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Ownership and Control in Multinational Joint Ventures Rafael Bautista School of Management Universidad de los Andes Cra. 1E No. 18A-10, Bogotá, Colombia This version: October, 2011AbstractIn international joint ventures, where one of the partners is a multinational enterprise(MNE) and the other is a local firm that possesses some significant advantage in itsmarket, there are sometimes issues of control (who is in charge of what) that may bereflected in the financial structure of the venture. In particular, it may be the case thatthe structure of equity is a signal of whether or not the distribution of control amongpartners has been efficiently achieved. This possibility seems to go against the intuitionthat equity, and capital structure should be irrelevant.JEL codes: D01, D21, F21, F23, G32.Key words: joint venture, equity structure, capital constraints, controlIntroduction In the last thirty years international cooperative ventures have become asignificant component of world business (Froot 1993). Such ventures now represent atleast 20% of the revenue of the 1,000 largest U.S. firms (Economist 1999). These jointventures (JV), at least in the case of many developing economies, are preceded, andaccompanied, by frequent conflicts and renegotiations. As the result of suchexperiences, some common elements of the negotiation process have become a Electronic copy available at: http://ssrn.com/abstract=1952681
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structural component of the JV experience. Within the frame of political economy, Dela Torre (1981) discusses several of these elements, including the crucial aspects relatedto capital restrictions. The factors determining why a multinational enterprise (MNE)and a local government, or a domestic firm embedded in a foreign legal environment,decide to enter in a JV seem to vary from country to country (Contractor 1990). Thisfact presents the challenge to build a theoretical frame that helps to account for at leastsome of the basic observations. Kogut (1988) classifies theories as belonging to one oftwo main streams: explanations based on transaction costs as derived from the workgiven by Williamson (1975, 1985), or strategic. The transaction costs approach benefitsfrom a wide range of perspectives, going from the costs of technology transfer (e.g.Teece 1977) to costs related to inefficient internal markets (Hennart 1988). The strategicframe is more a collection of approaches that share a common preoccupation withcompetitive positioning and its impact on profitability (e.g. Lecraw 1984). Harrigan(1988) proposes a general frame for competitive strategies through the use of jointventures and similar business arrangements. More recently there is a stream of literaturethat systematizes many of the separate streams coming from both the transaction costapproach as well as some of the ideas in the strategic approach, though still clingingcloser to the ideas in I/O (see Markusen, 2002). Ownership structure can depend on many factors, which have been qualitativelystudied by a number of authors (e.g. Fagre and Wells 1982; Sercu and Uppal 1995).Gomes-Casseres (1990) makes a statistical study comparing predictions from both thetransaction costs and strategic perspectives in their predictions about ownershipstructure. At least some of these factors can be explained by the existence of capital Electronic copy available at: http://ssrn.com/abstract=1952681
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restriction rules. These may explain, for example, why it is that many JVs have minorityparticipation by the MNE (Hladik 1985). International ventures are a fertile ground where to investigate the effects ofdifferent arrangements of bargaining power and of private information between thepartner firms. These effects will reflect on different types of contracts, structuredaccording to an optimization program that incorporates all constraints resulting fromlimited liability, reservation value constraints, participation constraints and variedassortments of incentive constraints. This line of research into the structure of jointventures is relatively less explored 1 than has been the motivations for the formation ofjoint ventures (Gomes-Casseres 1990). In a recent paper (Noe, Rebello and Shrikhande2002, from now on NRS) the authors build the problem of structuring internationalventures along four separate instances, depending on who has the information and whothe bargaining power. In their work the basic scenario consists of a multinational thatenters a joint venture with a foreign domestic firm. Different investment strategies resultfrom each of the four possible combinations. Overinvestment occurs when themultinational has both the bargaining power and the information about the trueprospects of the venture; this outcome assumes that there are no legal rules imposing acapital participation restriction on the multinational. If the equity participation of themultinational is restricted, then depending on the stringency of this constraint, theinvestment level that optimizes the utility of the multinational varies considerably. Themain aim of this paper is to find out the effects of capital restriction policies for thisparticular case. A second issue that is addressed in both NRS and the present workconcerns the quality of the private information possessed by the informed party. With1 See the observations to this point made by D. Yoffie, 1993.
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some frequency venture contracts between heterogeneous partners attempt to specify anoptimal schedule of transfer payments (Darrough and Stoughton 1989 and alsoStoughton and Talmor 1994). This kind of solution may indeed be optimal only if thereis no residual uncertainty left on the future cash flows, conditional on privateinformation. In Stoughton and Talmor (1994) the informed party has perfectinformation and they focus on a mechanism for the transfer of payments, with themultinational facing differential income taxes. Imperfect information begets thenecessity for contract design. Given limited liability, contracts have to be statedependent if private information is imperfect, this mechanism solves for the optimalcontract form, instead of the mechanism of a simple transfer payment used if allinformation were known to the informed part. NRS suggest that this reasoning followsthe same intuition underlying the models for takeover when the shareholders of thetarget firm have private information (Eckbo, Giammarino and Heinkel, 1990; Fishman1989; Hansen, 1987). This gives the problem characteristics similar to those found inoptimal security design and optimal mechanism design under asymmetric information,when investment policy is the main issue (see, for instance, Green 1984). Income taxconsiderations are left out of the present work, since the purpose of this work is to focuson the effect of capital restrictions on the structuring of the venture contract. Indeed,capital participation constraints can be seen as a form of regulatory taxation in theclassic sense.A review of previous work Fagre and Wells (1982) report results from an empirical study made usinginformation on the experiences of several U.S.-based MNEs in Latin Americancountries on the relationship between certain qualities of an MNE and its ability to
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obtain a certain level of ownership in a JV. This paper makes the central assumptionthat the determinants of the percentage of equity participation in a JV are best explainedby the concept of relative bargaining power. Relative bargaining power is defined interms of a set of characteristics that distinguish both the MNE and the host country. Theauthors propose that much of the relative bargaining power that a MNE musters reflectsin the proportion of ownership struck in the bargain with the local government.Therefore, they see ownership as an important measure of the MNEs bargaining power.They duly observe that there are other measures, such as control and allocation ofeconomic benefits that might be of importance. Economically, they point out, there aresome ways in which one could see ownership as the least important of the measures thathave been mentioned, due to the existence of other mechanisms, such as taxation andrights to name board members, in which governments can have effective control andredistribute allocations. Nevertheless, many governments have generally consideredlocal ownership as an important goal when they negotiate with foreign investors. Theirconcerns presumably arise from political motivations;...Whatever the facts about therelationship of ownership to control and economic benefits, both parties to negotiationsseem to view the distribution of shares as an important outcome in it own right. 2 Inbrief, the authors see ownership linked in practice, though in an imperfect way, tocontrol. The paper devotes its main efforts to investigate how some of the MNEresources relate to its overall bargaining power, as measured by equity participation,vis-à-vis the foreign government. Three different measures of ownership are introduced in the paper, each at anincreasing degree of refinement. Measure I takes the naive approach of assuming that a2 Op. cit. page 10.
