Master’s Thesis MSc. Business Administration: Strategic Innovation Management
HOST COUNTRY INSTITUTIONAL
INFLUENCES ON THE GOVERNANCE MODE
DECISION OF INTERNATIONAL STRATEGIC
ALLIANCES
Author: Jos Kraak
Student number: S1919571
E-mail address: joskraak@gmail.com
First supervisor: F. Noseleit
Co-assessor: Dr. K.J. McCarthy
January 20, 2015
Word count: 10,162
Abstract
While both research on governance choices in strategic alliances formation and institutional research are frequently observed in the literature, academics hardly combined the two different research streams. This study aims to increase the understanding of the influence of host country institutional environments on a major strategic decision faced by firms: the governance decision when forming international strategic alliances. The influence of specific host country institutional variables on the number of contract alliances and joint ventures is analyzed while controlling for distance between home and host country and GDP of the host country. The results show that a large government decreases the number of contract alliances while increasing the amount of joint ventures. Surprisingly, protection of property rights does not significantly increase contract alliances, while it does result in less joint ventures. Finally, a fair legal system results in more contract alliances and joint ventures, while foreign investment restriction result in less contract alliances and joint ventures. As a result, this thesis provides a starting point for further empirical research combining the streams of strategic alliance research and institutional theory, aiming to fully understand the governance choice of alliance formation in the future.
Keywords: Strategic alliances, governance mode, alliance formation, institutional environment,
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Introduction
During the last decades, firms increasingly seek to generate benefits by forming international strategic alliances. As a result of increased globalization, rapid changes in competitive environments, constant technological innovations and a different notion of competition (Das & Teng, 2000; Beamish & Delios, 1997; Robson, 2002a), collaborative advantage through strategic alliances is frequently believed to be the key to success (Das & Teng, 2000). Strategic alliances are a mechanism to gain access to desired strategic capabilities (Chen & Chen, 2008), thereby aiming to create a collaborative strategy by combining competition and cooperation (Prahalad & Doz, 1987). Effective alliances can result in growth and profitability in both domestic and global markets (Ernst, Halevy, Monier & Sarrazin, 2001), causing alliances to become an increasingly popular strategy for firms (Dyer, Kale & Singh, 2001). However, as many firms form alliances to pool technological resources and leverage intellectual property, there is a difficult trade-off between promoting technology transfer and learning on the one hand, and controlling intellectual property (Oxley, 1999).
In order to reduce the risks and leverage the benefits of a strategic alliance, choosing the right governance mode (e.g. joint venture or contractual alliance) is crucial (Oxley, 1999). However, according to Oxley (1997), the most efficient mode of governance is not determined by the characteristics of the firms. Rather, variables outside the firm are important. A large part of the variables outside the firms for strategic alliance partners consists of the institutional environment (Park & Ungson, 1997). According to Rondinelli and Behrman (2000), the institutional environment consists of arrangements created by governments that promote and facilitate effective macroeconomic policies, liberalize trade and finance, protect private property rights and privatize the ownership of state enterprises (Rondinelli & Behrman, 2000). These arrangements determine to a large extend the ability of firms to control intellectual property rights, through characteristics of the legislative system and nature of property right protection in a country (Hitt, Ahlstrom, Dacin, Levitas & Svobodina, 2004). Thereby, for organizations seeking to form a strategic alliance with a foreign partner, institutional arrangements might create entry barriers or risks, which can be reduced by selecting the most appropriate governance mode (Hitt et al., 2004). However, although the importance of institutional factors for collaboration between organizations is acknowledged by scholars (Hitt et al., 2004; Oxley 1999), there is still a lack of research in this field (Berchicci & King, 2007). While each field experiences growing interest and popularity and could strongly enrich the other, academics still hardly combine the streams of international strategic alliances and institutional theory (Parkhe, 2003). The result is a lack of understanding of the influence of institutions on the governance mode decision of international strategic alliances
3 integration and provide a starting point for new research on this topic. By taking a traditional transaction costs economics approach, this paper evaluates the influence of institutions on the choice of governance forms in international strategic alliances and increases the understanding of the influence of institutional environments on the governance choice of international strategic alliances.
While a large part of the existing literature on strategic alliances and joint ventures focused on alliances between firms from two countries or grouped firms into cultural or financial regions such as developed or emerging countries (Nielsen, 2003), the scope of this thesis is relatively wide, as the combination of institutions and alliances is relatively unexplored. This wide scope enables one to get an overview of the field and focus on parts of this field once the field matures due to more empirical research over time. The wide scope is reached through the focus on country level alliance data instead of firm level, the inclusion of a large number of both emerging and developed countries, and using institutional data from the Economic Freedom of the World (EFW) index. To further improve generalizability, a multi-industry approach will be adopted, which helps to avoid results that are biased by focusing on a specific industry. Moreover, this thesis does not focus on alliances with a specific purpose. Rather, the purpose of the alliances ranges from marketing and R&D to technical alliances. The central question throughout this thesis is:
What is the impact of the host country institutional environment on the governance mode decision of international strategic alliances?
