305

The Multinational Corporation's Degree
of Control over Foreign Subsidiaries: An

Empirical Test of a Transaction Cost Explanation
Downloaded from http://jleo.oxfordjournals.org at Aston University on August 17, 2010

HUBERT GATIGNON
University of Pennsylvania
ERIN ANDERSON
University of Pennsylvania
1. INTRODUCTION
Should a business function be vertically integrated? Increasingly, economists
have acknowledged that this is the wrong question. The right question is to
what degree a function should be integrated, whereby integration is a con-
tinuum anchored by the options of market and hierarchy (Williamson, 1985).
Movement along the continuum from market contracting to unified gover-
nance is accompanied by an increased degree to which resources are placed
at hazard. The firm is compensated for this by an increased level of control
that it presumably will use "correctly" in order to generate superior profit
outcomes. The central questions of transaction cost analysis are twofold:
When will the firm need more control (that is, when do lower-control out-
comes become less desirable), and when will the benefits of increased control
more than offset the costs of resource commitment and risk?
Oliver Williamson (1985) offers a theory to answer these questions. In
this paper we examine empirically the theory's predictions in the context of
the multinational corporation (MNC), which attempts to control the operations
of foreign "subsidiaries" (business units) that it owns in whole or in part. We
This project was funded by the Wharton Center for Internationa] Management Studies and
the Marketing Science Institute. We thank Louis Wells of the Harvard Multinational Enterprise
Project for access to the data base and William Davidson for assistance in using the data. The
capable research assistance of Wujin Chu is gratefully acknowledged. Helpful comments were
provided by Bruce Kogut, Jean-Francois Hennart, Paul Green. Thomas Robertson, Oliver Wil-
liamson, John Farley, and an anonymous reviewer.
Journal of Law, Economic*, and Organization vol. 4, no. 2 Fall 1988

C 1988 by Yale University. All rights reserved. ISSN 8756-6222
305
3 0 6 / JOURNAL OF LAW, ECONOMICS, AND ORGANIZATION IV:2, 1988
consider most of the integration continuum from very low levels of integration
(operationally, 5 percent equity) to completely unified governance (100 per-
cent equity), excluding only the outright market option.
In section 2 we review the relevant international economics and manage-
ment literature and propose a transaction cost explanation for the degree of
control an MNC will exert when it sets up a foreign subsidiary.1 This expla-
nation generates a set of hypotheses summarized in table 1. In section 3 we

present the data base, consisting of descriptors of 1,267 foreign subsidiaries,
launched between 1960 and 1975, of the 180 largest U.S. MNCS. These
launches consisted of four organizational forms: wholly owned subsidiaries,
partnerships in which the MNC held the dominant share of equity, balanced
(roughly equal) partnerships, and partnerships in which the MNC was a mi-
nority shareholder. These four governance structures progress from high con-
trol (integration) to low control (nonintegration).2 In section 4 we specify a
multinomial logit model to estimate how features of the subsidiary (for ex-
ample, country of operation) determine which of the four organizational forms
is employed. In section 5 the results are presented. We assess the robustness
of the results in section 6 and discuss the implications of our findings in
section 7.
2. RELEVANT TRANSACTION COSTS

A number of theoretical arguments have been advanced to explain why MNCS
integrate some operations in some countries and not other operations in other
(or even the same) countries.3 We use transaction cost analysis (Anderson
and Gatignon) as a framework for our review of the existing literature on the
proprietary nature of products and processes, external uncertainty, free rid-
ing potential, company experience, a country's sociocultural distance, and
scale of operations. We also provide empirical evidence concerning each of
these determinants of the level of control sought by MNCS. Richard Caves,
in an extensive review of the international trade literature, points out that
very little empirical research has been done at the level of the corporation.
Perhaps for reasons of data availability, research has focused on the level of
the country (for example, what determines the amount of foreign direct
investment in country X) or of the industry (for example, which industries
are most likely to operate internationally). The crucial decisions, however,
1. This explanation was first advanced in detail by Anderson and Gatignon. For reasons of
space, only the highlights of the arguments and evidence will be presented here.
2. We treat control from the standpoint of structural equity. There are other ways to gain
control (for example, by demanding the right to staff key positions), but such means are ill
understood at present and are beyond the scope of this study.
3. At first glance, the entire body of international trade theory would appear to bear on thii
issue. As pointed out by CaKet and Caves, however, most of this literature concerns why firms
choose to operate outside national boundaries. This is separate from the issue of which gover-
nance structure firms choose to employ when operating internationally.
MULTINATIONAL CORPORATION'S CONTROL OVER SUBSIDIARIES / 3 0 7
are made mainly at the firm level, and conclusions drawn for an industry or
country do not always apply to the individual firm.
2.1. OVERVIEW
The thrust of the transaction cost argument is that firms craft governance
structures designed to promote asset utilization while safeguarding against

hazards. The international context ushers in two problems that play minor
roles in domestic trading. The first involves cultural differences; joint ven-
tures may be seen as a way of bridging cultural gaps. The second is political;
joint ventures with local investors promise to reduce political complications
while diversifying against expropriation risks. Both political and cultural
problems reinforce the transaction cost arguments for market mediation and
weaken incentives to use wholly owned subsidiaries.
2.2. PROPRIETARY PRODUCTS AND PROCESSES

An oft-cited explanation of the MNC'S degree of control focuses on the diffi-
culty of using contracts to generate rents from proprietary or specialized
knowledge. The general line of argument (Arrow; Williamson, 1981b, 1985)
is that markets for information are fatally flawed because:
1. the bidder must evaluate the product in order to determine a price,
but in so doing the bidder comes to possess the product;
2. much knowledge is in "uncodified" form, difficult to transmit except
through the formation of close, continuing relationships, which are
difficult to set up and maintain without unified governance;
3. proprietary knowledge is a valuable transaction-specific asset that, if
shared, leads to a small-numbers bargaining situation and increases
the threat of opportunism.
These arguments (particularly the first two) figure prominently in the
international literature, where MNCS are seen as superior knowledge gener-
ators, obliged by the nature of markets for information to exploit their dis-
coveries themselves (Buckley and Casson; Hennart; Caves; Teece, 1983).
Thus it is proposed that greater control is appropriate (more efficient) for
highly proprietary products or processes. This appears as hypothesis 1 in
table 1, which summarizes the arguments to be tested, the measures we
employ, and the expected sign of the coefficient in the models we estimate.
There is some evidence that firms exert more control as proprietary con-
tent increases. Research and development expenditures (which generate pro-
prietary knowledge), lead to more licensing (Telesio) but expand direct
investment even more (Caves; Davidson, 1982). The relevance of this finding
is speculative, because foreign direct investment means amount of invest-
ment at the country or industry level, not necessarily unified governance of
Table 1. Hypotheses
Expected Sign
Hypothesii Measure of Relationship
HI Higher-control entry modes are more R and D/sales for the sub-
likely when the proprietary content of sidiary's line of business
products and processes is high. (FTC definition)
H2 Higher-control entry modes are more Country risk dummies
likely when the combined presence of

multiplied by R and D in-
country risk and asset specificity (rep- tensity for line of business
resented as proprietary content of of subsidiary
products and processes) is great.
H3 Higher-control entry modes are less Dummy for moderate vs.
likely when country risk is high. low risk, dummy for high
vs. low risk
H4 Higher-control entry modes are more Advertising/sales for the
likely for more heavily advertised subsidiary's line of busi-
products. ness (FTC definition)
H5 Higher-control entry modes are more Number of foreign market
likely when the parent (MNC) has entries to date
more international experience.
H6 Higher-control entry modes are less Dummy country variables
likely in cultures dissimilar from that Latin American vs. Anglo,
of the United States. Latin European vs. Anglo,
Germanic vs. Angk),
Other vs. Anglo. Based on
attitudes and values sur-
veys
H7 Higher-control entry modes are less Subsidiary's number of
likely for large foreign operations. employees
H8 Higher-control entry modes are less Dummy for six countries
likely in countries that tend to enforce identified by Stopford and
legal restrictions on foreign-owned Wells (1972)
operations.
investment vehicles at the firm level. But of research done at the firm level,
Stopford and Wells find, as expected, a negative correlation between re-
search and development expenditures and the proportion of subsidiaries or-
ganized as joint ventures rather than wholly owned subsidiaries. This implies
that firms tend to reserve proprietary knowledge for business units they
control completely, as transaction cost economics predicts.
In a similar vein, Coughlan and Flaherty and Anderson and Coughlan
study the use of wholly owned distribution (high control) versus independent
distribution (low control) by U.S. semiconductor manufacturers operating in
foreign markets. They find that high control is more often employed for
technically sophisticated products, which tend to have higher proprietary
content, than unsophisticated products. Davidson and McFetridge (1984)
find a more mixed pattern. They analyze 1,392 technology transfers abroad
by thirty-two American MNCs, modeling whether the transfer was accom-
plished by a high-control (at least 95 percent equity) method or a low-control
(less than 5 percent equity) method. High-control transfers did occur with
newer, more radical technologies (suggesting higher proprietary content).
High control methods were, however, less likely for innovative (rather than
imitative) technologies. This finding appears unstable, as Davidson and
McFetridge (1985) reanalyze the same data4 and find that innovativeness has
an insignificant impact on governance mode.

