Cultural distance and the pattern of equity ownership structure in international joint ventures

International Business Review 19 (2010) 457–467

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Cultural distance and the pattern of equity ownership structure in international joint ventures Mo Yamin a,1, Sougand Golesorkhi b,* a b

International Business, Manchester Business School, Booth Street West, Manchester M15 6PB, United Kingdom International Business, Manchester Metropolitan University Business School, Aytoun Street, Manchester M1 3GH, United Kingdom

A R T I C L E I N F O

A B S T R A C T

Article history: Received 26 June 2008 Received in revised form 30 July 2009 Accepted 25 November 2009

This paper develops and tests hypotheses linking cultural distant to the ownership distribution of equity capital across the partners in international joint ventures (IJVs). The paper’s underpinnings are linked to the role of equity shares in providing performance guarantees in joint ventures (JVs). It argues that for IJVs based in the home country of one of the partners, the vulnerability of the foreign partner to expropriation of partnership rents increases with its cultural distance from the home partner. We argue this implies the foreign partner is likely to own a smaller equity share of the IJV. Similar hypotheses are formulated with respect to whether the IJV partners are from the same or different triad regions, and cultural clusters. The hypotheses are tested with data on 442 UK-based joint ventures. Our empirical results demonstrate a significant impact of cultural distance on the pattern of equity ownership in IJVs. ß 2009 Elsevier Ltd. All rights reserved.

Keywords: International joint ventures Cultural distance Joint venture governance

1. Introduction Extant literature indicates that culture and cultural distance, defined as the difference between the national cultural characteristics of the home and of the host countries, has a robust influence on organisational choice. This literature has carried out pair-wise analyses comparing the choices between modalities; for example a joint venture (JV) versus a nonequity partnership, or JVs versus acquisition/wholly owned subsidiary formation (Brouthers, 2002; Hennart & Larimo, 1998; Kogut & Singh, 1988; Slangen & Hennart, 2008; Slangen & Van Tulder, 2009). The literatures also contain studies showing that firms based in countries where the dominant cultural traits are high power distance and low uncertainty avoidance may have an inherent preference for full ownership of their foreign affiliates (Erramilli, 1996). Other studies argue that cultural distance may make it difficult for MNEs to manage their foreign affiliates, making it efficient to enlist the help of a local partner (Stopford & Wells, 1972). Our contribution is to extend this literature by examining how cultural distance influences the governance mechanism within a particular modality. We focus our analysis on equity ownership structure in international joint ventures (IJVs), an important issue that prior literature has not considered explicitly (Barkema, Bell, & Pennings, 1996; Pennings, Barkema, & Douma, 1994). Existing studies in this area have mainly focused on partner asset characteristics as the main indicator of relative equity ownership patterns (Bowe & Golesorkhi, 2007, 2008). However, no previous study considers the direct

* Corresponding author. Tel.: +44 161 247 3751; fax: +44 161 247 6307. E-mail addresses: [email protected] (M. Yamin), [email protected] (S. Golesorkhi). 1 Tel.: +44 161 161 306 3462; fax: +44 161 306 3505. 0969-5931/$ – see front matter ß 2009 Elsevier Ltd. All rights reserved. doi:10.1016/j.ibusrev.2009.11.004

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influence of cultural distance on equity shares in IJVs. In this paper we address this issue by examining how cultural distance per se, operating independently of the characteristics of the assets contributed by the IJV partners, may help to define a structure of partner vulnerability and hence influence the equity share in IJVs. We acknowledge the influence of cultural distance in two distinct contexts. In one context, culture differences operate within a specific frame of the ‘liability of foreignness’ for one of the partners. However, there is a more general, second context, where an IJV may be based in a third country and thus neither party is operating domestically. Our study specifically focuses on the former context (i.e. ‘home– foreign’ IJVs) and develops hypotheses relating to the impact of cultural distance on the relative vulnerability of the ‘foreign’ partner in IJVs and the provision of a guarantee by the ‘home’ partner in the form of a higher equity ownership of the IJV. This paper is organised as follows. In Section 2 we briefly state the conceptual framework based on extant insights from the economics of organisation. This highlights the guarantee function of equity capital in IJVs, although the insights are equally applicable to any JV. Building on this, we develop hypotheses positing the relevance of cultural distance between the foreign and ‘home’ partners as an influence on partner equity shares in the IJV. Based on similar arguments additional hypotheses relating to the influence of the regional and cultural grouping of the home and foreign partners are developed. Section 3 sets out our empirical methodology, our data sample and discusses the empirical proxies used to measure cultural distance and the other firm-level factors that may influence equity ownership patterns in IJVs. The empirical results are presented and discussed in Section 4, and Section 5 concludes.

