Management Control of Joint Ventures: The Role of Contracts

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UNIVERSITY OF GRONINGEN FACULTY OF ECONOMICS AND BUSINESS

Management Control of Joint Ventures:

The Role of Contracts

Master Thesis, MScBA, Organizational & Management Control

20 June 2017

Diogo Miguel Abrantes Louro Santos Robles s2952106

Supervisor: prof. dr. J. van der Meer-Kooistra Co-Assessor: prof. dr. M. P. van der Steen

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Abstract

This study aims at understanding the role of contracts in controlling Joint Ventures(JVs) and more specifically the content of the contracts and the rationale of their content. A theoretical framework is proposed to provide, not only a better understanding of the existing attributes (transactional, relational, and real options) that influence the contract design, but also an understanding of the role of the contracts and relational governance in the management control of JVs. By conducting a case study in an international JV, the findings suggest that contracts have three main functions: safeguarding, coordination, and adaptation. The role of the contracts regards the formation of the JV by establishing the formal operating and governance mechanisms. On the other hand, throughout the course of the operations, these formal mechanisms are put aside and both parties attempt to seek mutual alignment to manage the JV by enhancing coordination and cooperation. Hence, the management control of the JV needs to be based on a complementary dimension between formal contracts and relational governance in order to promote more flexibility and reinforce the relationship between parties in order to reach their common goals, with a certain degree of discipline.

Keywords: Joint Ventures, management control, contracts, relational governance

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1. Introduction

By establishing strategic alliances, which are cooperative arrangements for the longer term, companies become interdependent (Sklavounos, Rotsios & Hajidimitriou, 2015). This implies that they have to deal with partners who may have different aims with respect to the strategic alliance and different knowledge and expertise. To make their collaboration a success the parties must coordinate their contributions to the strategic alliance and share their knowledge and expertise (Kamminga & Van der Meer-Kooistra, 2007). Furthermore, they have to take into consideration the interests of their partners and to focus on the goals of the strategic alliance instead of their private goals. Yet, one of the partners may behave opportunistically and thereby harm the other parties (Reuer & Ariño, 2007). As strategic alliances are long-term arrangements, circumstances may change over time and impact the collaboration. (Kamminga & Van der Meer-Kooistra, 2007). If these influences negatively affect the relationship, the parents must react, possibly by adapting certain control instruments of the strategic alliance.

In strategic alliances, contracts are a central mechanism for governing the interfirm exchange (Lumineau, Eckerd, & Handley, 2015). Although, their importance might be limited to solve conflict situations, that is, parent companies will only consider the contracts when there might occur any problem/conflict throughout the activities of the alliance. In their traditional view, transaction cost economics (TCE), contracts are seen as safeguarding mechanisms of parents’ investments and interests. Yet, recent literature claims that contracts also have a coordination function (Klein Woolthuis, Hillebrand & Nooteboom, 2005; Mellewigt, Madhok &Weibel, 2007; Reuer & Ariño, 2007; Schepker, Oh, Poppo, & Martynov, 2014; Schilke & Lumineau, 2016), by coordinating relationships, establishing roles and responsibilities, providing monitorization (Schepker et al, 2014) and creating the proper linkages between parents (Malhotra & Lumineau, 2011). Furthermore, Schepker et al. (2014) add the adaptation function of contracts which supports the relationship when there is need to adapt to unforeseen circumstances.

In a complex and long-term context of JVs, the management control of the partnership plays a crucial role, and contracts can be seen as a helpful control instrument to coordinate in an adequate manner the parent’s contribution, hence contracts might be seen as facilitators of coordination and adaptability (Schepker et al, 2014).

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6 order to understand to what extent previous experiences with other alliances influence the type of arrangements included in the contract. By doing so, this study will be a contribution to the theory stream arguing that contracts can be seen as safeguarding, coordination and adaptation mechanisms (Schepker et al, 2014). Moreover, this study will try to offer more evidence to the complementarity perspective of contracts and relational governance which promotes cooperation (Poppo & Zenger, 2002). Although the literature argues that contracts and relational governance are complementary, the specific role that contracts perform when they are used as complement of relational governance is not known (Schepker et al., 2014). Thus, it might be interesting to assess what kind of functions contracts have in stimulating the integration of contractual and relational capabilities into JV agreements. The complementarity aspect will also be analysed regarding the geographical distance between parent companies, since when parent companies are distant, monitoring is costlier and less likely to occur, and cultural distinctions may deter the development of relational capabilities and communication expectations (Schepker et al., 2014).

Taking this into consideration the main research questions are:

What are the content and the rationale of contractual arrangements in controlling Joint Ventures and what are the specific functions of contracts when they are used as complement of relational governance?

The following sub-question will be addressed:

How do managers coordinate more geographically distant activities?

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2. Literature Review

2.1. Theoretical background

2.1.1. Transaction Cost Economics

In the strategy field, Transaction Cost Economics (TCE) theory has been applied to explore the efficiency of executing transactions, however this theory has also been employed to inform about the contractual arrangements that firms use to manage their exchanges within those different types of governance structures (Reuer & Ariño, 2007).

