The role of the formal contract in controlling public sector
Joint Ventures: A case study.
By
RONALD EVERS
University of Groningen
Faculty of Economics and Business
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The role of the formal contract in controlling public sector
Joint Ventures: A case study.
Abstract
This study contributes to the field of organizational control, by focusing on the role of the contract in controlling public sector JVs, an underexposed sector in organizational control research. A case study was conducted, from both the perspective of the parent companies and the JV, at a public sector JV. The results based on semi-structured interviews and documentation analysis, show that both TCE and the sociologist view hold some merit with regard to the control embedded in the contract, and that an incomplete formal contract based on equality between parent companies, has a low need for clauses controlling the JV.
Keywords: parent control, public sector, joint venture, formal contract, trust, risk Supervisor: J. Meer-Kooistra, van der
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Table of contents
Abstract ··· 1 Table of contents ··· 2 List of abbreviations ··· 3 1. Introduction ··· 4 2. Research framework ··· 7 2.1 Control ··· 7 2.1.1 Dimensions of control··· 7 2.1.2 Types of control ··· 92.1.3 Contracts and control ··· 10
2.2 Risk ··· 11
2.2.1 Dimensions of risk ··· 11
2.2.2 Contracts and risk ··· 12
2.3 Trust ··· 12
2.3.1 Dimensions of trust ··· 12
2.3.2 Contracts and trust ··· 13
3. Research method ··· 14
3.1 Type of research ··· ·· 14
3.2 Case selection and background ··· ·· 14
3.3 Data collection ··· ·· 15 3.4 Data analysis ··· ·· 16 4. Results ··· 17 4.1 JV results ··· 17 4.1.1 Types of control ··· ·· 17 4.1.2 Dimensions of control ··· 18 4.2 Parent results ··· 20 4.2.1 Risk ··· 20 4.2.2 Trust ··· 21 4.2.3 Reasons for a JV ··· 22 5. Discussion ··· 24 5.1 Control ··· 24 5.2 Risk ··· 24 5.3 Trust ··· 25 6. Conclusion ··· ·· 28 6.1 Findings··· 28 6.2 Limitations··· 28 6.3 Future research··· 29 Acknowledgements ··· 30 References ··· 31
Appendix A: Interview protocol JV··· 35
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List of abbreviations:
BOC Board of commissioners
GMS general meeting of shareholders
JV Joint Venture
NWTR Nieuwater
TCE Transaction cost economics
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1. Introduction
Recently, there has been an increased interest in the academic literature on control across organizational boundaries (Cäker & Siverbo, 2011). This interest is attributed to an increase in closer relations between organizations (Cäker & Siverbo, 2011). Organizations choose to cooperate for different reasons, such as to achieve economies of scale, to gain access to new customers, capabilities and resources or to bypass trade barriers into foreign countries (Groot & Merchant, 2000; Kamminga & van der Meer-Kooistra, 2007). Most of the research done in this field has focused on cooperation in the private sector and to a lesser extent on public-private cooperation. While inter-organizational relationships in the public sector are as common as in the private sector, there is only limited research on them (Samuel et al, 2009). As a consequence there is a research gap in the academic knowledge on control across organizational boundaries in the public sector.
Establishing clear-cut distinctions between public and private organizations has proven difficult (Hvidman & Andersen, 2014). The three criteria most commonly used are ownership, source of financial resources and model of social control (Hvidman & Andersen, 2014; Perry & Rainey, 1988). In short we can state that the organizations that form the public sector are ‘wired’ differently to those in the private sector (Bejeroth & Hasselbladh, 2013). Some of the most far-reaching changes in the form, structure and control of organizations in a number of countries have been observed in the public sector (Berry et al., 2009) Recent studies in the UK indicated that 43% of National Health Service Trusts and one-third of local authorities entered in some form of strategic alliance or partnership (Ezzamel et al., 2005). As a result the image of local government as unitary, hierarchical organizations has become increasingly unsustainable (Berry et al., 2009).
There are several forms of inter-organizational relationships, such as joint-ventures, licensing, franchising and sub-contracting (Sydow, 1992). The past two decades have witnessed a tremendous rise of hybrid organizational forms (Van der Meer-Kooistra & Vosselman, 2006). Joint ventures (JVs) are a special type of strategic alliance offering a unique opportunity to combine the distinctive competencies and complementary resources of participating firms (Ozorhon et al., 2010). A JV is from an academic point of view an interesting relationship, for it is a legally independent entity formed by two or more parent companies (Chen et al., 2009). This structure gives rise to all new kinds of control problems, complicating traditional views of organizational control (Chen et al., 2009). To achieve their individual objectives, parent firms exercise control over JV operations (Geringer & Hebert, 1989; Groot & Merchant, 2000).
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alliance governance because it affects the possibilities for each partner to control the performance of activities within the boundaries of the relationship (Nielsen, 2010).
Although the formal contract as a form of control in JVs has been addressed in literature, its role in public sector JVs is yet to be explored. This gives an opportunity for theory development in this area. This leads to the following research question:
“How does the formal contract play a role in controlling public sector Joint Ventures?”
In order to answer this research question and to fully grasp the role of contracts in controlling public sector JVs a case study will be conducted. This study will focus on the role of the formal contract in a public sector JV. It will look at the role of the formal contract from two perspectives. First, this study looks at the development of the original contract from the point of view of the parent companies. The objective here is to determine what influenced the level of control imbedded in the contract and to determine the contemplated role of the contract on control the parent companies had before the actual establishment of the JV. This will be done by in-depth semi-structured interviews with employees of both parent companies who played a role in the establishment of the JV and through the study of relevant documentation. Secondly, this study will look at the actual role the original contract plays on the operational and strategic decisions being made in the JV. The objective here is to determine if the original contract has influence on the decisions being made in the JV and to what extent. This will also be done by in-depth semi-structured interviews with the top management of the JV and by studying relevant documentation. The objective of this study as a whole is to provide new insights and find new relationships between contracts and control in public sector JVs.
