A conceptual framework of relational governance in foreign distributor relationships

International Business Review 11 (2002) 1–16 www.elsevier.com/locate/ibusrev

A conceptual framework of relational governance in foreign distributor relationships A.S. Roath a, S.R. Miller b, S.T. Cavusgil

b,*

a The University of Oklahoma, USA Center for International Business Education and Research, The Eli Broad College of Business, Michigan State University, N356 North Business Complex, East Lansing, MI 48824-1122, USA

b

Received 21 June 2000; received in revised form 10 March 2001; accepted 26 July 2001

1. Introduction Relational governance refers to “interfirm exchange which includes significant relationship-specific assets” and “is embodied in both the structure and the process of an interorganizational relationship%” (Zaheer & Venkatraman, 1995, p. 374). It represents an organization’s active and ongoing intent to manage activities by employing governance mechanisms (Heide, 1994; Gundlach et al., 1995; Lusch & Brown, 1996), involving a combination of structure and process, which more completely describes the complexity and dynamics of the relationship. Scholars have dedicated considerable attention to the study of relational governance in distributor relationships (Heide, 1994; Lusch & Brown, 1996). Two issues arise that suggest further conceptual development is needed in this research domain. First, Lusch and Brown developed a model of interdependency, contracting, and relational behavior in marketing channels, but noted that research into international channel settings might reveal different results (1996: 33) than with domestic distributor relationships. As a result, our understanding of cross-border distributor relationships remains incomplete. Second, many researchers have focused on the transaction cost economics (TCE; Williamson 1975, 1979, 1981) perspective to explain relational governance (especially, contracting). However, scholars have begun to con-

* Corresponding author. Tel.: +1-517-432-4320; fax: +1-517-432-4322. E-mail address: [email protected] (S.T. Cavusgil). 0969-5931/01/$ - see front matter  2001 Elsevier Science Ltd. All rights reserved. PII: S 0 9 6 9 - 5 9 3 1 ( 0 1 ) 0 0 0 4 4 - 0

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sider the behavioral and legal dimensions of relational governance, suggesting that we need to adopt an integrated theoretical perspective. The objective of the present study is to extend the literature on relational governance in marketing channels to the international arena by developing a conceptual framework that examines the following research question, “What organizational and environmental factors influence legal and behavioral aspects of governance in manufacturer–foreign distributor relationships?” The primary objective of this study is to extend the important contributions of Lusch and Brown (1996) to the international arena by examining the legal and behavioral dimensions of relational governance for exporting manufacturer. We develop an integrated framework that draws upon TCE, agency theory and institutional theory. Though much of the international marketing channel literature on interorganizational relationships focuses on alliance formation and relational enhancement issues, scholars have yet to address effectively the decisions pertaining to relational governance. To date, research has been limited to determining the attributes of the relationship, which so far has limited the studies to explaining static relationship characteristics. We adopt Zaheer and Venkatraman’s (1995) contention that governance mechanisms are outlined in a formal structure and/or enforced in the partners’ social interaction. They referred to relational governance as a vertical exchange relationship. However, this paper examines relational governance between autonomous partners — the manufacturer and its foreign distributor.

2. Conceptual underpinnings The study of interfirm relationships has focused primarily on the choice of governance structures and their design issues. Recently, the TCE literature has concentrated on extending organizational design issues towards relational aspects (e.g. trust and commitment, culture, behavioral attributes) and their subsequent effects on performance as it relates to relational outcomes. For example, Mohr and Nevin (1990) built upon Macneil’s (1980) neo-classical approach to contractual exchanges (from which TCE evolved) to incorporate norms of behavior.1 Yet within the TCE framework, less attention has been devoted to the processes that keep the partnership viable (Rindfleisch & Heide, 1997) even though studies have gradually evolved from governance mechanisms that were oriented toward a bureaucratic structure to governance mechanisms that included more relational elements. What may be more appropriate is to incorporate a theoretical base that concentrates on the core element that binds the organizations. As Eisenhardt (1989) noted, “%the domain of agency theory is relationships that mirror the basic agency structure of a principal and an agent who are engaged in

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Organizational norms are expectations of behavior that are partially shared by a group of decisionmakers (Heide, 1994). Norms have been studied in many branches of social science and recently have been applied to marketing.

