FAROK J. CONTRACTOR
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WONCHAN RA
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Technology transfer lies at the heart of many alliances. This study links the choice of different organizational forms with various compensation formulae written in alliance agreements, a neglected area in academic research, but well-known to firms. Each formula for compensating the knowledge supplier carries with it different implications for return, control and risk or contingency, and affects the future behavior of each partner towards the alliance. The preferences of the knowledge-supplying versus technology-receiving partner regarding compensation and organizational mode are then explained by transaction, firm, and contextual variables, with negotiation power as a switching variable.
Key Words: Technology Transfer,Negotiations to Form an Alliance, Compensation Patterns, Choice of (Inter)organizational Mode
Today there are hundreds of thousands of corporate alliance agreements, both international and domestic. The academic literature has examined the rationale for alliance formation (Burgers, Hill and Kim, 1993; Contractor and Lorange, 1988; Eisenhart and Schoonhoven, 1996; Gomes-Casseres, 1994; Hagedoorn, 1993). It has examined the managerial processes in forming alliances (Fornell, Lorange and Roos, 1990). There is now a large literature on the determinants of alliance success and performance, or instability (Bleek and Ernst, 1991; Blodgett, 1992; Geringer and Herbert, 1991; Hagedoorn and Shakenraad, 1994; Harrigan , 1988; Park and Russo, 1996; Parkhe, 1993). It has treated the modal choice issue of when an alliance may be preferred over the alternatives of a newly formed, wholly owned subsidiary or acquisition (Balakrishnan and Koza, 1993; Beamish and Banks, 1987; Hennart, 1991; Kogut and Singh, 1988; Osborn and Baughn, 1990).
In this paper an "alliance" is defined as any joint or cooperative activity between otherwise unrelated companies, involving an exchange or transfer of knowledge, or a sharing of economic value in territorial, intellectual property rights, or market access. This could be under an implicit or formal contractual agreement, or under the aegis of a third joint venture company created by the principals.
This leads to a research question that has been neglected until relatively lately, namely
the choice between various alternative alliance modalities such as equity JVs versus, franchising, versus other contractual forms. Only a few studies ( Contractor and Kundu, 1998; Dutta and Weiss, 1997; Shane, 1996) have recently begun to address this issue. The modal choice question is no longer between just direct equity investment and licensing or trade. The choices include varieties of alliances involving a variety of organizational forms and compensation arrangements.
To complicate the situation even further, practicing managers today are increasingly structuring alliances with a mix of provisions. The same alliance can have equity investment, as well as licensing payments for intellectual property rights, as well as marketing arrangements involving raw material or finished good supply at internally negotiated transfer prices. In many equity joint ventures today, there are detailed auxiliary agreement provisions involving payment of royalties, lump-sum fees and negotiated mark-ups or margins on component supply. The old theoretical distinctions, between direct equity investment, licensing, and trade are no longer watertight compartments in many of today’s alliances. They may all be simultaneously present in the same alliance. In short, there are a variety of (inter)organizational forms under the "alliance’ rubric.
The (inter)organization form or structure is a function of the compensation arrangements in the alliance agreement, and vice versa. Thus the issue of compensation arrangements is central to the study of alliances, because compensation structure affects performance and the future behavior of the partners. Yet, there have been virtually no studies addressing this question. Blodgett (1991) looked at only one alliance type, namely international equity alliances and asked how the equity shares of the partners were affected by each partner’s negotiation power, which in turn was operationalized by technology ability, local knowledge and host government restrictions. Studies by Macho-Stadler, Martinez-Giralt and Perez-Castrillo (1996) involving 241 licensing agreements in Spain as well as Aulakh, Cavusgil and Sarkar (1998) examining 110 American licenses, ask what determines the mix of licensor compensation between lump-sum or fixed fees, versus running royalties. They explain the proportions of the two compensation types by variables such as the type of technology involved, the degree of patenting, host nation environment, firm size, competition, etc. These two studies were focused only on licensing.
However, the most general case involves a larger spectrum of alliance modalities and compensation types involving dividend returns on equity investment, running royalties, lump-sum payments for technology rights, and marketing or logistic supply markups for items traded between the principals and/or the joint venture company. This general case is treated in this paper.
Compensation Contingency and Interorganizational Relationships
An employee’s behavior and performance are affected by compensation structure and incentives written into the employee’s agreement. Why should not compensation incentives/disincentives, and the risk-payoff balance, also affect the behavior of allies in interorganizational partnerships? Indeed they do. Agency theory and transaction cost theory can be used to comment on the risk perceptions, incentives, shirking and opportunism that accompany each of the compensation types that appear in alliance agreements.
Virtually all alliances include one or more of the compensation elements shown in Figure 1 below. In return for the transfer of technology or knowledge, one of the allies, (as licensee in the agreement) may agree to pay the other (as licensor or knowledge supplier) a lumpsum fee and/or running royalties. Lumpsum fees are generally a flat or fixed amount due at the inception of the agreement. By comparison, royalties are typically indexed to a percentage of future sales to be achieved by the alliance or by the knowledge recipient (under license). Incidentally, in many alliances the equity joint venture itself signs an agreement with one of it’s own "parents" that is going to supply the joint venture alliance with requisite knowledge or technology. Markups can be earned as a compensation element by one of the principals that supplies components, or buys finished product back from the other partner, or from the joint venture company. These three compensation elements, lumpsum, royalties and markups can exist in an alliance which is based either on a simple contractual license basis and/or equity joint venture basis. The fourth compensation type, namely dividends, can only exist in the case of an equity joint venture created by the two allies.
Lumpsum Payments |
Running Royalties |
Markups on |
Dividends
|
Figure 1 shows not merely a spectrum of compensation types increasing in contingency from left to right – it also shows increasing inter-organizational ties from left to right. When lumpsum payments are the sole compensation, the arrangement is typically a one-time contract of short duration – a quick, discrete technology transfer. Running royalty licensing agreements are of longer duration, and involve some on-going technical or other collaboration between the allies. Traded components or goods makes for an even more extended relationship. And an equity joint venture investment, is at least in theory, a marriage for ever. A licensing alliance can encompass the first three compensation types; an equity joint venture can include all four types.
Each compensation type carries different levels of uncertainty and induces different expected behaviors in the knowledge supplying and knowledge receiving partner, according to agency and transaction cost theories. "Compensation Contingency" is defined here as the degree of uncertainty or risk associated with each type of compensation.
Each element of compensation entails a different relative degree of compensation contingency. First of all, lumpsum payments made to the technology supplier have zero or low contingency since they are assured based on the agreement, assuming contract enforceability. However, if this is the only compensation element, a knowledge supplier after receiving all the compensation at the start of the project has little incentive or rationale to make continuing commitment to the alliance and may be tempted to shirk from its duty to later support the alliance. For the knowledge supplier once the payment is received there is also no need to monitor the future performance or behavior of the recipient. This compensation type has therefore, by definition, low uncertainty or contingency for the technology supplier. On the other hand, the knowledge recipient may be fearful that the supplier might shirk and neglect to transfer the knowledge specified in the agreement.