2. Theoretical framework 2.1. Theoretical background: partner vulnerability and the guarantee function of equity in JVs One major governance issue in JVs stems from the fact that on the one hand each party in the JV has an inalienable de facto right to pursue their own interest at the expense of others.2 On the other hand, the two parties need to achieve a degree of cooperation if the (presumed) mutually beneficial outcomes of the JV are to be realised (Buckley & Casson, 1988). Agency theory considers how ex ante contracting may best govern the relationship between parties (Jensen & Meckling, 1976). While this logic is also applicable in the context of inter-firm collaboration, considerations of bounded rationality and asymmetric information imply that contracts are invariably incomplete as it is not possible to specify in advance all possible future contingencies (Hart, 1995; Williamson, 1979). In the JV context, one relevant factor is the vulnerability each party perceives as arising from its dependence on the other party for the achievement of the objectives of the JV (Golesorkhi, 2006). Such vulnerability is a function of the level of costly monitoring and enforcement that each party may anticipate as being necessary, vis-a`-vis the other party’s adherence to contractual obligations, in the operation of the JV (Alchian & Demsetz, 1972; Barzel, 1997; Barzel & Suen, 1992). The anticipated level of monitoring/enforcement costs reflects the degree to which the assets, information set and context of the partner may be expected to give rise to relatively greater variability in the future performance of the JV. From this perspective, the literature suggests that the negotiated equity shareholding in collaborative ventures may be a significant governance instrument. By choosing to collaborate through a JV, each partner effectively receives a financial return that is proportional to its ownership share of the JV’s equity capital. As equity in a JV is a residual claim the rights to which are foregone if the JV fails to attain profitability it acts as collateral, guaranteeing the value enhancing contribution of the JV partner. As such, specifying a higher equity share in the JV partnership ex ante reduces the need to incur monitoring and enforcement costs ex post (Barzel, 1982, 2005; Grossman & Hart, 1986; Teece, 1992). As such, the partner in the JV whose contribution and subsequent behaviour has a greater impact on the variability of the joint performance will, by owning the larger share of the equity capital, provide a measure of performance guarantee to the other party. Effectively, by contracting ex ante to make a greater portion of his/her income dependent on the residual payoff from the venture, the incentives of this partner are aligned with that of the JV to a greater extent than would otherwise have been the case. 2.2. Cultural distance and partner vulnerability in IJVs Recent evidence suggests that due to cultural distance, IJVs are particularly difficult to manage (Kaufmann & O’Neill, 2007) and that consequently cultural distance between the partners negatively affects the survival rate of IJVs (Meschi & Riccio, 2008). This suggests that partners in IJVs encounter relatively higher levels of monitoring and enforcement costs. However as Kaufmann and O’Neill (2007) point out, managers understand and anticipate the difficulties associated with cultural distance, and thus may take steps ex ante to minimize these problems by choosing less complex and demanding ‘types’ of IJVs which would require high levels of inter-partner interactions.3 The argument regarding the guarantee function of the choice of equity share inherently depends on the same logic. Given the anticipated problems of managing across

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The theoretical discussion in this section applies to both domestic and international JVs, which is why we use JV rather than IJV in the notation. For example when cultural distance is high, IJVs are more likely to be of the ‘unilateral’ type (buyer–seller IJVs). On the other hand, culturally distance partners are unlikely to form ‘bilateral’ types of JVs where the required level of inter-partner interaction will be high. 3

