What makes and what does not make a real option? A study of equity shares in international joint ventures

This paper examines the boundaries of real options logic, with an application to joint ventures (JVs). We distinguish between forms of uncertainty that are resolved endogenously and those that are resolved exogenously, and theorize that only exogenous uncertainty will have the impact predicted by real options theory on a foreign investor's choice of how large an equity share to take in a JV. We theorize that macroeconomic and institutional variables generate exogenous uncertainty whereas, by contrast, cultural distance and choices pertaining to corporate scope and product or process development activities involve endogenous sources of uncertainty that investors can both assess and act upon without having to “wait and see”. Using a sample of 6472 Sino-foreign JVs, we find support for our predictions. We discuss and implement proper methods to test for the existence of null effects, as is relevant to establish the boundaries of a theory such as real options theory. We draw implications for research and practice on JVs – specifically equity share decisions, which deserve more attention – and real options, including suitable uses and desirable extensions of the concept.

[1]  Philip P. Cowitt,et al.  Pick's currency yearbook , 1955 .

[2]  Jacob Cohen.  Statistical Power Analysis , 1992 .

[3]  Joanne E. Oxley,et al.  The Scope and Governance of International R&D Alliances , 2003 .

[4]  B. Kogut.  Joint ventures: Theoretical and empirical perspectives , 1988 .

[5]  R. Gulati.  Does Familiarity Breed Trust? The Implications of Repeated Ties for Contractual Choice in Alliances , 1995 .

[6]  J. Stewart Black,et al.  Toward a Comprehensive Model of International Adjustment: An Integration of Multiple Theoretical Perspectives , 1991 .

[7]  Nalin Kulatilaka,et al.  Strategic Growth Options , 1998 .

[8]  B Kogut.  Theoretical and empirical perspectives , 1988 .

[9]  Arthur J. Keown,et al.  Do strategic alliances create value , 1997 .

[10]  Douglas R. Wholey,et al.  Research Notes: Characterizing Environmental Variation , 1989 .

[11]  W. Poon,et al.  Loss of heterozygosity of chromosome 14q in low- and high-grade meningiomas. , 1997, Human pathology.

[12]  Will Mitchell,et al.  Incumbents' use of pre-entry alliances before expansion into new technical subfields of an industry , 1992 .

[13]  J. Campa,et al.  Multinational Investment under Uncertainty in the Chemical Processing Industries , 1994 .

[14]  Timothy B. Folta.  Governance and uncertainty: the trade‐off between administrative control and commitment , 1998 .

[15]  D. North,et al.  Institutional Change and American Economic Growth. , 1972 .

[16]  G. Pisano.  The R&D Boundaries of the Firm: An Empirical Analysis , 1990 .

[17]  Gerardo R. Ungson,et al.  Timing of Entry in International Market: An Empirical Study of U.S. Fortune 500 Firms in China , 2002 .

[18]  J. Hennart,et al.  A transaction costs theory of equity joint ventures , 1988 .

[19]  Jaideep Anand,et al.  Non‐additivity in portfolios of exploration activities: a real options‐based analysis of equity alliances in biotechnology , 2004 .

[20]  Masao Nakamura,et al.  On the determinants of foreign ownership shares: Evidence from US firms' joint ventures in Japan , 1994 .

[21]  W. Dugger.  The Economic Institutions of Capitalism , 1987 .

[22]  Daniel A. Levinthal,et al.  What Is Not A Real Option: Considering Boundaries for the Application of Real Options to Business Strategy , 2004 .

[23]  Arnd Huchzermeier,et al.  Valuing Operational Flexibility Under Exchange Rate Risk , 1996, Oper. Res..

[24]  Yadong Luo,et al.  Transactional characteristics, institutional environment and joint venture contracts , 2005 .

[25]  G. Pisano.  Using Equity Participation to Support Exchange: Evidence from the Biotechnology Industry , 1989 .

[26]  Robert M. Fuhrer,et al.  Coordinating Investment, Production, and Subcontracting , 1999 .

