Influence of managerial ownership and compensation structure on establishment mode choice: the moderating role of host country political risk.
| Verfasser | Datta, Deepak K. |
| Posten | RESEARCH ARTICLE |
Abstract Our study draws on arguments advanced in behavioral decision theory to examine the effects of managerial equity ownership and compensation structures on establishment mode choice (the choice between greenfield start-ups and cross-border acquisitions). It is based on a sample of 396 establishment mode choice decisions comprising of 291 cross-border acquisitions and 105 greenfield start-ups by non-diversified US manufacturing firms. Findings indicate that both managerial equity ownership and the proportion of contingent pay in key managers' compensation structures are associated with the preference for cross-border acquisitions over greenfield ventures. Our analysis also indicates that there is a greater propensity on the part of managers with significant equity ownership to select acquisitions when entry involves host countries characterized by high political risk.
Keywords Establishment mode * Governance quality * Political risk * Compensation structure * Equity ownership
1 Introduction
The selection of entry modes by firms seeking to enter foreign markets typically follows a "hierarchical" pattern (Kumar and Subramanian 1997; Pan and Tse 2000). The first step involves a decision on whether to pursue an equity or a non-equity mode of entry. Firms opting for an equity mode then decide between a shared ownership mode (e.g., a joint venture) and a wholly-owned subsidiary (WOS). If they opt for the latter, they have the option of choosing either a greenfield start-up or a cross-border acquisition. The selection between these two approaches has traditionally been referred to as establishment mode choice and has featured quite extensively in the international business literature (Dikova and Brouthers 2009; Slangen 2013; Slangen and Hennart 2007, 2008). Dow and Larimo (2011) highlight the significance of establishment mode choice identifying it as "arguably one of the more critical international business decisions ... one that can have a substantial impact on the overall performance of the foreign investment" (p. 322). While both establishment mode options entail full ownership and control, they are fundamentally different. A cross-border acquisition involves the purchase of a going concern in the foreign country, with much of the resources and knowledge (e.g., local market knowledge) needed to compete in the host country coming from the acquired firm. In contrast, a greenfield venture entails the creation of a new organization from scratch in the host country with initial investments being followed by subsequent build-up of resources with the foreign firm buying or contracting for such resources from local sources (Slangen and Hennart 2008).
Reviews of the empirical literature on establishment mode choice (Dikova and Brouthers 2009; Slangen and Hennart 2007) reveal that most studies are grounded in either transaction cost theory (the dominant theoretical perspective in the study of establishment mode choice) or the knowledge-based view of the firm. They also highlight that while the influence of corporate governance on strategic choice has been studied in international business (e.g., Musteen et al. 2009; Datta et al. 2009; Sanders and Carpenter 1998; Strange et al. 2009), it has not been so in the context of establishment mode choice. In this study, we sought to address this important gap in the literature by exploring how managerial equity ownership and compensation structures influence the choice of establishment modes.
In our study we posit that greenfield ventures and cross-border acquisitions are characterized by differences in outcome uncertainty and payoff horizons and these differences have important implications for managers with significant firm equity ownership and contingent pay based compensation structures. A key difference between our study and much of the literature on establishment mode choice relates to our use of behavioral decision theory (Wiseman and Gomez-Mejia 1998) in arguing for the relationships between equity ownership, compensation structures and choice of establishment mode. Based on prospect theory (e.g., Kahneman and Tversky 1979; Kahneman et al. 1997), the basic premise of behavioral decision theory is that managers are inherently loss-averse which makes them more sensitive to decreases, rather than increases, in their wealth. This loss aversion has important implications for strategic choice since it often results in managers being willing to forgo potential gains when faced with the possibility of losses relative to their current position (Miller and Reuer 1996). In addition to examining how equity ownership and contingent pay influence the choice of establishment mode, we also explore how the hypothesized relationships are contingent on the level of political risk in the host country.
