ISSUE LEADERSHIP THEORY AND ITS

STRATEGIC LEADERSHIP IN GLOBAL

BUSINESS ORGANIZATIONS:

BUILDING TRUST AND

SOCIAL CAPITAL Michael A. Hitt, Barbara W. Keats and Emre Yucel ABSTRACT To function effectively in both the near and distant future, leaders in global

organizations must understand, develop and exercise trust and social capital.

The competitive landscape in the new millennium necessitates that firms

develop strategic flexibility. To do so, they must continuously renew their

knowledge stock and produce innovations. To implement these strategies,

leaders must build effective relationships among members and units in the

organization. This relational capital is based on trust and eventually leads to

the development of internal social capital. Leaders must also build effective

relationships with external constituencies. This is often accomplished

through strategic alliances. Similarly, leaders must build mutual trust among

alliance partners that over time leads to the development of external social

capital. When employees trust leaders, they are more likely to be committed

to the organization’s goals, willing to develop firm-specific knowledge and

likely to exercise creativity. Likewise, partners in trusting alliances are more

likely to transfer knowledge, and contribute to a firm’s innovation. These

actions are important in global organizations, but difficult to achieve. Advances in Global Leadership

Advances in Global Leadership, Volume 3, 9–35

Copyright © 2003 by Elsevier Science Ltd.

All rights of reproduction in any form reserved

ISSN: 1535-1203/PII: S1535120302030022

9

10 MICHAEL A. HITT, BARBARA W. KEATS AND EMRE YUCEL

INTRODUCTION In the early days of the 21st century, the competitive battlefield has been strewn

with mortally wounded firms and top executives. Once highly successful, firms

such as Levi Strauss, Gap, Motorola and Arthur Anderson have experienced

severe problems. Other previously powerful firms such as Polaroid, Enron and

Global Crossing have filed for bankruptcy with people questioning their future

viability. Additionally, the strategic leaders in several firms (i.e. Enron, Global

Crossing, WorldCom) appear to have violated the “trust” placed in them by their

multiple constituencies (e.g. investors, employees, suppliers, etc.). Clearly, major

strategic errors were made by these firms. Top executives have either departed

or are in serious trouble. These firms provide examples of strategic leadership

failures.

In the 1990s, we learned that firms existed in a new competitive landscape that

differed from the past. This landscape is hypercompetitive and highly dynamic

(D’Aveni, 1994). The monumental and discontinuous change in this landscape

has been driven largely by new technology and globalization (Hitt, Keats &

DeMarie, 1998), along with major political events such as those which took

place on September 11, 2001. If we have learned little else, we now know that

success is often only temporary. Firms must be constantly changing or they are

dying. This means that firms must not only develop and implement successful

strategies, but they must also create sufficient strategic flexibility to allow them to

make often substantial and rapid changes in their strategies. Therefore, strategic

flexibility is necessary to help firms cope with uncertainty (Harrigan, 2001).

Faced with the increasingly complex and unpredictable global marketplace,

businesses are becoming more dependent on virtual internal relationships and

many forms of strategic alliances to maintain strategic flexibility. At the heart of

these relationships are social capital and its root – trust.We define social capital as

the web of social relationships between individuals and organizations that entails

norms, values and obligations, and yields potential opportunities for the members

(Gabbay & Leenders, 2001; Haley & Haley, 1999; Yli-Renko, Autio & Sapienza,

2001). With social capital, the relationships facilitate action and thereby create

value (Adler & Kwon, 2002; Seifert, Kraimer & Liden, 2001).

Strategic flexibility is partly a function of executive flexibility (Lee, Hitt&Jeong,

2002) and thus, strategic leadership. While much has been written about leadership

over the years, only recently have we started to focus on strategic leadership at

the top of companies (i.e. Finkelstein & Hambrick, 1996; Ireland & Hitt, 1999).

Additionally, as noted by Keats (2002), history is written by the victors, therefore

we often only hear the story from the victors’ perspective. There are good examples

of historically successful leadership practices at the top of organizations, such as Strategic Leadership in Global Business Organizations 11

those presented in Jack Welch’s (2001) Jack: Straight From the Gut. However,

the successful leadership of the past may not prove to be the best way to achieve

success in the future. Also, there may be much to learn from leadership failures.

Thus, here we examine successes and failures of strategic leadership, with special

emphasis on the roles that trust and social capital play.

Gessner, Arnold and Mobley (1999) noted that there is no commonly accepted

definition of leadership, and a large number of leadership theories exist. Our

purpose is not to offer the definitive theory of strategic leadership. Rather, we

focus on the development of important capabilities that produce the strategic

flexibility required to be competitive in the dynamic global business environment.

Critical resources for firms operating in global markets include human capital

and social capital (Nahapiet & Ghoshal, 1998; Quinn, 1992). Human capital

represents the knowledge, skills and capabilities of individuals (Coleman, 1988)

and is an especially important component of competitive advantage (Hitt, Ireland

& Lee, 2000b). Social capital is useful in leveraging this knowledge (Burt, 1997;

Coleman, 1988; Meyerson, 2000). In effect, social capital provides access to the

capabilities needed to leverage a firm’s current resource base that then leads to a

competitive advantage (Ireland, Hitt & Vaidyanath, 2002; Tsai & Ghoshal, 1998).

Effective strategic leaders develop and exploit human and social capital.

Managing human and social capital effectively requires an appropriate

managerial mindset. In fact, a unique managerial mindset, different from that of

the past, is needed to effectively navigate the 21st century’s dynamic and complex

competitive landscape (Nixon, Hitt & Ricart i Costa, 1999). An entrepreneurial

orientation is an important component of this mindset (Lumpkin & Dess, 1996).