The theoretical contribution of this study is threefold. First this study contributes to the literature in the field of organizational control, for it is one of the first studies with a focus on public sector JVs. The relationship between contracts and control is yet to be studied from a public sector point of view. Consequently, there is insufficient knowledge on these differences or similarities present in the current literature on control across organizational boundaries. Since inter-organizational relationships are as common in the public as in the private sector (Samuel et al, 2009), and since public and private companies differ in many ways (Berry et al., 2009), the opportunity is present for new insights to arise. Secondly this study can guide future studies on public sector JVs. Differences found in this study between public and private sector JVs can help focus future research effort on public sector JVs. Finally this study can help to increase the generalizability of existing theories on the role of contracts on organizational control across organizational boundaries. Finding the same relationships as existing theories on contracts and control will increase the generalizability of the results of studies using these theories.
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process. Also the specific setup of this study, focusing on both the perspective of the parent company and the JV, can provide evidence on what specific agreements result in certain levels of control. This in turn can help managers facing contract negotiations for JVs in the public sector with insights to achieve better contractual governance.
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2. Research framework
In the research framework we will present academic literature on control and on trust and risk, which have been recognized as determinants for control, in order to establish a theoretical framework for the remainder of this thesis. This study recognizes the notion of Eisenhardt (1989) that ideally there is no theory under consideration when conducting case studies, but in the interest of providing a framework on which to base the interview protocols we will shortly present both. As Eisenhardt (1989) admits, it is impossible of achieving this ideal of a clean theoretical slate. This does not mean that this study will withhold from searching for other explanations for the control embedded in the formal contract.
2.1 Control
Flamholtz et al. stated in 1985 that the literature on control can be characterized as confusing in regard to the meaning of the construct as well as the measurement of relevant variables (Flamholtz et al., 1985). Though the construct might be confusing in nature, the relevance of managing control in organizations has been widely recognized in academic literature. For example one of the more recent findings on control is that control is critical especially in situations in which parties have diverging interests (Santamaria & Surroca, 2011), as can usually be found in JVs and other types of inter organizational cooperation agreements. This study will focus on parent control, a specific type of organizational control. Organizational control can be defined as the business process by which organizational entities impact and motivate other entities to carry out collaborative plans to ensure that specific organizational goals are met (Kang et al., 2009; Rooney & Cuganesan, 2009). In turn parent control can be defined as the influence exercised by a partner over the JVs operations, and is used by parent firms to align the JVs activities and performance with their own venturing objectives (Chen et al., 2009). The next sections will focus on the dimensions of control and the types of control the parents can employ to reach their specific objectives.
2.1.1 Dimensions of control
Geringer & Hebert (1989) were the first to suggest that there are three dimensions or parameters which comprise JV control. Some prior studies have considered more than one parameter, though Geringer & Hebert (1989) argue that it appears necessary to consider all three dimensions of control in order to obtain an understanding of the control phenomenon for JVs. This study will employ the three dimensions of JV control: i.e. focus of control, extent of control and the mechanisms of control.
Focus of control
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confirmed by Schaan (1983) as he demonstrated that firms tend to seek control over strategically important activities.
This dimension of control can be found in contracts when a clause has been added stipulating the right of a parent to control a specific aspect of the JVs operations. For example a clause can be added that capital expenditures have to be approved by the shareholders meeting. This gives the parent companies the decision right to reject an investment decision made by the board of directors of the JV.
Extent of control
The extent of control is the degree of control achieved by the parents (Geringer & Hebert, 1989). It is the direct outcome of the controlling process, the degree to which we belief that proper behavior of the other party is ensured (Das & Teng, 1998). This dimension is also based on the studies of Killing (1983), who asked whether the decisions mentioned in the previous section where made by the general manager of the JV alone, by one of the parents alone, by the general manager with input from one of the parents or by both parents. This dimension is a significant contribution to the JV literature for it conceptualizes control as a continuous variable, rather than a dichotomous variable (Geringer & Hebert, 1989).
This dimension of control can be found in every clause of a contract. For example the capital expenditure decision mentioned earlier can contain the right for approval of only one parent, or can state that the general manager is allowed to make investment decisions without approval up to a pre-specified investment ceiling.
Mechanisms of control
The mechanisms of control are the mechanisms the parents use to exercise control (Geringer & Hebert, 1989). They are the organizational arrangements designed to determine and influence what organization members will do (Das & Teng, 1998). The objective of control mechanisms is to help achieve an adequate level of control (Das & Teng, 1998). According to Geringer & Hebert (1989) this dimension can be broken down into three components: i.e. content-oriented mechanisms, process-oriented mechanisms and context-oriented mechanism. Content-oriented mechanisms are typically bureaucratic in nature. The parents rely on direct interventions, either by top-managers or by the JVs board of directors (Geringer & Hebert, 1989). With process-oriented mechanisms, the parent firms exercise control through reporting relations or influence on the JVs decision-making processes (Geringer & Hebert, 1989) Context-orientated mechanisms encompass a variety of informal mechanisms and their purpose is to establish an organizational context appropriate for the achievement of parent company objectives (Geringer& Hebert, 1989). These components are closely related to three types of organizational control discussed in the next section, respectively output control, process control and social control.
2.1.2 Types of control
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have been used throughout control literature (Groot & Merchant, 2000; Das & Teng, 2001; Chen et al., 2009) by control researchers and are mainly based on earlier work by renowned scholars like Ouchi (Ouchi, 1979) and on the classic organizational control theory.
Output control
Output control focuses on defining the specific performance outcome goals that JVs should achieve (Kang et al, 2012). Output control measures and rewards outcomes and is based on output measurement (Chen et al., 2009). To exercise output control, parent firms specify explicit outcome requirements, measure the achievement of such requirements and exert rewards or penalties accordingly (Groot and Merchant, 2000; Das and Teng, 2001; Chen et al., 2009).