This question will be answered by studying the effect of multiple institutional variables on both contract alliances and joint ventures. The remainder of this paper consists of a literature review containing the most relevant theories of the two literature streams that will be combined (strategic alliance literature and institutional literature), resulting in hypotheses and a conceptual framework. The research approach, applied methods and regression analysis will be explained in the methodology section. After a discussion of the results, the limitations of this paper and suggestions for future research will be indicated. Finally, concluding remarks will be provided.
Literature review
This section will outline the relevant theoretical concepts and prior research outcomes by describing theories about strategic alliance formation and institutional environments. Furthermore, the relation between the theories and data will be hypothesized.
Strategic alliances
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understanding strategic alliances is to define the concept. Several authors have defined strategic alliances with definitions ranging from simple to more specific, of which two are highlighted in this thesis to aid understanding of the concept. Pansiri (2009, p.144) defines strategic alliances as “purposive arrangements between two or more independent organizations that form part of, and is
consistent with participants’ overall strategy, and contribute to the achievement of their strategically significant objectives that are mutually beneficial”. Gulati and Singh (1998, p.781) proposed a more
simple definition: “any voluntary initiated cooperative agreement between firms that involves
exchange, sharing, or co-development, and it can include contributions by partners of capital, technology, or firm-specific assets”. As one definition is fairly simply and the other is quite broad, the
definitions are combined to reach the following definition that will be used to define strategic alliances throughout this thesis: voluntary initiated cooperative agreements between firms that involve
exchange, sharing, or co-development (of capital, technology or firm-specific assets) in order to achieve strategic goals or objectives.
Firms may enter into strategic alliances for a variety of reasons, such as access to complementary resources (Eisenhardt & Schoonhoven, 1996), capabilities, knowledge, or to share risks and costs (Hagedoorn, 1993), reaching economies of scale, reducing competition, learning, facilitating international expansion and conforming to government policies (Glaister & Buckley, 1996). However, despite these clear motives for forming an alliance, several studies show that roughly half of all alliances fail (Kogut, 1989; Bleeke & Ernst, 1993; Porter, 1987; Parkhe, 1993). In order to reduce the risk of failure, companies need to effectively control and govern strategic alliances. To do so effectively, companies can choose between different governance modes, which is often explained using the Transaction Costs theory.
Transaction Costs Economics
The aim of reducing transaction costs is the most cited motive for alliance formation in the alliance literature (Dias & Magrico, 2011). Therefore, the traditional and dominant view for explaining strategic alliances behavior (Das & Teng, 2000), which will be the focus of this paper, is the Transaction Cost Economics theory (TCE) by Williamson (1975). This theory explains why firms partner with other organizations, arguing that transaction costs concerns are more important for firms than the goal of the alliance itself when the appropriate mode of organization is to be determined. From a transaction costs economics (TCE) perspective, firms’ only form alliances when sourcing one or more intermediate products provides benefits and when there are significant barriers for a merger (Buckley & Casson, 1988). Furthermore, firms only establish strategic alliances when the expected additional benefits from the alliance outweigh the expected extra costs (Geringer, 1991). In order to maximize potential benefits, reduce potential risks and to accomplish strategic objectives, selecting and retaining the right partner is essential (Buckley & Casson 1988; Hamel, 1991).
5 costs refer to the costs that are incurred from the necessary activities for an exchange between organizations, such as negotiating, writing and enforcing a contract, while production costs refer to costs that are incurred from in-house activities such as learning, organizing and managing production (Das & Teng, 2000). In order to minimize transaction costs, strategic alliances are an alternative to internalization on the one hand and market exchange on the other (Das & Teng, 2000), often referred to as the make (internalization)-or-buy (market exchange) decision. Thus, for each product or service that is required a firm may: (1) produce it on its own, in-house; (2) purchase it from the market; or (3) make it together with other firms. From a TCE perspective, the choice to collaborate rather than to make or buy from the market results from the argument that the total sum of production and transaction costs is lower for collaboration. In other words: collaboration is more efficient for the government of economic activities than making or buying (Chen & Chen, 2003).
An important concept in TCE for this collaboration dilemma is asset specificity, which refers to the investments needed for this specific transaction and the extent to which assets can be redeployed to alternative uses. According to Williamson (1981), the amount of the investment, although important, is less important than whether the investments are specialized for a specific transaction. There are three types of asset specificity: site specificity (location), physical asset specificity (physical components), and human asset specificity (human capital) (Williamson, 1981). When investments are unspecialized for a specific transaction and thus asset specificity is low, buyers can turn to alternative sources and suppliers can sell the output to other buyers without great difficulty. If asset specificity is high, however, investments might be (partially) lost if the buyer-supplier relationship is distorted or terminated. This explains why asset specificity is an important concept in TCE; once an investment is made, buyer and supplier are ‘locked into’ the transaction. As a result, buyer and supplier are likely to make extra efforts to make sure that the exchange continues over time (Williamson, 1981).
