Journal of International Business Studies (2004) 35, 385–406
& 2004 Palgrave Macmillan Ltd. All rights reserved 0047-2506 $30.00
www.jibs.net
Is knowledge power? Knowledge flows,
subsidiary power and rent-seeking
within MNCs
Ram Mudambi1,2 and
Pietro Navarra3,4
1
Institute of Global Management Studies,
Temple University, Philadelphia, USA; 2The ISMA
Centre, University of Reading, UK; 3Institute of
Economics and Finance, University of Messina,
Italy; 4London School of Economics and Political
Science, UK
Correspondence:
Ram Mudambi, Institute of Global
Management Studies, Temple C.I.B.E.R.,
Fox School of Business and Management,
Temple University, Philadelphia,
PA 19122, USA.
Tel: þ 1 215 204 2099; Fax: þ 1 215 204
8029; E-mail: ram.mudambi@temple.edu
Abstract
In recent years, as multinational corporation (MNC) subsidiaries have become
more closely linked to international networks, their knowledge intensity has
risen, and some of their R&D has gained a more creative role. Simultaneously,
and often connectedly, many subsidiaries have acquired considerable strategic
independence in all aspects of their operations, and therefore are able to
exercise considerable intra-firm bargaining power to influence the distribution
of the firm’s resources. In this context, we suggest that intra-MNC knowledge
flows are a key determinant of subsidiary bargaining power. We argue that
subsidiary managers can exploit such power to pursue their own ends. Such
rent-seeking behavior is implicit in much of the literature on managerialism,
but our analysis suggests that such behavior can now occur in headquarters–
subsidiary and subsidiary–subsidiary relations. Thus subsidiary strategic independence, designed to enhance the competitiveness of outputs (market knowledge) and inputs (asset-seeking and learning), can be corroded when the
pursuit of subsidiary objectives encourages rent-seeking. Empirical analysis of a
sample of high-technology subsidiaries in the UK provides strong support for
the theory. We examine several avenues whereby the incentives of units within
the MNC can be aligned.
Journal of International Business Studies (2004), 35, 385–406.
doi:10.1057/palgrave.jibs.8400093
Keywords: knowledge flows; subsidiary rent-seeking; intra-firm politics
Received: 16 January 2003
Revised: 9 December 2003
Accepted: 11 February 2004
Online publication date: 8 July 2004
Introduction
Over the past two decades, subsidiaries of multinational corporations (MNCs) have been expanding their role beyond traditional
downstream activities such as sales, service and assembly to
encompass upstream activities such as research and development
(R&D), component production, strategic marketing and support
activities (Gupta and Govindarajan, 1991; Cantwell, 1995; Bartlett
and Ghoshal, 1998). In this context, MNCs have been consolidating their subsidiaries to give them geographic or product range
responsibilities (Hood et al., 1994; Birkinshaw and Morrison, 1995).
Beginning in the late 1970s, Vernon (1979) observed a changed
pattern of MNC knowledge management. Particularly in hightechnology industries, he suggested that the product cycle had by
that time become highly compressed, so that many MNCs were
Knowledge flows, subsidiary power and rent-seeking
Ram Mudambi and Pietro Navarra
386
engaged in programs of almost simultaneous
knowledge creation in many major markets. This
finding has been supported and amplified by a
number of other studies (Dunning, 1992; Cantwell,
1995; Frost, 2001; Rugman and Verbeke, 2001; Frost
et al., 2002), though some conflicting evidence has
also been presented (Patel and Pavitt, 1991).
These two trends – increasing subsidiary operational responsibilities and the dispersal of knowledge-creating activities within the MNC network –
have loosened the traditional hierarchical structure
of MNC governance. This in turn has made MNCs
more like political coalitions and less like military
formations (Holm and Pedersen, 2000). This
implies that a subsidiary’s competence development also creates tensions. Indeed, such development may not always increase the subsidiary’s
ability to influence strategic decisions within the
MNC, and could actually hinder it. Forsgren and
Pedersen (2000) report that greater subsidiary
competence strengthens its role within the MNC
only to the extent that other units are able to
assimilate and use it. Greater effort spent in
developing its own competencies, at the expense
of transferring of its competencies to other units,
actually has a negative effect on the subsidiary’s
position within the MNC (Forsgren et al., 2000).
This position is supported by Asakawa (2001a), who
reports that the internationalization of R&D has
unleashed a considerable degree of tension within
MNCs, and that this tension is more strongly
related to information-sharing issues (knowledge
flows) than to autonomy-control issues.
Knowledge stocks and flows create the potential
for intra-MNC concerns of opportunism and holdup (Williamson, 1975). Thus, it is argued here that
the same (albeit attenuated) mixture of competition and cooperation that is found in interfirm relationships now characterizes intra-firm
relationships. The bargaining power of a subsidiary
to maintain and increase its share of the rents
generated by the operations of the MNC as a whole
is crucially dependent on the nature and pattern of
its knowledge flows. Asakawa (2001b) analyzes the
evolution of the subsidiary’s role in knowledge
creation within the context of headquarters–subsidiary relations. He stresses the need to reconcile
the pressures for subsidiary autonomy and smooth
knowledge transfer within the MNC. However, this
analysis, as that of much of the literature on
headquarters–subsidiary relations (e.g., Nohria and
Ghoshal, 1994), does not address the question of
why subsidiaries value autonomy.
Journal of International Business Studies
In this paper, we examine the effects of knowledge flows within dispersed MNC networks and
autonomy-control issues simultaneously with the
process of knowledge creation at the subsidiary
level. Our aim is to formulate a theory of subsidiary
behavior within MNCs, noting that subsidiaries
have their own objectives, which may diverge from
those of the firm as a whole. We posit that an
important subsidiary objective is its bargaining
power within the firm.
We hypothesize that the firm’s managers are
both profit seeking and rent-seeking, as their
actions take place with two different objectives in
mind. The first objective, which can be termed
external, is maximizing shareholders’ value through
market operations aimed at maximizing profits.
The second objective is internal, and comes about
when profits earned on the market become rents
available for transfer within the MNC. Subsidiary
bargaining power within the firm is the prime
determinant of the distribution of these rents,
which often take the form of divisional managers
‘extracting excessively large capital allocations
from headquarters’ (Scharfstein and Stein, 2000,
2540). This approach extends the managerial
model of the firm wherein managers and owners
(typically stockholders) engage in a principal-agent
game to apportion the wealth created by the firm.
We argue that rent-seeking by subsidiary managers
at lower levels of the organization can be yet
another drag on MNC corporate performance.
Indeed, such actions may well be encouraged by,
or develop, as a defensive reaction to rent-seeking
by headquarters.
Rent-seeking and rent-appropriating behavior are
manifestations of opportunism that destroys value
(Foss et al., 2003). The solution to this problem
proposed by transaction cost economics is monitoring. In the case of subsidiary management, this
implies limiting the extent of subsidiary autonomy.
This has an important bearing on the ability of
subsidiary managers to pursue their own objectives.
Managers in tightly controlled (i.e., highly monitored) subsidiaries may have less ability to appropriate rents, whereas managers in strategically
independent subsidiaries may have a greater ability
to do so (Mudambi, 1999). Hence we may not
observe intra-MNC operations in general as being
characterized by ‘a sea of opportunism’.1 However,
we do argue that subsidiary managers exercise
some level of bargaining power in all MNCs, and
that, as this level rises, ceteris paribus, headquarters’
ability to control them declines. For example, the
Knowledge flows, subsidiary power and rent-seeking
Ram Mudambi and Pietro Navarra
387
headquarters of Philips has often been unable to
control its giant North American subsidiary,
even though it owns a majority of its equity
(Bartlett, 2002). Examining cases in business history, such as the Hudson’s Bay Company, suggests
that this is not a recent problem (Carlos and
Nicholas, 1993).
Further, tight control by headquarters prevents the MNC from realizing the many welldocumented benefits of strategically independent
subsidiaries. These include learning from local
systems of innovation, using and integrating
local resources and competencies, and generally
introducing a heightened level of dynamism
into the parent MNC (Pearce, 1999; Rugman and
Verbeke, 2001; Andersson et al., 2002). The net
effects of tight headquarters monitoring may be
negative.
Alternatives to monitoring have been suggested,
and may alleviate the need for tight headquarters
control. Subsidiary managers who are intrinsically
motivated are less likely to behave opportunistically (Osterloh and Frey, 2000). Indeed, Frey (1998)
suggests that monitoring by headquarters may
make subsidiary managers more likely to behave
opportunistically, since ‘when such intervention is
perceived to be controlling by the individuals
affected, the reduced self-determination and selfesteem provokes a decrease in intrinsic motivation’.
In other words, subsidiary managers subjected to
excessive monitoring (and other forms of central
control from headquarters) will lose their identification with the firm and its goals.