A specific example of an output control is a fine. A fine can be incorporated in a JV contract to ensure certain behavior by the JV. A fine is generally imposed when a specific predetermined outcome is not met. Other rewards or penalties commonly used in output controls are bonuses, empowerment and job security. All have in common that the reward or penalties are only imposed when a certain predetermined outcome is achieved. Firms must consider that these outcomes may be revised during the review period, the period in which predetermined outcomes must be reached, due to technological or market uncertainty (Kang et al., 2012).
Output control is closely related to the market mechanism described by Ouchi (1979). He describes a market mechanism as a device which precisely evaluates each person’s contribution and permits each to pursue non-organizational goals, but at a personal loss or reward (Ouchi, 1979). It requires a norm of reciprocity that assures that, should a party attempt to cheat another, the cheater, if discovered, will be punished (Ouchi, 1979). In the case of a JV this entails that the parent companies have the power to reward or punish the JVs management when they are not working in the best interest of the parent company.
Process control
Process control regulates the activities of the JV (Chen et al., 2009). Process control refers to all activities related to supervision, regular inspection, and non-regular inspection. (Kang et al, 2012). To exercise process control, parent firms specify the behaviors and processes in which the JV must engage, and monitor the implementation of such activities (Groot and Merchant, 2000; Cardinal, 2001; Chen et al., 2009). Process control is also referred to as behavioral control in the control literature (Das & Teng, 2001).
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Process control is closely related to the bureaucratic mechanism described by Ouchi (1979). He describes that a bureaucratic mechanism partly evaluates performance as closely as possible, and it partly engenders feelings of commitment to the idea of legitimate authority in hierarchies (Ouchi, 1979). It requires a norm of reciprocity and legitimate authority, that entails the acceptance of the idea that higher office holders have the legitimate right to command and to audit or monitor lower persons, within some range (Ouchi, 1979). In the case of a JV this entails the acceptance that the parent companies have the legitimate right to monitor and command specific processes in the JV.
Social control
Social control refers to the distribution and expression of shared values, beliefs, and goals through formal and non-formal communication channels, such as meetings and other forms of social communication (Kang et al, 2012). Social control influences the JV through social interactions, which facilitate shared values and common understanding between parent firms and the JV (Chen et al., 2009). Firms may focus on shared values, beliefs, and goals through social interaction and communication that further enhances the JVs motivation and commitment (Chen et al., 2009; Das & Teng, 2001).
A specific example of a social control is a task force. Social control requires a high amount of interaction and communication through organizational mechanisms such as rituals, ceremonies, teams, task forces and other socialization methods. (Baker 1993; Chen et al., 2009). All have in common that there is a high amount of interaction between employees of the JV and employees of the parent companies.
Social control is closely related to the clan mechanism described by Ouchi (1979). He describes that a clan mechanism attains cooperation by selecting and socializing individuals such that their individual objectives substantially overlap with the organization’s objectives (Ouchi, 1979). It requires a norm of reciprocity, legitimate authority and shared values and beliefs, which assures that there is a deep level of common agreement between members on what constitutes proper behavior (Ouchi, 1979).
2.1.3 Contracts and control
One of the common features of every firm relationship is that a contract is signed (Beave & Saussier, 2012). Contractual governance is the distribution of rights among parties to an alliance, stipulated through contractual means (Nielsen, 2010). The distribution of rights is a central determinant of alliance governance because it affects the possibilities for each partner to control the performance of activities within the boundaries of the relationship (Nielsen, 2010).
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More recent studies suggest that formal contacting might go hand-in-hand with informal contracting (Poppo & Zenger, 2002). Their paper shows that well specified contracts promote cooperation and long term relationships, rather than hindering or substituting relational governance (Poppo & Zenger, 2002).
2.2 Risk
Risk, risk perception, and risk management are acknowledged as critical in management and strategy research (Das & Teng, 2001). We will present risk and its relation to control, as suggested in their framework by Das & Teng (2001). This paper will withhold from discussing the proposed relation that control has on risk, which is also embedded in the framework. This is because this study is interested in the risk before the signing of the formal contract, at the moment of the establishment of the JV, when no control is yet in place.
Das & Teng (2001) distinguished between two dimensions of risk that are important in strategic alliances: i.e. relational risk and performance risk. These will be discussed in the next section, followed by a section relating risk to the contract.
2.2.1 Dimensions of Risk Relational risk
Relational risk in strategic alliances is defined as the probability and consequences of not having satisfactory cooperation (Das & Teng, 1996). Relational risk relates to a partner’s inability to capture a fair share of the rents generated by an alliance and arises from behavioral uncertainty of the alliance partner, coupled with investments in alliance-specific assets and incomplete contracts (Anderson et al., 2014; Dekker 2004). It is the chance that the partner in the alliance will behave opportunistically.
Das & Teng (2001), argue that, the lower the acceptable relational risk level, the more the parents will make use of behavioral and social control in an alliance. This means that if relational risk is perceived as high, the more the parents will rely on process and social controls.
Performance risk
Performance risk consists of factors that are out of the scope of control of the parent company. They include, but are not limited to, changing government policies, lack of competence of the partner firms and new entrants (Das & Teng, 2001). They account for the probability that the parent’s specific objectives are not achieved, despite satisfactory cooperation among partner firms (Das & Teng, 1996) The primary role of controls in mitigating performance risk is effective coordination (Anderson et al., 2014).
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2.2.2 Contracts and risk
A way to deal with the risks of opportunistic behavior in strategic alliances is to make use of formal contracts, which provide a framework for cooperation (Beuve & Saussier, 2012). Depending on how much risk alliances can accept, different levels of control are needed (Das & Teng, 2001). As noted earlier the lower the relational risk and performance risk, the more parents will rely on social, process and output controls. Therefore if the risk is relatively high, we can expect more clauses incorporating different forms of control in the formal contract.