2.3. EXTERNAL UNCERTAINTY: COUNTRY RISK
Williamson (1979) argues that, a priori, market contracting (low control) is

the superior organizational mode for many transactions. Low control allows
the firm to benefit from the incentive and scale economies of a competitive
marketplace while evading the bureaucratic disabilities that tend to accom-
pany integration (Williamson, 1985). These benefits are sometimes offset,
however, by comparative cost burdens.
One circumstance favorable to integration, discussed above, is the pres-
ence of valuable, durable transaction-specific assets. These assets (such as
equipment, know-how, and working relationships) are specialized to a trans-
action, which binds the parties into bilateral exchange. If unchecked by
market forces, this exchange is subject to maladaptation and opportunism.
The solution, according to Williamson (1985), is managerial supervision and
the development of sophisticated, subtle incentive schemes. This necessitates
vertical integration (high control).
A second factor, "external uncertainty" (environmental unpredictability),
is particularly germane in the context of a high asset specificity condition.
When specificity is low, markets adapt readily, for they are well suited to
receive and process information, including information about uncertainty.
But contracting occurs in an incomplete context, and when asset specificity
creates extreme bilateral dependency, mounting levels of uncertainty put
strain on contracts, forcing the partners to effect successive adaptations in
their exchange relation. Ultimately, contracts will be abandoned in favor of
internal organization.
Uncertainty and asset specificity are thus hypothesized to determine
jointly the appropriate degree of control. The higher the combined level of
asset specificity and country risk is, the higher the appropriate degree of
control will be (hypothesis 2, table 1). This proposition suggests that external
uncertainty moderates the effect of transaction specificity of assets on the
integration decision. Conversely, risk by itself should lead to a need for
greater flexibility and therefore to use of lower-control governance modes
(hypothesis 3, table 1).
4. Davidson and McFetridge (1985) repeat their 1984 analysis with the inclusion of a number
of multiple demographic descriptors of the country entered. Most of the earlier results are
unchanged.
2.4. ADVERTISING INTENSITY
One type of specific asset is the value of a brand name. Brand name capital
creates control problems because it is especially subject to degradation
(Klein; Klein and Leffler). Control problems are acute whenever one party
can free ride on the efforts of others, receiving benefits without bearing
costs. Transaction cost analysis suggests that, ceteris paribus, where the
potential for free riding ("demand externalities") is high, entry modes offering

higher control are more efficient. This suggests that higher degrees of control
are more efficient when the value of a brand name is high.
When a brand name is valuable, short-term gains can be had at the ex-
pense of the long term. Firms will take control to prevent the local operation
from diluting or confusing the international positioning of the brand. Caves
highlights the danger of relying on local partners, who have less to lose from
degrading a brand than does the entrant. Thus, it is proposed that high
control is appropriate for heavily advertised products (hypothesis 4, table I).5
2.5. COMPANY EXPERIENCE
A firm often finds that it cannot assess its agents' performance accurately by
objective, readily available output measures—a circumstance Williamson
(1979) calls "internal uncertainty." In such situations, imperfect measurement
creates considerable transaction cost ramifications, which have been explored
by Alchian and Demsetz, Barzel, and Ouchi. Imperfect measurement makes
control more desirable; when performance cannot be specified or measured
easily, firms can monitor inputs rather than evaluate outputs. Further, firms
can use a variety of subtle incentives to develop goal congruence and loyalty.
Thus, employees may act in the firm's best interest even if a firm cannot
specify precisely what to do (Williamson, 1981a).
Firms inexperienced in the international setting, however, are not likely
to know how to manage subjectively, monitor appropriately, and assess inputs
in lieu of outputs. Further, firms that try to exert control before they know
how to use it will make serious errors that should depress efficiency (Teece,
1976:46). Low-control modes become especially advantageous if the firm
cannot manage an integrated structure properly. Accordingly, this paper tests
the proposition that an MNC'S degree of control of a foreign business entity
should be positively related to the MNC'S cumulative international experience
(hypothesis 5, table 1)."
5. In our case, the size effect will be vitiated because our data concern only very large
corporations, which are less pressed to finance and staff large foreign operations than are smaller
firms.
6. This argument is not without controversy. It has been suggested that MNCs need expe-
rience to know how to monitor partners effectively. In this view, they gain that experience by
running an integrated operation and then gradually learn to give up control and work with
partners. Davidson and McFetridge (1984, 1985) support this position, finding that the MNC'S
This argument has been discussed extensively in the descriptive inter-

national management literature. It has been suggested that the international
neophyte tends systematically to overstate risks and understate returns of
international markets (Davidson, 1980; Caves). Overly conservative, the firm
avoids setting up a foreign business entity and merely exports (Bilkey). With
the limited experience of exporting, the firm gains confidence and becomes
more aggressive in nondomestic markets, moving toward more direct in-

vestment rather than export (Bilkey; Weston and Sorge) or licensing (Telesio).
Further experience creates enhanced understanding, competence, and
confidence, as well as a more accurate perception of foreign risks and returns.
The firm enters more distant, different countries and, with a better under-
standing of how to run the business, is more capable and willing to assume
control (Davidson, 1980). In short, the descriptive literature is in accord
with our hypothesis that experience reduces internal uncertainty and aug-
ments control.
We now turn to three factors that, although not central to transaction cost
economics, are important for purposes of estimation and for our understand-
ing of the multinational's degree of control over foreign subsidiaries. These
factors are sociocultural distance, scale of operations, and legal restrictive-
ness.
2.6. SOCIOCULTURAL DISTANCE
A particularly potent form of internal uncertainty is caused by "sociocultural

distance," the difference between home and host cultures. It is often argued
that the greater the sociocultural difference between home and host coun-
tries, the lower the degree of control will be that an entrant should and does
demand. This is explained by the higher uncertainty executives perceive in
cultures that are truly foreign to them (Caves). Not being familiar, comfort-
able, or even in agreement with the values and operating methods of the
host country, executives shy away from the involvement that accompanies
ownership (Davidson, 1980, 1982; Richman and Copen). Uncertainty due to
sociocultural distance may also cause executives to undervalue foreign in-
vestments (Root). Further, they find it difficult to transfer home management
techniques and values to a dissimilar operating environment (Richman and
Copen). Finally, sociocultural distance creates high information needs, hence
high information costs, which firms may avoid by turning management over
to partners or licensees (Root). Hence, we hypothesize that MNCs will adopt
a lower-control governance structure in countries that are culturally very
different from their own (hypothesis 6, table 1).
experience is negatively correlated with the probability of using an integrated governance struc-
ture. Implicit in this view, however, is the notion that ignorant integration is a less serious error
than ignorant nonintegratton, the opposite of the transaction cost premise to be tested here.
3 1 2 / JOURNAL OF LAW, ECONOMICS, AND ORGANIZATION IV:2. 1988
2.7. SCALE EFFECTS
Assembling a sizable operation abroad taxes the resources of even the largest
multinationals, demanding great infusions of capital and managerial re-
sources. Further, it raises the level of risk sharply, asfirmsplace a substantial
portion of their investment overseas into one discrete chunk. Particularly
when operating in foreign environments, MNCS may find the level of risk and

commitment intolerable, at least initially (Hennart; Caves). Further, a large
organization is exceedingly difficult to run well (Williamson, 1985). The MNC
may, therefore, be willing to share control to gain a partner's expertise. We
expect, then, that, ceteris paribus, the larger the foreign operation is in a
given country, the lower the likelihood will be of using an integrated gov-
ernance structure (hypothesis 7, table 1).
2.8. LEGAL RESTRICTIVENESS
The legal restrictiveness of the country being entered can put constraints on
the multinational's choice. Some countries prohibit a foreign firm from es-
tablishing wholly owned subsidiaries in most industries, while others make
it so difficult to obtain high levels of control that it becomes effectively
impossible. Stopford and Wells conclude that in many countries the major
effect of such restrictions is to discourage foreign investment of any sort,
except by those few multinationals whose technology is sufficiently rare and
valuable that the host government will grant an exception. They also note
that six countries—Ceylon (Sri Lanka), India, Pakistan, Mexico, Spain, and
Japan—have laws so strict that the MNC is almost entirely constrained in its
choice of entry mode (hypothesis 8, table 1).
3. DATA ON FOREIGN OPERATIONS OF