In the following section, we characterize knowledge flows within the MNC. We develop arguments
for why the knowledge flows associated with a
subsidiary’s operations are the basis for its bargaining power within the firm. In the succeeding
sections, we use our characterization of subsidiaryrelated knowledge flows to set up and test our
main research hypotheses. These simultaneously
relate the nature of knowledge flows to extent of
subsidiary bargaining power within the MNC, and
bargaining power to the extent of rent appropriation. We test these hypotheses using data from a
sample of UK subsidiaries of non-UK MNCs. We use
a simultaneous equations approach so that we are
able to endogenize subsidiary knowledge production as well as subsidiary bargaining power. In the
final sections we present the results of our empirical
analysis, discuss their significance and examine
various strategies aimed at counteracting rentseeking activity within MNCs.
Knowledge flows within the MNC
Researchers in international business have long
recognized that intangible assets form a crucial
basis upon which a firm can expand into foreign
markets (Buckley and Casson, 1976). Specifically,
internalization theory predicts that a firm should
establish its own operations overseas only if it
possesses intangible assets and capabilities that give
it competitive advantages that cannot be transferred through licensing across firm boundaries
(Hennart, 1982). This has been found to be a
parsimonious and powerful insight into the occurrence and performance of foreign direct investment
(FDI) (Caves, 1996; Martin, 2002). Empirical work
in this area has repeatedly examined two sets of
intangibles – R&D intangibles and marketing
intangibles. Both of these sets of intangibles have
been found to predict strongly what firms will
undertake FDI and how stock markets view such
expansion (Grubaugh, 1987; Morck and Yeung,
1992). However, it is the R&D intangibles of MNCs
that have been found to be the principal source of
their value. Marketing intangibles have been found
to add value only in consumer goods industries,
and even here their effects are relatively weaker.
A more recent, but significant, strand of research
in international business has uncovered a growing
dispersal of knowledge creation within the MNC
network. These studies characterize MNCs as
decentralized knowledge management systems.
Cantwell (1989) argued that since the early 1980s
MNCs have been undertaking R&D in multiple
subsidiary locations. In a similar vein, Hakanson
(1995) reported that by the 1980s the volume of
industrial R&D performed in Sweden was declining,
but that ‘the total R&D performed by large Swedish
MNCs – including that in foreign subsidiaries – has
continued to expand’ (Hakanson, 1995, 121,
emphasis in original). Such knowledge creation by
subsidiaries has been operationalized in various
forms such as ‘world product mandates’ (Birkinshaw, 1996), ‘centers of excellence’ (Holm and
Pedersen, 2000; Frost et al., 2002), ‘home base
augmenting strategies’ (Kuemmerle, 1999), and so
on. This literature documents that the MNC’s R&D
intangibles reside increasingly in its subsidiaries
and are part of what Rugman and Verbeke (2001)
call ‘subsidiary-specific advantages’.
Subsidiaries that control a significant share of the
MNC’s R&D-based intangibles therefore control the
firm’s ‘crown jewels’. Williamson (1996) noted that
managers’ actions within the firm are characterized
by ‘self-interest seeking with guile’, so that – in the
Journal of International Business Studies
Knowledge flows, subsidiary power and rent-seeking
Ram Mudambi and Pietro Navarra
388
terminology of economics – they are ‘rent-seekers’.2
In the words of Coff:
Knowledge-based assets are promising (sources of resourcebased advantage) because firm-specificity, social complexity
and causal ambiguity make them hard to imitate. However
the roles of internal stakeholders (like subsidiary managers)
may grant them a great deal of bargaining powery(Coff,
1999, 119)
Therefore, we argue that subsidiary managers’
control of significant amounts of the MNC’s
knowledge assets can be used to exercise bargaining
power within the firm. Linking this argument to
that of Scharfstein and Stein (2000) implies that
control of knowledge assets may be used in
apportioning total MNC-wide rents.
Headquarters–subsidiary relations
Formally, the relations between headquarters and
subsidiary can be characterized as a principal–agent
relationship. Within this perspective, it is recognized that the subsidiary pursues its own interests
and is not a mechanical instrument of headquarters’ will. More importantly, ‘the local interests of
the subsidiaries may not always be aligned with
those of the headquarters or the MNC as a whole’
(Nohria and Ghoshal, 1994, 492). We use the lens
of agency theory to view subsidiary managers as
agents of headquarters. Within this framework,
agents (the subsidiaries) bargain with the principal
(headquarters) to maximize their share of MNCwide rents.
Subsidiaries are initially set up by the parent MNC
with certain goals and objectives. There is evidence
that the nature of the subsidiary mandate is related
to the motive for the initial investment (White and
Poynter, 1985; Tavares and Pearce, 1999). However,
an equally important factor is that subsidiaries
evolve over time in terms of their remit and
responsibilities, and this evolution can occur in
both directions (Birkinshaw and Hood, 1998).
Some subsidiaries gain expanded charters, whereas
others see their roles within the MNC reduced
and even eliminated. Many aspects of expanded
subsidiary charters have to do with controlling
knowledge assets. Applying the analysis of
Coff (1999), we suggest that the role of the
subsidiary within the MNC is the outcome of
headquarters–subsidiary bargaining, and that
subsidiaries with control of the MNC’s R&D
intangibles exercise a great deal of bargaining
power. Conversely, subsidiaries with limited control
over such intangibles have little bargaining power
in dealing with headquarters.
Journal of International Business Studies
Intra-MNC knowledge flows
How is a subsidiary’s control of R&D-based intangibles to be measured? Substantial literature has
now accumulated suggesting that the pattern of
knowledge flows within the MNC is of primary
importance in this context (e.g., Gupta and Govindarajan, 2000; Frost, 2001). In other words, the
pattern of knowledge flows within the firm indicates current sources of value creation and future
sources of potential value creation. Thus, the
pattern of intra-MNC knowledge flows is closely
related to subsidiary bargaining power.
Gupta and Govindarajan (2000) report that
knowledge flows into and out of subsidiaries
depend crucially on the motivation of the subsidiary to acquire knowledge and to share it. This
places a great deal of emphasis on firm organization, where the incentive structure of unit managers needs to be carefully designed.
The nature of the knowledge itself has a bearing
on how it is managed. Thus, the norm is for codified knowledge that is relatively easy to transmit to
be geographically dispersed, whereas highly tacit
knowledge tends to remain localized. However, in
some cases, highly tacit knowledge is sourced from
foreign subsidiaries, and this tends to be driven
either by particularly strong and unique local
competencies or by particularly strong companyspecific networking capabilities (Cantwell and
Santangelo, 1999). This finding complements and
qualifies earlier findings reported by Jaffe et al.
(1993) that knowledge creation tends to be highly
localized.3
Further, the position of the MNC in the knowledge hierarchy is also likely to have a bearing on its
knowledge management practices. Cantwell and
Janne (1999) report that MNCs emanating from the
leading technological centers in their industries are
likely to disperse their knowledge-creating activities, whereas those from weaker centers of the
same industries tend to replicate their technologies
in new locations. The subsidiary’s location also
matters: the more munificent the location, the
greater the potential knowledge creation (Cantwell
and Iammarino, 1998).
Cantwell and Piscitello (1999) find a trade-off
between the geographical and sectoral dispersion of
knowledge-creating activities. Thus, MNCs whose
knowledge development spans a wide spread of
industrial sectors tend to have knowledge networks
that are less geographically dispersed. Conversely,
those whose knowledge networks are widely dispersed in geographical space tend to develop
Knowledge flows, subsidiary power and rent-seeking
Ram Mudambi and Pietro Navarra
389
knowledge in a small number of industrial sectors.
This points to the highly complex nature of
knowledge management processes.
Characterizing knowledge flows
We use the organizational framework of Buckley
and Carter (1996), who propose that innovation
within the MNC occurs through ‘global synthesis’ –
that is, the integration of knowledge flows from
diverse sources. Highly evolved subsidiaries can
undertake such integration in the host location
(Birkinshaw and Hood, 1998). However, in this
model the MNC is beset with three organizational
problems: acquiring information (primary uncertainty regarding such things as the outcome of R&D
processes); coordination (secondary uncertainty
related to logistics and communications); and
motivation (tertiary uncertainty emanating from
opportunism). Rent-seeking subsidiary managers
are a manifestation of the third type of uncertainty.
Operationally, we view knowledge flows through
the source–target perspective (Mudambi, 2002).
Each knowledge flow occurs between a source and
a target along a channel (Gupta and Govindarajan,
2000). Two-way flows whereby knowledge transfers
occur in both directions are bifurcated into two
separate flows, one in each direction. Knowledge
flows are therefore taken to be node-specific and
dyadic. We will be concerned principally with four
knowledge flows (see Figure 1):
Flow 1
Flow 2
Flow 3
Flows from subsidiary to parent. These flows
may be called knowledge transfer, and form
the basis of the MNC’s network leverage.
High levels of these flows enable MNC
headquarters to exploit local competencies and act as a knowledge intermediary
or knowledge integrator (or as a facilitator
to such activities).
Flows from location to subsidiary. These
flows consist of the subsidiary’s learning,
local competence exploitation, and local
resource utilization. This is the pod or
‘listening post’ role of the subsidiary,
where the receiver competence (assessing,
filtering and choosing information) and
absorptive capacity (adapting inflows to fit
firm-specific requirements) become crucial.
