Trust, Competition and Innovation: Theory and Evidence from German Car Manufacturing
Abstract: Using unique data from buyer-supplier relationships in the German automotive industry, we unveil a puzzle by which more trust in a relationship is associated with higher idiosyncratic R&D investments, but also more competition. We develop a theoretical model of repeated procurement with non-contractible, buyer-specific investments rationalizing both observations. Against the idea that competition erodes rents needed to build trust and sustain relationships, we infer that trust and competition tend to go hand in hand. We show in both theory and the data that trust and rents from reduced supplier competition are substitutes, rather than complements as typically assumed.