Other factors influencing transaction costs are the frequency of the transaction, uncertainty and coordination costs; more frequent transactions are likely to be performed by the firm itself if there is a high degree of uncertainty, since organizations are unsure whether organizational actors will behave in the way that is most beneficial to the organization, whereas coordination costs are costs incurred because of coordination of tasks between organizations (Gulati & Singh, 1998). As uncertainty is greater, firms would like to have more control over the transaction and are likely to opt for a more hierarchical governance mode (Kogut, 1988), as transaction costs increase with higher uncertainty. The same holds for coordination costs: higher coordination costs result in higher transaction costs. In the case of high transaction costs, firms are more likely to integrate activities (make), whereas lower transaction costs make a market transaction favorable (buy) (Williamson, 1991).
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this strategic alliance category, the logic of TCE and the make-or-buy decision can be extended to the decision of the governance structure in an alliance. High transaction costs in strategic alliances lead to concerns about whether the firm is able to capture a fair share of the rents from its alliances, termed appropriation of rents. According to Gulati and Singh (1998) appropriation of rents are due to uncertainties about future specifications, costs, and partners’ contributions. According to Teece (1986) and Oxley (1997), these appropriability concerns originate from behavioral uncertainty, combined with the difficulties of specifying intellectual property rights and difficulties of drawing, signing and enforcing contracts.
Theorists agree that in alliances, greater potential concerns about asset specificity, coordination costs, appropriability and behavioral uncertainty lead to a more hierarchical governance mode of the alliance (Gulati & Singh, 1998; Oxley, 1997; Pisano, 1989). This is due to the additional possibilities for incentive alignment of a more hierarchical governance mode (Alchian & Demsetz, 1972; Demsetz, 1988; Klein, Crawford & Alchian, 1978). Furthermore, a more hierarchical governance mode can address appropriation concerns by controlling agency problems through control mechanisms like monitoring and incentive alignment (Williamson, 1975, 1985). This hierarchical governance mode is a joint venture; an alliance involving equity whereby partners create a new legal entity and share equity and a portion of their resources within that common legal entity (Kogut, 1988) or where one of the partners takes an equity interest in the other partner. Joint ventures are considered to be more hierarchical than contract alliances (Hennart, 1988; Pisano, 1989; Pisano, Russo & Teece, 1988; Teece, 1992), since the shared equity functions as a ‘mutual hostage’ and prevents contracts from being written, align the interests of partners. Furthermore, the separate legal entity and management structure of a joint venture allows for incentives, which reduce agency problems.
7 Table 1: Transaction Costs Economics ownership decision (adapted from Das & Teng, 2000)
Transaction Costs Rationale Logic behind the Ownership
Decision
“Minimizing the sum of production and transaction costs” (Kogut, 1988: p. 320)
Mergers/Acquisitions/Internal Development
High transaction costs (i.e., high asset specificity, uncertainty, and frequency of the transactions, and high costs for controlling opportunistic behavior) and/or low production costs (i.e., coordinating
and learning) (Kogut, 1988) Market Transactions Low transaction costs and/or high
production costs
Strategic Alliances Medium transaction and production costs, i.e., “when the
transaction costs associated with an exchange are intermediate and not high enough to justify vertical integration ...” (Gulati, 1995: p. 87)
“JVs are formed when transactional hazards suggest that internalization is efficient ... , but constraints of various kinds prohibit full internalization …” (Ramanathan et al., 1997: p. 57) “The situational characteristics best suited for a joint venture
[rather than a contract] are high uncertainty over specifying and monitoring performance, in addition to a high degree of asset specificity.” (Kogut, 1988: p. 320).
Transaction costs and consequently, the governance mode decision are influenced to a large extent by the institutional environment of firms. Thus, in order to completely understand the transaction costs rationale and strategic alliances, one needs to take into account the influence of the institutional environment on the governance mode decision (Oxley, 1997).
Institutional environment
According to Davis and North (1971), the institutional environment of firms consists of the fundamental political, social and legal rules that form the basis for production, exchange and distribution in a country. According to Makhija and Stewart (2002), the institutional environment is formally defined by constitutions, statute laws, common law, regulations, or contracts between individuals, or formally developed over time and reflected in cultural practices, customs, and traditions. A more concise definition by North (1986) that is adopted in this thesis is that the institutional environment defines the institutional rules of the game with differences in customs, laws and politics. These differences in the international arena can play a large role in governance choices in inter-firm alliances. Relevant features of these customs, laws and politics for strategic alliance governance mode decisions may include “intellectual property protection …, government regulation
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The relationship between the institutional factors and the resulting governance decision in international strategic alliances can be illustrated using the shift parameter framework (Williamson, 1991), which extends the transaction cost model. The shift parameter framework states that the underlying logic about governance decisions in strategic alliance does not differ across countries. Rather, differences in governance modes are affected by differences in institutional environments across countries. A visual representation of the shift parameter logic can be found in figure 1, where a relatively weaker institutional environment, resulting in appropriability hazards affects the choice between contract-based and equity alliances. Thus, if property protection becomes weaker, the relative governance costs of contractual alliances increase and firms are more likely to opt for an equity joint venture (Oxley, 1999).