For example, the absence of entrepreneurial orientation prevented Polaroid from

developing digital photographic technology, which led to its bankruptcy. Another

important element of this mindset is trust. In fact, trust is a critical component

of social capital because of the need for belief in reciprocity and mutual benefits

for such capital to exist. Trust is important to foster collective risk taking (for

innovation), and for knowledge transfer in firms (Portales, Ricart i Costa &

Rosanas; 1998). Therefore, effective leaders must emphasize the development

of a mindset of trust among the firm’s management team that emphasizes

developing and nurturing important external relationships in order to develop

social capital. Lastly, the mindset should have a global focus due to the increasing

globalization (Hollenbeck, 2001). As such, managers consider global markets

and competition, and build relationships with partners from multiple regions

of the world.

A mindset shared throughout the firm becomes a dominant logic by which the

firm is managed (Prahalad & Bettis, 1986). While an appropriate dominant logic

has several positive attributes, its effectiveness may fade in dynamic environments. 12 MICHAEL A. HITT, BARBARA W. KEATS AND EMRE YUCEL

An obsolete dominant logic retains inappropriate conceptual biases and may not

match the firm’s current reality (Prahalad & Bettis, 1986). Additionally, without

proper care a dominant logic creates a path dependency, thus making it difficult to

recognize the need for change or to formulate and implement an effective strategic

change (Lei, Hitt & Bettis, 1996). To create appropriate strategic flexibility, firms

must be able to simultaneously acquire new knowledge and “unlearn” outdated

and less valuable knowledge (Bettis & Prahalad, 1995; Hitt, Bierman, Shimizu &

Kochhar, 2001a).

Social capital provides access to information and valuable knowledge, thus

creating a source of learning. Information gained through relationships with

important external parties helps to identify opportunities. Prahalad and Hart (2002)

argue, for example, that many emerging markets provide good opportunities for

multinational firms. To take advantage of these opportunities, however, firms

need access to distribution channels, knowledge of customers and markets, and

relationships with government entities. They can gain access to these resources

through alliances with emerging market firms (Hitt, Dacin, Levitas, Arregle &

Borza, 2000a). In so doing, they build and/or use social capital to gain access to

resources that allow them to exploit opportunities (Hitt, Ireland, Camp & Sexton,

2001b). Prahalad and Hart (2002) suggest these firms then find fortune at the

bottom of the pyramid and bring prosperity to the aspiring poor. Firms rarely have

all of the necessary resources internally to compete effectively in global markets.

As such, firms must access complementary resources through relationships with

other firms (social capital) (Ireland et al., 2002).

To be successful, global strategic leaders must build and effectively manage

human and social capital. This chapter explains the processes involved in managing

these resources to create value for the firm.

STRATEGIC LEADERSHIP AND TRUST The GLOBE Research project asserts the importance of understanding interrelationships

among societal culture, organizational culture and leadership in

organizations (House, Hanges, Ruiz-Quintanilla, Dorfman, Javidan, Dickson

& Gupta et al., 1999). Developing and “exercising” social capital depends on

understanding these relationships and the pivotal role of trust in them. The

assumptions underlying the acquisition and exercise of social capital largely

emanate from cultural beliefs with regard to trust.

Trust and trustworthiness are important factors in the formation and maintenance

of social capital. History and literature suggest that trust is a universal

concept in the human condition. Against the backdrop of national, organizational Strategic Leadership in Global Business Organizations 13

or interpersonal conflict, exist the enduring themes of trust and betrayal, faith and

suspicion, responsibility and irresponsibility. Yet, the concept of trust has proved

difficult to define and understand. We turn to that task first, and then develop

a model of trust for strategic leaders as they build relationships with various

important internal and external constituents.

What is Trust?

Trust is a property of relationships – dyads, groups, organizations and nations

(Lewis & Weigert, 1985). Trust and mistrust are also sociological/cultural

phenomena. Thus, norms of trust may vary according to different understandings

of morality and assumptions about human nature. These understandings are

derived from general philosophies, cultural differences and specific characteristics

of a prevailing zeitgeist. However, trust also has roots in individual characteristics.

The exercise of trust involves three parts: the “trustor,” the “trustee” (both

parties are simultaneously the trustor and trustee), and the context, which includes

the roles of and relationships between people and the organization (Hardin, 1998;

Nieuweboer, 2001). It may also include knowledge of behaviors involved in

building and maintaining relationships (Bigley & Pearce, 1998).

Trust is demonstrated by the “undertaking of a risky course of action on the

confident expectation that all persons involved in the action will act competently

and dutifully” (Lewis&Weigert, 1985, p. 971). Trust involves one’s “expectations,

assumptions or beliefs about the likelihood that another’s future actions will be

beneficial, favorable or at least not detrimental to one’s interests” (Robinson, 1996,

p. 576). It includes elements of value and judgment, suggesting that there are

expectations of ethical behavior in a joint activity (Hosmer, 1995). Additionally, it

is a socially learned expectation regarding the behavior of others (Barber, 1983).

Where differences between parties exist, such as cultural beliefs, lack of knowledge

about the other party’s trustworthiness becomes important (Giddens, 1990).