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larger equity participation by the MNE corresponds to a larger measure of bargainingpower. The second measure recognizes the fact that there is no such thing as a universalattitude toward ownership that all multinational enterprises follow faithfully. Some mayvoluntarily place limits to their share of ownership, even in the absence of externalpressures from any particular government. Measure II therefore is constructed in orderto account for such idiosyncratic differences among MNEs. First, for each MNE in thesample an average value for ownership was calculated for its holdings in its subsidiariesin Europe. This geographical area was chosen because there ownership participation bythe MNEs in their subsidiaries is largely left to their own reckoning. Therefore, theproposed average is considered to be a true measure of attitude of the MNE towardownership. Measure II is then defined as the difference between the ownership share inthe Latin American subsidiary and its European average. The third measure tries toaccount for differences in attitude toward ownership adopted by the different countriesin Latin America. The third measure is defined as the difference between the parentsownership share in the subsidiary and the average U.S. ownership of subsidiaries for theparticular country. The model proposed in the paper attempts to establish the effect of fiveeconomic characteristics of the MNE on each of the measures defined above. Accordingto the authors, these measures are meant to represent the impact of these economiccharacteristics on the outcome of negotiations as a whole, though they concede that to amore skeptical reader those measures only represent the impact on equity alone. Thesecharacteristics are: the level of technology, the degree of product differentiation throughadvertising, to access provided to export markets, the amount of capital, and thediversity of the firms product line. These five characteristics act as independent
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variables and each separate measure of ownership as defined earlier act as thedependent variable. The level of technology is proxied by the percentage of sales revenues spent bythe parent on R&D during 1974. This choice is open to some criticism, since not allfirms are equally efficient at making the R&D budget to translate into tangible results.The justification for this choice resides in the fact that R&D expenditures are animperfect measure of the rate of technological innovation produced and put into practiceby the MNE. The higher the R&D expenditures as a percentage of sales, the more likelyis that innovation and technological uniqueness are at the heart of the strategiccommitments of the firm. Most developing countries are at a considerable disadvantagewhen negotiating with a firm that deals in markets with participants that competethrough a fast paced product improvement race. These conditions will not be met bythose countries without the involvement of a foreign investor that has the necessaryR&D experience and the required material and human resources. By comparing studieswhere each of the three measures of ownership is taken as dependent of this singlevariable, the results are all consistent with each other, and point to a not too simpledependence: If the percentage of R&D expenditures is less than about 5%, then there isno clear effect, as seen through any of the alternative dependent variables. However, ifit is higher than 5%, then all of the measures show a strong effect, where all MNEswithin this category take on average nearly 100% of ownership, regardless of industry,number of competitors in the particular industry, or other similar criteria. Fagre and Wells suggest that product differentiation seems to be one of the mainbargaining advantages for those MNEs that have strong marketing skills. Product
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differentiation by multinational enterprises presents a formidable barrier to potentiallocal enterprises in developing countries. Although the production technology needed tomanufacture satisfactory ball point pens and carbonated beverages is hardly secret,Parker pens and Coca Cola are still the preferred products in many developingcountries. 3 This independent variable is proxied by the percentage of sales that theMNE spends on advertising. Advertising technology is also a rather perfected art;therefore, in this case, there is a much higher confidence that the proxy represents moreclosely the associated concept than in the case for the level of technology. The authorsfind that advertising seems to be related to bargaining power at nearly all levels ofexpenditure. As with the previous criterion, they seem to distinguish a threshold valueof about 7% of total sales revenues, above which MNEs in this group attain on averagea level of ownership of 98% (see their TABLE 3.) The measures corrected for firmattitude toward ownership and for country attitude show this same tendency as well.This result must be taken with some caution, since the mix of MNEs at the top of thescale are to some extend of the same characteristics as those that have a strongtechnological background, therefore there is the possibility for confounding effects. Theauthors argue that since expenditures in advertising show significance for nearly theentire range of analysis, this variable is important on its own. To strengthen thisargument, they point out that no other variable nearly approaches the power to explainthe bargaining success of pharmaceutical and cosmetics multinational enterprises. A high capacity for exporting the product of the subsidiary is found by theauthors to be another important factor in the bargaining power of a MNE. Fundamentalto the strategy of some multinational enterprises is an ability to rationalize production3 Op. cit. page 12
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on a global scale and a capacity to acquire and utilize sophisticated knowledge offoreign markets. 4 In particular, if a large portion of the product from the subsidiary isfor export to another affiliate of the same multinational, this will result in considerablenegotiating strength for the MNE, although in general if the greatest part of productionis for exports, then Fagre and Wells find that this translates into high relative bargainingpower. The proxy variables for these concepts are the percent of total productiontransferred and the percent of total production exported, respectively. They find thatespecially the third measure: the country corrected ownership, shows a significantincrease when the proportion of exports in either category are in excess of 50% of thetotal product. Again there is here the ever present risk of confounding, caused by thefact that the multinational enterprises used in the sample may be also either strong intechnological level or marketing. The authors justify the independent relevance of thisvariable by looking at MNEs in the electronic part sector, where product differentiationor technology are not of particular importance, and find a marked difference betweenthe ownership measures for those subsidiaries that export most of its product, and thosethat do not. The case for capital as a source of bargaining power is less clear. From thesample used to make this particular study, there is no clear evidence for this to be afactor that favors the MNE. Only when the 1975 investments involved assets over 100million, there was a visible effect in equity participation. But then, the authors disclosethe fact that subsidiaries with assets of this size were usually located in countries thathave lenient policies toward foreign ownership.4 Op. cit. page 13
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The last of the independent variables, product diversity, is an additional factornot found, according to the authors, in the previous literature on the subject. Whensubsidiaries are classified by the number of products (3-digit SIC) they produce, a quitestrong relationship to ownership appears. The greater the number of products, thegreater the apparent bargaining of the firm... 5 They find somewhat puzzling thoughwhy this variable turns out to be very significant in their study. This is more strikingafter they confirm the fact that variable is not correlated to any of the others alreadydiscussed that are of particular interest to the host country. Differently from the otherfour variables, there doesnt seem to be a straightforward reason as to why this oneseems to weaken the relative bargaining position of the host country in Latin America.To be sure this is not a general sort of happening, the authors check the European case,and find that the effect there is almost the opposite. The authors attempt to understandthe reasons by concentrating in the single case of Mexico, where the numbers are largeenough to produce some significant statistics. When parent firms are classifiedaccording to the number of affiliates, and each affiliate is associated to a certain group,the authors find the following effect: Enterprises that have only one affiliate in Mexicouse it as a base for several product lines in 55 percent of the cases, roughly double thesimilar figure for corporations owning 5 or more affiliates in Mexico. Parent firms usinga single affiliate strategy also wholly owned their affiliate in 64 percent of the cases,again roughly double the similar figure for corporations having 5 or more affiliates. 6The possible reasons that they conjecture for these observations relate to highermanagement skills, preferences by the host country of larger, multi-product,investments over those for a single product, there may be a concentration of speciallysensitive industries which use a single affiliate with several products, and the one5 Op. cit. page 17.6 Op. cit. page 18.
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favored by the authors, that the observed relationship is the consequence of governmentregulations in the host country. Fagre and Wells not only consider enterprise related factors in order to measureits relative bargaining power, they also looked at the degree of competition that themultinational could face within its industry. They classified the parents into industrialsectors, using the 3-digit SIC classification and within each industry counted thenumber of MNEs acting in each country. As it turns out, the number of competitors hasa very significant effect on bargaining power, as measured by the average level ofownership, using any of the three measures. The authors report that 16 of the 18industries in which all foreign investment were wholly owned contained only onecorporation, and the average parent ownership of subsidiaries for the 24 single-corporation industries was 95 percent. 7 They obtain a consistently negative relationshipbetween ownership and degree of competition, as long as they exclude from the studythree industries that have a special meaning to most governments in Latin America:Pharmaceuticals (SIC 283), petroleum refining (SIC 291) and office machinery (SIC357); they discuss in some detail why these three are to be left out of the study. Thereasons they offer for the case of office machinery are a bit dated, and it might be worthto repeat this same study with modern data. The paper closes with a brief discussion of multivariate analysis, where thedifferent measures of equity participation are modeled using linear regression taking allfive independent variables at once. Their results show all coefficients but the one forsize (assets) of affiliate to be significant at least to the 0.05 level. The R2s are for all7 Op. cit. page 19.
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three measures in the neighborhood of 13%, with a total of 648 degrees of freedom.These results point to problems due to imperfection in the measures defined for bothdependent and independent variables, as well a to inadequacies due to the application ofa linear model. The main general concern left unanswered by this study is whether actually themain assumption made in the study; that equity participation is a sufficient measure ofbargaining power, can survive further inspection. This is one of the centralconsiderations, and the starting point, for some of the more recent studies. In LeCraw (1984) the problem posed by the relationship between bargainingpower and ownership in the JV is further analyzed, beyond the findings alreadydiscussed by Fagre and Wells (1982). In Fagre and Wells (1982) the driving concept isto define relative bargaining power through a set of five characteristics of the MNE, andthen to measure it via the MNEs percent of equity ownership participation. Whilerecognizing the important contribution of the bargaining power framework provided intheir paper, LeCraw, as well as others, is skeptical of the assumption made there thatequity participation alone is enough measure. LeCraw (1984) is a paper mostlyempirical in its content. It has three distinguishable components. In the first, LeCrawextends the study of Fagre and Wells (1982) to include countries in the ASEAN group:Thailand, Malaysia, Singapore, Indonesia and the Philippines. The second part studiesthe connection between the relative bargaining powers of a MNE vis-à-vis the localgovernment, as proxied by a chosen set of characteristics, to the degree of control theMNE exercises over its subsidiary in the host country. This particular dimension ofbargaining power is missing in Fagre and Wells (1982). Quoting from LeCraw (1984, p.
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27): Poynter [1982] has shown that a TNC [MNE] may find it advantageous to bargainnot for increased equity ownership, but for control over the variables critical to thesuccess of the subsidiary from the TNCs point of view. Control provides means otherthan equity participation by which the MNE may appropriate the return on itsinvestment: ...licensing and management fees paid by the subsidiary, sale of inputs tothe subsidiary, sale of outputs to other units of the TNC [MNE] or on world markets,and interest on intra-company debt. The TNC may use its bargaining power not toincrease its equity ownership, but to secure some other means by which to appropriatethis return, possibly by manipulating the transfer price of these other payments. 8 In thethird part of the study, LeCraw explores how the exertion of control over a specific listof important operations and functions in the MNEs subsidiary (marketing, finance,technology, production, imports, exports, etc.) affects the overall success of the JV, asperceived by the sampled MNEs. The paper draws its conclusions from a sample of 153subsidiaries operating in the five countries of the ASEAN community. These countriesdiffer widely in the characteristics of their respective policies toward foreign directinvestment. The MNEs operated in six different manufacturing sectors. The MNEssubject of the study were based in the United States, Europe, Japan, and several LDCs.The care in the construction of the sample encourages the author to believe that thesample then may give a good basis on which to reach generalizations concerning thedeterminants of ownership and control of the subsidiaries of TNCs [MNEs] in LDCs,and concerning the effects of ownership and control on the success of theseinvestments. 98 LeCraw (1984) page 30.9 Op. cit. page 28.