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cultural boundaries in IJVs, we maintain that the role of equity shares as governance mechanism in IJVs is at least as important as domestic JVs. In applying this framework to IJVs, we must first consider under what circumstances cultural distance between the partners necessarily creates a situation of vulnerability for one of the parties. We consider two specific contexts. One context is where, the IJV is ‘located’ in the home market of one the partners (‘home–foreign’ IJVs). The second is where both parties operate outside their home country (the IJV is located in a third country). In the former case, the structure of vulnerability is, as we explain in the following section, determined or least influenced by the ‘liability of foreignness’ for the foreign partner. In the second and more general case of IJVs, it is less straight forward to determine a structure of vulnerability. Thus, even though cultural distance may complicate inter-partner interactions and relationships generally, the existence of cultural distance between the partners per se does not indicate which partner may be more vulnerable. Of course, one of partners may operate in a cultural environment more similar to his (her) ‘home’ market but this is a special case or an extension of the ‘home–foreign’ type. In the more general case, there is no a priori basis on grounds of cultural distance alone, for detecting a structure of vulnerability. Arguably, partner vulnerability may depend on how the cultural distance between the two partners, interacts with the ‘local’ culture of the third country where the IJV is located. Thus, the influence of culture distance on IJV structures becomes more intractable in the general, cross-border case. However, it is arguable that cultural difference (and cultural distance) may be too broad a concept. If one focuses specifically on risk perception as a cultural trait then, intuitively, it is possible to define a structure of vulnerability. If it is the case that one party’s culture is associated with a higher degree of risk aversion vis-a`-vis the other, then there is basis for linking cultural distance (along the specific dimension of risk attitudes) to the ownership structure of IJV. There is some support for the notion that cultures differ along dimensions linked to risk attitudes (Bontempo, Bottom, & Weber, 1997; Weber & Hsee, 1998). For example, Bontempo et al. (1997) suggest that cultures differ in their relative emphasis on the fear of failure vs. desire to achieve success, also implied by Hofstede’s (1980) dimension of uncertainty avoidance. In their study, Bontempo et al. (1997) found a higher prevalence of the ‘fear of failure’ amongst Asian compared to Western respondents. Such observations provide a compelling basis for expecting systematic differences in the perception of risk across cultures. Clearly, risk attitudes can be a strong influence on partner preferences regarding particular ownership share in IJVs, the partner with a greater risk aversion, ceteris paribus, favours a lower share of the equity capital. However, there is a ‘missing link’ undermining the expectation that the ownership shares in IJVs will necessarily reflect this preference. The main problem is that risk attitudes are not transparent or manifest and thus cannot form a credible basis for the negotiation process between partners to determine capital share. Das and Teng (2001) explicitly develop a risk perception model of IJV structuring. While (as we have already suggested) risks perceptions define partner preferences with respect to the IJV structure in their model, it is the relative bargaining power of the partners that decides the structure adopted by the IJV. Overall, we conclude that the theoretical basis for the influence of cultural distance on equity shares in IJVs is not clear-cut in the general cross-border case. For this reason, our study concentrates on the impact of cultural difference on equity shares only in the context of ‘home–foreign’ IJVs. 2.3. Foreign partner vulnerability and equity shares in ‘home–foreign’ IJVs 2.3.1. The liability of foreignness and equity shares We consider that the foreign partner in ‘home–foreign’ IJVs incurs a greater level of vulnerability and that, to the extent that capital structure in IJVs reflect the provision of a guarantee to the vulnerable partner, the foreign partner is likely to own a smaller share of the capital invested in the JV. This proposition is strongly supported by the international business literature on the liability of foreignness (Hymer, 1976; Luo & Mezias, 2002; Luo, Shenkar, & Nyaw, 2002; Mezias, 2002; Nachum, 2003; Sethi & Judge, 2009; Zaheer, 1995). A key element of the liability of foreignness is the extra costs incurred in doing business in the foreign country. There are multiple bases for the extra cost incurred of which cultural distance and lack of familiarity with the institutions of the ‘host’ country is a central element. In the IJV context, the foreign partner will encounter significant obstacles in interpreting partner behaviour stemming from its lack of understanding of the partner’s culture and its institutional context (Rangan, 2000). Nor can the foreign partner fully acquire such knowledge ‘in advance’ by interpreting the information and clues emanating from their partner’s behaviour. Cultural and institutional knowledge contain a significant tacit dimension and can only be learned slowly and incrementally, usually as a by-product of operational experience (Johanson & Vahlne, 1977; O’Grady & Lane, 1996; Yamin & Sinkovics, 2006). While the home partner may likewise encounter cultural obstacles in understanding the foreign partner, it has the advantage of better appreciating the operating environment and of how the local culture and institutions may affect the performance of the IJV. Following Barkema, Shenkar, Vermeulen, and Bell (1997), (Barkema et al., 1996), the foreign partner faces a ‘double-layered acculturation’ task in as much as their understanding of partner behaviour is complicated by relatively poor appreciation of the (foreign market) context of the partner. By comparison, the ‘home’ partner only faces a ‘single-layer’ acculturation task. Thus, the foreign partner will likely depend on the home partner more than vice versa in terms of the managing the IJVs interactions with the institutional, business and regulatory networks in the host country market. The above discussion suggests a negative relationship between the level of cultural distance and the share of equity held by the foreign partner in ‘home–foreign’ IJVs. Thus, the more culturally distant the foreign partner is from the home