Royalties are agreement-specified and usually expressed as a percentage of the royalty base such as sales or production. Royalties have a high contractual enforceability just like the lumpsum type. However, the compensation can be variable depending on the sales or production performance of the alliance venture, so the compensation is contingent unlike the lumpsum type. In the royalty type of compensation, the technology supplier will have an interest in the future performance of the alliance, which relies upon the effectiveness of the transferred knowledge and the successful operation of the alliance. This applies to a license arrangement and even more so for a joint venture alliance company in which the licensor also has an equity interest. However, in the former case, the knowledge supplier is uncertain about an independent licensee’s behavior in reporting compensation properly, since a licensee has a natural incentive to under-report sales or production on which the total royalty is calculated in each financial reporting period. So a technology supplier (licensor) has a desire not only to get involved in improving the alliance venture’s performance, but also monitoring the knowledge recipient’s (licensee’s) activities. An empirical study comparing the royalty and lumpsum types confirmed that the licensor’s involvement in the licensee’s operation is higher with a running royalty agreement than in agreements with lumpsums alone (Aulakh et al. 1998).
Markups are earned on products such as components exported by the knowledge supplier to the licensee partner or to its own alliance joint venture company. But markup profits are contingent on the alliance’s production and sales volume. The component supplier has a commitment to the alliance venture because their compensation depends on the performance of the alliance venture. This is similar to running royalties. But expected compensation through markups has a higher contingency risk compared to royalties, because both volume and price of the traded products would have to be agreed upon between the parties, and specified in the agreement. This is not always the case. Even if component volume is specified, the unit price is often left unspecified in agreements, or subject to future renegotiation. In the long run local inputs might replace the component supplied under import from one alliance partner. From the point of view of the supplier, markups on traded products thus carry more contingency risk than the running royalty type of compensation. From the purchaser’s point of view, they fear the moral hazard problem relating to the supplier’s behavior regarding future transfer prices of the traded product.
A technology supplier can be a dominant, equal or minority shareholder in the alliance venture and earn dividends as a compensation element. Dividends are most directly linked to the success or failure of the alliance profits. The degree of contingency is highest with dividends, as compared with the other three compensation types. Figure 1 shows the four types in increasing level of contingency risk. While the uncertainty of returns on equity investment is highest, so also is the expected return, compared to pure licenses and other non-equity alliances (Contractor 1985). This is also seen in the national balance of payments statistics of technology exporting nations where the receipt of foreign licensing income is considerably smaller than dividend earnings of their multinational company investments abroad. But while licensing income is relatively steady over the business cycle, dividends based on profits are far more volatile. This is no surprise, as sales (on which most royalties are based) are axiomatically less volatile than profits (from which dividends are declared). Another element of uncertainty regarding dividend earnings in equity joint ventures is that the level of dividend declaration, per share, is a joint managerial decision by both partners. It is well known that -- especially in international joint ventures – the two partners often exhibit different payout /retention preferences. Therefore, dividends are the most contingent of the four compensation types, even though in the long run they may provide the largest total return.
Since profits and dividends are directly relate to success of the venture, this compensation element also provides the strongest incentive for a knowledge supplier to make continuing future commitments to the performance of the venture. The supplier’s commitment may include the transfer of managerial resources such as manpower or a broader range of knowledge beyond merely providing manufacturing knowledge. The partner that is a net knowledge recipient in the prospective joint venture know this and feels more assured about the technology supplier’s willingness to render continued assurance under an equity joint venture arrangements (as opposed to say a lumpsum where they may "take their money and run," or a more distant licensing relationship). But this assurance can come at a high price, as far as the knowledge recipient is concerned, because sharing dividends over the long term can be the most costly way to acquire technology, as opposed to royalty or other contractual arrangements that have a finite agreement life.
A knowledge supplier and knowledge recipient’s perspectives on each compensation type are therefore not necessarily congruent, even though, broadly speaking, both would agree that the level of contingency increases from lumpsums, to royalties to markups to dividends.
TABLE 1
Characteristics of Compensation Elements
Lumpsum Payments |
Running Royalties |
Markups on Traded Products |
Dividends |
|
Compensation Base and Source |
Agreement-bound fixed payment |
Fixed to an agreement-bound certain percentage of sales/production |
Volume, and possibly unit price of components specified and linked to sales/production |
Declared profit |
Contractual Enforceability |
Very high |
Very high |
High (depends on agreement) |
Low |
Volatility of Expected Total Return |
Near zero |
High |
High |
Very high |
Technology Recipient’s Perception of Moral Hazard from Supplier |
Very high |
Low |
High |
Very low |
Terchnology Supplier’s Perception of Moral Hazard from Recipient |
None |
High |
High |
Very low |
Technology Supplier’s Commitment |
Very low |
High |
High |
Very high |
These differing perspectives are summarized in Table 1. According to each partner’s perception of the inherent degree of compensation contingency, they will each exhibit different preferences as to compensation structure. From the viewpoint of a technology recipient, as a payer for the knowledge, they are at an informational disadvantage at the negotiation stage. Their preference for the degree of compensation contingency and the overall compensation structure written into the agreement will be influenced by various factors such as the nature of the knowledge transferred, the expected demand of the alliance product, and their perceptions as to the future behavior of the knowledge supplier which may be opportunistic.
Technology Versus "Knowledge"
In this paper the words "technology" and "knowledge" are used interchangeably. The former generally evokes production process expertise while the term "corporate knowledge" implies a broader organizational capability that goes beyond production operations to encompass other departments such as marketing, strategy. The successful implementation of a transferred technology does not stop with making a good product or service. Success also depends on good sales and competitive strategy in general. Hence in this paper both words are used interchangeably in their broader implications. We should recognize however, that as we go from left to right in Figure 1 (on the spectrum of inter-organizational modes and compensation types) that the alliance context gets broader. On the left hand side, with only a lumpsum contract, the likelihood is for a discrete technology transfer, in its narrower sense, involving mainly technical information. On the extreme right hand side, an equity joint venture generally involves much stronger inter-organizational ties in all areas of the alliance’s operations.
THE NEGOTIATION DYNAMICS OF THE CHOICE OF COMPENSATION TYPE AND ALLIANCE STRUCTURE
The choice of compensation types and alliance organization is the outcome of a joint negotiation between technology supplier and technology recipient. Each party’s preferences and aversions will not necessarily be congruent. Each party will be influenced during negotiations by their varying perspectives on transaction-specific factors such as 1. The newness of the technology, 2. Its degree of complexity, 3. Codifiability of the knowledge transferred, 4. Its relatedness to the recipient’s existing knowledge base, 5. The project capital cost; on firm-specific factors such as 6. The technological competence of the recipient, 7. Their experience in the technology, 8. Prior ties between the negotiating parties, 9. The knowledge supplier’s reputation, 10. The threat of competition from the supplier; and contextual factors such as 11. The expected variance of the alliance product sales over time and in general, 12. The relative bargaining power of the parties.
How do each of these twelve factors affect the choice of alliance mode and compensation along the spectrum shown in Figure 1? The empirical portion of this study is based on the acquisition by American firms of foreign technology. But obviously the alliance mode and compensation cannot be dictated by the American recipient alone, but by the foreign technology supplier as well, whose preferences and perceived uncertainty (Miller, 1992) may or may not coincide.
