Academic journal article Multinational Business Review

Parent-Affiliate Agency Conflicts and Foreign Entry Mode Choice

Academic journal article Multinational Business Review

Parent-Affiliate Agency Conflicts and Foreign Entry Mode Choice

Article excerpt

ABSTRACT: We theoretically identify two levels of agency conflicts related to foreign direct investment (FDI): within a parent firm and between parent(s) and an affiliated firm. For a sample of 182 firms that announced U.S.-related FDIs in 1995, we examine the effects of agency conflicts on the choice between a wholly owned subsidiary (WOS) and a joint venture (JV), and the relative share ownership of a parent. Firms with higher management ownership, especially the firms that made related FDIs, and firms with higher foreign affiliate monitoring efficiency are more likely to choose a WOS. Differences between U.S. and non-U.S. parents are also examined.

INTRODUCTION

When multinational enterprises (MNEs) enter a foreign country, they can use a joint venture (JV), a wholly owned subsidiary (WOS), a strategic alliance, a licensing agreement, a merger or an acquisition of an existing local firm (Eiteman, Stonehill and Moffett 2001). A JV is different from a WOS in that two or more partners in a JV share the profits according to their relative ownership. Shankar and Zeira (1987) give a more specific description of an international JV (IJV).

An IJV is a separate legal organizational entity representing the partial holdings of two or more parent firms, in which the headquarters of at least one is located outside the country of operation of the joint venture. This entity is subject to the joint control of its parent firms, each of which is economically and legally independent of the other.

Shapiro (1999) lists some benefits and costs of entering a JV. By forming a JV with a local partner, firms can obtain local capital, labor and management, an assured source of raw materials, marketing capabilities, an established distribution network, technology, assistance in government approvals, local currency loans, tax incentives and assurances of imports. They can also reduce nationalistic sentiments. Conversely, some sources of disagreement among JV partners are related to marketing programs, dividend policy, reinvestment of earnings, exports to third countries, sources of materials and components, transfer pricing, management selection and remuneration, and expansion. Profits need to be shared with partners, and technology may be given up.

Previous studies on entry mode choice are diverse but fragmented, calling for a need to recognize the conflicts between organizations, and their effects on inter-organizational transactions. Contracts are a key economic institution, and transaction costs are important as they determine why contracts take their specific forms (Williamson 1985). Transaction costs include the costs of negotiating a contract and the costs of monitoring the performance and enforcing a contract (Erramilli and Rao 1993). Although the costs of detecting and preventing opportunistic behaviors of counterparts are a key factor in the transaction cost economics (TCE) approach, such costs have not been fully recognized by the TCE-based studies of foreign entry mode choice.

This paper is the first attempt at analyzing the agency conflicts within a parent firm and between a parent and its affiliated firm. It empirically examines their association with foreign entry mode choices. The choice of a foreign entry mode is an important corporate decision, and agency theories may help to predict the corporate choice. Managers, as the agents of their shareholders, may not always choose the decisions optimal for their shareholders. A foreign affiliate firm, as the agent of the parent organization, may make sub-optimal decisions from the parent shareholders' point of view (Nohria andGhoshal 1994; O'Donnell 1997). We integrate agency theories related to the creditor-shareholder and parentaffiliate relationships as well as the shareholder-manager relationship, and develop testable hypotheses on management ownership, financial leverage, monitoring efficiency and degree of international experience.

For a sample of 182 U. …

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