2.3 Trust
Trust has been related to control and risk by various scholars (Das & Teng, 2001; Reed, 2001; Sydow, 1992). In the next section we will discuss trust and its relation to risk, as suggested by Das & Teng (2001). This paper will withhold from discussing their entire framework, for this study is solely interested in the possible relation that trust and risk have on the control imbedded in the formal contract signed at the establishment of the JV.
Trust is a coordinating device based on shared moral values and norms supporting collective co-operation and collaboration within uncertain environments (Reed, 2001). It can be defined as positive expectations regarding the other in a risky situation (Das & Teng, 2001) Trust is seen as a key element in cooperative relationships at the inter-firm level (Sydow, 1992). Das & Teng (2001) distinguished between two dimensions of trust: i.e. goodwill trust and competence trust, which will be discussed in the next section. This will be followed by a section relating trust to the contract.
2.3.1 Dimensions of trust Goodwill trust
Goodwill trust is about one’s good faith, good intentions, and integrity. It is about whether a firm has a reputation for dealing fairly and caring about its partner firm’s welfare (Das & Teng, 2001). Nooteboom (1996) stated that goodwill trust is a partner’s intention to perform according to agreements. Gulati (1995), states that goodwill trust can be formed through previous cooperation between the parent companies.
Das & Teng (2001) argue that a firm’s goodwill trust will reduce the perceived relational risk in an alliance. This means that goodwill trust will reduce the relational risk that managers believe their parent company takes when choosing to enter a JV. This in turn, as argued in the previous section, will also reduce the perceived need for behavioral and social control over a JV.
Competence trust
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Das & Teng (2001), argue that a firm’s competence trust will reduce the perceived performance risk in an alliance. This means that competence trust will reduce the performance risk that managers believe their parent company takes when choosing to enter a JV. This in turn, as argued in the previous section, will also reduce the perceived need for output and social control over a JV.
2.3.2 Contracts and trust
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3. Methodology
3.1 Type of research
This paper conducts research in the form of theory development. According to Eisenhardt (1989) development of theory is a central activity in organizational research. This study will follow the approach of van Aken, Berends & van der Bij (2012). This approach consists of four steps: (1) There is a business phenomenon that is not explained in academic literature (2) The observation of the phenomenon in one or more case studies (3) The development of explanations while comparing findings with existing theories (4) Provide propositions that are changes of or additions to existing theories.
The business phenomenon of interest in this paper is the role of the formal contract in controlling public sector JVs, and this will be observed by conducting a single case study. According to Yin (1994) case studies are well suited for answering ‘how’ questions, as is the case in this paper. Yin (1993) distinguishes between 3 types of case studies (i.e. exploratory, explanatory and descriptive research). This case study is exploratory in nature and will try to investigate a single situation, in order to provide insights to the researcher. The findings of this study will be compared to existing theories in the discussion section, where also the propositions will be provided.
3.2 Case selection & Background Case selection
In order for an organization to qualify to become a case in this study, it has to have at least one JV with another organization in the public sector and there must be a formal contract between the two parents stipulating the rights of each of the parents signed at the establishment of the JV. Furthermore the organizations that qualify must be willing to participate in the study and key members must be available during the time of the study. To guarantee that both parent companies where genuine public sector organizations the three commonly used criteria of Perry and Rainey (1988) where used: i.e. ownership, funding and mode of social control. This means that the ownership has to be public, the funding has to come out of public means and the mode of social control has to be on the polyarchy side of the continuum as opposed to the market side. This effectively excludes semi-public organizations to be taken into consideration.
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found and contacted by e-mail, of which two responded positively. After analysis one of them did not pass the three criteria of Perry and Rainey (1988) and was excluded. This resulted in the choice of Nieuwater (NWTR) as the case for this study1.
Case background:
Nieuwater (NWTR) is a 50/50 percent equity based public sector JV formed in 2004 between Waterschap Velt and Vecht (currently Vechtstromen) and waterleidingmaatschappij Drente (WMD). Both parent companies are public sector utility companies for different regions in the Netherlands of which Waterschap Vechtstromen is charged with the treatment of sewage and WMD with the quality and delivery of tap water. WMD is for fifty percent owned by the province and for fifty percent by the municipalities of their supply area, where Waterschap Vechtstromen is commonly referred to as the fourth tier of government. NWTR was created as a response to a demand for ultra-pure water from the private sector. The cooperation finally resulted in the construction of the pure water factory in Emmen. NWTR is further responsible for the operations and maintenance of the water factory of the Zoo in Emmen, the water treatment installation in Klazienaveen and the water treatment for greenhouses in south-east Drenthe.
3.3 Data collection
This study used multiple data collection methods. Eisenhardt (1989) states that triangulation made possible by multiple data collection methods provides stronger substantiation of constructs and hypotheses. Therefore we chose to conduct document analysis and to make use of semi-structured interviews for our data collection. Also research notes where kept during the entire research process, allowing every impression that occurred to be written down and to be checked against the gathered data.
Based on the theoretical framework 2 separate interview protocols have been created (See Appendix A & B). The interview protocols are set up to be semi-structured, for this allows the use of a structured approach while allowing emerging topics to arise. The first part of the interview protocol of the JV (Appendix A) is based on the literature on the types of control, while the second part is based on the literature on the dimensions of control and roughly confirms to the interview questions used by Killing (1983). The different types of decisions where based on the research notes of an informal meeting with the general manager of NWTR, to make sure that they were relevant for this case. The interview protocol for the parent company (Appendix B) was based on the literature about trust and risk. Both interview protocols have very broad opening and closing questions to allow for other ideas about the role of the formal contract in controlling the JV to emerge and to be discussed.
