Transaction Cost Perspectives on Alliances and Joint Ventures: Explanatory Power and Empirical Limitations

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1 Transaction Cost Perspectives on Alliances and Joint Ventures: Explanatory Power and Empirical Limitations Klaus E. Meyer China Europe International Business School Yi Wang University of Vaasa Published in: J. Larimo, N. Nummela & T. Mainela, eds Elgar Handbook of International Alliances and Network Research, p Pre-print version: November 14, 2013 ABSTRACT Transaction cost economics (TCE) has extensively been applied by international business scholars to analyze joint ventures and strategic alliances. It provides a theoretical basis to analyze how firms organize their transactions with other firms, and hence their choices of governance structures, for example between JVs and other organizational forms. However, TCE has also been frequently critiqued and empirical findings on some of the constructs derived from TCE find inconsistent results. 1. INTRODUCTION Transaction cost economics (TCE) has extensively been applied in the international business (IB) to analyze joint ventures (JVs) and strategic alliances, becoming probably the most commonly used theoretical perspectives in this field (see reviews by Tsang 2000; Zhao, Luo and Suh 2004; Geyskens, Steenkamp and Kumar 2006; Brouthers and Hennart

2 2007). TCE addresses the question of how a firm should organize its interfaces with other firms, and where to draw the organizational boundaries of the firm. Hence, TCE provides a theoretical grounding to analyze the choice of governance structures, for example the choice between JVs and other organizational forms, such as exports, contracts and wholly-owned subsidiaries (WOS). Despite its parsimony and its popularity, TCE has also been frequently critiqued and is arguably the most misinterpreted theory in JV research (Borys and Jemison 1989; Zajac and Olsen 1993; Ghoshal and Moran 1996). Further on, the same empirical measures chosen to test TCE-based hypotheses have been found to influence the organizational forms in different directions. Some studies support the arguments of TCE, whereas other studies found insignificant or even opposite results (Brouthers and Hennart 2007). This article has two objectives. First, we systematically review JV studies to provide a clear picture of the transaction cost determinants of JVs. The review is particular helpful in evaluating the explanatory power of TC constructs on organizational forms. Second, we assess the challenge to apply it in JVs research, outlining four major challenges to applying TCE in JVs research: 1) How to empirically test TCE on a large sample, 2) What really drives transaction costs in emerging economies, 3) Theoretical ambiguity of TCE arguments on distance and experience and 4) JVs do not enhance flexibility as argued by TCE. The article is structured as follows. The paper starts with a discussion of the most influential conceptual papers on TCE in JVs research. Chronologically, these papers are Williamson (1975, 1985), Anderson and Gatignon (1988) and Hennart (1988, 1991, 2009). The discussion of the conceptual papers is followed by a systematical review of early TCE-based JV studies. The review provides information about the research design, TCE constructs and level of TC. Further on, the findings about the TC constructs on the choice of JVs as opposed to other governance structures are presented. Then the paper discusses the major challenges to apply TCE in JVs research. This paper ends with a discussion of managerial implications and future research avenues.

3 2. LITERATURE REVIEW 2.1. Transaction Costs Economics on JVs TCE has its origins in Coase (1937) s classic article. It addresses the question how a firm should organize its transactions with other firms, distinguishing markets and hierarchies as two alternative modes of performing an economic function and the choice of which being determined by transaction costs associated with either mode (Coase 1937). Kogut (1988) referred transaction costs as the expenses incurred for writing and enforcing contracts, for haggling over terms and contingent claims, for deviating from optimal kinds of investments in order to increase dependence on a party or to stabilize a relationship, and for administering a transaction. Similarly, Hennart (1988) referred transaction costs as information, bargaining and enforcement costs. Williamson (1975; 1985) advanced and popularized TCE, arguing that transaction cost arise from the combination of bounded rationality (Simon 195///) and opportunistic behaviors of market participants. These human traits limit the rationality of market participants, and hence the efficiency of markets, especially when transactions are subject to asset specificity, uncertainty and low frequency. Asset specificity refers to assets that tailored to a particular transaction and cannot be easily redeployed outside the relationship of the parties to the transaction. Uncertainty arises either when the contingencies surrounding an exchange are too unpredictable to be specified ex ante a contract or performance cannot be easily verified ex post. Transaction frequency refers to the extent to which transactions recur between the same partners. The three concepts of asset specificity, uncertainty and frequency subsequently have become most popular constructs to empirically measure the presence of transaction costs, and to test their effects starting with the famous study by Anderson & Schmittlein (/// NEED TO CHECK ///). In the field of IB, Anderson and Gatignon (1986) draw most directly on Williamson s conceptualization of transaction costs. They distinguish seventeen types of entry modes

