Institutions and equity structure of foreign affiliates

Research output: Contribution to journalArticle

Abstract

Question/Issue: We combine agency and institutional theory to explain the division of equity shares between the foreign (majority) and local (minority) partners within foreign affiliates. We posit that once the decision to invest is made, the ownership structure is arranged so as to generate appropriate incentives to local partners, taking into account both the institutional environment and the firm-specific difficulty in monitoring. Research Findings/Insights: Using a large firm-level dataset for the period 2003-2011 from 16 Central and Eastern European countries and applying selectivity corrected estimates, we find that both weaker host country institutions and higher share of intangible assets in total assets in the firm imply higher minority equity share of local partners. The findings hold when controlling for host country effects and when the attributes of the institutional environment are instrumented. Theoretical/Academic Implications: The classic view is that weak institutions lead to concentrated ownership, yet it leaves the level of minority equity shares unexplained. Our contribution uses a firm-level perspective combined with national-level variation in the institutional environment, and applies agency theory to explain the minority local partner share in foreign affiliates. In particular, we posit that the information asymmetry and monitoring problem in firms are exacerbated by weak host country institutions, but also by the higher share of intangible assets in total assets. Practitioner/Policy Implications: Assessing investment opportunities abroad, foreign firms need to pay attention not only to features directly related to corporate governance (e.g., bankruptcy codes) but also to the broad institutional environment. In weak institutional environments, foreign parent firms need to create strong incentives for local partners by offering them significant minority shares in equity. The same recommendation applies to firms with higher shares of intangible assets in total assets.
Original languageEnglish
Pages (from-to)216-229
Number of pages14
JournalCorporate Governance
Volume22
Issue number3
Early online date10 Feb 2014
DOIs
Publication statusPublished - May 2014

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Monitoring
Equity
Foreign affiliates
Institutional environment
Minorities
Intangible assets
Assets
Host country
Agency theory
Incentives
Large firms
Investment opportunities
Institutional theory
Central and Eastern European countries
Selectivity
Ownership structure
Policy implications
Country effects
Information asymmetry
Corporate governance

Bibliographical note

© 2014 The Authors. Corporate Governance: An International Review published by John Wiley & Sons Ltd. This is an open access article under the terms of the Creative Commons Attribution License (CC-BY), which permits use, distribution and reproduction in any medium, provided the original work is properly cited.

Financial support from the ESRC; grant number RES-062-23-0986.

Keywords

  • corporate governance
  • cross border ownership
  • institutional theory
  • agency theory
  • minority shareholders

Cite this

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title = "Institutions and equity structure of foreign affiliates",
abstract = "Question/Issue: We combine agency and institutional theory to explain the division of equity shares between the foreign (majority) and local (minority) partners within foreign affiliates. We posit that once the decision to invest is made, the ownership structure is arranged so as to generate appropriate incentives to local partners, taking into account both the institutional environment and the firm-specific difficulty in monitoring. Research Findings/Insights: Using a large firm-level dataset for the period 2003-2011 from 16 Central and Eastern European countries and applying selectivity corrected estimates, we find that both weaker host country institutions and higher share of intangible assets in total assets in the firm imply higher minority equity share of local partners. The findings hold when controlling for host country effects and when the attributes of the institutional environment are instrumented. Theoretical/Academic Implications: The classic view is that weak institutions lead to concentrated ownership, yet it leaves the level of minority equity shares unexplained. Our contribution uses a firm-level perspective combined with national-level variation in the institutional environment, and applies agency theory to explain the minority local partner share in foreign affiliates. In particular, we posit that the information asymmetry and monitoring problem in firms are exacerbated by weak host country institutions, but also by the higher share of intangible assets in total assets. Practitioner/Policy Implications: Assessing investment opportunities abroad, foreign firms need to pay attention not only to features directly related to corporate governance (e.g., bankruptcy codes) but also to the broad institutional environment. In weak institutional environments, foreign parent firms need to create strong incentives for local partners by offering them significant minority shares in equity. The same recommendation applies to firms with higher shares of intangible assets in total assets.",
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Institutions and equity structure of foreign affiliates. / Driffield, Nigel; Mickiewicz, Tomasz; Temouri, Yama.

In: Corporate Governance, Vol. 22, No. 3, 05.2014, p. 216-229.

Research output: Contribution to journalArticle

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