[27]  Lenos Trigeorgis,et al.  Real R&D options with time-to-learn and learning-by-doing , 2007, Ann. Oper. Res..

[28]  J. Reuer.  Parent Firm Performance across International Joint Venture Life-cycle Stages , 2000 .

[29]  Jacob Cohen,et al.  THINGS I HAVE LEARNED (SO FAR) , 1990 .

[30]  L. L. Blodgett.  Partner Contributions as Predictors of Equity Share in International Joint Ventures , 1991 .

[31]  Kenneth Rogoff,et al.  The Modern History of Exchange Rate Arrangements: A Reinterpretation , 2002 .

[32]  S. Myers.  Determinants of corporate borrowing , 1977 .

[33]  G. Ruxton,et al.  What hypothesis tests are not: a reply to Johnson , 2005 .

[34]  Bernard Yeung,et al.  An empirical investigation of joint venture dynamics: Evidence from U.S.-Japan joint ventures , 1996 .

[35]  Albert A. Cannella,et al.  Agency problems as antecedents to unrelated mergers and diversification: Amihud and Lev reconsidered , 1998 .

[36]  Harbir Singh,et al.  The Effect of National Culture on the Choice of Entry Mode , 1988 .

[37]  Jane Lu,et al.  Intra- and Inter-organizational Imitative Behavior: Institutional Influences on Japanese Firms' Entry Mode Choice , 2002 .

[38]  E. H. Bowman,et al.  Strategy through the Option Lens: An Integrated View of Resource Investments and the Incremental-Choice Process , 1993 .

[39]  Timothy B. Folta,et al.  Option value and entry timing , 2002 .

[40]  S. Balakrishnan,et al.  Information asymmetry, adverse selection and joint-ventures* Theory and evidence , 1993 .

[41]  W. Sofka,et al.  An Information Economics Perspective on Main Bank Relationships and Firm R&D , 2011, SSRN Electronic Journal.

[42]  P. Lorange,et al.  Cooperative strategies and alliances , 2002 .

[43]  Introduction to the Symposium , 1998 .

[44]  Louis T. Wells,et al.  Bargaining Power of Multinationals and Host Governments , 1982 .

[45]  R. Royall.  Statistical Evidence: A Likelihood Paradigm , 1997 .

[46]  Paul W. Beamish,et al.  Equity Joint Ventures and the Theory of the Multinational Enterprise , 1987 .

[47]  J. Hennart,et al.  The Impact of Culture on the Strategy of Multinational Enterprises: Does National Origin Affect Ownership Decisions? , 1998 .

[48]  Timothy B. Folta,et al.  Real options in equity partnerships , 2002 .

[49]  Jacques Delacroix,et al.  Cosmetic, Speculative, and Adaptive Organizational Change in the Wine Industry: A Longitudinal Study , 1991 .

[50]  Jeffrey J. Reuer,et al.  Downside Risk Implications of Multinationality and International Joint Ventures , 2000 .

[51]  Kevin Au,et al.  How MNCs Choose Entry Modes and Form Alliances: The China Experience , 1997 .

[52]  Philip P. Cowitt.  World currency yearbook , 1985 .

[53]  S. Kobrin.  Testing the bargaining hypothesis in the manufacturing sector in developing countries , 1987, International Organization.

[54]  Yair Aharoni,et al.  The foreign investment decision process , 1966 .

[55]  B. Kogut.  Joint Ventures and the Option to Expand and Acquire , 1991 .

[56]  Eduardo S. Schwartz,et al.  Investment Under Uncertainty. , 1994 .

[57]  G. Ruxton,et al.  Confidence intervals are a more useful complement to nonsignificant tests than are power calculations , 2003 .

[58]  A. Raveh,et al.  National and corporate cultural fit in mergers/acquisition: an exploratory study , 1996 .

[59]  Tailan Chi,et al.  Collaborative Ventures and Value of Learning: Integrating the Transaction Cost and Strategic Option Perspectives on the Choice of Market Entry Modes , 1996 .

[60]  C. Wihlborg,et al.  Corporate Strategies in a Turbulent World Economy , 1991 .

