Innocents Abroad: The Hazards of International Joint Ventures with Pyramidal Group Firms

• Author: Susan Perkins,Bernard Yeung,Randall Morck
• Date: 01 November 2014
• Published date: 01 November 2014
• DOI: http://doi.org/10.1002/gsj.1087

INNOCENTS ABROAD: THE HAZARDS OF

INTERNATIONAL JOINT VENTURES WITH

PYRAMIDAL GROUP FIRMS

SUSAN PERKINS,1* RANDALL MORCK,2and BERNARD YEUNG3

1Kellogg School of Management, Northwestern University, Evanston, Illinois,

U.S.A.

2Alberta School of Business, University of Alberta, Edmonton, Alberta,

Canada

3NUS Business School, National University of Singapore, Singapore

We examine international joint ventures in the telecommunications industry in Brazil, where

pyramidal groups are ubiquitous. We explain how corporate governance differences between

pyramidal groups versus widely held freestanding firms can lead to joint venture failures.

Our empirical results show that joint ventures between pyramidal group-member firms and

partners from countries where pyramids are rare have significantly elevated failure rates,

while joint ventures with partners from countries where pyramidal groups are ubiquitous are

more likely to succeed. Further, we provide clinical examples illustrating the mechanisms

driving divergent partnership performance. © 2014 The Authors. Global Strategy Journal

published by John Wiley & Sons Ltd on behalf of Strategic Management Society.

INTRODUCTION

The occurrence of international joint ventures (IJVs)

has increased dramatically over the last few decades,

yet IJVs continue to have high termination rates, at

30 to 70 percent (Franko, 1971; Harrigan, 1988;

Kogut, 1989; Inkpen and Beamish, 1997; Reuer,

2001). The last two decades of research on this topic

have provided insightful explanations for some IJV

terminations. One school of thought argues that joint

venturing is a part of an organizational learning

process (e.g., Kogut, 1989; Hamel, 1991; Inkpen and

Beamish, 1997; Inkpen, 2000; Nakamura, Shaver,

and Yeung, 1996). Joint ventures are dissolved once

their intended purposes are attained (Makino et al.,

2007), particularly when the capabilities of two part-

ners become too similar (Nakamura et al., 1996).

This learning proposition assumes that firms do

not have full information about a host market or

business opportunities. Naturally, then, a second

school of thought argues that some terminations rep-

resent business failures driven by unanticipated fun-

damental differences between partner firms, which

leads to unstable partnership (Franko, 1971;

Harrigan, 1988; Kogut, 1989; Reuer, 2001; Reuer

et al., 2013). Scholars of this conviction have dem-

onstrated that unintended failures result from con-

flicts in knowledge sharing, competitive rivalry

(Kogut, 1989; Park and Russo, 1996), and poor per-

formance (Barkema, Bell, and Pennings, 1996;

Barkema and Vermeulen, 1997; Makino et al.,

2007).

These unintended terminations (Makino et al.,

2007) occur either at formation (e.g., in the selection

of partners) or post formation, when unanticipated

events occur. Some studies (Hambrick et al., 2001;

Reuer and Miller, 1997; Reuer, Zollo, and Singh,

Keywords: corporate governance; international joint ventures;

pyramidal group firms; foreign direct investment

*Correspondence to: Susan Perkins, Kellogg School of Man-

agement, Northwestern University, 2001 Sheridan Road,

Evanston, IL 60208, U.S.A. E-mail: s-perkins@kellogg

.northwestern.edu

The copyright line in this article was changed on 26 Novem-

ber after online publication.

Global Strategy Journal

Global Strat. J., 4: 310–330 (2014)

Published online in Wiley Online Library (wileyonlinelibrary.com). DOI: 10.1002/gsj.1087

© 2014 The Authors. Global Strategy Journal published by

John Wiley & Sons Ltd on behalf of Strategic Management Society.

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

NoDerivs License, which permits use and distribution in any medium, provided the original work is properly

cited, the use is non-commercial and no modifications or adaptations are made.

2002; Reuer et al., 2013) focus on formation issues

and reveal that poor partner selection, contract terms,

and board composition significantly contribute to

IJV failures. Other studies (Franko, 1971; Parkhe,

1993a; Ariño and de la Torre, 1998; Reuer et al.,

2002) examine post-formation joint venture partner

interactions, where unanticipated events occur, and

find similar results.

