Abstract

The behavioral theory of the firm rests on empirical observation of economic behavior in organizations, and was motivated by the 'disconnect ' between that observation and prevailing economic theory. We believe that there is a comparable tension between reality and theory with regard to the persistent, systematic relationships between organizations. Observation belies the traditional view that organizations are distinct and autonomous units of action. Instead, it appears that they are very often embedded in organizational groups comprised of close, robust and multidimensional ties that blur hierarchical boundaries (Granovetter 1994; Gulati & Gargiulo 1999; Powell & Smith-Doerr 1994). These groups, which we call interfirms, demand analysis. Why do they exist at all? What processes cause them to take the forms that they do? Under what circumstances are they more or less useful for their constituents? In this chapter we offer answers to these questions. Our approach to explaining interfirms builds on earlier arguments regarding the existence, structure and behavior of firms. First, we explain the existence of interfirms as a response to the transaction costs that emerge under conditions of bounded rationality. This argument locates the interfirm within broader justifications for institutions, which build on Coase’s ([1937] 1988) transaction cost explanation for the firm. Next, we offer an evolutionary process model of the emergence of one type of interfirm, the network organization – a production

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