Transaction-Specific Factors:
The Newness of the Knowledge
Much of the existing literature on the choice of foreign market entry mode, is based on the perspective of the knowledge supplier (e.g., Contractor 1984; Davidson and McFetridge 1985), and shows that the nature of the transferred technology is related to the transfer mode. Newer technologies tend to be transferred via intra-firm channels (e.g., wholly owned subsidiary) rather than through markets (e.g., licensing). Newer knowledge with greater uncertainty for commercial success, and more competition early in the product cycle, will induce the knowledge supplier to provide more technical assistance to the alliance in order to persuade the knowledge recipient and conclude the agreement. To recoup this greater commitment the knowledge supplier will likely seek compensation channels that provide greater absolute return (i.e. towards the right side of the spectrum shown in Figure 1).
To the knowledge recipient, newer knowledge can cause greater uncertainty because of their informational disadvantage. The transferred technology may not work properly in the new location, and even newer technology might displace it (Caves et al. 1983). The performance of newer and introductory technologies is not fully proven and the valuation of such knowledge will therefore be more difficult. So, in acquiring such knowledge, the recipient is more likely to prefer contingent compensation (i.e. compensation based on sales or profit performance) to avoid the risk of overpayment, and will want the supplier to make a greater commitment to the alliance to ensure the better performance of the transferred knowledge.
When the knowledge to be transferred is new, the knowledge recipient may discount its value heavily and put a low Net Present Value (NPV) price on it because its future performance is uncertain. This would reduce the possibility of concluding the agreement. In such case, the knowledge supplier also tends to avoid a lumpsum agreement whereby the value of the knowledge has to be agreed upon between partners in advance as a fixed payment. Instead, in such negotiation situations, a contingent or variable compensation formula can satisfy both parties. Royalties, expressed as a percentage of sales, are a variable cost to the payer – a "pay as you sell" arrangement (Contractor 1985a). Under conditions of even greater bounded rationality, an equity dividend arrangement is even more of a variable or contingent payment – a "pay if you make profits" arrangement.
Therefore, for this variable, the negotiating perspectives of both knowledge supplier and recipient are congruent.
H 1: The newer the knowledge to be transferred, the more likely a compensation structure entailing higher contingency will be preferred by both partners.
The Degree of Sophistication of the Knowledge
When the complexity or sophistication of the technology to be transferred is high, other things being equal, the knowledge recipient will need more help or commitment from the supplier in assimilating and applying the knowledge. Complex technology transfer is not a quick event, nor can it be effectuated over a short period. Effectual transfer of sophisticated technology can take many years. Hence a lump-sum payment schedule would not be congruent. At the same time, the knowledge recipient, being aware of this, may be unwilling to risk loss of commitment in the long run by a technology supplier that "takes their money and runs." Ongoing incentives are provided by running royalties and share of future profits. A knowledge supplier may demand, as insurance, a higher amount of up-front payment, which does not depend on the performance of the alliance, to cover their early costs, as part of an overall package. But both parties would be unwilling to hazard all compensation on this single up-front payment.
Also, from the standpoint of the supplier transferring sophisticated knowledge, they are more concerned about a) the possibility that the knowledge will be misused or misappropriated by the knowledge recipient and b) eventual competition from the recipient -- especially when transferring more sophisticated knowledge. Telesio (1979) showed in his empirical study that competitive threat and control needs inhibit arms-length licensing in sophisticated technologies. In general, knowledge suppliers are concerned about technological loss along with inadequate compensation (Contractor 1985a). In their thinking, how might they better control the opportunistic or competitive proclivities of the recipient? By being more involved in the alliance venture, in a relationship rather than as a one-time transactor. To get greater control and involvement, royalties are better than lumpsums, and an equity holding in the recipient alliance is even better. This increases the overall level of contingency, but in sophisticated technologies, the need for control and the lure of greater absolute returns via dividends becomes the dominant consideration. Therefore,
H 2: The higher the degree of sophistication of the knowledge, the more likely a compensation structure entailing higher contingency will be preferred by both partners.
The Codification of the Knowledge
Knowledge can be classified into codified or tacit knowledge. Non-codified knowledge cannot be easily written in manuals, blue prints and formulae, etc. because it is difficult to explicitly articulate and to demonstrate to others (Teece 1981). Uncodified knowledge can be hard to patent or register because its contents and boundaries are difficult to define (Anand and Khanna 1996). Patents, in any case, only provide some hint of codification, and are very synoptic. In addition, firms may be loath to patent for fear of revealing secrets and because not all information is patentable (Macho-Stadler et al. 1996). Thus much, perhaps most, technology is unpatented.
The transfer of tacit knowledge requires more face-to-face personal contact (Teece 1981) while the transfer of codified knowledge is more easily performed through documents without interface of personnel. Kogut and Zander (1993) explain that the degree of tacitness of the knowledge affects the choice of the mode of its transfer, and assert that foreign direct (equity) investment exists because of its superior efficiency over inter-firm modes in transferring tacit knowledge.
With uncodified knowledge, the recipient is not sure about its precise nature and quality because it is difficult to observe and measure. With asymmetric information about a technology’s transferred value, a recipient is usually reluctant to commit to large up-front or lumpsum payments. Even after the agreement is concluded, the recipient may not know if the uncodified knowledge supplier is truly transferring the agreed-upon nature and amount of knowledge. The recipient will prefer more a contingent compensation scheme dependent upon the future performance of the alliance venture.
Other things being equal, codification, especially in the case of patented information, increases the ease of monitoring the recipient, without strong intraorganizational ties. By the same token, uncodified knowledge makes it more likely that the knowledge supplier will demand a longer term licensing contract or even equity participation, as a control mechanism. This is congruent with the idea that uncodified knowledge will require more "hand holding" or long term, face-to-face technology transfer. Therefore, the contingency preferences of both partners are again in the same direction vis-à-vis the codification variable.
H 3: The greater the codifiability of the knowledge, the more likely a compensation structure entailing lower contingency will be preferred by both partners.
But the preferences of the two negotiating parties will not always be congruent, as shown in Table 2 for other variables.
The Relatedness of the Knowledge to the Recipient’s Existing Business
In utilizing knowledge acquired from an external source, the recipient needs to successfully assimilate and apply it within their firm. The recipient’s absorbtive capacity (Cohen and Levinthal, 1990) and their learning difficulty depend on the attributes of the knowledge to be transferred.
To elaborate on this point, the concept of diversification can be useful. Generally, a firm has the options of related and unrelated diversification (Hill and Jones 1995). Unrelated diversification usually requires the application of unfamiliar technology or knowledge far from the firm’s existing technological base. When the knowledge is unrelated to the firm’s existing knowledge, the recipient will need more commitment from the knowledge supplier regarding learning the transferred knowledge in question and the operation of the business created by this knowledge, as shown in Killing’s (1983) joint venture studies. On the other hand, when the knowledge to be transferred is related to the recipient’s existing knowledge base, it is more likely that the recipient can successfully utilize the transferred knowledge on their own. Consequently the recipient will prefer a less-contingent mode of payment, such as lumpsum fees, or just royalties. They need not have the knowledge supplier’s equity participation, interference, and perennial drain on profits by their equity presence in the alliance.