4 based on the degree of control and propose that the choice of a particular entry mode is a tradeoff between control and resource commitment. Anderson and Gatignon (1986) integrate the literature into a unified transaction cost framework and developed several testable propositions. Following TCE, four constructs are proposed to increase investing firm s preference of high-control as oppose to low-control modes: transaction-specific assets, external uncertainty, internal uncertainty and free-riding potential. Table 1 highlights the propositions pertaining to each of the four constructs. It should be noted that the join effects of external uncertainty and asset specificity leads to high transaction costs and therefore foreign investors are more likely to choose WOS in order to gain full control over their subsidiaries (Williamson 1975, 1985; Anderson and Gatignon 1986). *** Table 1 here *** Hennart (1988) moreover distinguishes two types of JVs, scale JVs and link JVs, that are subject to different types of transaction costs. Scale JVs are created when two or more firms enter together a continuous stage of production or distribution or a new market. However, the motives of partners in link JVs are not necessarily the same. In the first part of his paper, Hennart (1988) discuss the necessary and sufficient conditions under which equity JVs are preferable to non-equity modes, i.e., market exchange and contracts. Equity JVs are used to bypass the inefficient markets for intermediate inputs. For example, link JVs are selected when market sale of the complementary assets holds by two or more partners are subject to high transaction costs. Further on, Hennart (1988) describes the circumstances under which JVs are preferable to (full) acquisitions and greenfields investments. Scale JVs are preferable to acquisitions and greenfields investments in the circumstances where economies of scale and scope are large. It is more efficient to use link JVs or acquisitions as opposed to greenfields investments when the assets possessed by the local partner are public goods such as distribution channels and experiential knowledge. This is because share of the public goods incur none or low marginal costs. Link JVs are preferable to acquisitions when the complementary assets are difficult to be separated from unneeded assets. Hennart (1988) s paper mainly describes the benefits of JVs and he propose that a complete theory should also discuss the costs of JVs. Hennart (1991) extends and empirically tests this framework on a sample of Japanese manufacturing investments in the United States. Empirical results

5 indicate that Japanese MNEs opt for JVs when they need to combine the local assets which are subject to market failure, i.e., high transaction costs. A pivotal difference between the approaches by Hennart and by Andersoon and Gatignon to studying foreign entry is that Hennart considers the transaction costs incurred by all parties partaking in a transaction, whereas scholars such as Anderson and Gatignon (1986) consider entry mode choice only from the view point of foreign MNEs. In other words, Anderson and Gatignon (1986) s TCE framework and the work in their tradition (e.g. Hill Hwang & Kim, 1993; ///) neglect the perspective of owners who own local complementary assets. Similarly, Dunning s OLI paradigm (Dunning 1993; Dunning and Lundan 2008) and many applications of internalization theory focus on the internalization advantages from the perspective of the multinational firm. However, actual organization form is the outcome of a negotiation between all partners in the transaction. Hence, Hennart (2009; 2012) argues that the optimal entry mode choice depends on relative efficiency of inputs of both MNEs and local owners of complementary assets. Another important recent advance to transaction cost theory is Verbeke and /// s notion of bounded reliability, which substitutes for opportunism in Williamson s framework. Specifically, they argue that it is not opportunism that determines the choice of organizational form because opportunistic behaviors only happen ex post, if at all. Rather it is the anticipation of possible opportunistic behaviors, or a lack of trust in the business partner (Casson ///) that determine decisions such as the choice of foreign entry mode. Verbeke and /// call this bounded reliability, which refers to the inability of humans to be sure as to who other human will react in certain situations. The bounded reliability is influenced by contextual factors such as the trust that may exist between two business partners, or the ability to enforce contracts through arbitration or courts. Hence, transaction costs arise from the combination of bounded rationality and bounded reliability TCE Based Empirical Studies on JVs