We expect our study to make several contributions to the establishment mode choice literature. It represents, to the best of our knowledge, the first effort at understanding how behavioral and motivational issues related to managerial equity ownership and compensation structures impact establishment mode choice. In addition, study findings should provide important evidence on how such relationships are contingent on the level of host country political risk. Finally, our research contributes by providing a different perspective (grounded in behavioral decision theory) to the examination of establishment mode choice. In doing so we address Slangen and Hennart's (2007) call for incorporating new theoretical perspectives in studying establishment mode decisions towards obtaining a better understanding of the factors that drive such choice.
2 Theory and Research Hypotheses
As mentioned in the previous section, much of the research on establishment mode choice has been anchored in transaction cost economics (TCE) based on the argument that the choice rests on the effective and efficient transfer and use of firm-specific assets in foreign operations. For example, Hennart and Park (1993) and Larimo (2003) use TCE arguments to suggest that while MNEs with limited international experience are likely to favor acquisitions over greenfield ventures, those with greater experience are more likely to favor greenfields. Likewise, TCE tenets have been used to argue that firms which emphasize technology are more likely to prefer greenfields over acquisitions (Cho and Padmanabhan 1995). In addition, scholars (e.g., Cho and Padmanabhan 1995; Larimo 2003) have used TCE arguments to argue that high cultural distance results in firms selecting greenfields over acquisitions since cultural distance hinders the effective transfer of managerial practices to acquired entities.
There are some important differences between greenfield ventures and cross-border acquisitions that have implications for establishment mode choice. For one, they are characterized by different levels of outcome uncertainty. Greenfield startups are generally typified by high levels of outcome uncertainty given the twin liabilities of foreignness (Zaheer 1995) and newness (Slangen and Hennart 2008) that foreign entrant firms face in such ventures. Firms seeking greenfield investments in a foreign country are likely to have limited knowledge and understanding of local institutions and market conditions (customers, suppliers and competitors) at the time of entry, forcing them to expend significant resources to acquire such knowledge on their own (Hennart and Park 1993). Outcome uncertainty in wholly-owned greenfield start-ups is exacerbated by the internal uncertainties associated with the development of new business operations in host countries. According to McVea (2009), the establishment of new ventures in foreign markets represents an entrepreneurial process that is fraught with uncertainty and unpredictable returns. In addition to straining managerial resources, the establishment of greenfield subsidiaries can trigger retaliatory actions by incumbent firms who see capacity additions by foreign entrants as having adverse consequences for profit potential in their industries (Zejan, 1990). In contrast, acquiring firms in cross-border acquisitions benefit significantly from the knowledge of local markets and institutions that acquired firms bring with them (Harzing 2002; Hennart and Park 1993; Shimizu et al. 2004). Also, given that acquired firms already have in place established networks, acquiring firms do not have to expend resources in building networks of suppliers and buyers and also establishing relationships with government agencies soon after entry (Caves 1996). Furthermore, acquisitions entail lower outcome uncertainty given that target firms are "known entities" in host countries, with performance track records that can be carefully evaluated prior to the undertaking of acquisitions (Georgopoulos and Preusse 2009).
In addition to differences in outcome uncertainty, an important difference between greenfield start-ups and acquisitions relates to payoff horizons. Greenfield start-ups require firms to go through the time-consuming and resource intensive process of developing knowledge of local markets, establishing linkages with local stakeholders, and gaining local legitimacy. Given high establishment costs coupled with limited demand for their products in the host markets during the early years of the venture, payoff periods can be long in greenfield start-ups (Carman and Langeard 1980; Caves 1996). Also, given that greenfield investments are more vulnerable to the liabilities of foreignness and newness, there are greater conformity costs that delay the accrual of positive returns from such ventures (Georgopoulos and Preusse 2009). In contrast, the acquisition of a local firm provides immediate access to host country markets with potentially quicker payoffs (Dikova and van Witteloostuijn 2007) since entrant firms do not have to expend the time needed to build relationships with constituents in the host country. In other...
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