The interviews where recorded and where later transcribed. Interviewees received a copy of the transcripts in order to confirm their answers and increase controllability. The interviewees of the JV consisted of the general manager, the manager treatment plants, and the financial
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manager for NWTR. From the perspective of the parent companies two managers involved in the establishment of the JV where interviewed.
The documents for the document analysis where provided by the JV and found by searching the World Wide Web. They include, but are not restricted to: the formal contract, the code of the board of commissioners, the profile of the board of commissioners, the management by-laws and the records of board meetings of Velt and Vecht.
3.4 Data analysis
The transcripts of the interviews of the JV will be compared in the next section to the original formal contract, in order to establish the role of the formal contracts on the operational and strategic decisions being made in the JV. Yin (1994) states that multiple sources of evidence will enable the crosschecking of findings, making results more reliable and conclusions more convincing.
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4. Results
4.1 JV resultsIn this section we will present the results from the perspective of the JV. In general we can state that the formal contract, signed at the establishment of the JV is very broad and does not include a lot of specific controls. This is captured in the following quote:
“Look, the contract is not that exciting. Its main function is to guide the further cooperation, without putting in any limitations.”
As can also be seen in the paragraph of the formal contract relating to the goal of the JV: “The Joint Venture has as goal: The performance of any activity with relationship to the water cycle, in the broadest sense of the word.”
We will now present the results relating to the types and the dimensions of control.
4.1.1 Types of control Output control
There is made little use of output controls at NWTR. Only the shareholders perform this function in the annual GMS in respect to the financial statements. The formal contract stipulates their right of the GMS to approve the financial statements and discharge the directors and commissioners of their responsibility. Both parents are represented by one person in the yearly GMS; their role is captured in the following quote:
“And the role of the shareholders, they only have one role, which is the approval of the financial statements and determining the dividend payments. Of course you try to involve them with more aspects of the JV. So they are presented with the year plan and the policy plan. But formally they only have to meet once a year to approve the financial statement.” The formal contract stipulates more responsibilities for the GMS, as long as there is no BOC. But since there is a BOC, these responsibilities shifted to the BOC.
Process control
To a larger extent the parent companies make use of process controls. The BOC oversees these controls in the interest of the parent companies. They include the approval of budgets, investment decisions, and long term obligations. Both parents have one representative in the BOC; their role is captured in the following quote:
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In short the director needs approval for changes in every long term obligation or any changes in the budget that surpass a predetermined amount. An example from the formal contract relating to the need of approval of the BOC is the following specific point:
“The acceptance of settlements and compromises”
All these process controls have in common that they mainly focus on the strategic decisions being made in the JV and not on the operational decisions.
Social control
The parent companies heavily rely on social controls. All the personnel employed at the JV is secondmented from one of the parent companies, which means they all still fulfill a function at one of the parent companies. Also the supporting staff is hired from the parent companies. Furthermore the JV has its official seat in the same building as the WMD and the pure water factory is located directly next to the sewage treatment installation of Vechtstromen. This results in extremely short lines of communication. Also the secondment of personnel from the parent companies ensures that they already share the norms and values of the parent
companies. The precise allocation of personnel is summed up in the following quote:
“There is a contract for the secondment of personnel from both parent companies. Of this I’m also a part, so my 0.3 fte is set in that contract. For the rest there is another person for 0.83 fte from Vechtstromen. And I belief that 4.5 fte comes from WMD, but that is all part of a contract. … And that is for the secondmented personnel, there is also a lot of support staff we use from the WMD. Financial administration, documentation and information, legal, there are separate contracts for them. So we pay a predetermined sum a year to make use of their services.”
This contract, stipulating the secondment of personnel, was not part of the formal contract signed at the establishment of the JV. So this indicates that the formal contract provided a framework for the agreements made during the life of the JV.
4.1.2 Dimensions of control Focus of control
The formal contract has a strong focus on control over the power distribution between the parent companies, and on the financial aspects of the operations of the JV.
The focus on the control over the power distribution can be directly observed by looking at the number of related articles in the original formal contract. When studying the contract, we can observe that a third of all the articles deal with the issuing and obtaining of shares and certificates. These control the voting power during the GMS. A reason for this can be found in the following quote:
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This shows that the equivalence between the parent companies in the JV is seen as an
important factor for the success of the JV. And the formal contract in this respect provides the safeguard for guaranteeing an equal say in the operations of the JV.
The focuses on the financial aspects is shown in all the interview transcripts as in the provisions in the contract. For example there is permission needed for appointment or firing of staff with a salary above a certain amount, the acceptance of loans and the modifying and appointing of profit rights. This is also captured in the closing point of the paragraph with respect to the need of approval from the GMS or the BOC:
“In general, al the proceedings in which the interest of the JV exceeds a pre-specified set amount by the GMS…”
As in the following quote:
“Yes, it is part of the multi-year plan and the investments and budgets are part of it. This is approved by the BOC. The GMS approve the financial statements, so they are involved afterwards.”
This indicates that the finances of the JV are considered as important to the parent companies. The formal contract also stipulates the right of the GMS and the BOC to have control over some other aspects of the JV, but not to the extent as they focus the control on these 2 specific aspects. As a final note, nowhere in the formal contract or in the interview transcripts was indicated that one parent company had a different focus on the control over the JV, which suggests that both parent companies have an equal interest in the equal power distribution and the financial aspects of the JV.
Extent of control
The extent of control can be described in many respects as very mixed. For example the manager treatment plants states the following:
“No one assesses my performance here. It is not part of any assessment cycle. If the factory had a good year, I get a diner coupon from Gerrit, as a nice attention, but that’s just about it.”
Also the following quote shows a limited extent of control:
“There are agreements with regard to the budget. So I don’t exceed the budget with more than a hundred thousand euros. Else I first have to get permission from one of the two BOC members.”