6 Table 2 summarizes TCE based studies reviewed in this study. It provides information about home country, host country, sample size, TCE constructs, level of TC and major findings / implications. There are two criteria for selecting the reviewed articles: 1) the dependent variable must include JVs formed by foreign and local partner(s) and 2) the identified studies must include some TCE core constructs such as asset specificity, uncertainty and transaction frequency as the independent variables. In selected studies the same TCE constructs have been operationalized using different measures. Early studies have used both primary and secondary data to measure asset specificity. Asset specificity has been proxied by dividing R&D/advertising expenditure by total sales at both industry and firm level (Hennart and Larimo 1998; Padmanabhan and Cho 1996; Chen and Hu 2002; Chen and Hennart 2002; Dikova and Witteloostuijn 2007). Asset specificity has also been operationlized by managerial perceptual measures such as human asset specificity (Brouthers and Brouthers 2003; Brouthers et al. 2003), proprietary products/service (Gatignon and Anderson 1988; Brouthers and Brouthers 2003; Brouthers et al. 2003) and dedicated asset specificity (Brouthers and Brouthers 2003). Early studies have provided mixed findings for the relationship of R&D intensity and the choice of JVs as opposed to WOS. High degree of R&D intensity was found to increase the preference of WOS to JVs (Gatignon and Anderson 1988; Erramilli and Rao 1993; Padmanabhan and Cho 1996; Hennart and Larimo 1998; Chen and Hu 2002; Brouthers et al., 2003, Dikova and Witteloostuijn 2007), whereas non-significant relationship was found in the study by Gomes-Casseres (1989), Gomes-Casseres (1990), Hennart (1991), Taylor, Zou and Osland (1998), Brouthers (2002), Chen and Hennart (2002) and Brouthers and Brouthers (2003). Inconsistent findings were also found for advertising intensity. While Gatignon and Anderson (1988), Gomes-Casseres (1989) and Gomes-Casseres (1990) empirically found that MNEs prefer WOS to JVs when the degree of advertising intensity is high, Kogut and Singh (1988), Hennart (1991) and Chen and Hu (2002) pointed out insignificant relationship. Cultural distance and international experience have been considered as the most common constructs for internal uncertainty (behaviour uncertainty) (Andersson and Gatignon 1986;

7 Hennart 1991; Agarwal 1994; Erramilli and Rao 1993; Padmanabhan and Cho 1996; Hennart and Larimo 1998; Chen and Hu 2002; Zhao et al. 2004). Cultural distance has often been measured by Kogut and Singh (1988) s cultural index based on Hofstede s cultural dimensions (Gatignon and Anderson 1988; Kogut and Singh 1988; Erramilli and Rao 1993; Agarwal 1994; Hennart and Larimo 1998; Padmanabhan and Cho 1996; Chen and Hu 2002; Cho and Padmanabhan 2005). Early JVs studies have operationalized international experience in a wide variety of ways. International experience has been measured by count-years of prior international experience of the parent at the time of foreign entry (Padmanabhan and Cho 1996; Cho and Padmanabhan 2005), by number of years since the establishment of the first foreign subsidiary (Hennart 1991), by number of countries in which the parents have established subsidiaries (Kogut and Singh 1988) and by the proportion of assets in foreign country (Agarwal 1994). Other studies have proxied internal uncertainty by perceptual measures such as the problems associated with monitoring performance product/service quality (Brouthers et al. 2003), monitoring and safeguarding proprietary knowledge (Brouthers et al. 2003) and the costs of search, contracting and enforcement (Brouthers 2003). Gatignon and Anderson (1988), Erramilli and Rao (1993), Agarwal (1994), Hennart and Larimo (1998) and Taylor et al., (1998) found that cultural distance have a positive impact on preference of JVs to WOS, Padmanabhan and Cho (1996) found the revers relationship. Gatignon and Anderson (1988) and Hennart (1991) found that firms with limited or no international experience tend to prefer JVs as oppose to WOS, whereas Gomes-Casseres (1989) found reverse relationship and Padmanabhan and Cho (1996) found non-significant relationship. Overall, the impacts of cultural distance and international experience on organizational form have far been consistent. Country risk is an important indicator for external uncertainty ( uncertainty) (Andersson and Gatignon 1986; Zhao et al., 2004) and has been operationalized in a number of different ways. Country risk has been operationalized by the classification system developed by Goodnow and Hansz (1972) (Andersson and Gatignon 1988; Agarwal 1994). Some studies have used primary data to proxy country risk. For example, country risk has been operationalized by managerial perceptual measures such as the risk