Williamson (1991) defines three types of governance structures – market, hierarchy, and hybrid. The market governance structure is defined by means of price, where contracting parties’ behaviors are influenced by ex-ante designed rules. In this governance structure contracts tend to be complete. On the other hand, appears the hierarchy governance structure, where the parties’ behaviors are managed by authority, decreasing the necessity of contractual guarantees, leading to the existence of incomplete contracts (Brousseau & Fares, 2000; Ebers & Oerlemans, 2016). Furthermore, Williamson (1991: 283) characterizes hybrid governance structures as being “located between market and hierarchy with respect to incentives, adaptability, and bureaucratic costs. As compared with the market, the hybrid sacrifices incentives in favour of superior coordination among the parts. As compared with the hierarchy, the hybrid sacrifices cooperativeness in favour of greater incentive intensity.” In this governance structure appears the JV, which is characterized by long-term collaboration between two or more parties and medium intensity of contractual guarantees (Ebers & Oerlemans, 2016).

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8 Williamson (1991) identifies three critical dimensions of transactions: degree of asset specificity, the level of uncertainty to which the transaction is subject, and the frequency with which the transaction recurs. Furthermore, there are other transactional attributes, which are interrelated with the previous ones, such as the complexity of the contractual environment (Segal, 1999) and the bilateral dependency of the exchange parties (Lusch & Brown, 1996). Asset specificity regards the extent to which physical and/or human assets can be assigned to other relationships and business, without sacrificing productive value (Poppo & Zenger, 2002; Reuer & Ariño, 2007; Williamson, 1991). When specific assets are exchanged, the threat of relationship termination may lead one or both parent companies to seek for unmerited returns (Poppo & Zenger, 2002) and the need for safeguarding these specific investments will result in the increase of transaction costs, due to the necessity of designing more detailed contracts (Reuer & Ariño, 2007), which is the case when transactions are executed in the market. Uncertainty is another factor that must be taken into consideration when parties are involved in a transaction. It can be classified as environmental uncertainty, due to exogeneous conditions that are independent from the scope of the alliance, and behavioural uncertainty, that results from difficulty in foreseeing the actions of the other parties (Krishnan, Martin &, Noorderhaven, 2006). As stated by Williamson (1991) the frequency in which the transaction recurs is an important transactional attribute since it considers whether the frequency justifies investments in governance structures. However, since JVs are being investigated, the frequency of the transactions will not be considered as a critical aspect, because it is assumed that the transactions imply high frequency (Kamminga & Van der Meer-Kooistra, 2007). When the complexity of the contractual environment rises caused by environmental uncertainty, the benefit of writing the contracts as much detailed as possible, might decrease due to an increase in costs of designing such type of contract (Segal, 1999). Thus, potential outcomes might be subject to problems related to “incompleteness of contract” (Schepker et al., 2014). Furthermore, bilateral interdependency, that is created due to asset specificity (Williamson, 1991), will make parent companies reliant on each other (Schepker et al., 2014), and thus the bilateral interdependency also has critical implications in exchange environments.

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9 mitigated and how to deal with unexpected contingencies (Poppo & Zenger, 2002; Reuer & Ariño, 2007; Zhou, Poppo, & Yang, 2008; (b) extend the duration of the contract to safeguard specific assets (Joskow, 1988); (c) establish economic bonds or hostages, which connect parties to each other (Srinivasan & Brush, 2006); and undertake equity investments ( Helm & Kloyer,2004).

From a TCE standpoint, contracts are perceived as being instruments that safeguard the interests of exchange parties against opportunistic behaviour. Notwithstanding, if TCE is solely used to explain contract structure the real purpose of contracts might be undervalued (Barringer & Harrison, 2000), urging the need to consider other theories when discussing the role of contracts in controlling interorganizational relationships.

2.1.2. Social Exchange Theory (SET), Relational Exchange Theory (RET), and Firm

Capabilities

Granovetter (1985) argues that social factors must be added to the TCE perspective when studying interorganizational exchanges, and so SET extends the transactional perspective of contracts with a sociological perspective, by focusing on relational aspects within ongoing interfirm relationships (Faems, Janssens, Madhok, & Van Loy, 2008). In doing so, SET assumes that firms get involved in interfirm social exchange to obtain needed resources from each other (Das & Teng, 2002). From SET’s viewpoint, trust is assumed to be a preponderant relational attribute for safeguarding and coordinating alliances (Faems et al, 2008), and therefore, influencing interfirm contracts (Schepker et al., 2014). It has been argued that trust can increase cooperation and the quality of the relationship (Arino, de la Torre, & Ring 2001), enhances alliance flexibility (Young-Ybarra & Wiersema, 1999), minimizes transaction costs (Dyer & Chu, 2003), hinders conflicts (Zaheer, McEvily, & Perrone, 1998), promotes learning, innovation (Nielsen & Nielsen, 2009) and competitive advantage (Barney & Hansen, 1994), and improves JV performance (Nielsen, 2007).

Together with SET, appears the RET which rely on two assumptions: contracts only function if they possess common contracting norms; and transactions are embedded within the relationships that surround them due to the relational norms of the exchange parties. Thus RET focuses on contracting norms or shared expectations related to transactional behaviour (Palmatier, Dant, & Grewal, 2007). In the presence of high levels of relational norms, parties can better adapt to environmental contingencies, prolong the duration for assessing the outcomes of their relationships, and avoid behaviour that may hurt the relationship (Kaufmann & Stern, 1988).

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10 cooperative way, and in doing so they complement the employment of formal contracts in safeguarding the alliance (Schepker et al., 2014).

Regarding firms’ capabilities, some authors argue that they affect contract design. For instance, Kale, Dyer and Singh (2002) acknowledge that when exchange parties have previous alliance experience and possess specific resources used in coordinating alliances activities, they have more opportunities to be successful when dealing with other parties. Furthermore, the sensitivity to expropriation hazards can be reduced if parties own industry and country-specific experience, likewise international experience (Delios & Henisz, 2000). Finally, the capability of learning to write better contracts can be seen as a source of competitive advantage (Argyres & Mayer, 2007).