The factors noted above affect the trustor’s expectations about the trustee. In

particular, the trustee’s trustworthiness in the eyes of current or potential trustors

is quite important. Trustworthiness is difficult to define clearly, but is usually

based on past behavior either in the current relationship with the trustor or with

others familiar to the trustor. Common experiences or threats are often used to

make assumptions about the other party’s trustworthiness.Winston Churchill was

once quoted as saying “If Hitler invaded Hell I would make at least one favorable

reference to the Devil in the House of Commons.” Churchill thus emphasizes the

importance of a willingness to act against a common and worse enemy, in this

case, Hitler. However, other factors also affect trustworthiness. 14 MICHAEL A. HITT, BARBARA W. KEATS AND EMRE YUCEL

Important elements of trustworthiness include: the history of the potential

trustee’s behaviors in past exchanges (Curral & Judge, 1995), the prevailing

norms for trusting others (e.g. power or a good reputation) (McKnight, Cummings

& Chervany, 1998), and the trustee’s competence, reliability and integrity as

perceived by the potential trustor (Mayer, Davis & Schoorman, 1995). Like

trust, trustworthiness is socially constructed and grounded in cultural norms of

behavior.

Trust and trustworthiness are critical to business relationships both inside and

outside of the firm, specifically within the management team and in the formation

of strategic alliances between firms in the global marketplace. As noted by Reuer,

Zollo and Singh (2002), studies of international joint ventures in the 1990s

examined issues of environmental factors, cultural issues, transaction dynamics

(such as opportunism), and partner characteristics (such as prior experience in

collaboration). However, managing the ongoing alliance, of which building trust

is an important part, requires additional investigation (Ireland et al., 2002; Reuer

et al., 2002).

Trust and Alliances

There are several perspectives with regard to inter-firm behavior and relationships.

Two of the more prominent examples are Transaction Cost Economics (TCE) and

Resource Dependence Theory (RDT). These perspectives address alliance formation

and behavior quite differently. TCE suggests that organizations form alliances

and govern the behavior within them on the basis of expected transaction costs and

efficiency considerations. Governance is structured by formal contracts that outline

monetary agreements and role behaviors, as well as members’ expectations.

TCE employs typical economic assumptions about humans and their behavior.

For example, it assumes that opportunistic behavior by one or more of the alliance

members is likely. This assumption precludes or at least diminishes the role of

trust. As such, TCE does not address the important social and relational processes

regarding trust in alliance relationships.

Resource Dependence Theory (RDT) explains how organizations seek to

reduce uncertainty by creating favorable exchange relationships. Pfeffer and

Salancik (1978) noted that individual organizations make strategic choices to

collaborate with other organizations in order to gain economic advantages and

promote market survival (perhaps even market dominance). If the benefits exceed

the costs, the relationship is worthwhile (Provan & Milward, 1995).

As we noted, collaborative strategic alliances can contribute to a firm’s

strategic flexibility, shared resources and information and knowledge stock (e.g. Strategic Leadership in Global Business Organizations 15

intelligence). These actions and outcomes, however, may also make the partners

vulnerable because each partner has knowledge of the others’ resources and

services. Alternatively, the development of a strong relationship between the

alliance partners helps them gain a sense of control (based on trusting the partner’s

expected actions). Hence, trust can offset the potential costs of vulnerability

in alliances. Hitt et al. (2000) conducted interviews with managers of several

alliance partners that participated in their study. In one case, the U.S. partner was

pleased with the alliance but the Mexican partner was not. The Mexican partner

suggested that its U.S. partner did not care if it received benefits from the alliance.

While there was a formal contract governing the alliance, there seemed to be little

trust between the partners. The Mexican partner had plans to end the alliance

at the end of the contract term. In contrast, another alliance between a U.S.

firm and a Mexican partner seemed to involve significant trust. The U.S. partner

communicated that there was no formal contract between the firms. The manager

suggested that the Mexican partner was trustworthy based on its past performance

so there was no need for a formal contract. In the first case, the Mexican partner

felt vulnerable even though there was a formal contract because there was no trust

between the partners. Yet, in the second case, no vulnerability was present even

without a formal contract because of the trust that existed between the partners.1

Thus, the understanding of how firms manage alliances can be greatly enriched

by realizing the importance of trust in these relationships and how it might be

managed to form and maintain effective strategic alliances while avoiding bad ones.

Good lessons come from the formation of, and behavior in, informal alliances.

Informal alliances are the most common form of alliance, and are more social

than purely economic relationships (Nieuweboer, 2001). Informal alliances have

been examined in the publishing (Coser, Kadushin & Powell, 1982) and textile

(Lorenzoni & Ornati, 1988) industries, among others. Eccles (1981) referred to

them as “quasi-firms,” while Provan and Milward (1995) suggest that they consist

of two or more firms that collaborate on separate but complementary goods and

services within a particular industry. They may involve inter-firm exchanges, for

example, or two firms sharing a single set of customers or customer information

banks.

Because they are not founded on formal market contracts or hierarchical forms

of governance, effective informal alliances depend on trust (Larson, 1992; Ring

& Van de Ven, 1992). Larson (1992) and Dore (1987) observed that mutual

dependence, social norms and trust have profound effects on alliance partners’

behavior. The credibility and reliability of partners are influenced by shared

beliefs held about obligations (Lewis & Weigert, 1985), and thus play a role in

partners’ trustworthiness. This outcome is evident in the two alliances between

U.S. and Mexican firms described above. 16 MICHAEL A. HITT, BARBARA W. KEATS AND EMRE YUCEL

Both trust and trustworthiness are important in the management of alliances.

But managers, especially in western firms, often lack understanding of how they

function in inter-firm relationships (Hitt, Lee&Yucel, 2002). Thus, there exists the

need to further explore the role of trust and trustworthiness in a dynamic context

of strategic alliances.

A Dynamic Model of Trust

Individuals have an idiosyncratic orientation toward trust that derives from

cognitive characteristics and personal histories, both of which are embedded in

social and historical contexts.

