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1 Student First Name: Jaithen Student Surname: Alharbi Copyright subsists in all papers and content posted on this site. Further copying or distribution by any means without prior permission is prohibited, except for the purposes of non-commercial private study or research, as defined in the Copyright, Designs and Patents Act 1988, or as otherwise authorised by statute. To obtain permission, please contact the author of the relevant paper in the first instance or with details of your request. 1 P age

2 Abstract Headquarters-Subsidiary Relations in Multinational Corporations An Empirical Study of MNCs in Saudi Arabia Over the past two decades, research in the field of international business has been comprehensive in examining the nature, strategy, and, structure of various multinational corporations (MNCs). Additional studies are still required in order to investigate several aspects of MNCs, including headquarters-subsidiary relations. This study focuses on the least examined aspects and areas of headquarters-subsidiary relations in multinational corporations and attempt to contribute additional knowledge in the area. The research will address current gaps in knowledge by carrying out a comprehensive survey of headquarters-subsidiary relations in MNCs. 1. Introduction The purpose of this study is to carry out an empirically based examination of the types and degrees of control exerted by Multinational Companies on their foreign subsidiaries located in Saudi Arabia. Applying agency and stewardship theory, the study conceptualize and test the types and degrees of controls put on by Headquarters (HQs), located in a relatively stable environment, on their affiliated entities abroad in Saudi Arabia. A thorough review of literature as well as previous analyses of similar conceptual set-ups in different empirical contexts should not only help in developing an adequate framework and subsequently deriving hypotheses, but also should help us ultimately reveal through empirical testing whether and to what extent certain structural as well as environmental properties moderate types and degrees of control that are exercised by important organizations to coordinate actions, interests and goals with their affiliated entities abroad. The main objective of the present work thereby, is to apply a theoretical set of propositional arguments to a new empirical context in order to examine and contrast its predictive ability and limitations and to eventually not only contribute to the process of theory development through theory testing but to increase our understanding of control MNCs use to monitor their affiliated entities and the circumstances that influence its usage and to what extent the subsidiary will have more power. The current study is a logical consequence of extant research done in this field of international management (O'Donnell, 2000, Gupta & Govindarjan 2000, Chang & Taylor, 1999, Ghoshal & Nohria, 1989, Birkinshaw & Hood 1998). The motivation for this 2 P age

3 investigation is not only rooted in the magnifying role played by Saudi context as an attractive emerging and attracting market but also results from the circumstance that previous, large-scale empirical studies have mainly captured Anglo-American, Japanese or Korean, Malaysian HQs-perspectives. Research questions addressed in this research include the following: What organizational control is exercised by headquarters, and how does it affects the performance of the subsidiary? To what extent do subsidiary-specific resources and competences, such as language and cultural knowledge, affect the type of subsidiary control instituted in different countries? To what degree are headquarters-subsidiary relations affected by such characteristics as physical distance and interdependence between headquarters and subsidiaries? How do headquarters control over each subsidiary in terms of management style, knowledge flows, and human resource management, and how does this control affect subsidiary autonomy? How much does the national culture of the host country influence the control mechanism of the subsidiary? Table1: Research Gaps 2. Literature Review: The arena of international business has progressed through numerous changes over recent years, which has subsequently increased the requirement for additional synchronisation, dexterity and management between organisation headquarters and their subsidiaries. With this in mind, a number of researches have been conducted in this field with focus on the link of such. Importantly, it has been argued by Martinez (1989) that those investigations carried out during the 1960s through to the 1980s generally directed more focus towards formal coordination mechanisms. However, those researches conduced more recently particularly 3 P age

