Contractual Hazard, Political Hazard and FDI Ownership Structure in Joint‐venture Enterprises in China

• Author: Ting Jiang,Mingyue Fang,Yuxiao Zhang,Huihua Nie
• Date: 01 February 2016
• Published date: 01 February 2016
• DOI: http://doi.org/10.1111/rode.12211

Contractual Hazard, Political Hazard and FDI

Ownership Structure in Joint-venture Enterprises in

China

Yuxiao Zhang, Mingyue Fang, Ting Jiang, and Huihua Nie*

Abstract

This paper investigates how institutional environments, especially the contractual hazard and the political

hazard, affect foreign investors’ share ratios in joint-venture enterprises in China. We build a model

combining Transaction Cost Economics and Property Rights Theory to describe the tradeoff that foreign

investors face between choosing a larger share ratio and a smaller one. We argue that when the

contractual hazard increases, foreign investors request larger shares to avoid being held up by their

domestic partners, and when the political hazard increases, they hold smaller shares to circumvent the

local government’s grabbing hand. Moreover, the effect of the contractual hazard is channeled through

enterprises’ asset specificity. These theoretical predictions are verified by studying the relationship

between the ownership structure of Chinese manufacturing joint-venture enterprises and the provincial-

level institutions they are embedded in.

1. Introduction

Since the opening-up policy in 1978, foreign direct investment (FDI) in China has

grown dramatically. An FDI project may take the form of establishing a wholly

owned subsidiary or entering into a joint venture with local investors. The choice of

ownership structure is a primary decision for foreign investors to make when

organizing their business activities since it has significant performance implications

(Brouthers, 2002). It is also a complicated choice because the institutional

environments of the host country are more unfamiliar to multinational firms than to

domestic firms (Henisz and Williamson, 1999). Not only do foreign investors try to

choose the right ownership structure when they enter a new market, but they also

make necessary adjustments in response to changing incentives in subsequent years

following entry. Our data show that during the sample periods more than 70% of

joint-venture enterprises (JVEs, hereafter) have changed their foreign share ratios

and more than 40% of JVEs have shifted between majority foreign control and

minority foreign control after registration. A natural question is, therefore, what

can account for the variation in the ownership structure of FDI JVEs in China?

The existing literature has attempted the question from various perspectives. The

learning perspective (Barkema and Vermeulen, 1998) treats JVEs as an instrument

*Nie: School of Economics, Renmin University of China, No. 59 Zhongguancun Street, 100872, Beijing,

China. Tel: +86-1082500210; Fax: +86-1082500256; E-mail: niehuihua@vip.163.com. Zhang and Jiang:

School of Economics, Renmin University of China, Beijing, China. Fang: School of Economics, Capital

University of Economics and Business, Beijing, China. The authors wish to thank the participants of the

CFOS 2014 Conference, the IEFS 2014 Conference and the Henan Symposium 2014 for their insightful

comments. Additionally, they wish to thank the anonymous referee for his helpful suggestions. Financial

support is provided by the Outstanding Innovative Talents Cultivation Funded Programs 2014 of Renmin

University of China for Yuxiao Zhang and the National Program for Support of Top-notch Young

Professionals for Huihua Nie.

Review of Development Economics, 20(1), 14–24, 2016

DOI:10.1111/rode.12211

©2016 John Wiley & Sons Ltd