Flows from subsidiary to location. These
flows are part of what have been termed
spillovers. In the literature, spillovers have
often been used to refer to flows both
into and out of the firm. However, as our
analysis is firm-centric rather than location-centric, we define spillovers to include
only outflows from the subsidiary. Further,
we recognize that spillovers include both
intended and unintended elements. Thus,
P = MNE parent
S = Subsidiary
Spillover
Transfers
HOME
HOST
1
3
P
P
4
S
2
Numeraire knowledge flow (from
parent to subsidiary)
Learning
Internal
creation
Figure 1
Knowledge creation in the subsidiary.
Journal of International Business Studies
Flow 4
flows to local partners, customers and
suppliers may be largely planned. However, flows that occur through employee
mobility, local imitation and reverse engineering by competitors may be largely
unintentional. Combinations of these
flows are the focus of most public policy
measures, such as those implemented in
the context of national systems of innovation. For example, Fransmann (1997)
analyzes the factors underlying the success
of such policies adopted by MITI in Japan.
Mudambi (1998a) suggests that the
absence of some of these factors may
explain the relatively poor results of such
policies in Europe.
Flows from the parent (and other MNC units)
to the subsidiary. This knowledge flow from
the parent to the subsidiary is the traditional flow, where the subsidiary exploits a
home-base knowledge advantage. We do
not mean to minimize the importance of
this flow, but rather note that all flows are
generally measured relative to this flow:
that is, this traditional flow is treated as
the numeraire. Any of the three flows
above will be described as high or low
relative to the knowledge flow from parent
to subsidiary. Thus, in the terminology of
Gupta and Govindarajan (1991), if flow 1
is high, then the subsidiary is a net
provider of knowledge, whereas if flow 1
is low, then it is a net user of knowledge.
In Figure 1, flow 2 is subject to Buckley and
Carter’s (1996) primary uncertainty, as it relates to
inflows into the firm from outside. However, flows
1 and 4 are subject to problems of coordination and
motivation. They are influenced by the extent to
which managers are able to communicate (secondary uncertainty – logistics and communications) as
well as the extent to which they are willing to do so
(tertiary uncertainty – motivation). Szulanski
(1996) has pointed to the crucial role of motivational considerations in intra-firm knowledge
flows. Thus, flow 1 from the subsidiary to its parent
will in general be different from flow 2 from the
location to the subsidiary.
Research hypotheses: knowledge flows,
subsidiary power and rent-seeking
It is clear from our foregoing discussion that
knowledge flows, subsidiary power and rent appro-
priation are closely related. It has been argued that
the pattern of knowledge flows is a crucial part of
subsidiary power and hence its ability to appropriate rents, but a number of factors that affect
subsidiary power also affect the knowledge production process in the subsidiary. This means that
subsidiary knowledge production cannot be treated
as exogenous. Therefore, in the model developed in
this paper, subsidiary knowledge production, subsidiary bargaining power within the MNC and the
level of subsidiary rent appropriation are jointly
determined endogenous variables (see Figure 2).
Knowledge creation
Knowledge production depends, first and foremost,
upon the level of research intensity of the subsidiary. A more research-intensive subsidiary will
produce more knowledge output. Second, the
greater the knowledge inflow into the subsidiary,
the greater its knowledge output (Gupta and
Govindarajan, 2000). Third, the mode of entry that
created the subsidiary in the first place will have a
bearing on its knowledge output. Cantwell and
Mudambi (2001) provide evidence suggesting that
acquisitions are more likely than de novo or greenfield entries to be asset-seeking entries. This implies
that acquisition entries are likely to be associated
with higher levels of knowledge production. These
considerations lead to the following hypotheses
underlying knowledge production in the subsidiary:
Hypothesis 1a: The higher the level of the
research intensity of the subsidiary, the higher
its level of knowledge output.
Hypothesis 1b: The greater the knowledge
inflows into the subsidiary, the higher its level
of knowledge output.
Hypothesis 1c: Subsidiaries set up through
acquisition entry are associated with higher levels
of knowledge production than subsidiaries set up
through greenfield entries.
Subsidiary power
The second set of hypotheses studied in this paper
relate to subsidiary bargaining power within the
MNC. These generally relate to subsidiary-, firmand relation-specific factors: that is, a subsidiary’s
bargaining power within the MNC increases as its
control of key value-creating activities increases.4
One of the key bases of this paper is the proposi-
Knowledge flows, subsidiary power and rent-seeking
Ram Mudambi and Pietro Navarra
391
Exogenous Variables
Endogenous Variables
Firm, industry and
country controls
- KNOWLEDGE
INTENSITY
- Entry mode
H1(a),(c)
KNOWLEDGE
OUTPUT
H1(b)
H2(a)
Normal intra-firm
transfers
LEVEL OF RENT
APPROPRIATION
PATTERN OF
KNOWLEDGE
FLOWS
Explanatory
variables
SUBSIDIARY
BARGAINING
POWER
H2(b),(c),(d)(e)
- Duration of
operations
H6
H3,H4,H5
- External
orientation
- Process
control
Figure 2
The model: knowledge flows, subsidiary power and rent-seeking.
and increased subsidiary role have made MNCs more
like political coalitions (Holm and Pedersen, 2000).
Asakawa (2001a, b) reports that enhancement of a
subsidiary’s knowledge base also creates tensions
related mainly to knowledge control. Forsgren and
Pedersen (2000) report that greater subsidiary knowledge increases the subsidiary’s ability to influence
strategic decisions within the MNC only to the extent
that other units are able to assimilate and use it.
Greater effort spent in developing its own knowledge
base, when this is carried out at the expense of
transferring knowledge to other units and aiding in
its use, actually has a negative effect on the subsidiary’s position within the MNC (Forsgren et al., 2000).
Theoretically, these effects can be understood as
outcomes of rent-seeking within coalitions
(Krueger, 1974; Osborne and Rubinstein, 1990). A
subsidiary whose knowledge assets are widely used
by (and create a lot of value for) other units within
the MNC has a strong bargaining position within
the firm. This is because the opportunity costs to
other subsidiaries (and headquarters) of not coop-
erating with this subsidiary are very high. Consider
the converse – a subsidiary whose knowledge assets
are equally large, but unusable by other units. Such
a subsidiary has a weak bargaining position within
the MNC as the opportunity costs of marginalizing
it are low.
Zander (1999) finds that the structure of knowledge networks differs significantly across industries
and also among firms, concluding that there does
not appear to be a single approach to knowledge
management. Industry- and firm-specific factors
appear to have a significant role in influencing the
strategies that are implemented. Further, he also
casts doubts on a systematic link between the
geographical dispersion of knowledge capabilities
and firm performance. He is therefore doubtful
whether a strategy of tapping into local competencies is a sure route to developing competitive
advantage.
However, a joint reading of Zander (1999) and
Forsgren and Pedersen (2000) suggests that it may
be the implementation and not the strategy that is
Journal of International Business Studies
Knowledge flows, subsidiary power and rent-seeking
Ram Mudambi and Pietro Navarra
392
the problem. In other words, subsidiaries embedded
in leading technological centers of competence
(Cantwell and Janne, 1999) may be sources of
potential competitive advantage that remains unrealized owing to the internal political structure of the
MNC. Indeed, this is very likely to be the case. As
Forsgren and Pedersen (2000) conclude, actually
realizing the benefits of the MNC’s geographically
dispersed knowledge network is a daunting task.
These arguments imply the following hypotheses:
Hypothesis 2a: The greater the total knowledge
output of the subsidiary, the greater its bargaining power within the MNC.
Hypothesis 2b: The greater the knowledge outflows from the subsidiary to units within the
MNC (transfers – flow 1), the greater its bargaining power within the MNC.
Hypothesis 2c: The greater the knowledge
inflows from other units in the MNC to the
subsidiary (the numeraire flow – flow 4), the
lower its bargaining power within the MNC.
Hypothesis 2d: The greater the knowledge outflows from the subsidiary to its location (spillovers – flow 3), the lower its bargaining power
within the MNC.
Hypothesis 2e: Conditional on a given level of
total knowledge output, the greater the subsidiary’s local dependence (learning – flow 2), the
lower its bargaining power within the MNC.
Subsidiaries vary in terms of the tenure of their
operations within the life of the firm. Older
subsidiaries may have been set up at the founding
of the firm, whereas newer subsidiaries may be
recent start-ups or acquisitions. A business unit’s
duration of operations has been linked to organizational knowledge: that is, longer-lived operations
tend to have superior levels of such knowledge
(Benito and Gripsrud, 1992). It has been shown that
older subsidiaries of multinational corporations
are more likely to receive investment funds than
relatively younger subsidiaries (Mudambi, 1998b).
This implies that a subsidiary’s longer history of operations translates into an increased ability to influence headquarters’ policies to its own advantage.
Hypothesis 3: The longer the duration of operations of a subsidiary, the greater its bargaining
power within the firm.
It has been shown that firms with a greater
external orientation (e.g., through exports and
activities in multiple markets) have more stable
Journal of International Business Studies
cash flows and better abilities to weather downturns and market turbulence than firms that are
locally focused (Campa and Shaver, 2002). Subsidiaries within a firm differ with regard to their
level of external orientation. It follows that more
externally oriented subsidiaries provide a valuable
service to the firm in consolidating their competitive advantages (Katrak, 1983; Edwards et al., 2001).