8 of converting and repatriating profits, nationalization risk, political, social and economic stability (Brouthers 2002; Brouthers and Brouthers 2003; Brouthers et al. 2003). While the studies by Gatignon and Anderson (1988) and Agarwal (1994) found that country risk leads to the preference of WOS as opposed to JVs, Brouthers (2002), Brouthers and Brouthers (2003) and Brouthers et al. (2003) found reverse relationship. In a metaanalysis study, Zhao et al. (2004) found that country risk is the most influential TCE factor to explain the choice of JVs and WOS. To a much less extent, external uncertainty has also been proxied by market uncertainty for a firm s product or service (Taylor et al., 1998) and overall market potential and attractiveness (Agarwal 1994; Taylor et al., 1998; Brouthers 2002; Chen and Hu 2002). A greater number of studies found that market potential in the host country increase the preference of WOS to JVs (Agarwal 1994, Taylor et al., (1998) and Chen and Hu (2002). However, Brouthers (2002) found nonsignificant relationship between market potential and governance structure.

9 Table 2. Key IB studies applied TCE to JV research Study Gatignon & Anderson (1988) Kogut and Singh (1988) Gomes- Casseres (1989) Gomes- Casseres (1990) Hennart (1991) Erramilli & Rao (1993) Design of the paper U.S. manufacturing investments Empirical analysis of 506 investments in the U.S. Empirical analysis of U.S. manufacturing investments in the globe Empirical analysis of U.S. manufacturing investments in the globe 158 Japanese manufacturing subsidiaries in the U.S. 381 U.S. service subsidiaries in the globe TC constructs R&D intensity, Advertising intensity, Cultural distance, International experience, country risk Cultural distance, Uncertainty avoidance Diversification, Country specific experience, International experience, Firm size R&D intensity, advertising intensity, Industry dummy MNE s industry experience, Host country experience, Size of host country s industrial sector, Intra-system sales, Resource based industry, R&D / advertising intensity, R&D intensity, advertising intensity, MNE s industry experience, resource-based industry, size of the host industry, host country experience, parent assets, subsidiary assets, GDP growth of the host country R&D intensity, international experience, advertising intensity, diversification, industry sales growth; industry concentration ratio, resource intensive industry; relative size of subsidiary / parent and age of affiliate Asset specificity, Capital intensity, Inseparability, Cultural distance, Country risk, Firm size Level of TC Transaction and Firm, industry and Firm, industry and Firm, industry and Firm and industry level Firm and level Major findings / implications Both R&D/sales and advertising/sales increase the preference of WOS. International experience is positively related with WOS, whereas country risk and cultural distance encourage JVs. Cultural distance and uncertainty avoidance exert significant influences on the choice of JVs, greenfields and acquisitions. JVs are selected when 1) the capabilities of local firm complement those of the MNEs, 2) it is costlier to transfer the contributions of both firms contractually and 3) benefits outweigh costs of JVs (i.e., Shirking and conflict) It is useful to analyze ownership mode choice by integrating TCE and bargaining power perspective. JVs are selected when the benefits outweigh costs of shared ownership Low degree of asset specificity increases the preference of JVs to WOS. This relationship is strengthened 1) when the services are inseparable, 2) with increased country risk and 3) with smaller firms.

