Attacked from Both Sides: A Dynamic Model of Multinational Corporations' Strategies for Protection of Their Property Rights

Date01 February 2015
DOIhttp://doi.org/10.1002/gsj.1090
Published date01 February 2015
ATTACKED FROM BOTH SIDES: A DYNAMIC
MODEL OF MULTINATIONAL CORPORATIONS’
STRATEGIES FOR PROTECTION OF THEIR
PROPERTY RIGHTS
MARCELO BUCHELI1* and MINYOUNG KIM2
1Department of Business Administration and History, University of Illinois at
Urbana-Champaign, Champaign, Illinois, U.S.A.
2School of Business, University of Kansas, Lawrence, Kansas, U.S.A.
Multinationals operating in site-specific industries face two types of opportunistic behavior. If
they vertically integrate, host governments have incentives to change existing legislation
challenging the firms’ property rights. If they do not, they can be held up by business partners
or lose control over the production process. These conflicting problems are reflected in the
contradictory assessment made by the obsolescing bargaining power and transaction costs
economics theories. Drawing on property rights theory, we introducepolitical integration as a
strategy to address the two conflicting problems. It involves the integration of the host coun-
try’s polities within the multinational’s structure to avoid government opportunism, while still
benefiting from the advantages of vertical integration. However, this strategy can backfire after
institutional changes in the host country. Copyright © 2015 Strategic Management Society.
INTRODUCTION
Beginning in the 1990s, the world seemed to tell
multinational corporations (MNCs) that the times of
challenges to their property rights through actions
such as expropriations had ended. MNCs involved in
business with significant investments in immobile
fixed assets such as mining, petroleum, or infrastruc-
ture had been particularly affected by a wave of
government expropriations in the 1960s and 1970s
(Jones, 2005; Kobrin, 1980; Wilkins, 1974). The fall
of the Soviet bloc, China’s insertion in the world
economy, and the abandonment of protectionism in
Latin America and Asia that came parallel to new
foreign business-friendly policies in most countries
confirmed that perception (Fukuyama, 1992). Events
taking place in the twenty-first century, however,
proved any celebration of the end of expropriations
premature. The 2008 financial crisis gave new
impetus to the voices advocating for a return to pro-
tectionism and resuscitated what were believed to be
long-forgotten nationalist policies, particularly in
industries in which MNCs had little mobility (The
Economist, 2009). This was apparent with the cases
of the expropriation of Brazilian-owned oil property
in Bolivia in 2006, the Venezuelan expropriations
under the late Hugo Chávez rule, and growing
threats to foreign investors in the mining industries
in Africa (Flores-Macías, 2012). In April 2012, the
Argentinean government expropriated Spain’s
Repsol properties using similar legal mechanisms as
the ones used four decades before (The Economist,
2012). The return of expropriation policies, the com-
plexity behind the processes leading to them, and the
difficult strategic choices the most vulnerable MNCs
face (i.e., those operating in the natural resource or
infrastructure sectors) make it imperative for schol-
Keywords: property rights theory; obsolescing bargaining
power theory; transaction costs economics theory; business
history
*Correspondence to: Marcelo Bucheli, College of Business,
University of Illinois at Urbana-Champaign, 1206 South Sixth
Street, Champaign, IL 61820-6978, U.S.A. E-mail: mbucheli@
illinois.edu.
Global Strategy Journal
Global Strat. J., 5: 1–26 (2015)
Published online in Wiley Online Library (wileyonlinelibrary.com). DOI: 10.1002/gsj.1090
Copyright © 2015 Strategic Management Society
ars to understand the political and historical issues
that undergird this new expropriation wave.
MNCs operating in industries with mobile assets
(e.g., retail or finance) have the option of moving
out (or threatening to do so) of a country if they
perceive the possibility of the host government
changing the existing legislation in a way to expro-
priate their assets. For companies operating in
industries that depend on a large amount of immo-
bile assets such as mining or petroleum, however,
this is not an option. These type of firms have ‘few
alternatives’ (Nygaard and Dahlstrom, 1992: 4).