Figure 1: The shift parameter framework (Oxley, 1999)
Hypotheses
9 Size of government
A substantial part of the institutional environment is consists of the size of a country’s government. Unfortunately, there is little empirical literature on the influence of government size on the governance mode of strategic alliances. However, there is literature available on the more general influence of the size of the government on economic growth. According to Berggren (2003), economic growth and prosperity can be influenced positively or negatively by the size of a country’s government, which represents the extent to which the government intervenes in the economy through consumption, redistribution through transfer schemes, public investments, and marginal taxation. According to Berggren (2003), a relatively large size of the public sector as compared to GDP results in negative effects on economic growth. To aid economic growth, governments must do a number of things while refraining from doing others: governments should enable legal institutions that protect property rights of owners, enforce contracts and provide access to sound money, while refraining from interfering with voluntary exchange between individuals and organizations, limiting access to labor, capital and product markets (Gwartney, Holcombe & Lawson, 2006). A larger government implies higher taxes (AmirKhalkhali & Dar, 2002), resulting in greater risks for strategic alliances in general and appropriation concerns, because a larger share of turnover has to be transferred to the government as taxes. Thus, it is hypothesized that a large government is likely to result in greater risks and appropriation concerns for strategic alliances, resulting in the following hypothesis.
Hypothesis 1a: A large government in host countries has a negative effect on the number of contract alliances.
Hypothesis 1b: A large government in host countries has a positive effect on the number of joint ventures.
Protection of property rights
A part of the institutional environment that is analyzed before with regard to the governance of strategic alliances is the protection of property rights. Protection of property rights refers to the extent to which property rights are secure over time (North, 1990). According to Teece (1986), leakage of valuable intellectual property is a major potential appropriability hazard which has to be prevented. When property rights are weak and poorly protected, organizations will be reluctant to risk capital and time, as their returns might be appropriated by others (Gwartney et al., 2006). According to Furubotn and Pejovich (1975, p. 4) property rights consist of three elements: “the right to use the asset …, the right to appropriate returns from the asset …, and the right to change the asset's form and/or substance".
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Europe (Kondo, 1994), and other countries (e.g. India) where companies are obliged to license their patents to local firms. Furthermore, while most countries grant the patent to the first company that applies, other countries (e.g. the United States) grant the patent to the company that is ‘first to invent’. According to Oxley (1997), enforcement issues and cross-national differences in protection of intellectual property rights and other aspects of the institutional environment on the choice of governance form in alliances between firms in different countries should be examined in future alliance research.
In this thesis, the focus will be on the question whether property rights in countries provide companies with adequate protection against expropriation by rivals, suppliers or customers (Williamson, 1991). Well-defined and ensured property rights reduce contracting costs, appropriation concerns and thus transaction costs (Teece, 1986; Oxley, 1997). As high transaction costs result in more risks associated with forming strategic alliances (Pisano, 1989; Oxley, 1997), companies are likely to use integration in order to overcome the appropriability hazard they cannot adequately and lawfully protect investments in knowledge and technology, or if patents are ineffective (Teece, 1986). Thus, if appropriability is weak, organizations might prefer a more hierarchical alliance (Oxley, 1997; Willliamson, 1991). As a result, countries with weak protection of property rights are likely to have a higher number of joint ventures and less contract alliances, since joint ventures prevent contracts that ensure protection of contract from being written (Oxley, 1997). Countries with strong property rights protection on the other hand, are likely to have a higher number of contract alliances and a lower number of joint ventures, as appropriability risks are reduced.
Hypothesis 2a: Adequate protection of property rights in host countries has a positive effect on the number of contract alliances.
Hypothesis 2b: Adequate protection of property rights in host countries has a negative effect on the number of joint ventures.
Legal system
Comparable to adequate protection of property rights, a well-developed, solid and fair legal system reduces uncertainty and appropriation risks (Oxley, 1997). Therefore, the quality of the legal system is another important institutional aspect in this thesis.
11 associated with forming strategic alliances, countries with a fair and highly integer legal system are likely to have more contract alliances and less joint ventures.
Hypothesis 3a: A fair and integer legal system in host countries has a positive effect on the number of contract alliances.
Hypothesis 3b: A fair and integer legal system in host countries has a negative effect on the number of joint ventures.
