To better understand the relationship between the headquarters and subsidiaries of multinational corporations, we introduce and test a theoretical framework that builds on and extends the positive agency theoretic corporate governance literature. Results indicate that there are three types of subsidiary bundles of corporate governance mechanisms that are used by multinational corporations. In addition, the following factors can help predict what type of subsidiary bundle a multinational corporation will use to align the interests of its headquarters with a particular subsidiary: the multinational corporation's international strategy, its subsidiary's importance, environmental uncertainty faced by its subsidiary, and its subsidiary's age.
Key hallmarks of the modern economy are the continuing expansion and increasing significance of multinational corporations. Furthermore, multinational corporations already account for a sizable portion of world output and trade. As the influence of multinational corporations grows, managers and researchers alike are trying to better understand the complex relationships that exist between headquarters and subsidiaries of multinational corporations because the headquarters-subsidiary relationships have a tremendous impact on a wide variety of issues ranging from the competitiveness of multinationals to the amount and distribution of wealth created by them.
Faced with this intriguing task, management scholars have suggested that one of the ways to deepen the understanding of headquarters-subsidiary relationships is to apply existing theories to generate and test predictions about these relationships (Doz and Prahalad 1991; O'Donnell 2000). Following these suggestions, agency theory and corporate governance literature has recently been used by researchers to explain headquarters-subsidiary relationships (Björkman and Warner-Rasmussen 2004; Bobillo, de Andres Alonso, and Gaite 2002; Chang 1999; Hamilton and Kashlak 1999; Krieger 1988; Krieger 1991; Mirchandani and Lederer 2004; O'Donnell 2000; Roth and O'Donnell 1996; Sanders and Carpenter 1998; Yu and Wong 2006). Some of these researchers have highlighted that the agency relationship that is created when ownership is separated from management in the modern corporation (Berle and Means 1932) is similar to the agency relationship that is created when subsidiaries are formed to run separately from a multinational corporation's headquarters; and in either set of agency relationships, conflict of interest is a very significant force. These researchers also propose that corporate governance mechanisms, which have evolved over time, both internally (e.g., board of directors) and externally (e.g., capital markets), to monitor and bond managers, are the very building blocks of parent-subsidiary and shareholder-manager corporate governance relationships that are formed to reduce the costs created by the conflict of interest of the agency relationships.
Following these interpretations, agency theoretic researchers focus on corporate governance mechanisms that would be available to multinational corporations for the purpose of aligning the interests of the principals in headquarters and agents in subsidiaries, and they try to observe if agency theoretic predictions about the variations in the use of mechanisms hold true. So far, the implications of their studies have been puzzling and they raise more questions than they answer. However, one implication that seems common to all of the studies is that there is considerable unexplained variation in the different corporate governance mechanisms that are used by different subsidiaries. In addition, there is disagreement about the extent to which agency theoretic explanations predict the variation in the corporate governance mechanisms that are used.
One reason for the inconsistency among the predictions and results of previous studies could be an incomplete utilization of the existing positive agency theoretic corporate governance literature about how corporate governance mechanisms complement and substitute for each other, what constitutes bundles of corporate governance mechanisms, and what determines the composition of bundles of corporate governance mechanisms. …