Exploring the Relationship Between Decision and Ownership Rights in Joint
Ventures
Evidence from Hungarian Joint Ventures
Josef Windsperger A1, Eva Kocsis A2, Miklos Rosta A3
A1
Center of Business Study, University of Vienna, Bruenner Str. 72, A-1210 Vienna,
Austria
A2
Corvinus University of Budapest
A3
Corvinus University, Fövám tér 8, H-1093 Budapest, Hungary
International Studies of Management and Organization
Issue: Volume 39, Number 4 / Winter 2009-10
Pages: 43 - 59
1
Exploring the Relationship between Decision and Ownership Rights in Joint
Ventures: Evidence from Hungarian Joint Ventures
Abstract
By applying property rights theory, we argue that the structure of residual decision
and ownership rights in joint ventures depends on the distribution of intangible
knowledge assets between the joint venture partners. Our analysis derives the
following hypotheses: The more important the joint venture partner's knowledge
assets for the generation of residual surplus, the more residual decision rights are
assigned to her. In addition, we examine two views on the relationship between
residual decision and ownership rights in joint ventures: Under the complementarity
view, ownership rights increase the knowledge and incentive effect of residual
decision rights. Under the substitutability view, residual decision and ownership
rights are negatively related because a certain level of control may result either from
the allocation of ownership rights or the transfer of residual decision rights to the
joint venture partners. These property rights hypotheses are tested in the Hungarian
market. Our data confirm the hypotheses that (a) the joint venture partner’s
intangible assets positively influence her proportion of residual decision rights, and
(b) residual decision rights are positively related with ownership rights.
Introduction
Starting from Barzel, Grossman, Hart and Moore (Barzel 1997; Grossman, Hart 1986;
Hart, Moore 1990), the allocation of residual decision and ownership rights depends
on the distribution of intangible (noncontractible) knowledge assets that generate the
firm’s residual surplus (see also Baker et al. 2004; Windsperger, Yurdakul 2007).
Intangible knowledge assets refer to the knowledge and skills (know-how) that cannot
be easily codified and transferred to other agents, since they have an important tacit
component (Kogut, Zander 1993; Zander, Kogut 1995). In joint ventures intangible
knowledge assets refer to the joint venture partners’ noncontractible capabilities
(know how in R&D, production and procurement management, marketing and
advertising, human resource management, organization design, strategy formation)
that cannot be easily transferred by contract (Hennart 1988; Nakamura, Xie 1998).
2
The thesis of the paper is: The more important the JV-partner‘s intangible knowledge
assets relative to the other for the generation of residual income, the more residual
decision rights should be assigned to her. In addition, we examine two views on the
relationship between residual decision and ownership rights in joint ventures: Under
the substitutability view (Lecraw 1984), residual decision and ownership rights may
be negatively related because a certain level of control may result either from the
allocation of ownership rights or the transfer of residual decision rights to the joint
venture partners. Under the complementarity view (Milgrom, Roberts 1990, 1995;
Brickley et al. 1995), residual decision and ownership rights are positively related
because the JV-partner’s motivation to use her knowledge assets to generate residual
income is increased if ownership rights are co-located with residual decision rights.
These property rights hypotheses are tested in the Hungarian market.
Although many theoretical and empirical studies dealing with the allocation of
residual decision rights exist in the organizational economics (Aghion, Tirole 1997;
Christie et al. 2003; Baiman, Larcker, Rajan 1995; Nagar 2002; Arrunada et al. 2001;
Lerner, Merger 1998; Brickley et al. 2003; Kaplan, Stromberg 2003; Elfenbein,
Lerner 2003; Hendrikse 2005; Vázquez 2005), no prior research tests a property rights
approach applied to joint ventures. This deficit may result from the difficulty in
collecting data on intangible knowledge assets and decision rights in joint ventures. In
addition, several studies in the international management literature investigate the
problem of control in joint ventures (Killing 1983; Schaan 1988; Geringer, Hebert
1989; Mjoen, Tallmann 1997; Chalos, O’Connor 1998; Calantone, Zhao 2000;
Pangarka, Klein 2004; Choi, Beamish 2004). However, in this literature control is a
very heterogeneous concept that is only partly related to decision rights. It has been
modelled by relative degree of ownership and/or a high level of management control
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and/or a high level of control of specific activities (Blodgetts 1991a, 1991b; Gray,
Yann 1992; Mjoen, Tallman 1997;Yan, Gray 2001).
