public-private joint venture GasTerra

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ii

Management control system within the

public-private joint venture GasTerra

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Management control system within the public-private joint venture GasTerra

Master Thesis, MSc Organization & Management Control University of Groningen, Faculty of Economics and Business

December 29

2014 T. de Boer S2224771

Evertsenstraat 5 9801 GK Zuidhorn Tel.: + 31 6 455 145 25 e-mail: t.de.boer.14@student.rug.nl

Supervisor University D.M. Swagerman

Supervisor GasTerra

W. Bousema

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Preface

On the occasion of writing a graduation thesis for completion of the Msc O&MC program I was given

the opportunity to conduct a research assignment within the joint venture of GasTerra. Under

supervision of the manager financial reporting within GasTerra, Willem Bousema, I was able to

perform research on the management control system within this joint venture. From the start of the

project and during the process I focused on studying existing research, company documents and

performed interviews with both internal personnel as well as external shareholders. The process

appeared relatively flexible due to the support of different employees within the department and

GasTerra in general, as well as the openness of different external shareholders. For all the support,

guidance and clarifying insights I would like to thank all participants, colleagues and other

employees, as well as both supervisors - Willem Bousema from GasTerra and Dirk Swagerman from

the RuG.

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Abstract

In this study the management control system within the joint venture GasTerra has been examined.

Several theoretical notions provide guidance on what is regarded as an optimal form for management control frameworks. The central aim of this research was to provide clarity on the structure of the current management control system considering objectives/interests of the four shareholders and based on this provide possible improvements. Data was gathered both from existing research, company documents as well as internal and external interviews. Some of the theoretical expectations stated beforehand are confirmed. However conclusions cannot confirm all notions. Based on the research outcomes recommendations are made and theoretical and practical implications, together with future research directions are discussed.

Key words: management control system, control mechanisms, control focus, control tightness, joint

venture, public-private joint partnership, energy business.

1

Table of content

Introduction 3

1. Company description 5

Mission statement 6

Vision 6

Strategy 7

Shareholders 7

Shell Nederland B.V. 8

Esso Nederland B.V. 8

EBN B.V. 8

Dutch government 8

Governance 9

Energy transition 11

Research motivation 11

Research approach 12

2. Theoretical framework 14

Partnerships 14

Joint ventures 16

PPP & joint ventures 18

Production sharing agreements 19

Management control systems 20

Objectives 26

Fit between joint venture and parent business 26

Performance 26

Trust 27

GasTerra 27

3. Methodology 32

Research type 32

Qualitative research 33

Case study design 33

Interview method 35

Analysis 36

4. Research 37

Conducted interviews 37

5. Conclusions 39

The current form of management control within the joint venture of GasTerra 39

Control mechanisms 40

Control focus 42

Control tightness 42

Establishment of the current form of management control 43 Variables of influence on the management control system 43

Objectives and management control 44

2 Fit between the parents’ and GasTerra’s business and management control 44

Joint venture performance and management control 45

Trust among partners 45

Influences of the public-private partner combination 46

6. Recommendations 47

Theoretical implications 48

Practical implications 49

Limitations and suggestions for future research 49

Finally 50

References 51

3

Introduction

In the past decades many researchers have focused their attention to the combination of management control and joint ventures. “Management control systems are fundamental to all organizations, making the concept of organizational control central to theories of organization and strategy” (Chen, Park and Newburry, 2009, p. 1133).

Until the 1950s, organizational control was primarily focused on costs and finances, with a lead role for budgets and cost accounting systems. During the mid-sixties this focus shifted towards planning and control based on broad information (Claes, 2008). Control has many definitions and is interpreted in various ways by different researchers. Additionally, many of the terms are used interchangeably by various authors; for instance management accounting, management control systems or frameworks and organizational control. Management control in the research of Geringer and Hebert (1989) refers to “the process by which one entity influences, to varying degrees, the behavior and output of another entity through the use of power, authority and a wide range of bureaucratic, cultural and informal mechanisms” (p. 236). Cäker and Siverbo (2011) state the essence of control is affecting behavior. Management control in specific, encourages, enables and forces both management and employees to divert their attention towards the interests of the organization.

More recently Tillema (2013) adds to these definitions by stating management control is a continuous process of close observations regarding the fluctuations in processes, and the best way to deal with these fluctuations. In this paper we will use the term management control system, or management control in short. The term management control encompasses all devices and/or systems as used by management to control work processes, and ensure employee behaviors and decisions are accordant with the specified organizational objectives and strategy (Merchant and Van der Stede, 2007; Tillema, 2013).

A joint venture can be defined as a partnership, formed by at least two separate parent

organizations, in order to gain one or more advantages. Some known advantages of engaging in a

joint venture construction are the gain of new resources, new customers, economies of scale,

increase in market share and/or to reduce risk (Groot & Merchant, 2000; Kamminga & Van der Meer-

Kooistra, 2007). The first author to recognize potential conflict from the joint venture construction,

and perform research on the topic of joint ventures in general and control within joint ventures in

particular, was Malcom W. West (1959). The interest in the (research) topic of joint venture

corporations originated from the growing number of partnerships across organizational boundaries

as found in various industries. In contrast to some of the more obvious advantages, joint venture

4 constructions also bring about challenges for the different parent companies. Compared to single- owned organizations, a joint venture is a so-called hybrid organizational form in which the parents have to share and divide not only the benefits, but also the control issues of the partnership (Yan and Gray, 2001). The cooperation of two or more parents makes a joint venture difficult to manage, which is often a cause of poor or deteriorating performance (Geringer and Hebert, 1989).

Even though there has been extensive research in the field of management control systems and joint

ventures, more attention could be paid to public-private partnerships; joint ventures with

shareholders that originate both from the governmental/non-profit sector as well as the profit

sector. GasTerra is a perfect example of such a public-private partnership. The starting point of this

research is a practical matter; an existing management ‘problem’ within the joint venture of

GasTerra.