4 during the last ten years have more keenly investigated and analysed the informal coordination mechanisms. It has been highlighted by Cary (1984) that the link between coordination and control as two fundamental elements together provides the overall process of integration. Importantly, it should be recognised that there is a distinction to be made between control and coordination diversity, which suggests that the two concepts do differ collectively. Moreover, these two factors act in response to organisation-related variables in a number of different ways and also with varying force. In 1989, the agency theory was examined and appraised by Eisenhard, who subsequently case a positive light on the theory in terms of its influences in relation to organisation theory, and accordingly posed testable suggestions. Essentially, his particular research was constructed in such a way that it focused on answering four research questions: 1) What is it?; 2) What does it contribute to organisational theory?; 3) Is it valid empirically?; and 4) What topics are fruitful for organisational researchers utilising agency theory. It should be noted that the study provides a number of key inputs, such as evaluating the existing literature in the field, identifying previous contributions made in relation to the theory, and thirdly presenting testable suggestions. In conclusion, Eisenhard (1989) states that benefits may be achieved when the agency theory is used in conjunction with organisational theory. Subsequently, in 1992, Roth & Nigh carried out a research concerned with investigating the value of the link between organisation headquarters and their subsidiaries and their corresponding struggles. As a result, two fundamental integration developments were noted: control and coordination. As these findings emphasise, there is a positive link between bureaucratic integrating mechanisms, coordination, and personal integrating mechanisms. Following the study of Roth & Nigh (1992), various hypotheses were provided by O Donell (2000) in relation to those mechanisms utilised for the purpose of handling the overseas subsidiaries of MNCs. In his research, O Donell stated that the agency theory was not able to explain or describe how control was maintained in relation to this foreign subsidiary; however, it was nevertheless determined that an interdependent-based model would have a more practical ability. In 2001, Ann-will Harzing et al. examined control relations in consideration of the headquarter-subsidiary relation, with the case study directing focus to two countries: 4 P age

5 Germany and the UK. Moreover, in this study, attention was also directed towards comparing such controls in Japan and the US in order to determine the degree to which mergence could be recognised. As a result, it was argued that the control mechanism apparent between a subsidiary and its headquarters ultimately rests on the origin of the MNC. Prior to the previous works, EgelHoff (1984) investigated and analysed the type and level of control implemented in the case of (foreign) subsidiaries and headquarters. This particular research considered two different kinds of control: the existence of foreign individuals at the subsidiary in question and performance reporting. Subsequently, it was further stated by Egelhoff (1984) that the MNC s nationality played a key role in affecting the degree of means of managerial control. Essentially, it has been recognised that a greater degree of emphasis is placed on performance data and subsidiary output by US MNCs as opposed to European. Moreover, it was further established that the control of US MNCs considers more impartial and measurable elements of foreign subsidiaries and their environments to be more important compared with those in Europe, which seek to measure qualitative elements more closely. Importantly, it is stated that more in-depth budgets and plans are required by US MNCs in terms of control in an attempt to provide proper comparative standards; in Europe, on the other hand, it is recognised that a greater understanding of behaviours and practices, and how these assist in achieving organisational goals, is required across the entire firm. With the aforementioned in mind, it is further argued by researchers that the overall independence of the subsidiary is notably affected by the headquarters nationality. Furthermore, a number of different organisation-related factors namely the size of the host country and its overall openness are significantly influential when examining the relation between the headquarters and its subsidiaries. In 2005, Kim, Prescott & Kim examined and verified international businesses governance structures, and how these should be differentiated between in order to fit various different roles adopted by the foreign subsidiary. Furthermore, they also considered and assessed the influences and effects of agency-related issues in relation to foreign subsidiary governance in the case of international organisations. In direct consideration of the agency theory, the research made the suggestion that corporate governance witnessed in the case of foreign subsidiaries of international organisations should be created and implemented in such a way that they consider agency-related problems related to fluctuating tactical roles. Disparities between the strategic roles adopted by different foreign subsidiaries mean that the 5 P age

6 relationships between themselves and their headquarters will ultimately fall within different contexts and, with this in mind, this research seeks to provide further knowledge in terms of how international organisations and their headquarters seek to create and adopt corporate governance mechanisms in consideration of their subsidiaries with the aim of ensuring stakeholder fortification; with this in mind, and in respect to the agency theory, this study aims to consider this fundamental element and how this can be applied. This is carried out with the aim of expanding the knowledge base in this arena. Notably, it has been examined by Lovett et al. (2009) through the utilisation of US parent organisations and their Mexican affiliates how a number of different subsidiary features namely management nationality, subsidiary performance, and the aim of determining how the subsidiary will affect the control that the headquarters adopts in relation to the subsidiary. Furthermore, the research also seeks to analyse whether or not headquarters control in this context will have an impact on the performance of the subsidiary. With the aforementioned taken into consideration, this research provides a framework model which makes the proposition that a number of different subsidiary features, i.e. those aforementioned, are able to affect the degree and mechanisms of control applied by headquarters over their subsidiaries. Importantly, the findings suggest that headquarters views and assessments over subsidiaries are linked contrariwise to the degree of control implemented. In the research carried out by Vora, Kostova & Roth (2007), the various roles adopted by a subsidiary manager, as well as the degree to which obligations were fulfilled, were examined with the aim of investigating the impacts associated with the dual organisational identified of the subsidiary managers of MNCs in direct relation to their overall performance within their job role. Importantly, subsidiary managers were found as having to tackle a number of different challenges spanning across two difficult managerial roles, i.e. those in consideration of their subsidiary, and those in mind of the headquarters and organisation as a whole. Accordingly, it is emphasised by this research that complicated, diverse or difficult roles are better satisfied, with goals realised, in instances where managers are able to acquire and expand upon dual organisational indemnification in consideration of both units, i.e. subsidiary and headquarters. Undoubtedly, the subsidiary manager has a fundamental function in terms of gathering information from headquarters and relaying and applying this within the respective 6 Page