Elements of Trust

Individual trust has two dimensions – stable and transitory. Stable traits are those

differences that occur consistently in an individual’s responses across a variety of

circumstances (Spielberger, 1972). We might say “John is a much more trusting

person than Bill is.” Transitory states reflect an individual’s responses to an

immediate set of circumstances (Spielberger, 1972). That is, over time we would

observe that John more frequently responds to interpersonal circumstances with

trust than does Bill. On the other hand, in any particular set of circumstances, Bill

might respond with trust when John does not. Typically, both stable and transitory

responses are involved whenever an individual is confronted with circumstances

that require a decision involving trust or trustworthiness.

When several potential trustors form collective judgments about, and take

combined action based on the trustworthiness of a potential trustee, they exercise

collective trust. Therefore, the critical component for a dynamic model of trust

at the organizational level is the exercise of collective trust by management

teams.

Dominant Trust

Because this “collective trust” is a characteristic of management teams, it may

be manifested in much the same way as the firm’s Dominant Logic (Bettis &

Prahalad, 1995; Prahalad&Bettis, 1986). Just as each member of the management

team brings a unique set of cognitive abilities and experiences to the team that

informs the dominant logic, each member of the team also brings an individual

history of trust experience to the collective decision-making process. Thus,

members of a management team develop a collective dominant trust (DT) through

their interactions with one another and their organizational context, which also

consists of stable and transitory components. Strategic Leadership in Global Business Organizations 17

When the management team encounters situations involving trust, the

conditions of that situation will trigger a DT response – either to trust or not to

trust. The consequences of the actions taken are either positive (confirming the

appropriateness of the DT response) or negative (the DT response was inappropriate).

In either case, those consequences will affect the future content of DT.

Hence, DT is dynamic and subject to change, whether that change is intentional

or unintentional. Failure to attend to this dynamic process will likely impair

the firm’s strategic flexibility and overall effectiveness. While managers cannot

directly affect the historical experience each member brings to a management

team, they can affect team members’ interactions in various situations, particularly

with regard to interpretive behavior.

There are two important issues to be addressed in this dynamic process – building

trust internally (among management team members), and building an effective DT

for the formation and management of important external relationships, such as

strategic alliances. As noted earlier, trust is important to the creation of social

capital both within the organization and in inter-organizational relationships. The

following two sections address these internal and external trust issues.

INTERNAL TRUST, SOCIAL CAPITAL

AND LEADERSHIP Internal trust contributes significantly to a firm’s economic life in various ways

(e.g. Gambetta, 1988; Mistzal, 1996; Rousseau, Sitkin, Burt & Camerer, 1998;

Smith, Carroll & Ashford, 1995). For example, trust can strongly affect cooperation

among employees and units while working on joint tasks (Mayer et al., 1995;

Smith et al., 1995). We noted earlier that trust could provide a valuable addition

to TCE theory. That is, trust in an organization decreases agency and transaction

costs (Frank, 1988; Jones, 1995), and thus increases an organization’s ability

to operate efficiently and to adapt to complex and volatile changes (Korsgaard,

Schweiger & Sapienza, 1995; McAllister, 1995).

Building Internal Trust and Social Capital

As noted in the introduction, strategic flexibility is needed to meet the challenges

of today’s dynamic and competitive landscape (Hitt et al., 1998). Such flexibility

is directly related to building trust within the management team. When trust exists

in the team, individual team members are willing to think creatively, express

new and different ideas and to take risks, in general. Through the effective 18 MICHAEL A. HITT, BARBARA W. KEATS AND EMRE YUCEL

management of trust, a top management team encourages broad participation

and cooperation within multiple heterogeneous teams (Bass, 1985; Bryman,

1996; Bryman, Gillingwater & McGuinness, 1996). Heterogeneous teams are

increasingly important business resources because of their use and integration

of different knowledge stocks (Haleblian & Finkelstein, 1993), particularly

in high velocity environments that require rapid utilization of diverse sets of

information (Eisenhardt, 1989). The rapid application of knowledge and skills

in heterogeneous teams is only possible when there is an environment of mutual

trust among team members (Thamhain & Wilemon, 1977).

Hitt, Nixon, Hoskisson and Kochhar (1999) describe the outcomes of a

heterogeneous team in which little trust existed. They studied a new product

development team composed of technical (e.g. scientists and engineers) and staff

(e.g. strategic planning, marketing) professionals charged with the responsibility

of developing an important new product for the firm. Although top management of

the firm designated the team and established its primary goal, no effortwas made to

build trust in the team or to facilitate cooperation. The result was overt resentment

expressed by the technical team members, especially toward the marketing team

members. Because the technical team members represented the unit controlling

the budget for the team activities, the technical co-team leader (with a marketing

co-team leader), took over the team, blocking the marketing team members’

inputs. Marketing team members distrusted the technical team members’ efforts

and eventually quit trying to participate. The team developed a new product design

that was never implemented; the new product was technically well designed but

did not have adequate features attractive to the market. As a result, the team failed

to meet its goal and the firm failed to beat competitors to the market with a new

product.2 This example suggests that leaders must be responsible for building this

trust. In effect, leaders build internal social capital that allows joint actions within

and by heterogeneous teams.

Social capital offers a unique advantage to those charged with strategy making.

Developing and maintaining trusting relationships (i.e. among employees, among

units and between employees and leaders/managers) is the responsibility of the

chief executive, who delegates it to team leaders, who in turn use it to promote

collaboration (Morell, Caparell & Shackleton, 2001). Fortunately, social capital is

a renewable resource as long as it is not abused. Trust facilitates communication

and the flow of information within and among teams operating in the organization

(Dutton, Ashford, O’Neill, Hayes & Wierba, 1997; Koka, 1999). Thus, relationships

are critical to the transfer of knowledge in organizations (Hitt et al., 2001a).