In other areas there is more control on the operations as shown in the following quote:
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So exceeding the budged seems allowable to some regard as long as it is underpinned correctly. Furthermore these quotes indicate that there is more control on the part that was also highlighted in the focus of the formal contract, in respect to other areas.
Mechanisms of control
The mechanisms of control used in this JV are not limited to the formal contract established at the beginning of the JV. For example since the original formal contract there has been added the code for the board of commissioners, a contract for the secondment of personnel from the parent companies, a profile for the board of commissioners, and management by-laws. Though the original formal contract does proceed the agreements established later on. The position of the original formal contract is captured in the following quote:
“There is the original formal contract in which the general affairs are treated. Later on, the agreements become more specific with respect to the responsibilities of each party and there influence.”
This indicates that the original formal contract is set-up broad in order to facilitate the
cooperation. Later on the equal distribution of power protected in the original formal contract ensured that both parent companies had an equal say in the more specific formal agreements.
4.2 Parent results
In this section we will present the results from the perspective of the parent companies. In the methodology we indicated that we used deductive and inductive coding on the records of the board meetings of Velt and Vecht to look for other possible factors influencing the control embedded in the formal contract. This analysis resulted in no other factors than trust and risk to be found. Also no other factors where indicated in the answers to the broad opening and closing questions of the interview protocol. We will now present the results relating to risk and trust as well as an unexpected finding in regard to the reason to choose for a JV.
4.2.1 Risk Relational risk
The relational risk can be described as relatively low for both the parent companies. There was a business case before the establishment of the JV, which was judged as positive. This included the chance that the NAM was unable to fulfill their payment obligations, which was judged as null. Also the formal contract provided a framework for equal input on the strategic directions the JV would take. This is captured in the following quote:
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An input that was not considered to be equal was the specific knowledge both the parent companies put in to the JV. As is shown in the following quotes:
“Yes, our input was bigger. WMD has all the knowledge for the purification of water.” “Yes, the entire pilot, the tests and the ideas is a combination of Velt and Vecht and WMD. There are also a lot of smart people working over there. The knowledge in respect to wastewater comes from us; the knowledge in respect to purification comes from WMD. But, I think that the input of WMD was a bit bigger.”
Though this input was not equal, it was not considered as a higher risk for WMD. This is because the parent companies indicated they do not compete or see any possible case in which they would compete in the future. So it was indicated that there is no specific need to protect the knowledge input from either of the parent companies in the JV.
A relational risk that was considered important, but that was also judged as acceptable was the reputation of the parent companies. Failure of the JV would have been broadly broadcasted by the media, which could result in reputation damage for the parent companies:
“As a public organization you’re always under a magnifying glass from a political point of view. It’s something we always keep in mind. In general with these kinds of decisions you always have to be very careful and there is always someone watching.”
All these risks where captured in the business case and judged as acceptable before the start of the JV.
Performance risk
Also the performance risk was captured in the pre-mentioned business case, and judged as acceptable. For example the parent companies looked at the risk of earthquakes since the pure water factory would be built in a relative high earthquake area. Also the competence of the parents was judged, whether they would have or could produce the required knowledge needed to build this pure water factory. The thoughts about these risks are captured in the following quote:
“The image, the risks of the NAM, an earthquake area, yes, it was exciting. At a certain point we decided that we could take these risks.”
The interviewees indicated that this was also captured in the business case and judged as acceptable before the start of the JV.
4.2.2 Trust Goodwill trust
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there is no competition between the parent companies, nor is it thought that there ever will be. This influenced the way the parent companies perceived each other, as described in the following quote:
“It’s a completely different world. We treat dirty water; they pump up clean water and deliver it, so no, we’re never in each other’s fairway. So what is there to protect if in the end you are all accountable to the public”
The results show us that trust relating to the goodwill of the parent companies was relatively high. The interviewees also both indicated that the goodwill trust likely affected the way they judged the risks in the case study.
Competence trust
Also the competence trust between the two parent companies can be described as high. The parent companies had successfully worked together in previous projects and where aware of each other’s capabilities and resources. This is captured in the following quote:
“They already had a reasonable service record. They exploited a couple of factories, including the zoo, two irrigation water projects, a factory in northern Klazienaveen. So that they were capable was well known. There was no doubt whatsoever about their capacity, knowledge, or skills.”
A similar statement was made in the interview with the other parent company. This shows us that trust relating to the competence of the parent companies was relatively high. The
interviewees also both indicated that the competence trust likely affected the way they judged the risks in the case study.
4.2.3 Reasons for a JV
An unexpected result from the interviews that is worth mentioning is the reason to start a JV. The reason was not indicated to have an effect on the control embedded in the formal contract, but did shine an interesting light on the choice for the type of cooperation. This is best
captured in the following quotes:
“Exploiting commercial activities, as well as for the government as for the WMD is simply not done. You have the NMA, the Dutch Competition Authorities, etc. And what if NWTR makes a loss, should the parents than pay for the losses, that is simply not possible. …… So yes, uncoupling, letting 2 separate public organizations work together efficiently. I belief that in that case a JV is the best option available.”
“Yes, you have to separate it for 100 percent. We are not allowed to exploit commercial activities, nor is Velt and Vecht.”
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5. Discussion
In this section we discuss the results presented in the previous section in the light of existing theories.
5.1 Control
In the results we showed that there is a low reliance on output controls and a higher reliance on process controls in the formal contract of the establishment of the JV. Furthermore we showed that there was a high reliance on social controls, but that type of control was no part of the original formal contract. Furthermore we looked at the focus and extend of control and indicated that both where limited. Finally we showed that there where different mechanisms of control, next to the original formal contract, and that the basis of equality in the formal contract facilitated these agreements. According to transaction cost economics (TCE) (Williamson, 1975, 1985) relations that involve specific investments bring dependence and vulnerability to opportunistic behavior. From this point of view we should have seen all types of control and no limited focus and extend. We will take a deeper look into this in the next sections, as we discuss the factors that influenced the control embedded in the formal contract.
