Dual-option subsidiaries and exit decisions during times of economic crisis.
| Verfasser | Chung, Chris Changwha |
| Posten | RESEARCH ARTICLE |
Abstract:
* This study examines the dual implications of dual-option subsidiaries on exit decisions during times of economic crisis. Retaining dual-option subsidiaries in crisis-stricken countries means leaving a shadow option open for future growth once a crisis ends. However, MNCs may encounter problems pursuing either option due to challenges in managing dual-option subsidiaries with clashing strategic mandates.
* The equivocal nature of dual-option subsidiaries points to the possibility of another factor playing an important moderating role in exit decisions--subsidiary performance--which has been rarely considered in the MNC real options literature. Our primary argument is that lower subsidiary performance increases the influence of shadow option value embedded in dual-option subsidiaries.
* Analyzing a sample of 703 Korean overseas manufacturing subsidiaries in Asian countries, we find that when profitability falls, subsidiaries with dual options are less likely to be exited than those with single options.
Keywords: Within-country growth * Across-country flexibility * Dual options * Subsidiary exit * Economic crisis
Introduction
Real options theory explains two different types of foreign direct investment (Belderbos and Zou 2009; Kogut and Kulatilaka 1994a). According to a within-country growth option perspective, multinational corporations (MNCs) use foreign subsidiaries to test host country potential and create growth options (Brouthers and Dikova 2010; Fisch 2011; Kogut 1991; Kulatilaka and Perotti 1998; Li and Li 2010; Tong et al. 2008; Xu et al. 2010). According to an across-country flexibility option perspective, MNCs can enhance operational flexibility by shifting value chain activities across multinational networks in response to changing conditions in individual countries (Allen and Pantzalis 1996; Chung et al. 2008; Fisch and Zschoche 2012; Driouchi and Bennett 2011; Lee and Makhija 2009a; Rangan 1998; Tang and Tikoo 1999). Most real options studies focus on either within-country growth-driven or across-country flexibility-driven subsidiaries, and therefore pay insufficient attention to subsidiaries embedded with both options; in this paper we will refer to these as dual-option subsidiaries. We argue that from the MNC top management standpoint, some MNC subsidiaries might not be seen as either within-country growth-driven or across-country flexibility-driven. Potentially a third kind, dual-option subsidiaries might be another type of subsidiary that MNC top management may have in mind in making decisions on the fate of each subsidiary.
The lack of attention to dual-option subsidiaries has resulted in a significant gap in the literature, since the majority of MNC-affiliated subsidiaries operating in two or more countries (including an MNC's home country) have potential to take advantage of both within-country growth and across-country flexibility options (Belderbos and Zou 2007; Chung et al. 2010). For example, Chung et al. (2010) argue that MNC subsidiaries can have both within-country growth and across-country operational flexibility options, with the first based on a host country's economic growth potential and the second emphasizing operational flexibility among affiliated subsidiaries within a multinational network.
In this paper we investigate the implications of dual-option subsidiaries for host country exit decisions. Most real options research has focused on investment initiation decisions (e.g., Brouthers and Dikova 2010; Cuypers and Martin 2010; Li and Li 2010; Tong and Li 2011). The question of whether firms use real options logic when considering reasons for salvaging an investment has received much less attention (Li et al. 2007). Exit decision research is important because many entry decisions can be characterized as mistakes (Vivarelli and Santarelli 2007), resulting in considerable weeding-out activity as firms abandon individual overseas investments (Bartelsman et al. 2005). According to Boddewyn (1979), one of every two foreign subsidiaries added to an MNC network is abandoned. Similar foreign entry-to-foreign exit ratios have been reported by Padmanabhan (1993) for UK MNCs; Barkema et al. (1996) for Dutch MNCs; and Benito (1997) for Norwegian MNCs.
Our study context--economic crisis--helps establish a boundary condition under which one option has greater value over another. During such periods, a dramatic downturn in a local economy can make a location unattractive for MNCs motivated to exploit within-county growth, while at the same time creating a low-cost manufacturing opportunity for MNCs capable of exploiting the operational flexibility embedded in their multinational networks (Chung et al. 2010; Lee and Song 2012). Exit decisions for dual-option subsidiaries are more complex due to their dual implications: Retaining such subsidiaries preserves options for future growth in local markets once a crisis period passes, therefore dual-option subsidiaries are less likely to be exited because of the value associated with a shadow within-country growth option. However, some MNCs find it difficult to pursue either option due to conflicts between the strategic mandates of dual-option subsidiaries. Such conflicts may increase the odds of exiting a dual-option subsidiary.