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1. Company description

The business activities of GasTerra

date back to the early sixties, and all started with the discovery of the ‘Groningenveld’ in 1959 and the subsequent rise of natural gas. The Nederlandse Aardolie Maatschappij (NAM) discovered the natural gas reserves in Groningen - Slochteren - in 1959. In the years following these reserves - around 2800 billion cubic meters - appeared to be the largest natural gas reserve ever found in the world. In order to extract, store, transport and market such a vast amount of natural gas, coordination of extraction, transportation and distribution became inevitable.

To ensure adequate distribution and production of the natural gas resources, the Dutch state drafted a perpetual collaboration agreement between the NAM, and the newly founded joint ventures Maatschap Groningen (extraction) and Gasunie (distribution) in 1963. Together, these three parties form the ‘Gasgebouw’. This perpetual collaboration agreement contains all arrangements made between the different parties involved. From the start, the objective of GasTerra (separated from Gasunie in 2005) has been to maximize the value of the Dutch natural gas reserves.

Within ten years after the discovery of the Groningenveld around 75% of all Dutch households transferred from the use of coal and oil to the use of relatively clean natural gas. Hereafter, industrial organizations, electricity companies and others realized the great potential of natural gas. It was in these years that the basis for European use of natural gas was developed. In the years following - throughout the seventies, eighties and nineties - the value of natural gas kept increasing due to several oil crises and increasing environmental awareness. When society recognized natural gas as a long term source of energy, the ‘kleinevelden’ policy was established. Natural gas from smaller fields was, and still is, recovered prior to/in combination with gas from the Groningenveld, in order to strategically stock gas for future purposes. In later years a more cautious energy policy emerged leading to a more sustainable use of and focus on energy in The Netherlands. At this moment 98% of all households in The Netherlands is supplied with gas and around 50% of all electricity in The Netherlands is produced in natural gas-fuelled plants. GasTerra buys natural gas from (inter)national suppliers and sells this product to large industrial consumers, energy suppliers and foreign customers.

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www.gasterra.nl

6 Figure 1 - ‘Gasgebouw’

The figure above, figure one, graphically displays the Gasgebouw and all parties involved in its

current structure.

Mission statement

The mission statement of GasTerra is “maximization of value of Dutch natural gas”. In doing so, GasTerra has a public responsibility in executing the governments’ ‘kleinevelden’ policy - a policy stimulating the production of natural gas from smaller gas fields.

Vision

Economic value and social importance of natural gas in The Netherlands are at the basis of GasTerra’s business as supplier of natural gas in the Netherlands and EU. Therefore the organization strives for a safe and efficient use and development of natural gas. Subsequently, GasTerra recognizes the value of sustainability, keeping both economic and ecologic interests in mind.

Customer-, result-, and improvement-orientation are three core values at GasTerra. Additionally, all

employees work in accordance with a behavioral code in which integrity and respect are leading. As a

7 whole, the organization strives towards long term relations. Consequently, the organization focusses on corporate social responsibility (CSR) through “Gas, Green, and Groningen” - corporate results, responsible energy transition and being part of the community of Groningen.

Strategy

The organization implements the preceding mission statement and vision by maximally exploiting the EU market, especially in those sections where the demand for natural gas is combined with a demand for supplementary services. If necessary, natural gas from foreign gas reserves is bought and sold. In all services GasTerra aims to be a reliable and competitive supplier for customers and at the same time the organization aims to improve its position in the market.

Shareholders

Today, GasTerra is an internationally operating trading company in natural gas, primarily focused on the European market. Additionally, GasTerra offers services connected to the trade of natural gas.

The organization has a strong market position due to its experience of over 50 years.

Figure 2 - shareholders

GasTerra has a limited liability due to its joint venture structure with four shareholders; Shell

Nederland B.V. (25%), Esso Nederland B.V. (25%), EBN (40%) and the Dutch government (10%). A

graphic display of this structure can be found in the figure above.

8 Shell Nederland B.V.

Shell

is a group of energy- and petrochemical organizations operating worldwide in over 70 different countries, with headquarters in The Netherlands. As one of the most prominent power companies in the world, Shell focusses on detection and extraction of both natural gas (50% of the total production) and petroleum. The organization plays a key part in energy supply and helps to provide in the worlds’ ever-growing energy demand in an economically-, socially- and environmentally- responsible manner. Their policy is to increase their business in a sustainable way and at the same time provide a competitive return for their shareholders, while also contributing to a responsible completion of the worlds’ energy demands. Shell Nederland B.V. has a 25% share in the GasTerra joint venture.

Esso Nederland B.V.

ExxonMobil

is the eldest, still operating, oil company in the Benelux. In over a hundred years the company has adapted itself to its changing environment and transformed into what it is today. From a regional marketer of kerosene in the U.S. to the largest traded petroleum and petrochemical enterprise in the world. One of their most interesting issues is energy supply. Via the NAM and GasTerra, ExxonMobil within The Netherlands is involved in detection, extraction, sale, and supply of natural gas and petroleum. Esso Nederland B.V. has a 25% share in the GasTerra joint venture.

EBN B.V.

Together with national and international oil- and gas industries, EBN B.V.

is active in detecting, producing, storing and trading gas and oil. The focus of EBN is on investment, facilitation and knowledge sharing. Additionally, EBN has shares in gas pipelines in the ocean, underground gas storages and a 40% share in GasTerra. The organization is looking to make a contribution to a stable and sustainable energy supply in The Netherlands. All profits EBN B.V. makes are completely transferred to the Dutch government - represented by the minister of economic affairs - the sole shareholder of this partner.

Dutch government

The Dutch government

has a 10% share in GasTerra. About half of the complete energy supply in The Netherlands comes from natural gas. All companies that have ambitions to extract natural gas in The Netherlands need permission from the government in the form of a collaboration agreement. As

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www.shell.com

3

www.exxonmobil.com

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www.ebn.nl

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www.rijksoverheid.nl

9 much as natural resources are beneficial to The Netherlands, and the government, there are downsides to natural gas as well. For instance, as a consequence of gas extraction there have been several small earthquakes. Therefore the Dutch government had to establish a cut-off amount for gas extraction from the Groningenveld.

