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Susan Perkins
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Kellogg Faculty Research: Susan Perkins, MORS

The power of the pyramid

Different ownership structures can make global joint ventures a challenge, says Professor Susan Perkins

By Adrienne Murrill

When conducting international business, companies have more than a language barrier to navigate.

Cultural differences, legal frameworks and taxes all influence strategic decisions. But something not typically at the forefront of a firm's strategy is how corporate governance and ownership structure differences in other countries can impact a business seeking global partnerships.

According to research by Susan Perkins, Kellogg assistant professor of management and organizations, the differences in ownership that exist around the world can make or break a firm's success if its leaders are unaware of such variations and the potential risks inherent to partnership. Perkins' recent research paper, "Innocents Abroad: Failure Rates of International Joint Ventures with Firms in Pyramidal Groups," addresses some of the consequences of not understanding those dynamics. This research is a collaboration with Randall Morck, distinguished chair and professor of finance at the University of Alberta School of Business, and Bernard Yeung, professor of global business, economics and management at New York University's Stern School of Business.

The typical ownership structure of a U.S. or U.K. company, where owners and managers are separate entities, is not common elsewhere, Perkins explains. With the exception of these two countries and others like Canada, Australia, Germany and Singapore, the dominant ownership structures are business groups in which owners and managers are often the same. Therefore, the core agency problem is one of shareholder protection for outside investors or joint venture partners. In Brazil, the focal country of this research, and throughout Latin America, these pyramidal ownership structures are called grupos.

One of the distinguishing features of grupos is their ability to leverage control of lower-tiered firms within their overall portfolio of firms. They achieve this through an extraordinarily disproportionate amount of "voting stakes" compared with "equity stakes" in the partnering firms. For example, in 2005 the ultimate owners of all Brazilian-listed firms retained 85 percent of the voting rights with only 51 percent of the equity stakes in the company. Insiders who control firms with these pyramidal structures are able to siphon resources between the various companies they control to further their own agendas rather than those of outside investors or the joint venture partnership.

"In thinking about the expropriation risks of joint venturing with a grupo, this paper attempts to illuminate the pitfalls and provide strategic insight on how to avoid falling into expropriation traps," says Perkins.

She and her research colleagues examined 96 companies that have entered the Brazilian telecommunications industry as joint ventures. They found that the Brazilian ownership structures combine with a foreign company in one of three ways: with a stand-alone firm, with another pyramidal structure, or with another form of business group (e.g. the Japanese keiretsu or South Korean chaebols). "We measure the success of these corporate governance and ownership structure combinations and find a significant relationship between market failure and having differing types of ownership structures," Perkins says.

Her research shows that 27 percent of partnerships between stand-alone firms and those with pyramidal structures fail. "However, we find that pyramidal groups that partner with other pyramidal groups have only an 8 percent likelihood of failure," says the Kellogg professor. "And if we compare that to the best form of foreign entry, which is a wholly owned subsidiary, those firms only have a 4 percent failure rate, which is not statistically different than the 8 percent failure rate of the pyramidal joint ventures."

In other words, how different governance and ownership structures interact will affect the success of these joint ventures. Perkins says firms with pyramidal structures know how to manage risk against one another better.

For example, when the pyramidal groups Portugal Telecom and Telefónica from Spain formed a partnership, they created strategies of reciprocity by purchasing cross-holdings in each other's companies. Other pyramidal firms have also used strategies of multiple point competition to pose a credible threat of retaliation for expropriation, thus reducing this risk. "If it looks like, instead of maximizing the joint venture, I'm starting to maximize my own wealth by siphoning out of the joint venture, then my partner can retaliate by competing against me in other markets," Perkins says.

The research team also found evidence that companies originating from a home country market where pyramids are dominant function better in host countries that also are dominated by pyramids because the players are more aware of how pyramidal grupos behave. Conversely, firms that are from home countries that do not have pyramids are at increased risk when entering pyramidal environments.

"The timing of this study is exciting given global trade and its importance to development of nations," says Perkins, who uses her research insights when teaching courses like International Business Strategy in Nonmarket Environments. "When we think about world economies and strategies to enable trade flows or foreign investment between nations, much of this challenge falls at the bedrock of figuring out the most effective alliance strategies to enable nations and firms within nations to work together."

These strategies require conducting due diligence within local markets to learn about potential partners before forming an alliance, she says. Equally important is thinking about nonmarket strategies. Questions of how one navigates the 'rules of the game' in a given corporate governance arena and the direct impact of those decisions on one's shareholder agreement are critical for managers.

Perkins will continue to explore market volatility driven by institutional difference to understand the strategic implications for managing such risks. This is an area she says is underexplored. She often refers to a large map of the world hanging in her Kellogg office to help her frame her perspective when contemplating dynamics of business moving between the U.S. and emerging markets. And she constantly probes the changing institutional landscapes in these nations.

"I have an interest in foreign investment and what drives economic development and growth, particularly in emerging market economies," she says. "Where opportunities are the largest comes the greatest chance of risk."

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