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cooperative behavior, but have differing goals and differing attitudes toward risk” (p. 59). Studies of interorganizational relationships in which goal incongruence, governance and incomplete information are characteristics of the relationship, find that agency theory provides a very applicable theoretical base. Agency theory emphasizes the elements of trust, cooperation and commitment that belie organizations’ intentions to create value from their organizations’ structures. Accordingly, the study focuses upon both legal (formal/explicit) and behavioral (relational) dimensions of governance in manufacturer–foreign distributorships. Agency theory can be useful in explaining the relationship between the manufacturer and foreign distributor. In the context of this study, the principal’s aim is to effectively co-align the goals of both partners to reduce the conflicts that inherently arise from differing goals and to minimize any potential for opportunistic behavior. Yet, what is intriguing about relational governance in the context of cross-border relationships is that the contract, as defined by agency theory, includes the understanding that the principal does not necessarily have to induce the agent, through potentially destructive coercion, to act in the principal’s interests. The principal recognizes that the agent has goals that may not always co-align with those of the principal. Recognizing this, the principal must work with the agent, as this is the best way for the manufacturer to minimize the agent’s potential for opportunistic behavior.2 The partners must be able to develop a set of mutually compatible goals and create an incentive system that incorporates more than economic objectives in order to increase the efficiency and effectiveness of their relationship (Jensen & Meckling, 1976; Lassar & Kerr, 1996). Agency theory addresses the structure of the relationship, recognizes the behavioral aspects that are the incentive components inherent to any relationship, and allows testing the extension of these elements in an international context. Further, in the manufacturer–foreign distributor setting, agency theory directly considers which governance mechanism maximizes the efficiency of individual transactions (Eisenhardt, 1989). Institutional theorists have suggested that organizations are influenced by “common understandings of what is appropriate and, fundamentally, meaningful behavior” (DiMaggio & Powell, 1983, p. 105). Institutional theory underscores the ability of institutions to influence organizations to conform to practices, policies, and structures that are consistent with institutional preferences (Meyer & Rowan, 1977). In highly institutionalized environments, the structure of firms is strongly influenced by coercive isomorphism (formal pressure from other organizations), mimetic isomorphism (imitation of structures by other organizations in response to pressures), and normative isomorphism (conformance to normative standards established by external institutions) (DiMaggio & Powell, 1983). Several researchers have adapted the institutional theory perspective to the international domain (Ghoshal & Bartlett, 1990; Rosenzweig & Singh, 1991; Westney, 1993). They argued that firms are rewarded for isomorphism with increased legitimacy, resources, and survival capabilities, whereas

2 Agency theory predicts that the two parties will not have compatible goals due to their propensity to maximize their utility; a reflection of organizational economy (Karunaratna & Johnson, 1997).

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failure to conform adversely affects the legitimacy of multinational enterprises (MNEs). 2.1. Legal and behavioral dimensions of relational governance One form of governance emphasizes the legal dimension — a formalized, legally binding agreement, or a contract. A contract is an agreement between two or more competent parties in which an offer is made and accepted, and each party benefits. The agreement can be formal, informal, written, oral, or simply an ‘understanding’. For instance, western contractual relationships are based on the common law structure, which is oriented towards self-protection (Gonzalez, Braumiller, & Rodriguez, 1999 — an international law firm). In contrast, many cultures, particularly the Asian cultures, create informal contracts based on a ‘handshake’ implying that the particular roles and responsibilities are understood inherently as part of a cultural norm. This type of contracting is similar to the ‘sensemaking’ approach to contracting, which is also referred to as a psychological contract consisting of unwritten and largely non-verbal expectations and assumptions (Ring & Van de Ven, 1992). Contracts can be formulated in an explicit and detailed nature whereby future situations are anticipated and incorporated in the contract’s terms. In a highly legalistic approach, all of the responsibilities and expectations in the relationship are specified in the contract. The attention to contractual detail is designed to address as many unforeseen circumstances and contingencies as possible (Dwyer, Schurr, & Oh, 1987; Moorman, Deshpande, & Zaltman, 1993). One lawyer working with international contracts explained the role of the contract’s legal dimension succinctly: “Manufacturers design the contract to address the “what ifs” or the various contingencies and circumstances of the partnership. Therefore, the contract usually will have explicit language, identify partner roles and specific responsibilities.” (Deming 1999, interview with international lawyer) The behavioral dimension of governance captures how the manufacturer manages interfirm interactions in order to develop self-enforcing safeguards (Heide & John, 1988). Macneil (1980) envisioned the parties to a relationship to be guided by relational contracting, which he proposed to be a form of governance based on a social component. Sociologists also consistently advocated this idea and recognized the role of social, or personal relationships that are part of any economic transaction (Granovetter, 1985; Ring & Van de Ven, 1992). The comments from an international manager working with foreign distributors illustrates best the idea of the importance of the social aspect of relationships in contractual arrangements: “The best contract is the one that is placed in the drawer%” (Thielen, 1999).3 The implication is that

