A contingency theory of entrepreneurial debt governance

Access to debt can be crucial for entrepreneurs who need capital. Embedding economic ties within a social relationship with the debt provider can ensure capital availability and attenuate opportunism. However, such a relationship requires substantial investments in time and effort. We advance a solution to this entrepreneurial conundrum by proposing a contingency theory which prescribes aligning the fundamental transactional properties (i.e., asset specificity, uncertainty and frequency) with the nature of the entrepreneur-bank relationship (i.e., embedded versus arm's length). Our theory predicts that transactional properties affect the optimal governance of the entrepreneur-bank relationship, and that social embeddedness can transform what looks like a market transaction (e.g., a debt transaction) into a hybrid form of governance more akin to a hierarchy. Using a sample of small businesses in the U.S., we find that congruence between the optimal governance structure and the actual governance structure results in higher firm performance.