5.2 Risk
The results indicated that the formal contract signed at the establishment of the JV was used as a basis for future agreements in the JV. This was possible because the formal contract is based on equality; both parent companies have an equal say over the future directions the JV takes and an equal share in the financial benefits from its operations. Both parents are represented by one person in the yearly GMS and have one representative in the BOC, both with equal voting power. This equal equity based division of power incorporated in the formal contract seems to facilitate adjustments to the types, the focus, the extent and the mechanisms of control during the JV lifespan. In relation to JVs where this division of power is not equal, for example 51/49 percent equity based JVs; the parent who controls the lower share has a higher risk regarding opportunistic behavior. For the parent with the larger share has the ability to use his weight to change all kinds of informal agreements. In such a situation we can expect more controls incorporated in the formal contract. This leads to our first proposition:
Proposition 1: Formal contracts based on equality in public sector JVs will contain fewer
clauses for controls in relation to formal contracts where one parent has a larger say, as the parents perceive a lower total risk, and control can be established later on during the lifespan of the JV.
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The formal contract based on equality was a result of an equal financial contribution of both the parent companies at the establishment of the JV. It would be realistic to assume that the formal contract would not be based on equality if the financial contribution of both the parent companies had differed, for this would result in a higher risk for one of the parent companies. The results also showed that the contribution in specific knowledge of both the parent companies was not equal. Both the interviewees of the parent companies stated that the input of specific knowledge of WMD for the JV was higher. Though, this did not result in inequality in the formal contract or more control for WMD. This can be explained by the lack of current or future competition between the parent companies. Since the parent companies do not and will not compete in any area, there is no need to protect the knowledge that is put in to the JV. This leads to the second proposition:
Proposition 2: A difference in the contribution of specific knowledge of the parent companies
will not influence the power distribution in the formal contract of public sector JVs, for the absence of competition, now or in the future, will remove the risks involved.
This proposition is in accordance with TCE (Williamson, 1985), since the lack of competition removes the risks, and thus the need for more control by one of the parent companies. This proposition will not be true for the private sector, for there will always be the possibility of one of the parent companies to start competing with the other in the private sector, even though they might not be competing at the start of the JV.
The results further showed a high focus on the financial aspects of the JV. This can be explained by the relational risk the parent companies took by establishing a JV. As indicated in the results, the parent companies are always under a magnifying glass from a political point of view. The expenditure of taxes has to be substantiated or it could result in unwanted media attention, and finally have consequences for the job security of the managers involved. This leads to the following proposition:
Proposition 3: Formal contracts in public sector JVs will always have a high focus on the
financial aspects of the JV, for unsubstantiated expenditures of taxes could result in unwanted media attention and finally have consequences for the job security of the managers of the parent companies.
This proposition is in accordance with TCE (Williamson, 1985), for a higher risk results in more control. In relation with the private sector this proposition is not always necessary the case. Parent companies in the private sector could focus on other aspects, depending on the specific goals the parent companies have for the JV. For example, a JV in which the parent companies are in a learning race, as described in the paper by Hennart & Zeng (2005), could to some extend ignore the financial aspects of the JV, since the final goal is to outlearn the other parent and become independent of the other parent company.
5.3 Trust
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that trust is no reliable safeguard to opportunistic behavior (Woolthuis et al., 2005; Williamson, 1985). From this point of view we should expect, even though there is a high level of trust between the companies, that the contracts signed at the establishment of the JV would include very high levels of control, stipulating every right of the parent companies and protecting every asset that the parent company contributed to the JV.
The results showed contrary to this point of view that there is a very low reliance on control in the formal contract. Most of the controls where put in place after the establishment of the JV and only to a limited extend (i.e. primarily on strategic decisions and financial aspects). Bradach and Eccles (1989) took a sociologist view to this relationship, and hypothesized that trust can successfully substitute contracts. Although we do not want to go that far with the results from our case study, we do endorse the proposed relationships of Das & Teng (2001) that goodwill trust and competence trust reduce the perceived relational and performance risk of the parent companies. This leads to the following two propositions:
Proposition 4: Relative high levels of goodwill trust will lower the number of clauses for
control in the formal contract of public sector JVs due to a decreased perceived relational risk.
Proposition 5: Relative high levels of competence trust will lower the number of clauses for
control in the formal contract of public sector JVs due to a decreased perceived performance risk.
The propositions of Das & Teng (2001) where mainly based on literature on the private sector. The results allow us to extend these propositions to the public sector, thus making them independent on the sector in which the parent companies operate.
In the previous section we discussed a formal contract based on equality. A formal contract based on equality can have some additional risks which need to be considered. If the contract is incomplete, as was the case at NWTR, and control has to be established during the lifespan of the JV, you must be able to trust that both parents involved can come to an agreement on the remaining controls. If both parent companies are unable to come to an agreement this could result in a gridlock, where the operations of the JV could be seriously hampered by the inability of the parent companies to work together. The case company showed that there was a high level of competence and goodwill trust between the parent companies, which was a result of earlier cooperation between the parents. Goodwill trust is required for the parent companies to belief that the other parent will not use the threat of gridlock to her advantage in the establishment of the untreated controls of the formal contract. Competence trust is required for the parent companies to belief that the other parent is aware that an inability to come to future agreements could seriously hamper the operations of the JV. This leads to our sixth proposition:
Proposition 6: A prerequisite for an incomplete formal contract based on equality in public
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6. Conclusion
6.1 FindingsThis thesis started out with the question: ““How does the formal contract play a role in
controlling public sector Joint Ventures?” By taking an in-depth look into a public sector JV
through a single case study and by making use of both documentation analysis and semi-structured interviews the researcher tried to answer this question, both from the perspective of the JV and from the perspective of the parent companies. While the use of a single case study urges us to be careful, the results indicate that equality based original formal contract in the public sector has a limited need for control and mainly function as a framework for future agreements and control in public sector JVs. Furthermore both goodwill and competence trust are indicated to have an indirect role on the control embedded in the formal contract, through their influence on the perceived risk of the cooperation. By discussing the results this study came to six propositions. These propositions are partly contributions to existing propositions, extending them to the public sector, and partly new propositions on the role of the formal contract in controlling public sector JVs. The new propositions in turn are partially specific for the public sector, though some might be extended to the private sector.