3 Interview with Bruce Thielen, a lawyer who develops and writes export contracts for international corporations.

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contractual arrangements have guidelines, but must be managed through relational means. Heide (1994) argued that transactional exchanges actually encompass relational/behavioral features (include trust, commitment, legalities, social norms and reputation) imbedded in markets and hierarchies. He argued that the ongoing maintenance of interfirm relationships requires assignment of decision rights to the parties (e.g. roles and responsibilities); development of plans/contingencies (Barney & Ouchi, 1986); adjustment to changing environmental circumstances (Macneil, 1978); and monitoring of the relationship (Ouchi, 1979; Rubin, 1990). These mechanisms are the building blocks that are the key to complex exchanges in channels of distribution (Nevin, 1995). Scholars have recognized that contractual relationships have an economic (in this case, formal or explicit) dimension as well as a behavioral or attitudinal dimension (Dwyer et al., 1987; Eisenhardt, 1989; Heide, 1994; Macneil, 1980). Given that both legal and behavioral aspects exist in a manufacturer–foreign distributor relationship, the manufacturer (principal) has two non-mutually exclusive options to reduce agency costs: (1) incentive manipulation and (2) agent monitoring. Arguably, the manufacturer regulates the relationship through the contract structure in order to reduce agency costs by aligning the interests of the foreign distributor (agent) with those of the manufacturer. It is also possible to monitor the behavior of the agent directly to reduce information asymmetry. Both alternatives form part of the agency costs that the principal intends to reduce. Explicit (legal) and normative (behavioral) governance are not the same constructs in spite of their relation (Lusch & Brown, 1996).4 For example, a discrete exchange does not necessarily imply a high emphasis on the legal contract. Neither does normative governance imply a high emphasis on behavioral exchange; essentially, a discrete exchange can occur in a behavioral contract. Indeed, Celly and Frazier (1996) and Bello and Gilliland (1997) found that economic (legal) and behaviorbased governance mechanisms are strongly correlated, and hinted that each of the mechanisms may play different roles in the relationship. Lusch and Brown (1996) found that the manufacturer’s emphasis on the relational or behavioral aspects of the relationship enhanced performance. Bello and Gilliland (1997) examined output and process control in international relationships. They found output control contributed to high performance, however, the mechanism through which control was exercised — legal and/or behavioral —

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Various authors have described a contractual relationship as explicit (Dwyer et al., 1987), legal, or economic (Williamson, 1979; Macneil, 1980). These terms refer to the contract’s degree of specified rules and regulations. This paper has consolidated the terminology into ‘legal’ to emphasize the part of the relationship that is oriented to outlining the tangible structure of the relationship. Likewise, normative (Gundlach et al., 1995; Lusch & Brown, 1996), implicit (Dwyer et al., 1987) or relational contracts (Macneil, 1980) describe the behavior between partners in a relationship that supplements and/or complements the legalities of the contract. Similarly, this paper has consolidated the terminology into the term ‘behavior’ to emphasize this aspect of the relationship. Subsequently, the paper uses ‘legal’ and ‘behavior’ to parallel and consolidate the literature’s varied terminology.

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was not discussed. Moreover, the implication behind these results is that governance rests on two different elements (Bradach & Eccles, 1989); that legal and behaviorbased controls are separate dimensions that influence the relationship differently, and that these dimensions may be contingent upon the environment. 3. Research model and propositions5 The context for the study is the relationship between the manufacturer and its (independent) foreign distributor. A proposed framework of relational governance in manufacturer–foreign distributor relationships is depicted in Fig. 1. The following discussion provides the theoretical justification for the conceptualization and offers several propositions.

Fig. 1.

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A conceptual framework of relational governance in foreign distributor relationships.