It may therefore be argued that external orientation
provides a subsidiary with leverage relative to other
subsidiaries.
Hypothesis 4: The greater the level of external
orientation of a subsidiary, the greater its bargaining power within the MNC.
Multinational firms differ in terms of the extent
to which headquarters controls the production
process that takes place at subsidiary level (Schroeder, 1990). A higher level of control over the
production process exercised by the subsidiary is a
form of operational (as opposed to strategic)
independence. Such operational independence
provides subsidiaries with greater leverage within
the firm. There are two reasons why this is the case.
First, such subsidiaries have more autonomy with
regard to the design and implementation of the
production process (Levinson, 1983). Second, such
subsidiaries have more private information regarding the strengths, weaknesses and costs of the
production process than subsidiaries where process
control is exercised by headquarters (Schroeder,
1993). This information asymmetry contributes to
the subsidiary’s bargaining power within the firm.
Hypothesis 5: The greater the level of process
control exercised by a given subsidiary, the greater
its bargaining power within the firm.
Rent-seeking and rent appropriation
Subsidiary managers are stakeholders in the firm,
and are driven by both firm-focused and individual
objectives (Coff, 1999). Their individual objectives
are generally more aligned to their subsidiaries than
to the firm as a whole. Thus, managers’ attempts at
serving firm-focused shareholder value maximization objectives (profit seeking) coexist uneasily
with their attempts at maximizing their bargaining
power within the firm (rent-seeking) (Scharfstein
and Stein, 2000). The extent of rent-seeking and
consequent resource misallocation is dependent
upon the extent to which bargaining power can be
influenced by subsidiary actions. As internal bargaining power considerations become more impor-
Knowledge flows, subsidiary power and rent-seeking
Ram Mudambi and Pietro Navarra
393
tant, resources devoted to firm-focused support of
other units of the MNC fall. This is consistent with
results reported in the literature (Avila and Ronen,
1999). Thus, we may state:
Hypothesis 6: The greater the bargaining power
of a subsidiary within the MNC, the higher the
level of rents it can appropriate for its own use.
The scheme of causal links implied by the above
hypotheses is presented in Figure 2.
Data and variables
We are interested primarily in knowledge and
financial flows at the subsidiary level. Hence we
draw a sample of subsidiaries operating in a foreign
host environment. Our data are from UK subsidiaries of non-UK MNCs. Further, we restrict attention to firms in high-technology industries. The
definition of high technology is based on that used
by the OECD (1996). The sectors that are covered
by the OECD definition and the UK 1992 SIC codes
for each are shown in Table 1. An overview of the
composition of the sample used in the study is
shown here as well.
As suggested by Buckley and Casson (1976), the
current study uses three levels of data: locationspecific data, industry-level data and firm-level
data. Most of the location- and industry-specific
data are derived from secondary sources. Many
measures of firm-level characteristics are obtained
from primary sources. Appendix A includes definitions of all the variables used in the estimation,
Table 1
ELEC
Measuring knowledge flows
Knowledge flows are measured using patent data.
The use of patents as measures of knowledge flows
is well established in the literature (Jaffe et al., 1993;
Almeida, 1996; Almeida and Kogut, 1997). Following the reasoning and approach of Cantwell (1995),
we use US patenting by these UK subsidiaries as the
best common comparable measure. The data are
obtained from the US Patent and Trademark Office
database.
Table 2
Summary statistics
Variable
Mean
Standard deviation
Dependent variables
TCIT
SPWR
NF
6.2754
0.0064
22.4117
9.4288
1.0403
32.4740
Explanatory variables
RD
CREF
LREF
CCIT
LCIT
ACQUIRE
DT
EXTERNL
PROCESS
4.1822
3.8406
4.6449
1.2246
1.6957
0.6044
9.8889
0.0280
0.1113
2.7963
4.9512
6.3749
1.9143
4.1935
0.4901
5.5050
0.9980
1.0016
732,398.21
54,504.77
0.0984
48.0796
0.4089
0.1200
0.8254
0.5564
0.0560
0.4255
0.3273
2.8489
0.0359
0.0068
3.6927
374,644.49
0.2089
0.2044
0.0711
968,933.7854
55,869.5865
0.0576
108.3002
0.4927
0.3257
0.5002
0.2371
0.0296
0.4957
0.4709
1.0956
0.0177
0.0391
5.1599
327,726.1990
0.4074
0.4042
0.2576
High-technology industries and the sample
Industry Sector
group
CHEM
MECH
along with the source of the data. Descriptive
statistics related to all these variables are presented
in Table 2.
Pharmaceuticalsa
Aerospace
Precision
instruments
Office machinery
and computers
Electrical/electronic
engineering
including telecoms
UK SIC 1992
Sample
firms
24.4
35.3
33 except 33.3
68
90
30.0 and 72.5
117
31.1, 31.2, 31.4,
31.6, 32, 22.14,
22.3, 72
The definition of high-technology industry is based on that used by the
OECD. This table shows the sectors that are covered by the definition
‘high-tech’, and the UK Standard Industrial Classification (SIC) 1992
codes correspond to each. The authors drew up the correspondence
above using the definitions provided by the UK Office for National
Statistics (Office for National Statistics, 1996). It matches the current
official UK Department of Trade and Industry correspondence almost
exactly (White et al., 2002).
a
Includes biotechnology.
Control variables
STKMKT
BKCAP
TAX
RLOCRSK
R1
R2
CDUK
CR5
INDGRW
ELEC
MECH
FSCOPE
RORFF
ABROR
FINRSK
SALES
DIVERS
USDUM
JAPDUM
Journal of International Business Studies
Knowledge flows, subsidiary power and rent-seeking
Ram Mudambi and Pietro Navarra
394
Patent data directly pick up only codified knowledge. This leaves out a lot of knowledge, particularly in the context of strongly networked firms
such as MNCs. Second, patenting is a strategic
decision, so that we do not pick up even codified
knowledge that MNCs choose not to patent. Third,
patent citations are a ‘noisy’ measure, as they are
subject to spurious inclusion as well as omission
biases. However, there is a large literature using
patent data to measure knowledge, where it is
argued that patent data have the significant
advantage of objectivity and are representative of
knowledge as a whole.5
Patents vary in terms of the amount of knowledge
that they embody. Rather than use a simple count
of patents, we use the total citations of patents
assigned to a particular subsidiary as a measure of
its flow of knowledge output. We use the number of
citations by patents assigned to other units within
the same MNC as a measure of knowledge transfers
(Flow 1). We use the number of citations by patents
assigned to other firms in the UK as a measure of
spillovers (Flow 3).
Patents are also representative of the incremental
advance of knowledge. We use the references
provided in the patents as measures of knowledge
inflows into the UK subsidiary. The number of
references to patents assigned to other units within
the same MNC is used as a measure of the numeraire
knowledge inflow from the parent MNC (Flow 4).
Finally, the number of references to patents assigned
to other firms in the UK is used as a measure of
subsidiary learning (Flow 2).
Measuring the extent of subsidiary rent
appropriation
The literature on internal capital markets in multidivisional firms (see in particular Lamont, 1997)
indicates that units with weaker bargaining power
subsidize units that are stronger. Further, it has
been argued that, in sufficiently diversified firms,
units with stronger bargaining power are often
those with weaker financial performance (Rajan
et al., 2000). We posit that such cross-subsidies are a
manifestation of rent appropriation (an outcome of
rent-seeking). However, we suggest that the internal capital markets literature does not adequately
consider the effects of many non-financial factors
on subsidiary bargaining power.
The resource transfers between the UK subsidiary
and headquarters are measured using the level of
net flows within the firm between subsidiary and
parent. It is well known in the international
Journal of International Business Studies
business literature that these flows, which are
implemented in the form of dividends, royalties,
license and management fees and so on, are used to
transfer resources within the MNC (e.g., Bartlett
and Ghoshal, 1998). This variable represents the
sum of normal intra-firm financial flows and rentseeking flows, and is used as a dependent variable
in the estimation. As originally pointed out by
Buckley and Casson (1976), we expect these flows
to be affected by location-, industry- and firm-level
control factors. As will be noted below, we carefully
control for these factors, taking particular care to
include controls related to the internal and external
capital markets.
Primary data collection
Much of the firm-level data were derived from large
1995 postal surveys of FDI into the UK, supported
by telephone and field interviews. The resulting
data set includes measures of financial risk, relative
rate of return on capital, cash flow position, duration
of operations, factors underpinning subsidiary
bargaining power and R&D intensity.
The sample frame for this survey was constructed
from Dun & Bradstreet indexes (Dun & Bradstreet,
1994, 1995), supplemented by the London Business
School company annual report library. The sample
frame yielded a preliminary list of 701 firms with
personal contact names. Firms where separate data
for the parent firm were unavailable were deleted.
The final usable sample frame consisted of 670
firms. The main survey was mailed out in two
waves of 224 and 446 in March and April 1995.