The knowledge supplier’s preferences are the opposite. When transferring knowledge closely related to the recipient’s existing business, the knowledge supplier has more confidence in the ability of the knowledge recipient, and in their future sales and profits. The knowledge supplier is consequently less risk averse, and more willing, or even eager, to receive contingent payments via royalties, and dividends in the future. So a lower up-front payment can be demanded of the recipient, while asking for a compensation structure with higher contingency and higher return in the future. So, the greater the relatedness of the technology to the recipient’s knowledge base, the knowledge supplier will prefer a compensation structure with higher contingency. Thus, we hypothesize that the preferences for compensation structure will be different between the negotiating allies.
H 4.1: The greater the relatedness of the knowledge to the recipient’s existing knowledge
base, the more likely a compensation structure entailing lower contingency will be preferred by the knowledge recipient.
H 4.2: The greater the relatedness of the knowledge to the recipient’s existing knowledge
base, the more likely a compensation structure entailing higher contingency will be preferred by the knowledge supplier.
The Transaction-Specific Capital Investment to be Incurred by the Recipient
A transaction-specific investment refers to dedicated assets invested for specific uses which cannot be re-deployed without incurring significant switching costs, or whose value is much lower outside the specialized use for which it had been intended (Williamson 1975). Transaction-specific investment can take various forms such as physical investment or investment in human capital (Williamson 1975).
From the viewpoint of the recipient, a capital investment made to utilize the transferred knowledge such as a manufacturing technique or a brand may be ‘transaction-specific if such assets cannot be re-deployed easily. In that event, the recipient fears that if the technology is not properly transferred from the supplier, or if the transferred knowledge does not perform well, the specialized capital investment may have much less value for other purposes, or even be useless. In much of the literature on foreign market entry choices (e.g., Hill et al. 1990), it is often stated that the risk borne by the knowledge supplying company increases from licensing to joint ventures, and is highest with a wholly owned subsidiary because of their greater resource commitment. However, what is forgotten is that a knowledge recipient also faces a capital investment risk. Other things being equal, the higher the project capital investment cost, the recipient may also wish to lower their risk by involving the technology supplier (as licensor) and even as equity co-investor to share the risk.
The recipient will want the technology supplier to make a more dedicated investment as "mutual hostage" since asking for non-recoverable investments can serve as an ex ante deterrent to opportunism (Parkhe 1993a). The more dedicated investment both partners make, the higher the exit barrier and the lower the flexibility in the alliance venture will be. Therefore the preferences of the two parties are congruent for this variable.
H 5: The greater the dedicated capital investment to be incurred by the alliance, the more likely a compensation structure entailing higher contingency will be preferred by both allies.
Firm-Specific Factors
Firm-specific factors refer to the partner firms’ general capacity or internal situation and the general relationship between the knowledge recipient and supplier. Those factors include the technological competence of the knowledge recipient, the relationship between allies, and the recipient’s experience regarding the knowledge and future competitive threat to the knowledge recipient from the supplier.
The Relative Technological Competence of the Knowledge Recipient
We saw earlier that the attributes of the knowledge to be transferred can affect the degree of learning and uncertainty perceived by the knowledge recipient. Learning uncertainty about the recipient’s absorbtive capacity is also a function of the recipient organization’s technological competence (Cohen and Levinthal, 1990).
Since the core concept of international strategic alliances is sharing knowledge between alliance partners, learning of the other partner’s skills and know-how is crucial for successful alliance success (Hamel 1991). Kogut’s (1988) study shows that inter-organizational learning is a dominant motive in joint ventures.
The technological competence of the recipient should be viewed relative to that of the supplier. When the knowledge recipient is less competent compared to the supplier, the former will expect more cooperation from the latter in utilizing the transferred knowledge and thus will prefer stronger, long term ties. These can be induced by offering a royalty, component trading, or even an equity share in the alliance. In short, we hypothesize that the less competent recipient exhibits a preference for a compensation structure of higher contingency on the spectrum shown in Figure 1. By the same token, a technologically competent recipient will attempt to avoid a compensation structure with higher contingency payments, because royalties and equity shares can be a high amount, in the long run, that is paid out to the knowledge supplier – a sharing of benefits that would otherwise have accrued to the recipient alone. This may be seen as too high a price for the knowledge supplier’s commitment and long run support. A relatively competent recipient will prefer an alliance structured with lower contingency compensation.
The knowledge supplier’s preferences will typically be the opposite, we hypothesize. With their greater confidence in the ability of the recipient, when the recipient’s technological capability is seen by them to be high, there is more confidence of future sales (royaltries) and profit (dividends) success. Hence the more likely will the supplier favor a compensation structure of higher contingency, basing their demand on more lucrative future compensation and in turn being willing to accept a lower up-front payment from the recipient.
Therefore, two partners have different preferences for compensation structure regarding the technological competence of the knowledge recipient.
H 6.1: The greater the technological competence of the knowledge recipient compared to that of the supplier, the more likely a compensation structure entailing lower contingency will be preferred by the knowledge recipient.
H 6.2: The greater the technological competence of the knowledge recipient compared to that of the supplier, the more likely a compensation structure entailing higher contingency will be preferred by the knowledge supplier.
Recipient’s Experience With Successful Use of Similar Technology in the Past
The implications of knowledge suppliers’ experience in international business has been researched by many authors. Johanson and Vahlne (1977) proposed that, as the firm gradually acquires more firm-specific experiential knowledge about an individual foreign market, the firm will increase its commitment to the market on an incremental basis from exporting to subsequent investment. This stream of literature relates, of course, to market and not technological experience which is the focus of this hypothesis. Zander and Kogut (1995) assert that a firm with more experience at internal transfer tends to continue to conduct internalized transfers, but once the knowledge is codified, the firm will increase external transfer using inter-firm transfer modes.
The recipient firm with a successful past experience in the same or related knowledge area will feel comfortable in making fixed or flat payments which do not depend on the future performance of the knowledge. They have a better understanding of the new knowledge, and will need less commitment and help from the supplier in assimilating transferred knowledge. By the same token, a recipient that does not have a successful past experience in the area will avoid an up-front fixed payment because their perception of uncertainty about the knowledge is high, and they will then try to make compensation more dependent on the alliance’s future performance.
On the other side of the negotiating table however, the knowledge supplier will have less confidence in the ability of a recipient, inexperienced in this technology, to utilize the knowledge. In such case, the supplier will demand a higher up-front payment from the recipient and be less likely to want contingent future payments, because of uncertainty regarding the input of the recipient and the success of the alliance. So from the technology supplier’s perspective a positive relationship is hypothesized between recipient experience in the knowledge area and compensation contingency.
H 7.1: The greater the prior experience the knowledge recipient has in the technology to be transferred, the more likely a compensation structure entailing lower contingency will be preferred by the knowledge recipient.
H 7.2: The greater the prior experience the knowledge recipient has in the technology to be transferred, the more likely a compensation structure entailing higher contingency will be preferred by the knowledge supplier.