The paper incorporates information from interviews with international lawyers and managers who are directly involved with the strategic and daily export operations of US-based multinational companies that distribute through independent foreign agents. The objective of the interviews was to outline the legal and behavioral dimensions of the contract that managers employ as part of their approach to maintaining effective relationships with foreign distributors. The interviews were conducted in two parts. First, international lawyers who develop contracts for exporting companies were interviewed. These lawyers worked with companies of all sizes that had operations in many different countries. The lawyers were able to provide insights into the strategic motivations behind some of the legal dimensions of the contractual relationship. Subsequently, the interviews with export managers provided insights into some of the behavioral aspects that supported the operational management of their relationships with foreign agents. Interviews were conducted in person and by telephone. The interviews were open-ended, however, they followed a consistent format of questions regarding the firm’s contractual relationships. These interviews, in combination with a review of the relevant literature, provided the basis for the propositions.

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3.1. Unilateral dependence Many researchers (Anderson & Weitz, 1989; Anderson & Narus, 1990; Lusch & Brown, 1996; Mohr & Nevin, 1990) have observed that dependency levels of individual parties are important to understand interorganizational structures and interactions. Within the context of this study, we assert that the degree of resource dependence of the manufacturer on the foreign distributor will impact the manufacturer’s approach to relational governance.6 A low level of dependency may enable the manufacturer to impose highly formal (explicit) contracts in which it has an ‘upper hand’, thereby achieving the concessions and safeguards it desires (Lusch & Brown, 1996). Such a manufacturer does not rely upon the distributor for resources; rather, it commands the majority of critical resources in the relationship. In the same situation, the high-dependent distributor (with less resources) may also prefer a formal contract because: (1) although the distributor may not receive the benefits of contractual safeguards in the same way as the manufacturer, the distributor may have no other choice but to go along with the wishes of the more powerful manufacturer unless it finds more attractive alternatives (Heide & John, 1988); and (2) in a resource asymmetric relationship a contract written along explicit terms at least will set the “parameters on what the more powerful party can legitimately do” (Lusch & Brown, 1996, p. 21). This situation reduces the uncertainty for the more-dependent distributor in terms of its partner’s behavior (Etgar & Valency, 1983). Thus, under conditions of high unilateral dependence of either the manufacturer or the distributor, both firms may prefer the type of governance that incorporates more legal elements. 3.2. Resource interdependence Interdependence between the manufacturer and distributor leads to a situation whereby the outcomes or the payoff for both parties depends upon the actions of each other (Pfeffer & Salancik, 1978). The interdependence (especially when it is symmetrical) creates mutual safeguards for both parties because it discourages the development and expression of behaviors that may be detrimental to the relationship (Cook & Emerson, 1978; Williamson, 1985; Zaheer & Venkatraman, 1995). Moreover, interdependence provides both parties with incentives to make the relationship work and endure (Buchanan, 1992). Accordingly, they are likely to increase interaction, share information, and create a mutual understanding regarding their obligations to each other (Ring & Van de Ven, 1992). Therefore, we draw upon Lusch and Brown (1996) in stating the following proposition: P1: In manufacturer–foreign distributor relationships involving high unilateral dependence, the manufacturer is inclined to place emphasis on the legal dimension of relational governance regardless of whether it is the party with high or

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In this case, one party has low dependency and the other party has high dependency.

