International Joint Ventures and the Boundaries of the Firm

This paper links the declining propensity of multinational firms to share ownership of their foreign operations to increasing returns to coordination associated with managing globalized operations. The paper isolates the characteristics associated with the decision to share ownership in international operations and then employs two exogenous shifts in the relative cost of sharing ownership to identify the underlying dynamics of ownership decisions. The evidence indicates that firms are more likely to establish joint ventures in settings in which it is attractive to purchase inputs from, and sell to, local markets, suggesting a potential role for joint venture partners in facilitating learning about local markets. Joint ventures are less commonly established in situations in which doing so requires a firm to forego what would otherwise be attractive opportunities to use wholly owned affiliates to coordinate integrated production activities across different locations, transfer technology, and engage in worldwide tax planning. Since operational characteristics and ownership levels are endogenously determined, further empirical analysis employs the liberalization of ownership restrictions by host countries in the 1980s and 1990s, and the joint venture tax penalties imposed by the U.S. Tax Reform Act of 1986, as instruments to identify this relationship. The evidence indicates that firms responded to these regulatory and tax changes by expanding the volume of their intrafirm trade as well as the extent of 100 percent affiliate ownership. Point estimates indicate that four percent greater sole ownership of an affiliate is associated with two percent higher intrafirm trade volumes. Taken together, the evidence suggests that growing returns to managing global operations through wholly owned affiliates, together with regulatory and tax changes, gave rise to the sharply declining propensity of American firms to organize their foreign operations as joint ventures over the last two decades. JEL Classifications: F23, L23, H87. Mihir A. Desai C. Fritz Foley James R. Hines Jr. Harvard Business School Harvard Business School University of Michigan Morgan 363 Morgan 228b Business School Soldiers Field Soldiers Field 701 Tappan Street Boston, MA 02163 Boston, MA 02163 Ann Arbor, MI 48109-1234 [email protected] [email protected] [email protected]