10 Agarwal (1994) Padmanab han & Cho (1996) Hennart & Larimo (1998) Taylor et al. (1998) Meyer (2001) Brouthers (2002) Chen & Hennart (2002) 148 U.S. investments in the globe 839 Japanese manufacturing subsidiaries in the globe Japanese and Finnish manufacturing subsidiaries in the U.S. 343 American and Japanese manufacturing investments in the globe 576 FDIs made by Germany and UK firms in Czech Republic, Hungary, Poland, Russia and Rumania 178 investments made by EU firms Empirical analysis of 269 Japanese investments in the globe Cultural distance, Degree of multinationality, Technological intensity, Firm size, Country risk, Market potential R&D intensity, international experience, cultural distance, Host country experience, Parent firm size, Subsidiary size, Relatedness of investment, Government restriction. Power distance, Uncertainty avoidance, Cultural distance Relatedness of investments, R&D intensity, Host country experience, Firm size, Industry sales, Industry concentration, Resource intensive industry, establishment mode strategy Asset specificity, Cultural similarity, Uncertainty of demand of product, Overall market attractiveness, Frequency of transactions, Inability to get fair price, Parent firm size Progress of institutional reform, Psychic distance, R&D intensity, Human intensity, Technology transfer, Management transfer, Consumer goods TCE variables: General transaction costs, Asset specificity Institutional variable: Legal restrictions Cultural variables: Country risk, Market potential Industry reputation barrier, Industry distribution barrier, Cultural specific advertising expertise, Industry technological barrier, Access to natural resources, Parents advertising resources created in the U.S., Parents advertising resources created in the Japan, Parents R&D Firm and level Firm and level Firm, industry and Firm and Transaction, firm and Transaction and level Firm level This study indicates that contingency approach is useful for modeling the choice of JVs. TCE variables need to be supplemented by cultural contexts of home and host country to explain ownership choice of Japanese investments. Culture distance leads to the choice of JVs. TCE variables are useful to explain U.S. firms choice of JVs as oppose to WOS. However, TCE variables are not applicable to explain the choice of JVs of Japanese investors. Host country s progress in institutional reform increases the preference of trade, contracts and JVs to WOS. Psychic distance encourages WOS as opposed to trade, contracts and JVs. MNEs use different forms of entry for technological and management knowledge transfer. Explanatory power of TC variables (general TC and asset specificity) can be improved by including aspects of both institutional and cultural context Japanese entrants tend to choose JVs when facing high market barriers in the target industry, whereas Japanese possessing competitive capabilities prefer WOS as opposed to JVs.

11 Chen & Hu (2002) Brouthers & Brouthers (2003) Brouthers et al. (2003) Cho & Padmanab han (2005) Meyer & Nguyen (2005) Wei et al. (2005) Empirical analysis of 470 investments in China 227 manufacturing and service FDIs made by Dutch, German and UK firms in CEE 218 Dutch, German and U.K firms in CEE 604 Japanese investments in the globe 171 investments in Vietnam Empirical analysis of investments made by overseas Chinese and other investors in China capabilities, Parents industry knowledge and Parents acquired capabilities Proprietary assets, advertising intensity, cultural distance, market potential by industry, market potential by provinces, capital intensity, planned duration of the project in China Asset specificity (Human specific assets; Proprietary products and services; dedicated assets); Internal uncertainty (The cost of writing and enforcing contract; difficulty of monitoring and controlling product / service quality; dissemination and misuse of proprietary knowledge); External uncertainty (General stability of political, social and economic conditions in the host country; the risk of converting and repatriating income from host country; Risk of target government actions) Asset specificity (Human specific asset; Proprietary products and services; general transaction costs), Internal uncertainty (The cost of writing and enforcing contract ; Difficulty in monitoring performance; Difficulty in monitoring /safeguarding proprietary knowledge) and external uncertainty (General stability of political, social and economic conditions in the host country; the risk of converting and repatriating income from host country; Risk of target government actions) Cultural distance, International experience, Host country experience, decision specific experience Efficiency in supporting markets for critical resources, Dominance of State-owned Enterprises, Local oriented FDI Host country experience, Specific location, Resource commitment, Cultural distance, Asset intensity Firm and Transaction and Transaction and Firm and Firm and Firm and Transaction costs are helpful for explaining entry mode strategy of contractual JVs, equity JVs and WOS. Internal uncertainty leads to the choice JVs for service firms, external uncertainty encourages JVs in the case of manufacturing FDIs. Asset specificity is positively related the choice of WOS as oppose to JVs, external (economic) uncertainty increase the choice of JVs. Decision specific experience moderates the relationship of cultural distance and ownership mode choice. Institutional pressures arising from SOEs and local oriented FDIs increase the preference of JVs as opposed to Greenfields TC variables are also applicable in explaining the choice of joint stock company, JVs and WOS in an emerging market of China.

