Allocation of property rights and technological innovation within firms

• Date: 01 April 2020
• Author: Catherine Magelssen
• DOI: http://doi.org/10.1002/smj.3103
• Published date: 01 April 2020

RESEARCH ARTICLE

Allocation of property rights and technological

innovation within firms

Catherine Magelssen

Strategy and Entrepreneurship, London

Business School, London, UK

Correspondence

Catherine Magelssen, Strategy and

Entrepreneurship, London Business School,

Sussex Place, Regent's Park R342, London,

NW1 4SA, UK.

Email: cmagelssen@london.edu

Funding information

London Business School

Abstract

Research Summary:This paper examines whether

ownership rights to strategic assets within firms affects

innovation. Although existing research maintains that stra-

tegic assets can be leveraged freely within the firm, many

firms allocate ownership rights to strategic assets to busi-

ness units or subsidiaries. While scholars have examined

strategic asset ownership rights as a tool for tax avoidance,

scholars have yet to study its effects on innovation. In the

context of multinational firms, I find evidence that subsidi-

aries with ownership rights produce more technological

innovations and are more responsive to shocks to R&D

opportunity than those without ownership rights. Addition-

ally, the results provide evidence of the cost of tax avoidance

strategies. When subsidiaries in technologically advantaged

locations do not hold ownership rights, they produce fewer

and less impactful innovations.

Managerial Summary:A key decision made by multina-

tional firms is which subsidiaries should hold ownership

rights to the firm's strategic assets. The choice often entails

a trade-off between allocating ownership rights to subsidi-

aries best positioned to innovate and manage the strategic

asset versus to s ubsidiaries in inc ome shielding l ocations to

reduce the firm's tax bill. This paper examines whether sub-

sidiary strategic asset ownership rights matter for subsidiary

innovation. I find evidence that subsidiaries with ownership

rights produce greater quantity and quality of innovations

and are more responsive to changes in R&D opportunity

than subsidiaries without ownership rights. This study high-

lights an important ramification of tax avoidance strategies:

Received: 17 September 2015 Revised: 16 September 2019 Accepted: 17 September 2019 Published on: 22 November 2019

DOI: 10.1002/smj.3103

758 © 2019 John Wiley & Sons, Ltd. Strat Mgmt J. 2020;41:758–787.wileyonlinelibrary.com/journal/smj

locating strategic asset ownership rights away from subsidi-

aries in regions of expertise can adversely affect i nnovation

within the firm.

KEYWORDS

innovation, multinational firms, patents, property rights, subsidiaries

1|INTRODUCTION

Central to firm strategy is the creation and management of strategic assets. Strategic assets are the

intangible assets, such as technologies, manufacturing processes, and know-how, that can provide

the firm with a competitive advantage (Amit & Schoemaker, 1993). Existing research holds that

firms freely leverage strategic assets across geographically dispersed locations (Dunning, 1977). Yet,

many firms allocate ownership rights to strategic assets within the firm. The business units or subsidi-

aries with strategic asset ownership rights (ownership rights) have both the right to income from

the strategic asset and the right to control it.

1

While both multi-unit firms in a single country and

multinational firms (MNEs) alike may allocate ownership rights, the management of strategic

assets in MNEs is particularly interesting because subsidiaries are legally separate entities

located in different countries.

2

MNEs use formal written contracts between subsidiaries to assign

strategic asset ownership rights. MNEs choose to allocate ownership rights to subsidiaries to

maximize the value of the strategic assets. However, this choice is not simple, as value is a func-

tion of both “income shielding”and “innovation”aspects. Specifically, because ownership

rights include income rights, MNEs often allocate ownership rights to subsidiaries in income

shielding locations to save on their tax bills (Griffith, Miller, & O'Connell, 2014) rather than

allocate them to subsidiaries best positioned to create and manage the strategic assets.

3

Although

scholars have examined subsidiary ownership rights as a tool for tax avoidance (Griffith et al.,

2014; Karkinsky & Riedel, 2012), scholars have yet to study the effects of subsidiary ownership

rights on innovation. This paper examines whether subsidiary ownership rights matter for sub-

sidiary innovation, and whether there are adverse consequences to not allocating ownership

rights to subsidiaries with innovation potential.

A large literature studies the allocation of ownership rights to strategic assets between firms and

its effect on innovation (e.g., Leiponen, 2008; Lerner & Merges, 1998). The ability to control the

asset and appropriate income from it motivate the owner to maximize value creation (Grossman &

Hart, 1986; Hart & Moore, 1990).

Relatively less is known about ownership rights to strategic assets within firms. Scholars maintain

that, within firms, ownership rights to strategic assets cannot be credibly allocated to business units

or subsidiaries since formal contracts between business units or subsidiaries assigning ownership

1

This study focuses on the property rights concept of economic ownership rights, which are the rights to control the assets and

the rights to income or losses from the assets (Grossman & Hart, 1986). While economic ownership may overlap with equity

and legal ownership, it is conceptually distinct. Barzel (1997) argues that economic ownership rights are the ends that agents

seek whereas legal rights are the means to achieve the ends.

2

A firm is defined hereafter as a MNE. A subsidiary is any legal entity wholly owned by the MNE. While the parent holds

legal ownership over subsidiaries, property rights creates a sub-hierarchy of strategic asset ownership rights.

3

Governments lose an estimated $100 to 240 billion in tax revenue each year from MNEs shifting income from high to low tax

jurisdictions (OECD, 2015), half of which is attributed to R&D strategic assets (Grubert, 2003).

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