2.1.3. Real Options Theory

Real options give firms the flexibility to adapt their future actions in response to uncertainty (Reuer & Tong, 2005). The ROT has been used in the context of strategic alliances, since they are a way to enhance flexibility to share and jointly exploit growth opportunities (Trigeorgis & Baldi, 2013). Kogut (1991) applies real options to the JVs’ context, and he perceives JVs as structural mechanisms that support a firm in dealing with different types of uncertainty in a proactive manner. By forming JVs parent companies are able to reduce their risk of failure to a certain amount, as well as to expand by acquiring equity from a partner.

Furthermore, Schepker et al. (2014) posit that ROT contributes to the contracting theory in three aspects. First, ROT contradicts TCE regarding uncertainty since the options reduce the need for immediate action due to flexibility. Second, it assumes that contractual governance is dynamic regarding changes in the environment, contradicting the static assumption of TCE. Finally, it complements TCE, because the inclusion of option rights, such as call options which are safeguarding elements against exchange hazards (Reuer & Tong, 2005), and termination clauses lower ex post negotiation and opportunistic bargaining.

2.2. The Functional Approach of Contracts

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11 coordination and/or adaptation, and in doing so contracts are perceived as safeguarding, coordination, and adaptation mechanisms.

2.2.1. Contracts as safeguarding mechanisms

The structural perspective of contracts recognises contracts as safeguarding instruments that are used to hinder the risk of opportunistic behaviour, by means of detailed and complete contracts (Faems et al., 2008), which demonstrate a positive association with alliance performance (Luo, 2002). The safeguarding arrangements are used, and generally strong, when (a) transferred knowledge is complex, tacit, and less codified; (b) specific assets are exchanged; and (c) parties are dependent on resources with equity ownership (Schepker et al, 2014). For instance, safeguarding clauses include allocation of property rights (Klein Woolthuis et al, 2005) and control rights (Adegbesan & Higgins, 2011), unilateral termination rights, and processes for conflict resolution (Argyres & Mayer, 2007).

2.2.2. Contracts as coordination mechanisms

When the contractual environment is complex and uncertain, parent companies must rely on high levels of coordination (Dekker, 2004). Contracts are used to facilitate coordination by defining the intervenient’ roles and responsibilities (Klein Woolthuis et al, 2005), the monitoring requirements of the activities (Argyres & Mayer, 2007), and enhance communication between parent companies (Mayer & Argyres, 2004). Furthermore, Schilke & Lumineau (2016) argue that coordination provisions can ease the effect of safeguarding clauses on conflict. Because, if coordination clauses facilitate the alignment of activities and goals between partners. Goal direction through safeguarding provisions will bring less conflict than if no coordination clauses are prescribed. At the same time, safeguarding provisions may strengthen the negative effect of coordination on conflict. For coordination to succeed and an alignment of actions to be possible, some agreement on the contributions of both partners is a prerequisite. A context in which partner responsibilities are clearly defined by safeguarding provisions will thus improve the effectiveness of coordination provisions in reducing conflict (Schilke & Lumineau , 2016)

2.2.3. Contracts as adaptation mechanisms

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2.3. Complementarity Relationship of Contracts and Relational Governance

The structural perspective of contracts posits that contract functions serve as a source for trust since it limits opportunistic behaviour (Williamson, 1985). A contract enables parties to trust each other, because they have no other choice than to behave trustworthy, as opportunism will be at the cost of agreed upon sanctions (Klein Woolthuis et al., 2005). Furthermore, as contracts are inherently incomplete, trust and relational norms play an important role in stimulating the “continuance and bilateralism” of the relationship (Poppo & Zenger, 2002). Relational attributes can reduce the rigidity of the contract, through partners’ flexibility regarding change, the resolution of problems in a collaborative fashion, and ease of information exchange (Schepker et al., 2014). Thus, the coupled use of formal contracts and relational governance endorses cooperation between parties (Poppo & Zenger, 2002).

Luo (2002) argues that contract completeness (which is comprised of term specificity (“i.e., the extent to which all relevant terms and clauses are specified (Luo,2002: 904) and contingency adaptability) and cooperation complement each other, since the contract completeness provides a legally bound institutional framework in which cooperation proceeds, while cooperation mitigates the adaptive limits of the contracts. In his study about JV performance, the author finds that when contracts and cooperation interact with each other, such interaction stimulates JV performance (Luo, 2002).

The above mentioned perspective, is in line with the functional approach of contracts where contracts are seen as safeguarding mechanisms that attempt to drive coordination by cooperation, and this cooperation can facilitate the adaptation of contracts to contingencies. Hence, the complementary relationship between contracts and relational governance will be assumed, in this study, as having an important role in the management control of JVs.

2.4. Management Control of Joint Ventures

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13 As JVs usually are long-term settlements, they may be influenced by changing environmental circumstances. Such influences may need changes in their governance and control. These changes can comprise “changing regulations, parents leaving the joint venture, the joint venture deciding to enter new activities, personnel being replaced, and inter-partner learning undermining the raison d’être of the venture.’’ (Kamminga & Van der Meer-Kooistra, 2007) which produce JV dynamics (Kamminga & Van der Meer-Kooistra, 2015).