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low dependence, ceteris paribus. The greater the interdependence between the manufacturer and its foreign distributor, the more likely the manufacturer will emphasize the behavioral dimension of relational governance, ceteris paribus. 3.3. International experience A number of studies have highlighted the role of the firm’s international experience in foreign markets as a determinant of entry mode choices and the governance structures associated with those choices. These studies have examined experience both in terms of time and scope of operations (Anderson & Gatignon, 1986; Johanson & Vahlne, 1990). However, the findings have been mixed and contradictory (Genc¸ tu¨ rk & Aulakh, 1995). In the present study, we concern ourselves with the potential relationship between the manufacturer’s experience in a foreign market and the governance structure. It can be argued that a manufacturer with extensive international experience possesses sufficient knowledge of the host market and the organizational practices of potential distributors and therefore, would be more confident about its abilities to choose an appropriate distributor. Because the manufacturer is confident about operating in foreign markets and with foreign distributors, it is well positioned to anticipate circumstances and select relational governance mechanisms that addresses such scenarios. Therefore, an internationally experienced manufacturer is likely to prefer a legal governance structure. Additionally, the manufacturer can turn to its ability and experience to work with foreign distributors to enforce the contractual provisions. Following this logic, an experienced manufacturer possesses better perceptions of host market risks and returns which it can incorporate a priori into an explicit contract (Genc¸ tu¨ rk & Aulakh, 1995). In contrast, when the manufacturer exhibits a low degree of international business experience, it is likely to opt for normative governance because of its unfamiliarity with international transactions in general, and local market conditions, in particular. Arguably, it is difficult for a less-experienced manufacturer to have clear perceptions of potential outcomes that will allow formulating comprehensive contracts detailing partners’ roles and performance expectations. Thus, the manufacturer may prefer behavioral governance, and engage in greater interactions and trust-building relationships with the distributor. A form of governance that does not emphasize legalities may enhance the manufacturer’s access to knowledge of the host market. As the manufacturer operates abroad, it acquires knowledge about local markets, business practices and customer preferences. However, its prior foreign distributor relationships may involve negative or positive experiences, which can shape the manufacturer’s current perspective on relational governance with foreign distributors. For example, MNEs that have encountered opportunistic behavior by the foreign distributor are inclined to prefer detailed explicit contracts. In contrast, MNEs that have encountered trustworthy foreign distributors may prefer behavioral contracts. Therefore: P2: In general, the greater the international experience of the manufacturer, the

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more likely the manufacturer will place more emphasis on the legal dimension of relational governance. If the manufacturer’s previous experiences with foreign distributors were favorable (unfavorable), then it will place more emphasis on the behavioral (legal) dimension of relational governance, ceteris paribus. 3.4. Environmental determinants Ghauri and Holstius (1996) underscored four aspects of the host country-environment: cultural, political, legal, and economic. MNEs may face institutional pressure to conform to host-country environments. As a result, relational governance decisions may be based on the need to conform. For example, countries differ with respect to the emphasis placed on relationship building versus arm’s length business transactions. In host countries that are relationship-oriented, the manufacturer may be compelled to devote additional effort to the behavior dimension of relational governance. Therefore: P3: The greater the relationship orientation (as opposed to arm’s length business transactions) in the distributor’s country, the more likely that the manufacturer will need to place more emphasis on the behavioral dimension of relational governance. 3.5. The cultural environment Following the work of Hofstede (1980), national culture has become an important concept in the international business literature. Social scientists have defined national culture as patterns of thinking and feeling which are parts of the fabric of common values of a society (Jusdanis, 1995). Culture has also been defined as representing a system of values and norms that are shared among a group of people that constitute a design for living (Hill, 1997). The values that a group or society possesses constitute their collective outlook or beliefs in how the members of the group should interact. Essentially, these values become established and evolve into ‘appropriate’ behavioral standards and norms that tend to vary among different groups and societies (Trompenaars, 1996). In this study, cultural distance is treated as an influence of the manufacturer’s desire to reduce the level of uncertainty by using various control mechanisms. The level of uncertainty is illustrated by the manufacturer’s degree of unfamiliarity with the business and law practices of the host country (Kogut & Singh, 1988). The manufacturer’s attempt to control and/or reduce this perceived discomfort through contract mechanisms is an example of one possible way to diminish the perceived level of cultural distance. The manufacturer may increase monitoring and information sharing by emphasizing a formal contract structure, encouraging and ensuring the use of learning mechanisms and by working towards the adaptation of self-enforcing governance safeguards. Thus, cultural distance influences the manufacturer’s view that the contract is a control mechanism and a means to manage the relationship. Arguably then, a high degree of cultural distance may lead the manufacturer to insist