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The study proceeds along methodological lines that are similar to thosediscussed above for Fagre and Wells (1982). This work concentrates its attention inthree dependent variables: Actual equity ownership, MNE bargaining success, andeffective control. These measures are related through multivariate linear regression tothe following set of independent variables: Technological leadership, Advertisingintensity, Subsidiary assets, Capital/output, Export/sales, MNE assets, MNE-subsidiarylinkages, Host-country attractiveness, Potential MNE investors, Time (1960=1),Dummy-Japanese MNE, Dummy-LDC MNE, and European MNE. The measure of actual equity participation is immediate. What the author callsbargaining success is defined thus EO − DE HC S MNE = DE MNE − EO Where EO is the actual equity ownership, DEHC is the resulting equityownership of the MNE, if the host country gets its desired level of equity ownership,and DEMNE is the desired level of equity ownership of the MNE. This measure isapproximately equivalent to the ratio of the country-corrected to the company-correctedmeasures devised by Fagre and Wells. There are three observations that come to mindabout the introduction and intended use of this measure. First, the author does not stateall the arguments for why this particular construct is a good representative of bargainingsuccess. Second, inspecting the regression results that he presents in TABLE 2 of thepaper, there doesnt seem to be any new insight gained from this variable that it is notalready included in the results for actual equity ownership. Third, if the idea is that themeasure is an increasing function of bargaining power, then it is worth noticing that forfixed values of DEHC and DEMNE, the measure is monotonically increasing with actualequity ownership. This seems, at least superficially, somewhat at odds with the J-shaped
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relationship between equity ownership and the company and country corrected successpresented in Figure 3 of the same paper. The third measure is effective control. This measure is constructed usingmanagerial evaluations. Each manager of the 153 subsidiaries rated the importance ofcontrol over each of a list of 18 factors: output pricing, output volume, output quality,technology transfer, technology control, capital expenditures, financing source,financing cost, financing amount, dividends timing, dividends amount, fees paid to theMNE, advertising and marketing expenditures, channels of distribution, import price,import source, import volume, export price, export destination, export volume andoverall management. The rating system used a scale from 1(none) to 10(critical). Themanagers were also asked to rate the degree of control that the MNE had over eachfactor from 1(no control) to 10(complete control). These data were then used toconstruct the measure of effective control by averaging the scores for the degree ofcontrol over the 18 factors, weighed with the scores for the importance. The authorinterprets this measure by stating that ...Effective Control measured the degree ofcontrol over the critical success variables retained within the TNC [MNE] compared tothe control lost to those outside the TNC, such as, local partners or the hostgovernment. 10 He finds the correlation between effective control and equity ownershipto be 0.57, much less than a 1 to 1 correspondence. Next, using multiple regression, the connection is established between the threedependent variables and the set of factors associated with relative bargaining strength.The independent variables used to describe bargaining power were: technological10 Op. cit. page 37.
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leadership, advertising intensity, subsidiary assets, capital/output, export/sales, MNEassets, MNE-subsidiary linkages, host country attractiveness, potential MNE investors(this refers to the number of potential competitors), time (1960=1), dummy for JapaneseMNE, dummy for LDC-based MNE and dummy for European MNE. Now we provide abrief description of the measures for each independent variable, and place inparentheses the respective sign for each dependent measure (Actual equity, Bargainingsuccess and Effective control) in the results for the regression. The measure oftechnological leadership (intensity) (+ all) 11 was made by asking the managers of the153 subsidiaries to rate from 1 to 10 some aspects that are usually associated with thischaracteristic. The measure includes ratings for the technology that was initiallytransferred and the potential for further transfers in the future. ‘Advertising intensity’ (+all) was represented with the advertising to sales ratio of the subsidiary relative to otherfirms in the industry; capital intensity (+ all) and capital requirements (+ all) weremeasured using total assets/output and total assets of the subsidiary, respectively, butsince these two are correlated, when put together in the regression the first showssignificance below the ten percent level and the second is significant to only ten percentlevel. ‘Export intensity’ (+ all) was measured as exports/sales; this was significant at theone percent level in all three regressions. The total assets of the parent MNE (+ all)relative to others in the same industry were included to test the hypothesis that smallerMNEs would take a minority equity position, this variable showed high significance inboth the first and third dependent measures, it was not significant for ‘Bargainingsuccess’. The ‘Linkage effects’ (-, -, +) is proxied by the ratio of total flow of resourcesbetween the parent and the subsidiary over sales, the flows considered included inputs,interests on loans and intrafirm suppliers credit, intrafirm sales, management and11 This means that all signs in the regression positive. The same interpretation applies if the sign inparentheses is negative.
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technical service fees, and imputed rental value on machinery and equipment suppliedby the MNE. 12 Notice the opposite sign between ‘Actual equity’ and ‘Effectivecontrol’, this confirms the hypothesis that if linkages are strong, then the MNE will beless interested in equity and more interested in having control over critical operationsand functions; the coefficients for these two measures were significant at least at thefive percent level, the coefficient for ‘Bargaining success’ was not significant. Forattractiveness of the host country (- all), the managers of the subsidiaries in the samplewere asked to rank the country on a 1 to 10 scale; the results show that the moreattractive the country the lower the relative bargaining power of the MNE vis-à-vis thehost country, the coefficient for ‘Effective control’ was not significant. Potential MNEinvestors (- all) represents the degree of competition found by the MNE at its arrival.The number of MNEs that had already undertaken FDI in the same industry in theparticular country was used as the measure; all coefficients for the three regressions aresignificant to the five percent level or better. An absolute reference for Time (1960=1)(- all) was introduced to show the learning effect of the host countries, which got betterin their bargaining ability over time; all coefficients are significant at the five percentlevel. The coefficient of the dummy for a Japanese MNE showed a somewhatunexpected result, it was negative for Actual equity and positive for effective control,with both significant to the five percent level. The apparent interpretation is that theJapanese bargain less for equity participation while keeping a relatively higher degree ofcontrol over operations. The LDC dummy (-, +, -) shows that these MNEs haverelatively less bargaining power; this is stressed by the fact that the coefficient forBargaining success is not significant. The European dummy was not significant to any12 Op. cit. page 35.
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2of the dependent measures. The R for each of the three regressions were 0.63 for‘Actual equity’, 0.47 for ‘Bargaining success’ and 0.55 for ‘Effective control’. LeCraw also analyses in more direct ways the relationship between equityownership, effective control and the overall success of the JV, from the MNEs point ofview. ...TNCs [MNEs] may bargain for increased equity participation in order toincrease their control over the operations of their subsidiary, to try to ensure that theinternalization advantages are in fact realized. The link between the level of equityparticipation and the TNC’s control over its subsidiary, however, may not bestraightforward. Depending on type of technology transferred, the capabilities of thelocal partners, and the host government policies, a TNC may be able to control theoperations of its subsidiary that are critical from its viewpoint without a majorityownership, or, conversely, may have little control over these operations despite majority(or even complete) ownership. A TNC may therefore be willing to trade reduced equityownership for increased control of variables crucial to the success of the venture fromits point of view...The link, therefore, between the bargaining power of the TNC, thelevel of its equity participation, its control of the subsidiary, and its perception of thesuccess of the investment is complex and may be difficult to trace. 13 In an attempt tomap the relationships among these factors introduces three measures of success: theprofitability of the subsidiary, the success of the subsidiary as rated by the MNE (on ascale from 1 to 10); and a country and industry corrected success (CICS) measure.This way of measuring success was introduced to account for the perception thatprofitability was not the only measure of success and for the fact that profitabilityreports from subsidiaries of MNEs have sometimes been found to differ from actual13 Op. cit. pages 30-31.
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profitability. The CICS was plotted against Effective control, using the latter asindependent variable. The plot is shown as FIGURE 2 in the paper, and it displays astrong linear dependence. In FIGURE 3 CICS is plotted against the percent of actualequity ownership; it shows a J-shaped diagram, with its lowest points drawn around theequity region where ownership is roughly equally distributed between the partners.Meaning that in the sample studied, ventures were the least successful when ownershipwas split roughly equally between the partners, condition that possibly reflects a hardbargaining process where both parties saw a close tie between ownership and control,resulting in a poor managerial structure. This result is consistent with the findings inKilling (1982).On relative bargaining power and project control There are several reasons given by different governments for the existence ofequity participation restrictions: better access to information, control of payments fortechnology transfer and management fees, control of pricing of output and intra-company trade, reinvestment and remittance of capital. These reasons sometimes do notprovide a coherent information set on which to draw conclusions, much less to predictthe outcome of a particular negotiation. Also, it is common to find equity participationrestrictions related to politically sensitive issues to the host government, quite apartfrom economic considerations. The main purpose of this section is to propose a starting point for theformalization of the ideas contained in Poynter (1982) and LeCraw (1984). It may beuseful first to summarize briefly the relevant aspects of what has been found andpresented in the previous section. In Fagre and Wells (1982) the plausible assumption is
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made that there is a close relationship between the bargaining power of the MNE andthe level of equity participation that it can negotiate with local firms and governments.Their study shows results where this assumption finds empirical support. Nevertheless,Poynter (1982) makes the observation that such bargaining power will not necessarilybe focused on equity participation alone, but that often it is used in order for the MNEto keep decision control over operations that are critical to the success of the venture,even if the MNE has minority participation. After additional empirical research LeCraw(1984) finds that the implied additional assumption made by in Fagre and Wells (1982):that increased equity participation goes hand in hand with increased control of criticalfunctions, is not necessarily true. Control of critical operations and percentage of equityparticipation are not, in general, perfectly correlated. These empirical results have abearing on the theoretical side of JV studies. If an important part of the contributionfrom the MNE to the JV is related to managerial skills, then it is not adequate todescribe models for JV only in terms of equity participation, but control must also beincluded as part of the model. In terms of bargaining power, it is difficult not to see assomewhat odd the fact that the MNE has the bargaining power, and yet it has no say in anegotiation process with a local government which is perhaps acting under its ownpressures to seek outside investment, especially for the increase of the nations exportcapacity. The main items over which there is something to bargain for are equityparticipation and project control, therefore, if such power is on the side of the MNE, itwould have to reflect in at least the second of these two components. A more carefulinspection of this argument though would hint at a stronger characterization of theconcept of bargaining power itself. The standing literature limits its scope of bargainingpower to setting the bargaining problem such that the party having the power maximizesits own utility, subject to some rationality constraint given by the counterpart. This
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maximization is done with respect to a set of variables that specify the terms of theproblem; these variables represent the main items that are subject to negotiation at thebargaining table. However, in order for this maximization exercise to make sense,there are sometimes conditionality restrictions that the set of variables most satisfy. Inthe present literature, the treatment of ownership and governance variables, even whenthe latter is directly treated at all, does not seem to follow clear rules of conditionality.This does not seem to be an entirely satisfactory scheme. Consider an MNE that doesindeed wield a big stick in terms of, for instance, marketing power. If it faces anegotiation process with a government that is lenient in its capital participation policy,then it is to be expected that the MNE will must certainly have full control of the maincomponents of the project as well. Assume on the other hand that the same MNE facesnegotiations in a country with tough policies regarding foreign investment in certainindustries. Then it may be the case that capital participation restrictions could act as abarrier for the MNE to have access to majority participation. However, if it is true thatthe MNE carries weight in the negotiation, it still should be able to keep the full controlof critical parts of the project. This can always be the case, since project control is notan aspect that is easily visible to outsiders, as opposed to what happens with equityparticipation. On the other hand, it is not easy to conceive of a situation in which theresult of negotiations between a local government and an MNE were that the latter getsto keep, say, 95% of equity, but it has no effective control of operations. In other words,a clear sign that the MNE has any true bargaining power is that it keeps control of atleast those components of the project that are critical for a successful outcome, from theMNEs point of view. We will refer to having control, or having effective control to asituation in which managerial control is not shared to the extend where decisions resultin actions that are inconsistent among each other, and with the well being of the project.