Starting from this deficit, we operationalize residual decision rights as control
over the use of assets in a joint venture (Hansmann 1996; Nagar 2002; Elfenbein,
Lerner 2003; Windsperger 2004). This view is also closely related to Rajan and
Zingales’ concept of access to critical resources (Rajan, Zingales 1998; 2001). They
argue power stems from control over critical assets that generate the residual income
stream. Our main contribution to the joint venture literature is the following: First, we
present a property rights view on the allocation of residual decision and ownership
rights in joint ventures, and second we empirically investigate the structure of
decision and ownership rights in Hungarian joint ventures.
The paper is organized as follows. Section two uses the property rights
approach to examine the relationship between the characteristics of the joint venture
partner’s knowledge assets and the allocation of residual decision rights. Section three
investigates the relationship between residual decision and ownership rights in joint
ventures. In section four we apply this framework to derive testable hypotheses. The
hypotheses are finally tested in Hungary.
The Structure of Residual Decision Rights in Joint Ventures
According to the property rights view, the allocation of residual decision rights
depends on the distribution of intangible (noncontractible) assets: The more important
a person’s intangible knowledge assets for the generation of the residual income
relative to another person, the more residual decision rights should be assigned to that
person. Which knowledge assets are generated and used in joint ventures? We analyse
4
a joint venture (JV) with two joint venture partners (P1, P2). The JV-partners that
create a joint venture company face the problem of maximizing the returns to
intangible knowledge assets of the JV-company when they are dependent on both
partners’ investments in these assets. For instance, in international business relations
the intangible knowledge assets (know-how) of P1 includes knowledge and skills
(organizational capabilities) in product development, procurement, production and
branding, and the intangible knowledge assets of P2 refer to the local market access,
cultural and institutional know-how and human resource capabilities (Lecraw 1984;
Fagre, Wells 1982; Hennart 1988; Nakamura 2005).
How does the distribution of intangible knowledge assets between the JVpartners influence the distribution of residual decision rights in joint ventures?
Residual decision rights refer to the strategic and operational decisions of the JV, such
as strategy formation, organization design, product, price, marketing, advertising,
procurement and production, finance and investment, human resource management,
and controlling system, that generate the residual income stream. According to Jensen
and Meckling (1992), two ways for allocating decision rights exist: Either knowledge
must be transferred to those with the right to make decisions or decision rights must
be transferred to those who have the knowledge. Thus, decision rights are allocated to
P1 when the costs of transferring knowledge from P2 to P1 are relatively low. This is
the case when P2‘s knowledge assets are less intangible and, therefore, more
contractible. In this case, P1 has a stronger bargaining power, due to her intangible
knowledge assets that generate the residual surplus, and P1 can easily acquire the
knowledge assets from P2, due to its high degree of contractibility (low degree of
intangibility). On the other hand, residual decision rights have to be transferred to P2
when her knowledge is very specific and consequently the knowledge transfer and
5
control costs are very high. In this case, the bargaining power of P2 is relatively
strong due to her noncontractible know-how. Furthermore, if it is important to take
advantage of both partners’ intangible knowledge assets to generate a high residual
income stream of the JV, residual decision rights must be allocated to both partners to
efficiently utilize their specific knowledge. Therefore, an efficient decision structure
implies co-location of knowledge assets and decision rights (Brickley et. al. 1995). As
a result, the property rights view on the allocation of decision rights in joint ventures
can be summarized by the following hypothesis:
H1: The higher the intangible knowledge assets of partner 1 relative to
partner 2, the higher partner 1’s fraction of residual decision rights.
The following example illustrates this view. We compare two situations (see figure 1):
(A) P1 has a large fraction of intangible knowledge assets (for instance,
technological and brand name know-how) and the know-how of P2 (for
instance, local market knowledge and human resource capabilities) is less
intangible and hence more contractible. Due to P1’s dominant know-how
position she should get a large fraction of residual decision rights to maximize
the JV’s residual income stream.
(B) P2 has a large fraction of intangible knowledge assets (for instance,
local market knowledge and cultural know-how) that generate a high residual
surplus and the P1’s assets are less intangible. In this case, the residual
decision rights must be assigned according to P1 and P2’s know-how position.
Therefore, compared to case A, P2 has a stronger bargaining power and hence
more residual decision rights are transferred to P2.
6
Insert figure 1
If these conditions are not fulfilled, the following inefficiencies may arise: (a)
Inefficiencies arise because a large fraction of residual decision rights is transferred to
P2 although P1 has the most important part of intangible knowledge assets that
generates a large fraction of the total residual income stream of the JV (see (2) in
figure 1); (b) inefficiencies arise because a low fraction of residual decision rights is
transferred to P2, although P2 has a large part of intangible knowledge assets (see (3)
in figure 1). In this case, P1 mainly influences the JV-decisions, although he has not
the most relevant knowledge assets that generate the residual income stream.