The first (pilot) wave focused on entries into the
Midlands region (the most successful region in the
UK in terms of attracting FDI), and the second
wave-targeted entries into the rest of the country.
The questionnaire was accompanied by a covering
letter explaining the aims of the study and
guaranteeing confidentiality. In order to improve
the response rate, the questionnaire had to be
short, concise and of current interest or salient to
the respondent (Heberlein and Baumgartner, 1978).
Two reminders were faxed to all companies that
had not yet responded, 10 days and 21 days after
the survey was mailed out.
Overall, 288 responses were received to the mail
survey (42.98%). Of these, seven were found to be
UK firms mistakenly identified as non-UK firms,
and six were unusable for various other reasons,
leaving 275 (41.04%) complete records for evaluation. For an unsolicited mail survey, the response
rate is excellent.
Knowledge flows, subsidiary power and rent-seeking
Ram Mudambi and Pietro Navarra
395
Non-response bias was investigated with the
widely used method suggested by Armstrong and
Overton (1977). This involved comparing early and
late respondents. Two sets of late respondents were
defined corresponding to those who responded
after receiving the first reminder and those who
responded after receiving the second faxed reminder (the first set includes the second). Each set of
late respondents was compared with the early
respondents on the basis of six sample measures.
The comparisons were carried out using a w2 test of
independence. In both cases the responses from
early and late respondents were virtually identical.
Survey responses were tested for veracity by
comparing postal responses with responses obtained
from field interviews. A total of 28 field interviews
were carried out. Using a w2 test of independence,
responses from field interviews were found to be
virtually identical to those obtained from the postal
survey on the basis of four sample measures.
Finally, 20 respondents were randomly selected
and interviewed by telephone to confirm their
survey responses.
Control variables
A number of location- and industry-specific variables are included as controls. Location data include
measures relating to the MNC’s home country,
to the host country (the UK), and comparative
measures. Also included are measures of the
external capital market in the home country of
the MNC. The level of stock market activity is used
to proxy the access to equity finance, and the
amount of bank assets is used to proxy the access to
debt finance. Measures relating to the host country
include the classification of the subsidiary’s location in terms of the Regional Selective Assistance
(RSA) program, and are based on the relevant
Department of Trade and Industry (DTI) assisted
areas map (August 1993). Data comparing location
risk characteristics of the UK with those in the
companies’ home countries were drawn from the
publication Euromoney, and the relative corporation
tax rate was drawn from the Doing Business series
published by Price Waterhouse (1995). We expect
the cultural distance between the home and host
country to affect intra-firm financial flows (Buckley
and Casson, 1976, 42–43). Hence we include the
Hofstede measure of cultural distance between the
home country of the MNC parent and the UK.
Finally, as the US and Japan were home to a
significant percentage of the sample parent firms,
dummies were introduced to control for countryspecific effects.
The subsidiary’s industry-level classification
relates to its industry subgroup, and was drawn
from the 1992 UK Standard Industrial Classification
code (Office for National Statistics, 1996). Three
industry subgroup dummies were constructed corresponding to the mechanical and related, electrical and related, and chemical and related subgroups
(see Table 1). In addition, the market power in each
SIC 92 four-digit category was measured using the
five-firm concentration ratio, and the attractiveness
of each category was measured using the category
sales growth rate over the period 1989–94.
Estimation and results
Summarizing the firm-specific data
Two problems arise in using many of the firmspecific variables. First, several of them are categorical and/or ordinal. Second, several of them are
highly correlated with one another. Thus, they
are unsuitable for direct use as regressors. These
problems are addressed by running sets of problem
variables through principal component factor analysis. The latent root criterion is used to determine
the number of factors (or summary variables)
extracted. The rationale is that the variation in
each variable is unity after it has been standardized.
Thus, each factor should account for the variation
in at least one variable if it is to be considered useful
from a data summarization perspective (Churchill,
1995). The factor analysis results are presented in
Table 3. Three groups of variables are analyzed, and
in each case one factor emerges with an eigenvalue
greater than unity. This analysis yields our measure
of subsidiary bargaining power (SPWR). It is based
on the subsidiary’s influence on the MNC’s global
buyer–supplier relationships, the extent of its
authority for senior management hiring, its
responsibilities for global strategy and marketing,
the proportion of the corporate officers of the
parent MNC who are current or former executives
of the UK subsidiary, and (the absence of) senior
management from the parent country in the UK
operation.
The second set of variables that are summarized
are exports as a percentage of the subsidiary’s
sales, duration of the subsidiary’s export operations
and the geographical scope of the subsidiary’s
output mandate. This yields our measure of the
subsidiary’s ‘external orientation’ (EXTERNAL).
Finally, the subsidiary’s responsibilities in process
Journal of International Business Studies
Knowledge flows, subsidiary power and rent-seeking
Ram Mudambi and Pietro Navarra
396
Table 3 Factor analysis of firm-specific qualitative variables:
varimax rotation
Variable
Factor 1: SPWR
SUPPLY
HIRE
STRAT
TMT
LCTRL
Eigenvalue
Variance
% Variance
Factor 1: EXTERNL
EXPER
EXPT
GSCOPE
Eigenvalue
Variance
% Variance
Factor 1: PROCESS
PROC
TRAIN
Eigenvalue
Variance
% Variance
Factor loadings
Communality
0.884
0.812
0.809
0.798
0.792
0.804
0.791
0.754
0.749
0.740
1.6847
1.4008
0.807
0.860
0.891
0.902
0.814
0.802
0.891
1.1784
1.4226
0.862
0.898
0.794
0.712
0.735
1.3084
1.3802
0.844
implementation and training are summarized
in the factor ‘process responsibilities’ (PROCESS).
The varimax rotated factor loading matrices are
displayed in Table 3. All factor loadings
are extremely high, and the communalities of the
individual variables are very high as well, with
the lowest value in excess of 70% and the highest
value near 90%.
Estimating the model
We have set up hypotheses to explain three
interrelated dependent variables: knowledge creation, subsidiary bargaining power and subsidiary
rent-seeking (see Figure 2). The interrelated nature
of these variables requires that we use a simultaneous equations approach to estimate the model.
The method we use is iterated three-stage least
squares. The results of the simultaneous estimation
of the three equations are provided in Table 4. The
system converges quickly to stable estimates, and
the overall fit of the equations is good.
The first equation in the system estimates knowledge creation in the subsidiary. We use a production function approach, and both knowledge
creation (output) and knowledge inflows (inputs)
Journal of International Business Studies
are measured using natural logarithms. Our results
indicate that intra-location knowledge inflows and
intra-corporate flows (Flow 2 and Flow 4) have very
significant and positive effects on the subsidiary’s
knowledge output. The effect of intra-location
inflows is more than twice as large as that of
intra-corporate inflows, and the two effects sum
approximately to unity. The subsidiary’s research
intensity has a significant positive effect as well,
suggesting a form of ‘increasing returns to scale’ in
knowledge production. Acquisition entries appear
to be associated with slightly larger knowledge
production, but the statistical significance of this
finding is marginal. The data appear to provide
support for Hypotheses 1a and 1b, but we find only
weak support for Hypothesis 1c.
We proceed to examine our estimates of subsidiary bargaining power. The first set of estimates
relate to the effects of knowledge flows on subsidiary bargaining power within the MNC. The
total knowledge output of the subsidiary (an
endogenous regressor) has an extremely significant
and positive impact, providing support for Hypothesis 2a. Similarly, larger knowledge outflows from
the subsidiary to other MNC units (Flow 1) increase
subsidiary power, supporting Hypothesis 2b. The
effect of knowledge inflows from other MNC units
to the subsidiary is negative as predicted, but not
statistically significant, so Hypothesis 2c is not
supported. The effect of knowledge outflows to the
subsidiary’s location appears to significantly reduce
its bargaining power within the MNC, so that
Hypothesis 2d is supported. Finally, the effect of
local knowledge dependence measured by the
extent of knowledge inflows from its location (Flow
2) is very significant and negative. This provides
support for Hypothesis 2e.
The next set of explanatory variables for subsidiary bargaining power relate to subsidiary-specific
characteristics. The subsidiary’s duration of operations and its process control responsibilities have
significant and positive effects, providing support
for Hypotheses 3 and 5. However, the subsidiary’s
external orientation does not seem to have an effect
on its bargaining power, so that Hypothesis 4 is not
supported.
The effects of the control variables are generally
in line with our expectations. A subsidiary operating in an industry with a higher growth rate
and one with a wider functional scope has more
bargaining power within the MNC. However,
operating outside the MNC’s main line of business
does not have a significant effect.
Knowledge flows, subsidiary power and rent-seeking
Ram Mudambi and Pietro Navarra
397
Table 4
Knowledge flows, subsidiary power and rent-seeking: iterated 3SLS estimates
Regressor
Constant
LN(TCIT)a
SPWRa
RD
LN(CREF)
LN(LREF)
LN(CCIT)
LN(LCIT)
ACQUIRE
DT
EXTERNL
PROCESS
STKMKT
BKCAP
TAX
RLOCRSK
R1
R2
CDUK
CR5
INDGRW
ELEC
MECH
FSCOPE
RORFF
ABROR
FINRSK
SALES
DIVERS
USDUM
JAPDUM
Diagnostics
Adj. R2
F-stat. (df)(p value)
Log-L.