7 subsidiary. This notion is further reinforced by Riege (2007) who states that a number of different actions may be carried out by managers in order to help them to achieve their jobrelated goals and fulfil their responsibilities. Furthermore, the research also provides a wideranging list of actions, which aims to aid managers in terms of overcoming obstacles associated with the communication and conveying of important information. Notably, this list comprised almost 40 items relating to human, organisational and technological aspects. In order to gain a good understanding of the overall nature of the relationships apparent between MNC subsidiaries and their respective headquarters, it is necessary to investigate and analyse the formal structures as well as how such forces affect either directly or indirectly different methods adopted for control and coordination, as well as the requirement for such. The subsequent sections of this study will evaluate a number of the more importance factors, and accordingly debate their possible impacts in relation to the formal organisational structure as well as the relationships witnessed between headquarters and subsidiaries. Table2. Classification of control in two dimensions Personal/Cultural Impersonal/Bureaucratic/Technocratic Direct/explicit Centralization, Standardization, formalization,output Indirect/implicit direct supervision Socialization, control, planning informal, Communication, training and task forces Source: Adapted from Ann-Wil Harzing (2001). 3. Theories of Control The study of headquarter-subsidiary relationships in multinational companies (MNCs) represents a very challenging research task definitely. The object of the study, the MNC, is a very complex organization. It tends to be of considerable size and to be highly differentiated in structure. It is by definition geographically dispersed, thereby facing diverse environmental conditions. As a result of these and other factors, we can expect that intra-organizational relationships, i.e. mechanisms and processes for coordination and control of foreign subsidiaries in MNCs, are very difficult to describe, analyze and to understand. The headquarter-subsidiary relationships are furthermore not only static, structural arrangements but dynamic processes of decisions and exchanges. 7 Page

8 In the study of intra-organizational relationships in MNCs, as defined herein, many theories are explaining the control phenomena. Each one contributes to the understanding and conceptualization of the research data. The first current is found in the theory of complex organizations and in particular what represent the "contingency theory" of organizations. The second current relates to research on business strategy and on the growth of the business firm and the strategic and organizational consequences of this growth. The third major current consists of research on organizational control. The theory of complex organizations helps us to identify the forces behind the need for organizational control and coordination. Furthermore, it gives a deeper understanding of how the organizational context may influence the instruments for and processes of control and coordination of foreign subsidiaries in MNCs. The theory of complex organizations employs primarily a static perspective. Headquartersubsidiary relationships are by contrast a dynamic in nature. The impact of organizational growth and corporate strategy can therefore be assumed to influence the relationships. Corporate strategy is also a part of the context of the relationships. A review of the major research efforts in the area of business policy can therefore be assumed to give further valuable insight into the need for and modes of control and coordination of the foreign subsidiaries. While the first two research currents above specify the context of the headquarter-subsidiary relationships, the last one focuses on the specific instruments and processes used to manage the relationships. The research on organizational control integrates a diverse body of research which employs sociological, organizational and administrative perspectives. Based on these theories, it seems that the agency theory will be the best fitting theory for this kind of study. In the next section, I will explain about agency theory and how it is used in the research of Headquarter-subsidiary relations. 3.1 Agency Theory Applied to the particular context of multinational organizations, the headquarters-subsidiary relationship by all means, has a principal - agent (Roth & O Donnell, 1996) or principal multi agent structure. In this regard, agency theory highlights the principal-agent relationship between the parent company acting as a principal and the subsidiary acting as an agent. The design of control plays a significant role while organizations expand and internationalize, particularly, as it serves as an important integration function in MNCs. Growing difficulty 8 Page