Consequently, if there is a misfit between the distribution of intangible knowledge
assets and the allocation of decision rights the JV’s residual surplus cannot be
maximized.
Residual Decision and Ownership Rights: Complements versus Substitutes
Since the governance structure of the JV consists of ownership and residual decision
rights, the question to ask is which relation exists between ownership rights and
residual decision rights. There are two views on the relationship between residual
decision rights and ownership rights:
(I) Complementarity view: This view was developed by Milgrom and Roberts
(1990; 1995). Milgrom and Roberts’ supermodularity theory predicts that investments
in one organizational practice (e.g. information technology) will generate increased
residual income of the firm only if they are bundled with investments in other
organization design variables, such as more decentralized decision-making, more
highly skilled workers and more performance-based incentives (see also Arora,
7
Gambardella 1990; Brickley et al. 1995). Thus, a joint implementation of several
organizational practices may lead to economies of scope (Baumol et al.1988). Applied
to the governance structure of joint ventures, complementarity means that the transfer
of ownership rights increases the residual income-increasing effect of the transfer of
decision rights, and the transfer of decision rights increases the residual incomeincreasing effect of ownership rights (Van den Steen 2006). Therefore, residual
decision and ownership rights are positively related.
(II) Under the substitutability view, residual decision and ownership rights are
negatively related. In this case, the transfer of ownership rights decreases the residual
income-increasing effect of the transfer of decision rights, and the transfer of decision
rights decreases the residual income-increasing effect of ownership rights (Lokshin et
al. 2004). As Lecraw (1984) has already argued, residual decision and ownership
rights in joint ventures may be negatively related because a certain level of control
may result either from the allocation of ownership rights (as formal authority) or the
transfer of residual decision rights (as real authority) (Aghion, Tirole 1997). Under
this view, the more residual decision rights are assigned to a joint venture partner, the
less ownership rights must be transferred to her to maintain a certain level of control
over the firm’s intangible assets. Hence, a lower proportion of ownership rights must
be compensated by a higher proportion of residual decision rights. We can derive the
following hypotheses:
H2a: Complementarity view: The JV-partner’s residual decision rights are
positively related with the proportion of ownership rights.
H2b: Substitutability view: The JV-partner’s residual decision rights are
negatively related with the proportion of ownership rights.
8
Empirical Analyses
Data Collection and Measurement
The empirical setting for testing these hypotheses is the Hungarian market. We used a
questionnaire to collect the data from a sample of 530 Hungarian companies. The data
set was collected between October 2004 and March 2005. The questionnaire took
approximately 15 minutes to complete. We received 80 completed responses. To trace
non-response bias, we investigated whether the results obtained from analysis are
driven by differences between the group of respondents and the group of nonrespondents. Non-response bias was measured by comparing two groups of
responders (October 2004, March 2005) (Amstrong & Overton 1977). No significant
differences emerged between the two groups of respondents.
To test our property rights hypotheses, the following variables are included in
the regression analysis:
Intangible knowledge assets, ownership rights, residual
decision rights, as well as firm size, age and technological uncertainty as control
variables (see appendix).
Intangible Knowledge Assets (KNOW): The joint venture partner’s intangible assets
refer to the specific knowledge of local markets, distribution channel, procurement,
human resource management, technological know how, organizational capabilities,
and knowledge of cultural and the institutional environment. In the questionnaire, the
general managers of the Hungarian JV-companies were asked to rate on a seven-point
scale the JV-partner's intangible assets. A ten-item scale measures the relative knowhow advantage of partner 1 compared to partner 2 (partner 1 is the partner with the
higher equity stake). The ten-item measure was extracted by employing factor
analysis. All variables had a loading in excess of 0.7. The total amount of variance
9
explained by the factor solution is 64 percent. The reliability of this scale was
assessed by Cronbach’s alpha (0.93).
Residual Decision Rights (DR): The indicator of decision rights (DR) is a measure
about the distribution of decision-making authority between the joint venture partners.
Our decision rights variable includes the following decisions of the JV: Procurement
decision, price and product decisions, advertising decision, human resource decisions
(recruitment and training), investment and finance decisions, strategy formation and
organization decisions, and decisions concerning the application of accounting and
control systems. The indicator of decision rights addresses the extent to which
residual decisions are influenced by partner 1 compared to partner 2. Hence, it is a
measure for distribution of the decision-making power in the joint venture company
that is compatible with Nagar’s measure of decision rights in retail banking (Nagar
2002) and Windsperger’s measure of decision rights in franchising networks (2004).