For more information on GasTerra, Shell Nederland B.V., Esso Nederland B.V., EBN B.V., and the Dutch government, their products and their services, consult the following websites:

www.gasterra.nl www.shell.nl www.esso.nl

www.rijksoverheid.nl

Governance

When we look at the governance of an organization, the use of two-tier boards is conventional in

European countries. A so called two-tier board means the organization has both a management

board, also called the executive board or board of directors, as well as a supervisory board that exist

side by side. Generally, the board of directors - all executive members - is responsible for the daily

management of the organization and acts independently. The supervisory board - all non-executive

members - in the two-tier structure is limited to supervisory functions (Jungmann, 2006). It is only

since 2013 that it is possible for Dutch organizations to implement a one-tier board, also called a

unitary board, which is more common in for instance Britain or the US (www.ondernemersplein.nl,

2014). With a one-tier board the organization chooses a single-layered (monistic) governance

structure in which supervisors are part of the organizations’ board. Organizations that choose to use

a one-tier model thus have one board in which both the executive board/board of directors as well

as supervisors are seated (Jungmann, 2006). Partly due to the complex structure of the Gasgebouw

in which GasTerra has a function, the governance structure of the joint venture is extensive. In

general the governance structure can be gathered under a two-tier structure, however it has some

additions to the basics.

10 Figure 3 - governance structure

A complete overview of the governance structure of the organization is graphically displayed in figure three. At the bottom is the CEO who is the director of the joint venture, appointed by the general meeting of shareholders as displayed above the supervisory board. This appointment is based on a binding nomination made by the supervisory board. Additionally, this nomination requires approval by the minister of economic affairs. Legally the CEO of the joint venture performs the role of the managing director of the joint venture. The managing board consists of the CEO, the CFO, the COO and the CCO. The managing board exercises decisions within the joint venture under the control of the supervisory board. The supervisory board (RvC) of the joint venture consists of eight members.

One of these members is appointed by the minister of economic affairs. This member is complemented by two members representing Shell, two members representing ExxonMobil and three members representing EBN. Out of these eight members the board chooses one chairman which again has to be approved by the minister of economic affairs. Five of the eight members of this supervisory board are also member of the board of delegated commissioners (CvG). The board of delegated commissioners has an important role within the joint venture. All mandate proposals regarding the general business of the joint venture have to be approved by this board (www.gasterra.nl, 2014; Gastel, Van Maanen and Kuijken, 2014). This significant influence of the

Advies Commissie van Aandeel- houders (AvA) Raad van Commissarissen

(RvC)

Advies Commissie Capaciteitsmaatre

gelen (ACC) Audit

Commissie (AC)

College van Gedelegeerde Commissarissen (CvG) Algemene Vergadering van

Aandeelhouders

Minister van Econ. Zaken

GasTerra

CEO (1) goedkeuring en verantwoording (2) goedkeuring (2)

advies (3)

Informatie uitwisseling (3) delegatie en

verantwoording

overleg tussen commissies van aandeelhouders en GasTerra (3) College van Beheer Maatschap

advies (3)

advies (3) advies (3)

Overleg tussen AC en GasTerra (3)

11 board of delegated commissioners on GasTerra policy is a particular feature of the governance structure and results in a deviation from the conventional two-tier board.

Energy transition

The energy industry in general and the gas industry specifically is facing a fast and important transition. The environment is changing due to liberalization and internationalization. The demand for energy is ever increasing, as well as attention for environmental concerns. Aside from all the advantages of natural gas, there is a downside as well. A recent series of light earthquakes shocked the Groningenveld site, and future, more powerful earthquakes cannot be ruled out. Together with exhaustion of natural resources, this leads to a need for sustainable energy and a transition into a non-fossil era. In the opinion of GasTerra natural gas is the indispensable link in the transition to a CO

neutral supply of energy. It provides the resources to flexibly complement solar- and wind energy when these appear insufficient, and most importantly: natural gas is the cleanest safe fossil fuel available at this moment. To accomplish the necessary transition, GasTerra supports new initiatives and innovative energy application technologies by sharing knowledge, starting projects and financial support to develop, introduce and implement new technologies.

In 2000 the so called ‘Gaswet’ was introduced by the Dutch government. This law states that as of July 2004 all recipients are free to choose a gas supplier of their choice. Up until that moment, smaller consumers could only purchase gas from their local supplier. For larger consumers this obligation was dropped in 2002. As a consequence of the liberalization Gasunie and GasTerra were divided in 2005. Since this split, Gasunie became a 100% government owned organization and is now sole owner of the national gas transport network. GasTerra became the independent trading company.

Research motivation

The financial reporting department of GasTerra recognized there is ambiguity in the current

management control system and is looking to improve this system in such a way that the underlying

rationale of the system becomes clear, and if necessary, the system can be refined to attend to the

various interests of the different shareholders. Additionally, there has been recent attention to the

developments within the organizational context such as maturation of de market, more attention for

corporate governance and geopolitical developments. Topicality furthermore shows from the recent

attention the Gasgebouw in general and GasTerra in specific have received in newspapers regarding

modifications/restructuring on the short term, and on the long term demolition of the Gasgebouw.

12 There is a recent discussion regarding the continued existence of the current agreements within the Gasgebouw (Den Brinker and Willems, 2014). Moreover, recent research performed by Van Gastel, Van Maanen and Kuijken (2014) commissioned by the minister of economic affairs addressed related topics. These authors focused on the governance structure, in current and future society, of the Gasgebouw in relation to its changing context. In sum, this practical issue matches the aforementioned theoretical research gap as GasTerra is a joint venture cooperation of the Dutch government and several profit organizations. This has resulted in the following research statement:

In what way can GasTerra structure its management control system considering objectives/interests of Shell Nederland B.V., Esso Nederland B.V., EBN B.V. and the Dutch government.