12 Dikova and Witteloost uijn (2007) Meyer et al. (2009) Chiao et al. (2010) 160 EU FDIs in the globe Empirical analysis in Egypt, India, South Africa and Vietnam Taiwan manufacturing firms in China TCE variables: technological intensity Institutional variable: institutional advancement in the host country Institutional variable: Market supporting institutions Resource-based variable: resource needs TCE variables: Firm specific assets, Complementary assets Resource-based variables: R&D capability, International experience, Customer following Institutional variable: perceived institutional differences Firm and Firm and Firm level Host s institutional advancement moderates the effect of technological intensity on ownership mode choice. In weaker institutions, JVs is preferable to acquisitions and greenfields to access resources. In stronger institutions, acquisitions is preferable to access intangible and organizational embedded resources. The impacts of TC variables on the choice of JVs are moderated by perceived institutional differences.

13 3. CHALLENGES TO APPLY TCE IN JV RESEARCH 3.1. How to Empirically Test Hennar (1988) s Framework on a Large Sample. Transaction cost reasoning has been widely used in alliances and JVs research (Zhao et al. 2004). However, many of early JV studies implicitly assume that the local partners contributions play no role in MNE s entry mode strategy (Hennart 2009), or at least not correlated with the focal variables in the empirical test. The TCs of accessing complementary assets hold by local partners influence entry mode strategy of MNEs (Gomes-Casseres 1989; Brouthers and Hennart 2007; Hennart 2009). Gomes-Casseres (1989) and Hennart (1991) argue that as local firms normally enjoy the privilege to access resources, MNEs are more likely to opt for JVs as opposed to WOS when entering resource-based industries. This would require a dataset with ex-ante information on both partners, and the JV operation itself (preferably the contribution from both parents as intended at the outset). However, this is virtually impossible to construct (Meyer 2001). Extent work that neglects the viewpoint of local partners who possess complementary resources may lead to misleading managerial implications (Hennart 2009). This is to suggest that when making a decision of organizational form, MNEs need to consider the TCs for accessing complementary assets held by local partner. The level of analysis for TCE is the transaction and therefore the area of interest is on characteristics of transactions (Andersen 1997; Williamson 1975, 1985; Madhok 1997; Leiblein and Miller 2003; Tsang 2006). However, most of early empirical JVs studies made implicit assumption that the characteristics of foreign firms are a good proxy of TC it faces for a specific transaction. The most striking example is asset specificity. Several studies have proxied asset specificity by R&D / advertising intensity of the firm (Hennart 1991; Dikova and Witteloostuijn 2007; Chaio et al. 2010). A very few studies operationalized asset specificity at the transaction level (Brouthers 2002; Brouthers and Brouthers 2003; Brouthers et al. 2003). This is a common mismatch of level of analysis. TCE has been designed to analyze the attributes of transactions, i.e., transaction specific

14 assets, uncertainty surrounding transactions, and frequency of transactions. Thus, the core construct of TC, i.e., asset specificity, should be proxied at transaction level. The inconsistent findings in early studies for the relationship between asset specificity and organizational form can be explained by the different level of analysis. Selected studies that proxied asset specificity at the firm level found the impacts of asset specificity on WOS is positive (Erramilli and Rao 1993; Padmanabhan and Cho 1996; Hennart and Larimo 1998; Chen and Hu 2002; Dikova and Witteloostuijn 2007), whereas non-significant relationship is found in studies operationalized asset specificity at the transaction level (Brouthers 2002, Chen and Hennart 2002 and Brouthers and Brouthers 2003) What Really Drives Transaction Costs in Emerging Economies TCE explicitly assume that the market is relatively static and well developed (Meyer and Peng 2005). The underlying assumptions of TCE may not hold true when applying it in emerging markets such as China and Central Eastern Europe (CEE). Although TCE was developed in developed and mature markets, the core elements of TCE such as transaction costs, opportunism and uncertainty are highly relevant in emerging markets (Hoskisson, Eden, Lau and Wright 2000; Wright, Filatotchev, Hoskisson and Peng 2005). It is of great challenge to IB scholars to measure pertinent TCs in emerging markets. The sources of TCs identified in developed markets such as asset specificity, (internal and external) uncertainty and transaction frequency may not holds true when probe into emerging markets. Lack of information system and weak legal system (i.e., inefficient court system) increases contractual searching, monitoring and enforcement costs in emerging markets (Meyer and Peng 2005). Further on, regulatory ambiguity and corruption tends to increase external uncertainty when operating in emerging markets (Li and Meyer 2009). As a consequence, opportunistic behaviour of contractual partner(s) in emerging markets is difficult to constrain (Choi, Lee and Kim 1999).