JV management control can have preponderant roles in these JV dynamics (Kamminga & Van der Meer-Kooistra, 2015). First, JV management control can create JV dynamics if it does not match the characteristics of the JV relationship. Second, if the management control is tight, it creates complex JV dynamics. Third, JV management control can be used to successfully cope with JV dynamics and thereby cement the JV relationship, although in a situation of JV dynamics, if the JV management control is not used to counteract the effects of these dynamics, the JV relationship can weaken. (Kamminga & Van der Meer-Kooistra, 2015).

However, this study will not focus on JV dynamics, yet as stated before if the management control does not match the characteristics of the relationship, JV dynamics must arise. In this sense, contracts and relational governance (with all attributes that comprised them) might have an important role in minimizing these dynamics, through safeguarding and coordination, and in facilitating the adaptation to new environmental settings, and so it is important to study what is the role of contracts in controlling JVs. In doing so a theoretical framework, depicted in Figure 1, is proposed, and it will be the basis to investigate and develop theory about the role of contracts in controlling JVs.

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3. Case Research Design

This section aims to describe the methodology employed in the study. The following includes an explanation of the research approach that was used, the description of the case selection and data collection methods, and an explanation of the data analysis process.

3.1. Research approach

The literature review shows that the role of contracts in strategic alliances has been subject of research. Although, the research on management control of JVs is not yet so mature, especially regarding the role of contracts in controlling JVs. Taking this into consideration, this study attempts to refine the existing literature about management control of JVs. In doing so, this study will follow the theory development process by building theory based on observations, identification, and explanations of the phenomenon, in order to achieve new insights about the role of the contracts in the management control of JVs.

In order to achieve a better understanding of the role of contracts in controlling JVs, a qualitative approach will be employed, since it helps to understand a phenomenon in its context-specific settings and it yields answers to the questions what, why and how (Saunders, Lewis & Thornhill, 2007).

According to Ahrens and Chapman (2006), a case study is a theoretical process which helps the researcher to interpret practical phenomena in order to contribute to theory. Since the objective of this study is to understand the rationale of the content of contracts of JVs, it was important to collect the perceptions of the JV management at the time of the contract design, which could explain their reasons for including such clauses in the contracts. In doing so the case study seems an adequate research methodology for this purpose.

3.2. Case selection

According to Blumberg, Cooper, and Schindler (2008) within case study research it is possible to conduct single and multiple case studies. In this study, a holistic approach will be used, since a single case study will be performed (Yin, 2003).

The case study concerns a JV that operates in the energy sector to develop hydro-electric projects in emerging markets. This JV is formed by a European and a Chinese company. Due to confidentiality issues, this JV will be named The Company, the European company, PartnerA, and the Chinese company PartnerB.

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16 PartnerA.

3.3. Data Collection

In order to guarantee construct validity by the process of triangulation multiple sources of information were collected (Yin, 2003). This study focused on three data sources, namely: initial telephonic contact, semi-structured interviews, and secondary data.

The initial contact with the Company’s Chairman of the Board of Directors had the purpose to ask permission to study this JV and to have access to the contract of the JV, and to get a better understanding of the general operation of the JV.

Afterwards, two semi-structured interviews (which scripts can be seen in Appendix 1) were conducted with the Company’s Chairman of the Board of Directors (Interviewee 1) and the Company’s Project Development Director (Interviewee 2), both representatives of PartnerA. These two interviewees were chosen because this study wanted to investigate the perspective of one partner of the JV, and because they were directly involved in the design of the contract (Interviewee 1) and in the operation of the JV (Interviewee 2), being the latter an expat who is located in the headquarters of the Company, and who is responsible for the coordination of the JV. Interviewee 1 was interviewed in the European headquarters of the parent company of partner A, and the interviewee 2 was interviewed by telephone due to his distant location at the moment of the interview. Both interviews lasted approximately between 30 to 45 minutes, they were recorded and transcripts were made. Additionally, both interviews were not conducted in English, but in the mother language of the interviewees, hence in the moment of proceeding with the transcripts of the interviews it was necessary to translate them to English.

The secondary source of data covered the Shareholders Agreement of the JV. Due to confidentiality issues, the interviewees asked to not mention any detail of the content of the contract, although it was possible to observe what kind of clauses were included in this document and they are described, in a general manner, in section 4.2.

3.4. Data Analysis

The analysis of the data of the interviews was conducted after the translation of the transcripts of the interviews.

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4. Analysis

This section aims to analyse the inputs obtained from the interviews and the Shareholders’ Agreement of the JV. The structure of the analysis follows the theoretical framework presented in chapter 2, and it is divided into the content of the contract, and the complementarity issue between contracts and relational governance. The section starts by analysing the scope of the JV.

4.1. The scope of the Joint Venture

The Company is equally owned by an international subsidiary of a private-owned European energy company (PartnerA), and a state-owned Chinese energy enterprise (PartnerB). PartnerB is the main shareholder of PartnerA. The JV arose from the strategic agreement between both parties to develop hydro-electric projects in Latin American and African countries.

There were three main reasons that led to the formation of this cooperation. Firstly, the existing strategic partnership between both parties. Secondly, the background of both companies in hydro-electric projects. Finally, the fact that hydro power is an extremely competitive type of energy.