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upon a more formal contract structure, whereas a low degree of cultural distance may convince the manufacturer that a less formal contract structure is more applicable because it emphasizes self-governing mechanisms. The concept of cultural distance in the cross-border relationship leads to the following proposition: P4a: The greater the cultural difference between the home countries of the manufacturer and its foreign distributor, the more likely the manufacturer will need to emphasize the legal dimension of relational governance. Relational governance decisions may be linked not only to cultural differences between the home countries of the manufacturer and distributor, but also to specific cultural attributes of the distributor’s country. For instance, three of Hofstede’s (1980) culture dimensions — uncertainty avoidance, individualism–collectivism and Confuscian dynamism (long-term orientation) — may be linked to relational governance. Hofstede defined uncertainty avoidance as “the extent to which people feel threatened by uncertain or unknown circumstances.” This is typically expressed in a need for formality, predictability and clear rules. In host countries with high uncertainty avoidance, local distributors are inclined to prefer uncertainty-reducing contracts. In manufacturer–distributor relationships, the use of explicit contracts reduces uncertainty (Lusch & Brown, 1996). Therefore, manufacturers are inclined to adapt by using a detailed explicit contract with a broad range of contingencies. Therefore: P4b: The greater the level of uncertainty avoidance in the distributor’s country, the more likely the manufacturer will need to place more emphasis on the legal dimension of relational governance. In individualistic societies there are few ties beyond those of the nuclear family, whereas in collectivist societies people belong to strong, cohesive in-groups. In collectivist cultures, there is an emphasis placed on consensus building. As Lusch and Brown noted, “social consensus or mutual understanding among group members” leads toward a preference for normative contracts in that country (1996: 20). As such, manufacturers may need to adapt to local practices by emphasizing the behavioral dimension of relational governance. Collectivism may moderate the relationship between dependence and relational governance. As we discussed above, manufacturers will place more emphasis on behavioral contracts in highly interdependent manufacturer–distributor relationships, yet as the level of collectivism increase, the importance of focusing on the behavioral dimension grows. Therefore: P4c: The greater the level of collectivism in the distributor’s country, the more likely the manufacturer will need to emphasize the behavioral dimension of relational governance. Hofstede’s fifth culture dimension is Confuscian dynamism (long-term orientation), which reflects “the extent to which people favor a pragmatic, futureoriented perspective — fostering virtues like perseverance and thrift — over short-

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term thinking.” Ganesan suggested that firms with a long-term orientation seek “to maximize profits over a series of transactions,” rather than in one transaction” (1994: 3). With long-term orientation, manufacturer–distributor relationships grow in complexity due to increasing interdependence. Governance of such complexity requires a corresponding increase in contractual complexity (Rousseau & Parks, 1992). In addition, firms with long-term orientation are inclined to be more trusting, cooperative, and embrace similar norms and values (Anderson & Weitz, 1989; Ganesan, 1994; Morgan & Hunt, 1994), increasing the complexity of normative contracts. As a result, in long-term oriented countries may need to conform to local practices by placing greater emphasis on both legal and behavioral dimensions of relational governance. Therefore: P4d: The greater the degree of long-term orientation in the distributor’s country, the more likely the manufacturer will need to emphasize both the legal and behavioral dimensions of relational governance. Lusch and Brown (1996) posited that manufacturer–distributor relationships become more complex with a long-term orientation, due to increased interdependence. In host countries with long-term orientation, manufacturers and distributors with high interdependence, the manufacturer will need to place more emphasis on both the legal and behavioral dimensions of relational governance. Therefore: P4e: Among manufacturers and distributors with high interdependence, the degree of long-term orientation in the distributor’s country will positively affect the manufacturer’s need for greater emphasis on both the legal and behavioral dimensions of relational governance. P4f: Among manufacturers with high dependence on the distributor, the degree of long-term orientation in the distributor’s country will positively affect the manufacturer’s need for greater emphasis on both the legal and behavioral dimensions of relational governance. 3.5.1. The economic and political environment Another relevant consideration is the economic and political environment in the distributor’s home country. Hennart noted, “In conditions of uncertainty, long-term contracts will become relatively risky and contracting relatively less efficient” (Hennart, 1982, p. 41). Further, he asserted that exchange within the firm is preferable as uncertainty increases. In the context of the present, study, which focuses on manufacturer–distributor relationships, we expect that manufacturers are inclined to use more formal contracting (legal dimension) — more contingency clauses and/or shorter length contracts in high uncertainty environments than in low uncertainty environments. Contracts offer the manufacturer many advantages in terms of strategic and operational flexibility. For example, when confronted with rapidly changing global economic conditions well-constructed contracts help to reduce exposure to environmental risks (Bello & Williamson, 1985; Stern & Al-Ansary, 1982), and form