The general managers of the joint venture companies were asked to rate the joint
venture partner's influence on these decisions on a seven-point scale.
Ownership Rights (OR): The joint venture partner’s ownership rights (OR) are
measured by the percentage of ownership of the joint venture partners in the joint
venture company (= equity ratio).
Control Variables
We controlled for three variables that might affect the allocation of decision rights in
joint ventures.
Firm Size (SIZE): We use the sale value of the JV-partner’s parent firm as proxy of
the firm size representing economies of scale of coordination and monitoring
(Brickley et al. 1991).
The larger the size of the parent firm, the larger its
10
coordination and monitoring capacity, the more easily the parent firm can control the
joint venture company, and hence the lower the propensity to transfer residual
decision rights to the other partner.
Joint Venture Experience (AGE): We use the number of years of the joint venture
company’s existence as proxy for interorganizational learning. The older the joint
venture company, the larger the knowledge conversion effect from tacit
(noncontractible) to more explicit (contractible) knowledge due to interorganizational
learning (Inkpen 2000; Nonaka, Takeuchi 1995), and the more control can be
exercised.
Technological Uncertainty (UNCERT): We use technological uncertainty as proxy for
knowledge spillover costs. Knowledge spillover costs may arise because the joint
venture partner has access to intangible knowledge of the other partner(s) after the
joint venture company was created (Inkpen 2000; Nakamura 2005; Hennart, Zeng
2005). Under given intangible knowledge assets, the spillover costs may increase with
technological uncertainty. The higher the technological uncertainty, the higher the
knowledge spillover risk, and the more residual decision rights are required to capture
a large fraction of the residual surplus.
Results
Table 1 and 2 contain descriptive data of the Hungarian joint venture companies.
Insert Table 1 and 2
11
H1: Decision Rights-Hypothesis
To test this hypothesis (H1) we carry out an ordinal regression analysis with the index
of decision rights (DR) as dependent variable (Chu, Anderson 1992): The explanatory
variables refer to joint venture partner’s knowledge advantage (KNOW), firm size
(SIZE), age (AGE), and technological uncertainty (UNCERT). We estimate the
following regression equation:
DR =  +  1KNOW+  2SIZE +  3AGE +  4UNCERT
Based on our property rights hypothesis, decision rights (DR) positively vary with the
P1’s know-how advantage (KNOW). Further, we include three control variables: DR
positively vary with SIZE due to economics of scale of coordination and monitoring,
AGE due to organizational learning, and technological uncertainty (UNCERT) due to
the knowledge spillover risk. Hence  1,  2,  3 and  4 have a positive sign.
The results of the ordinal regressions are provided in table 3. The fit of the
models was based on the log of the likelihood ratio. The chi-square value of 31.178 is
significant at p < 0.001 thus rejecting the null hypothesis that the estimated
coefficients are zero. The overall fit of the ordinal regression model point to the
appropriateness of the set of variables in predicting the distribution of residual
decision rights in joint ventures. The coefficient of intangible knowledge assets
(KNOW) is highly significant and consistent with our property rights hypothesis. The
larger the know-how advantage, the more residual decision rights are transferred to
P1. In addition, the coefficients of SIZE and UNCERT have the expected positive
sign and are significant. On the other hand, AGE is not significant. Finally, colinearity
12
diagnosis was performed using correlations between the independent variables (see
table 4).
Insert Table 3 and Table 4
H2: Interaction between Decision and Ownership Rights
Several studies (Arora & Gambaredella 1990; Ichniowski et al. 1997; Laursen &
Mankhe 2001; Hitt & Brynjolffson 1997) empirically measured interactions between
organizational variables. We test the interaction effects between residual decision
rights (DR) and ownership rights (OR) - hypotheses (H2a, H2b) – by using partial
correlations. Following Arora & Gambardella 1990 and Arora 1996, we apply the
correlation analysis for examining possible complementarities/ substitutabilities
between residual decision rights and ownership rights in joint ventures. Since a simple
correlation might be spurious, because a common set of factors influences the
governance structure variables, we compute conditional correlations between the
decision and ownership rights variables (Hitt & Brynjolffson 1997). Therefore,
correlation analysis is done, controlling for the knowledge assets, technological
uncertainty and size. The correlation coefficient between the JV-partner’s proportion
of ownership rights and the decision index is positive and highly significant (0.411; p
< 0.01). This result suggests that residual decision and ownership rights are
complements in joint ventures. In addition, ordinal regression analysis also confirms
this result (see table 5. The coefficient of the proportion of ownership (OR) is positive
and highly significant.