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Some arrangements of shared management in JVs result in each of the partiescontrolling some vital components of the project, leading almost always to conflicts thatcause the JV to fail (Killing, 1982). An example may help to clarify the arguments given above. Consider thefollowing simple model: suppose that a JV project produces a certain amount L if thingsdo not turn out well. This amount can be seen as a riskless cash flow that the partnersget for the very fact of undertaking the project. If all comes out perfect, then the finalcash flow for the project is L+ where is a premium that defines the degree of ,success over failure. Suppose moreover that the probability of success for the project issome concave, increasing function of initial investment I , and that it also depends onthe degree of control c exerted by the MNE over critical parts of the project. Letsdenote this probability by p(∆ | c, I ) . Then the expected utility for a risk-neutral MNEwill be given by U (c, β , γ , I ) = γL + β∆p(∆ | c, I ) − I . Here γ corresponds to the share theMNE gets of the riskless part of the cash flow contributed by the mere undertaking ofthe project, and β is its equity participation. This formula assumes that all initialinvestment comes from the MNE. This assumption makes sense at least in the scenariowhen the MNE has both the bargaining power and privileged information, because thenone can not expect the local firm to have an incentive to put cash up front as part of theinitial investment in the project. To simplify matters, lets assume that c ∈ {0,1} , wherec = 0 if the MNE has no control and c = 1 if it has total control. The probability functionis assumed to be such that p(∆ | c = 1, I ) ≥ p(∆ | c = 0, I ) andDI p(∆ | c = 1, I ) ≥ DI p(∆ | c = 0, I ) for all feasible I . In what follows we shall incur in asmall abuse of notation and rename these two probabilities simply as p1 (I ) and p0 (I ) ,
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respectively. The stated conditions are meant to ensure that the project with full controlwill be comparatively more successful than the project with no control. Lets analyze ahypothetical situation in which the MNE has to choose between having a higher than50% equity participation β H , but with little or no control, and having a minorityparticipation β L , but with the possibility of having full control of critical operations.Then, all else been equal, the MNE will have to decide the best use of its bargainingpower on the basis of which of the two products, β H p0 (I ) or β L p1 (I ) is higher. Giventhat there exist some indifference point of investment level between these two options,then the MNE will have an incentive to put a larger investment I into the second case 14,if constraints so allow it. Therefore, it wont choose the first case. Another issue that goes to the heart of the benefits of control to the MNE is theone related to transfer prices and fees. Clearly, the more economically significant is theinternal transactions between a parent and its subsidiary, the greater the total size ofsuch fees. These cash movements can be seen as riskless rents that the MNE derivefrom the JV. If the MNE exerts no control over the critical decisions of the venture, thetransfer of these riskless cash flows is not likely. Another scenario could be that the JVdoes not come with the convenience of frequent internal transactions, leaving the MNEwith the need to obtain maximum results out of the risky part of the cash flow, plus anyriskless part that has to be shared with the subsidiary. Assuming that the MNE willprefer riskless gains to risky ones, it is useful to recognize the importance of anyriskless cash flow that results from internal pricing and fees, as opposed to any risklesscash flow that is shared by the partners. In other words, instead of writing γL , the sharedriskless cash flow, we should write lc + γL as the complete expression for the riskless14 This is so because the second term eventually has a higher slope than the first, for I large enough.
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component, where l represents the amount stemming from internal pricing and fees.Observe that if the MNE has no actual control, then the additional profits arising frompricing and fees vanishes. Realizing that the description of bargaining power may be a more complexmatter than it is usually taken for in much of the present literature; it is worth toconsider a more direct representation of this concept. It is possible to picture thebargaining process between the MNE and the local firm/government with a dynamicswhere the final outcome in terms of control and equity participation is uncertain to somedegree. At an early stage, when the MNE is considering whether or not to enter a JV, itwill have to decide on the convenience of the proposed JV pretty much based onexpectations of some kind. The setup of the problem for the MNE must consider thisex-ante expectation. There is then the matter of how to make operational thisexpectation. Clearly what is meant by bargaining power is a relative notion. It is notreasonable in general to suppose that the MNE can exert it equally well with differentcompanies spread across different countries. In the case of Latin-American countries, asis remarked in Fagre and Wells (1982), there are obvious differences in negotiatingwith, say the Dominican Republic, than doing so with Mexico. The lesson that we canextract from these considerations is that we can talk only of relative bargaining power,and that if this power is to be measured in terms of the more or less uncertain outcomeof some negotiation, then a likely candidate to represent it in a formal way is aconditional probability. This probability should meet at least three criteria: First, weassume that the most relevant element in the negotiation is the extent to which the MNEcan gain control of critical parts of the project. Second, the extent to which it is able tokeep such control at a given level of equity participation. Third, once the first two issues
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have been settled, there are no other significant elements left that can characterize theoutcome of the bargaining process. This is not to say that in order to reach a final statein terms of control and equity participation there might not be other factors that weighin as chips used in the bargaining game. This could be the case, for instance, of the sizeof the investment. Given the above criteria, we propose ρ (β ) = Pr (c = 1 | β ) as a direct measure ofthe true relative bargaining power of the MNE. We argue that this conditionalprobability summarizes the conditions that best reflect the findings in the empiricalliterature, in particular those in LeCraw (1984) and Fagre and Wells (1982). It isnecessary to carefully state the interpretation given to this choice for the bargainingpower of the MNE. First, it means that if the MNE is not able to retain control of criticalparts of the project, then this outcome is a strong indicator of a relatively low bargainingpower with respect the local firm/government. Second, the given part of the formula must be read as given that it is able to get at least in the bargaining process.Much too often reaching agreements for carrying out a JV between a MNE and a localfirm, with the local government as a third interested party, brings the spotlight on theissue of ownership, as represented by equity participation. Arrangements that may leadto successful outcomes - or possible equilibrium solutions if we see it as a bargaininggame - include either having a majority participation, up to 100%, by the MNE, as wellas having full control, or alternatively they may lead to the MNE settling for a minorityparticipation, so that it can have full control. A different sort of outcome results if equityconsiderations are closely tied to the issue of control of critical operations. This may bethe case if the local government is, for example, a strong advocate that the JV must alsobe a learning process that contributes to increase local managerial skills. Assume that
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the informational advantage possessed by the MNE truly represents a superiororganizational and technical know-how. If the MNE gets into a situation in which bothsides of the table see more equity as more control, then this may result in a mixedgoverning body, quite possibly in the neighborhood of a fifty-fifty composition. Thenits knowledge advantage may be seriously diluted (i.e. c = 0 ) by a hampered andsomewhat unpredictable decision making process. The resulting inefficiencies are likelyto have bad consequences for the project. From these considerations we can gather thatthe particular shape of ρ (β ) is not necessarily simple; this function is somehowsummarizing all the essentials of what the MNE and the locals can achieve, or arewilling to concede, in the negotiation. Further discussion of this model is deferred tosection 1.7.Structuring international cooperative ventures Noe, Rebello and Shrikhande (2002) explore the relationship betweenbargaining power, regulations, information asymmetry and financing policies ininternational joint ventures. They consider a cooperative arrangement between amultinational and a local firm; the partners determine the scale of the venture and itsfinancial structure. This scenario assumes that the local firm is capital constrained, andit will not undertake direct investment unless circumstances, in terms of its own privateinformation, would indicate otherwise. The multinational may find legal barriersestablished by the host government for it to realize its desired equity ownershipparticipation in the venture. Either one or both of the parties may face competition andmay hold private information about the ventures prospects. The approach in NRSconsists of studying four different allocations of information and bargaining power:First, the multinational has the bargaining power and also has the information
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advantage; this could be the case, for instance, if the local firm faces competition andthe main product from the venture is marketed outside the host country. Second, themultinational has a bargaining advantage, but the local firm has more information aboutthe ventures prospects; this may happen, for instance, when the multinational has arecognized brand name, but the product of the venture is directed toward the hostcountrys market, where the local firm has better knowledge of markets conditions.Third, the local firm finds several multinationals competing to enter the local market; inthis case the local firm has both the bargaining power and the information advantage.Fourth, bargaining power rests with the local firm, but the multinational has aninformational advantage. In the four cases mentioned, the authors stress the importanceof contract structures that favor firm-value contingent payments over simple transferpayments for the firm with the information advantage. This is in line with the literatureon takeover bids, when the target firm has private positive information (Eckbo,Giammarino and Heinkel (1990), Fishman (1989), and Hansen (1987)). This intuitionabout the optimal contract is not fully in line though with actual JV experience 15, wherean important part of the motivations underlying the interest of a multinational enterprisein entering a JV is related to riskless transfer payments. In the first case, when the multinational has both the bargaining power and aninformational advantage, the multinational has to make sure that the local firm valueshighly its participation in the venture. The multinational may achieve this goal bysignaling the goodness of the project through taking as much equity as possible.Government regulations on capital participation restrictions can prevent this form ofsignaling and then the multinational will be forced to use a costlier form of signaling via15 See, for instance, the account in Killing (1982).