The Effect of Prior Ties Between the Allies and the Knowledge Supplier’s Reputation
The hypotheses relating to prior ties and reputation are taken up together in the following discussion. Traditionally, economic theories tended to ignore the importance of the relationship and trust between market transactors (Zaheer and Venkatraman 1995; Saxton 1997) and focus on economic efficiency. In studies of international joint ventures, non-economic ‘softer’ aspects had been largely ignored (Parkhe 1993b), until recent literature on alliances which emphasizes the social aspects of the partner relationship, the congruence of the background of partners and the frequency of inter-partner contact embedded in the social network (e.g., Deeds and Hill 1996) and the extent of top management’s experience and social connection (e.g., Eisenhardt and Schoonhoven 1996). . The level of inter-partner trust is related to the relational uncertainty (Das and Teng 1996).
In the relationship between corporate allies, reputation (Saxton 1997; Hall 1993) and cooperative history (Parkhe 1993a; Saxton 1997) can affect the willingness of the partners to cooperate. From the agency-theoretic perspective, good reputation of a partner and a strong pre-agreement relationship between partners, may mitigate and deter opportunism and agency problems, and enhance trust (Buckley and Casson 1988). The importance of inter-firm relationship is viewed from a more dynamic perspective in Gulati (1995) indicating that the greater the number of repeated ties between partners measured as the number of prior alliances, the less likely their current alliance will be equity-based because they have already established trust. With a strong positive previous relationship with the technology recipient will put more trust in the quality of the knowledge to be transferred and the future behavior of the supplier, other things being equal. Thus, the recipient will be more agreeable to compensation with a lower degree of contingency. The knowledge supplier will also more likely accept a less contingent payment such as a lumpsum fee because they can predict and trust the recipient’s future behavior.
The reputation of the technology supplier will work in the same way, to assure the recipient that they are not risking much by paying up-front lumpsums to a party whose reputation they can trust. With this assurance, the technology recipient can count on the supplier being willing to help out in future years, even if the payment was made long ago. From the perspective of the knowledge supplier however, the effect of a good reputation may work in the opposite direction, and make them believe they are in a position to demand royalties and equity shares in the prospective alliance. True, the level of contingency is higher, but so also is the total expected return as we move to the right hand side of the spectrum in Figure 1
Thus, the hypotheses that
H 8: The stronger the pre-agreement relationship between the knowledge recipient and supplier, the more likely a compensation structure entailing lower contingency will preferred by both partners.
H 9.1: The better the knowledge supplier’s reputation as perceived by the recipient, the more likely a compensation structure entailing lower contingency will be preferred by the recipient.
H 9.2: The better the knowledge supplier’s reputation as perceived by the recipient, the more likely a compensation structure entailing higher contingency will be preferred by the supplier.
The Competitive Threat from the Knowledge Supplier
An alliance is often recognized as a strategy option through which partners exchange knowledge, and the exchange relationship is viewed in a dynamic sense. The acquisition of one partner’s knowledge and skills by another can change their relative bargaining power and cause instability in the alliance (Hamel 1991; Inkpen and Beamish 1997). The technology recipient can feel the competitive threat in several ways. For instance, the knowledge supplier can obtain information on the local market and become an eventual market entrant as competitor to their former ally.
Perceiving a potential competitive threat from the knowledge supplier, it is more likely that the recipient will want more commitment from the supplier, to learn and extract more information from the latter. Through ongoing contacts with the knowledge supplier, the recipient can learn not only more about the knowledge itself, but also additional information regarding the supplying side regarding the supplier’s home market or global operations(Caves et al. 1983). For these purposes, as far as the recipient is concerned, a license agreement is better than a lumpsum contract, and an equity relationship better than a license. In short, the recipient will prefer, on this variable alone, to move towards the higher contingency end of the compensation spectrum.
At the same time, alliance arrangements towards the right side of the Figure 1 spectrum (i.e. towards the equity JV end) are longer term and less reversible, thus mitigating the recipient’s fear of eventual supplier competition.
How will the knowledge supplier’s competitive capability and future intent affect their preference? If they wish to use the alliance as a springboard to learn about the technology recipient’s local market, and push them aside later on, more temporary, and less reversible arrangements would be preferred by them. This means short term contracts or limited term licensing agreements instead of an equity investment stake. Thus the knowledge supplier’s compensation contingency preference is in the opposite direction to that of the recipient on this variable. Our hypotheses are
H 10.1: The greater the knowledge recipient’s perception of a potential competitive threat from the supplier, the more likely a compensation structure entailing higher contingency will be preferred by the knowledge recipient.
H 10.1: The greater the knowledge recipient’s perception of a potential competitive threat from the supplier, the more likely a compensation structure entailing lower contingency will be preferred by the knowledge supplier.
Contextual Factors
Here two contextual factors, frequently discussed in the literature on foreign market entry (e.g., Anderson and Gatignon 1986) are considered: the intensity of competition in the target market and the expected degree of variance in the sales of the alliance product.
The Expected Degree of Competition in the Target Market
Environmental uncertainty as a risk-related factor was considered by Eisenhardt (1989) as affecting the structure of the agency relationship. Expected competition in the target market is one of the most common environmental uncertainties facing firms. With more intense competition in the technology recipient’s market, the recipient will see the need for more help, especially if, as in this empirical study, the knowledge supplier is a foreign company. Moving towards the more contingent compensation end of the spectrum (i.e. towards licensing and JVs) typically means stronger inter-organizational linkages and a greater likelihood that the needed help will be provided. At the same time, by moving towards more contingent payments, as a quid pro quo, the front end fee and up-front uncertainty is reduced for the recipient in a competitively uncertain marketplace.
However, from the point of view of the knowledge supplier, the opposite preference emerges. The supplier may have a lower incentive to make long term resource commitment in a very competitive market, preferring to take their return in a larger up-front lump sum. Evidence is seen in Contractor and Kundu (1998) where, in very competitive markets global hotel chains preferred franchising (mass licensing) over fully-owned investments. Hence,
H 11.1: The greater the expected intensity of competition in the target market, the more likely a compensation structure entailing higher contingency will be preferred by the knowledge recipient.
H 11.2: The greater the expected intensity of competition in the target market, the more likely a compensation structure entailing lower contingency will be preferred by the knowledge supplier.
The Expected Variance of the Alliance Product Sales
In project planning, or Capital Budgeting exercises, an estimate of the volatility of future sales is a key consideration, and affects the discount rate and net present value (NPV) of the project. Uncertainty regarding sales is another common environmental uncertainty facing firms. Change in expected sales of a product depends on various factors such as changes in consumer tastes, the availability of substitute product, the scarcity of complementary goods, and government policies towards on imported goods (Miller 1992).
For a knowledge recipient, a more volatile and less certain sales projection will tip their preference in favor of more contingent compensation modes, because of four reasons. With greater variance in the sales figure, calculating NPV, and thus appropriate lumpsums, is more problematic, because of ambiguity surrounding the discount rate to be used. Second, by the same token, with volatility, reducing or eliminating lumpsum payments altogether is desirable, to reduce the risk of overpaying for the technology. But this may only be achieved by, in turn, offering the supplier royalties, component margins, or dividends. Third, involving the supplier in license or equity arrangements means they now share the risk, to a lesser extent in royalties (being a percentage of sales) or larger extent as shareholders (with returns contingent on making profits). Fourth, the knowledge recipient’s risk is also reduced because, unlike a front end lumpsum, royalties and dividends are a "pay as you earn " compensation to the technology supplier.
