Institutions and Equity Structure of Foreign Affiliates

• Author: Yama Temouri,Tomasz Mickiewicz,Nigel Driffield
• Date: 01 May 2014
• Published date: 01 May 2014
• DOI: http://doi.org/10.1111/corg.12054

Institutions and Equity Structure of

Foreign Aff‌iliates

Nigel Driff‌ield, Tomasz Mickiewicz*, and Yama Temouri

ABSTRACT

Manuscript Type: Empirical

Research 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 parentf‌irms 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.

Keywords: Corporate Governance, Cross Border Ownership, Institutional Theory, Agency Theory, Minority

Shareholders

INTRODUCTION

It is well established that weak institutions and weak cor-

porate governance frameworks lead to more concen-

trated ownership structures of f‌irms. Equally, there is a large

literature arguing that because such environments fail to

protect minority investors, this leads to the values of

these investments being discounted (Boubakri, Cosset, &

Guedhami, 2005; La Porta, Lopez-de-Silanes, Shleifer, &

Vishny, 1998; Morck, 2007; Shleifer & Vishny, 1997; Wu, Xu,

& Yuan, 2009). However, absent from this literature is any

discussion of the size of the stake which is offered to minor-

ity partners. We contribute to the literature by f‌illing this gap

with respect to the equity structure of foreign aff‌iliates.

First, we argue thatsince foreign direct investment (FDI) is

characterized by strategic interests, by a high degree of com-

mitment and by exercise of control through equity (Aguilera

& Jackson, 2003), the choice of ownership structure and the

associated control over both physical capital and knowledge

capital becomes critical (Carr, Markusen,& Maskus, 2001). In

this context, the ownership structure of aff‌iliatesbecomes an

important consideration for retaining control of strategic

assets, and seeking to mitigate the risks associated with dif-

ferences in the attributes of institutionalenvironments across

countries (e.g., Brouthers, 2002; Gatignon & Anderson, 1988;

Meyer, Estrin, Bhaumik, & Peng, 2009). At the same time,

domestic partnersprovide resources complementary to those

of foreign partners, and offering larger minority shares to the

*Address for correspondence: TomaszMickiewicz, Aston Business School, Aston Uni-

versity, Aston Triangle, Birmingham B4 7ET, UK. Tel: +44 121 204 3000; E-mail:

t.mickiewicz@aston.ac.uk

This is an open access article under the terms of the Creative Commons Attribution

License, which permits use, distribution and reproduction in any medium, provided

the original work is properly cited.

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Corporate Governance: An International Review, 2014, 22(3): 216–229

© 2014 TheAuthors. Corporate Governance:An International Review published by John Wiley & Sons Ltd.

doi:10.1111/corg.12054