The most effective relationships require a collective and mutual trust between

parties (trustees and trustors) (Jeffries & Reed, 2000; Wicks, Berman & Jones,

1999). Without trust, the relationship is likely to be contract- or rule-based and Strategic Leadership in Global Business Organizations 19

unlikely to promote the transfer of knowledge (Chow & Holden, 1997; Smith

et al., 1995; Zaheer, McEvily & Perrone, 1998). Mutual trust is based on a

process of interactions between leaders and members, which is used by leaders in

dealing with team members. As such, truth and justice are critical to the process

of building and maintaining trust.

Truth and Justice

Building trust, and hence social capital, requires honesty in interchanges between

leaders and employees and among team members, as well as a perception of

justice, particularly procedural and interactive justice (Clawson, 1999; Kim &

Mauborgne, 1991). If a leader has exhibited integrity in the past, team members

expect similar behavior in the future (Mayer et al., 1995). This expectation of

integrity contributes to trust formation, stronger relationships, a willingness to take

risks (innovate) and, ultimately, to the continued development of social capital.

Interactional justice refers to the equality in interpersonal treatment that

members receive from their team leader (Byrne & Cropanzano, 2001). Leaders

who are honest with and display respect for their team members are the most

likely to build trust. Trust is an important precursor to effective relationships and,

eventually, to social capital.

Interactional justice is considered a derivative of procedural justice. While

distributive justice involves the fairness in outcomes received by individuals,

procedural justice refers to the procedures used to determine the outcomes

(Moorman, 1991). Thus, justice deals with the fairness of outcomes, procedures

and the interpersonal treatment provided by the leader. Perceived fairness is

critical to the development and maintenance of trust and effective relationships

between leaders and team members (Zaheer et al., 1998).

Commitment and Community

Trustworthy leaders create an organizational climate of trust that fosters commitment

on the part of employees and team members. Commitment is important to

employees as they assess the value of continued membership in the organization,

and is also important in the accomplishment of tasks and team goals. Trust and

fairness in relationships foster commitment to the team’s and organization’s goals,

and to the decisions made to achieve them. They create social capital that produces

a spirit of cooperation, and a willingness to do what is necessary to achieve

those goals. In fact, commitment facilitates the implementation of firm and unit

strategies (Hitt & Tyler, 1991), and provides a foundation for developing a sense

of community both among team members and employees in general (Lee, 2002).

A climate of fairness (distributive, procedural and interactional) developed by

leaders contributes to building community. Naumann and Bennett (2000) found 20 MICHAEL A. HITT, BARBARA W. KEATS AND EMRE YUCEL

that an effective justice climate produced cohesion among group members and

commitment to the organization. They suggested that the leader played the most

critical role in the establishment of this climate. However, they also found that the

climate of fairnesswas more difficult to achieve with a heterogeneous membership.

This result has important implications for leadership in international settings.

Opportunities and Challenges of Internal Social Capital

The ability of the chief executive to create a climate of trust will allow him or her to

shape the dominant trust of the management team. This becomes extraordinarily

important when the context is one of building social capital in large transnational

firms (Hitt et al., 2002). The cultural heterogeneity in the countries in which the

firm operates poses challenges to the formation of the relationships needed to

build trust, form dominant trust and create social capital. In some countries, social

capital is a part of the interpersonal framework, such as “guanxi” in China. While

guanxi greatly facilitates the development of social capital within the country

or among ethnic Chinese, it also creates path dependencies in relationships and

makes it even more difficult to form trusting relationships among employees

and units that link China with other countries, particularly outside of Asia (Hitt

et al., 2002). According to House, Wright and Aditya (1997), “What is expected

of leaders, what leaders may or may not do, and the influence that leaders have,

vary considerably as a result of the cultural forces in the countries or regions in

which the leaders function” (p. 536). Even the meaning of justice and fairness

can vary across cultures. Thus, trust is difficult to achieve in these settings.

Regardless of the challenges, coordination and cooperation between individuals

and units operating in different cultures and countries is critical for transnational

firms, particularly in the development of the entrepreneurial mindset. Risk-taking,

the heart of entrepreneurial thinking, is more likely to occur when an organization’s

members trust their colleagues and leaders. Furthermore, in order for

these firms to achieve economies of scope with their international strategies,

coordination is required to share resources, activities and knowledge across units

operating in different geographical markets (Hitt, Hoskisson & Kim, 1997). Trust

is vital to this coordination, as is the expectation of procedural justice exercised

by the leaders of the organization in conjunction with the subsidiaries operating

in different countries across the globe.

Procedural justice is important to a global organization because it communicates

corporate leaders’ concern for fairness and the desire for involvement of subsidiary

managers in the development and implementation of strategy (Kim & Mauborgne,

1993). Strong relationships between corporate and subsidiary managers allow Strategic Leadership in Global Business Organizations 21

subsidiary managers to provide input to and participate in the development of international

strategies (Kim & Mauborgne, 1991; Luo & Peng, 1999). Of course, the

subsidiary managers play a critical role in the implementation of those strategies,

and thus their commitment to the organization and its strategies is important.

To gain such commitment, leaders at the top of the organization need to build

trust throughout the firm (Barney&Hansen, 1994). Therefore, they must develop a

dominant trust (or collective trust) that forms the basis for decision making across

the global operations. In this way, internal social capital is developed, almost a

form of internal “guanxi,” that facilitates their interactions and collectivework. The

utilization of internal social capital, for example, can overcome many bureaucratic

and organizational obstacles to achieve diffusion of innovation. Thus, we conclude

that internal trust and social capital are vital ingredients to effective leadership in

global organizations.