On the other hand, the knowledge supplier may not wish to make much of a resource commitment in a volatile market. So it is highly probable that they would demand a high up-front payment from the knowledge recipient and favor a compensation structure with lower contingency. This has been frequently argued in many studies on foreign market entry modes (e.g., Anderson and Gatignon 1986; Hill et al. 1990). Therefore,
H 12.1: The greater the expected variance of sales in the alliance market, the more likely a compensation structure entailing higher contingency will be preferred by the knowledge recipient.
H 12.2: The greater the expected variance of sales in the alliance market, the more likely a compensation structure entailing lower contingency will be preferred by the knowledge supplier.
EMPIRICAL ANALYSIS: ACQUISITION OF TECHNOLOGY BY AMERICAN FIRMS FROM FOREIGN ALLIES
Data Collection
To test the above hypotheses, data were collected in 1998-1999 by questionnaire on a sample of alliance agreements where US companies had acquired technology from foreign companies. Initial information was drawn from the SDC (Securities Data Company) which has compiled information on alliances worldwide. A subset of this data base, comprising US acquirers of foreign technology, comprised the statistical universe against which the sample may be compared. From several hundred initial phone and fax approaches, 137 American firms agreed to participate, and received questionnaires. Subsequently, 50 firms returned a completed questionnaire, 40 firms declined to complete it, 29 indicated non-applicability of the questionnaire, and 18 failed to respond. The response rate therefore was 46.3 percent (50/(137-29)). A relevant question is how the distribution of the sample compares with that of the universe, in terms of coverage of product areas (SIC code). The sample is representative in this regard.
Methodology
The model is a cumulative logistic regression, the proportional odds model estimated by the maximum likelihood method. The general form of this model is,
Logit [P(Y £ j)]
= log = a j
+ b x, j = 1, 2 ……, J - 1
For each response level, the model can be rewritten
Logit
= log
= a 1
+ b x ; Logit
= log
=
a 2 + b
x ;
Logit=
log
= a 3
+ b x and so on, where pi = Probability(Y = i½
X)
Earlier, two kinds of hypotheses were proposed: (1) ‘harmony hypotheses,’ where the compensation contingency preferences of both allies are in harmony, i.e., in the same direction and (2) ‘conflict hypotheses’ where their preferred directions are opposite. When partners’ preferences are the same as in harmony hypotheses, the final choice will be made by the congruent preferences of partners and will not be affected by the negotiation. On the other hand, when their preferences are different as in conflict hypotheses, the actual choice of compensation structure will be made both by their preferences and by the relative negotiation power of partners. In order to test both kinds of hypotheses, a variable representing the relative negotiation power of the allies will be added, based on the hypothesis that the party with greater negotiation or bargaining power will impose their preferred compensation structure on the outcome.
For this purpose, a dummy or switching
variable D representing the relative negotiation power is introduced and the
model for a single covariate can be rewritten as
Logit [P(Y
£ j)] = a j + b 1D + b
2 x + b 3D x ; j = 1, 2 ……, J - 1 where
D = 0 when the knowledge recipient has a weaker negotiation power relative to the knowledge supplier, i.e., when the supplier has a stronger negotiation power
D = 1 when the knowledge recipient has a stronger negotiation power relative to the knowledge supplier
b 3 , the coefficient of the interaction term, indicates how much greater or smaller is the coefficient for the class coded D=1, i.e., for the agreement whereby the knowledge recipient is deemed to exercise the higher negotiation power in this study. So for a harmony hypothesis to hold, b 2 and (b 2 + b 3) should be significant and have the same expected sign. Similarly, for a conflict hypothesis to hold, b 2 and (b 2 + b 3) should be significant and have the expected opposite signs specified in each hypothesis.
This model is equivalent to the combined form of the following two.
Logit [P(Y £ j)] = a j + b 2 x when D = 0 and Logit [P(Y £ j)] = a j + b 1 + (b 2 + b 3) x when D = 1
Operationalizing the Dependent and Explanatory Variables
Earlier in Figure 1 a continuum of four compensation types was presented, increasing in contingency from left to right. We noted how, in today’s alliances, these are not necessarily discrete alternatives, but that more than one type of compensation can be included in the agreement between allies. This indeed proved to be the case in the alliances in the sample. Anticipating the coexistence of more than one compensation category, and to measure the relative importance of each, the questionnaire included a question asking respondents to state the percentage of overall compensation made under each of the categories 1. Lumpsum, 2. Running Royalties, 3. Markups, and 4. Dividends, over the life of the alliance agreement. With the combinations of more than one compensation types, more than four categories are needed. Each sample response can be classified into 11 ordinal categories (a through k) shown in Table 3. The operationalization of independent variables is shown in Table 4. The relative negotiation power switching variable (NEGO) is to be introduced as an interaction variable, with other independent variables.
Regression Models With Relative Negotiating Power As an Interaction Variable
Highly correlated independent variables could not be entered in the same model. Instead, several reduced models were built and tested, as shown in Table 5.
Model 1 has the twelve main variables plus NEGO (relative negotiation power), without any interaction terms. For the interaction term, only one different model can be built for each interaction with NEGO because of the natural high correlation among interaction terms (having NEGO as the interaction variable present in each case). Two models containing main variables with NEGO*EXPER or NEGO*PREREL could not be established because as shown above, these variables are highly correlated with their own main variables, EXPER and PREREL, respectively. So Hypotheses H 7.1, 7.2 and 8 could not be tested. Also NEGO could not enter into each of ten models because of its high correlation with the interaction terms, e.g., NEGO and NEGO*NEW for Model 1.a. Each of ten other models Model 2.a to Model 2.j has twelve main variable and one of interaction terms between NEGO and a main variable, e.g. NEGO*NEW in Model 2.a.
Checks for Model Fit
The proportional odds test for all runs showed very small p-values for this test (Row 34 in Table 5). Next, the goodness-of-fit of the models was checked through deviance and Pearson Goodness-of-Fit Statistics. When the p-values for these statistics are high, the model can be said to fit the data adequately: The deviance statistics for the estimated models are all 1.0000 and the Pearson statistics are between 0.9475 (Model 2.j) and 0.9823 (Model 2.b) (not shown). Concordant values (row 39 in Table 5) are fairly high ranging from 74.8 percent to 77.9 percent and those for discordant (row 40) are all under 24.0 percent, showing that the models fit the data well. Other statistics for model fitting in row 42 to 45 in Table V-9 such Somers D, Gamma, Tau-a and c statistics (rows 42 to 45) also show that the models fit the data relatively well. In Table 5, the – 2 LOG L and Score tests (rows 35 and 36) also have low p values.
Table 6 is a summary of Table 5. The third column displays the coefficients and their significance from the simple Model 1. The fourth column summarizes those from Models 2.a to 2.j for the twelve main variables only. The fifth column summarizes the coefficients from the interaction of the main variables with the "Negotiation Power" variable NEGO in Models2.a to 2.j. In the simple Model 1 with only main variables, the coefficients indicate the total or combined effects of both allies’ preferences. b 2 indicates the preference of the knowledge supplier with regard to compensation contingency and (b 2 + b 3) expresses the preference of the knowledge recipient.