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partner, the more likely it is that the foreign partner will own a lower share of the capital invested in the IJV. More, specifically the following hypothesis is warranted: H1. In home/foreign IJVs, the foreign partner is likely to provide a smaller share of the equity capital as the cultural distance between home and the foreign partner increases. 2.3.2. Regional differences and equity shares Cultural distance as a construct captures the differences in the cultural traits and value systems of different groups and countries. However, it does not necessarily fully indicate the barriers that companies expect to encounter in learning about a focal foreign market environment, including its culture. The barriers to learning are not merely a function of cultural distance. A particularly influential line of argument in recent years has been that company knowledge acquisition and processing about foreign market opportunities is easier in the ‘home’ region of the company (Rugman, 2005; Rugman & Verbeke, 2004). This is not only because of the smaller distance (both physical and cultural) between countries in the same region, but also because there is specifically a regional effect in terms of ‘rules of engagement’, which, as Rugman (2005) points out, differ between the triad regions. Inter-regional differences and the distance between the partner countries increase the cost of knowledge acquisition (Eriksson, Johanson, Majkgard, & Sharma, 1997). Thus, ceteris paribus the foreign partner may encounter greater difficulty in acquiring knowledge pertaining to ‘home’ partner behaviour if the countries are not in the same region. By the same token, the foreign partner may anticipate higher levels of monitoring and enforcement costs after the IJV formation with a partner outside its home region. This reasoning supports extending the logic behind H1 generally with respect to the regions of alliance partners. Thus: H2. In home/foreign IJVs, the foreign partner is likely to provide a smaller share of equity if it is not from the same triad region as the home partner. 2.3.3. Cultural clusters and equity shares A number of studies suggest that the impact of cultural distance on firm behaviour may be subject to a group or cluster effect (Barkema et al., 1996; Ronen & Shenkar, 1985; Tsang & Yip, 2007). Cultural groups or clusters are usually identified on the basis of common language or linguistic similarities between countries. Theoretically, the significant point about cultural clusters is the possibility that within a given cultural cluster the similarities between countries may be more salient factor in firms’ perceptions than the differences between them, while across cultural clusters the reverse may be true. This does not mean that cultural distance between countries within the same cluster is uniformly low. However, especially when countries have the same language, firms may effectively disregard other aspects or implications of cultural distance. O’Grady and Lane’s (1996), study of Canadian retail firms in the USA showed that such firms frequently assumed that the organisational requirements and operational environments for the retail business in Canada and the USA were almost the same. Fenwick, Edwards, and Buckley (2003) indicate similar findings in relation to Australian managers in the UK. Of course, such perceptions may prove misleading, and can be diluted as a result of managerial international experience. Nevertheless, the cluster effect implies that, ceteris paribus firms are likely to be relatively more cognisant of cultural differences when transacting with firms from different cultural clusters. Considering IJVs, partners’ perceptions of vulnerability will likely reflect whether partners belong to the same cultural cluster or to different ones. In our context, the perception of vulnerability of foreigners and their need for guarantee from their UK-partner is reduced when they are in the same or culturally closer cluster to that of the home partner. Thus, the following hypothesis is warranted: H3. In home/foreign IJVs, the foreign partner is likely to provide a smaller share of equity capital if it does not belong to the same cultural cluster as the home country. 3. Methodology 3.1. Specification of the model We adopt an ordered logistic regression specification to test H1–H3. We maintain that this is appropriate because the dependent variable takes three ordinal values.4 The logistic regression is often used in studies on ownership strategies, and it has previously been suggested that this classification is more appropriate than using an equity share contribution measured using a simple percentage continuum (Chadee & Qiu, 2001; Gomes-Casseres, 1990; Hennart, 1991; Pan, 1996). This is because the same given percentage difference in equity ownership can have very different strategic implications. For example, the organisational relevance of a change from a 25% to 26% equity ownership share is obviously very different to that between a 49% and a 50% change. The decision as to the division of equity ownership is in this sense, very much a categorical one, and is often driven by the desire to exercise effective control over the venture. Therefore, the first key

4 To test the sensitivity of the results to the selection of the modelling procedures, we also ran OLS (the equity ownership can range from a minimum 1% to a maximum of 99%) regressions. The results were strongly consistent across OLS, and LOGIT specifications. The results are available on request.

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decision is whether to go for a minority, a 50%, or a majority equity share (Chadee & Qiu, 2001; Pan, 1996). Because of the categorical and ordinal nature of the dependent variable, i.e., y = 1, . . ., j + 1 and 1 < 2 < 3, an ordered logit model is more appropriate, and in our specification it takes the following general form: 0

gð prðY ¼ ijXÞÞ ¼ ai þ b x where 1  i  j and ai, . . ., aj are the j intercept parameters, and b is the vector of slope coefficients. This equation is estimated using the maximum likelihood routines of the logistic procedure contained in the LIMDEP software package. 3.2. Sample selection The IJV data sample used in this paper includes IJVs consisting of two partners formed during the 1995–2000 period and based in the UK. The data are obtained from the SDC Platinum alliances/JVs database. This provides a sample of 1800 IJVs during this period. We narrow our focus to consider only IJVs based in UK in order to control for the diverse regulatory and jurisdictional requirements of the countries in which the IJV is located based on reasons outlined previously. Given the above considerations, as well as the availability of detailed financial data for the foreign partner in the IJV, the number of observations is further reduced to 442 IJVs. We segment the foreign partners based on their respective: (i) country, (ii) triad region and (iii) cultural clusters according to the procedures outlined in Section 3.4.1. Our sample contains four regional groupings: North America 31%, China (China and neighbouring countries with ethnic Chinese population e.g. Hong Kong, Taiwan, Macau and Singapore) 37%, Europe 24% and others 8%. From data on the SIC classification on each IJV it may be possible to make some inferences as to the possible strategic objectives underpinning the formation of the IJV. However, we consider such inferences are rather subjective and possibly unreliable as a basis of providing systematic information on how IJVs varied in terms of their objectives, so we did not control for such factors when analysing the equity capital shares of the foreign partners. 3.3. Dependent variable The dependent variable is the foreign partner level of equity share ownership. In the specification of our dependent variable we distinguish between minority and majority equity share contributions through the use of a categorical dependent variable, with partners with less (more) than 50% equity shares categorised as minority (majority) contributors, respectively. IJVs where partners each contribute 50% equity are categorised as equal contributors (Hu & Chen, 1993; Pan, 1996). Using this classification, the categorical dependent variable (Y) assumes values of: Y = 1, reflecting a negotiated equity contribution of less than 50%, Y = 2; indicating a 50% equity contribution and Y = 3; signalling an equity contribution of more than 50%. 3.4. Independent variables 3.4.1. Explanatory variables: cultural distance; regional proximity; cultural clusters To test H1 we utilize the Kogut and Singh’s (1988) index, which has been used frequently in previous research (Barkema et al., 1996; Hennart & Larimo, 1998; Kogut & Singh, 1988; Slangen & Hennart, 2008; Slangen & Van Tulder, 2009). Kogut and Singh’s index measures cultural distance as the difference between the local (UK domestic) and other IJV partner nation, classified on each of the four cultural dimensions of Hofstede (1980), namely: power distance, uncertainty avoidance, masculinity/femininity and individualism. The Kogut and Singh (1988) index (henceforth K&S) is given by: n o 4 ðIi j  Iiu Þ2 =V j X ðCultural distanceÞ j ¼ 4 i¼ j where Iij stands for the index for the ith cultural dimension and jth country, Vi is the variance of the index along the ith dimension, u indicates the baseline nation with respect to which the cultural distance is calculated (here UK) and (cultural distance)j is the cultural distance of the jth country from the UK.5 To test H2, leaving one category (others) as the benchmark we create three 0–1 dummy variables for North America, Europe and China to account for the regional proximity of foreign partners. To test H3 we use the classification of cultural clusters based on Ronen and Shenkar (1985), henceforth termed the R&S index. As outlined in Section 2.3.3 these cultural clusters are broadly based on linguistic similarities (e.g. Anglo, Germanic, Nordic, Far Eastern clusters). The R&S index ranks eight clusters. This index has a lower score if the cultural cluster to which the foreign partner belongs is deemed closer to the UK. Following the procedures utilised by Barkema et al. (1996), and Tsang and Yip (2007), adopting the UK as the home country, the scores range from 1, when the foreign partner belonged to the Anglo cluster, to a value of 8 for the Germanic cluster, which is theoretically regarded as farthest from the Anglo cluster.6 A shortcoming of using the R&S index is that it effectively treats an ordinal variable as an interval variable. To remedy this, following Ronen and Shenkar (1985), we also

