by $.50
per share (line d).
The offering price (line e) usually reflects the decline in market value
(line b) that occurs when a new issue is announced (Asquith and Mullins
1986a, 1986b). The gross spread (linef) is the difference between the price
at which the bank buys the security from the issuer and the price at which
the bank offers it to investors. It includes the management fee (compensa-
tion to the lead manager for costs and risks), the underwriting fee (com-
pensation for underwriting risk), and the selling concession (discounts to
brokers selling the issue).
Price competition among banks involves pricing advice (line e) and
gross spread (linef). A bank can hold its compensation (spread) constant
but compete by offering to sell the issue "close to the market" (i.e., in-
crease line e). This increases distribution effort. If the offering price is too
close to the market price, the bank could have difficulty selling the issue.
A "suicide bid" is a price so close to the market that the bank's costs
exceed its compensation. A bank can give the same pricing advice but
compete by lowering its compensation. This should not affect distribution
effort, but it would lower profit margins.
APPENDIX B
Allocation of Credit
Interface Measures
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TABLE B1
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