EXTERNAL TRUST, SOCIAL CAPITAL

AND LEADERSHIP To be an effective leader in global organizations requires that trust and social

capital be developed in relationships with other organizations, particularly in

strategic alliances. The number of strategic alliances has increased dramatically

in recent years. For example, U.S. firms with at least $2 billion in annual revenue

formed an average of 138 strategic alliances from 1996 to 1999. There were

over 10,000 alliances formed in the year 2000 (Schifrin, 2001). Many of these

alliances were formed with firms with home bases in other countries (i.e. in Asia,

Europe, Latin America). Some of these alliances are informal, but many represent

formal inter-firm collaborations (Simonin, 1997). Very few firms have all of the

resources or knowledge needed to successfully compete in many global markets.

Thus, they form alliances with other firms to gain access to resources that are

complementary to their own. In general, strategic alliances provide access to

information, special resources, technology and markets (Hitt et al., 2001b).

Unfortunately, many of these alliances fail, suggesting problems in their

formation or management (Reuer, 1999; Young-Ybarra & Wiersema, 1999). We

argue, along with others, that a common reason for their failure is an absence

of trust, which makes it difficult for the firm to build and exercise social capital.

The problem in the strategic alliance between a U.S. and Mexican firm described

earlier provides an appropriate example. The Mexican firm did not trust the U.S.

firm to reciprocate in the relationship and thus neither firm had social capital with

the other. The lack of trust and social capital led to the demise of the alliance

between the firms. If firms do not trust their partners, they will be less willing 22 MICHAEL A. HITT, BARBARA W. KEATS AND EMRE YUCEL

(or unwilling) to allow access to their resources (e.g. knowledge, technological

capabilities). Given that one of the primary reasons that alliances are formed is

to gain access to the partner’s resources, a lack of trust can lead to failure of the

alliance. The follow-up interviews conducted by Hitt et al. (2000) suggested that

a lack of trust and reciprocity between alliance partners reduced the alliance’s

effectiveness.

Clark and Matze (1999) suggest that leaders must develop a relational competence

that involves effective management of relationships across diverse settings.

Such relational competence requires good communication and interpersonal skills.

A relational competence also involves the ability to understand and empathize

with heterogeneous partners. But most of all, we argue that relational competence

entails the development and maintenance of trust and trustworthiness among

partners. Trust among partners in strategic alliances builds social capital, thereby

contributing to the success of the alliance and to the development of other alliances.

Kale, Singh and Perlmuter (2000) argue that relationships producing social

capital are based on mutual trust. Partners must trust each other in order to allow

access to resources and the transfer of knowledge. Lane and Lubatkin (1998)

suggest that strategic alliances allow partners to work closely enough to transfer

even tacit knowledge. However, firms are unlikely to allow partners close enough

to learn tacit knowledge unless there is trust between them (Barney & Hansen,

1994). In support of this notion, Tsai and Ghoshal (1998) found that resource

exchange was higher between organizations that enjoyed mutual social capital.

In other words, firms are willing to share their resources with partners when they

expect that their actions will be reciprocated.

As noted earlier, trust substitutes for more costly forms of monitoring and

control in alliances. When control is exercised through a formal contract, it is

enforced by partners’ monitoring each other’s behavior (Das & Teng, 1998).

Essentially, contracts and monitoring of partners’ behavior are used to prevent

opportunistic behavior by partners. However, relationships based on formal,

contractually-specified behaviors are unlikely to allow maximum access to

partners’ resources. Furthermore, the monitoring required can greatly increase

transaction costs. Take, for example, the two alliances between U.S. and Mexican

firms explained earlier. One of the alliances was based on a formal contract

and the other one had no formal contract. The alliance based on the formal

contract was unsuccessful and failed, yet the one without a formal contract was

successful. In the successful alliance the partners trusted each other and developed

social capital over time. As a result, no formal contract was believed to be

necessary.

If firms act opportunistically, the alliance will fail. Hamel (1991) argued that

strategic alliances provided an opportunity for learning races between partners. Strategic Leadership in Global Business Organizations 23

The firm that learns the desired capabilities first can dissolve the alliance before

its partner learns its capabilities. Then, the firm with the new capabilities can

possibly become the former partner’s competitor and gain a competitive advantage.

Similarly, Inkpen and Beamish (1997) suggested that after firms obtain the desired

knowledge, their motivation and need for the alliance may be diminished. In this

case, cooperation may cease, and eventually the alliance will fail and be dissolved

(Ireland et al., 2002).

Trust implies vulnerability between partners; where there is mutual trust,

there is also mutual vulnerability. Social capital is built when the trust placed

in a partner is rewarded with mutual benefits. With social capital, there is an

implied responsibility to cooperate and help the partner; there is an expectation of

reciprocation at some time in the future. As a result, norms of reciprocity develop.

Thus, effective leaders must work to build trust in strategic alliances. Often, trust

and social capital in alliances are based on interpersonal relationships among

the leaders representing each partner. Thus, social capital is based on relational

capital and relational capital is based on relational competence. Leaders with high

relational competence emphasize mutual growth and returns for all involved in

the relationship (Clark & Matze, 1999). Eventually, the most effective leaders try

to develop a collective trust between the parties that transcends individual leaders

(Beekman & Robinson, 2002).