MAJOR U.S. MULTINATIONALS
Our main data source is the Harvard Multinational Enterprise Project, a
census of the foreign direct investment activities of the 180 largest American
multinationals from 1900 to 1975. Thesefirmsestablished over 19,000 foreign
subsidiaries (defined operationally as any business entity in which the MNC
held at least a 5 percent share) over the seventy-five-year time span. Data
were collected from published sources, principally corporate annual reports
and corporate directories. Information from these sources was supplemented
and cross-checked by reports from the business press and interviews with
MNC management.
Most of the data are of the annual report variety (for example, country of
operation, Standard Industrial Classification [sic] codes), and data are often
missing. Nonetheless, they cover ownership patterns at the level of the busi-
ness entity. Such data are scarce; most international information exists at the
country or industry level only. Hence, they afford a rare opportunity to

examine international choices at the level of the individual firm.
We focus on the "entry modes" (governance structures) that MNCs used
when launching manufacturing operations in any of eighty-seven countries
between 1960 and 1975. As noted earlier, these choices are subject to change
as circumstances unfold. In modeling the firm's choice, we assume that MNCs
attempt to select an appropriate structure at the outset. This assumption

may, we realize, be flawed, particularly for lower degrees of control. Joint
ventures can be an experimental mode bridging to either a relatively painless
withdrawal or the establishment of a wholly owned subsidiary. Indeed,
Franko and Kogut (1987) find that joint ventures are inherently unstable,
prone to eventual takeover by one partner or to relatively early dissolution,
even though this might not have been anticipated at the time of entry. For
our purposes, the impact should be to dilute predictive power, especially
among the minority, balanced, and majority options. We will return to this
issue at the conclusion of the paper.
The period 1960-1975 was selected for several reasons. First, host country
interference in the management of the subsidiary, including legal restrictions
on ownership, increased considerably after the mid-1970s. Earlier, however,
interference was at low, and generally tolerable, levels (Doz and Prahalad).
MNCs could usually find ways to circumvent ownership restrictions, including
refusal to invest at all unless they were allowed to select the governance
structure (Stopford and Wells). This period also corresponds to the availa-
bility of data useful for supplementing the data base. Finally, 1960 is late
enough to eliminate postwar effects (Curhan, Davidson, and Suri), and 1975
is early enough to avoid a number of political shocks (notably Iran) believed
to have caused perturbations in investment patterns (Kobrin). Following is
a description of the measures employed.
3.1. CLASSIFYING EQUITY ENTRY MODES
The objective of transaction cost analysis is to determine when high-control

entry modes are worth their price to the entrant. Unfortunately, there is no
tested, accepted theory as to how much control each entry mode affords.
We propose a relationship between control and ownership structure (the
entrant's percentage of equity and the number of partners). In our taxonomy,
an entrant is likely to have more control with higher percentages of equity.
This simple relationship is complicated, though, by the number of partners
the firm has, if any. In general, the more partners the entrant has, the smaller
each partner's relative position will be, the less unified partners will be, and
the greater the entrant's chances will be of exerting control (Root).
Kindleberger and Hayashi point out the potential for variation in control
in any structural arrangement. For example, a minority partner might ex-
ercise influence out of proportion to ownership due to such factors as a special
contractual arrangement, expertise, or status as a government body. None-

theless, over a broad range of considerations it is reasonable to expect that
an entrant's control increases with the proportion of ownership and, given
that proportion, with the number of partners (Root; Davidson, 1982; Bivens
and Lovell; Friedmann and Beguin; Killing).
Because the level of control is a relative construct, governance structure,
the dependent variable, is subdivided into four organizational forms:

1. wholly owned subsidiaries (the MNC holds 100% of equity)
2. dominant partnerships (the MNC holds the dominant share of equity,
that is, owns more equity than any other partner)
3. balanced—roughly equal—partnerships (the MNC'S share is the same
as that of the largest partner)
4. minority partnerships (the MNC holds less equity than the largest part-
ner).
These four governance structures progress from high control (integration) to
low control (nonintegration). In most cases (84 percent of the sample of
partnerships), there was only one partner, and that partner was a local entity.
3.2. EXPLANATORY VARIABLES
The measures associated with each hypothesis are recapitulated in table 1.

Proprietary content was measured via research and development (R and
D) spending, which is an oft-used proxy for proprietary content and tech-
nological sophistication (Caves). No direct information on the individual sub-
sidiary's R and D spending is available. Most of these subsidiaries market
only one product line, though, for which the four-digit sic code is known.
The measure of proprietary content we employ is the R and D intensity (the
ratio of R and D expenditures to sales) of the line of business in which the
subsidiary is engaged. R and D intensity is gathered from the Federal Trade
Commission's (FTC'S) Annual Line of Business Report for 1974 and 1975.7
We use the two-year average8 for the FTC-defined line of business of the
7. A line of business, as defined by the Federal Trade Commission, is an operational defi-

nition of a "meaningful economic market" (Scherer). The classification, based on sic codes,
represents a trade-off among three criteria: maximizing industry detail, minimizing compliance
cost, and minimizing such accounting problems as the allocation of common costs. Scherer
defends the trade-offs, calling the final line of business definitions "extraordinarily useful, even
though far from an unattainable ideal" (p. 23). The lines of business were drawn after careful
study by the FTC. For older, more homogeneous industries, such as logging camps and logging
contractors, a line of business may be at the three-digit level (sic 241). For less homogeneous,
often new industries, such as inorganic pigmenU, a line of business may be at the level of seven
digits, five digits, or four digits (sic 2816). A line of business may also be a combination of
selected four-digit codes, such as metal forgings, ferrous and nonferrous (sic 3462, 3463).
8. Although R and D expenditures at the time of entry theoretically would be a more
appropriate measure, R and D expenditures for the line of business should not change signifi-
cantly during the period of investigation.
subsidiary's principal product line. R and D intensity is a major structural

feature of industries and is strongly related to the nature of the product class.
Hence, we would not expect industries to appear highly proprietary in one
year and not proprietary in the next. In other words, the relative degree of
R and D intensity among industries should be stable. R and D is widely
viewed as an acceptable indicator of the likelihood of innovation and thus
suggests which subsidiaries are likely to be engaged in highly proprietary

product classes.
Country risk is a wide-ranging concept that is difficult to assess empiri-
cally because of its multidimensionality. It is generally understood to mean
the extent to which a country's political, legal, cultural, and economic en-
vironment threatens the stability of a business operation (Davidson, 1982).
A "safe" country (at least for a U.S. firm) is politically stable, noninterven-
tionist (vis-a-vis business), not legally restrictive of business, culturally har-
monious, and economically developed. Such countries tend to be
socioculturally more similar to the United States than "unsafe" countries.
Because "country risk" has so many facets, there is disagreement over
what the concept entails and how to measure it. Empirical treatments of
country risk have focused on the political facet and have generally found no
consistent relationship between country risk and a firm's investment deci-
sions (Nigh). The discrepancy between these findings and managers' asser-
tions that they weigh country factors heavily has been attributed to
measurement problems (Kobrin; Nigh) and/or the possibility that managers
assess country risks so impressionistically and unsystematically that, in effect,
country risk has little importance (Kobrin; Caves). The impact of country
characteristics is usually assessed by examining the effect of individual vari-
ables, such as GNP per capita or number of coups d'6tat, on investment
decisions. These studies (for example, Davidson and McFetridge, 1985) typ-
ically find no or very small relationships.
A more generalized approach is used here. Country risk is an aggregate
concept: based on a large range of factors, countries can be classified broadly
as safe, somewhat risky, and highly risky; we make no attempt to subdivide
countries further. We use the classification system developed by Goodnow
and Hanz. Via cluster analysis, based on fifty-nine country descriptors span-
ning the decade of the 1960s, they sort one hundred countries into three
groups that correspond to high, medium, and low country risk (shown in
table 2).9 The "safe" countries have very stable governments, relatively few
foreign investment restrictions, temperate climates, and cultures not ex-
tremely dissimilar to that of the United States. As one moves toward the
"highly risky" countries, governments and economies become less stable,
9. Goodnow and Hanz group entry modes into three types: strong control/high investment,
moderate control/modest investment, and weak control/low investment. They find that firms
reduce their control and investment as they move away from relatively safe countries.
Table 2. Country Risk Clusters