[61]  F. Black,et al.  The Pricing of Options and Corporate Liabilities , 1973, Journal of Political Economy.

[62]  Raffaele Oriani,et al.  Uncertainty and the Market Valuation of R&D within a Real Options Logic , 2008 .

[63]  Michael Y. Hu,et al.  Ownership Strategy of Multinationals from ASEAN: The Case of their Investment in Sino-foreign Joint Ventures1 , 2002 .

[64]  Scott W. Geiger,et al.  Statistical Power and the Testing of Null Hypotheses: A Review of Contemporary Management Research and Recommendations for Future Studies , 2004 .

[65]  Kent D. Miller.  A Framework for Integrated Risk Management in International Business , 1992 .

[66]  K. Murphy,et al.  Statistical Power Analysis: A Simple and General Model for Traditional and Modern Hypothesis Tests, Second Ediction , 1998 .

[67]  H. Gatignon,et al.  The multinational corporation's degree of control over foreign subsidiaries : an empirical test of a transaction cost explanation , 1988 .

[68]  Jing Li,et al.  Real Options Theory and International Strategy: A Critical Review , 2007 .

[69]  Daniel A. Levinthal,et al.  Real Options and Real Tradeoffs , 2004 .

[70]  Xavier Martin,et al.  Joint Ventures and Real Options: An Integrated Perspective , 2007 .

[71]  Andrew Delios,et al.  Uncertainty, Imitation, and Plant Location: Japanese Multinational Corporations, 1990‐1996 , 2001 .

[72]  A. Seth,et al.  A dynamic model of the choice of mode for exploiting complementary capabilities , 2009 .

[73]  Grzegorz Pawlina,et al.  Real Options in an Asymmetric Duopoly: Who Benefits from Your Competitive Disadvantage? , 2002 .

[74]  N. Noorderhaven,et al.  When Does Trust Matter to Alliance Performance , 2006 .

[75]  D. Heisey,et al.  The Abuse of Power , 2001 .

[76]  Daniel A. Levinthal,et al.  ABSORPTIVE CAPACITY: A NEW PERSPECTIVE ON LEARNING AND INNOVATION , 1990 .

[77]  Anand Swaminathan,et al.  Organizational Evolution in the interorganizational Environment: Incentives and Constraints on International Expansion Strategy , 1998 .

[78]  Jacob Cohen.  Statistical Power Analysis for the Behavioral Sciences , 1969, The SAGE Encyclopedia of Research Design.

[79]  Joseph P. H. Fan,et al.  Does 'Good Government' Draw Foreign Capital? Explaining China's Exceptional Foreign Direct Investment Inflow , 2007 .

[80]  Jeffrey J. Reuer,et al.  Real Options in International Joint Ventures , 2005 .

[81]  J. Oxley.  Institutional environment and the mechanisms of governance: the impact of intellectual property protection on the structure of inter-firm alliances , 1999 .

[82]  Paul W. Beamish,et al.  Ownership Strategy of Japanese Firms: Transactional, Institutional and Experience Influences , 1999 .

[83]  Elizabeth L. Rose,et al.  FDI location at the subnational level: a study of EJVs in China , 2003 .

[84]  Yigang Pan.  Equity Ownership in International Joint Ventures: The Impact of Source Country Factors , 2002 .

[85]  X. Martin,et al.  Knowledge transfer capacity and its implications for the theory of the multinational corporation , 2003 .

[86]  Thomas Roehl,et al.  The Structuring of Interfirm Exchanges in Business Know-How: Evidence from International Collaborative Ventures , 1997 .

[87]  Douglas R. Wholey,et al.  CHARACTERIZING ENVIRONMENTAL VARIATION , 1989 .

[88]  Jeffrey J. Reuer,et al.  International Joint Ventures and the Value of Growth Options , 2008 .

[89]  J. Stewart Black,et al.  Cross-Cultural Training Effectiveness: A Review and a Theoretical Framework for Future Research , 1990 .

[90]  G. Hofstede.  Culture′s Consequences: Comparing Values, Behaviors, Institutions and Organizations Across Nations , 2001 .