Restricted Log-L.
Iterations
Parameter estimates (t-stat.)
Eqn 1: LN(TCIT)
Eqn 2: SPWR
Eqn 3: NF
0.098 (1.57)
—
0.012 (0.13)
H1a: 0.023 (2.76)***
H1b: 0.243 (3.78) ***
H1b: 0.757 (11.8)***
1.94 (1.16)
H2a: 3.945 (2.96)***
—
0.062 (1.67)
H2c: 0.736 (1.24)
H2e: 2.280 (5.81)***
H2b: 0.485 (2.19)**
H2d: 0.294 (3.81)***
0.756 (2.14)**
H3: 0.049 (2.77)**
H4: 0.023 (0.19)
H5: 0.336 (2.08)**
31.106 (2.35)**
0.745 (0.31)
H6: 4.024 (2.81)***
1.342 (1.59)
1.620 (1.12)
3.506 (1.09)
0.521 (0.34)
2.323 (1.44)
6.628 (1.16)
H1c: 0.018 (2.03)**
0.024 (2.50)**
3.319 (1.73)*
0.176 104 (2.70)**
0.74 103 (2.30)**
24.054 (2.28)**
0.631 102 (0.27)
5.124 (2.22)**
10.212 (1.98 )**
0.673 (2.11)**
9.257 (1.06)
104.262 (1.20)
11.678 (1.92)*
5.225 (0.87)
0.098 (3.00)***
0.117 (1.42)
0.6958
9.96 (5, 269) (0.000)
1482.6873
2007.0148
0.5867
16.94 (13, 261) (0.000)
1413.3394
2018.4306
14
58.238 (1.75)*
145.380 (1.98)**
0.970 (2.45)**
0.294 105 (1.37)
21.073 (3.61)***
6.344 (1.74)*
5.327 (0.60)
0.5278
22.25 (26, 248) (0.000)
1148.1558
2025.2758
Estimates significant at the 10, 5 and 1% levels are marked with *, ** and ***, respectively.
a
Endogenous regressor.
The third equation includes a test of our last
hypothesis concerning the effect of the subsidiary’s
(endogenously determined) bargaining power on
its ability to extract rents from the resources
generated by the MNC. We find that the subsidiary’s power has a significant and negative effect on
the net financial flows to its parent. In this
equation, we control for knowledge flows – none
of them has a significant direct effect on net
financial flows. Further, we control for a substantial
number of location-, industry- and firm-specific
factors that affect normal intra-firm financial
transfers. Therefore, we interpret this significant
effect as providing support for Hypothesis 6. In
other words, for two subsidiaries with identical
location-, industry- and firm-specific factors, the
one with greater bargaining power remits significantly smaller financial resources to its parent
MNC. As net financial flows in the sample are
found to be both positive and negative, rent appro-
Journal of International Business Studies
Knowledge flows, subsidiary power and rent-seeking
Ram Mudambi and Pietro Navarra
398
priation can occur either through smaller financial
outflows or through larger financial inflows. These
inflows can be direct flows from the parent MNC
or flows from other MNC units routed through
headquarters.
Most of the control factors have effects that can
be explained intuitively. A larger external capital
market in the home country of the parent MNC (in
terms both of equity and of debt) reduces the net
flows from the subsidiary. Larger capital markets are
generally more sophisticated (Morck et al., 2002),
and well-functioning external capital markets
reduce the need for the MNC to depend on its
internal capital market. Subsidiaries operating in
relatively backward regions of the host country (the
UK) seem to make relatively larger remittances.
There is evidence that subsidiaries in locations with
weak infrastructure tend to be less sophisticated
(Cantwell and Iammarino, 1998), so this may be
another indirect effect of subsidiary bargaining
power. Increased cultural distance of the home
country from the host country is associated with
larger net financial remittances from subsidiary to
parent.
The other strongly significant control effects
are associated with the subsidiary’s excess rate of
return on capital over average in the parent MNC
and the subsidiary’s main line of business. Better
subsidiary financial performance is associated with
lower net outflows to the MNC parent. Thus, a
better-performing subsidiary, after controlling for
intra-firm bargaining power, does not subsidize
poorer-performing units within the MNC. This
is apparently at odds with the findings reported
in the literature on internal capital markets in
multi-divisional firms (Lamont, 1997; Stein, 1997).
However, this literature does not explicitly include
measures of intra-firm bargaining power.
Finally, subsidiaries that operate outside the
parent MNC’s main line of business remit larger
financial flows to their parents than subsidiaries
that operate in their parents’ mainstream business.
Thus, a subsidiary that operates in an area that is
peripheral to the firm’s main activities is likely to be
used as a cash cow.
Discussion and managerial implications
Discretion, bargaining power and knowledge
There is considerable literature documenting the
existence of a diversity of headquarters–subsidiary
relationships within MNCs. In their classic work,
Bartlett and Ghoshal (1998) analyze the growth of
Journal of International Business Studies
Matsushita in the 1990s, during which time it
overtook Philips, its major MNC competitor. The
organizational structure at Matsushita was extremely centralized, and subsidiaries had very little
power. In contrast, Philips had been characterized
by a decentralized organizational structure where
subsidiaries (national organizations) exercised considerable control over their own destinies.
Strategically independent subsidiaries have been
the subject of a large literature, beginning with the
pioneering work of Hedlund (1980, 1984). However, with some exceptions (e.g., Hedlund, 1986),
this literature has focused on MNCs where power,
in terms both of decision-making and of bargaining, is concentrated at headquarters. Further, this
literature has been concerned mainly with identifying strengths that such strategically independent
subsidiaries bring to the MNC as a whole. However,
as the illustrative comparison between Matsushita
and Philips indicates, subsidiary strategic independence can unleash unproductive forces as well.
The internal capital markets literature suggests
that, in multi-divisional firms, headquarters needs
to provide incentives to divisional managers to
cooperate to further the interests of the firm as a
whole. In the words of Rajan et al.:
Even though the efficient investment maximizes firm value,
a divisional manager may prefer the defensive investment
that would benefit her more directly, especially when her
resources and opportunities are much better than the other
division’s. y Once the divisional manager makes the
unprotected, albeit efficient, investment, she will have to
share some of the surplus created with the other division. y
if the other division also makes the efficient investment, our
manager will get a piece of the surplus created by the other
division. If the surplus created by the other division is not
too small relative to what she is giving up, the divisional
manager will prefer the efficient investment. Thus appropriate incentives are created for both divisions when they
do not differ too much in the surplus which is the product
of resources and opportunities they create. Diversity in
resources and opportunities is costly for investment incentives! (Rajan et al., 2000, 38)
Thus, as subsidiaries become more diverse, the
pursuit of cooperative strategies becomes more and
more costly in terms of the subsidiary’s own goals.
Headquarters strengthens the incentives for subsidiaries to cooperate by reducing intra-firm financial diversity. This involves transferring resources
from subsidiaries with strong financial performance
to those with weaker performance. Such transfers
will, in general, destroy shareholder value and be
met with resistance from managers in subsidiaries
with strong performance.
Knowledge flows, subsidiary power and rent-seeking
Ram Mudambi and Pietro Navarra
399
The literatures both on strategically independent
subsidiaries and on internal capital markets incorporate autonomous decision-making by subsidiary
managers. However, in both literatures, the subsidiary’s decision-making autonomy may be categorized as discretion in the sense of Williamson
(1996). The subsidiary has ‘delegated decision
rights that are ‘loaned, not owned’’ (Foss and Foss,
2002). Headquarters has the power of veto – that is,
the ability to overrule any subsidiary decision.
We do not dispute that much subsidiary autonomy is based on discretion granted by headquarters. However, we suggest that discretion is not the
only form of subsidiary decision-making autonomy. A second and stronger form of autonomy stems
from subsidiary bargaining power. This is fundamentally different from discretion, in the sense that
it is much more difficult for headquarters to revoke.
This is our approach in this paper. In other words,
we focus on the situations where the subsidiary has
a degree of ‘ownership’ over its decision rights
rather than holding them at the pleasure of headquarters. We propose an over-arching approach to
all subsidiary decision-making autonomy as a
mixture of discretion (granted by headquarters)
and bargaining power (developed by the subsidiary). Subsidiaries with strong bargaining power can
resist headquarters’ attempts to control their
resources in the MNC’s internal capital market
(Mudambi, 1999; Bartlett, 2002).
Indeed, some of the findings in the internal capital
markets literature support this argument. For instance, in a sample of oil companies, Lamont (1997)
finds that resources were transferred from the nonoil divisions to their main oil divisions during
a period when the oil industry was performing
poorly. However, if we note that the oil divisions
are likely to have the strongest bargaining power in
the oil companies, Lamont’s results are consistent
with our findings. Subsidiaries with lower levels of
bargaining power, and lines of business at odds
with the parent’s line of business, have higher levels
of resources extracted by their parents. Importantly,
we find that, after incorporating the effects of
bargaining power, subsidiaries with better financial
performance have lower levels of resources
extracted by their parents – a result that is counter
to the predictions of the internal capital markets
literature. As seen in Table 5, it is in the bottom
right-hand box, where subsidiary profitability
and bargaining power are both high, that the
impact of subsidiary bargaining power can be
seen.