Low risk countries
Australia France Norway
Austria Iceland Sweden
Belgium-Luxembourg Italy Switzerland
Canada Japan United Kingdom
Denmark Netherlands West Germany
New Zealand

Moderate risk countries
Barbados Honduras Panama
Brazil Hong Kong Portugal
Chile Ireland Singapore
Colombia Israel South Africa
Costa Rica Jamaica South Korea
Cyprus Kuwait Spain
Dominican Republic Lebanon Taiwan
Ecuador Malaysia Trinidad
El Salvador Mexico Uruguay
Finland Netherlands Antilles Venezuela
Guatemala Nicaragua Yugoslavia
High risk countries
Afghanistan Indonesia Peru
Algeria Iran Philippines
Angola Iraq Saudi Arabia
Argentina Ivory Coast Senegal
Bolivia Jordan Sierra Leone
Burma Kenya South Vietnam
Cambodia Laos Sudan
Cameroon Liberia Syria
Ceylon (now Sri Lanka) Libya Tanzania
Congo (now Zaire) Malagasy Republic Thailand
Egypt (U.A.R.) Malawi Togo
Ethiopia Morocco Tunisia
Gabon Mozambique Turkey
Ghana Nepal Uganda
Greece Nigeria Upper Volta
Haiti Pakistan Zambia
India Paraguay
SOURCE: Adapted from Coodnow and Hanz, p. 39.
markets become poorer, cultural homogeneity declines, legal and geographic

barriers go up, and cultural differences become extreme. Note that country
risk and sociocultural distance are somewhat entangled in this measure. This
reflects the prevailing conception of country risk in the international litera-
ture.
Legal restrictiveness is represented by a dummy variable for the six coun-
tries—Sri Lanka, India, Pakistan, Mexico, Spain, and Japan—with tight laws
against foreign ownership of assets.
Adixrtising is assessed through the advertising intensity (advertising/sales
ratio) of the subsidiary's line of business, a statistic obtained by averaging
figures from the FTC Annual Line of Business Report for 1974 and 1975.
This measure indicates the extent to which products can be made valuable
by advertising in the type of business in which the subsidiary is engaged.10
Cumulative company experience is measured by the number of foreign
entries the parent (MNC) has made to date (that is, when the entry being
examined is made) in the data base.
Sociocultural distance, like country risk, is difficult to quantify. Again,
we use a generalized approach. Culture is widely viewed as the set of atti-

tudes and values that are common to a people. Ronen and Shenkar (1985)
review eight comparative (cross-cultural) studies of work-related attitudes
and values, conducted largely during the 1960s and early 1970s. Each study
uses individual-level attitudinal data to delineate clusters of countries based
on similarity; the largest such study uses sixty-five thousand respondents to
classify forty countries. Examples of attitudes or values measured include
those toward achievement, practical mindedness, sharing of information, tak-
ing of initiative, democratic leadership styles, and commitment to an orga-
nization. Although the constructs measured are disparate, these studies tend
to show similar clusters, which Ronen and Shenkar synthesize into nine
groupings (table 3). The "Anglo" cluster is most similar to U.S. culture. The
other eight groups are different; we have no measure, though, of how dif-
Table 3. Sociocultural Distance Clusters

Anglo Arab Latin European Near Eastern
Australia Abu Dhabi Belgium Greece
Canada Bahrain France Iran
Ireland Kuwait Italy Turkey
New Zealand Oman Portugal
South Africa Saudi Arabia Spain
United Kingdom United Arab Emirates
United States
Latin American Nordic Far Eastern Germanic
Argentina Denmark Hong Kong Austria
Chile Finland Indonesia Switzerland
Colombia Norway Malaysia West Germany
Mexico Sweden Philippines
Peru Singapore
Venezuela South Vietnam
Taiwan
Thailand
SOURCE: Adapted from Ronen uid Shenkar, p. 444.
10. Benston criticizes the Line of Business (LB) data bate. While acknowledging that it is
the most complete data base available for lines of business, he argues that accounting biases
and measurement errors compromise the data's usefulness. Notably, most of his criticisms center
on the profitability measures, not the cost categories of R and D, advertising, and sales. Indeed,
Benston specifically asserts that the sales figure is not seriously "contaminated" and that the
jelling expenses figures, of which advertising is one, are useful descriptors. There is no reason,
then, to suspect that accounting biases are systematically correlated with the MNC'S choice of
governance structure.
ferent. Due to the small number of observations in many categories, of the

eight socioculturally similar clusters, three were retained: Latin European,
Latin American, and Germanic. All other countries, including forty-seven
countries that could not be classified socioculturally, usually because of the
dearth of attitude studies in these countries, were grouped into an "other"
(unclassified) category. We use a dummy variable for each group and hy-
pothesize that in all non-Anglo countries, less integration will be observed

than in Anglo countries.
Size of operation is measured by the number of employees of the sub-
sidiary.
A potentially important variable, not explicitly measured due to lack of
data, is the size of the MNC. However, all 180 MNCS are enormous conglom-
erates well within the Fortune 500; hence, in practical terms, size does not
vary greatly.
The correlation matrix of the independent variables indicates very little
collinearity. Most correlations are less than 0.10, and the highest correlation
(between the legal restrictions dummy and the high country risk dummy) is
only 0.37. Hence, the independent variables seem to tap domains with little
overlap.
3.3. SAMPLE REPRESENTATIVES
From 1960 to 1975 there were over nine thousand foreign entries by the 180
largest MNCS, as reported in the Harvard Multinational Enterprise data
base.11 As noted, this is a census. Missing data pose a significant problem.
In particular, governance mode, sic code, country of entry, number of em-
ployees, or time of entry caused a loss of 77.7 percent of the observations,
and the nonavailability of R and D, advertising, and country risk data further
reduced the sample to 1,267 complete observations. The representativeness
of this sample was assessed by comparing the distribution of each variable
in the sample with the corresponding distribution in the census. In general,
the distributions are very similar, although our data base undersamples
lower-control structures (23.8 percent of the sample versus 29.4 percent of
the census) and oversamples wholly owned subsidiaries (76.2 percent of the
sample, 70.6 percent of the census). This difference is not large in practical
terms, however, and is unlikely to create significant biases in the results,
particularly given the general representativeness of observations on the in-
dependent variables as shown in table 4.
11. Many of these 9,737 entries are not manufacturing entries and are hence beyond the
scope of the study. A large number of excluded forms are in extractive industries, which are
subject to special considerations (Kobrin).
MULTINATIONAL CORPORATION'S CONTROL OVER SUBSIDIARIES / 319
Table 4. Descriptive Statistics of Population with Complete Data and of Final Sample
Cumulative distribution
(*)
Population with complete
observations on country of
entry, sic code, governance
Governance mode mode, number of employees (N = 2J02) Final sample (N = 1J67)
Minority 8.4 6.0
10.0 9.2

Balanced
Majority 11.0 8.6
Wholly owned 70.6 76.2
Number offoreign
entries
0-10 24.8 12.7
10-20 43.2 30.2
20-50 77.3 69.3
50-100 94.9 92.8
100-150 99.2 99.1
150-200 100.0 100.0
Number of employees
1-100 26.6 27.0
100-500 73.5 73.9
500-1,000 86.4 88.1
1,000-2,000 94.2 95.4
2,000-10,000 99.4 99.6
10,000-35,000 100.0 100.0
4. MODELING THE ENTRY-MODE CHOICE
4.1. NATURE OF THE DECISION PROCESS
The entry mode decision involves determining the level of control that the
parent company should have in the subsidiary's management. Yet it is not
clear whether that determination is a single decision (with all options weighed
simultaneously) or a set of sequential decisions, each involving a subset of
options. It has been suggested that managers go about making the level-of-
control decision in a two-stage fashion, which simplifies the problem and
thereby economizes on bounded rationality (Williamson, 1985). In stage 1,
the choice is simply whether to own the subsidiary outright. Indeed, many
companies refuse to operate in a given country if they cannot own their
subsidiary (Fagre and Wells; Doz and Prahalad). If the MNC decides to seek
partners instead, stage 2 commences, wherein the MNC decides from among
less-control options.
We expect the transaction cost explanation to apply to both stages. In
stage 2, however, a number of other factors may influence the level of equity
sought, including the characteristics of each available partner and the details
of the possible arrangements that can be made. Hence, the transaction cost
explanation may perform better in stage 1 (deciding whether to integrate)

than in stage 2 (deciding the level of equity vis-a-vis partners). In the fol-
lowing section, we will use both a one-stage and a two-stage approach.
4.2. T H E MULTINOMIAL L O C I T CHOICE M O D E L