The equivocal nature of dual-option subsidiaries points to the possibility of another factor playing an important moderating role in exit decisions: Subsidiary performance. The international business literature clearly states that the most important reason for subsidiary exit is unsatisfactory performance (Benito 2005; Rugman 1979), yet subsidiary performance is rarely incorporated into MNC real options research. We therefore compare the likelihood of subsidiary exit changes as a function of performance level between dual- and single-option subsidiaries. A real options approach is most appropriate when other quantifiable benefits are negligible (O'Brien and Folta 2009; Tiwana et al. 2007). When subsidiary performance is strong, the option value of continuing in a host country is negligible because MNCs are unlikely to exit profitable subsidiaries. However, when subsidiary performance is weak and when easily quantifiable benefits of retention are absent, the option value of persistence should become more influential. In this paper we will describe our proposal that the shadow option value embedded in dual-option subsidiaries becomes more influential when subsidiary performance is weak. In other words, when profitability is low, dual-option subsidiaries are less likely to be exited than those pursuing a single option.
Theory and Hypothesis Development
Much of past real options research has focused on MNC flexibility at the corporate level, therefore insufficient attention has been paid to individual subsidiaries compared to aggregate subsidiary operations. Real options researchers have tended to assume that MNC subsidiaries are more or less equal because they belong to the same parent firm, and have therefore treated them as if their individual real options orientations do not affect MNC flexibility (Allen and Pantzalis 1996; Tang and Tikoo 1999). It is only recent that real options researchers have started examining the role of each subsidiary in its contribution to the MNC flexibility (Fisch and Zschoche 2012; Lee and Song 2012). For example, Fisch and Zschoche (2012) examine the impact of MNC subsidiaries' country uncertainties on new subsidiary establishment. Lee and Song (2012) examine an interrelationship among MNC subsidiaries in such way that production increase in a particular subsidiary would be associated with production decrease in another. While these studies look into the role of each MNC subsidiary in the whole MNC subsidiary network, still these studies do not look into the real options orientation of each MNC subsidiary.
Each subsidiary's real options orientation is based on its path-dependent strategic assignment (Kogut and Kulatilaka 1994b; Rangan 1998). MNCs interested in penetrating host country markets make subsidiary localization their priority in order to establish better fits with market preferences (Monteiro et al. 2008; Ozsomer and Gencturk 2003; Roth and Morrison 1990). In comparison, compatibility with other subsidiaries is a priority for MNCs interested in improving coordination within their global production networks (Allen and Pantzalis 1996; Chung et al. 2013; Kogut and Kulatilaka 1994a; Tang and Tikoo 1999). While this strategy might be viewed as cumbersome during normal times (Chung et al. 2008), it can provide significant benefits when a local market collapses. However, among subsidiaries established for within-country growth purposes, host market difficulties increase the odds of being exited (Benito and Welch 1997; Borde et al. 1998; Kogut 1991).
Real options theory is based on the idea that in times of uncertainty, opportunities to wait before making an irreversible decision have value; traditional net present value criteria fail to consider this flexibility benefit (Dixit 1992; Fisch 2011; Li and Li 2010). For an MNC that has established a subsidiary in a host country, uncertainty and sunk costs may give rise to an option value embedded in a delayed decision to exit (Dixit 1989; Chung and Beamish 2005a). If an MNC can delay its exiting decision so as to determine if the benefits of exiting cover the sunk costs of the investment, then the ability to wait has value (Pindyck 1991). The usual subsidiary exit decision threshold therefore increases beyond conventional net present value (Dixit and Pindyck 1994). If the benefit of abandoning a subsidiary exceeds this higher threshold, the subsidiary exit option is immediately exercised; otherwise the MNC is more likely to stay in a local market longer than expected under traditional net present value criteria. Under real options logic, an MNC will be reluctant to exit a local market in an uncertain environment due to...
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