Pakistan Institute of Development Economics



Replacing Contracts with Handshakes: A Study of Social Networksof Entrepreneurs in the Weaving Sector

Informal institutions like kinship based networks play acrucial role in business activity. The flow of information in suchnetworks, based on trust and reciprocity helps in creating anenvironment where opportunism is curtailed and relational basedgovernance mechanism prevails. This paper studies, whether such factorsplay a role as an alternative governance mechanism for contracts asopposed to the formal institutions or not. The effectiveness of suchnetwork factors hinges on the network structure, and therefore networkdensity and network size are taken as independent variables. Thoughnetwork density was positively and significantly related to the use ofsocial networks for management of breach of contracts, network size wasnegatively related to management of breach of contracts. Network sizeand network density were positively related to ex-post transaction costsof dispute resolutions however, they were not statistically significant.JEL Classification: D850, O17, L14 Keywords: Social Capital, SMEs,Transaction Costs, Entrepreneurship, Networks

Moina Rauf,

Zahid Pervaiz