Document Type

Working Paper

Publication Date

2017

Center/Program

Center for Contract and Economic Organization

Center/Program

Program in the Law and Economics of Capital Markets

Abstract

This Essay examines the dramatic increase in business networks in recent decades and considers whether the law can play a useful role in supporting the efficient functioning of these inter-firm relationships for coordination and cooperation. Repeat play, reputational sanctions, and norms of trust and reciprocity are the common explanations for the flourishing of networks in many industries and places. But the evidence also shows that a certain class of networks often fail to survive or function effectively and beneficial cooperation among these network members is impaired. These fragile networks develop organically without a controlling party or hierarchy at the center of the network to facilitate network formation. Lacking a controlling entity, they are “webs without any spider.” Clusters of industrial districts are traditional examples of this class of networks. More recently, the information revolution has stimulated a dramatic increase in another type of “spiderless” network: networks of strategic alliances are now a common means of organizing collaborations among firms in high technology and R & D intensive settings. In both types of spiderless networks there are no legal mechanisms to control moral hazard and free riding risks during the period of network formation and operation. We show how in theory the law could support spiderless networks by allowing firms who externalize benefits to other firms in the network to recover for those benefits. Practical considerations may limit the implementation of a full-blown right of restitution. Nevertheless, by recognizing a limited right to recover for uncompensated costs and benefits in appropriate cases, the law can function as a background norm for sharing costs and benefits among network members, motivating them to overcome daunting coordination problems. We consider several implementation issues, show how they might be resolved, and apply our analysis to a set of well-known spiderless networks.

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