15 Emerging market scholars have long been interested in external factors that are likely to enhance or inhibit the efficiency of markets. For example, Meyer (2001) argues that institutions in emerging countries shape TCs and therefore determine the organizational form. Meyer (2001) operationalized institutional development by European Bank for Reconstruction and Development (EBRD) indices and found that MNEs prefer WOS as opposed to JVs and contracts in economies that have progressed further in institutional reforms. Drawing on a sample of FDIs in Vietnam, Meyer and Nguyen (2005) found that the less efficiency are markets, the more foreign investors would use JVs as opposed to Greenfields to access critical local resources in Vietnam. The similar result is found in the study by Meyer et al. (2009), where JVs are preferable to Greenfields to access intangible local assets such as market knowledge and distributor relationships. Dikova and Witteloostuijn (2007) measured the host country s institution advancement by World Bank s Governance Indicators and pointed out that institutional advancement in the CEE positively moderate the preference of technological intensive firms to choose JVs. Chiao et al. (2010) found that perceived institutional differences moderates the relationship of TCE variables and ownership mode strategy in China. The above mentioned studies have clearly shown that institutions in emerging markets shape the TCs. The above empirical studies clearly pointed out that host institutions moderate TCs of operating business in emerging markets such as China, CEE and Vietnam. Future studies probing into emerging markets should consider how the external environment moderates TCs by either studying it, control for it or explicitly assume it creates random noise The Theoretical Ambiguity of TCE on Experience and Cultural Distance Early TCE based IB studies have considered MNEs experience and cultural distance as important determinants of IJVs as oppose to WOS (Andersson and Gatignon 1986; Hennart 1991; Kogut and Singh 1988; Hennart and Larimo 1998; Meyer 2001). Transaction cost reasoning argues that experience is expected to reduce internal uncertainty, whereas cultural distance tends to increase internal uncertainty. Foreign

16 investors having no or limited experience are more likely to use IJVs to lower the costs of accessing local partners knowledge and relationships. However, experienced firms are able to select the right partner and to better manage JVs, which in turn, increases the probability to opt for JVs (Li and Meyer 2009). This is to suggest that experience, on one hand, encourages foreign investors to establish WOS, on the other hand, experience facilitates cooperation between foreign investors and local partners. Cultural distance between home and host country increases internal uncertainty and therefore is predicted to increase preference of JVs over WOS (Anderson and Gatignon 1986; Hennart and Larimo 1998). However, cultural distance has also been predicted to increase the needs for control as high control mode such as WOS is more efficient than that of JVs when transferring entrants operating procedures and methods in dissimilar countries (Anderson and Gatignon 1988). In this literature we argue that TC explanation of organizational form is always about the transaction costs of external markets (i.e., searching, monitoring and enforcement costs) relative to internal coordination (i.e., training, staffing and communication). However, existing empirical research made implicit assumption that the costs of internal coordination to be independent of focal variables such as experience and (inverted) cultural distance. However, key constructs of internal uncertainty such as experience and cultural distance simultaneously affect external and internal costs in the same direction. The relative importance of the two opposing effects is contingent on type of experience, local context of the operation and MNE s own context (Li and Meyer 2009). Early influential IB study has distinguished two types of experience: general IB and country specific experience (Johanson and Vahlne 1977). MNEs having more general IB experience have developed general capabilities to adapt and manage idiosyncrasies of new international markets (Tallman and Fladmoe-Lindquist 2002; Eden and Miller 2004). Since MNEs are able to exploit competences in international markets, there is less preference for MNEs with IB experience to opt for JVs. On the other hand, MNEs having more country specific experience accumulated knowledge about economic, political and