“The main reason is the strategic partnership between our company and our main shareholder. If they were not our main shareholder this JV would not exist. Then, there are more specific reasons due to the willingness of creating something regarding hydro opportunities. […] both companies have a huge hydro-electric background, […], so it can be said that it is a combination of know-how. Furthermore, hydro power is an extremely competitive type of energy, regarding its average cost, there is no need for subsidies. [...]. For most countries in the world that do not have the capacity to pay energy production subsidies, the hydro power is the obvious solution.” (Interviewee 1)

The JV is an independent company that operates with all the features of a normal enterprise. While enjoying from the parties’ complementary expertise, know-how and available resources to capture growth opportunities in emerging markets.

“The know-how is provided by both parties. We made a deal, that governs the JV, where we distributed the responsibilities without prejudice that decision making is done in common agreement.” (Interviewee 1)

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19 three representatives from each partner, meets on a monthly basis, and it is responsible for the appointment of the Executive Committee, comprised by two members of the Board of Directors from each partner, having meetings every week. Furthermore, the Board also appoints three committees: a Technical Committee responsible to analyse the projects to be developed by the Company; a EPCM Committee with the responsibility to implement the projects selected to be developed; and an O&M Committee, to supervise the operation and the maintenance of the operational plants.

The distant geographical activities are coordinated by expats appointed by each partner, who ensure the connection between the JV and the shareholders. The Company has also its own employees who work in the operation plants where the projects are being developed.

In this JV, there are no investments in specific assets by the partners. The Company is responsible for developing/acquiring the majority stake ownership in any project that they undertake. In doing so, they have total autonomy regarding the necessary investments and they possess their own assets, not requiring additional investments in specific assets by the parent companies.

“Regarding specific assets of any of the shareholders, we do not have them. All assets are

from the JV. Shareholders provide know-how but not assets.” (Interviewee 1)

“All the power lies at the Board of Directors and Executive Committees. Furthermore, there are six expats, three representatives of each partner, who ensure the connection between the JV and the shareholders. Of course, we have local employees who have a labour contract with the Company.” (Interviewee 1)

“The Company has the responsibility of coordinating the activities by having its own team. [...] For instance, we turn to our shareholders’ resources when a technical study is needed. At the moment, we are working on a project, and teams from both parties were called to the site to give us technical advice, although all processes are coordinated by our own team. […] We have our own internal mechanisms, and both shareholders receive our reports, accounting statements, and we also have to report to the Technical Committees.” (Interviewee 2)

4.2. The content of the contract

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“[…] the Company rely on three types of contracts. First, the contract of the constitution of the JV, which was written in accordance to the local law, that is the standard legal piece which govern any company in that specific country. Second, the Shareholders’ Agreement, which is more important than the JV contract, because it sets up the way the company operates. For instance, this agreement includes the operating mode of the Board of Directors, and of the Technical Committees. It explains the purpose of these committees and how they are established. Finally, there are specific service agreements that the Company has established with subsidiaries of both parties for specific types of works.”

At the time of the contract design, both parties sought to achieve a balance between principles and procedures in order to promote greater flexibility. These principles and procedures cover the mode of how the Company should be operated and governed.

“The chosen contract model was a mixture of principles and procedures. For example, the Unanimity principle, in any situation that there is no unanimous agreement, it will be discussed again until an agreement is reached. This is the principle that rules all decision-making processes of the Company. Another principle and this is a more general one is the business object, in which the types of hydro-electric projects are described that should be developed. In terms of procedures, for example, it can be mentioned the establishment of technical committees, the size of the Board of Directors, the periodicity of the Board’s meetings, the definition of exclusive and excluded markets, and in the case of impossible agreement, the scale procedure, where both parties’ CEOs are called to solve the disagreement. Hence, we cannot state that this contract is solely procedural neither solely based on principles. We tried, based on common sense, to implement a balance in order to promote flexibility but with a certain degree of discipline.” (Interviewee 1)

By analysing the content of the Shareholders’ Agreement, it was possible to observe the existence of thirty-six main clauses. These clauses were divided into four main categories, i.e. Safeguarding, Coordination, Adaptation, and General, which are depicted in Table.1.

Table 1. Categories of the main contractual clauses

Safeguarding Dividend Policy

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21 Audit

Arbitration

Benefits Only to Parties Accounting and Consolidation Coordination Strategic Cooperation

Company governance and organization: principles Shareholders Meeting

Board of Directors Board Meetings Financial Support

Management of Subsidiaries and Projects by the Company Development of Strategic Projects

Access to Information Notices

Adaptation Deadlock

Asset Split and Envelope Procedure Termination

General Definitions

Severability Entire Agreement Unlawful Fetter

Undertakings by the Company Successors

Choice of Law; Remedies Descriptive Headings Confidentiality; Publicity No Strict Construction Organization Documents Further Assurances

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22 there are clauses related to financial accounting where is established which financial reporting standards should be followed, and Auditing where is defined that an independent and reputable accountant, approved by the Board, shall be engaged by the Company as its internal auditor to examine a verify the annual financial statements. Each shareholder also has the right to appoint an accounting firm to audit the Company accounts, to detect any possible difference that may exist from the audit that was done by the Company. Finally, both parties agree to implement the Arbitration principle to solve any dispute that may occur, through an independent court.

“[…] there are some clauses, as an example, Accounting and Consolidation, and Audit, where there is a shareholders’ intervention to safeguard their interests in the best way.” (Interviewee 2)

The Coordination clauses put down on paper how the Company should operate and be managed. In these types of clauses, it is possible to observe the statement of the business object, by means of a definition of the category of projects the Company should develop and acquire, investment principles and guidelines, and in what countries they should be developed. Furthermore, these types of clauses include the appointment of the representatives of the Board of Directors, the Executive Committee, and Technical Committees, and the definitions of their responsibilities and the periodicity of the meetings that should be held by them. Finally, it is expressed how the communication and share of information should be done.