Research approach

This construing research aims to clarify the aforementioned practical matter by following the so- called problem-solving cycle (Yin, 2003; Van Strien, 1997; Dewey, 1910; Hedrick, Bickman and Rog, 1993; Easterby-Smith, Thorpe and Lowe, 2002; Saunders, Lewis and Thornhill, 2007). This practical matter should be interesting to examine and should not have been adequately addressed in existing literature. “In related literature streams it is not clear how to deal with the type of business problem.

So, at least the ‘how’ question is a gap in the academic literature.” (Yin, 2003, p.8). Next, the practical matter and its context within GasTerra are analyzed and the main causes of the ‘problem’ are established. A sequential solution focuses on the problem causes found within this specific case and the design must tackle the most important ones. This solution can be implemented within GasTerra, afterwards evaluated and by the different departments involved such as financial control and financial reporting, and if necessary, redesigned. The final step in the process of general academic problem solving based on the problem-solving cycle moves beyond this point to a more aggregate level. Through generalization across different cases the specifics of GasTerra are removed and future research could test the propositions to provide possible solutions to a generic type of business problem at other organizations.

In order to find and answer to the abovementioned research statement, a singular case study

research within the joint venture of GasTerra will be conducted. Case studies in general are known to

answer ‘how’ questions and focus on depth rather than width. An advantage of this type of research

is the overview the researcher obtains, in this case the broad insight regarding the different

shareholders. The context of the situation is well documented and identified. Additionally, this type

of research demands less structure before the actual research is conducted which leads to an open

13 research question that can be adjusted during the course of the research. This makes the process more flexible to changes when these are desirable. Finally, outcomes of case study research, and in the case of GasTerra possible recommendations, are more likely to be accepted by ‘the field’ since the results are often identifiable - a necessity when changes have to be made (Verschuren and Doorewaard, 2005).

In short, interviews with financial experts of all four shareholders will be conducted, as well as interviews with two internal experienced financial experts and the CFO of GasTerra. The interviews will be open, unstructured and non-directive in order to retain the opportunity of gaining additional insights. Because the research is focused on a single case, internal validity is an issue of caution.

Therefore, the aim is to use additional sources of information e.g. internal document and employee

insights. A more detailed description of the research process can be found in the methodological and

research section of this paper on pages 32-36.

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2. Theoretical framework

In this part of the research theory regarding partnerships, joint ventures, and management control systems as well as case specific theory is addressed and the research framework and specific situation of GasTerra are outlined.

There is a variety of organizational linkages within and across industries. Thompson and McEwen (1958) note that the existence of these various organizational linkages stems from environmental constraints organizations face. No matter what goals and actions an organization might pursue, it is always constrained by its environment to a greater or lesser extent. “The sheer complexity of the current society which is full of ‘wicked problems’ as Rittel and Webber (1973) call it, this often means no player can reach its goal independently” (Saz-Carranza and Longo, 2012, p. 331). Not all organizations have the resources, financial as well as non-financial, to compete on their own in today’s competitive environment. Especially in industries where for instance investment costs and/or risks are substantial. To ensure continuation or start up new ventures many organizations have requested cooperation with other firms. This cooperation leads several firms to rely more on ‘the other’ firms’ performance. As a consequence it might lose part of its own independence (Pfeffer and Nowak, 1976). There are many different forms of cooperation/partnerships. In the basis this research will focus on the concept of partnerships and joint ventures in general and joint venture public- private partnerships in particular.

Partnerships

As mentioned in the introduction of this research, collaborations between different organizations across industries and national borders have become more and more common due to various reasons.

Organizational cooperation or collaboration - the combination of resources of multiple organizational

ventures - is called an organizational partnership. These partnerships enable organizations to

compensate for resource gaps like knowledge, market share etcetera (Trafford and Proctor, 2006). A

partnership can be defined as “a relationship involving the sharing of power, work, support and/or

information with others for the achievement of joint goals and/or mutual benefits” (Kernaghan,

1993, p. 60). Following this definition, a partnership requires a division of resources as well as

activities with an emphasis on mutual goals and benefits (Trafford and Proctor, 2006). These

partnerships are likely to give rise to problems of collaboration and coordination since the strategic

focus is more difficult to manage. The diversity of resources brought in by the partners are their

source of advantage, but they are a function of organizational differences leading to inherent

15 tensions within the partnership as well (Saz-Carranza and Longo, 2012). Partnerships generally base accountability on trust. One of the risks of basing business on trust, is mistrust or hostility among partners. This adds to the difficulties of reaching thriving business (Trafford and Proctor, 2006). In this research the focus specifically lies on a special form of partnerships, namely public-private partnerships - PPP. “Public-private partnerships involve organizations whose affiliations lie in respectively the public and private sector working together in partnerships to provide public services” (Broadbent and Laughlin, 2003, p. 332). These partnerships between public and private institutions generally concern the provision of public services and accommodate these services to come not exclusively from the governmental/not for profit sector. Broadbent and Laughlin (2003) indirectly appoint utilities (gas, water, electricity) as a PPP: “Beyond privately owned public service suppliers (such as utilities) are the PPP that have been developed in a more proactive or collaborative mode and which, from the start, have been recognized and labelled as such” (p. 334). Baker (2003) provides an example of a PPP by stating: “tangible assets such as buildings, and intangible assets such as services, are supplied by the private sector, even though the responsibility for provision of these services still lies with the public sector” (p. 447-448). With this statement he refers to healthcare and education. This author also mentions the differences between the USA and UK regarding PPP. It is emphasized that in the USA the scope of the public sector is much smaller than that of European countries. Therefore public services have traditionally been supplied by the private sector. This shows that partnerships in European countries between the public and private sector on the provision of natural gas can be seen as a PPP.