17 social conditions in that particular context. Such MNEs are able to better manage JVs and therefore they prefer to use JVs as the governance structure in that particular context. However, the positive impacts of general IB experience and negative impacts of country experience on organizational form such as WOS depend on the local context of operations. For example, Li and Meyer (2009) found that the positive relationship between general IB experience and the choice of high-control (i.e., WOS) as opposed to low-control (i.e., JVs) organizational form is stronger in developed economies, whereas the negative impact of country specific experience on the needs to obtain high level of control is strengthened in developing countries JVs do NOT enhance flexibility Several TCE theorists made implicit assumption that JVs are less risky and more flexible than that of WOS in volatile and uncertain markets (Anderson and Gatignon 1986; Gatignon and Anderson 1988; Erramilli and Rao 1993; Kim and Hwang 1992). Anderson and Gatignon (1986) further argue that without the presence of asset specificity, there is a less need for flexible operation mode, i.e., JVs, in markets characterized by environment volatility and uncertainty. In the present study we argue that JVs are a highly inflexible mode of operating and therefore not suitable for high risk environment. JVs are based on long-term contracts that one of the JV partners cannot simply abandon the relationship (Meyer and Tran 2006). For any strategic movements in JVs, there has to be a mutual agreement between foreign and local partner(s). Regardless of the equity shares owned by foreign investors, without local partner s agreeing foreign investors can rarely push through their proposed strategic actions. Consequently the time you need to react to radical external environment change is bound to be longer. As can be seen from table 3, although newly established JVs suffer less from investments risk due to lower capital commitment, they suffer more from high coordination risk (Gomes-Casseres 1989, 1990). Investing firms opt for acquisitive JVs bear limited

18 investments risk due to low capital investments, however, partial acquisitions suffer more from integration problems and risk of conflicts between co-owners. Table 3: Types of FDI entry mode in relation to risk Entry modes Risks Wholly-owned Greenfield No co-owner related risks, no integration failure risk High investment risk due to large capital commitment and long pay-back periods. Full acquisitions High investment risk due to large up-front capital commitment Integration process related risks No co-owner related risks Newly established joint ventures Limited investment risk due to lower capital commitment High risk of coordination failure Partial acquisitions Limited investment risk due to lower capital commitment High risk of integration problems, high risk of conflicts between co-owners (Source: Peng and Meyer 2011, chapter 12)

19 4. SUMMARY AND CONCLUSIONS This paper presents a critical review of existing TCE-based JVs studies. It is clearly that TCE has been the most commonly used theoretical perspective in the past three decades to address organizational forms (i.e., JVs). However, a review of existing studies points out that early findings for the impacts of core TCE constructs such as asset specificity, internal and external uncertainty tend to be inconsistent. Table 4: Challenge to apply TCE in JV research (under work) Challenge to apply TCE in JV research How to empirically test assetbundling model (Hennart 1988) in JV research Sources of TCs in emerging markets are host s institutions Experience and distance as the core constructs in TCE both facilitate and inhibit the use of JVs JVs are a highly inflexible operation mode Implications Organization form (i.e., JVs) is determined by the TCs of combing resources from both partners. TCs are harder to measure in emerging markets, which lower the predictive power of the theory Experience and cultural distance simultaneously affect the external and internal costs in the same direction. JVs are NOT a flexible mode of entry and TCE argument for using JVs in high risk environments does not holds true Future research directions Construct of TCE such as asset specificity should be proxied at the transaction level. Future studies probing into emerging markets should consider host s institutions either study it, control for it or assume it only creates random noise

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24 Table 1. Anderson and Gatignon (1986) s transaction cost propositions TCE constructs Propositions Transaction specific assets 1) Highly proprietary products and processes (+) 2) Unstructured and poorly understood products and processes (+) 3) Customized products (+) 4) Immature products (+) External uncertainty 1) Country risk (non-significant) 2) Country risk X transaction specific assets (+) Internal uncertainty 1) International experience (+) 2) Socio-cultural distance (-) Free-riding potential Valuable brand name (+) + = increase the need for control over foreign subsidiaries