“If you consider the Shareholders Agreement, you can observe that issues such as non-compete, exclusive and excluded geographies, and appointment of Directors are aspects that aim to guide the coordination of the Company’s activities.” (Interviewee 2)

The Adaptation clauses are used as procedures to deal with situations when an agreement between the parties is not achieved. For instance, situations regarding the Company’s approval of the business plan, yearly budget, strategic plans, annual accounts, distribution of dividends, incurring indebtedness for borrowed money, the appointment of corporate bodies, and other situations. In the case of disagreement, a “Deadlock” procedure is employed until an agreement is achieved. If the agreement is not accomplished, the “Asset Split and Envelope Procedure” is put into practice in order to allocate the assets of the JV, and to terminate the cooperation.

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a disagreement regarding a crucial issue of the operation. In this case, termination of the JV is the only option available. It is necessary to define what should be done to the JV’s assets, and that was the mechanism that the shareholders decided to employ to divide the assets, when this particular situation happens.” (Interviewee 2)

4.3. Contracts and relational governance

As discussed earlier, this JV is of a specific nature because of the fact that one partner is the main shareholder of the other partner’s company. This fact implies that the parties were already related to each other before they established the Company. The parties had concluded a strategic partnership in order to develop projects in other countries. Taking into consideration the existence of the strategic partnership it is expected that both parties have a high level of trust on the other side and that they will act in the best interest of common benefits.

The established strategic partnership was mentioned by the two interviewees as the main reason that promote the existing relationship between both partners. The interviews showed that the two sides were aware of the necessity of seeking common interests. In addition, the contract layout, and the way the contract was used, were means that sought to promote flexibility for the JV’s operation and coordination, based on the existing trust and shared interests between the parties.

“Without our shareholder relationship and strategic partnership, this JV would not exist” (Interviewee 1)

One good example of the existing complementarity between the formality of the contract and the existing relationship, is the weekly meetings that are hold by the main representatives of both parties. In these meetings, the Company’s Chief Executive Officer, representing PartnerB, and the Company’s Chairman of the Board of Directors, representing PartnerA, seek to achieve a common understanding before any JV’s issue goes to be voted in the Board of Directors meeting. These meetings are not formal stated in the contract, but the two parties try to achieve an agreement beforehand, because they recognize the necessity of finding the best solution for the common interest and to the future of the JV.

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to an agreement before things went to be discussed in the Board of Directors meetings in a more formal way.” (Interviewee 1)

The interviewees were aware of the importance of the contract, and the role that the contract has in controlling the JV. Though, Interviewee 2 recognized that the contract was there and it was useful to define general terms, but it would be only used in the case of conflict that could not be resolved through common agreement. Both interviewees described the contract as being an institutional framework that established the operation mode of the JV and a mechanism to safeguard partners’ interests, which confers a certain level of discipline to the relationship. Although, based on common sense and on the existing relationship, the partners attempted to write the contract as flexible as possible. By doing so, they intended to provide some degrees of freedom to both parties to enhance cooperation and value creation.

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5. Discussion

This study aims at gaining an insight into the role of contracts in controlling a JV and more specifically their content and the rationale of their content. On the basis of the literature a theoretical framework has been developed to provide a better understanding of the attributes that influence the contract design. This framework included the three functional aspects of contracts suggested by Schepker et al. (2014). Furthermore, this study attempted to understand the complementary link that may exist between the more formal characteristics of the functional aspects of contracts and the relational governance aspects of JVs, and moreover, the influence of this complementarity on the management control of JVs.

5.1. Contextual attributes of the JV

The case shows that, in order to get a better understanding of the role of the contract in controlling the JV and more specifically on how the contract is designed, it is important to understand the contextual attributes that characterize the JV, which is in line with the existing literature (see Kamminga & Van der Meer-Kooistra, 2007). One example of a contextual attribute was the fact that one party of this JV was the main shareholder of the other parent company. This relational detail was of great importance not only at the time of drafting the contract, but also throughout the operation of the JV, and to its management control as well. This fact is consistent with what Zollo, Reuer and Singh (2002) suggest that prior relationships enhance partners’ relations and coordination because they have better knowledge of each other’s culture, management systems, capabilities, and weaknesses.

The pre-existing relationship between partners provided a high level of trust regarding the expectations on each party performing their role competently (competence trust), carrying out their obligations (contract trust), and fair dealing even in unforeseen circumstances (goodwill trust). This was only possible due to both parties’ awareness about the necessity of seeking their common interest, and about their own responsibilities and inputs to the relationship.

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26 The pre-existing relationship, the structural organization of the JV, and the autonomy of the JV discourage the presence of information asymmetry, specifically between the parties and the JV management. The equal presence of representatives of both parties in the Board of Directors, Executive Committees, Technical Committees, and the appointment of three expats from each party to coordinate the JV operations promoted the mitigation of information asymmetry and enhanced the connection between the parties and the JV management.

Taking the transactional attributes into consideration, this case shows that both partners do not invest in specific assets for this JV. Another important finding that should be noted concerns the bilateral interdependency concept. In this JV both representatives provide hydro-electric know-how, since both entities have a great experience with this kind of power. They are not dependent on the resources or a specific asset of one of the parties. In the establishment of the JV, it was defined by both parties what were the inputs that each one should yield. This definition facilitates the measurement of each partner’s contribution, and their clear understanding of each other’s contribution is an advantage in reaching their common goal. Furthermore, the level of uncertainty and complexity of the operations of the JV can be considered high, since the projects are developed in emerging markets and there is a different cultural context between partners.

