Academic journal article Academy of Strategic Management Journal

When Are International Joint Ventures Too Inflexible to Exit?

Academic journal article Academy of Strategic Management Journal

When Are International Joint Ventures Too Inflexible to Exit?

Article excerpt

INTRODUCTION

For a firm to employ some logic in its strategic decision making process, it needs to identify conditions under which the firm can apply that logic to a particular decision. From institutional legitimacy and experiential learning perspectives, this paper identifies the boundary conditions of real options theory as strategic decision making logic within the context of the divestment flexibility of international joint ventures (IJVs).

In recent decades, real options theory has been suggested as an important form of strategic decision making logic because it explicitly considers the value of future flexibility (Bowman & Moskowitz, 2001). That is, flexibility and uncertainty explain the core themes of real options theory (Dixit & Pindyck, 1994). The rationale behind real options theory is that possessing flexibility provides decision makers with greater value when the future state is unpredictable. In other words, when the future is fairly predictable, flexibility is not valuable.

The conventional wisdom in the real options literature posits that the value of flexibility stemming from IJVs is greater in a host country with a volatile environment (Reuer & Tong, 2005). At the same time, however, empirical studies have indicated that high economic volatility in emerging economies may not contribute to the option value of having IJVs (Reuer & Leiblein, 2000; Tong, Reuer, & Peng, 2008). Given this seemingly contradictory empirical puzzle, this paper raises the question of under what circumstances, does high uncertainty not increase the options value of an IJV. This paper focuses on the option value of divestment flexibility because divestment flexibility has received little attention in the IJV literature (Zardkoohi, 2004). Only a few studies have examined the effects of divestment flexibility at the parent firm level instead of at the subsidiary level (Chung, Lee, Beamish, & Isobe, 2010). In this regard, the focal question is, when an IJV is not a real option in terms of divestment flexibility.

Before addressing this research question, there is a need to define the option value of IJVs. According to Chi and Seth (2002), one can classify types of flexibility that an IJV creates into three categories: an option to expand/contract, an option to acquire/divest, and an option to use knowledge learned by IJV. This paper focuses mainly on divestment flexibility because the difficulty in terminating sequentially committed investments is one of the most understudied domains in the real options literature (Zardkoohi, 2004).

Then what does divestment flexibility mean? IJV divestment flexibility is the option value that the option holder (foreign parent firm in this case) has in terms of the right to sell its equity stake to a local partner or the third party when the option holder expects the economic payoff for maintaining the IJV is less than divesting it (Chi & Seth, 2002). Because all options are not obligations but rights, divestment flexibility provides a foreign parent firm with a safeguard that prevents further losses in case the focal IJV faces an unfavorable local economic condition.

In terms of the original research question, what factors make IJVs operating in volatile local environments not as valuable as the conventional wisdom of real options theory predicts? This paper argues that institutional pressures and behavioral uncertainty offset the positive effect of environmental volatility on IJV divestment flexibility. In this sense, this research implicitly assumes that foreign parent firms as multinational corporations (MNCs) are willing to invest in building host-country-specific capabilities (Song, 2002). That is, only those parent firms with economic incentives to maximize long-term benefits from the host country are posited to concern about local legitimacy in the country. Therefore, if an IJV investment has been made to serve as an export platform, then the parent firm of the IJV is less concern about gaining and maintaining local legitimacy. …

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