This study enriches the plausible explanations for

unintended IJV failures by combining the partner

choice and post-formation interaction arguments.

We argue that a lack of understanding of the joint

venture partner’s corporate governance and owner-

ship structure subjects a partnering firm to expro-

priation risks and, thus, unsatisfactory performance

unless the governance incentives are aligned and

rights are protected.

Based on data on 96 multinational subsidiaries’

entries into the Brazilian telecommunications indus-

try from 1997 through 2004, our hazard rate regres-

sions show that joint ventures between widely held

freestanding firms and pyramidal group firms are

most at risk for failure, while partnering between

two firms with compatible governance structures is

less hazardous. Our field research includes studies of

joint venture governance agreements and interviews

with senior executives about their experiences and

lessons learned from unanticipated partner behav-

iors. We consolidate the information into four clini-

cal examples to illustrate the causal mechanisms of

international joint venture failure and success

(Parkhe, 1993b). These examples showcase how

widely held freestanding firms unfamiliar with pyra-

midal groups lost control of their joint ventures, suf-

fered from wealth expropriation, and ultimately

exited these underperforming joint ventures. In con-

trast, joint ventures of pyramidal group firms with

other pyramidal group firms have the highest inci-

dence of survival. In these cases, partnering firms

understand each other’s governance and related

incentives and, thus, engage each other on recipro-

cating arrangements that safeguard the joint ven-

ture’s success.

This article proceeds as follows: the next section

discusses differences in corporate governance and

ownership around the world. An ownership form

more commonly found outside of the U.S. is pyra-

midal groups; we discuss how and why pyramidal

group control structures are particularly problematic

for a partnering firm unfamiliar with pyramidal

groups. We then present empirical results linking

joint ventures’ statistical hazard rates in the Brazil-

ian telecommunications industry to foreign partners’

unfamiliarity with pyramidal groups. Next we intro-

duce the case analyses that explore partners’ strate-

gic interactions. The information affirms our

interpretation that a partner unfamiliar with pyrami-

dal group behavior falls victim to a pyramidal part-

ner’s expropriation, leading to unsatisfactory joint

venture experiences. Techniques for expropriating

wealth from foreign joint venture partners are

explained. Countermeasures adopted by joint

venture partners familiar with pyramidal groups are

described, and hazard rate analysis is used to gauge

their effectiveness. We conclude with a discussion

and implications for strategy scholars and foreign

investment managers.

CORPORATE GOVERNANCE AND

OWNERSHIP AROUND THE WORLD

The international corporate governance literature

describes large cross-country variations in corporate

governance (Granovetter, 1994; La Porta et al.,

1999; Aguilera, Desender, and Kabbach-Castro,

2012; Colpan, Hikino, and Lincoln (2010). Widely

held freestanding firms are common only in the

United States, the United Kingdom, the Netherlands,

and Ireland (Morck, Wolfenzon, and Yeung, 2005).

Elsewhere, controlling shareholders—usually very

wealthy families and occasionally state-owned

enterprises (SOE)—prevail. La Porta et al. (1999)

examine 27 high-income countries and find that,

using a 20 percent definition of control and taking

worldwide averages, only 36 percent of large firms

are widely held. The remaining 54 percent are affili-

ated with pyramidal groups. Of this majority, two-

thirds are controlled by families and one-third by

SOEs. Similarly, regional studies on corporate own-

ership also find a high incidence of pyramidal

ownership—Morck, Stangeland, and Yeung (2000)

report a high incidence of pyramidal group control in

large Canadian firms; in nine East Asian countries,

Claessens, Djankov, and Lang (2000) find a control-

ling shareholder in more than 67 percent of the firms;

Faccio and Lang (2002) find that 37 percent of

Western European firms are widely held firms and 44

percent are family controlled; and Pedersen and

Thomsen (1997) find similar results in 12 European

countries. Fogel (2006) confirms the preponderance

of wealthy family control over the 10 largest busi-

ness entities (groups or freestanding firms) in most

countries. In Brazil, Portugal, Mexico, Argentina,

Innocents Abroad: The Hazards of International Joint Ventures 311

© 2014 The Authors. Global Strategy Journal published by

John Wiley & Sons Ltd on behalf of Strategic Management Society

Global Strat. J., 4: 310–330 (2014)

DOI: 10.1002/gsj.1087