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a basis upon which to increase the organization’s alignment with its environment (Ghoshal, 1986; Kogut, 1986). Essentially, the contract contributes to maintaining the MNE’s strategic focus. Therefore: P5: The greater the economic and political uncertainty in the host country, the more likely the manufacturer is to emphasize the legal dimension of relational governance. Political uncertainty can be reduced in the presence of economic integration. Member countries of a regional trade agreement (i.e. economic groups) are inclined to have less political tension between them. Furthermore, as the level of economic integration increases between member countries (e.g. from free trade agreement to customs union to common market to monetary union), we expect the level of political risk between member countries will decline. Therefore: P6: For manufacturers and distributors from different countries that are both members of the same economic group, there will be lower political uncertainty, and therefore, the manufacturer is likely to place less emphasis on the legal dimension of governance and more emphasis on the behavioral dimension. P7: For manufacturers and distributors from different countries that are both members of the same economic group, as the level of economic integration increases, the level of political uncertainty is expected to decline, and the manufacturer is likely to place even less emphasis on the legal dimension of governance and even more emphasis on the behavioural dimension.

4. Conclusion This article suggests a conceptual framework to examine relational governance in the context of manufacturer–foreign distributor relationships. Central to the framework are the organizational and environmental factors that influence legal and behavioral aspects of relational governance. At least three contributions are offered by the study. First, the study extends the important work of Lusch and Brown (1996) to the international channels of distribution. Second, it adopts an integrated theoretical approach — incorporating TCE, agency theory, institutional theory, and to a lesser degree strategic management. In doing so, we highlight the moderating effects of the environment. Third, it clarifies two distinct aspects of direct relational governance — legal and behavioral — and the implications for the manufacturer favoring one or the other. Much of the recent literature that addresses manufacturer–distributor relationships relates the relationship to some aspect of performance (Harrigan, 1988; Heide & Stump, 1995). Assuming that partnerships between the manufacturer and distributor are formed to reduce the risks involved in foreign operations, exporting manufacturers should place priority on aspects of strategy that emphasize supply chain

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relationships and organizational structure. Also, the manufacturer must be cognizant of the institutional environment in the host country because the pressures of conforming to “how business is done” will influence the approach the manufacturer will take towards the relationship. The combination of the legal and behavioral dimensions that the manufacturer will emphasize in the relationship, as long as they fit with organizational environmental influences, should enhance working relationships and performance in a foreign environment. Resource-based theory suggests that performance depends upon the value and the difficulty in imitating a relationship’s resources and unique capabilities. If the partners are able to develop these unique capabilities, then the relationship is in a better position to sustain competitive advantage, which leads to higher performance (Barney, 1991; Peng, 1998). Within the international context, Rosson and Ford (1982) have shown that performance is positively associated with flexibility and information exchange. Noordewier, John, and Nevin (1990) also support these findings. In this sense, a flexible partnership implies that communication and trust-oriented relational processes are being exercised between the partners. The presence of flexibility also suggests that the partners have dedicated a higher degree of commitment and willingness to invest in the relationship, contrary to a partnership that emphasizes the legal dimensions over the behavioral aspects of the contractual arrangement. Under these circumstances, flexibility does not disrupt the confidence of managing the partnership that is confronted with uncertainty. Thus, flexibility contributes to the partnership’s productivity while increasing the potential for higher economic performance. Similarly, stable relationships enable the firms to monitor better their internal and external performance. Moreover, the degree of satisfaction achieved in a partnership probably depends upon subjective assessments about the state of the relationship as well as high economic performance because the former will have some bearing upon the assessment of the desired performance outcomes from the relationship (Cullen, Johnson & Sakano, 1995). While producing further research in this area, scholars may examine the dyadic nature of manufacturer–distributor relationships. Examining both sides of the partnership should reveal interesting aspects of how each party contributes and manages the relationship. Given that distributors are taking a more active and participative role in the management of the relationship (Stump & Heide, 1996), power, control and interdependency elements of the relationship may challenge some of the basic assumptions of agency theory regarding risk management, monitoring and incentive structures. A starting point is to investigate how different industries vary their approaches to the management of their foreign distributors. Are there differences between pharmaceuticals and appliances, for example? Growing complexity associated with business networks compels researchers to examine the manufacturer approach to managing different contractual structures as well as to investigate their coordination of these international network structures. These and other issues represent productive research avenues for future research. Hopefully, scholars will continue to shed additional light in this important area of relational governance.

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