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

The widely accepted conventional viewpoint of Jensen and Meckling (1976) suggests that large listed firms have diffuse shareholders and no controlling owner. However, recent research shows that large corporate sectors of many economies outside the U.S. and U.K. are dominated by pyramidal corporate groups, not widely held firms. Thus, corporate governance behaviors and agency issues in the context of the pyramid take on new meaning. These pyramidal structures have entrenched controlling insiders who impose exacerbated agency problems to under-informed outside investors, particularly joint venture partners from host countries dominated by widely held firms. The controlling insiders are thought to divert resources between companies they control to advance their private agendas of wealth or utility maximization and not the joint venture. We identify the differences in the agency problems in widely held stand alone firms versus pyramidal firms and expose the pitfalls of joint venturing with firms belonging to pyramidal groups. We show that joint ventures between multinationals based in countries where pyramiding is rare and pyramidal group member companies have significantly elevated failure rates. We infer that this reflects the multinationals' unfamiliarity with the expropriation risks associated with pyramidal groups. Conversely, joint ventures among pyramidal groups are more likely to succeed. We present clinical examples that illustrate the mechanisms that drive such divergent performance in joint venture partnerships. While our results are based on a single industry in a single country, we believe the concerns are general.