Working Papers

The Multinational Corporation’s Degree of Control over Foreign Subsidiaries: An Empirical Test of a Transaction Cost Explanation

Jan 1, 1987

Choice of mode of entry.

Presentation of hypotheses; empirical test.

To determine the conditions that influence the degree of control a multinational corporation will seek over a new foreign subsidiary. The degrees of control studied are (1) sole ownership, (2) majority equity position, (3) equal equity position (partnership), and (4) minority equity position.

Reviews the international economic and management literature and proposes a transaction cost explanation of the degree of control a multinational corporation will exert when it sets up a foreign subsidiary; examines 1,267 foreign market entries made by 180 large U.S. corporations between 1960 and 1974; specifies a multinomial logit model to estimate how features of the subsidiary determine which form of equity involvement is employed; presents management implications.

Academic researchers and international marketing strategists.

Main Findings
Certain propositions suggested by the authors in earlier work are tested. These propositions include:

Modes of entry offering greater control are used for highly proprietary products or processes.

Proprietary knowledge is often difficult to transmit across organizational boundaries. Yet it is very difficult to set a value on such knowledge: The buyer cannot know what it is worth before it is disclosed, but once disclosure occurs, the acquirer need not pay for the knowledge.

It was found that highly proprietary products and processes were more likely to be 100 percent owned. However, if the 100 percent level is ruled out for some reason, proprietary content does not appear to distinguish among different partnership options.

Lower control entry modes are more likely to be used in risky countries.

It is often recommended that a firm operating in an unstable environment avoid ownership, since the commitment that comes with ownership may become inappropriate if an environmental shift occurs. Instead, a firm should retain flexibility and shift risk to outsiders.

In international operations, a major source of instability is country risk. This risk can take many forms, including political instability, economic fluctuations, and currency changes. Some countries, in particular some of the riskier ones, legally bar 100 percent foreign ownership. Even after accounting for this factor, firms tend to avoid 100 percent ownership when entering highly risky countries, while moderate levels of risk seem not to affect entry mode decisions.

The entrant’s degree of control of a foreign business entity should be positively related to the firm’s cumulative international experience.

Newcomers to the international setting are unlikely to know how to manage well. For such firms, control exacts a high price without yielding high benefits. But experienced firms can reap the benefits of control in international markets.

By measuring experience as the number of foreign entries the firm has made to date, it was found that more experienced multinationals are more likely to take a 100 percent equity position. However, experience does not seem to affect decisions about level of equity if less than complete ownership is being considered.

American multinationals take lower control levels when operating in non-anglo cultures.

The difference between home and host cultures (“sociocultural distance”) may explain the higher uncertainty executives perceive in cultures that are truly “foreign” to them. Because they do not understand the values and operating methods of the host country, executives may shy away from the involvement that accompanies ownership.

Entry modes offering higher degrees of control are used in highly advertising-intensive businesses.

When a brand name is valuable, firms will take control to protect their brand name from degradation by free riders or inconsistent usage. It was inferred that in businesses where brands are valuable, multinational corporations protect brand names by assuming control.

The results accord with expectations. Firms in advertising-intensive businesses favored complete ownership over any level of partnership. They also tended to opt for majority positions and shun minority positions.

The larger the scale of the foreign operation, the more likely it is that the MNC will seek partners.

Large foreign entities oblige parent firms to take on considerable risk and to make heavy resource commitments. This in turn encourages MNCs to take on partners to spread the risk and commitment.

Size was measured as the number of employees of the foreign entity. The results, taken together, indicate that MNCs, even large ones, tend to spread risk and resource commitment as projects grow larger.

Researcher Comments
The authors suggest that these results are quite general, explaining:

“The findings should apply to operations in many countries and in diverse industries. It is noteworthy, however, that our data stop at 1975. What is different now? This study uncovers a strong tendency to set up a wholly owned subsidiary–that is, almost a knee-jerk aversion to sharing control and resource commitments.

“We believe this tendency has changed in recent years. Intensifying competition and shortened product life cycles have forced American multinationals to move more quickly and have exacted a higher-than-ever price for mistakes. Added to this has been increasing pressure by host governments to share ownership. In response, firms have become more willing to consider tapping the expertise and resources of partners and piggybacking on a partner’s established successes.

“The U.S. firms’ new willingness to deal with partners (both local and international) is facilitated by the widespread presence of local personnel trained in U.S. business practices. This pool of local personnel versed in foreign practices has been enlarged by the popularity of U.S.-style business school training, as well as by the extensive training programs of firms that have operated internationally for decades. Hence, now more than ever, alternatives to vertical integration are gaining acceptance. Strikingly, this is an area where non-U.S. multinationals are well ahead of American firms. Prior research has noted that the tendency to integrate, so strong in our data, has long been more pronounced among U.S. firms than elsewhere.”

About the Authors
Hubert Gatignon is Assistant Professor at the Wharton School, University of Pennsylvania. Erin Anderson is Assistant Professor at the Wharton School, University of Pennsylvania.

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