9 and differentiation of structures, as side effects of increasing degrees of internationalization of Multinationals, make a crucial need to observe and coordinate activities (Geringer & Hebert, 1988), as headquarters do have to make sure that the various activities originating and executed in its foreign subunits are compatibly coordinated and support the commonly shared objectives of the overall organization (Egelhoff, 1984). While operating the strategic objectives and interests (especially in culturally distant and different contexts), management practices or types of control may diverge and might not be outstanding for the principal at the Headquarters (Yan,Zhu & Hall, 2002). According to Holmstrom, the more autonomy the agent enjoys, the greater the information the agent possesses, the greater the specialized knowledge required to perform the task and consequently the greater the chances for the occurrence of moral hazard and hidden information (Holmstrom, 1979).This will probably result in higher risks and uncertainties and therewith in higher agency costs (Davis, Schoorman & Donaldson, 1997). In such cases, agency theory traditionally suggests governing contracts like behavior control, culture control or output control for monitoring agents (Ekanayake, 2004). Explanatory factors HQ-Subsidiary Relations (Mediating Factor) Response Subsidiary factor performance Knowledge flows Management style Language Size Age Control and Coordination Mechanism MNC Factors Nationality Geographical distance Cultural distance Response Factor Subsidiary Power The proposed Framework 9 P age

10 4. Conclusion This study will make a promising beginning in understanding the choice of control mechanisms and the extent of control in parent subsidiary relationships. As coordination and control of geographically dispersed activities become central problems in the management of the multinational corporations, greater understanding of the dynamics of control becomes an extremely important topic for researchers in the field of international business. By focusing on relationships between MNC parents and subsidiaries in the context of Saudi Arabia. The study with the help of applied data analysis of facts and information collected hopes to make both theoretical and applied contribution to the field. 10 P age

11 References Birkinshaw, J. & Hood, N., Multinational Subsidiary Evolution: Capability and Charter Change in Foreign-Owned Subsidiary Companies. The Academy of Management Review, 23(4), p.773. Björkman, I., Barner-Rasmussen, W. & Li, L., Managing knowledge transfer in MNCs: the impact of headquarters control mechanisms. Journal of International Business Studies, 35(5), pp Davis, J.H., Schoorman, D.F., and Donaldson, L. (1997): Toward a stewardship theory of management, in: Academy of Management Review, Vol. 22, No. 1, pp Egelhoff, W.G. (1984): Patterns of control in U.S., UK and European Multinational Corporations, in: Journal of International Business Studies, Vol. 15, No. 2, pp Eisenhardt, K.M. (1989a): Agency theory. An assessment and review, in: Academy of Management Review, Vol. 14, No. 1, pp Gupta, A.K. & Govindarajan, V., Knowledge Flows and the Structure of Control within Multinational Corporations. The Academy of Management Review, 16(4), p.768. Ghoshal, S. & Nohria, N., Internal differentiation within multinational corporations. Strategic Management Journal, 10(4), pp Harzing A, Noorderhaven N Knowledge flows in MNCs:An empirical test and extension of Gupta and Govindarajan s typology of subsidiary roles. International Business Review.; 15(3): Holmstrom, B. (1979): Moral Hazard and Observability, in: Bell Journal of Economics, Vol. 10, No. 1, pp Kim B, Prescott J, Kim S, 2005.Differentiated governance of foreign subsidiaries in transnational corporations: an agency theory perspective. Journal of International Management. 11(1): Lovett, S.R., Pérez-Nordtvedt, L. & Rasheed, A. a, Parental control: A study of U.S. subsidiaries in Mexico. International Business Review, 18(5), pp O'Donnell, S. (2000): Managing foreign subsidiaries. Agents of headquarters or an interdependent network, in: Strategic Management Journal, Vol. 21, No. 5, pp Roth, K., Nigh, D. (1992): The Effectiveness of Headquarters-Subsidiary Relationships. The Role of Coordination, Control, and Conflict, in: Journal of Business Research, Vol. 25, No. 4, pp P age