Putting all the relational and transactional attributes together, it is possible to demonstrate why the contract design of this particular JV aims to promote flexibility in the course of the JV’s operations. The contract flexibility of this JV, which is characterized by a balanced mixture of principles and procedures, was implemented to give degrees of freedom to the JV management in dealing with unexpected circumstances while facing a certain level of discipline. This JV operates in a transactional environment where asset specificity and bilateral dependency are low. In this context, the existing literature supports the proposition that there is no need for detailed contracts (Schepker et al., 2014). As uncertainty and complexity are present in this JV, there is a necessity to create a more flexible contract. Such a contract is only possible when trust and relational norms exist between the partners, what is the case in this JV. Hence, the flexibility of the contract of this JV is in line with what Poppo and Zenger (2002) support regarding the fact that when contracts are incomplete, and when trust and relational norms are present in the relationship, these attributes will influence the behavior of both parties to work in a cooperative way, even when unforeseen circumstances occurred.

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27 proposition that Schepker at al. (2014) support, that real options theory offers the possibility to contractual governance to be more dynamic/flexible regarding changes in the environment could not be supported by this study.

5.2. The content and rationale of the contractual clauses

All three functional aspects of the contracts could be found in practice. The safeguarding, coordination, and adaptation mechanisms were observed in the Shareholders Agreement and were supported by the interviews. However, it is important to mention, that the adaptation mechanism has a partial difference in terms of its definition, when compared with the existing literature. This difference will be explained later in this section.

The analysis of the JV’s contract shows the presence of many clauses that can be divided into safeguarding, coordination, and adaptation clauses. These findings seem consonant with existing studies that claim that contracts are safeguarding and coordination mechanisms (Faems et al., 2008; Luo, 2002; Klein Woolthuis et al., 2005; Malhotra & Lumineau, 2011; Mellewigt et al., 2007; Reuer & Ariño, 2007; Schilke & Lumineau, 2016) and with Schepker et al. (2014) who defined the functional approach of contracts by adding adaptation mechanism to the two mechanisms mentioned above.

The safeguarding clauses, present in the contract of the studied JV, concern the protection and insurance of equity investments and rights, allocation of control rights and procedures for conflict resolution, which it is consistent with what Schepker et al. (2014) support as being types of safeguarding clauses. The safeguarding clauses in the studied contract, aiming at protecting the equity investments and rights and allocation of control rights, were related to the ownership structure of the JV, where it is established that both partners have an equal amount of ownership and shared control of the JV. Furthermore, there are certain provisions to be employed when one party desires to transfer its shares, safeguarding its own interests and the interests of the other party. Moreover, the financial reporting standards and audit procedures described in the contract should be followed in order to control the financial accounts of the JV and protect the shareholders’ interests. Additionally, the arbitration principle was chosen to deal with any conflict that may arise during the operation of the JV. On the other hand, this JV does not involve investment in specific assets or complex knowledge transfer. Hence, both parties assumed that there was no need to implement strong mechanisms to safeguard partner’s investments to reduce exchange risks as suggested by Leiblein (2003).

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28 are defined and coordinated by the management of the JV in accordance with the purpose of a specific activity/service. Hence, the coordination clauses, present in the studied contract, have a more general scope. They are used to define roles and responsibilities by appointing the Board of Directors, Executive Committees, and Technical Committees. Furthermore, they define the business’s object of the JV by describing in what markets the JV will operate and what kind of investment principles should be followed. They also have an important role in promoting communication between the partners having a positive impact on the coordination of the operations, since these clauses establish the necessity of the existence of personal meetings to discuss the issues of the JV, to clarify the expectations and responsibilities of both parties or to deal with problems that may arise and that were not initially taken into consideration at the moment of designing the contract, which is in line with what Mayer & Argyres (2004) argue. One important aspect that also have a positive impact on coordination, is that both partners of this JV take an interests-based approach which not only enhance the achievement of the common goal, but also decreases the possibility of conflict, as argued by Lumineau and Malhotra (2011).

In this contract, the adaptation clauses are used as procedures to deal with situations when the parties are not able to reach an agreement. The Asset Split clause appears as an adjustment procedure to divide the assets of the JV, when JV’s termination is the only possible solution, by giving the option to both parties to propose a fair price to acquire the JV’s assets. Furthermore, there was not any evidence of contingency planning clauses in the studied contract. Hence, it can be said that what Luo (2002) supports regarding the necessity of employing contingency clauses in contracts was not satisfied in this JV.

Using the characterization of control mechanisms employed by Kamminga and Van der Meer-Kooistra (2007), that comprises personnel mechanisms, financial mechanisms, formal information, and meetings and personal contacts, Table 2 shows the mechanisms that were present in the analysed contract.

Table 2. Control Mechanisms

Control characteristics Instruments

Personnel Board of Directors: 3 of each partner

Executive Committee: 2 Board Members of each partner

Technical Committees Expats: 3 of each partner

Financial 50-50 equity share

Dividend policy

Formal Information Financial statements

Internal reports

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From the table above, it is possible to infer that the contract specified some mechanisms the JV management could use to control the JV. In this particular case, the personnel and the meetings and personal contact mechanisms are of extremely importance not only for the JV’s operations, but also to reinforce the existing relationship.

