Relationship Scope and Cooperation in Interfirm Relationships: Evidence from Airlines Nicholas Argyres Olin School of Business Washington University in St. Louis St. Louis, MO Ricard Gil Smith School of Business Queen’s University Kingston, ON Giorgio Zanarone Olin School of Business Washington University in St. Louis St. Louis, MO January, 2021 Abstract This paper provides empirical evidence that broad relationship scope, whereby a buyer engages in multiple simultaneous exchanges with a single supplier, increases both parties’ willingness to cooperate with each other. It also provides evidence that the effect of such broad scope on mutual cooperation is greater when externalities between suppliers, which are internalized in broad scope relationships, are more important. Our cooperation measures are based on landing time slot exchanges between major airlines and their regional partners during inclement weather, while our measure of relationship scope is based on outsourcing concentration in various airports. Our measures of externalities are based on numbers of regional partners per airport and the number of flights outsourced to alternative regionals per airport. Because our data are at the airport and day level, we are able to include relationship fixed effects in the regressions. Therefore, our results are not driven by relationship-specific governance mechanisms such as trust, norms of reciprocity, expectations of future exchange, and the like. We thank Janet Bercovitz, Fabrice Lumineau, and seminar participants at Purdue University, London Business School, Duke University, Washington University in St. Louis, and University of Venice for many helpful comments. 1 Introduction One of the most important decisions a pair of collaborating firms makes in designing their relationship is how many transactions or business activities to include in it: that is, the relationship’s scope. For example, a manufacturer may procure most of its parts or components from the same supplier, or may instead spread those purchases across multiple suppliers. Similarly, a franchisor may assign multiple retail outlets to the same franchisee, or may split them among multiple franchisees. This paper describes an empirical study of how choices of relationship scope affect cooperation in interfirm relationships. While there is anecdotal evidence that broad-scope buyer-supplier relationships support more cooperation in the context of auto manufacturing (e.g., Womack, Jones & Roos 1990; Helper & Henderson 2014), to our knowledge there have been only two efforts to systematically measure and isolate the distinctive impact of relationship scope on cooperation. These two efforts are Ahmadjian & Oxley (2006) and Aral, Bakos & Brynfolffson (2018), both of which find empirical support for models of hostage exchange (Williamson 1983), dependence balancing (Heide & John 1988), and property rights theories (Grossman & Hart 1986; Bakos & Brynjolffson 1993) of relationship scope. Each of these theories implies that broad relationship scope serves as a safeguard against holdup by the buyer, and therefore encourages the supplier to make relationship-specific investments. The two studies are limited in important ways, however. First, they study supplier cooperation only; they do not study whether and how broad relationship scope might support cooperation by both supplier and buyer. Clearly, understanding whether broad scope supports supplier cooperation alone or mutual cooperation is critical for predicting when and where firms will use broad scope vs. narrow scope relationships. Second, both studies focus on “holdup protection” as the main mechanism through which broad scope 2 supports cooperation, although in many interfirm relationships the central cooperation problem is not incentivizing ex ante specific investments, but instead securing (non-contractible) ex post adaptation (Simon 1951; Williamson 1991; Gibbons 2005; Baker, Gibbons & Murphy 2011). Examples of such relationships include (but are not limited to) those in construction procurement (Bajari & Tadelis 2001), franchising (Arrunada, Garicano & Vasquez 2001), the airline industry (Forbes & Lederman 2009), and the feature film industry (Barron, Gibbons, Gil & Murphy 2019). In this paper, we seek to fill these gaps in the literature by empirically examining whether broad buyer-supplier relationship scope is associated with better mutual cooperation (rather than one- sided cooperation only), in a context in which cooperation does not take the form of relationship- specific investment. Our empirical analysis tests the implications of the theoretical model proposed by Argyres, Bercovitz and Zanarone (2020) (henceforth “ABZ”), which shows that broad relationship scope improves bilateral cooperation by internalizing externalities among suppliers. Consider for example a buyer’s product that requires two complementary inputs, A and B. If supplies of input A are of poor quality, the buyer’s brand is damaged, which could reduce the buyer’s future sales as well as its future purchases of both inputs. When the same supplier sells the two inputs to the buyer (i.e., the buyer-supplier relationship has broad scope), however, this cross-input externality is internalized. Similar externalities exist between franchised retail outlets that operate in the same territory (e.g., Brickley & Dark 1987). Importantly, the ABZ model shows that the internalization of inter-supplier externalities enabled by broad relationship scope stimulates cooperation not only by the supplier but also by the buyer, for two reasons. First, if the buyer’s and the supplier’s cooperative actions are complementary, the buyer may gain more from cooperating when the supplier also cooperates – 3 that is, the buyer has stronger “static” incentives to cooperate. Second, when the relationship is repeated, the buyer shares in the supplier’s increased “relational capital” induced by the internalization of externalities, and therefore has a stronger “relational” incentive to cooperate. That is, internalization creates value that can be used to incentivize both parties to cooperate. Our empirical context involves the relationships between major airlines and their regional airline partners in the U.S. These partnerships are important: the number of routes and flights operated by major-regional partnerships has increased exponentially in the last twenty years, primarily due to the lower labor costs that such partnerships enjoy (e.g., Forbes & Lederman 2009; Gil, Kim & Zanarone, 2021). A key element of bilateral cooperation between majors and regional partners is the exchange of landing time slots under adverse weather conditions and slot rationing by airport authorities (Forbes & Lederman 2009; Vossen & Ball 2006; Gopalakrishnan & Balakrishnan 2017). A landing time slot (hereafter simply “time slot” or “slot”) provides permission for a aircraft to land at a particular airport at a particular time. Note that refusing to exchange a landing slot reflects a lack of cooperation, but does not represent refusal to make a specific investment, or to hold up such an investment made by the counterparty. Using data on time slot exchanges in U.S. airports, we examine whether a given major airline and regional partner exchanged slots more frequently in those airports in which their relationship accounted for a larger share of the major’s flights – holding constant the major’s and the regional’s number of joint flights at the airport. Our measure of cooperation is thus specific and well-defined, and does not rely on self-reported assessments. It also varies across airports within the same major- regional relationship, thus providing a more nuanced view of cooperation than is available in the literature. We find strong and robust evidence that broader relationship scope is associated with greater two-sid4ed cooperation (i.e., greater provision of time slots to partners by both majors and 4 regionals). In addition, we show that this evidence supports implications of the ABZ model more than those of alternative theoretical models. Importantly, the granularity of our data allows us to include major*regional relationship fixed effects, major*airport fixed effects and airport*day fixed effects in our regressions. The relationship fixed effects ensure that our empirical results are not driven by characteristics of a major-regional relationship that are invariant across airports, and that are more typically studied in the literature on interorganizational relationships, such as expectations of future interactions (Axelrod 1984); availability of punishment threats (Bernheim & Whinston 1990); interorganizational trust (Zaheer & Harris 2005); and norms of reciprocity (Cropanzano & Mitchell 2005). The major*airport and airport*day fixed effects ensure that our results are not driven by relationship-invariant airport or by major/airport characteristics such as local demand, airport hub structure or airport-specific proclivity to slot rationing. To our knowledge, this study provides the first systematic yet detailed evidence on how relationship scope affects two-sided cooperation in interfirm relationships in which cooperation does not require specific investment.1 Literature Review A long tradition of research in industrial organization economics emphasizes the disadvantages of broad relationship scope to the extent that it studied the negative impact of supplier concentration on buyer profitability (e.g., Bain 1959; Porter 1980), and of buyer concentration on supplier investment incentives