Ownership increase in international joint ventures: the within- and across-country flexibility perspective.
Verfasser | Song, Sangcheol |
Posten | RESEARCH ARTICLE |
Abstract We employ the real options perspective to examine how multinational corporations (MNCs) increase ownership levels in their international joint ventures (IJVs) to exploit (or utilize) both within- and across-country flexibility. This paper utilize a rich dataset of South Korean firms' foreign affiliates to test hypotheses derived from the real options theory. It examines the roles of growth options that require small equity stakes under uncertainty as well as switching options that require controlling equity stakes to coordinate switching implementation. Specifically, we examine how the ownership of jointly-owned foreign subsidiaries changes under the influence of changing labor cost uncertainty. We utilize a two-stage model to address the sample selection bias associated with a subsidiary's choice of joint venture under the influence of high labor cost uncertainty. In the first stage, we run a probit model with a dummy variable for JVs and wholly-owned subsidiaries (WOSs) (1: JV, 0: WOS) as the dependent variable. In the second stage, we run a panel logistic regression model (STATA command, "xtlogit"). We found that MNCs engaged in greenfield IJVs increase their initial ownership when labor cost uncertainty within their host countries is favorably resolved. We also found that MNCs' tendency to increase their IJV ownership intensifies when their subsidiary networks are exposed to negatively correlated labor cost growth rates across countries. Taking within and across country flexibility perspective, this study adds new insights on MNC ownership changes, especially in IJVs. Based upon our findings, we conclude that MNCs make flexible ownership adjustments for their foreign subsidiaries in response to different uncertainty conditions within and across countries.
Keywords Ownership increase * IJVs * Flexibility * Labor cost uncertainty
1 Introduction
The real options theory posits that, under conditions of high uncertainty, firms benefit from strategic investments in real assets that permit them to "keep their options open" (Adner and Levinthal 2004a, b; Bowman and Hurry 1993; Cuypers and Martin 2010; Dixit and Pindyck 1994). The decision-making rights embedded in real options investments enable a firm to respond to environmental uncertainties with more flexibility and thus preserve valuable upside benefits in favorably resolved situations and limit downside risks in unfavorably resolved situations (Chi and McGuire 1996; Dixit and Pindyck 1994; Folta 1998; Kogut 1991; Kumar 2005; Reuer and Leiblein 2000; Tong and Reuer 2007). Foreign direct investment (FDI) also provides options that can safeguard multinational corporations' (MNCs) decision-making rights (Kogut and Kulatilaka 1994; Lee and Makhija 2009a, b; McGrath and Nerkar 2004; Tong and Reuer 2007). These options are important for international business managers because MNCs need a high degree of flexibility to cope with macro-economic uncertainties within and across their host countries (Lee and Chung 2007; Chung et al. 2012; Cuypers and Martin 2010; Kogut and Kulatilaka 1994; Huchzermeier and Cohen 1996; Song et al. 2014). How MNCs retain and realize flexibility under uncertainty determines their performance and longevity (Belderbos and Zou 2009; Fisch and Zschoche 2012; Lee and Song 2012).
Recent research on real options in FDI examines two types of flexibility: within-country and across-country (Chung et al. 2012; Kogut and Kulatilaka 1994; Lee and Chung 2007; Song et al. 2014). Within-country flexibility is enabled through international investments that provide a foothold or platform in a host country with which the firm identifies and exploits growth opportunities and the potential for incremental investment (Chang 1996; Fisch 2008; Kogut 1991; Tong et al. 2008). This corresponds with the growth options in the real options literature. In one relevant study, Tong et al. (2008) studied the value of growth options associated with the international joint ventures (IJVs) of American MNCs. Across-country flexibility is attained by scattering operations across countries, allowing MNCs to transfer resources or relocate production among subsidiaries in various locations as a flexible response to cross-country cost or value differentials (Allen and Pantzalis 1996; Belderbos et al. 2014; Fisch and Zschoche 2011; Huchzermeier and Cohen 1996; Lee and Song 2012; Tang and Tikoo 1999). This corresponds with the switching options in the real options literature. In one relevant study, Chung et al. (2010) examined the switching options embedded in Japanese FDIs in Asian countries during the Asian economic crisis in the late 1990s. Fisch and Zchoche (2011) examined the relocation of employees across European countries using a German FDI dataset.