[91]  H. Barkema,et al.  FOREIGN ENTRY, CULTURAL BARRIERS, AND LEARNING , 1996 .

[92]  J. Oxley.  Appropriability Hazards and Governance in Strategic Alliances: A Transaction Cost Approach , 1997 .

[93]  J. Hennart,et al.  The transaction costs theory of joint ventures: an empirical study of Japanese subsidiaries in the united states , 1991 .

[94]  Nicolas P. B. Bollen,et al.  Real Options and Product Life Cycles , 1999 .

[95]  L. Trigeorgis.  Real options and interactions with financial flexibility , 1993 .

[96]  D. Mowery,et al.  Strategic alliances and interfirm knowledge transfer , 1996 .

[97]  M. Kotabe,et al.  Gaining from vertical partnerships : Knowledge transfer, relationship duration and supplier performance improvement in the U.S. and Japanese automotive industries , 2003 .

[98]  Lars Oxelheim,et al.  Macroeconomic Uncertainty: International Risks and Opportunities for the Corporation , 1987 .

[99]  Douglas H. Johnson.  What hypothesis tests are not: a response to Colegrave and Ruxton , 2005 .

[100]  W. Shan,et al.  Environmental Risks and Joint Venture Sharing Arrangements , 1991 .

[101]  Tailan Chi,et al.  Option to acquire or divest a joint venture , 2000 .

[102]  L. Trigeorgis.  Real Options in Capital Investment: Models, Strategies, and Applications , 1995 .

[103]  H. Gatignon,et al.  Modes of Foreign Entry: A Transaction Cost Analysis and Propositions , 1986 .

[104]  Daniel A. Levinthal,et al.  Reply: Real Options and Real Tradeoffs , 2004 .

[105]  John Child,et al.  Organizations As Adaptive Systems in Complex Environments: the Case of China , 1999 .

[106]  M. Weitzman,et al.  FUNDING CRITERIA FOR RESEARCH, DEVELOPMENT, AND EXPLORATION PROJECTS , 1981 .

[107]  Yigang Pan.  Influences on Foreign Equity Ownership Level in Joint Ventures in China , 1996 .

[108]  Jürgen Kai-Uwe Brock,et al.  The ‘power’ of international business research , 2003 .

[109]  M. V. Shyam Kumar,et al.  The value from acquiring and divesting a joint venture: a real options approach , 2005 .

[110]  K. Sauvant.  World Investment Report , 1999 .

[111]  Ilya R. P. Cuypers.  Essays on equity joint ventures, uncertainty and experience , 2009 .

[112]  R. Morck,et al.  Innocents Abroad: The Hazards of International Joint Ventures with Pyramidal Group Firms , 2008 .

[113]  R. C. Merton,et al.  Theory of Rational Option Pricing , 2015, World Scientific Reference on Contingent Claims Analysis in Corporate Finance.

[114]  Jeffrey J. Reuer,et al.  On lemons and indigestibility: resource assembly through joint ventures , 2000 .

[115]  Doren Chadee,et al.  Foreign ownership of equity joint ventures in China: a pooled cross-section-time series analysis , 2001 .

[116]  Joop J. Hox,et al.  Applied Multilevel Analysis. , 1995 .

[117]  L. Cronbach,et al.  Construct validity in psychological tests. , 1955, Psychological bulletin.

[118]  F. Knight.  The economic nature of the firm: From Risk, Uncertainty, and Profit , 2009 .

[119]  Jeffrey J. Reuer,et al.  Post-formation dynamics in strategic alliances , 2002 .

[120]  Rachelle C. Sampson,et al.  The Cost of Misaligned Governance in R&D Alliances , 2003 .

[121]  Paul W. Beamish,et al.  The Characteristics of Joint Ventures in the People's Republic of China , 1993 .

[122]  David K. Eiteman.  Multinational Business Finance , 1973 .

[123]  Ashoka Mody,et al.  Journal of Economic Behavior and Organization 20 (1993) lSlLl70. North-Holland Learning through alliances , 1991 .