Insert Table 5
13
Discussion and Implications
The goal of the paper is to provide a property rights view on the allocation of residual
decision and ownership rights in joint ventures. First, we test the hypothesis that the
joint venture partner’s residual decision rights directly vary with the importance of her
intangible knowledge assets to generate the ex post surplus of the joint venture. The
data from 80 Hungarian joint ventures confirm the hypothesis that the joint venture
partner’s intangible assets positively influence the tendency toward a higher
proportion of residual decision rights. Second, we investigate the relationship between
residual decision and ownership rights of the joint venture partners. Our results are
compatible with the complementarity view of governance structure (Milgrom, Roberts
1995; Jensen, Meckling 1992; Roberts 2004). The JV-partner’s motivation to use her
intangible knowledge assets to generate residual income is increased if ownership
rights are co-located with residual decision rights. The data from 80 Hungarian joint
ventures support this hypothesis.
Compared to previous research, our study made an important contribution to
operationalize the residual decision rights of the joint venture partners. Consistent
with Yan and Gray’s view (Yan, Gray 2001), we developed a measure for residual
decision rights consisting of strategic and operational decisions. However, our
empirical study has some limitations: First, although the database in the survey
sample is diverse, it remains far from a large and statistically random sample. Second,
while the empirical results provide support for the property rights hypotheses,
additional empirical evidence is required to increase the generalizability of the results.
Furthermore, future research has to investigate the relationship between allocation of
decision and ownership rights and the performance of the joint venture. Our property
14
rights proposition suggests a positive relationship between complementarity of
decision and ownership rights, on the one hand, and performance of the joint venture
company, on the other hand.
This study also has managerial implications. First, the result of this study
indicates that the allocation of decision rights in joint ventures must be based on the
distribution of the JV-partners intangible knowledge assets for the creation of residual
surplus. Therefore, this study provides companies with guidance to structure residual
decision rights in joint ventures. High noncontractible know how may generate high
residual surplus for the joint venture company, if the joint venture partner has the
relevant residual decision rights to efficiently use her intangible knowledge assets for
the creation of the total income stream. Conversely, low intangible and hence
contractible know how does not influence the residual income stream of the joint
venture even if the joint venture partner has a high proportion of residual decision
rights. Second, our results suggest that the use and creation of knowledge in joint
ventures can be improved, if residual decision rights are co-located with ownership
rights. This is especially important in the case of joint ventures for the creation of
innovations (Grandori, Furlotti 2006). For instance, high innovation capabilities of a
joint partner with a high fraction of residual decision and ownership rights are likely
to generate a high residual surplus because the partner is motivated to efficiently use
her intangible innovation assets. On the other hand, high innovation capabililties of a
partner with a low fraction of residual decision rights are unlikely to maximize the
residual income stream because the joint parnter is unable to influence the use of
innovation assets, even if she has a large fraction of ownership rights. Moreover, high
innovation capabilities of a partner with a high fraction of decision rights but a low
fraction of ownership rights are also unlikely to generate a high residual surplus
15
because the partner has not the incentive to efficiently use her innovation assets under
a small proportion of ownership rights.
16
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APPENDIX: MEASURES OF VARIABLES
Intangible knowledge assets (KNOW) (1 – 7) (ten items; Cronbach Alpha = 0.93):
JV-partner 1’s relative know-how advantage compared to JV-partner 2 concerning the
following value chain activities:
(Production and logistics, recruiting, local market services, strategic planning,
controlling, R&D, organization design, strategy formation, local market
knowledge, local institutional knowledge)
Firm size (SIZE): Average sale value of the parent firm of JV-partner 1 (per year)
Technological uncertainty (UNCERT) (1 – 5):
The JV-manager has to evaluate technological uncertainty on a 5-point scale:
Extent of technological changes.
Decision rights index (DR) (Mean):
To which extent does JV-partner 1 influence the following decisions compared
to JV-partner 2? (1 – 7)
(Recruiting, training, selection of cooperation partners, selection of suppliers,
incentives and wages, promotion and advertising, investment projects, price
decisions, organization structure and strategy, marketing, product
management, production and procurement, accounting and controlling system,
selection of lenders)
Age of the JV-company (AGE): Number of years of existence
Ownership rights (OR): Percentage of asset ownership of joint venture partner 1
(= equity ratio)
20