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overinvestment. Overinvestment caused by capital regulations will have a positiveimpact on the level of local employment and on the possible rents that the local firmcould derive from this situation. Therefore, in the present case of bargaining power andinformation allocation, the local firm and government stand to benefit from capitalrestrictions 16. In the second case, when the MNE holds the bargaining power, but the localfirm has an informational advantage, as it might be the case when the end product of theJV is directed to the local market. In this case, the local firm has an incentive to declarethe state to be B. With this news the local firm is interested in convincing the MNE thatit needs a larger share of the profits (i.e., a larger β ) in order to meet its opportunitycosts. The right response of the MNE, should the local firm declare B, is to offer acontract that severely restricts project investment, reduces to a minimum domestic firminvestment participation, and deprives the domestic firm of upside cash flows 17. Theway in which the MNE limits upside the upside cash flows to the local firm is bymaximizing its own equity participation, and therefore capital restriction rules arerelevant, as in the first case. The third case is when the local firm has both the bargaining power and aninformational advantage; this might be exemplified by an arrangement where the MNEacts as a simple financier of the venture. In this case the local firm is the one interestedin taking an all equity position, as a signal of the projects good prospects. This measurealone might not be enough, and a degree of overinvestment might still be a necessarysignal. The local firm will indicate in this way that it can bear the costs of16 As noted earlier, this sort of reasoning makes strict sense only in the total absence of the possibility ofinternal transfer payments.17 Noe, Rebello and Shrikahnde (2002), page 3.
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overinvestment. In this case any rule restricting the capital participation of the local firmwould benefit the MNE. The fourth case considered in NRS occurs when bargaining power rests with thelocal firm, but the MNE has the informational advantage, situation that may arise if thelocal is in a monopoly position, but the end product is directed to the MNEs homemarket. The MNE may have an incentive to report bad news, in which case the responsefrom the local firm must be to offer a contract were investment is restricted to aminimum and it will take a100% equity participation. Again, any rule restricting thecapital participation of the local will go in favor of the MNE. In conclusion, capital participation restrictions on FDI have an effect on theMNE mainly when it has the bargaining advantage, while any rule restrictinginvestment participation by the local firm affects it mainly if it has the bargainingpower. Investment distortions result from asymmetry of information between thepartners, with overinvestment occurring when the partner having the bargaining poweralso possesses an informational advantage, and underinvestment occurring when thepartner that has the bargaining power is at an informational disadvantage. In whatfollows, we shall explore the combined effects of capital restrictions and informationasymmetry in the first case, when the MNE has both the bargaining power and aninformational advantage. The main question to be addressed is whether capitalrestrictions can eliminate the effects due to asymmetric information, restoringinvestment to its Pareto efficient level, or even inverting the original effect and creatingunderinvestment.
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The model The project requires of a total investment I that is bounded by exogenousconditions, so that I ∈ [ I min , I max ] . Throughout this work we assume that themultinational (from now on the MNE) makes all the necessary investment and itspartner - from now on the domestic firm - doesnt have to put any cash up front. Thisassumption, as explained earlier, is consistent with the case when the multinational hasthe bargaining power, which is the main focus of the subsequent analysis. The projectsfuture cash flow can only be one out of two possible outcomes, either H or L , whereH > L > 0 . The probability for realizing the high cash flow H depends on the value ofthe information signal. The information types are either G , for good news, or B for badprospects. These states determine probabilities Pt ( I t ) for cash flow H , with t ∈ {G, B} .These probabilities are assumed to be common knowledge, and are such thatDI Pt ( I ) > 0 and PG ( I ) > PB ( I ) , for I ∈ [ I min , I max ] , and they are strictly concave over thesame interval. In order to ensure that there is a solution to the optimal investmentproblem we assume lim I → I min DI Pt (I ) → ∞ Since information in the G state is more valuable than in the B state, we alsorequire (Reily, 1979) DI PG (I ) DI PB (I ) > PG (I ) PB (I ) This will ensure that there is no more than a single crossing in the iso-utilitydiagrams in the plane of investment-equity participation, condition that then guaranteesthe existence of a separating equilibrium for the adverse selection problem.
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The domestic firm incurs in an irreversible cost Vmin if it undertakes the project;this will constitute its reservation value. The MNEs reservation value will be taken tobe zero, and all its initial sunk costs are included in I min ; this simplification helps toproduce more transparent expressions, without any loss of generality18. The project isnot so good as to be riskless; the riskiness of the project is summarized by theconditions L < I min and L < Vmin . Presumably, both the MNE and the local firm borrow the necessary funds inorder to carry out the project; therefore, L plays the role of that (riskless) part of thefinal cash flow of the project that help repay the initial debt, and the rest of theobligation will have to come from the risky part ( H − L ) Pt ( I ) of the cash flow. Theexpected net present value for the overall project in state B would be enough to cover allcosts, so that there is a positive incentive to enter the joint venture in the first place. Thiscondition is written as N B (I min ) := L + (H − L )PB (I min ) − I .Where N t (I ) − Vmin (I ), with t ∈ {G, B}, is the net present value for state t . Notice that weare working with a zero rate of return on capital. The contract between the two parts can be specified by stating the partition ofboth equity and debt that each will take. β is the equity participation for themultinational, then the risky part of its profits will be β t ( H − L ) Pt ( I ) . There is also theproportion γ t that the multinational takes from the risk-free part of the project,18 The choice of a reservation value U 0 > 0 just defines the lowest utility acceptable for theMNE to be willing to undertake the project in association with the domestic firm. It would act asthe equivalent of an opportunity cost.
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represented by γ t L . The full specification of the contract is contained in the triadSt := ( I t , β t , γ t ) ; the set of all feasible contracts in state t will be denoted Σt . From thesedefinitions we can construct the expected utility of the multinational, which will be U t (S t ) := γ t L + β t (H − L )Pt (I t ) − I t From this expression is not difficult to see that the MNE will have an incentiveto seek an equity participation as long as the risk-free component of the project does notbecome important compared with the risky part, i.e., as long as L < β t (H − L )Pt (I t ) forall St ∈ Σt . If this were not the case, the riskless cash flows would generate a tensionwith the signaling purpose for the MNE to take a large portion of equity in the venture.Such tension will indeed be present for any amount L , and there is an inverserelationship between the maximum portion of equity that the MNE is interested intaking and the size of L . From now on we shall assume that the above mentionedinequality applies. The expected utility for the domestic firm is given by Vt (S t ) := N t (I t ) − U t (S t ) = (1 − γ t )L + (1 − β t )(H − L )Pt (I t ) As will be stated in the next section, this expected value needs to be at least thereservation value Vmin . This condition would turn equality, if it weren’t for the effect ofthe capital restriction rules. The constraint on capital participation is taken to be a stateindependent rule that puts an upper bound to the equity portion of the multinational.This rule is formally expressed as βt ≤ α .
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Where α (≤1) is the capital participation constraint. As discussed below, this constraintwill have the effect of substituting investment distortion for equity participation as asignaling mechanism for the multinational.The optimization problem We address the case when the multinational has the bargaining power and alsothe informational advantage. In the G state of the world the optimization problem is(MB/MI-G): max S U G (S G ) = γ G L + β G ∆PG (I G ) − I Gs.t. U B (S G ) − U B (S B ) ≤ 0 Vmin − VG (S G ) ≤ 0With I G ∈ [I min , I max ] , β G ∈ [0,α ], γ G ∈ [0,1] . The notation ∆ = H − L will be used throughout the rest of the paper. The first :constraint is the incentive compatibility, or no-mimicry constraint, which prevents themultinational with B B information to mimic the strategy of the one with Ginformation. U B ( S B ) is the optimal solution to the maximization problem if the signal isB . The second constraint is the reservation value constraint for the domestic firm. Theproblem when the MNE has information B is stated as (MB/MI-B): max S U B (S B ) := γ B L + β B ∆PB (I B ) − I Bs.t. Vmin − VB (S B ) ≤ 0With I B ∈ [I min , I max ], β B ∈ [0,α ] , γ B ∈ [0,1] .