The advantages of PPP work both ways; private institutions obtain a chance at a (often long term) stable return on investment, while on the other hand public institutions get to benefit from the experience of professional cost-conscious profit firms. PPP have been used in industries such as infrastructure, education, and healthcare (Yang, Wang and Hou, 2013). In addition to these public services, the energy business - for instance natural gas - could also be seen as a PPP. Yang, Wang and Hou (2013) confirm this assertion: “Since their creation, the use of PPP has spread from traditional hard infrastructure (transit, railways, bridges, and highways) to soft infrastructure (education, health care, and emergency service)” (p. 301). As described above, public private partnerships are often used to sustain temporary (development) projects such as the construction of bridges, tunnels and other infrastructure. More recently we have seen public private partnerships emerge into the more

‘soft’ branches consequently leading to more long-term partnerships between government, non-

profit organizations and profit organizations (or any combination of these parties). Today, more and

more discussions are conducted on the subject of PPP regarding the energy sector, often in

16 combination with natural resources and the future transition to a green energy supply. In general a distinction is made between the oil & gas sector, and the power sector (ppp.worldbank.org, sept.

24

, 2014). The way PPP in this sector are defined and shaped differ according to the applicable circumstances e.g. location, government, specifics of the operation etcetera. In the dissertation of Sanders (2013) the focus is on PPP in the Dutch energy sector as well. This author aims his research at the future of green gas in combination with a PPP organizational structure. Following this, (inter)national energy provision could be seen as so-called soft infrastructure. “The appealing ‘public- private partnership’ label encompasses a broad spectrum of creative, intersectorial initiatives. Some rely on private philanthropy to achieve a public objective; others use public funding to support the missions of private, non-profit organizations; and still others are business transactions, many of which take the form of novel contracting arrangements” (Bloomfield, 2006, p. 400).

Joint ventures

A joint venture can be seen as a specific form of an organizational partnership as described above.

There are several definitions of the term joint venture. For instance: “The creation of a new organizational entity by two or more partner organizations. The creating organizations are referred to as the parents” (Pfeffer and Nowak, 1976, p. 399). Chen, Park and Newburry (2009, p. 1133) define joint ventures as “legally independent entities formed by two or more parent firms that share equity investment and consequent returns”. Cäker and Siverbo (2011, p. 330) define a joint venture as “an organization form used by two or more organizations (parents or owners) to gain access to new capabilities, customers and resources, to reduce risk and exploit economies of scale”. A joint venture has many similarities with a merger in that companies combine forces. However, as Pfeffer and Nowak (1976) quote Bernstein (1965, p.25): “In a joint venture, two or more companies combine less than all of their assets to create a new entity” (p. 400). We could therefore see it as somewhat of a partial merger; shareholders - or parents - commit part of their resources and in doing so preserve

“most of the organizational autonomy of the participants, while permitting them to enjoy whatever benefits may be accrued from coordinated activities” (Kent, 1991, p. 388). The oil and gas industry appears to be an exception to the general rule that managers prefer mergers over joint ventures.

“This is particularly true in the exploration for, production of, and transportation of crude oil and gas” (Kent, 1991, p. 388).

In a joint venture, both costs and benefits are shared according to predetermined agreements. There

are several advantages for the different parent companies to engage in a joint venture. A few rather

obvious examples discussed in previous research are economies of scale, access to more/new

17 resources - including information and knowledge - access to new customers and markets, side-lining of trade restrictions, and the reduction of risk (Kent, 1991; Groot and Merchant, 2000; Kamminga and Van der Meer-Kooistra, 2007). However, the concept of a joint venture also brings about several disadvantages which all seem to have one major cause: “There is more than one parent” (Killing, 1982, p. 121). Killing (1982) states that engagement in a joint venture is a situation unlike split ownership in a large, publicly owned organization. In this latter case, ownership is divided among many shareholders, leaving them with relatively little influence per shareholder. In a joint venture where shares are split among a few parents, shareholders have a large influence and become more evident. Additionally, shareholders are often very much involved in the joint venture and are likely to have differing and divergent objectives. Kamminga and Van der Meer-Kooistra (2007) specify two different types of relationships considering joint ventures; the hierarchical relationship between the parent companies and the joint venture entity, and the inter-firm relationship between the different parents of the joint venture. It is especially this last relationship that causes complexities regarding management control, since the parents are independent organizations with possibly differing interests. Therefore the focus is not solely on the joint venture as such but also on the other shareholders. Shareholders might for instance be competitors outside of the joint venture partnership.

Joint ventures work according to a contract between the partners. In some cases a separate, jointly owned enterprise is set up represented by both parties - an incorporated joint venture. In other situations the joint venture is run solely based on contracts, without actually setting up a separate entity - an unincorporated joint venture. The latter form provides more flexibility, however it also requires more elaborate governance structures. Many joint ventures rely on production sharing agreements, on which we will elaborate later on in the theoretical framework (Ahmadov, Artemyev, Aslanly, Rzaev and Shaban, 2012).

For joint ventures with parents in both the public as well as the private sector it is custom to set up a new organization - an incorporated joint venture - in which the government often holds a majority share and the private partners, who split the remaining, usually minority share, bring about the capacity to optimize the business (Castro and Janssens, 2011).

In sum, in this research a joint venture is defined as a business partnership in which two or more

shareholders, the so-called ‘parent companies’, agree to set up a new entity to reach a certain

common goal. One important note is that this is referred to as an incorporated joint venture; a

separate, jointly owned enterprise set up, controlled and represented by two or more shareholders -

18 the parents - which undertakes activities in its own name. Additionally, the financial and/or legal position of the different shareholders is only endangered to the extent of the separate investments made in the joint venture (Pfeffer and Nowak, 1976).

PPP & joint ventures

Looking beyond the traditional joint venture structure and PPP, this research focusses on a combination between the joint venture and public-private partnership structure - joint venture public-private partnerships. Both joint ventures and PPP provide an opportunity to gain from strengths of both public and private sectors. Public services can be provided at a lower cost with excellent quality and accessibility by combining the best of both worlds - private and public organizations. In such a collaboration both parties accept risks and rewards are shared and contributions are made on both sides (Van Ham and Koppejan, 2001). Objectives differ depending on the industries the different parent companies are in. In this case, where the parents come from both the private and the public sector, objectives might be further apart. However, the objectives of the parties involved in a joint venture PPP - public as well as private - do not have to be equal. “One partner may be interested in financial return while the other is concerned with improving customer service, yet both share the common goal of creating a viable and sustainable organization” (Bennet, James and Grohmann, 2000, p. 11). What is most important for a joint venture PPP is that goals are at least compatible and focused on a shared outcome.