Cultural, economic and institutional differences across countries make trust

between partners in international strategic alliances difficult to achieve (Hitt et al.,

2000a). Cultures and institutional frameworks affect the mindsets of managers

operating within them (Peng, 2000). For example, the cultural and institutional

differences between China and the U.S. are significant. Thus, managers of firms

in China and the U.S. may experience trouble developing trusting relationships

in alliances with each other. Differences in the legal protection of intellectual

property rights can create conflicts or distrust. Additionally, the emphasis on

relationships as a way of doing business in China (guanxi) is much greater than

in the U.S. Thus, Chinese managers believe strongly in building relationships,

whereas U.S. culture places more emphasis on contractual forms of control (and

relationships). Yet, trust is critical to the sharing of resources and knowledge

in these alliances. Partnerships in which there is greater interdependence and

to which the alliance is highly important have incentive to develop mutual

trust (Luo, in press). Mowery, Oxley and Silverman (1996) found that greater

knowledge transfer existed in alliances where both partners owned equity. Even

equity arrangements do not fully substitute for mutual trust. For example, equity

arrangements do not prevent learning races. Therefore, it remains incumbent on

leaders in partner firms to use their relational competences to establish trust and

build relational capital (Cullen, Johnson & Sakano, 2000). 24 MICHAEL A. HITT, BARBARA W. KEATS AND EMRE YUCEL

OUTCOMES OF LEADERSHIP BASED ON

TRUST AND SOCIAL CAPITAL While there are many potential outcomes from the process of leaders building

internal and external trust and social capital, we will emphasize three – alliance

success, building knowledge and innovation. These three are interdependent.

Alliance Success

First, we conclude that mutual trust leading to the development of social capital

is a necessary prerequisite for successful strategic alliances. The cost of failure

in strategic alliances can be very high. Assuming that firms form alliances for

increased access to resources, a failed alliance suggests that access to those

resources is lost. The resources were needed to gain or maintain a competitive

advantage. Thus, an alliance failure provides opportunity for another firm to gain

a competitive advantage in the market. Even if the alliance does not fail, the

lack of mutual trust will disallow achieving maximum returns from the alliance.

Partners will not share their most valuable resources without trust. Therefore,

trust among alliance partners could mean the difference between competitive

parity and advantage or worse – the gain or loss of market power. If firms form an

alliance to gain access to resources, they will not be able to obtain those resources

without mutual trust between partners. Trust also reduces the cost of an alliance

(i.e. reduces transaction costs). Trust limits the need for monitoring a partner’s

actions or developing elaborate formal contracts. Formal contracts rarely maximize

returns from alliances. The effects of trust and outcomes of contracts can be seen in

the two alliances between U.S. and Mexican firms explained earlier. In the strategic

alliance with the formal contract, theMexican firm did not trust the U.S. firm to help

it gain benefits from the relationship and the alliance failed. In the other strategic

alliance, no formal contract was used because of the mutual trust between the two

firms. This alliance appeared to have been successful over time. Trust affords the

opportunity, then, to develop a collaborative advantage (Dyer, 1997; Lado, Boyd

& Hanlon, 1997). The success of an alliance may be at least partially based on

the ability to transfer knowledge.

Recently, Citigroup, a massive financial organization, has experienced a “crisis

of trust.” Its linkages to the Enron and WorldCom debacles and bankruptcies, the

lawsuits filed by three California state pension funds against the firm for “illegal

conflicts of interest” in theWorldCom case and its subsidiaries’ questionable practices

regarding loans to high-risk clients have sullied the firm’s reputation. While

the vast financial assets of Citigroup will likely help it develop additional alliances

Strategic Leadership in Global Business Organizations 25

in the future, potential partners may be more wary of developing relationships and

will monitor their behavior more closely. A recent speech by Citigroup CEO, Sanford

Weill referred to the importance of integrity and trust. He stated that, “When

all is said and done, we must recognize that neither we as leaders, nor the companies

we head, can regain the confidence of the public without instilling within our

corporations a dedication to integrity above all else” (Beckett & Sapsford, 2002).

Building Knowledge

Grant (1996) suggested that a firm’s knowledge is a highly important competitive

asset. Additionally, Spender (1996) argued that knowledge, and the ability to

generate specific and valuable knowledge, are at the core of the firm. As such,

knowledge forms the basis for competitive advantage. Firms that know more

about their markets, customers, suppliers and competitors, as well as their own

technology, can sustain a competitive advantage. Given its importance, how firms

gain access to and build knowledge is a highly important competitive issue.

Firms can build their knowledge stock by developing it internally or by learning

from external sources. Effective leadership is critical to both. Some knowledge

can be stored in organizational routines, but most important tacit knowledge is

held by the firm’s human capital (Hitt et al., 2001a; Liebeskind, 1996). Thus, a

primary means for a firm to build knowledge is to develop its human capital. Most

important to the firm is the development of employees’ tacit and firm-specific

knowledge. However, to do so requires effective leadership (Hitt et al., 2001a).

First, leaders must encourage their followers to learn new skills and gain new

capabilities. Next, they must facilitate the learning process. But most importantly,

leaders must build effective relationships and trust with employees for them to

be willing to develop tacit and firm-specific knowledge. Building firm-specific

knowledge entails skills that are unlikely to be valuable to other firms. These

skills do not aid employees’ job mobility. Thus, they must trust their leaders.

Furthermore, leaders must build commitment to the organization and community

in an effort to encourage employees to develop and apply new knowledge.

Relationships play a prominent role in employees’ willingness to apply this

knowledge to help the organization gain a competitive advantage.