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The optimal solution to MB/MI-B is then used as the constraint for no mimicryin the G problem. How this constraint acts on the problem with good informationdepends in general on the level of the capital participation restriction α and on thedomestic firms reservation value Vmin . In Appendix A we show the precise form of thisdependence. The main facts about the solution can be intuited from the situation facedby the multinational when its information is B . Under this condition the multinationalwill not use costly overinvestment to signal its type, instead, it will keep all equityparticipation compatible with constraints. If the value of α is so high as to be toolenient, then we may expect that the MNE will proceed to take an all equity position 19, PO ( )up to a maximum β ≤ α such that L + (1 − β B )∆PB I B = Vmin , where I B is the Pareto POoptimal investment level. The multinational, having the bargaining power, will structurea contract that keep the domestics rationality constraint binding, if this is possible.Under informational disadvantage, the domestic firm will be more interested in theriskless cash flow component L , in order to cover as much as possible of its reservationcosts. A second regime comes if the capital restriction rule is such that α < β B . If the ( )reservation value is high, and by this we mean L + (1 − α )∆PB I B ≤ Vmin , the POmultinational will invest at the Pareto optimal level, but no more than that. This requiresthat the multinational take some share γ B > 0 of the riskless cash flow L . If the ( ) ( )reservation cost is not so high, such as when (1 − α )∆PB I B > Vmin > (1 − α )∆PB I B , PO F Fwhere I B is the full information investment, the multinational will take all the share of ( )debt ( γ B = 1 ) and will invest at a lower level I * ∈ I B , I B in order to just meet the F PO ( )reservation constraint. If the reservation value is too low, that is if (1 − α )∆PB I B > Vmin , F19 See the observation made about the value of L in the previous section.
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then the reservation constraint will not bind and the multinational will choose the full Finformation level of investment I B . Since this level of investment corresponds to theglobal maximum of the multinationals utility, we can not expect it to lower it evenfurther, no matter how small Vmin may become, therefore the domestic will derive ( ( ))forced rents in the B state for any α < 1 − Vmin / ∆PB I B . F If the multinational type is G then it will need to convince the domestic firm ofits goodness through signaling. This means taking as much equity as allowed by theimposed capital constraint and the reservation value of the domestic firm. NRS showthat as long as the reservation value constraint remains active, signaling will take theform of overinvestment, and the contract structure will be such that either β G = α or *γ G = 0 . 20 * The way investment strategy changes with α can be depicted as follows: if α istoo high, then the capital restriction constraint will not be binding, and overinvestmentwill come solely as a consequence of the no-mimicry constraint. As α grows smaller,the effect is to suppress the signaling value of equity participation, which will furtherdistort the investment policy, and from that point on we get β G = α and γ G > 0 . The * *reservation value constraint remains active provided α is not too low. In other words, itdepends on the truth value of the inequality (1 − α )∆PG (I G ) < Vmin * . Once is so low that this inequality fails, the reservation constraint stops being binding and the multinationals signaling through overinvestment no longermatters, since once the domestic firm starts deriving forced rents, it will not care for any20 We use * to indicate the values of the quantities that correspond to the optimal solution.
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other form of signaling. As α diminishes further, the no mimicry constraint wi l stop lbeing binding, since paying rents for the G MNE is costlier than for the B type. Since atthis point both constraints have become non-binding, the MNEs investment level will Freach the full information, unconstrained value I B . Therefore, for a range of values ofα the investment policy will have gone from overinvestment to underinvestment.Consequently we can state the following proposition Proposition 1: When the multinational has both bargaining power and theinformation, there is a degree of capital restriction for which the investment level willbe the Pareto efficient level. The proof is left to Appendix B. Continuity arguments indicate that there must be some value α c for which the POmultinational will invest at the Pareto optimal level I B . In Appendix B we show thatthis value is given by the equation α c ∆PB (I G ) = I G + ∆PB (I B ) − I B − Vmin . PO PO PO PONotice that this formula only involves quantities related to general structural andtechnological aspects of the project, meaning that α c can serve as an objective referencefor any negotiation process. Proposition 2: When the multinational has both bargaining power and theinformation, capital participation restrictions can be Pareto improving even when theinformation is G. The level of the Pareto optimizing restriction depends only on thestructural characteristics of the project and not on any particular strategic variable.
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Observe that as α grows smaller, the value of expected utility for the domesticfirm can only either to increase or stay at the reservation value. This proves thefollowing Proposition 3: When the MNEs information is G and it has the bargainingpower and the informational advantage, capital restrictions are beneficial for thedomestic firm. As is argued above, and more formally demonstrated in Appendix C, capitalrestrictions increase the degree of overinvestment to a certain point, namely up to thepoint where the MNE with G news starts paying rents to the local firm. After thatthreshold is surpassed, then investment levels quickly descend until they reach theunconstrained level for the optimization problem. Therefore, we can state the following Proposition 4: Capital restrictions imposed on the MNE when it has thebargaining power and an informational advantage are good for employment level up toa certain point, beyond which become detrimental.A numerical example At this point it is useful to introduce a case example in order to illustrate all thefeatures of the optimal solution described in the previous paragraphs. This is the samecase example used in NRS, but we will make a fuller use of its possibilities, in order toillustrate in detail the evolution of some of its main variables with changes in .
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The specific form for the probabilities is Pt (I t ) = Pt 0 + (I t − I min )c t . 100With I t ∈ [25,33] , and PG = 0.75 , PB0 = 0.5 , cG = 0.4 , c B = 0.001 . 0For the cash flows we choose L = 20 and H = 300 . The specific value of Vmin that is used to produce the output graphs is Vmin = 29 .This particular value has no special significance, it was chosen only for illustrationpurposes. The best way to see all the features described in the previous section is through agraphic representation of some of the more significant variables as a function of α .Figure 1.1 illustrates the changes undergone by the optimal investment as α descendsfrom 100% down to 70% of maximum participation. This graph is a plot of theparameter κ versus α , where κ is a more easily readable measure of I G , defined by the *relation I G = I min + κ (I G − I min ) . In terms of this measure κ = 1 is the Pareto optimal * POinvestment level, κ > 1 means overinvestment and κ < 1 corresponds tounderinvestment. Figure 2 shows the comparative evolution of the utilities for themultinational and the domestic firm in the G state across the same range of values of αas in Figure 1.1. Reading the graph in Figure 1.1 from right to left we can see that very looselevels of capital restriction have no effect on the multinationals level of investment,which corresponds to a degree of overinvestment ( κ = 2.5 ) that is just the necessary tomeet the reservation value constraint, and avoids imitation by a B copycat. How thisreflects in both partners utilities is shown in Figure 2. As the restriction tightens,
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additional overinvestment, up to κ = 8.2 , substitutes for lost equity participation as asignal. At this point the domestic firm starts getting more utility than its reservationvalue and the multinationals starts to decline in the same amount. As the maximumparticipation goes on reducing, it reaches the point where the multinational starts payingforced rents to the domestic firm in the G state. At this point signaling throughoverinvestment is no longer meaningful, because the B copycat would start havingeven a more difficult time sustaining any attempts at mimicry. The investment levelplummets quickly across a very narrow range of values of α , until it reaches the valueI G , the unconstrained level of investment. At this value of α the mimicry constraint Fceases to be binding, the multinational with B information no longer capable ofreaching the necessary contract structure.Further considerations on the relation between effective control and bargainingpower In several respects, the treatment of the problem as presented in NRS presumescircumstances and attitudes toward equity ownership in JVs that are at variance to thoseknown to the author, at least in the Latin American context. It is not frequent the casethat, even in the presence of adverse selection problems, the locals will simply seatwaiting for the MNE to choose its most convenient level of equity as a signal. It is notin general the case either that governmental restrictions on equity participation act assort of stone wall, against which the MNE has no negotiating power. The statementsin LeCraw (1984) are a more realistic guide. There, equity ownership is the result of anegotiation process in which there are no firmly defined stop points, and this result isseen as a relatively complex conjunction of four basic conditions 21: 1) The desired ownership level of the MNE.21 LeCraw (1984), p. 28. See also Vernon (1971), Stopford and Wells (1972) and Franko (1971).
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2) The bargaining power of the MNE. 3) The desired level of local equity participation of the host country. 4) The bargaining power of the host government (including the bargaining power of locally-owned firms in the host country). The combination of these four factors brings about the immediate consequencethat for MNEs operating within the same industry actual ownership participation varieswithin the same country. No such thing as a constant, repetitive top ownership share isobserved. The observed distribution of actual ownership is more the equilibrium resultof the negotiation process, where the above mentioned factors act as forces. Being thisthe case, a MNE seeking to establish a JV in any given country has to consider at leastthree variables: its desired equity level, the equity level that is most likely to achieveafter negotiations, and the degree of effective control attained after negotiations. Otherconsiderations, such as the degree of competition that is likely to find may be seen aspart of the bargaining power that MNE has. This part of the essay is mostly concerned with the explicit introduction of theconcept of effective control in the description of the bargaining process. One of thesimplifications made in NRS is the implicit assumption that control of criticaloperations within the project is not relevant. Whichever of the partners that carriesthrough the project, or whatever the composition of governance, will have no effects oneither total welfare or the efficacy to get results. However, it can easily be argued on thebasis of the available empirical evidence that this assumption is not justified. Inparticular, the J shaped form in FIGURE 3 of LeCraw (1984) would become hard toexplain within the NRS model, not to mention that it would not be able to say anything
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at all about the results presented in FIGURE 2 of the same reference. The presenttreatment is an attempt at including these components missing in NRS, so that with aminimum of additional complications, the expanded model becomes rich enough to dealwith the above mentioned facts. It is important to clarify from the outset that the maximization problem faced bythe MNE is ex-ante. Therefore, it does not know before hand the results of negotiationswith the local firm/government. In what follows we will voluntarily limit our analysis tothe case of no adverse selection problems, when there is no need for the MNE to beconstrained by an incentive compatibility condition. This is done only for the sake oftransparency of the arguments that follow. Full treatment in the case with adverseselection will be done elsewhere. If the MNE has the bargaining power, then when considering the bargainingprocess with the local firm/government there are at least two possibilities for the rolethat the size of the investment can play: either it is part of the bargaining or it is not. Incase the size of the investment does matter, the ex-ante problem that the MNE mustsolve is given by 22max U (β , γ , I ) = ρ (β )U 1 (β , γ , I ) + (1 − ρ (β ))U 0 (β , γ , I ) . β ,γ , I22 Note that this treatment is simplified. The fact that the MNE has no control does not meanautomatically that the local firm has the control. It may be the case that none of the parties haseffective control, situation that seems to happen often enough. In this case the analysis wouldentail a third term. The only change with respect to the formulas given in the text is that wewould have P(β , I ) := ρ MNE (β ) p MNE (I ) + ρ LOC (β ) p LOC (I ) + ρ NONE (β ) p NONE (I ).Where we must have ρ MNE (β ) + ρ LOC (β ) + ρ NONE (β ) = 1 ,with all terms being non-negative. But at this stage we choose to keep matters as simple aspossible.