In a conventional joint venture the state often remains the regulatory partner. This allows a controlling interest in order to monitor the needs and interests of the public as well as a continuing role in corporate governance. On the other hand, the private partner(s) often maintain responsibility concerning day-to-day operations. Combining strengths of the private sector - knowledge, efficiency, dynamism, access to funding and an entrepreneurial mind set - with those of the public sector - local knowledge, environmental awareness and social responsibility - leads to results no public or private organization would be able to undertake individually. Or as Hodge and Greve (2007, p. 546) state:

“The line of reasoning is simple - both the public and private sectors have specific qualities, and if

those qualities are combined, the end result will be better for all”. The joint venture PPP

organizational form in which public and private sector organizations work together has made parties

aware of benefits such as reduction of investment costs, insurance of long-term survival, employee

motivation, attendance to public needs in an efficient and effective manner at an adequate rate of

return etcetera. Bennet, James and Grohmann (2000) have provided us with a model visualizing the

vast array of options in public-private partnerships.

19

A similar model with a more graphic expression can be found above in figure four. This model provides us with an overview of all possible relationships ranging from the fully public- to the fully private sector. As the model shows, the joint venture PPP is near the right side of the spectrum.

Production sharing agreements

In the oil and gas industry, production sharing agreements - PSAs - are frequently used to contractually define arrangements regarding extraction of natural resources. These agreements date back decades and are a form of contract between the government and one or more contractors. The reason these arrangements are commonly used in the oil and gas industry is because these natural resources usually are, and remain, ownership of the country in which they are found. Natural resources can only be explored and produced there where they are located. PSAs differ from

‘regular’ contracts in two ways. First, the contractors - anyone other than the government or state- owned firms - bare all risks in the exploration phase. This means that all investments are made by these organizations. Do they find no natural resources, the exploration costs are still fully at their expense. Second, the government owns all resources found (Bindeman, 1999). The exploration of natural resources often requires large investments under incomplete information and uncertainty.

Some of the unknown factors are whether new resources will be discovered, what type of resources will be discovered, what the size of the potential deposit (gas field) is, what the economic viability of the product is, what technical requirements there are to explore the resources, what future price developments will be, and also the general economic and political risks (Bindeman, 1999, p. 30).

Risks are thus quite substantial considering the uncertainties and difficulties regarding for instance

Figure 4 - the spectrum of public-private partnerships

20 the amount of resources and their quality. Additionally, natural resources are finite and therefore new sites have to be discovered continuously. Besides these risks, organizations that delve natural resources are strongly bound by governmental policies and legislations. Partly due to these substantial risks, PSAs are often signed for a period of twenty to thirty years, sometimes even longer (Ahmadov, Artemyev, Aslanly, Rzaev and Shaban, 2012). Bindeman (1999) specifies four properties of PSAs in their most basic form: 1. The (foreign) partner pays the concerning government a pre- specified royalty based on gross production. 2. The (foreign) partner is entitled to a pre-specified share (after deduction of the previous royalty) of the total production in order to recover part of its costs. 3. The remainder of the production is shared between the government and the other partners according to a stipulated share. And finally 4. The contractors pay income taxes on their share of the profit gained from the natural resources. Since objectives of the government versus the private organizations often contradict, it is very important to identify possible sources of (future) conflict and comprehend these aspects in the PSA. What is often found in countries with substantial natural resources, is that these resources form a large part of that country’s economic viability. When this is the case, Bindeman (1999) states that the government’s involvement is often increased, for instance through the use of joint ventures. In joint ventures the government as a shareholder has influence on the organizational processes. Additionally, they could come to an agreement in which the government determines what individuals fill management vacancies within the joint venture.

Bindeman (1999) makes a distinction between PSAs and joint ventures. Under PSAs, on the one hand the exploration risks and a share of the rewards are accrued by the private companies, whereas the government only shares in the rewards. Under a joint venture construction both the private companies as well as the government share in risks and rewards.

Management control systems

The different interpretations of control are of special interest in joint venture organizations, since these organizations have to cope with various differing objectives from the different shareholders.

The control challenges are enhanced further when we look at control mechanisms in public-private joint ventures. Public and private organizations are more likely to have divergent objectives than do organizations in the same business. In short: management control within joint ventures is difficult. Or as Groot and Merchant (2000) conclude: “control of IJVs is complex and multidimensional” (p. 581).

These partnerships need special cooperation from the different parent companies because neither of

them holds full control. Insufficient management control is limiting to the coordinating abilities, and

is therefore likely to lead to less efficient use of resources and more difficulties in strategy

implementation (Geringer and Hebert, 1989). Management control helps the organization to reach

21 the desired level of control and thus make organizational outcomes as predictable as possible (Rashid and Aziz, 2012). By making outcomes more predictable management control provides opportunities for joint venture success.

As mentioned in the introduction of this paper, there are various definitions of management control.

In this research the definition of the term management control is based on that of Merchant and Van der Stede (2007) and Tillema (2013) who state that management control encompasses all devices and/or systems as used by management to control work processes, and ensure employee behaviors and decisions are accordant with the specified organizational objectives and strategy. Simply said, management control can be seen as a continuous process of close observations regarding the fluctuations in organizational processes, and the best way to deal with these fluctuations (Tillema, 2013).