Another means of knowledge building involves the transfer of information

between partners in an alliance (Kogut & Zander, 1993). As noted earlier, a major

reason alliances are formed is to acquire new capabilities and to gain access

to knowledge that boosts a firm’s competitive advantage, such as cutting-edge

technology (Dyer & Singh, 1998). Learning and knowledge transfer are difficult

to achieve. Leaders from both firms must work to establish mutual trust and 26 MICHAEL A. HITT, BARBARA W. KEATS AND EMRE YUCEL

social capital so that each partner feels that the transfer of knowledge is not

risky. Without the trust that produces social capital, there is potential for a

learning race, or actions that buffer critical knowledge (e.g. technology) from

partners, especially in international strategic alliances (Barney & Hansen, 1994).

Building new knowledge is often important in the firms’ innovation development

process.

Innovation

Hamel (2000) argues that firms must be innovative if they are to achieve even

competitive parity and to navigate in a dynamic competitive landscape (Hitt et al.,

1998). In fact, Hamel argues firms must create innovation or they will be replaced

by more innovative competitors. Amit, Lucier, Hitt and Nixon (2002) make a

similar argument and suggest that new winners in the business environment often

emerge quickly based on a disruptive innovation they develop and introduce to the

market. Hamel (2000) reported research findings suggesting that most industries

are changed by newcomers rather than by incumbents.

Of course, internal processes are critical to innovation. For example, many

firms use cross-functional teams to develop innovation (Hitt et al., 2000b).

The productivity of these teams, however, is predicated on the quality of their

leadership. While heterogeneity among individuals’ knowledge stocks on these

teams lends itself to innovation, the diversity of perspective and approaches,

as well as knowledge bases, require effective leadership to build relationships

among team members. In addition, commitment and a sense of community are

necessary for the knowledge to be integrated and to produce innovative ideas.

Moreover, proposing creative ideas can be perceived as risky. People must trust

the leader and team members to propose such ideas. Trust is even more important

in the development of creative ideas into inventions that are then commercialized.

People must trust that they will not be penalized for failures (Smith&Di Gregorio,

2002). Without effective leaders who build trust and social capital among team

members and within the organization, innovative efforts such as these are doomed

to failure. Robert Reich, the former U.S. Secretary of Labor, argued that when

firms invest in their employees’ learning and development, provide them with

autonomy and consider their personal aspirations, the result is increased trust and

employee energy directed toward innovation (Reich, 1998).

External trust and social capital can also contribute to a firm’s innovation. For

example, some firms use strategic alliances to enhance their innovation. Networks

of alliances provide information to firms and help them identify opportunities

(e.g. in the market) (Cooper, 2002). Other firms use alliances for their Strategic Leadership in Global Business Organizations 27

Fig. 1. Model of Trust, Social Capital and Strategic Flexibility.

28 MICHAEL A. HITT, BARBARA W. KEATS AND EMRE YUCEL

resources and knowledge, which can prove helpful in developing innovations

(Anand & Khanna, 2000; Dussauge, Garrette & Mitchell, 2000). Finally,

some firms enter alliances to learn new skills that directly enhance innovative

capabilities. For example, Rothaermel (2001) found that large pharmaceutical

firms were able to increase their innovation by learning about new technology

through alliances with newer biotechnology firms. Firms can only obtain the

needed benefits from alliances when leaders have established mutual trust among

alliance partners and built social capital. Without trust, partners are unlikely

to transfer knowledge or other desired resources. There must be a free flow of

communication and norms of reciprocity among the partners.

Successful alliances, knowledge and innovation are outcomes of social capital

based on strong relationships (with internal and external constituents) and trust.

In turn, these outcomes contribute to a firm’s strategic flexibility. Alliances

provide access to resources the firms do not possess, allowing them to develop

and implement new strategies. New knowledge contributes to the development

of new capabilities and possibly even new core competencies that can produce a

competitive advantage. Finally, innovation can help firms to enter new markets and

remain ahead of their competition. These relationships are presented in the model

shown in Fig. 1.

CONCLUSIONS We have established that leaders must build trust as part of their relational

competence. Leaders apply relational competence in order to build relational

capital, which in turn leads to the development of social capital. These actions

are necessary in internal and external relationships. Effective leaders build

trust within the organization through displays of integrity and fairness. They

demonstrate distributive, procedural and interactional justice. They build trust in

external relationships through effective communication and the establishment and

practice of norms of reciprocity. Establishing trust and reciprocity norms is more

challenging in global organizations (crossing country boundaries) because of the

firms’ heterogeneity and diversity. Leadership that builds trust, and eventually

social capital, is even more critical in these environments and organizations.

An entrepreneurial mindset is needed to identify and exploit significant

opportunities (McGrath & MacMillan, 2000). In fact, recent work suggests that

the most effective firms practice strategic entrepreneurship in which opportunities

are actively sought while simultaneously seeking to achieve competitive advantages

(Hitt, Ireland, Camp & Sexton, 2002). Information and ideas are needed to

identify opportunities. Resources and knowledge are often required to exploit those Strategic Leadership in Global Business Organizations 29

opportunities and to establish a competitive advantage. A free flow of information

and ideas in the organization, and access to resources and knowledge externally

occur through the relationships that leaders build with internal and external

constituents. Effective relationships are built on mutual trust. Over time, effective

relationships promote the development of social capital. The logical conclusion is

that effective leadership produces relationships that help firms build knowledge,

produce innovation and disruptive technologies (Ahuja & Lampert, 2001), and

help firms gain competitive advantage. This type of leadership is especially

critical in global organizations.

NOTES 1. The managers were promised anonymity for them and their firms in order to participate

in the study. Therefore, the firms mentioned must remain anonymous.

2. The name of the firm must remain confidential as promised by the researchers.

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