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Where U 1 (β , γ , I ) and U 0 (β , γ , I ) are the utilities for the MNE in case of full control orno control, respectively. Expressions for each are U 0 (β , γ , I ) = γL + β∆p0 (I ) − Iand U 1 (β , γ , I ) := l + γL + β∆p1 (I ) − I In these expressions all symbols used are as they are explained in other parts of this essay. If we substitute the above equations back into the maximization problem we get max U (β , γ , I ) = ρ (β )l + γL + β∆P(β , I ) − I . β ,γ , I Where P(β , I ) = ρ (β ) p1 (I ) + (1 − ρ (β )) p0 (I ) [1.1] Notice that if the site of control is irrelevant, i.e., if p1 (I ) = p0 (I ) and l = 0 , then the above expressions are indistinguishable from those found in Section 1.5 of this essay, where we discuss the model in NRS. Under the present formulation, the effective conditional probability for project success P(β , I ) incorporates all the risk structure associated with the possible outcomes from negotiations. This function represents the best information that the MNE can count on in order to make its own estimates for the prospects of success of the JV. The absence of adverse selection in this problem is not tantamount to an absenceof information asymmetry. The information asymmetry of the problem resides in thefact that the MNE has no credible way to pass on the knowledge contained in theeffective conditional probability function to the local firm/government. The knowledgecondensed in P(β , I ) is the product of a long process of organizational learning, and
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there is simply no way in which this can be meaningfully revealed to an external partyover a short period of time. It is telling how is it likely that projects success prospectsare going to be influenced by ownership structure, since ownership structure will mostlikely have a bearing on how decisions are made and implemented. This knowledge-trapbrings us to the matter of the rationality constraint imposed by the local firm. First,consider the not unlikely case where the MNE is seeking an already established firm toserve as a service provider for a line of products for the MNEs home market. The localfirm/government does not have information about the prospects for success of theproject, beyond that contained in some average conditional probability p(I ) . Thisprobability function does not contemplate the effects of the structure of governance,because the locals may not believe the MNEs claims to the contrary. From such claimsthey may construe that the true conditional probability p(I ) is somewhere betweenp1 (I ) and p0 (I ) , but no more and no less. For the sake of this discussion we shallassume that p(I ) = (1 2 )( p1 (I ) + p0 (I )) . This understanding of the problem by the localsis fully known to the MNE. Under these circumstances, if the local firm/government isassumed to be risk neutral, the rationality constraint takes the form (1 − γ )L + (1 − β )∆ p(I ) ≥ 1 I + Vmin . 2Where Vmin corresponds to the reservation value of the local firm. It is important torealize at this point that this value may not, in general, be invariant with respect to thecondition of which of the parties - if any - does exert effective control of the JV.Continuing with our simplified scenario of either/or for the possession of effective 0control, lets call Vmin to the reservation value if the local firm exerts effective control, 1and Vmin when the MNE has the control. Then, on general grounds related to thestructure of costs, one might expect these two values to differ. If we can attribute these
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reservation values as due mostly to operating costs, then the main cost factors are thoserelated to managerial compensation. Certainly, the costs associated with a localmanagerial team, assuming control rests with the local firm, are going to differsignificantly from those caused by managerial fees coming from the MNE, if it hascontrol. Call C 0 the managerial costs in the first case, and let them be C1 in the secondcase. Then in general we must assume C0 ≠ C1 (and in the Latin American context, wecan assume that most likely it is C0 < C1 .) With this notation, if the described factorsmake the only important difference between the two circumstances, then we could writeVmin = Vmin − C 0 as the connection between the two values, while C1 (or at least an 1 0important part of it) would become a part of I . In all likelihood, there are other reasonswhy the two reservation values will be different; for example, the reservation value maybe altered by the efficiencies that one style of management may bring over the other,independent from the changes in the risk structure represented by the pi (I ) . In thereservation value constraint given above, the right hand side could be seen only as someexpected reservation value. Another feature of the rationality constraint is the presence of the internaltransfer value l . The concept that it represents may not be assimilated to that of L . Onehas to keep in mind that, contrary to L , which acts as value added by the project to totalwelfare, l is an internal - forced - type of payment, and therefore it adds nothing to totalwelfare. It would not be adequate to absorb l into a redefinition of Vmin either, becausethe presence of l is conditioned by the access to control by the MNE, and includes rentsdue to internal pricing, while Vmin is mainly related to operating costs. Finally, andperhaps most important, the constrained quantity is not the result of the remaining
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welfare, once the MNE has taken its share; rather, it is the result of what the locals areexpected to believe about the value of such residual claim. Therefore, it will have adistortionary effect over the investment policy. Obviously, the extend of the distortionwill depend on how misaligned are the beliefs of the locals with respect to theknowledge contained in P(β , I ) . The particular role played by l becomes even more significant if in order tosolve its optimization problem the MNE must assume that the locals are risk averse.Then, instead of the single constraint above we must write (1 − γ )L + (1 − β )∆p1 (I ) ≥ l + Vmin 1 [1.2a]and (1 − γ )L + (1 − β )∆p0 (I ) ≥ Vmin 0 [1.2b] It must be remarked that, depending on the value of l , these two constraints donot necessarily produce feasibility sets such that, for instance, the one for the firstconstraint would be a subset of the one for the second constraint. This could be the caseperhaps if l = 0 , but in general for l > 0 this will not be the case. Second, consider the case when the MNE wants to set up a subsidiary fromscratch in the foreign country, because of labor and/or tax advantages, or perhapsbecause of the existence there of natural resources that represent interesting potentialprofits. Ideally the MNE would wish to fully own its subsidiary, if it werent because ofgovernmental restrictions that may be negotiated within limits dictated in part by thedegree of relative bargaining strength of the MNE. In this case, the proposed firm wouldshare the full know-how of its parent, and it would be willing to share as well the
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associated risks resulting from negotiation. Therefore we would expect the followingrationality constraint to apply: (1 − γ )L + (1 − β )∆P(β , I ) ≥ ρ (β )l + Vmin [1.3] We may see the two cases presented above as opposite corners in the space ofpossible JV scenarios. The latter case will in general preserve the Pareto optimal levelof investment, while the former will in general distort investment and produceinefficiencies. These scenarios are depicted by the specifics of the constraints and by theshape of ρ (β ) . The solution set to the optimization problem composed of (D1) plus any { }of the appropriate constraints will be characterized by a triplet S = γ * , β * , l * . The conception of relative bargaining power introduced here presents achallenge when the time comes to be more specific about the properties of ρ (β ) . If itsinterpretation is the conditional probability for the MNE to keep effective control, giventhat it is able to get at least β in the bargaining process, then we can imagine at leastone particular situation: any MNE should be able to bargain for a β = 0 equityparticipation with a 100% chance to succeed. This could even be the case in practice, ifl is sufficiently large. Therefore we believe that the boundary condition ρ (0 ) = 1 is areasonable proposition. Then we could model the bargaining process itself as one inwhich, as the MNE advances in the negotiation to reach and achieve a position in β , itdoes so by spending probability for a further gain in equity participation. In otherwords, the marginal probability for advancing from β to β + δβ grows smaller withβ ; therefore we make the speculation that ρ (β ) ≤ 0 , for all β ∈ [0,1] . Without makingany claims for the universality of the properties proposed above, we believe themsupported by the dynamics expected in many negotiations. Finally, we must remember
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the necessary condition 0 ≤ ρ (β ) ≤ 1 for all β ∈ [0,1] . The simplest case that serves asan example of ρ (β ) is when the MNE has absolute bargaining power, in which case weget ρ (β ) = 1 , for β ∈ [0,1] . As relative bargaining power is less complete, we mayexpect in general to have ρ (β ) smaller, for any given value of β . Except for theseproperties, it seems hard to be more specific about the shape of ρ (β ) . There is theadditional problem that this construct is not, in principle, an observable. This is not todiscourage us from representing ρ (β ) with a gauge function, or perhaps we shouldcall it an envelop function, of a rather simple structure, that meets the generalrequirements already mentioned. Only to leave on the record an example that is easy tointerpret, consider the function ρ (β ) := 1 , (1 + β )νwith ν ≥ 0 . This expression meets all the requisites made earlier. The case of absolutebargaining power would correspond to ν = 0 . In this case the MNE keeps 100%probability of achieving any desired level of ownership. As ν grows larger, the relativebargaining power of the MNE vis-à-vis the local firm/government is weaker, since themarginal probability for achieving β + δβ starting from β is smaller the higher ν . Thisprovides an easy way to rank relative bargaining power for the MNE; its only drawbackis that ν relates monotonically decreasing to the bargaining power of the MNE. ν hasthe convenient feature that its range covers the entire non-negative real axis, we couldthen interpret the value 1 /ν as a positively related index for the relative bargainingpower of the MNE, since this has the same qualities as ν , but its relationship tobargaining power is now monotonically increasing.