If the two-stage process described above represents the choice sequence,
the entry mode choice can be modeled by (1) a binomial choice model of
whether to have a partner at all, and, given that the decision to have a
partner has been made, by (2) a multinomial model of the choice among the
three remaining options: majority ownership, balanced equity, or minority.
Because the binomial choice is a special case of the multinomial choice
model, the more general multinomial choice model used in this study is
presented first.
A multinomial logit (MNL) model (McFadden; Amemiya) was specified to
estimate the impact of the independent variables on the probability that each
of the four governance structures would be selected. This quantal choice
model is particularly appropriate in this context, as the determinants of the
utility of one type of governance could be different for each governance mode.
Let G, be the governance mode of the «lh entry chosen by a U.S. firm. Let
X, be the vector (of size 12) of independent variables explaining the utilities
of the various governance modes for that observation. The vector X, contains
a value 1 corresponding to a constant term for the utilities Xn and measures
of (1) R and D intensity in the line of business of activity, X,2, (2) a dummy
variable for moderate country risk group, X(3, (3) another dummy for high
country risk group, XH, (4) a dummy variable for whether the entry was
made in a legally restrictive country, Xi5, (5) the MNC'S number of foreign
entries to date, X,6) (6) the number of employees of the subsidiary, X,7,
(7) advertising intensity in the line of business of activity, X,8, (8) a dummy
variable for whether the entry was made in a Latin European country, X,9,
(9) a dummy variable for whether the entry was made in a Latin American
country, Xll0, (10) a dummy variable for whether the entry was made in a
Germanic country, X,,,, and (11) a dummy variable for whether the entry
was made in any other non-Anglo country, X n2 . The multinominal choice
model (McFadden, 1974) can therefore be expressed as:
= 0
where, in addition to the definitions of G, and X, above,

Ftf = probability that the entry i is of the governance mode j where j c
(1,2,3,4),
$j = vector (of size 12) of coefficients of the marginal utilities of each of

the independent variables.
The option with a utility of zero serves as a base of reference. Given that
the reference choice in transaction cost analysis is the lowest control option,
the utility of the minority option was assigned a value of zero. All the other
parameters can therefore be interpreted only in reference to the minority

option. The significance of a coefficient indicates the extent to which the
corresponding variable contributes to the utility of that choice option beyond
the contribution that this variable would have in determining the utility of
the base option. Consequently, the parameters explain deviation from the
reference, minority shareholding.
The parameter vectors Bk' (for k = 2, . . . 4) were estimated by maxi-
mizing the log likelihood function below using the Newton-Raphson method
(Schmidt and Strauss):
K
N x
LnL = 2
where L = likelihood
N = number of entries
J = number of governance mode
y,j = 1 if G, = j , 0 otherwise
X^ = independent variable r
PJr = coefficient of variable r for governance mode j .
At the final step of the iteration procedure, the inverse of the information
matrix provides an estimate of the asymptotic covariance matrix of the max-
imum likelihood estimation of the parameter (Rao, 1965).
5. EMPIRICAL RESULTS
Table 5 gives the parameter estimates for the one-stage decision multinomial
logit (MNL) model. As per Williamson (1981a), the lowest-control mode.(mi-
nority shareholder) is set as the base case from which we measure deviations.
Hence, all coefficients for this case are set to zero, and we can make no
empirical statement about which circumstances favor minority ownership.
The relative utility of higher levels of control (vis-a-vis the base case) should
increase with proprietary content, the combination of proprietary content
and country risk, advertising, and the MNC'S number of prior foreign entries;
and it should decrease with sociocultural distance, country risk, legal re-
strictions, and number of employees. These hypotheses are represented by
the coefficients of higher-control equations in the system.
Table 5. Parameter Estimates for Multinomial Model of Governance Modes (N = 1,267)
Explanatory variables
Governance mode Constant Rand D/ Dummy. Dummy: Dummy: MNC'J Number Advertising/ Sodocultural distance
sales moderate high legal number of of sales Latin Latin Germanic Other
country country restriction* foreign employees European American dummy dummy
risk risk entries x 10"1 dummy dummy
Minority share 0 0 0 0 0 0 0 0 0 0 0 0
Balanced ownership .078 7.819 -.140 -.721 .156 .005 -.232* 14.101 .440 -.852 .216 .126
(equal shares) (.18Y (.70) (.33) (1.35) (.40) (1.06) (1.68) (1.24) (.79) (1.14) (.33) (.26)
Majority ownership -.010 -.006 .533 .114 -.622 .002 -.183 27.602" .919' -.364 .334 -,079
(.02) (.00) (1.26) (.22) (1.55) (.39) (1.54) (2.61) (1.70) (.53) (.51) (.16)
Wholly owned 2.453" 15.279* .139 -1.237" -1.737" .010" -.147** 33.624" -.172 -.44 -.48 -1.337"
(95-100%) (7.22) (1.64) (.38) (2.68) (4.86) (2.41) (2.43) (3.27) (.37) (.77) (.91) (3.29)
Log likelihood » -898.601.
a. Numbers In parentheses are t-jUtistics Tau - 23.7.
• p < .05.
•• p < .01.
Before discussing the results individually for each hypothesis, it should

be noted that interaction terms corresponding to situations with a combi-
nation of medium or high proprietary content and medium or high country
risk did not contribute to explaining the mode of entry. The log likelihood
gain of 4.37 with six additional parameters is not statistically significant. The
same results occurred for the two-stage decision models. Consequently, the
results reported in tables 5 through 7 do not include interaction terms but

only the main effects of R and D intensity and country risk.
We discuss the results by considering the effect of each variable on in-
creasing levels of control and commitment. Judging by the constant term of
the wholly owned option, complete control (hence commitment) is always
preferred. The coefficient intercept term (2.453) is positive and significant,
indicating that unified governance is preferable to minority status. Similarly,
100 percent ownership is preferred to minority status in R and D intensive
lines of business (15.279).
Country risk is represented by two dummy variables. The first dummy is
coded 1 for moderate risk countries: this dummy has no apparent impact on
entry mode choice. The second dummy contrasts high- and low-risk coun-
tries. As expected, the utility for wholly owned subsidiaries relative to other
options is significantly reduced for entries in high risk countries ( — 1.237).
Strong legal sanctions also act as an effective restraint against 100 percent
ownership (-1.737).
The MNC'S experience, as indicated by the number of foreign entries the
MNC has made to date, is associated with greater utility for unified gover-
nance (0.010). The larger the scale of operations becomes, however (as in-
dicated by the subsidiary's number of employees), the more likely the MNC
will be to share ownership, steering away from unified governance (— 0.147)
and balanced ownership ( — 0.232). Hence, a minority share appears to be
an attractive option for extremely large-scale foreign business entities.
Advertising intensity has a considerable impact. MNCs appear unlikely to
hold a minority position in subsidiaries whose lines of business are charac-
terized by intensive advertising. Instead, MNCS seek higher levels of con-
trol—majority ownership (27.602) and unified governance (33.624)—to
protect their brand-name capital.
Sociocultural distance also appears to influence the MNC'S utility for own-
ership, but only on a selective basis. The effect of these country cluster
dummy variables is interpretable in relation to entering within the Anglo
cluster (coded 0, hence part of the intercept term). Relative to the control
level pursued in Anglo countries, majority ownership does have some appeal
in Latin European countries (0.919). Also MNCS shy away from ownership in
"other" countries (-1.337), but this coefficient should be interpreted with
caution, as the unclassified countries might have little similarity. MNC own-
ership patterns are unaffected in Germanic or Latin American countries once
country risk and legal restrictiveness have been accounted for.
Viewed by row rather than by column, table 5 indicates that the prefer-
ence for complete ownership rather than minority status is the most amenable
to the transaction cost explanation advanced here (judging by the large num-
ber of significant coefficients). This result corroborates the overall preference
for a wholly owned subsidiary represented by the positive constant utility
term of that option. This also corresponds to the larger number of entries
with that mode of entry (76.2 percent of the sample). In fact, the unbalanced