5

China is not included in Hofstede’s (1980) sample. Therefore, the ratings for Taiwan are used as a surrogate measure for China (see also Pan, 1996). We only include cultural blocks for which we had enough observations. Therefore, the Arab, Near Eastern, and Latin American blocks are excluded. There has to be a reasonable number of foreign partners in each block before one can obtain a reliable statistical estimate of the coefficients of these blocks. 6

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employ a second measure where the eight cultural clusters are used to form seven cluster dummies, omitting one cluster dummy (in our case the Anglo cluster) to serve as a benchmark in the analysis (Barkema et al., 1996; Tsang & Yip, 2007). 3.4.2. Control variables In this section, using insights from the financial economics literature with respect to modes of financing the firm and the organisational choice literature in international business, we document the controls we introduce for other relevant firmlevel factors that may influence equity ownership in IJVs. Growth options of the foreign firm are capital assets that add value to a firm, but they cannot be easily collateralized. We proxy this variable by the ratio of capital expenditure to total assets (Rajan & Zingales, 1995; Vicente-Lorente, 2001). However, as firms generally engage in R&D to generate future investment and growth options, the R&D intensity also serves as an indicator of growth potential. Growth options may also have an industry dimension as IJVs may be preferred in high growth markets, since in these markets the opportunity costs of a delayed entry is argued to be higher (Brouthers & Brouthers, 2000; Hennart & Larimo, 1998; Hennart & Park, 1993). The size of the firm is included as various studies have found that firm size correlates with the mode of ownership structure of foreign ventures (Larimo, 1993; Stopford & Wells, 1972). The traditional argument is that small firms do not have the necessary resources to dedicate much of their capital to the IJV, so the smaller the partner the higher the probability that it will share the equity of its affiliates (Larimo, 1993). However, the empirical evidence on the relationship between firm size and preference for sharing equity is mixed (Hennart & Larimo, 1998; Hennart & Reddy, 1997; Kogut & Singh, 1988). We measure size of the foreign firm by the natural logarithm of its sales (Titman & Wessels, 1988). Pecking-order theory outlines the inherent advantage associated with internal financing for new projects (Myers & Majluf, 1984) and predicts profitability is negatively related to leverage. It also seems plausible to assume that profitability of the foreign firm may influence its preferred degree of equity ownership in the IJV. This feature capturing use of internally generated free cash flows measured by the ratio of operating income to total assets (Harris & Raviv, 1991; Titman & Wessels, 1988). Another control variable we utilize in our analysis is an attempt to reflect foreign partner assets whose productive contribution is more difficult to measure/monitor. It is assumed that such assets can inherently generate performance variability and, therefore, may influence the governance structure of the IJV (Gatignon & Anderson, 1988; Hennart, 1991; Hill, 1990; Williamson, 1985). We measure foreign partner’s assets characteristics by the level of R&D intensity, here defined as the ratio of R&D expenses to total sales (Balakrishnan & Fox, 1993; Brouthers & Brouthers, 2000; Lu & Hebert, 2005; Hennart, 1991; Vicente-Lorente, 2001). Finally, we also incorporate dummy variables to control (broadly) for the foreign partners’ industry on the basis of their 2-digit SIC codes (Gomes-Casseres, 1990; Hennart & Larimo, 1998). Our IJVs are in the following industry sectors: manufacturing (31%), transportation, communication and utilities (27%), mineral industry (24%) and construction (18%). In order to assess whether the levels of foreign equity ownership has changed significantly over time we also control for temporal changes over the years of data (1995–2000) used in this study. We define dummy variables for each year other than the baseline, coded 0–1, to capture temporal changes that may had taken place over the period of study. 4. Results and discussions Table 1 presents the characteristics of our sample and Tables 2 and 3 list the summary descriptive statistics and correlations of the key variables guiding our model specifications. Table 4 presents the results from the ordered logit model estimations for four different model specifications M1–M4, which test our hypotheses exhibiting the coefficients and their significance level. M1 considers the effect of cultural distance measured by K&S index, incorporating control variables. M2 estimates the effects of regional proximity the control variables on the level of foreign equity shareholding. M3 and M4 measure the effect of R&S index of on cultural clustering (in both its interval and dummy variable specifications) and the Table 1 Sample characteristics: UK–Foreign IJVs (n = 442). Numbers