Table 5
Subsidiary profitability vs subsidiary bargaining power
Subsidiary
bargaining
power
Subsidiary current profitability
Low
High
Low
Some inward transfer
of profits from more
profitable subsidiaries
Considerable outward
transfer of subsidiary
profits to less
profitable units
High
Considerable inward
transfer of profits from
more profitable
subsidiaries
Greater retention/less
outward transfer of
subsidiary profits
How can a subsidiary have bargaining power when
it is not an independent legal entity and therefore
has no legally defensible property rights? The legal
status of a subsidiary implies that its control over
tangible assets can only be in the form of discretion
– headquarters can always re-take control of such
assets. A subsidiary’s bargaining power must be
based on intangible assets over which property
rights are hard to define and enforce. The bulk of
such assets are in the form of knowledge (Nonaka
and Takeuchi, 1995). Knowledge and knowledgecreating potential are therefore the key source of
subsidiary bargaining power. Knowledge-intensive
subsidiaries have strong bargaining power, and have
greater ability to resist headquarters’ attempts to
control their resources. As the subsidiary’s bargaining power rises, the range of decisions over which
headquarters can exercise veto power declines. Our
empirical results support such hypotheses. Subsidiaries that control knowledge that is vital to the MNC
generate greater levels of bargaining power in their
relationships with headquarters.
Further, we find empirical support for the
hypothesis that it is not merely knowledge intensity, but the pattern of knowledge flows, that is
crucial in determining the bargaining power of the
subsidiary. In particular, subsidiaries with large
knowledge outflows to other MNC units attain
strong bargaining power, whereas those with
knowledge outflows to other firms have less intrafirm power. We interpret the findings of Forsgren
and Pedersen (2000) (see the discussion of Hypotheses 2) as supportive of our findings.
Limiting intra-firm rent-seeking
Rent-seeking by subsidiaries with strong bargaining
power is inefficient from the perspective of the firm
as a whole, and destroys shareholder value. Yet, as
Journal of International Business Studies
Knowledge flows, subsidiary power and rent-seeking
Ram Mudambi and Pietro Navarra
400
amply demonstrated in the literature, subsidiary
strategic independence can play a vital role in
enhancing knowledge inflows and learning, and
hence in developing and preserving competitive
advantage (Holm, 1992; Birkinshaw and Morrison,
1995; Andersson et al., 2002). The problem becomes
one of increasing strategic independence in subsidiaries without provoking rent-seeking by subsidiary managers.
We will explore two avenues towards this goal.
The first avenue focuses on the organization, and
examines control structures. The second focuses on
the individual manager, and examines motivation.
Obviously, motivation is very much a part of
control structures, so that the two avenues are
closely related. We will attempt to synthesize the
roles of motivation and control structures in
discussing our empirical findings.
Control structures in MNCs involve a delicate
balance between coordination, traditionally
achieved through centralization, and incentives,
derived from the autonomous pursuit of subsidiary
objectives. Bartlett and Ghoshal (1998) document
the problems at Philips when subsidiary autonomy
hindered the performance of the firm as a whole.
Argyres (1995) documents similar problems at
General Motors, which he traces to the firm’s Mform structure. In contrast, he finds that IBM was
able to avoid many of these problems through a
structure that involved judicious intervention by
headquarters.
Argyres suggests that this structure, where subsidiary ‘y managers bargain with each other
knowing that failure to reach agreement will lead
to a decision by corporate management’ is an
example of the centralized M-form or C-M form,
as defined by Hill (1988). When intra-MNC coordination requires multilateral bargaining, specific
investments and high levels of uncertainty, the
payoff to subsidiary opportunism rises. Such situations are likely to be the norm in high-technology
firms, and here the C-M form is likely to outperform the M-form. In implementing the C-M form
to solve coordination problems, headquarters needs
to exercise ‘leadership’ in the sense of Foss (2001) to
set up common knowledge conditions among
subsidiaries.
However, in order for the C-M form to be
successful in preserving subsidiary managers’
incentives, it must incorporate the considerations
of motivation. Both managerialism and transaction
cost economics are based on the assumption of
individual utility-maximizing managers, which
Journal of International Business Studies
implies the pursuit of rents. However, Frey (1998)
points out that individuals are both extrinsically
and intrinsically motivated. Standard utility maximization only picks up extrinsic motivation.
Intrinsic motivation derives from the satisfaction
of undertaking the activity for its own sake. In the
firm, it arises ‘y in the form of identification with
the firm’s strategic goals, shared purposes and the
fulfillment of norms for its own sake’ (Osterloh and
Frey, 2000).
Intrinsic motivation is particularly important in
tasks related to knowledge-intensive activities that
require creativity. This can be harnessed to limit
rent-seeking behavior by subsidiary managers.
Participation (an agreement on common goals)
and personal relationships (to build emotional
loyalties) are two suggested methods of fostering
intrinsic motivation (Osterloh and Frey, 2000).
Joint goal-setting between headquarters and subsidiary managers is a method of operationalizing
the former method. Inter-subsidiary team-based
structures can be used to operationalize the latter.
Cross-subsidiary teams and task forces have been
reported to enhance inter-unit communication
(Ghoshal et al., 1994) and the use of rich communication media so necessary in the transmission of
knowledge (Daft and Lengel, 1986). Both of these
methods aid in alleviating the divided loyalties of
subsidiary managers, socializing them and influencing them to behave like ‘dual nationals’ (Mudambi, 1999; Asakawa, 2001b).6
The theory of intrinsic motivation (Frey, 1998)
provides a theoretical foundation to support the
recommendations of organization theorists regarding the use of teams and ‘integrators’ to resolve
tensions between organizational and subsidiary
objectives (Lawrence and Lorsch, 1986). The foregoing discussion simultaneously provides us with
some limitations of the present study and indications regarding a fruitful path for further research.
We find that the pattern of knowledge flows within
the MNC is a powerful predictor of the ability of
subsidiary managers to pursue and appropriate
rents. The extent of such opportunistic behavior
should be sensitive to organizational design. In
other words, firms that have structures that foster a
strong organizational culture and intrinsic motivation in their subsidiary managers should witness
lower levels of rent-seeking.
Finally, we find some preliminary evidence of
time inconsistency in the distribution of bargaining
power within the MNC. Duration of operations is a
strong predictor of subsidiary bargaining power.
Knowledge flows, subsidiary power and rent-seeking
Ram Mudambi and Pietro Navarra
401
This suggests that older subsidiaries with declining
strategic prospects may wield greater bargaining
power within the MNC than younger subsidiaries
with strong promise. The older subsidiaries may
also be units embedded in the traditional national
system of innovation, whereas younger subsidiaries
may be foreign units with linkages to dynamic
technological centers. In this case, the powerful
home operations may create inertia, preventing the
MNC from implementing an optimal knowledge
management strategy. The findings of Narula (2002)
may be interpreted as support for this conjecture.
This issue clearly merits further study.
Concluding remarks
In this paper, our objective is to study some of the
implications of the dispersal of knowledge-creating
activities within the MNC. In particular, we suggest
that this trend has increased the extent and scope
of subsidiary bargaining power within the firm. In
turn, we suggest that such power may underlie
findings of increased intra-organizational tension
in knowledge-creating activities (Asakawa, 2001a, b).
Further, fears of subsidiary rent-seeking may lead
many MNCs to forgo the benefits of subsidiary
independence.
Much of the study of intra-firm knowledge flows
has focused on motivational and cognitive barriers
(Foss and Pedersen, 2001). The form of subsidiary autonomy within which these knowledge
flows occur may be characterized as discretion,
rather than power, as headquarters retains the
right of veto. Even here, there has been relatively
little empirical work, as noted by Gupta and
Govindarajan (2000).
We believe that our study offers some significant
novelties. First, we distinguish between discretion
and bargaining power at the subsidiary level, where
the latter is the extent to which the subsidiary is not
subject to headquarters veto. We find strong evidence
that such power is exercised by MNC subsidiaries.
Second, we attempt to study not only knowledge
flows per se, but also the pattern of knowledge flows.
We find that this pattern, rather than the extent of
flows, has the more significant effect on subsidiary
bargaining power within the firm and consequently
on the level of rent-seeking behavior.
Rent-seeking is an inefficient activity from the
perspective of the system as a whole. The next step
in this research program would be to link the extent
of rent-seeking to firm-wide performance and
thence to the design of organizational structures
that would limit the incentives for such activity,
incorporating the role of intrinsic motivation.
As with any study, ours has limitations. First, we
implicitly assume that subsidiary managers are
united in the pursuit of common goals. Many of
these subsidiaires are multi-departmental units
whose sub-units have a diversity of linkages to the
parents firm. Second, our measures of knowledge
and knowledge flows are based entirely on patent
data, and therefore relate only to codified knowledge. Further, we do not distinguish between
knowledge flows from the parent MNC (hierarchical flows) and from other subsidiaries (lateral
flows) – a potentially interesting avenue for future
research. Our findings are remarkably strong and
robust to adjustments in model specification,
indicating that – at least for codified knowledge –
we have uncovered some significant relationships.