Mines and oilfields cannot simply moved out of a
particular country and their infrastructure requires
enormous investment in fixed assets for a long
period of time. As such, these MNCs are vulnerable
to potential ex post opportunistic behavior of the
host government once they make significant
difficult-to-redeploy investments.
The origin of this issue can be traced back to the
very nature of the transactions in the site-specific
industries. Scholars following the transaction costs
economics tradition articulate that most MNCs oper-
ating in these types of industries cannot simply sub-
contract or outsource production to domestic
providers (Buckley and Casson, 1976; Hennart,
1982; Klein, Crawford, and Alchian, 1978; Rugman,
1981). First, more often than not, there are no
domestic firms with the technological capabilities or
the domestic country might lack the necessary infra-
structure to exploit the resource (Buckley and
Casson, 1976; Dunning, 1988). And second, even if
they have those capabilities, MNCs face the possi-
bility that domestic providers will act opportunisti-
cally by holding up production to force the MNC to
renegotiate prices, offering production to the MNC’s
competitors or acquiring particular know-how to
compete against the MNC. This means that in order
to operate in site-specific industries with immobile
or highly specific assets, most MNCs have few
choices other than vertically integrating their opera-
tions in order to minimize domestic providers’
opportunism or to simply keep the business running.
However, as the scholars who developed the obso-
lescing bargaining power theory maintain (Kobrin,
1979, 1980; Vernon, 1971a, 1971b; Wells, 1977;
Wells and Smith, 1975), the more immobile fixed
assets an MNC invests in for vertical integration, the
weaker its bargaining power vis-à-vis the host gov-
ernment will be if the latter decides to change the
rules governing the MNC’s property rights (which
can go from higher taxation and royalties, stronger
participation of domestic actors, or even expropria-
tion (Fosgren, 2013)). The decrease in the post-
investment bargaining power of the MNC can be
attributed to the loss of redeployability of the sunk
investment for the vertical integration. In sum, in the
context of site-specific foreign direct investment
(FDI), MNCs face two types of opportunistic behav-
iors (one from business partners and the other
form host government) that create a dilemma:
MNCs’ efforts to mitigate the opportunistic behavior
from business partners via vertical integration
unintentionally increase potential risks from host
governments.
We developa theoretical framework to investigate
this dilemma. Reconciling the tension in the obso-
lescing bargaining power theory and transaction
costs economics, we maintain that an MNC can
overcome or mitigate problems of opportunistic
behavior from the host government, while keeping
the advantages of vertical integration by following a
process we define as political integration. This
process consists of incorporating under the MNC’s
control the host country’s political actors or institu-
tions responsible for defining, delineating, and
enforcing the property rights affecting the MNC. In
order to advance a theoretical framework on political
integration, we first analyze the nature of the phe-
nomenon in question through the lens of the property
rights theory (Coase, 1960; Demsetz, 1964; Foss and
Foss, 2005; Kim and Mahoney, 2005; Klein et al.,
2012; Haber, Razo, and Maurer, 2003). The property
rights theory provides an ideal lens to investigate this
phenomenon because it enables us to link the insti-
tutional environment and institutional arrangement
and, thus, provides an arena to facilitate a conversa-
tion between the transaction costs economics and
obsolescing bargaining power theories. We then
investigate a set of strategies for MNCs to address
this dilemma, focusing on motivations, conditions,
and consequences of political integration. In particu-
lar, we pay special attention to the implications of
changes in the institutional environment because we
do not consider the political environment in which
an MNC operates as static, rather a historically
determined constantly changing one. Weassume that
the strategies followed by an MNC not only are
determined by the existing political framework, but
also determined by the previous social and political
processes that led to the creation of that specific
political framework. Therefore, our model incorpo-
rates the role of institutions in both their static and
dynamic dimensions. With these focuses, we try to
2M. Bucheli and M. Kim
Copyright © 2015 Strategic Management Society Global Strat. J., 5: 1–26 (2015)
DOI: 10.1002/gsj.1090

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