Foreign ownership or investment restrictions
According to Oxley (1999), government regulations on foreign investment follow the shift parameter logic. Following that logic, a host country that restricts foreign ownership or foreign investments, would have a higher number of joint ventures; foreign investment restrictions increase risks, which could be reduced or shared by forming a joint venture. However, forming a joint venture requires shared equity and thus investment or ownership, which is restricted or forbidden by the foreign ownership or investment restrictions. Contract alliances, on the other hand, do not require shared ownership and might not be restricted or relatively less restricted by the ownership or investment restrictions. Furthermore, as contract alliances might require no or little investment as compared to joint ventures, the restrictions on foreign investments might not apply to or have less effect on contract alliances due to the smaller size of the investment.
Since starting a joint venture in the host country might not be possible or less attractive, the hypothesized relationship for joint ventures is negative. Forming a contractual alliance on the other hand, could be one of few options that are available due to the restrictions. As a result, the hypothesized effect of foreign ownership or investment restrictions in host countries on contract alliances is positive.
Hypothesis 4a: Foreign ownership/investment restrictions in host countries have a positive effect on the number of contract alliances.
12 Independent variables Control variables: Size of government Protection of property rights
Integrity of the legal system Foreign ownership / investment restrictions Number of contract alliances Number of joint ventures Host country GDP Distance between countries
Figure 2: Conceptual model
Methodology
Although the field of institutional influences on governance forms in alliance is immature, theory allows for a number of propositions. Therefore a theory testing approach is adopted in this paper, with the goal of testing hypotheses using quantitative data from two different data sources. By means of statistical analyses, the impact of the institutional variables on the number of contract alliances and joint ventures is examined, controlled by two control variables. In this methodology section, the formation of the data set and the final set of institutional variables are discussed in more detail. Data and sample
Data from two different sources is utilized in this thesis. First, data about the number of alliances between country pairs during each year was derived from a dataset which was compiled in a previous study of international strategic alliances by Florian Noseleit. This comprehensive dataset consists of year-country pair combinations of strategic alliances in multiple industries, allowing for high generalizability. Furthermore, the dataset contains the Gross Domestic Product (GDP) of both the host countries and distance between the two most populated cities in the home and host country, which serve as control variables. Next to the data about the number of contract alliances and joint ventures, data about the institutions of the country pairs had to be obtained from a different source. This data was derived from the Economic Freedom of the World (EFW) index constructed by Gwartney, Lawson and Hall (2014), which consists of a large number of factors which measure the degree to which policies and institutions of countries are supportive of economic freedom. The following section describes how the final sample is formed.
13 joint ventures contains data of the years 1990 until 2011. However, the EFW index dataset only contains complete data between 2000 and 2012. As a result, conclusions in this thesis are drawn from a sample of strategic alliances and institutional influences between 2000 and 2011. For these years, the strategic alliances dataset contained 176 unique countries of the continents Asia, Africa, North America, South America, Europe and Australia, resulting in approximately 220,000 combinations of country pairs and years. However, a number of host countries that were present in the first dataset were not present in the second dataset and vice versa, resulting in a reduction of cases to approximately 145,000. However, of these country pairs, most did not form any strategic alliances in the majority of years. After matching the data using Stata, the final dataset consists of a total number of 1,568 strategic alliances. As according to the TCE view, the alliance governance form is decided in order to mitigate risks of starting new activities in the host country, the unit of analysis is the institutional environment and the number of contract alliances and joint ventures of the host country. Dependent variables
In order to test the influence of institutional factors on the governance decision of both contract alliances and joint ventures, two different models are tested. The dependent variable of the first model is the number of contract alliances in the host country, whereas in the second model, the dependent variable is the number of joint ventures in the host country.
Independent variables
The original aim of this paper was to include a large number of factors that determine the legal environment in the host country, as the legal system plays an important role in TCE and determining appropriation risks. However, several of the legal variables (Judicial independence, Impartial courts,
Legal enforcement of contracts) in the EFW index were highly correlated with Protection of property rights (correlations above 0.7). Furthermore, data for the variable Judicial independence data was not
complete for a large number of countries, and Legal enforcement of contracts was not included in the dataset until 2002.
Since Protection of property rights is mentioned in the literature as an important determinant of alliance activity, an important factor for the governance mode decision in TCE and often cited issue for appropriation (Oxley, 1997; Teece 1986; Pisano, 1989), dropping that variable or combining it with other legal variables would not be in the best interest of this thesis. Therefore, using the summary rating of Legal System (consisting of Judicial independence, Impartial courts, Protection of property
rights Military interference in rule of law and politics, Integrity of the legal system, Legal enforcement of contracts, Regulatory restrictions on the sale of real property, Reliability of police and Business costs of crime) was not appropriate. Rather, Protection of property rights remained as a
separate variable in the analysis, while Judicial independence, Impartial courts and Legal enforcement
of contracts were dropped from the regression analysis in order to reduce multicollinearity issues and
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variable with the lowest correlation with Protection of Property rights was kept as a determinant of the overall quality of the legal system. The result is the following final set of independent variables, of which the correlations can be found in Table 3.