This study contributed to the literature in the field of organizational control by showing that both TCE and the sociologist view to some extend hold merit on how the formal contract plays a role in controlling a public sector JV. It further contributes to the proposed framework of Das & Teng (2001) by acknowledging two of their propositions for this specific case study. Finally it contributes to future research in the field of organizational control by providing directions in the final section of this paper.
The managerial contribution of this paper is evident in the results of this case study. This paper showed that there is a limited need for control in the original formal contract if the contract itself is based on equality. Such a contract provides a framework for future agreements on both the directions and the control of the JV. So managers might choose for an incomplete formal contract based on equality at the start of the JV, if they wish to have more maneuverability during the lifespan of the JV, without the loss of control. Such a contract can provide this room for maneuverability, since there is no direct need for every possible risk of opportunistic behavior by a dominant partner to be locked in from the start. Furthermore more risk adverse managers might note that both goodwill and competence trust might result in a lower perceived risk of entering a JV, and try to factor this out when conducting their own business case.
6.2 Limitations
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gathering. Also the high reliance on interviews might be viewed as a limitation, though we tried to mitigate this by conducting simultaneous documentation analysis.
6.3 Future research
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Acknowledgments
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Appendix A: interview protocol JV (Dutch)
Ten eerste wil ik u graag bedanken voor het vrijmaken van uw tijd voor dit interview. Ik zal even kort toelichten waar dit interview precies over gaat. Voor mijn master thesis voor de studie Organizational and Management Control aan de Rijksuniversiteit Groningen onderzoek ik de rol die het formele contract van de oprichting speelt op de controle bij publieke sector joint ventures. Ik ben met dit interview specifiek opzoek naar of en hoe de beslissingen die binnen Nieuwater bv worden gemaakt worden beïnvloed door de afspraken die zijn gemaakt door de moedermaatschappijen in het contract van de oprichting van de joint venture. Graag zou ik in dit interview dieper met u op dit onderwerp ingaan.
Hebt u er bezwaar tegen als dit interview wordt opgenomen? De opnames worden enkel gebruikt voor deze thesis en zullen daarna gewist worden. Een uitwerking van het interview zal u worden toegestuurd ter controle en goedkeuring.
Hebt u nog vragen voor aanvang van dit interview? Naam geïnterviewde:
Datum:
Tijdstip van aanvang:
Inleidende vraag:
1. Zou u een korte omschrijving van uw functie kunnen geven?
2. Hoe heeft in uw ogen het contract van de oprichting van de Joint Venture invloed op de beslissingen die u maakt in uw functie bij NWTR?
Control types:
Output control (focus on the outcomes of the joint venture)
3. Zijn er in het contract specifieke doelstellingen bepaalt waar u mee te maken heeft? (welke? voorbeeld?)
In geval van nee, ga door naar vraag 6.
4. Hoe worden deze doelstellingen gemeten? (voorbeeld? Gespecificeerd in het contract?) 5. Heeft het behalen van deze doelstellingen consequenties voor u? (Wat voor? Voorbeeld? Gespecificeerd in contract?)
6. Zijn er specifieke doelstellingen voor de JV bepaalt? (Welke? Hoe zijn deze bepaalt? Gespecificeerd in het contract?))
Process control (regulates the activities of JV operations)
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In geval van nee, ga door naar vraag 10.
8. Hoe wordt er toezicht gehouden op deze activiteiten ? (voorbeeld? Gespecificeerd in contract?)
9. Heeft het schenden van deze beperkingen consequenties voor u? (Wat voor? Voorbeeld? Gespecificeerd in contract?)
10. Is er toezicht met betrekking tot de activiteiten die u in uw functie kunt uitvoeren? (Welke? Welk? Hoe zijn deze bepaalt?)
Social control (influence the JV through social interactions).
11. Zijn er in het contract of elders afspraken gemaakt over sociale interacties of
samenwerkingsverbanden tussen werknemers van de JV en de moedermaatschappijen? (Wat voor? Hoe gespecificeerd?)
12. Deelt de JV naar uw mening dezelfde normen en waarden als de moedermaatschappijen? (hoe zijn deze gerealiseerd?)
13. Bestaat er naar uw mening een goede onderlinge verstandshouding tussen de JV en de moedermaatschappijen? (Wat veroorzaakt dit?)
Dimensions of control
Focus of control (scope of activities over which parents exercise control)
14. Zou u van de volgende verschillende soorten beslissingen kunnen aangeven of 1 of beide moedermaatschappijen hier toezicht ophouden?
1. Kapitaal uitgaven 2. Budgettering
3. Vervanging van managers 4. Promotie van managers
5. Het aannemen van nieuw personeel 6. Nieuwe bedrijfsactiviteiten
Extent of control (degree of control achieved by the parents)
15. Zou u van de activiteiten waar u hebt aangegeven dat 1 of beide moedermaatschappij hier toezicht op houden kunnen aangeven in hoeverre deze controle gaat? (Praktijkvoorbeeld?)
Mechanisms of control (mechanisms the parents use to exercise control)
16. Zou u van de activiteiten waar u hebt aangegeven dat 1 of beide moedermaatschappij hier toezicht op houden kunnen aangeven of dit in het contract gespecificeerd is.(hoe anders?)