In order to maximize the value of their knowledge
networks, MNCs need to pay close attention to
organizational design and the motivation of their
subsidiary knowledge workers.
Acknowledgements
We would like to thank participants at the third LINK
conference in Copenhagen, Denmark, and especially
Nick Argyres, Lars Hakanson, Rajneesh Narula, Torben
Pedersen and Sid Winter for helpful comments that
significantly improved the paper. We would also like to
acknowledge a substantial intellectual debt to Anil
Gupta, many of whose ideas appear in this paper. The
usual disclaimer applies.
Notes
1
We are grateful to Rajneesh Narula for this colorful
phrase.
2
Whenever a person or group has power over an
organization, the person or the group will seek to
obtain special favors at the expense of all others in the
organization (Krueger, 1974).
3
We are aware of the large literature on the nature of
knowledge, and refer the interested reader to the
wonderful survey of Cowan et al. (2000). For our
purposes, it is sufficient to recognize that codified
knowledge has more of the characteristics of ‘information’, that tacit knowledge is more holistic, and that
the distinction between the two relates largely to
issues of articulation.
4
Power in a bargaining game is derived from the
value of a player’s outside options (Osborne and
Rubinstein, 1990). Subsidiary bargaining power must
also arise from such calculus; however, this can only
occur implicitly, as it is not an independent legal
Journal of International Business Studies
Knowledge flows, subsidiary power and rent-seeking
Ram Mudambi and Pietro Navarra
402
entity. Although the subsidiary itself is generally tied to
the parent firm, many of its resources (particularly
its human and relational resources) are not, and
therefore have outside options that can be exercised.
For example, key managers can quit, key relationships
may not be leveraged, and so on.
5
For a more general discussion of the advantages,
limitations and interpretation of US patent data, the
reader is referred to the classic work of Griliches (1992).
6
Managers’ loyalties are often divided along cultural
lines between the MNC parent and the local opera-
tion, as summarized in the table below. See Mudambi
(1999) for details.
Allegiance to local subsidiary
Allegiance to
MNC parent
Low
High
Low
Free agents
High
Local managers
Expatriate
managers
Dual nationals
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About the authors
Ram Mudambi is an Associate Professor at the Fox
School of Business and Management at Temple
University and a visiting Reader in International
Business at the ISMA Centre, University of Reading.
His work has appeared in the Strategic Management
Journal, the Journal of International Business Studies
and the Journal of Political Economy, among others.
Pietro Navarra is an Associate Professor in the
Institute of Economics and Finance at the University of Messina and a Research Fellow at the
London School of Economics and Political Science.
His work has appeared in Management International
Review, the European Journal of Political Economy and
Public Choice, among others.
Appendix A
Variable definitions are shown in Table A1.
Table A1
Variable
Definition
Dependent variables
TCITa
Total forward citations of UK subsidiary’s US patents, 1995–2002
SPWR
SUPPLY
HIRE
STRAT
TMT
LCTRL
NF
Source
US PTO database
Power of UK subsidiary. Measured as the first principal component factor score based on the following variables (Table 2).
Extent to which decisions on global suppliers are made in the UK
Survey
(seven-point Likert scale)
Extent of UK subsidiary’s responsibility for senior management hiring
Survey
(seven-point Likert scale)
Extent of responsibilities in global strategy and marketing (seven-point
Survey
Likert scale)
Proportion of the parent MNC’s top management team (directors and
Company annual reports
above) that are current or former executives from the UK subsidiary
Percentage of UK subsidiary top management (directors and above)
Survey, company annual reports
from host country (UK)
Net financial outflows from UK subsidiary to its MNC parent, that is, all
Survey, company annual reports
outflows of dividends, royalties, overhead charges, license and
management fees and miscellaneous transfers, less inflows of capital
from the parent, not including day-to-day treasury-based cash flows
management, 1994
Journal of International Business Studies
Knowledge flows, subsidiary power and rent-seeking
Ram Mudambi and Pietro Navarra
405
Table A1
(Continued)
Variable
Definition
Explanatory variables
RD
UK subsidiary’s total R&D intensity (R&D/sales ratio), 1994
UK subsidiary US patent citations of patents assigned to other units of
CREFa
the parent MNC
LREFa
UK subsidiary US patent citations of patents assigned to other firms in
the UK
Citations of UK subsidiary’s US patents by other units of the parent
CCITa
MNC, 1995–2002
LCITa
Citations of UK subsidiary’s US patents by other firms in the UK, 1995–
2002
ACQUIRE
Entry into the UK was through acquisition (dummy variable)
DIVERS
EXTERNL
EXPER
EXPT
GSCOPE
DT
PROCESS
PROC
TRAIN
UK subsidiary operations are in parent’s main line of business (dummy
variable)e
Source
Survey, supplemented with ONS data
US PTO database
US PTO database
US PTO database
US PTO database
Survey, company annual reports, ONS
data
Survey, company annual reports, ONS
data
External orientation of the UK subsidiary. Measured as the first principal component factor score based on the following
variables (Table 2).
Exports as a percentage of UK subsidiary sales, 1994
Survey, company annual reports
Duration of UK subsidiary export operations as a percentage of
Survey, company annual reports
duration of UK operations, 1994
Geographical scope of UK subsidiary’s output mandate: (1) UK only;
Survey, company annual reports
(2) UK and mainland Europe; (3) worldwide
Duration of UK subsidiary operations (years)
Survey, company annual reports
Process responsibilities of the UK subsidiary. Measured as the first principal component factor score based on the
following variables (Table 2).
UK subsidiary’s process implementation operational responsibilities
Survey
(seven-point Likert scale)
Extent to which UK subsidiary has responsibility for training in process
Survey
implementation (seven-point Likert scale)
Control variables: Location
STKMKT
Home country stock market liquidity, measured by the annual value
traded, 1994 (US$ million)
BKCAP
Home country: extent of debt finance availability, measured by total
bank capital, 1994 (US$ million)
TAX
Percentage differential in corporation tax rate, home country/host
country (UK); 1994.
RLOCRSK
Percentage differential in country risk, home country/host country
(UK); average, 1993–1994
R1
UK subsidiary is in a development areac
R2
UK subsidiary is in a split development/intermediate areac
CDUK
Cultural distance from the UK
UK Department of Trade and Industry
UK Department of Trade and Industry
Hofstede (1980)
Control variables:
CR5
INDGRW
ELEC
Census of Industry
Census of Industry
Business Register
MECH
CHEM
Industry
UK three-digit industry five-firm concentration ratio, 1994
UK industry annual output growth (%), 1989–94
UK subsidiary is in an electrical engineering and related industry
(dummy variable)
UK subsidiary is in a mechanical engineering and related industry
(dummy variable)
UK subsidiary is in a chemical engineering and related industry
(dummy variable)
International Finance Corporation
Bank for International Settlements
Price Waterhouse
Euromoneyb
Business Register
Business Register
Journal of International Business Studies
Knowledge flows, subsidiary power and rent-seeking
Ram Mudambi and Pietro Navarra
406
Table A1
Variable
(Continued)
Definition
Control variables: Firm
FSCOPE
Functional scope of the UK subsidiary’s output mandated
RORFF
FINRSK
Rate of return on subsidiary liquid funds (free cash flows as defined by
Jensen 1994.
UK subsidiary’s ROR on capital less parent firm’s corporate ROR on
capital, 1994
Variance of UK subsidiary’s rate of return on capital, 1986–1994
SALES
UK subsidiary’s total sales, 1994
USDUM
1, if parent firm HQ is in the US
ABROR
Source
Survey, supplemented
annual reports
Survey, supplemented
annual reports
Survey, supplemented
annual reports
Survey, supplemented
annual reports
Survey, supplemented
annual reports
Survey, supplemented
annual reports
by company
by company
by company
by company
by company
by company
0, otherwise
JAPDUM
1, if parent firm HQ is in Japan
Survey, supplemented by company
annual reports
0, otherwise
Notes: Company annual reports were obtained at the London Business School Annual Report Library.
a
In the statistical analysis, all patent citations are normalized by the appropriate industry group average.
b
Euromoney risk index: includes economic performance, political risk, debt indicators, debt default, credit ratings, access to bank, short-term and capital
market finance, and the discount on forfaiting.
c
Based on the Department of Trade and Industry (DTI) Assisted Areas map (revised, August 1993).
d
FSCOPE is generated on the basis of the functional scope of the UK subsidiary’s output mandate. Output mandates were categorized as: (1) sales and
service; (2) assembly; (3) manufacturing; (4) product development; (5) international strategy development.
e
The parent firm’s main line of business is defined to be its largest non-UK sales segments whose cumulative contribution to the entropy index of
diversification just exceeds 50%.
Accepted by Nicolai Juul Foss and Torben Pedersen, Departmental Editors, 11 February 2004. This paper has been with the author for two revisions.
Journal of International Business Studies