The influence on both dependent variables is tested with the same independent variables, which are variables from the EFW index measuring institutional conditions in the host country. Each variable in the EFW index is expressed on a scale of zero to ten. As the dataset measures the rate of economic freedom of countries, the value is relatively close to ten when there is a large degree of economic freedom, whereas a small degree of economic freedom results in a value relatively close to zero. This can be quite contradicting, which will be explained using Size of Government as an example.
Intuitively, one would assume that countries with a high value for Size of Government have a large government, while the opposite is true. As a large government has a negative effect on economic freedom, countries with a large government have a Size of Government value that is closer to zero on a scale of 0-10, while countries with a smaller government have a Size of Government value that is closer to ten on a scale of 0-10. For the sake of completeness and to ensure clarity, the ratings are explained for each independent variable below. Furthermore, the exact calculations and explanations of each variable that is derived from the EFW index can be found in Appendix 1.
Size of Government is calculated based on government consumption (as a percentage of total consumption), transfers and subsidies (as a share of GDP), government enterprises and investment (as a share of total investments in a country) and top marginal tax rate (at lower income thresholds). Each country received a rating ranging from 0-10, with countries with a large government receiving a rating that is relatively close to zero, whereas countries with a small government received a rating that is relatively close to ten.
Protection of property rights is calculated based on the Global Competitiveness Report by the World Economic Forum. Countries with poorly defined and protected property rights received a rating that is relatively close to zero, whereas countries with clearly defined and protected property rights received a rating that is relatively close to ten.
Integrity of the legal system is calculated based on an indicator of the International Country Risk Guide by the PRS Group. The variable assesses the strength and impartiality of the legal system as well as general observance of the law. Countries with a weak and partial legal system and bad observance of the law received a rating that is relatively close to zero, whereas countries with a strong and impartial legal system received a rating that is relatively close to ten.
15 Control variables
In order to make the statistical analysis more reliable, this study controls for the influence of two country level variables that might impact the number of contract alliances and joint ventures. One frequently included control variable in empirical studies of foreign market entry modes to account for country differences that might influence business decisions in general and alliance formation is GDP (Oxley, 1999). Countries with fast growing and large markets have more bargaining power, which could allow them to enforce the governance mode of their preference (Contractor, 1990). As a result, the number of contract alliance and joint ventures could be altered by GDP. To control for that influence on the type of alliance, GDP is included as a control variable.
Furthermore, the type of cooperation might be influenced by the distance between home and host country. According to Walt (1985), alliance partners that are closer to each other are more likely to form alliances. Furthermore, when forming a strategic alliance with partners that are in relatively short distance, perceived risks could be lower, this could influence the governance decision in a way that makes contract alliances more likely. To control for this effect that is outside the institutional effects, the distance between the two most populated cities in home and host country is the second control variable.
Statistical analysis
In order to test the hypotheses, calculations were performed using Stata. To select the most appropriate statistical analysis, a number of characteristics of the data are important. First, the number of contract alliances and joint ventures in each country and year in this study are count data. Second, the data is panel data, since the data consists of different levels of analysis, which are year and host country. Third, the mean largely differs from the variance. Taking into account the aforementioned characteristics of the data, negative binomial regression is the most appropriate statistical analysis. The results of the negative binomial regression are utilized to determine whether the proposed hypotheses are supported.
Results
Table 2 provides the descriptive statistics for the dependent, independent and control variables that are included in the analyses. A correlation matrix of the final independent variables of the analyses can be found in Table 3.
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Table 2: Descriptive statistics of dependent, independent and control variables
N Mean SD Min Max
Dependent variables
Contract alliances 220320 0.119 0.292 0 53 Joint ventures 220320 0.001 0.048 0 5
Independent variables
Size of Government 168607 6.345 1.371 2.288 9.934 Protection of Property rights 154002 5.673 1.985 0.906 9.608 Integrity of the legal system 158661 6.671 2.221 0.000 10.000 Foreign ownership/investment restrictions 153179 6.750 1.439 2.486 10.000
Control variables
Host country GDP (x1,000,000 US $) 209385 284,000 1,100,000 251 11,700,000 Distance (most populated cities in km) 220320 7598.516 4535.737 59.617 19812.040
Table 3: Correlation matrix Size of govern-ment Protection of property rights Integrity of the legal system Foreign ownership/i nvestment restrictions Host country GDP Distance (most populated cities in km) Size of government 1
Protection of property rights -0.270 1
Integrity of the legal system -0.439 0.684 1
Foreign ownership/investment restrictions -0.032 0.465 0.139 1
Host country GDP -0.050 0.232 0.170 0.069 1
Distance (most populated cities in km) 0.200 -0.076 -0.166 0.027 0.030 1
Table 4: Negative Binomial Regression Results Model 1 (Contract alliances) Model 2 (Joint ventures) Control variables Host country GDP 0.000000000000454*** (0.0000000000000238) 0.000000000000323*** (0.0000000000000239) Distance (most populated cities in km) -0.0000356***
(.00000712) -0.0000773*** (0.000169) Institutional variables Size of government 0.052** (0.025) -2.202*** (0.052) Protection of property rights 0.032
(0.027)
-0.114** (0.057) Integrity of the legal system 0.312***
(0.027)
0.186*** (0.599) Foreign ownership/investment restrictions 0.311***
(0.281) 0.781*** (0.647) -2 log likelihood 7328.42*** 277.07*** Pseudo R2 0.11 0.14
Standard errors in parentheses.