Merchant and Van der Stede (2007) stress the importance of management control systems. They state that with a well-designed management control system, employees’ behaviors are directed in the desired way and organizational goals are more likely to be reached. Management control therefore addresses the following questions: “are our employees likely to behave appropriately, do they understand what is expected from them, will they work consistently hard and try to implement strategy as it was intended, and moreover are they capable of doing a good job?” (p. 7). The same researchers found that when an organization focusses on improving the management control system, payoffs can be expected to be higher: “A Fortune study showed that seven out of 10 CEOs who fail do so not because of bad strategy but because of bad execution” (p. 7). However, the authors also stress that improvements should only be made when the benefits to being ‘in control’

exceed the costs. Organizations should thus never aim for perfect control, but rather for optimal control (Merchant and Van der Stede, 2007). Besides the many definitions that can be found on management control, the interpretations vary significantly as well. Next some previous work is elaborated on.

Ouchi (1979) has focused on the different mechanisms that can be deployed in order to move an

organization towards its objectives and how these mechanisms could be improved. This author

makes a distinction between market, bureaucracy and clan control mechanisms. Under the market

control mechanism, all information is incorporated in the market price and decisions can be based

fully on this price which would make any control framework beyond this point obsolete. This

approach would only work in a perfect, frictionless market however and these are extremely rare in

practice, if not non-existent. With a bureaucracy control mechanism the organization focuses

22 decision making and task completion on rules, surveillance and direction of subordinates by superiors. The rules concern both the process as well as the outcomes and quality. This differs from the market control mechanism in the fact that rules only comprise part of the information whereas prices convey all information. Moreover, a bureaucratic control mechanism brings about a substantial amount of administrative burden. In addition to these two formal control mechanisms, Ouchi (1979) presents a more informal mode of control to be used: the clan control mechanism. In practice it appears that this informal system of socialization based on local values and behaviors is subtle but widespread. When this process refers to properties associated with a specific profession, for instance nurses, it is referred to as a clan. In a broader context when it refers to properties associated to all members of for instance an organization or society it is referred to as a culture. In theory, the market control mechanism seems the more efficient mean of the three options discussed. However, in practice conditions for a perfect frictionless market are rarely ever met. The same holds for the social conditions of clan control, which are often impossible to achieve. Therefore the bureaucratic control mechanism is often preferred. “Which form is more efficient depends upon the particulars of the transactions in question” (Ouchi, 1979, p. 836). Based on these three forms of control, Ouchi (1979) concludes there are basically two ways to achieve effective people control in an organization: 1) recruit and hire individuals who perfectly fit the organizational needs or 2) hire anyone and install management in order to instruct, monitor and evaluate these individuals.

A decade later Geringer and Hebert (1989) also focus on mechanisms of control, specifically within joint ventures. When these authors discuss control mechanisms they do not focus on the market, bureaucracy and clan mechanisms by Ouchi (1979) but on the control context, -content, and -process. The control context refers to mechanisms that encompass various informal and/or cultural mechanisms. The intention of these informal/cultural mechanisms is establishing such a context within the organization that the objectives of the different parent companies are met. The focus on informal/cultural mechanisms may be very effective and cost efficient. Schaan (1983) refers to these control mechanisms as positive: employed to motivate certain behaviors within the joint venture.

Under the next control mechanism, control content, the authors state that parent companies focus

their attention more on direct interventions, the placement and function of management/managers

and bureaucracy - rules. These mechanisms are referred to by Schaan (1983) as negative mechanisms

for control - used to constrain behavior by stopping or preventing the joint venture to implement

certain activities or decisions. The final mechanism described by Geringer and Hebert (1989) is the

control process. The control process provides parent companies with the opportunity to exercise

control over the joint venture by influencing reporting relationships, planning and the general

23 decision-making process. “It appears necessary to consider all three dimensions of control in order to obtain a thorough understanding of the control phenomenon for IJVs, although this integration has yet to be accomplished.” (Geringer and Hebert, 1989, p. 241).

Other authors have, more recently, built on the dimensions of Geringer and Hebert (1989). Groot and Merchant (2000) have performed research on several (international) joint venture entities regarding management control in combination with business failure. They found similarities as well as differences in relation to the use of control mechanisms, control tightness/extent, and control focus. These three dimensions of control are what they refer to as the three primary control dimensions needed to thoroughly understand joint venture control. The interpretation of control mechanisms differs slightly from that of Geringer and Hebert as described above.

Considering control mechanisms, these authors refer to the object of control - actions, results, or personnel/culture. Most recently, Merchant and Van der Stede (2007) have extended this research on management control systems in general, and in particular performance measurement, evaluation and incentives based on an unique range of (inter)national case studies. These authors have provided state of the art insights in management control mechanisms. Control exercised over actions requires specific predefined actions as established in contracts, policies and procedures and additionally review and approval of planned decisions. It is the most direct form of control and ensures employees will act conform the organizations’ best interests. To effectively use action control, management can employ three different methods: physical and administrative constraints - such as passwords or a separation between operational and controlling positions, pre-approval of plans and decisions, and bureaucratic control - who does what, when, how, and what are the consequences when things go wrong. In order to effectively use action controls the organization has to consider two minimum conditions. First, the organization has to determine which actions are deemed desirable. And second, the organizations has to be able to ensure these desirable actions occur, or in contrast prevent the occurrence of undesirable actions. This can only be done when management is aware of what actions are (un)desirable and has the ability to influence actions (Merchant and Van der Stede, 2007). Action control is often used when the manner in which products and services are produced determine organizational success. The gathered information provides opportunities for coordination, however the downside of action control is the rather expensive process (Claes, 2008).

Considering results control, performance targets are set beforehand and are monitored continuously

during the process. Advice is provided when necessary, performance is reported and intervention is

possible. The steps are relatively similar to those of action control: definition of desired result

dimensions, observance/measurement of the action in the result dimensions, setting performance

24 targets to strive for, and finally reward/punishment of the action (Merchant and Van der Stede, 2007). Since results control focusses only on the outcome it is far less costly. This is also a downside of results control; the end results are a product of (non-)impressionable factors, which employees cannot always influence (Claes, 2008). This type of control is rather dominant and can only be focused on those employees that have decision-making authority - so called professional employees like managers and principals within the organization. The three minimum conditions that determine results control effectiveness are the possibility for the organization to determine what the desired results are, employees have to have a significant influence on results for which they are held accountable, hence the focus should be on employees with decision-making authority, and finally, there must be a possibility to measure results effectively (Merchant and Van der Stede, 2007). This form of control appears very effective in organizations where specific actions are unclear or of less importance. Moreover it provides employees with great autonomy on how to perform their tasks.

