A model of inter-organizational network formation

Abstract

How do inter-organizational networks emerge? We address this question using an equilibrium framework where firms' decisions to form links with other firms are modeled as a strategic game. In this game, firms weigh the costs and benefits of establishing a relationship with other firms and form ties if their net payoffs are positive. We characterize the equilibrium networks as exponential random graphs (ERGM), and we estimate the firms' payoffs using a Bayesian approach. We apply the framework to a co-investment network of venture capital firms in the medical device industry, providing economic interpretations ERGM parameter estimates. We learn that firms rely on their joint partners (transitivity) and prefer to form ties with firms similar to themselves (homophily). These results hold after controlling for the interdependence among ties. Our structural approach allows us to simulate the effects of economic shocks or policy counterfactuals. We test two such policy shocks, namely, firm entry and regulatory change. We show that while entry of few firms does not have meaningful effects on the shape of the network, a regulatory shock of minimum capital requirements increases the co-investment network's density and clustering.