Percent

Country of origin of foreign partner North America China Europe Others

136 165 107 34

31 37 24 8

Sector Manufacturing Transportation, communication and utilities Mineral industry Construction

137 119 106 80

31 27 24 18

Ownership share Minority: 1–49% Equal: 50%/50% Majority: >50%

141 146 155

32 33 35

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Table 2 Summary of descriptive statistics (n = 442). Variables

Mean

S.D.

R&D intensity R&S index K&S index Growth Profit Size

1.02 2.13 1.75 1.03 19.12 13.72

0.03 2.14 1.45 0.05 0.62 2.52

Table 3 Pearson correlation matrix .

A B C D E F G H I J K L M N

A

B

C

D

E

F

G

H

I

J

K

L

M

N

1

0.14* 1

0.20** 0.53* 1

0.06** 0.08** 0.07** 1

0.05** 0.12 0.10* 0.11* 1

0.03 0.14* 0.12 0.23* 0.09 1

0.02 0.32 0.28 0.01** 0.04 0.05 1

0.08 0.23* 0.31* 0.02 0.19 0.05** 0.04 1

0.02 0.26* 0.33* 0.14* 0.07 0.16* 0.11 0.06 1

0.05 0.15 0.22* 0.02 0.06** 0.01 0.08** 0.12 0.10 1

0.04 0.15 0.27* 0.01 0.15 0.24* 0.11 0.23* 0.08** 0.03 1

0.07 0.13* 0.24 0.06 0.01** 0.02 0.27* 0.06** 0.09 0.08** 0.03 1

0.03 0.10* 0.14* 0.22 0.04 0.09** 0.05 0.32 0.03** 0.21* 0.06** 0.03** 1

0.17 0.11 0.13* 0.06 0.03 0. 13* 0.05 0. 33** 0.04 0.16 0.04** 0.01 0.02* 1

n = 442; A: R&D intensity; B: R&S index; C: K&S index; D: Growth; E: Profit; F: Size; G: North America; H: Europe; I: China; J: Latin Europe cluster; K: Far East cluster; L: Anglo cluster; M: Nordic cluster; N: Germanic cluster. * Correlations significant at 0.05 level (two-tailed). ** Correlations significant at 0.01 level (two-tailed).

control variables, respectively, on the level of foreign equity shareholding following the interpretation of Barkema et al. (1996), and Tsang and Yip (2007) as explained in Section 3.4.1. Table 4 reports that estimated ordered logit regressions are statistically significant at the 1% level for all models, according to the relevant models Chi-squared statistic. Furthermore, the percentage of correctly predicted outcomes ranges from an acceptable 68% to 70%. Overall, the M2, the model, which includes the regional dummies, has the greatest Table 4 Results of the ordered logit analysis. Model

M1

Constant R&D intensity Growth Profit Firm size K&S index R&S index Latin Europe Far East Nordic Germanic North America Europe China

366.078 48.051 14.014 48.437 1.202 0.143

Log likelihood function Restricted log likelihood Chi-squared p-value of Chi-squared Predicted (%) McFadden’s R2

M2 (0.324) (0.002)*** (0.046)** (0.048)** (0.331) (0.001)***

66.079 42.985 16.664 29.042 4.179

1.731 2.164 3.582 57.362 87.237 62.450 0.005 68 0.342

M3 (0.833) (0.028)** (0.024)** (0.183) (0.037)**

M4

123.336 45.097 9.718 43.623 3.139

(0.393) (0.003)*** (0.251) (0.037)** (0.042)**

0.312

(0.002)***

316.649 49.162 5.257 45.023 2.235

(0.308) (0.001)** (0.293) (0.021)** (0.054)*

0.032 0.132 1.219 1.337

(0.142) (0.001)*** (0.126) (0.115)

(0.261) (0.034)** (0.003)*** 50.312 82.428 70.233 0.002 70 0.390

56.615 86.843 59.489 0.003 69 0.348

55.236 83.174 57.354 0.001 68 0.336

n = 442; r values in parentheses; * significant at 10% level, ** significant at 5% level, and *** significant at 1%. Wald test for industry x2 = 2.143 (r = 0.032).