Something that is often very much appreciated by employees, especially among professionals (Merchant and Van der Stede, 2007). Finally there is personnel (individual)/cultural (group of employees) control which is more focused on the individuals performing the work. The aim is to select trustworthy partners to ensure qualified personnel in key positions. This type of control clarifies the expectations of the organization towards the employee and provides resources and other means for the employee his ability to perform well. This theory builds on employees’ natural tendency for self-control/self-monitoring. Self-control/self-monitoring is a natural human characteristic that focusses employee attention on ‘doing a good job’, which subsequently leads to an automatic commitment to organizational goals. Personnel control builds on the idea that employee consciousness leads the individual to do exactly that what is deemed appropriate since this is known to lead to a positive self-image of respect and satisfaction, especially when these actions in turn lead to organizational success (Merchant and Van der Stede, 2007). Additionally, focusing on self-dependence this increases employee engagement. Cultural control aims at ‘mutual monitoring’:

positive group pressure on individuals to stay aligned with organizational norms and values.

Personnel/cultural control can be enhanced through selection and placement, with intensive training

and socialization, group incentive schemes and for instance increasing internal support by enhancing

cultural understanding regarding the parent companies. Personnel/cultural control is the best

position to start the management control system since self-control as well as social control are

naturally present. Therefore this type of control is very cost efficient. However, especially on the long

term it is unsure to what extent the positive contribution of personnel/cultural control develops. For

this reason it is often complemented by both action- and results control (Claes, 2008; Merchant and

Van der Stede, 2007; Groot and Merchant, 2000). In his recent research, Tillema (2013) finds that to

25 create balance, it is beneficial in many organizations to put the main emphasis on cultural/personnel control rather than action or results control. Within organizations processes of interaction and development are continuous, leading to doubts concerning the use of rigid, restraining and suppressive methods for control. Effective control depends upon employee reactions, which can be expected to be unpredictable. This often leads to a situation which calls for flexible methods that change accordingly as a reaction to the interactional processes within the organization (Tillema, 2013).

In addition to the aforementioned mechanisms of control, Geringer and Hebert (1989), Merchant and Groot (2000) and Merchant and Van der Stede (2007) point out two other essential dimensions of control: extent/tightness and focus. The dimension of extent of control as described by Geringer and Hebert (1989) refers to centralization of decision making authority and the locus of control. The authors show that joint venture control is a continuous process rather than parent companies making a decision to keep complete control of the joint venture or no control. Groot and Merchant (2000) and Merchant and Van der Stede (2007) describe a similar phenomenon named control tightness. Control tightness regards the certainty joint venture personnel will act in accordance with the parent companies’ wishes. In order to achieve a tight management control system, there are again a couple of conditions to be met: the results dimension has to be congruent with the organizational objectives, set targets have to be specific, the organization needs short-term feedback loops, results should be communicated and internalized and finally all measures have to be complete (Merchant and Van der Stede, 2007). “Control becomes more tight when managers use multiple forms/mechanisms of control - action, results, personnel and cultural - to complement or overlap each other” (Merchant and Van der Stede, 2007, p. 127). The final dimension, the focus of control, regards a wider versus a narrower scope of controlled activities. Parent companies approach management control selectively with a focus on those dimensions they deem critical. Shareholders can choose to either control all activities within the joint venture, or narrow their control scope and focus on those areas of performance they think are most critical (Merchant and Groot, 2000).

Financial results cannot undoubtedly show whether objectives of the different parent companies have been achieved. What is considered successful can go beyond financial results (Geringer and Hebert, 1989).

In sum, the success of management control based on the theory by Ouchi (1979), Geringer and

Hebert (1989), Merchant and Groot (2000) and Merchant and Van der Stede (2007) is achieved

through successfully issuing control mechanisms, control extent/tightness and control focus in such a

26 way that the intended strategy is executed without an administrative burden that exceeds the gains from management control.

Groot and Merchant (2000) found several variables from previous research that could help explain the differences in joint venture control systems. These variables are partner objectives, the fit between the joint venture and the partner business, trust in other partners, and recent joint venture performance. Each of these is described next.

Objectives

One of the main variables explaining the differences in joint venture control systems are the parent objectives. As mentioned throughout the introduction and theoretical framework, different parents are likely to have diverging objectives. Some examples are cost reduction, economies of scale, gaining access to new markets and/or technological developments and expertise, reducing risks etcetera. The objective is likely to determine the choices each parent makes concerning control mechanisms, -focus and -tightness. Merchant and Groot (2000) found that partners with a broad set of objectives are prone to have a broad control focus and vice versa. Important to note, as pointed out under PPP & joint venture, the objectives of the parties involved in a joint venture PPP - public as well as private - do not have to be equal as long as goals are at least compatible and focused on a shared outcome.

Fit between joint venture and parent business

Parent companies can enter into a joint venture based on two basic goals - either to extend their existing product or service throughout the (inter)national market, or to diversify their product or service when the current market is saturated. According to Franko (1971) both have different consequences regarding the management control system. This author found that when parents aim for diversification, it is likely that they will use relatively loose controls. This outcome is confirmed in the case study performed by Merchant and Groot (2000).

Performance

As found by Franko (1971) in case studies among 169 multinationals involved in over 1100 joint

venture entities, recent levels of joint venture performance seem to be directly related to the

different parents’ attitudes towards the management control system. Franko, as well as other

researchers before him (e.g. Tomlinson, 1970) found that an increase in joint venture performance

generally leads to a less constraining control attitude. Indicating a narrower and looser control

framework when performance is high versus a broader and tighter control framework when

performance is low. Tight or lose control is reflected in the intensity of the parent companies’