RESULTS FROM THE
EMPIRICAL ANALYSIS
In the simple or combined preference Model 1, coefficients for NEW (the newness of the knowledge), SOPHI (the degree of the sophistication of the knowledge) and EXPER (the recipient experience regarding the knowledge) are significant and positive, indicating that the newer and more sophisticated the knowledge to be transferred, and the more prior experience regarding the knowledge the recipient has, the more likely a compensation structure entailing higher contingency will be chosen. On the other hand, RELAT (the relatedness of the knowledge to the recipient’s existing knowledge base), REPUT (the supplier’s reputation), MCOMP (the expected degree of competition in the target market) and SVAR (the expected variance of the alliance product sales) had a significant negative effect on the degree of the compensation contingency in the choice of the compensation structure on the aggregate level. However, CODIF (the codifiability of the knowledge), INVEST (the transaction-specific investment incurred by the recipient), TCOMP (the relative technological competence of the recipient), PREREL (the pre-agreement relationship between partners) and THREAT (the competitive threat from the supplier) had no effect on the contingency preference.
Findings and Interpretation With Respect to Each Hypothesis
H1 The Newness of the Technology: When acquiring newer knowledge, the recipient preferred a compensation structure entailing higher contingency, i.e. towards the joint venture end of the spectrum shown in Figure 1. However, the age of technology had no effect on the supplier’s preference.
H 1 (NEW) predicted that when the knowledge to be transferred is newer, both partners will prefer a compensation structure entailing higher contingency. (b 2 + b 3), the coefficient of NEW for the recipient is positive and significant at the 0.05 level, while b 2, that for the supplier is insignificant. The newness of knowledge induces the recipient to desire greater help and involvement from the knowledge supplier, and make the latter share in the risks of the venture on a more contingent payment basis.
The results support the agency-theoretic view that with uncertainty regarding the performance or commercial success of new knowledge, knowledge recipients will be risk averse and favor contingent compensation. However, the results did not support some literature such as Davidson and McFetridge (1985) that knowledge suppliers will prefer to transfer newer technologies via intra-firm modes.
H2 Degree of Sophistication of the Technology When the knowledge was highly sophisticated, both recipient and supplier preferred a compensation structure entailing higher contingency, and the degree of the recipient’s preference was much higher than that of the supplier’s.
H 2 (SOPHI) proposed a positive relationship between the degree of sophistication of knowledge and a higher compensation contingency preference by both allies. The coefficients of SOPHI for both recipient and supplier are positive and significant at the 0.01 and 0.05 levels, respectively, supporting the hypothesis. These results can be explained thus: the knowledge supplier’s concern for technology leakage and the recipient’s greater need for extended learning with more sophisticated technology. When transferring more sophisticated knowledge, the supplier needs to monitor the alliance venture better and has a strong motivation to make a stronger commitment. The recipient wants more commitment and help. As opposed to short lumpsum contracts, royalty agreements involve the allies more, over a longer time span. With equity joint ventures (JVs) the involvement is greatest. Both are in a corporate marriage, supposed to last for ever.
The coefficient for the recipient is larger than that for the supplier. This means that for sophisticated knowledge, the recipient’s desire for a compensation structure with higher contingency is even stronger than that of the knowledge supplier.
H3 Codifiability of Technology did not appear to significantly affect the preferences of either partner for compensation structure.
H3 (CODIF), predicted a negative relationship between the degree of codifiability of the knowledge and the preference of both partners for greater compensation contingency organizational forms. Coefficients for CODIF for both partners are statistically insignificant. This result does not support much of the literature (e.g., Kim and Hwang 1992; Kogut and Zander 1993) that implies that less codified knowledge tends to be transferred through intra-firm modes involving higher compensation contingency. A possible explanation is that in this study all the technology acquirers are US-based companies – presumably among the most technically proficient. In such as case, the non-verifiability issue may not be important, and less or highly codified technologies are equally learnable or absorbable to them. This result emphasizes the need to consider the knowledge recipient side. In this regard, Kogut and Zander (1993) admit the neglect of the knowledge recipient perspective as one of the weaknesses of the literature.
H4 Relatedness of the Technology to the Recipient’s Knowledge Base: When the knowledge to be transferred was more related to the recipient’s existing knowledge base, both partners preferred a compensation structure entailing lower contingency and the recipient’s preference level was much higher than that of supplier’s.
H 4.1 and 4.2 (RELAT) proposed opposite effects of the degree of the relatedness of the knowledge on the negotiating allies’ preferences for the compensation contingency: a positive effect on the supplier’s, but a negative effect on the recipient’s. The results show that the coefficient of RELAT for the supplier is negative and very significant at the 0.01 level, and that for recipient is also negative and significant at the 0.05 level. This indicates that both allies have the same preference on this independent variable with respect to compensation contingency, i.e. both would prefer lumpsum or royalty agreements when the technology is familiar to the recipient. However, since the coefficient for the recipient is larger, i.e., its absolute value is smaller, it can be said that the recipient favors higher level of contingency when knowledge is related to his existing knowledge base than the supplier does.
The result for the recipient side supports the relational view of knowledge transfer (e.g., Killing 1983) that when the knowledge to be transferred is less related to the recipient’s existing business, the recipient will need more commitment from the supplier, and vice versa. However, the supplier’s preference for lower contingency is contrary to expectation and can only be explained by positing that a technology that a prospective acquirer can relate to is one whose value they can assess better. If so, a recipient is more willing to pay larger sums up front in a low-contingency lumpsum agreement. This hypothesis should be a subject for further study.
H6 Capital cost of the Transaction-Specific Investment and H6 Recipient’s Relative Technological Competence: Neither had a statistically significant effect on preferences for organizational type or compensation contingency.
H 5 (INVEST), and H 6 (TCOMP) are not supported since all the coefficients are insignificant at any level. So both the extent of transaction-specific investment incurred by the knowledge recipient and the relative technological competence of the recipient have no effect on the preferences of both partners for compensation contingency. The insignificance of INVEST to the supplier may be due to their lack of concern with the transaction-specific investment which the recipient has to make in the case of lumpsum or licensing, It is only in a joint venture context that they may partially share in the cost. With regard to the relative technological competence between allies, considering the fact that the technology acquiring side were U.S-based companies, the technology gap between such U.S. companies and foreign knowledge suppliers does not seem to be a critical factor with regard to compensation contingency. These hypotheses, offered as possible explanations for lack of statistical significance, should be researched further.
H7 The Technology Recipient’s Experience: The greater the experience of the technology recipient, the greater the preference for higher contingency compensation formulae and stronger interorganizational linkages.
H 7.1 and 7.2 (EXPER), and could not be tested separately because of the high correlation between EXPER and NEGO*EXPER (0.78). However, in the simple aggregate Model 1 the aggregate level effect shows that EXPER does have a significantly positive effect on the degree of the compensation contingency. That is, the more prior experience regarding the knowledge the recipient has, the higher will be the level of contingency chosen by both partners, and the more they will tend towards the joint venture end of the organizational choice spectrum shown in Figure 1.
H8 Previous Ties Between the Allies: No significant result
H 8 could only be tested in Model 1 where the result was non-significant. The interaction between PREREL and NEGO*PREREL has a high collinearity (0.93), and consequently could not be entered together. S No conclusion is drawn therefore regarding the effect of this variable on the partners’ preferences for compensation structure. This does not vitiate Gulati (1995) whose work on "repeated ties" addressed the issue of trust and performance, and not the choice within alliance organization alternatives. The "internationalization" literature (Johanson and Vahlne, 1977) does imply stronger interorganizational ties as the firm internationalizes, but this is usually operationalized by familiarity with the foreign market rather than familiarity with a particular ally firm in that market.