size of entries could bias the explanatory variables toward insignificance,
since the constant utility term by itself will explain the entry mode choice.
To ascertain whether the model fits the data well, it is necessary to use
the model to classify the observations. The correct classification rate is un-
interpretable, though, when there are large numbers of cases concentrated
in one category (here, wholly owned). The classification rate will be artifi-
cially high (here, 77 percent) merely because the model will tend to classify
many observations into the largest (100 percent ownership) category (Ame-
miya).
To circumvent this problem, we adapt a procedure suggested by Morrison.
Of the 1,267 cases, 77 are minority, 107 are equal, 118 are dominated, and
965 are wholly owned. We divide the cases into nine "samples," each of
which contains the same 302 non-wholly-owned cases plus approximately 107
of the wholly owned cases, selected at random without replacement. Hence,
each sample has a fresh set of wholly owned cases and, more important,
each sample is more or less evenly balanced among the four options, ren-
dering the correct classification rate interpretable and removing the tendency
to overclassify into the wholly owned category.
We estimate the multinomial logit model nine times, once for each bal-
anced sample. The estimation results are very stable across the nine runs.
Table 5 shows 11 significant coefficients and 25 insignificant ones. Each of
the 25 insignificant coefficients is also insignificant in each of the nine split-
sample runs. Of the 11 significant coefficients, all are of the same sign in
each of the 9 runs. Further, 5 coefficients are significant in all 9 runs, 2 are
significant in 7 runs, one is significant in 6 runs, one in 4 runs, one in 3
runs, and one in one other run. Overall, of the 99 estimated coefficients (9
runs of 11 significant coefficients), all are of the same sign as the pooled
("master") run, and 74 are also significant. Hence, the pooled model appears
to replicate well, that is, it is not driven by only a few observations.
The model also classifies well. Averaging across the nine replications, 43.4
percent of the observations are correctly classified, and the rate varies little
from run to run (the low is 40.5 percent for split 1 and 47 percent for split 6).
The tau statistic (Klecka) is 23.7, indicating that the 43.4 percent classifica-
tion rate represents 23.7 percent fewer classification errors than would be
expected by chance. '*
12. The tau statistic is computed here as follows:

In sum, the model seems to fit the data reasonably well. On an overall
basis, however, these results, which consider level of control in once-and-
for-all fashion, leave room for improvement. Many variables are insignificant,
especially for options representing less than complete control. These results
suggest that the transaction cost framework is more applicable to the decision
to own the subsidiary 100 percent (versus some level of partnership) than to
the decision regarding level of control. The transaction cost theoretical frame-

work, which was initially developed for a continuous level of integration,
seems to be better supported by the data for the dichotomous case than for
the more continuous case of control level. Given the importance of the de-
cision to integrate, this could indicate a two-stage decision process whereby
first a decision for a fully owned subsidiary or a partner is made. If and only
if it is decided to use a partner (stage 1) is a choice made as to the degree
of ownership (stage 2).
5.1. A TWO-STAGE MODEL
In order to test the plausibility of this hypothesis of a two-stage decision

process, a binomial choice model was estimated for stage 1 with the same
independent variables, but where the reference option is to use a partner.
The alternative, then, is to establish a wholly owned subsidiary.
The results, shown in table 6, are strongly supportive of the transaction
cost explanation for the dichotomous choice (whether to integrate). Integra-
tion (unified governance) is more likely when subsidiaries engage in an R
and D-intensive line of business (12.410) or an advertising-intensive line of
business (13.313). Integration is also more likely when the MNC has experi-
ence with foreign entries (0.007). By contrast, the utility for the partnership
modes is higher in highly risky countries ( — 1.048) and for socioculturally
distant countries: Latin European ( — 0.722), Germanic ( — 0.676), and all
other non-Anglo (— 1.377) countries. Legal restrictions also increase the util-
ity of partnership arrangements ( - 1.564).
In sum, every variable is of the expected sign, and only three (the number
tau =
where n, is the number correctly classified by the model, j is an entry mode, n is the number
of observations, and p is the proportion of the sample in group J. The summation term indicates
the number of cases that would be correctly classified by chance, given each group's size and
its proportion of all observations. Hence, the numerator shows the model's improvement (e*-
pressed as the number of cases) over a chance prediction rate. The denominator indicates the
number of errors expected by chance. Hence, tau varies from 0 to 1 and is the percentage
reduction in erron achieved by a model.
Table 6. Binomial Choice Model Logit Model: Maximum Likelihood Estimation

Wholly Owned Subsidiary Versus Partnership (N = 1,267)
Coefficient t-ttatistic
Intercept 1.402** 7.50
R and D/sales 12.410* * 2.33
Moderate country risk dummy 0.008 0.04
High country risk dummy -1.048** 3.47
Legal restrictions dummy -1.564** 6.69

MNCs number of foreign entries to date 0.007** 3.22
Number of employees -0.055 1.08
Advertising/sales 13.313** 4.80
Latin European dummy -0.722** 3.22
Latin American dummy -0.087 0.25
Germanic dummy -0.676** 2.46
Other dummy -1.377** 6.07
Log likelihood -593.872.
Tau •> 38.1
•p < .05.
**p < .01.
of employees, the Latin American dummy, and the moderate country risk
dummy) are not significant. Further, consistent with the oft-noted tendency
of U.S. multinationals to prefer integration per se, the intercept is positive
(1.402) and highly significant.
Once again, this model's ability to classify cannot be assessed because 965
of the 1,267 of the subsidiaries observed are wholly owned, thereby unbal-
ancing the two groups into which the model classifies the observations. To
correct the unbalance, the 965 wholly owned cases were randomly split into
three roughly equal groups. Each group was paired with the 302 partnership
observations, making three samples. The binomial logit model was estimated
on each sample. Results are very stable. Of the nine coefficients significant
in the pooled sample, all are replicated with the same sign in all three runs.
Of these 27 coefficients, 23 were again significant. Of the three nonsignificant
coefficients, all nine replications were also nonsignificant. The "observations"
in the three samples are split almost evenly between wholly owned and
partnership observations, making 50 percent correct classification likely
merely by choice. The models from the three samples predict correctly, on
average, 69 percent of the cases, yielding a 38.1 percent improvement in the
expected number of errors. Further, the correct classification rate varies little
across samples (from 67.1 percent in split 1 to 70.67 percent in split 2).
Hence, the binomial results appear to be stable and to fit the data well.
The second-stage decision involves the level of ownership to hold. Table 7
presents a multinomial logit model concerning only the three partnership
options. Again, minority ownership is the reference option, given that unified
governance is not an option (hence, there are 302 observations rather than
the 1,267 of the earlier model). The scale of operations still influences the
control level sought. As the number of employees increases, MNCS become
Table 7. Parameter Estimates for Multinomial Model of Governance Modes Involving a Partnership (N = 302)
Explanatory variables
Governance mode Constant Rind D/ Dummy: Dummy: Dummy: UNC'S Number Advertising/ Socfaxultunl distance
tiles moderate high legal number of of sale) Latin Latin Germanic Other
country country restrictions foreign employees European American dummy dummy
risk risk entries x 10-J dummy dummy
Minority share 0 0 0 0 0 0 0 0 0 0 0 0
Balanced ownership .293 6.126 .048 -.575 .166 .006 -.660** 13.014 .674 -.940 .247 .033
(equal shares) (.66)- (.53) (.11) (.99) (.39) (1.27) (3.04) (1.13) (1.18) (1.18) (.37) (•06)
Majority ownership .089 -1.544 .680 .317 -.382 .004 -.603** 28.361** 1.218** -.650 .273 -.178
(.20) (.13) (1.47) (.58) (.91) (.82) (2.94) (2.62) (2.16) (.89) (.40) (.32)
Log likelihood - -300.219.

a. Numbers in parentheses ire t- statistics. Tau - 26.9.
• p < .05.
• • p < .01.
less likely to take majority (— 0.603) and balanced (— 0.660) positions relative
to minority positions. In contrast, MNCS elect majority positions when sub-
sidiaries operate in an advertising-intensive line of business (28.361). Ma-
jority ownership is more likely to be used than a minority position in Latin
European countries (1.128). Other effects of sociocultural difference are in-
significant. The model classifies 52 percent of the observations correctly, a
reduction of 26.9 percent in the number of errors expected by chance.

