Trust, governance, and performance: The role of institutional and interpersonal trust in SME development

abstract: This article explores the relationship between trust and control by investigating the direct and indirect effects of different types of trust on company performance. A survey of small and medium size firms in Slovenia and Bosnia-Herzegovina is used to demonstrate how the level of trust entrepreneurs have in institutions and business partners influences the choice of governance mechanisms that co-ordinate economic activities among actors. The article shows that the institutional environment in Slovenia generates more trust, which enables actors to base their business relationships on trust rather than contract. In addition, when actors rely on trust it is usually institutional trust rather than interpersonal trust. In contrast, Bosnia, with a weaker insti-tutional environment, generates less trust, leading actors to base their economic relationships on contract. However, when trust is used in Bosnia as a basis of business relation-ships it is likely to be centred on interpersonal trust. These results have important implications for the understanding of the process by which trust affects economic performance. The use of institutional trust as a basis for a governance mechanism may lead to increased economic performance of companies due to the inclusive nature of sociability patterns and tie formation since institutions generalize trust beyond a specific set of exchange partners. The use of interpersonal trust may limit economic potential due to its reliance on strong ties embedded within cohesive groups marked with closure