Through the personnel mechanisms, it is established the shared control and decision-making process of the JV, where the interests of both parties are safeguarded. In addition, the JV management use the meetings and personal contacts to coordinate the distant geographical activities and deal with any problem that might arise.

In summary, the JV management recognize the contract as a formal institutional instrument that put on paper the governance and the mode of operation of the JV, while, on the other hand, they rely on the shared sense of pursing the best interests of both parties, as the best way to achieve the JV’s goals and control the operations. By doing so, both parties attempt to draft the contract as flexible as possible, in order to be ready to adapt to circumstances that might arise, and show good faith to the other party in the course of the JV operations.

5.3. The role of contracts as complement of relational governance

Taking the context of this JV into consideration, it is possible to conclude that the existing relationship plays an important role in the course of the JV’s operations and cooperation, where the relationship is preserved through a mutual alignment.

Notwithstanding, the control of this JV cannot only rely on the existing relationship, and in this situation the contract appears as a legal mechanism that binds both parties to behave in accordance with the JV’s best interest.

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6. Conclusion

This research has studied the role of contracts in the management control of JVs. By analysing the transactional and relational attributes that characterize the context of a JV it was possible to understand the reasons why the contract, when designed, has a more complete or incomplete structure. Moreover, through the testimonials provided by the interviewees and the analysis of the JV contract, it was possible to understand what kind of clauses were present and the motives for that clauses being written in the contract.

6.1. Theoretical and managerial implications

The study of the existing literature allowed the development of a theoretical framework in which transactional, relational, and real options attributes determine the functional approach of contracts. This in complement with relational governance has an important role in the management control of JVs.

The findings of this study confirm the functional approach of contracts, suggested by Schepker et al. (2014) in controlling JVs. This approach distinguishes safeguarding mechanisms, that are used to protect the interests and rights of the parties, coordination mechanisms, that are employed to guide the operations of the JV, and adapta

tion mechanisms, that appear as instruments to adapt to circumstances when agreement is not achieved. However, regarding the adaptation mechanisms, the findings of this study are different from what Schepker et al. (2014) and Luo (2002) argue, because they are not related to adapting to environmental contingencies. It should be recognized that this finding is only based on a single case study.

In doing so, these findings contribute to the literature stream that supports the necessity to integrate transaction cost economics, social, and relational characteristics in addressing the topic of interorganizational exchanges.

Furthermore, this study also supports the claim of complementarity between formal contracts and relational governance. When the context of the JV is characterized by a strong relational dimension, the contract assumes a secondary role throughout the operation of the JV, being only used in situations where conflict resolution is needed. Hence, in this type of context, the contracts are recognized as being legal institutional frameworks that are used to provide a certain level of discipline to the relationship. And, on the other hand, with a certain degree of flexibility, the relational attributes such as trust, prior-relationship, and mutual orientation are put forward in the management of the operations to enhance coordination, cooperation, and to adapt to unexpected circumstances.

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32 into the management and coordination of distant geographical activities, where the contract establishes the necessity of regular meetings and personal contacts, and the existing relationship helps both parties to coordinate and manage the operations by promoting the achievement of common interest.

Regarding the managerial contribution, this study provides knowledge to managers that might want to establish JVs with partners with which that they already have (or had) a prior relationship. By looking into this study, they can observe which clauses they should include in the contract, given the context of the JV they are involved in. It is more important to invest in the relationship then investing in complex contractual clauses to promote flexibility and efficiency of the JV operation.

6.2. Limitations and future research

Although it was attempted to perform this study as careful as possible, there are some limitations that need to be mentioned.

The first limitation regards the case sample. Only one case study, with only two interviews, was conducted. In this case, generalization might not be easy to achieve. In future research, it would be preferable to enlarge the scale of case studies, by following a multiple case study approach, in order to analyse other industries and cultures involved in JVs.

The second limitation concerns the particularity of this JV regarding the fact that one parent company is the main shareholder of the other parent company. In future research, it should be interesting to study whether the role of the contract differs if there is no prior relationship between the partners.

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Appendix: Interview script

General Questions

What is your role in the Joint Venture (JV)?

Is this your first time dealing with a JV or did you have previous experience with JVs? Can you describe what is the scope of this JV?

Can you describe the reason(s) why your company entered in this JV? What are the inputs that your company offer to this JV?

What does your company expect from this JV? Role of Contracts

How do you perceive the importance of contracts in JVs?

At the moment of the design of the management guidelines for the contract, what determinants did you consider important to be included? And why?

Does the JV involve specific assets? If yes, how are they safeguarded in the contract?

Is your company resource-dependent on the other party? If so, how does your company deal with this fact in the moment of the design of contract?

How do you try to mitigate uncertainty and complexity of the transaction by means of contract? Can you describe how the allocation of decision rights are done by means of contracts?

How is coordination of JV’s activities achieved by means of contract? What kind of clauses are included and why?

Being an international JV, how its geographical distant activities are coordinated? And to what extent are those coordination measures included in the contract?

Does your company have prior experience with JVs? If so, to what extent this prior experience had influence in the design of the contract of this JV?

Did your company have prior experience with the other party of this JV? If so, in what circumstances and to what extent this prior experience had influence on the design of the contract of this JV?

Does the contract include contingency adaptability clauses? If so, what is included in those clauses and why?

To what extent do you consider trust an important characteristic of the relationship with the other parent company?

What is the influence of trust in designing the contract?

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Management Control of Joint Ventures: The Role of Contracts