17 Hypothesis 1(a) states that a large government in host countries has a negative effect on the number of contract alliances, and a positive effect on the number of joint ventures (H1b). As explained in the methods section, the results have to be interpreted with caution. Because the variable Size of
government expresses a grade for economic freedom, it is higher for relatively small governments,
while it is lower for relatively large governments. In other words: an increase in the variable Size of
government essentially means a decrease in the actual size of a government. The coefficient for Size of government in model 1 is positive and significant (p<0.05), thus an increase in Size of government
results in an increase in the number of contract alliances. As this has to be interpreted the other way around, hypothesis 1a can be confirmed: a larger host country size of government results in a smaller number of contract alliances. In model 2, with joint ventures as the dependent variable, the coefficient is negative and significant. Thus, a decrease in the variable Size of government results in more joint ventures. As the value of Size of government has to be interpreted the other way around, an increase in the absolute size of a government result in an increase of the number of joint ventures: hypothesis 1b is supported as well. It is interesting to note that the relationship between Size of government is stronger for joint ventures than for contract alliances (0.521 and -0.202, respectively), which will be discussed in more detail in the discussion section.
Hypothesis 2(a) states that adequate protection of property rights in host countries has a positive effect on the number of alliances, and a negative effect on the number of joint ventures (H2b). The interpretation of the results concerning this variable is more straightforward than hypothesis 1: an increase in Protection of property rights means an increase in the actual protection of property rights. Hypothesis 2a is not supported, as model 1 does not provide evidence for a significant relationship between the Protection of property rights and the number of contract alliances. However, Protection
of property rights does show a significant (p<0.05) negative relationship for the number of joint
ventures in model 2. This implies that an increase in the protection of property rights results in a smaller number of joint ventures, and a decrease in protection of property rights results in a larger number of joint ventures, supporting hypothesis 2b.
Hypothesis 3(a) states that an integer legal system in host countries has a positive effect on the number of contract alliance, and a negative effect on the number of joint ventures (H3b). Hypothesis 3a is supported, as model 1 provides evidence for a significant (p<0.01) and strongly positive relationship between the integrity of the host country legal system and the number of contract alliances. Hypothesis 3b is not supported, since model 2 provides evidence for a significant (p<0.01) and positive relationship between the Integrity of the legal system and the number of joint ventures, while hypothesis 3b predicted a negative relationship. The relationship between Integrity of the legal
system is stronger for contract alliances (0.312) than for joint ventures (0.186), which will be discussed
in more detail in the discussion section.
18
of joint ventures (H4b). Like the results for the size of host country government, the results of the independent variable Foreign ownership/investment restrictions have to be interpreted with caution. Since the variable expresses a grade for economic freedom, it is higher for countries with few or low restrictions, while it is lower for countries with many or large restrictions on foreign investment or ownership. In other words, an increase in the variable Foreign ownership/investment restrictions essentially means a decrease in actual foreign ownership or investment restrictions imposed by a host country. The coefficient for Foreign ownership/investment restrictions in model 1 is positive and significant (p<0.01), which implies that an increase results in a higher number of contract alliances. As this has to be interpreted the other way around, hypothesis 4a is not supported: an increase in actual ownership or investment restrictions results in a decrease of the number of contract alliances. With joint ventures as the dependent variable in model 2, the coefficient is strongly positive and significant (p<0.01). Thus, an increase in the variable Foreign ownership/investment restrictions results in an increase in the number of joint ventures. As the value of Foreign ownership/restrictions has to be interpreted the other way around, an increase in actual restrictions results in a decrease in the number of joint ventures. Thus, hypothesis 4b is supported. It is interesting to note the difference in the strength of the relationship for contract alliances (0.311) and joint ventures (0.781), which will be discussed in more detail in the discussion section.
Discussion
The most relevant theoretical and managerial implications of the results of the analysis will be discussed in this section. For a clear overview of the results, a summary of the support for the hypothesis is provided in Table 5.