In general, the findings for the multinomial logit model without the un-
ified governance option (table 7) are similar to the findings with integration
as a fourth option (table 5). The role of transaction cost variables in predicting
entry modes when a partnership has been opted for is usually not as clear
as for the decision as to whether to set up a wholly owned subsidiary or joint
venture.
Taken together, these results conform to the idea that MNCS make their
foreign entry decisions in two-step fashion, since the binary choice model
clearly outperforms all others. The data tend to indicate that in step 1 MNCS
make a dichotomous choice between integration and shared ownership. This
step is very well represented by a transaction cost approach (table 6). If
unified governance is ruled out, step 2 commences and involves the choice
among several nonintegrated options (table 7). This process is not well rep-
resented by a transaction cost approach, as most variables are insignificant.
Only advertising, scale of operations, and sociocultural distance appear to
influence this decision, suggesting that other variables are at work here.
6. ASSESSING THE ROBUSTNESS OF THE RESULTS

To this point, the results presented have been based on a four-part catego-
rization of the entry modes elected by U.S. multinationals. As with any
categorical dependent variable, the question arises of whether the results
differ if entry modes are measured differently. The results should be robust
to changes in measurement, and even in estimation.
To assess robustness, we used ordinary least squares (rather than binomial
and multinomial logit) to model degree of control measured four different
ways. Rather than the four-part categorization of wholly owned, majority
ownership, balanced ownership, and minority ownership, we used the en-
trant's share of equity to construct four different but conceptually related
operationalizations of the entrant's degree of control.
The first measure is simply the entrant's share of equity (from 5 percent
to 100 percent). In order to take into account heteroscedasticity that could
be introduced by the range restriction (0-100) of the dependent variable,
the second measure is a logit transformation, wherein the entrant's share,
X, is transformed to log [X/(100 — X)], that is, the logarithm of the entrant's
share divided by the combined share of the other partners. As this term is
undefined for wholly owned subsidiaries, these are rescaled to 99 percent.
The third measure is the entrant's relative share, that is, its share divided
by that of the next largest partner. This term is also rescaled to 99 percent
for wholly owned subsidiaries, so that relative share is represented as [99/
(100 - 99)] or 99. Hence, relative share assigns an extremely high value to
complete ownership, which may distort the results. To combat this, the
fourth measure is the natural logarithm of relative share.
These four measures all represent, in different fashion, the entrant's de-

gree of control of the entry vehicle. If our four-part categorization is robust
and the results are not dependent on the method of estimation, then our
Ordinary Least Squares [OLS] models of these four dependent variables
should yield results similar to those presented earlier.
Estimation results appear in table 8. The first four columns are results
using the entire data base and should be compared to tables 5 and 6. The
last four columns use only the partnership observations and are comparable
to table 7. The results are highly consistent. Using the full data base, the
entrant's degree of control, measured all four ways, is high if all else is
constant (judging by the positive intercepts). Control increases for more
research intensive product categories, more advertising intensive product
categories, and more experienced multinational entrants. Control declines
for highly risky countries, legally restrictive countries, larger projects (sig-
nificant in three models), Latin European countries, Germanic countries
(three of four models), and for an assortment of non-Anglo countries. Control
is unaffected for moderately risky countries and Latin American countries (a
facet of sociocultural distance). These results are very similar to those for
the full sample and binomial logit. They are also generally consistent with the
full sample multinomial logit results for wholly owned subsidiary utilities.
For partnerships only, eliminating 100 percent ownership, few coefficients
are significant. Entrants elect higher-control partnerships for more advertis-
ing-intensive lines of business (all four coefficients significant) and lower-
control partnerships for larger projects (3 of 4 coefficients significant). Other
coefficients are insignificant, with isolated exceptions that do not repeat
across operationalizations of degree of control of the partnership. This pattern
(size and advertising connected to increased control, null or mixed effects
otherwise) is comparable to the multinomial logit results for partnerships.
Taken together, these results imply that the four-part categorization and
multinomial or binomial logit results are robust and that the full sample size
results are driven by the wholly owned subsidiary choices. These multiple
analyses are thus consistent with the argument that transaction cost analysis
is well equipped to explain full ownership versus partnership but does not
apply well to the level of partnership at time of entry.
7. CONCLUSION
These results suggest that a transaction cost perspective is a useful, albeit
partial, explanation of where on the integration continuum American multi-
Table 8. Multiple Operationalizations of Degree of Control
Full sample (N = 1,267) Shared equity (excluding 100% ownership; N = 302)
Percent Logit:t Relative Log of Percent Logit:t Relative Log of
ownership r_/ * \ ownership: relative ownership Ln( ) ownership: relative
(OLS) % ownershiptt ownership (OLS) 100-X % ownershiptt ownership
100-X
% ownership % ownership
of 1st partner of 1st partner
Intercept 88.95" 3.63" 77.72** 3.62** 50.94" 0.68 1.77** .09
(63.51) (29.35) (29.85) (29.90) (17.46) (•47) (4.52) (•63)
R and D/sales 73.02* 8.03* 187.82* • 7.94* 129.29 -6.43 -15.97 -4.66
(1.72) (2.14) (2.38) (2.16) (1.63) (1.63) ' (1.51) (1.23)
Moderate country risk dummy 1.22 .06 -.04 .02 1.59 .053 .18 .05
(.68) (.37) (.01) (.14) (.55) (.37) (.47) (.34)
High country rilk dummy -9.14" -.91" -20.70" -.93** 2.58 .116 .14 .05
(3.35) (3.79) (5.07) (3.93) (.67) (.61) (.28) (.27)
Legal restrictions dummy -17.73" -1.57" -31.53" -1.48" -2.95 -.12 .09 -.06
(8.48) (8.52) (8.11) (8.19) (1.08) (.89) (.25) (.49)
MNC'S no. of foreign entries .052** .005** .099** .005** .029 .001 .001 .002
to date (experience) (3.03) (3.16) (3.11) (3.23) (.91) (.87) (.35) (1.28)
Number of employees (size) -1.12" -.075* -.85 -0.6* -2.46** -.12** -.11 -.10"
(2.62) (1.98) (1.07) (1.74) (3.44) (3.35) (1.11) (2.83)
Advertising/sales 90.52* 7.87" 158.99** 7.97** 145.92** 6.95" 19.52** 7.94"
(5.56) (5.46) (5.25) (5.66) (3.29) (3.15) (3.28) (3.73)
Latin European dummy -3.18* -.38** -9.37" -.38** 6.18* .26 .18 .24
(1.85) (2.49) (2.94) (2.54) (1.75) (1.47) (.39) (1.39)
Latin American dummy 1.16 .14 4.16 .18 -1.65 -.06 .40 .01
(.39) (.54) (.76) (.70) (.33) (.24) (.60) (.05)
Germanic dummy -2.79 -.32* -8.53* -.34* 5.02 .26 .45 .25
(1.29) (1.66) (2.13) (1.80) (1.12) (1.16) (.75) (1.16)
Other (non-Anglo) dummy -11.88** -1.06" -20.69** -.99** -2.65 -.15 -.38 -.09
(6.41) (6.47) (6.01) (6.16) (.75) (.83) (.80) (.52)
R« = .17 .17 .16 .16 .12 .11 .06 .10
Not*: Numbers in parentheses are t-stattstlcs. R* values are not directly compartble across models because they apply to different dependent variables.
: parent's percentage of ownership. If wholly owned (X - 100), share is set to 99 to allow computation.
t t l f X - 100. share Is set to 99 to allow computation.
• p < .01.
•• p < .05.
national firms choose to locate their international manufacturing operations.