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explanatory power at 70%. It is also noted that M2 in Table 4, gives the highest value for McFadden’s R2 (0.39) offering the best measure of model fit among the specifications. In the light of these results, the regressions appear to have reasonable explanatory and predictive ability. The interpretation of the estimated coefficients of the independent variables is as follows; for the non-dummy variables, a positive (negative) coefficient implies that the variable increases (reduces) the equity ownership of the foreign partner, and for a cluster or a regional dummy variable, a positive (negative) coefficient means the equity ownership of that category is higher (lower) than the relevant base category’s (Anglo cluster and others, respectively). Model M1 indicates that cultural distance is significant at a 1% level measured by the K&S index and is likely to decrease the equity ownership of the foreign partner. It suggests partners from countries that differ greatly from the home country (UK) acquire lower equity ownership shares in the IJVs than foreign firms from countries sharing similar cultural backgrounds to the UK, holding other factors constant. Thus, our results strongly support H1. This result is consistent with previous studies showing that as cultural distance between the source and host countries increases, the investment in the non-redeployable assets in the host country is perceived as riskier (Erramilli & Rao, 1993; Gatignon & Anderson, 1988; Kogut & Singh, 1988). This is partly because of the higher cost of acquiring information to monitor and evaluate partners (Barkema et al., 1996; Kogut & Singh, 1988). However, there is evidence suggesting that when cultural distance is high the foreign firm wishing to operate in the market may prefer high control modes of operation linking effective control of the IJV to a higher level of equity ownership when the cultural distance increases (Pan, 1996). This may be particularly attractive when the firm risks its high value intangible assets in the foreign market and thus prefers to internalise their exploitation in foreign markets (Buckley & Casson, 1988). In this study we are concerned not with the choice of organisational form to serve foreign markets, but with explaining the distribution of equity ownership shares in IJVs. Our results indicate that given an IJV has been selected as the appropriate organisational form, cultural distance can have an important affect on its governance arrangements, notably through the distribution of the equity capital contributed by the partners. In the ‘home–foreign’ IJV context, the foreign partner favours a lower level of equity ownership as the cultural distance between the source country and the host country increases. With regard to H2, the significance of regional dummies in the case of both Chinese and European partners at the 1% and 5% level, respectively, in M2, highlights that there are significant differences across the three regional origins of the partners with respect to their equity ownership. When other factors are held constant, the overall results suggest that on average the Chinese partners hold the lowest share of equity capital, followed by the European partners. In particular, the significance and magnitude of the coefficient for the Chinese partners partially confirms H2. When a foreign partner is from a region outside that of the ‘home’ partner the vulnerability of foreign partner increases and this will increase the likelihood of a higher equity ownership from their home partner. However, with regard to North American partners, this hypothesis was not confirmed. It can be argued that of all the regions examined, the North American partners are closest to the UK in terms of their cultural similarity even though they do not belong to the same ‘region’. In model M3, the R&S index, reflecting cultural clusters, is significant at a 1% level and negatively signed as expected, indicating the observed level of foreign equity shareholding falls when a foreign partner is located outside the cultural cluster of their ‘home’ partner. The further the foreign partner is from their home partner’s cultural cluster, the more likely that they will own a smaller share of the IJV’s equity as outlined in Section 2.3.3. Finally, in model M4 which utilises the second (dummy variable) measure of the R&S index with the Anglo cluster as the base cultural cluster, the signs and relative magnitudes of the coefficients of the cultural clusters look reasonable, although only in this specification only the coefficient for the Far East cluster is statistically significant at a 1% level. One possible reason for lack of significance of the other cultural clusters could be due to the smaller numbers of IJVs in those clusters (Germanic = 46 IJVs, Nordic = 30 IJVs and Latin Europe = 31 IJVs). Overall, we consider that our findings provide partial support for H3 in as much as if the foreign partner belongs to a cultural cluster farthest from the home country on the R&S index, this will impact negatively on the likelihood of equity ownership by that partner. Although not always significant, the pattern of the sign and magnitudes of the coefficients are nevertheless suggestive and are in line with prior findings in the literature (Barkema et al., 1996). For example, the Germanic and Nordic clusters, respectively, tend to have the lowest shares of equity ownership relative to the home (UK) partner, while partners from the Far East and Latin European clusters tend to have less equity ownership than those from the Anglo cluster. One interpretation is that foreign partners from the Anglo cluster share a similar culture to that of the UK-partner, therefore, the vulnerability of being a foreigner is reduced. Our results highlight the shortcomings of capturing cultural similarities and differences with a single index, or at a primarily national or regional level. Finally, the significance of the European partners in M2 as opposed to North American partner suggest a limitation of regional proximity in facilitating cultural understanding and reducing the liability of foreigner partners. Following Ronen and Shenkar (1985), the significance of R&S index in M3 and its dummy measures in M4 does suggest that the various dimensions of cultural distance are a salient influence on partner firm behaviour when negotiating equity shares in IJV contracts located in country belonging to a ‘distant’ cluster. Our results in M3 and M4 are consistent with this perspective. Although we find no significant level of influence for Germanic and Nordic clusters, which are hypothesised as being the farthest from the home country in M4, the magnitudes of their coefficient is in line with our expectations. The significance of the Far East finding in M4 also provides some support to our argument. The overall results in Table 4 are in line with our expectation that vulnerability of foreigner partners and their need for equity-based guarantees from the ‘home’ partner increases with cultural distance between home and foreign countries,