The inherent difference between these types of flexibility requires different ways of structuring a firm's international investments. In particular, investment sizes and types have been actively studied as a crucial part of MNCs' flexible strategies. From the real options perspective on FDI, determining the appropriate investment size is an important step in gaining flexibility. Small investments are considered to have higher real options value since they provide MNCs with more flexibility to increase or decrease according to environmental changes in their host countries at relatively low costs. IJVs, as entry modes, provide more growth options with respect to acquisition or wholly-owned subsidiaries (WOSs) (Cuypers and Martin 2010; Li and Li 2010; Reuer and Tong 2005; Tong et al. 2008). Literature claims that IJVs serve as platform investments by which MNCs test host markets and gain preferential access to growth opportunities in favorable situations. Further, IJVs can also provide relatively easy and inexpensive exits from host markets in unfavorable situations (Kogut 1991; Kogut and Chang 1996; Kulatilaka and Perotti 1998; Reuer and Tong 2005; Tong and Li 2008).
However, the two flexibility perspectives may offer conflicting explanations of IJVs' real options effects. As discussed, an IJV is a reasonable choice from the within-country flexibility perspective; however, it may not be reasonable from the across-country flexibility perspective because the weak managerial control and governance associated with shared ownership may undermine the MNCs' coordination of jointly-owned subsidiaries across countries. Due to these countervailing effects, an investment that creates flexibility under certain conditions may be costly under others.
Considering these contrasting joint ownership aspects, this paper examines the conditions under which the two flexibility perspectives converge to explain MNCs' real options-based decisions on ownership changes. We focus on ownership changes in each MNC's IJV as their first-time investment in each host country since these investments are platforms for subsequent investment and thus have growth options value (e.g., Cuypers and Martin 2010; Tong et al. 2008). Specifically, we focus on MNCs' increase in ownership of their IJVs since an ownership increase reflects both the actual exercise of the growth options embedded in IJVs and the managerial control and coordination within IJVs. Additionally, to examine the potential within-IJV-heterogeneities that are less examined in prior studies, we compare the difference in the ownership increase in two IJVs investment modes (greenfield vs. acquisition) and two IJV ownership types (minority vs. majority). We also focus on labor costs within and across countries as a key macro-economic factor affecting production costs and product prices. We examine the potentially positive interplay between the two flexibility types by considering both favorably resolved labor cost uncertainty within countries and negatively correlated labor costs across countries as two environmental triggers for MNCs' ownership increase in their IJVs.
For our empirical tests, we used a sample of jointly owned first-time investments made between 1990 and 2009 by 147 publicly traded Korean manufacturing MNCs. Employing a panel data methodology, we found that MNCs increase the ownership levels of their IJVs, specifically, greenfield IJVs with respect to acquired IJVs, when labor cost uncertainty within the host country is resolved favorably and when labor costs across countries are negatively correlated. Thus, the two conditions under which MNCs' IJV ownership increases imply a convergence between the two flexibility perspectives.
2 Theory and Hypotheses
2.1 Within-Country Flexibility Perspective on Ownership Level
Foreign direct investment usually includes growth options within host countries because MNCs are entitled to decision-making rights without obligation, allowing them to increase their involvement flexibly and incrementally according to the changes in the host market's conditions (Kogut and Chang 1996; Kogut and Kulatilaka 1994; Kogut 1991; Tong et al. 2008). Foreign subsidiaries will increase their local commitment to host markets with considerable scope for growth by increasing their investments (Kogut 1991; Kogut and Kulatilaka 1994; Tong et al. 2008). However, foreign subsidiaries will reduce their investments or divest entirely if there is little or no scope for growth in a host market. Firms can thus adapt their strategy to the unique conditions of the host countries and avoid strategic errors by gathering information on the host countries' emerging economic conditions before making further investments.
The within-country growth option perspective endorses IJVs as MNCs' initial choice over WOSs or full acquisitions. The smaller firm outlays during first-time investments provide growth options that allow MNCs to monitor the host country's markets and adjust their initial investments to changing market conditions at relatively low costs. Using IJVs as first-time investments provides on-the-ground sensors of host market conditions that help MNCs test the...
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