Table 5: Overview of supported hypotheses
Hypotheses Support
1a: A large government influences number of contract alliances negatively Yes 1b: A large government influences number of joint ventures positively Yes 2a: Adequate protection of property rights influences number of contract alliances positively No 2b: Adequate protection of property rights influences number of joint ventures negatively Yes 3a: Fair and integer legal system influences number of contract alliances positively Yes 3b: Fair and integer legal system influences number of joint ventures negatively No 4a: Foreign ownership/investment restrictions influences number of contract alliances positively No 4b: Foreign ownership/investment restrictions influences number of joint ventures negatively Yes
19 relatively less important for contract alliances than for joint ventures. However, one would expect it to be the other way around, being relatively more important for contract alliances, since they are more vulnerable for risks than joint ventures. A possible explanation for this difference could be that contract alliances do not form a separate legal entity in the host country, while joint ventures do. As a result, contract alliances might experience less disadvantages that come with the larger government, such as higher taxes and slower economic growth (AmirKhalkhali & Dar, 2002). Furthermore, theorists are uncertain of the direction of the impact of the size of government on economic growth, since arguments exists for both positive (e.g. legal infrastructure) and negative impacts (e.g. taxes), according to AmirKhalkhali and Dar (2002). As the influence of the size of government is disagreed upon, the influence of the host country size of government might have an inverted u-shape, resulting in a positive effect on contract alliances and joint ventures until up to a certain point where the government becomes too large and exerts a negative influence.
Theory stresses adequate protection of property rights as important for international strategic alliances and reduction of risks and transaction costs (Teece, 1986; Oxley, 1997), with strong property protection resulting in more contract alliances and weak property protection resulting in more joint ventures (Pisano, 1989; Oxley, 1999). Nonetheless, the insignificant result of our model for contract alliances does not support this theory. However, according to Chen and Chen (2003), R&D alliances often pool and integrate their assets into a joint venture rather than a contractual alliance, as protection of intellectual property rights in R&D alliances is of critical importance. As a result of joint ventures being the preferred governance mode for alliances in which intellectual property protection is most important, contract alliances might consider intellectual property protection as less important than joint ventures.
The analysis shows that an integer legal system has a positive effect on both the number of contract alliances and joint ventures. Thus, the total number of strategic alliances in the host country increases. One could imagine that the risks associated with joint ventures are lower than when forming a contract alliance (Oxley 1999), which might explain the difference in strengths of the relationship between a solid legal system and contract alliances (0.312) as compared to joint ventures (0.186). A solid legal system in the host country could make organizations more willing to perform any business activity in that country, due to low risks associated with the country. The reduced risks might be beneficial for both contract alliances and joint ventures, regardless of the difference in risks associated with the respective governance forms. Furthermore, organizations might choose for a joint venture for reasons other than reducing risks, such as preferring more control over the alliance partner.
20
higher, since a contract alliance is one of few option left. However, it could be the case that companies refrain from forming an alliance with organizations based in a country with foreign ownership or investment restrictions, since future or further investments in the cooperation might be impossible.
Limitations and suggestions for further research
This thesis might function as a starting point for future research on the influence of institutional environments on the governance choice in international strategic alliance formation. Like any paper, this thesis is bound by limitations, which will be discussed in this section. First, there are limitations concerning available data and matching of data. As described in the methodology section, the EFW data is only complete as of 2000, while the alliance data was complete from 1990-2011. Future research could include a longer period of time, including a larger number of strategic alliances and years with institutional variables. Furthermore, inconsistencies between the countries which are included in both datasets reduced the number of strategic alliances to 1,568, of which only 53 were joint ventures. Moreover, since this study is a master’s thesis to be completed before a set deadline, limited time was available for each phase of the study. Future research that is not bound by a strict deadline could especially devote more time to data collection, data merging, variable selection and data analysis.
A subsequent step in discovering the links between institutions and strategic alliances would be to perform an analysis with more institutional variables or constructs consisting of a number institutional variables. Unfortunately, the EFW dataset that is used for our analysis consists of a large number of variables that are highly related. Due to correlations between independent variables in this research, a number of variables which might be relevant for the governance decision had to be excluded. Combining the EFW dataset with other (new) datasets that contain data about institutional environments could enable a more thorough analysis of the institutional influences.
Furthermore, more research that focuses on the influence of government size on strategic alliances could be helpful in understanding the exact relationship between the two. As noted in the discussion section, the exact influence of the size of government on the economy remains unclear. This thesis suggests a negative effect of a large host country government on the number of contract alliances and a positive influence on the number of joint ventures, with a large difference in the size of the effect. It would be helpful and interesting to study the exact influence of the size of governments on strategic alliances governance, as the influence of governments might change from positive to negative as the size increases, implying an inverted u-shape of the relation.
21 purpose or type of alliance, as previous alliance research showed that R&D alliances, which typically involves high risk (Das & Teng, 2001), are often joint ventures (Oxley, 1999).
Furthermore, extending the link between institutional environments and governance choices in strategic alliances could be done by including alliance performance data in the dataset. It would be highly interesting for both academics and managers to investigate whether strategic alliances partners who choose to cooperate as a joint venture in weak institutional environments display better alliance performance on the long term. In future research, including this alliance performance data could enhance understanding of the influence of institutional environments on alliance performance.
Conclusion
While both research on governance choices when forming international strategic alliances and institutional literature are popular among academics, the two literature streams developed in relative isolation. This study linked host country institutional influences to the number of contract alliances and joint ventures, attempting to answer the central question: What is the impact of the host country
institutional environment on the governance mode decision of international strategic alliances? The
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