H9 When the Reputation of the Knowledge Supplier was better, both partners favored a compensation structure with lower contingency and the recipient’s preference level was much higher than that of the supplier.
H 9 (REPUT) predicted a negative effect of the knowledge supplier’s reputation on the preference of the recipient for more contingent compensation, and a positive effect for the knowledge supplier’s preference in this regard. Results reveal that both coefficients of REPUT for the recipient and the supplier are negative and significant at the 0.10 level and at the 0.05 level, respectively. For the recipient, the result is consistent with the prediction in the existing literature that better reputations of partners will can enhance trust between allies (e.g., Saxton 1997) and will render the recipient more willing to make less contingent compensation (e.g., Gulati 1995). Also, the finding that knowledge suppliers with better reputations prefer a lower level of contingency could suggest (as a hypothesis proposed here in explanation) that such suppliers may be able, as a result of their superior reputation, to command higher fixed payments in lumpsum compensation from the technology recipient. Since the absolute value of the coefficient for the supplier (b 2) is lower than for the recipient (b 2 + b 3) in Table 6, we can say that the supplier prefers a lower level of contingency than the recipient does, when the supplier has a better high reputation.
H 10 When the Competitive Threat From the Knowledge Supplier was perceived as high, the recipient favored a compensation structure of higher contingency, but it did not affect the supplier’s preference.
H 10.1 and 10.2 (THREAT) posited that the effect of a perceived competitive threat from the knowledge supplier would be positive in terms of the recipient’s preference for compensation contingency, but negative for the supplier. The coefficient of THREAT for the recipient is positive and significant at the 0.10 level, supporting Hypothesis 10.1 that when the recipient’s perception of competitive threat from the supplier is higher, the recipient favors a compensation structure entailing higher contingency. The knowledge recipient may wish, in this circumstance to co-opt this competitive threat, by involving them in longer term relationships such as equity joint ventures to moderate their opportunistic future behavior. On the other hand, the results show that for knowledge suppliers, the possibility of them becoming future competitors to their allies is not an issue affecting organizational choice or contingency preference.
H11 When the Intensity of Competition in the Target Market Served by the Alliance was high, the supplier preferred a compensation structure involving lower contingency and towards the lumpsum end of the Figure 1 spectrum. But the intensity competition degree had no statistically significant effect on the recipient’s preference for compensation contingency.
H12 When the Expected Variance of the Alliance Product Sales was high, both partners preferred a compensation structure entailing lower contingency and the recipient’s preference extent was much higher than that of the supplier’s.
Hypothesis 11.1 and 11.2 (MCOMP) Hypothesis 12.1 and 12.2 (SVAR) treat contextual factors having to do with conditions in the market to be served by the alliance. These two variables address uncertainties in the market. Stated as the intensity of expected competition and the expected variance of sales of the alliance’s products. The hypotheses posited for both factors, a positive effect on the recipient’s contingency preference and a negative one for the supplier’s. For the supplier, as expected, both coefficients, MCOMP and SVAR are negative and significant at the 0.05 level and 0.01 level, respectively. This is consistent with the propositions of existing studies (e.g., Hill et al. 1990): the knowledge supplier tends to avoid more resource commitment in a volatile environment.
For the recipient, however, the coefficient for MCOMP is not significant, but that for SVAR is significant at the level of 0.05, although this is the opposite of the hypothesis. This indicates that the degree of expected competition does not affect the recipient’s preference for compensation contingency, while it has a significant negative effect on the supplier’s preference. This seems plausible when one considers that the recipient should be more familiar with their own market’s competitive environment especially when all or most of the sales of alliance products is to be in the recipient’s market. However, the significance of SVAR for the recipient indicates that they also favor a compensation structure entailing lower contingency even in an environment where the size of the compensation basis is difficult to ascertain. However, relatively speaking, the recipient’s level was higher than that of the supplier’s, although both partners prefer lower contingency. It can be said that although the recipient anticipates a higher level of sales variance for alliance products, they favor less contingent compensation as long as they are familiar with the target market.
SUMMARY AND CONCLUSION
This study advances our understanding of the link between the choice of different organizational forms in alliances and the compensation formulae written into alliance agreements, a hitherto neglected area in academic research, although well known to firms. At the heart of most alliance agreements is the transfer of technology or knowledge from one ally to another. Each different formula for compensating a knowledge supplier carries with it different implications for return, control and risk or contingency. The type of compensation arrangement also affects the future behavior of each partner towards the alliance. Knowing this, during the negotiation stage, each prospective ally seeks to choose a compensation (and organization) mode that will best serve their interest, in light of their competitive position and capabilities vis-à-vis their partner, characteristics of the technology to be transferred, and characteristics of the market served by the prospective alliance.
This paper makes a theoretical contribution by proposing a compensation contingency spectrum, that correlates with a continuum describing the strength of the inter-organizational relationship. Payments for the acquisition of technology can be made in the form of lumpsum fees, royalty agreements, contractually promising the other partner a purchase component or products (at an agreed markup), and finally, by forming an equity joint venture with the knowledge supplier. As one moves along this conceptual spectrum (shown in Figure 1) from left to right, the intensity of inter-organizational ties increases, and so does the level of contingency of payments (from one time lumpsum contract to royalty licensing to equity joint venture). The desires of negotiating partners are not always congruent in terms of their choice of organization type, or their preference or aversions vis-à-vis the compensation contingencies that each organizational type entails.
Compensation structure can be understood from the perspectives of agency theory, which explains double-sided hazard problems between the knowledge recipient and supplier, transaction cost theory, and the relational view of knowledge transfer, which emphasizes the importance of the ongoing post-agreement relationship between the two. Based on these theoretical frameworks, the study showed that compensation contingency, i.e., the dependence of the compensation on the performance of the alliance venture, is a critical property which can differentiate between various compensation elements.
Each ally’s desired position on the organizational or payment contingency spectrum was then sought to be explained by an empirical study of American companies which acquired technology from foreign knowledge suppliers. The study separated the negotiation effect from the aggregate effect by adding a switching variable describing the relative negotiation power of two partners. Thus separate prediction can be made for the preferences of the two negotiators. For the knowledge recipient, the newness, and the degree of sophistication, of the knowledge to be transferred and their perception of the competitive threat from the supplier, had a positive effect on their preference for a compensation structure entailing higher contingency. On the other hand, the relatedness of the knowledge to their existing knowledge base, the supplier’s reputation, and the variance of the expected sales, negatively affected their preference. For the technology supplier, the degree of sophistication of the knowledge had a positive effect, while the relatedness of the knowledge to the recipient’s existing knowledge, the supplier’s own reputation, the degree of competition, and the sales variance, had a negative effect.
Although the data cover US firms’ acquisition of foreign technology, the conceptual framework and findings can be applied to both international and domestic alliances. Another contribution made by this approach is that it includes the negotiating perspectives of both technology recipient and supplier, whereas most of the existing literature has treated only the knowledge supplier’s viewpoint.
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