Embeddedness is the way individuals and organizations are constrained by social relations, such that they cannot be viewed as distinct entities (Granovetter 1985). This means that social relations are a critical aspect of economic behavior. As such, embeddedness examines the effect of embeddedness on the behavior of organizations by focusing on the social network.
The social network is a social structure map made up of relations between social actors. In order to understand the social network, researchers have developed concepts such as pipes, prisms and structural holes.
Social networks can work as pipes (Podolny 2001). This means that embedded relations can facilitate the flow of information and resources between one organization and another.
Social networks can also work as prisms (Podolny 2001). This means that embedded relations effect not only the two actors involved in the exchange, but others who view the exchange of two external actors and judge them based on their perception of the exchange. Podony (2001) argues the way social networks work as prisms is more important than how they function as pipes- the exchange is not nearly as important as how the exchange influences the conceptions of others.
The social embeddedness of economic actors plays a function. Functions of embeddedness include: facilitating innovation through joint problem solving (Powell, Koput and Smith-Doerr 1996), regulating social behavior and facilitating trust (Crutchley, Jensen and Marshall 2007), managing uncertainty (Podolny 2001), and providing information and understanding of the environment (Uzzi 1997).
Social networks provide economic actors with the capacity to have flexible working groups, better capable of innovation. Powell, Koput and Smith-Doer (1996) find when knowledge base is complex and expanding, innovation occurs within networks rather than individual firms. Social networks facilitate learning and knowledge. When knowledge is complex and expanding, it is difficult for knowledge to be obtained within the rigid, single organization. Knowledge is created within a community made up of a social network of individuals and organizations. As such, a social network is an effective vehicle for learning. Individuals within the social network can join to solve problems faced by the community, facilitating innovation.
Embeddedness is a critical aspect of economic behavior as economic exchange requires trust. Embeddedness serves the function of regulating social behavior and ensuring trust. Organizations with little embeddedness are more likely to exploit information asymmetries and act wrongfully, as embeddedness regulates social behavior. For example, Crutchley, Jensen and Marshall (2007) found when outsiders are less involved in an audit committee, accounting fraud is more likely to occur. With little involvement from external actors, the audit committee is less pressured to cause problems within the organization by pointing out possible problematic activity. In short, economic embeddedness regulates behavior to ensure trust.
Embeddedness also serves the function of managing uncertainty by providing information and understanding of the environment (Uzzi 1997). Particular social relations facilitate the management of different types of uncertainties. Structural holes are more beneficial and social status less beneficial in environments characterized by egocentric uncertainty (Podolny 2001). Egocentric uncertainty is the uncertainty of the focal actor in efficiently producing a commodity that will be desirable by exchange partners. By having numerous structural holes, organizations can have a broader reach and better obtain information about the broader market. Structural holes are less beneficial and social status more beneficial in environments characterized by altercentric uncertainty (Podolny 2001). Altercentric uncertainty is the uncertainty of exchange partners in the quality of the commodity brought to the market. Status provides a way for external actors to judge the likelihood that the commodity will be of good quality based on collective interpretations. Market uncertainty influences the value of particular social positions: network position and social status.
Embeddedness affects the internal organization of individual corporations. For example, Castilla (2011) found that embeddedness effects social inequality in organizations. Managerial assessment of employees is affected by: (1) the social network of past and current managers, (2) the similarity between past and current managers, and (3) the social similarity between the manager and the employee. As such, individual advancement in an organization is related to the individual's social network and status. This results in inequality in organizations, where those in positions of power all have similar characteristics and social networks.
Embeddedness affects the network of organizations- how organizations are related to each other. The economic position of the organization in the network is not related to things the individual organizations control. Instead, it is the result of how the organization compares to others, the actions of others and its status (MacKay and Phillips 2005).
Embeddedness also affects the behavior of institutional fields. According to Stearns and Allan (1996), economic behavior (mergers) is not because of efficiency, but institutional embeddedness. A permissive state allows those on the fringe to innovate which facilitates mergers. Merger waves occur when those actors are viewed as successful and others imitate.
Embeddedness affects the political action and power of economic elites. Classwide rationality (a major factor contributing to the power of the economic elite) is related to the way economic actors are included in diffuse social networks (Useem 1982). Furthermore, capitalist PAC contributions are related to regulatory embeddedness, social status and network position (Burris 2005). In short, the political action of economic actors is not just affected by rational economic reasoning, but social embeddedness.
However, the extent to the effect of social embeddedness on corporate behavior is not constant over time. According to Mizruchi, Stearns and Marquis (2006), the effect of social embeddedness is historically contingent. The effect of social network on corporate behavior has declined over time due to the following factors: (1) professionalization of finance, (2) internalization of financial and (3) increased market volatility.
Embeddedness is related to organizational efficiency. For example, embeddedness is related to the cost of capital (Uzzi 1999). At the dyad level, firms with strong social ties with their lender get the lowest rate. At the network level, firms with a network of embedded and arms-length ties get the lowest rate. However, embeddedness is beneficial only up to a certain extent (Uzzi 1997). Embedded ties help distill information when time is of importance. However, too many embedded ties can decrease efficiency. Furthermore, embeddedness can lead to the development of broader social problems.
Embeddedness relates to broader social problems, like corporate fraud and the financial crisis. For example, Prechel and Morris (2010) found political and organizational embeddedness created dependence, opportunities and incentives for individuals to commit financial malfeasance. Although embeddedness is related to major economic problems, this can be empowering. Once the underlying social arrangements are identified, they can be rearranged to improve the problem. This is why Abolafia (2010) emphasizes the need to fix academic, political and regulatory structures to ensure we do not have another financial crisis. Economic structures can be fixed by also fixing the institutions in which the economic structures are embedded.
Embeddedness effects a range of factors including corporate and institutional behavior and market relations and outcomes. However, the effect of social embeddedness on corporate behavior is not constant- it varies over time (Mizruchi, Stearns and Marquis 2006). As such, future research should reveal precisely which conditions relate to the effect of embeddedness on organizations.