Our findings underscore the importance of country risk. In highly risky
countries, firms avoid outright ownership of their subsidiaries, although their
subsequent decisions as to the level of partnership appear unaffected. Inter-
estingly, sociocultural distance on the whole seems not to have a large impact:
most coefficients in most equations are not statistically significant.
As MNCS gain experience abroad, however, they do tend to opt for wholly

owned subsidiaries, as predicted by the framework. Presumably, there is a
body of information about how to operate abroad that is either difficult to
transmit or requires tailoring to a given firm's operation. The result, appar-
ently, is a need to learn by doing. Kogut (1983) suggests that firms with
international experience have moved so far down the international learning
curve that other firms will have difficulty catching up and competing with
them. Our results are consistent with Kogut's assertion. Nonetheless, they
indicate that the scale of foreign operations appears to force even the very
large MNCS to share ownership for large projects.
The role of advertising is intriguing. It has been suggested that valuable
brand names can be efficiently marketed via low-control entry modes. Lall
and Helleiner and Lavergne argue that heavily advertised products tend to
be unsophisticated consumer goods, which many agents are capable of han-
dling, making low control appropriate. Hennart adds that advertising, by
creating consumer loyalty to the product, can itself be a method by which
the manufacturer influences independent channels. In this view, advertising
can provide control, rather than creating the need for control. Yet in our
choice models, advertising's positive impact on control was substantial, both
in the integrate-or-not (stage 1) model and the level-of-control-given-partners
(stage 2) model. This suggests that advertising may, on the whole, pose se-
rious free riding risks that necessitate a higher degree of control.13
R and D intensity appears to influence the first decision (whether to in-
tegrate) but does not influence the second (what kind of partnership to se-
lect). This suggests that proprietary knowledge is indeed difficult to transmit
when control is diluted. However, once the decision is made not to own the
subsidiary 100 percent, it appears that varying degrees of partnership are
viewed as equivalent, even for highly research-intensive types of products.
Our relative inability to explain lower-control entry modes is somewhat
surprising. Our models succeed much better in explaining the high/low con-
trol contrast than in predicting intermediate levels of control. One possible
explanation is that intermediate levels involve complex adjustments to ensure
the smooth operation of the subsidiary and the protection of both parents'
interests. Once high control is ruled out, then, choosing a point along the
13. An intriguing issue for future research would be to examine different kinds of advertis-
ing-Intensive products (for example, consumer packaged goods versus other kinds of products)
to determine whether the tendency to take control is uniform among all heavily advertised
product categories.
integration continuum is an exceptionally complex endeavor that involves

weighing features of the proposed partners) and contract(s).
We have compared several models that might correspond to different
decision processes, and we infer from the fit of the transaction cost framework
(hypotheses) which process is more likely to be used. Our models are de-
signed, though, to test both the decision process (one versus two stages) and
the transaction cost framework. Underlying this joint test is the presumption

that the decisions made are normatively "correct" by transaction cost stan-
dards. It is possible that different model specifications should be used for
different processes or stages. This line of reasoning suggests several expla-
nations for the poor fit of the second stage (what kind of partnership to select)
decisions.
First, transaction cost economics is a normative (efficiency-based) frame-
work. Our data describe actual choices, which may be subject to other in-
fluences. Second, equity share vis-a-vis partners may not completely reflect
the parent's degree of control of a joint venture. Details of the agreement
(such as veto power, credible commitments, and the right to name personnel)
may be necessary to discern the parent's real degree of control. Third, we
use transaction cost analysis to form hypotheses about which kind of joint
venture is most efficient in the long run. It is possible, however, that firms
do not enter joint ventures with a long-run perspective in mind. Much of
the descriptive literature on joint ventures portrays them as inherently frag-
ile, short-lived arrangements. Harrigan, for example, suggests that many joint
ventures are primarily experiments that, if successful, will be converted to
wholly owned subsidiaries. Harrigan also argues that many joint ventures
are created for limited purposes (such as learning how to make a product),
and that firms willingly terminate participation when the purpose is met.
Indeed, some empirical evidence does suggest that joint ventures have a
short life span (Kogut, 1987). If so, the transaction-cost considerations we
have outlined may not be of paramount importance in choosing a mode of
entry, and this may explain our poor results for stage 2 (level of partnership).
Nonetheless, there is some evidence that firms do elect joint ventures to
enter markets with the intention that the arrangement will be lasting. Con-
tractor argues that the problems of joint ventures have been overemphasized,
that reports of their failures have been exaggerated, and that firms indeed
view them as viable permanent arrangements. Contractor and Berg and
Friedman argue that when joint ventures change their ownership patterns,
it is in response to environmental shifts, not because the arrangement was
never intended to be permanent. And Janger, in an extensive survey of man-
agers of firms that create joint efforts, concludes: "Most of the executives
interviewed regard their joint ventures as open-ended, long term commit-
ments. They said they would reject—in many cases had rejected—venture
proposals that rested on short-term or temporary benefits to the partners.
'If I can't see at least ten years ahead of us,' an executive noted, 'then it's
not worth the trouble.'" (Janger: 8)
It is noteworthy, however, that even Janger found executives who stress
the short-term view in selecting joint ventures. Hence, a possible explanation
for the poor fits of our stage-2 models is that when 100 percent ownership
is ruled out, at least some firms do not base their entry-mode decisions on
long-term criteria.

Transaction cost economics predicts low-control entry modes (market me-
diation) where such factors as proprietary content are not operative. Yet these
results show the opposite: integration seems to be the preferred option. It
has been noted elsewhere that American multinational corporations (MNCS)
have a strong tendency to integrate their overseas operations vertically, pre-
ferring virtually full ownership to shared ownership or such contractual ar-
rangements as licensing (Stopford and Wells; Brooke and Rentiers; Curhan,
Davidson, and Suri).
A likely explanation for the strong tendency to integrate might come from
factors beyond and independent of our hierarchical framework. In particular,
many MNCS strive to rationalize production and marketing decisions in their
"portfolio" of foreign business entities, forcing each to suboptimize for the
benefit of the parent corporation (Caves; Hennart). This, rather than indi-
vidual market advantage over local producers, may be the most important
basis of the MNC'S advantage (Kogut, 1983). Further, Caves (1982) has noted
that non-American MNCS appear to be willing to employ lower-control gov-
ernance structures more frequently than American MNCS, perhaps because
non-U.S. multinationals often have less market power. Hence, the U.S. or-
igin of the parent corporations may account for part of the tendency to assume
higher-control entry modes. Interestingly, the business press reports a grow-
ing willingness to substitute lower-control entry modes for complete own-
ership and attributes the trend to increasingly formidable competition, thus
reducing the multinational's freedom to exercise its preferences (Business
Week).
Our study is, of course, subject to limitations. We consider only the MNC'S
"mode of entry" rather than how the governance structure changes over time.
The latter is operationally an extremely difficult question, particularly in
terms of data requirements. Lack of good data is a notorious problem in
international research, and this has obliged us to use proxy variables. More
micro-level indicators, while difficult to obtain, give more accurate readings,
particularlyforsuch subtle constructs as asset specificity. A further limitation
stems from the manufacturing emphasis of this study. Other sectors (such as
financial services, transportation, and agriculture) remain to be explored.
Nonetheless, our results suggest that MNC foreign operations can be under-
stood, at least in part, in terms of trading degrees of control for degrees of
flexibility in uncertain, unknown environments.
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The Multinational Corporation's Degree

of Control over Foreign Subsidiaries: An

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Journal of Law, Economic*, and Organization vol. 4, no. 2 Fall 1988

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2. RELEVANT TRANSACTION COSTS

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2.2. PROPRIETARY PRODUCTS AND PROCESSES

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Williamson (1979) argues that, a priori, market contracting (low control) is

2.4. ADVERTISING INTENSITY

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2.5. COMPANY EXPERIENCE

This argument has been discussed extensively in the descriptive inter-

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2.6. SOCIOCULTURAL DISTANCE

A particularly potent form of internal uncertainty is caused by "sociocultural

2.7. SCALE EFFECTS

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2.8. LEGAL RESTRICTIVENESS

3. DATA ON FOREIGN OPERATIONS OF

country or industry level only. Hence, they afford a rare opportunity to

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3.1. CLASSIFYING EQUITY ENTRY MODES

The objective of transaction cost analysis is to determine when high-control

contractual arrangement, expertise, or status as a government body. None-

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3.2. EXPLANATORY VARIABLES

The measures associated with each hypothesis are recapitulated in table 1.

7. A line of business, as defined by the Federal Trade Commission, is an operational defi-

subsidiary's principal product line. R and D intensity is a major structural

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Table 2. Country Risk Clusters

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markets become poorer, cultural homogeneity declines, legal and geographic

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Table 3. Sociocultural Distance Clusters

SOURCE: Adapted from Ronen uid Shenkar, p. 444.

ferent. Due to the small number of observations in many categories, of the

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3.3. SAMPLE REPRESENTATIVES

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4. MODELING THE ENTRY-MODE CHOICE

4.1. NATURE OF THE DECISION PROCESS

explanation may perform better in stage 1 (deciding whether to integrate)

4.2. T H E MULTINOMIAL L O C I T CHOICE M O D E L

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where, in addition to the definitions of G, and X, above,

$j = vector (of size 12) of coefficients of the marginal utilities of each of

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Before discussing the results individually for each hypothesis, it should

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12. The tau statistic is computed here as follows:

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5.1. A TWO-STAGE MODEL

In order to test the plausibility of this hypothesis of a two-stage decision

Table 6. Binomial Choice Model Logit Model: Maximum Likelihood Estimation

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Log likelihood - -300.219.

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6. ASSESSING THE ROBUSTNESS OF THE RESULTS