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regional differences, and for partners belonging to ‘distant’ cultural clusters. The underlying argument reflects considerations of costs of knowledge acquisition for the ‘foreign’ partner (Barkema et al., 1996; Eriksson et al., 1997; Rugman, 2005). With respect to control variables, the coefficient sign for profitability is positive and statistically significant at 5% level. This confirms the conjecture that profitable firms have extra cash flow that can be invested in IJVs, even if they face the liability of being foreigners. The coefficient sign on the asset characteristics variable (R&D intensity) is positive and significant at either 1% or 5% level in all models. This indicates that the intangibility of the partners’ assets characteristics measured by R&D intensity increases the likelihood of a larger equity ownership. When the asset, such as R&D, contributed by a partner to the IJV is more difficult to measure/monitor this is likely to increase the variability of the IJV performance and, therefore, impact positively on the demand for guarantees in terms of a larger equity share ownership by the other partner. This phenomenon is explored more fully in Bowe and Golesorkhi (2007, 2008). The variable growth option is signed positively and it is statistically significant at the 5% level. This may indicate that as firms grow, they tend to diversify and combine their resources with another partner. Moreover, the influence of the growth variable on IJV shares is perhaps related to that of asset characterises growth options are also partially captured by R&D intensity, therefore, similarly signed effects could be expected. The coefficient sign for the variable size is negative and is significant at a 5% or 10% level. The meaning of this result is that large foreign firms are more likely to possess a lower level of equity share ownership. One interpretation of this is that large firms have already a well diversified portfolio of investments, and may find it inefficient to add a large equity ownership IJVs to this portfolio. One reason may be that the addition of an IJV with a majority equity ownership to an already large and diversified foreign firm may increase the cost of managing the IJV. The empirical evidence in support of those studies that examine the effect of the firm’s size on the organisational choice is mixed (Hennart & Larimo, 1998; Hennart & Reddy, 1997; Kogut & Singh, 1988). The industry dummy variables are jointly significant at the 5% level for the manufacturing and transportation, communication and utilities sectors based on a Wald test. We note that the dummy variables controlling for temporal changes over five years of data (1995–2000) used in this study are not significant and, therefore, are not reported. 5. Conclusion Although many studies examine the performance, as well as the management of IJVs, the questions of what variables determine the equity ownership at the formation (ex ante) of the IJVs has not been a main focus of the literature. In particular, as noted in the introduction, the effect of cultural distance has been mainly applied to issues of organisational choice and there is rather limited empirical evidence which investigates the impact of cultural distance on the governance structure of the IJVs (Barkema et al., 1996; Pennings et al., 1994). Our research builds on the argument that equity ownership in IJVs may be a significant governance instrument because it is a device which can somewhat reduce the need for ex post contractual monitoring and enforcement. We utilise insights from organisational economics maintaining that the ‘guarantee’ function of equity ownership partly resides in its assignment of residual claims. In particular, the partner in the JV whose behaviour and contribution to value-added within the partnership has more potential impact on the variability of the joint performance should also own a larger share of the joint output. This will serve as a measure of guarantee to the other partner (Alchian & Demsetz, 1972; Barzel, 1982; Grossman & Hart, 1986). This paper contributes to the literature in this area by demonstrating the relevance of the guarantee function in the context of IJVs. It broadens and thus enhances our understanding of ownership structure in JV literature. We also contribute to the international business literature by demonstrating empirically the effect of cultural distance on the distribution of equity ownership in the context of IJVs. We define a structure of vulnerability for the partners in the IJV influenced by the ‘liability of foreignness’ for the foreign partner that can also determine the extent of their equity share ownership. Our investigation confirms role of culture in influencing governance structure of IJVs, an issue that has not been the focus of empirical investigation in previous studies. Our paper clearly has limitations. We have based our context of IJVs on those that are ‘located’ in the home market of one of the partners (‘home–foreign JVs). While this sample selection focuses on a particular (important) subset of IJVs further research is needed to better understand the role of cultural distantness in IJVs beyond the home–foreign context. Progress on this front requires theory development to examine how cultural distance may influence the structure of vulnerability for partners; one interesting question is whether cultural distance is mainly a moderating variable interacting with other features of IJV vis-a`-vis the ownership structure or whether it may have a direct effect. Further research along the same line is called for, with specific reference to the relevance of risk perceptions as a cultural trait. Another limitation of our empirical investigation is that we did not control for the strategic objectives of the partners when forming the IJVs as our data only captured this construct very crudely. For example, asset seeking IJVs and market seeking IJVs may differently influence the structure of the negotiated process and, thus, the risk perceptions across IJV partners. Future research that more adequately allows for incorporation of IJV objectives can help generate a more fine-grained understanding of the role of cultural distance on IJV equity share structures. Acknowledgements The authors are grateful to anonymous reviewers for extensive and constructive suggestions, which have improved the paper. The usual caveat applies.

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