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It is worth to summarize here some of the main results that follow from thisapproach. In order to prove them we shall need to write down the Lagrangian for aparticular problem. We choose the case where internal transfers are negligible from thestart, therefore l = 0 . We also focus on the case of a subsidiary created from scratch,represented by the choice of constraint (1.3). In this particular case the Lagrangianfunction is Λ = [γ + (1 − γ )λ ]L + [β + (1 − β )λ ]∆P(β , I ) − I − λVmin Where λ is the Lagrange multiplier, positive if and only if the constraint is binding, and zero otherwise. The first order conditions that follow from this Lagrangian are given by ∂Λ = (1 − λ )L [1.4g] ∂γ ∂Λ = (1 − λ )∆[βP(β , I )]β + ∆λPβ (β , I ) [1.4b] ∂β and ∂Λ = [β + (1 − β )λ ]∆PI (β , I ) − 1 = 0 [1.4i] ∂I In the above set of equations a subindex represents partial differentiation withrespect to the corresponding variable. The last equation is a first order condition thatrequires the investment level to be an interior solution to the problem. This should bealways possible, since both p1 (I ) and p0 (I ) will be required to satisfy the Inadacondition dpi (I ) lim →∞ I → I min dIfor i =0,1 and I ∈ [I min , I max ].
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By assumption p1 (I ) > p0 (I ) for all I ∈ [I min , I max ]. In addition we want the second Lagrangian derivative to be negative at the optimal solution. To make sure thisis the case we impose the sufficient condition p1 (I ) < p0 (I ) < 0 for all I ∈ [I min , I max ]. Then P(β , I ) will allow interior solutions. Investment policy is determined in a very similar way as in the case for NRSalready shown in Appendix C. From (1.4i) we can get an expression for λ : 1 − β∆PI (β , I ) λ= . (1 − β )∆P(β , I ) The Pareto optimal investment policy for a given β obtains from the condition ( ) ∆PI β , I PO = 1 . Notice that, different from the case in NRS, Pareto optimality, and therefore theexpected total social welfare, is conditional on how the cake is cut. This is notsurprising, because in this case there is an association between ownership participationand the decision about who runs the project, which clearly affects total welfare; we shallrefer to this form of Pareto optimality as conditional Pareto optimality (CPO). If wechoose the CPO investment level, then from the expression for λ we get λ = 1 . Sincethe general shape of P(β , I ) as a function of I is the same as for the pi (I ) , then we canconclude that underinvestment will correspond to λ < 1 and overinvestment to λ > 1 .Underinvestment may go down to the point where the MNE reaches its unconstrainedmaximum profit, given β . This investment level I U can be calculated from theequation: β∆PI (β , I U ) = 1
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The MNE would not have any incentive to invest below this point for theobvious reason that it would start paying rents to the subsidiary; observe that the aboveequation implies λ = 0 . We shall derive next some of the most immediate results that come out of (1.4g),(1.4b) and (1.4i). In the absence of transfer payments, the MNE needs to get somethingout of the project, therefore it must be the case that ∂Λ ∂Λ max , ≥ 0 [1.5] ∂γ ∂β In order to be able to discuss the consequences of this statement, it is necessaryfirst to recall some of the basic arguments brought to bear in this part of the essay. Thecorrelation between control and equity ownership makes it important for the MNE tobargain for as much share of ownership as it is possible in order to undertake asuccessful JV. The product ∆βP(β , I ) represents the stakes of the MNE, the reason whyit will want to bargain for more equity, at least up to some value, is because it has theincentive to do so due to reasons of control. This incentive can be expressed byimposing the condition that ∂ [βP(β , I )] ≥ 0 , β ∈ [0, β ]. [1.6] ∂γWhere 0 < β ≤ 1 . Otherwise the MNE would have no reason why to enter the venture in the firstplace. The implication of the above condition is that [βP(β , I )]β ≤ 0 . Therefore, weshould not expect this latter range of values of β to be included in any feasible solution
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to the MNEs optimization problem 23. This condition leads to some concreteconsequences. First, from the general properties of ρ (β ) it follows that Pβ (β , I ) ≤ 0 .Combining this result with the condition above, it is immediate to see that the MNEwould never overinvest. Because in such case, using condition [1.6], we have λ > 1 ;both derivatives of the Lagrangian would be negative, and therefore overinvestment isinconsistent with the given equity share of the project for the MNE. This result can beargued as well from the very setup of the problem, since there is no asymmetry ofinformation associated to adverse selection, the MNE does not need to incur inoverinvestment as a signal. Second, in general, investment at the Pareto optimal levelfor any given β will only be possible if the MNE has absolute bargaining power, i.e. ifρ (β ) = 1 for β ∈ [0, β ]. This is so because, from [1.4g] and [1.4b], if the MNE does nothave absolute bargaining power then it would attempt to take all the riskless part of thecash flows (i.e., γ = 1 ) and, due to the local firms rationality constraint, it would alsotake as low an equity participation as possible, consistent with the holding of effective ( )control. The rationality constraint is binding, calling β * , I * any pair of values thatwould solve the constraint, we have (1 − β )∆P(β * * ) , I * = Vmin .Differentiating this expression with respect to β * we get ( ) ( ) ( ) ( ) ( ) dβ * dI − P β * , I * + 1 − β * Pβ * β * , I * + 1 − β * PI * β * , I * * =0.23 At the extreme, should we have [βP(β , I )]β ≤ 0 for all β , a rational MNE should findpreferable to offer a licensing agreement instead of internalizing through a JV.
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dI * From the stated properties for P(β , I ) , this equation leads to the result >0. dβ *Therefore, as β * gets smaller, it takes down the value of I * , below the CPO optimum.The only exception may happen only if we have Pβ (β , I ) = 0 , in other words, when theMNEs bargaining power is absolute, in which case the associated Lagrangian derivativewould be nil and it would not require the optimal value of β to drift downward. Thistendency to underinvest is the result of uncertainties in the outcome of negotiationsabout the true degree of exertion of effective control.Discussion Results in the last section show that investment policy can be significantlyaffected by the particular level of capital participation restriction imposed on the MNE,when it has the bargaining power and also an informational advantage. The MNE willhave an increasing trend of overinvestment as a response to stricter capital participationrestriction, as long as this does not lead to a the MNE paying rents to the local firm.Once this is the case, and with further reductions in its participation, the MNE willquickly abandon such trend, and will reduce its investment level to the minimum,unconstrained value. The utility going to the MNE is a monotonically increasingfunction of α , while the utility to the local firm shows the opposite behavior. This isconsistent with NRS appraisals. Overall welfare also shows a dependence on the levelof capital participation restrictions, through its dependence on the level of investment,with its minimum at the point of maximum overinvestment. When we inspect the particular numerical example presented in the previoussection, it is interesting to see that the relationship between investment policy and
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capital restriction predicted is not one-to-one. For a wide range of values of α , there aretwo possible values associated to a single value of the investment level. This suggeststhe interesting possibility that any regulator seeking to increase the level of employmentonly needs to consider the lower end, positive-slope, side of the investment-restrictiongraph, since on that side the local firm also gets to derive rents, beyond its opportunitycost. Additionally, the extreme variations shown by the optimal investment over theanalyzed range of α , seems to confirm the statements in NRS, that countries with strictcapital restriction policies must show wide variations in the size of investments comingfrom multinationals. These features though deserve some further comments, morerelated to their empirical relevance. This is admittedly anecdotal evidence; neverthelesswe believe it of some use in the context of the present essay. When actual entrepreneursfrom Colombia who have some international experience were told of these results, theyfound it somewhat at odds with their working knowledge of the subject. They arguedthat what really happens is that increased capital restriction policies induce theprospective MNE to underinvest systematically. In terms of the results of this paperthey thought Figure 1.1 should be a simple one-to-one, positive slope curve. Thisperception could be due to more than one reason: First, they are most likely right, andthe present model simplifies too much the problems related to asymmetric and/orimperfect information. Perhaps those MNEs seeking a potential partner for a JV read ina too strict equity participation restriction signs of uncertainty about the future actionsof the local government, and this form of information asymmetry inducesunderinvestment. Second, it might be that a too strict capital restriction policy actuallyscares away MNEs with big investment projects, and therefore such policies act as asort of filter that is likely to result in that most of the FDI made in the country is defacto small scale, and therefore what the entrepreneurs see is just a statistical effect.
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FIGURES 9 8 7 G investment policy 6 5 4 3 2 1 0 60% 65% 70% 75% 80% 85% 90% 95% 100% capital constraint levelFigure 1.1: The vertical axis shows the investment policy, as represented by the scaledinvestment variable κ. The Pareto optimal investment level corresponds to κ =1. Noticethe tendency of the G MNE to overinvest, as long as the B MNE could mimic itsstrategy. If capital participation constraints are too tight, excess investment by the GMNE quickly drops.
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180 160 profits (arbitrary scale) 140 120 100 80 60 40 20 0,4 0,5 0,6 0,7 0,8 0,9 1 capital constraint levelFigure 1.2: The vertical axis shows profits for the G MNE (upper, continuous) and forthe local partner (lower, dashed) as a function of capital participation constraint level.
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