The end of the opportunism vs trust debate: Bounded reliability as a new envelope concept in research on MNE governance
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Modern transaction cost economics (TCE) thinking has developed into a key intellectual foundation of international business (IB) research, but the Williamsonian version has faced substantial criticism for adopting the behavioral assumption of opportunism. In this paper we assess both the opportunism concept and existing alternatives such as trust within the context of IB research, especially work on multinational enterprise (MNE) governance. Case analyses of nine global MNEs illustrate an alternative to the opportunism assumption that captures more fully the mechanisms underlying failed commitments inside the MNE. As a substitute for the often-criticized assumption of opportunism, we propose the envelope concept of bounded reliability (BRel), an assumption that represents more accurately and more completely the reasons for failed commitments, without invalidating the other critical assumption in conventional TCE (and internalization theory) thinking, namely the widely accepted envelope concept of bounded rationality (BRat). Bounded reliability as an envelope concept includes two main components, within the context of global MNE management: opportunism as intentional deceit, and benevolent preference reversal. The implications for IB research of adopting the bounded reliability concept are far reaching, as this concept may increase the legitimacy of comparative institutional analysis in the social sciences.
Keywordsinternalization theory transaction cost economics opportunism
Transaction cost economics (TCE) has fast become one of the most influential theories within the social sciences (Carter & Hodgson, 2006; Carroll & Teece, 1999). Its applications in the international business (IB) context have shown its relevance to explaining and predicting a wide variety of IB phenomena, including inter alia the existence of MNEs (Buckley & Casson, 1976; Hennart, 1982; Rugman, 1980; Teece, 1981), MNE foreign entry mode decisions and interactions with external parties (Beamish & Banks, 1987; Buckley & Casson, 1998a; Chen, 2005; Hennart, 1988, 2009), and also MNE internal governance choices (Hennart, 1993; Verbeke & Kenworthy, 2008).
TCE thinking as applied in the IB context (usually referred to as internalization theory or transaction cost internalization – TCI theory) relies heavily on Coase's (1937) original analysis of the relative costs of external vs internal markets, and parallels to a large extent Williamson's (1975, 1985, 1996a) development of TCE as a general theory of the firm (Safarian, 2003). However, Williamson's TCE approach relies heavily on the behavioral assumptions of bounded rationality and opportunism, whereas other TCE-related theories do not appear to require the latter concept (North, 1990). In the IB field, a number of scholars have developed MNE theories that allow for opportunism, but do not assume it is necessarily the decisive factor in governance choices: see inter aliaCasson's (2000) information cost perspective and Rugman and Verbeke's (2003) joint transaction cost and strategic management explanation of internal MNE functioning. Despite these efforts, concerns surrounding the behavioral assumption of opportunism, a cornerstone of Williamsonian thinking (Williamson, 1993a), continue to reduce the legitimacy of TCE as a general theory of the firm, and as the core of IB theory (Conner & Prahalad, 1996; Ghoshal, 2005; Ghoshal & Moran, 1996). The present paper's purpose is to advance IB theory through proposing a more valid concept, substituting for simple Williamsonian opportunism.
Simon (1985: 303) has clearly acknowledged the importance of specific behavioral assumptions: “Nothing is more fundamental in setting our research agenda and informing our research methods than our view of the nature of the human beings whose behavior we are studying. It makes a difference, a very large difference” A number of recent decade award-winning articles in the Journal of International Business Studies (JIBS) also reveal the continued relevance of exploring the models of man upon which much of IB theory rests. For example, the opportunism assumption has been addressed (utilized, extended or discounted) in papers as varied as Gomes-Casseres’ (1990) integration of the ownership and bargaining perspectives in MNE decision-making, Kogut and Zander's (1993) knowledge view of the MNE, Oviatt and McDougall's (1994) perspective on international new ventures, and Madhok's (1995) emphasis on trust in international joint ventures. More generally, a search of the JIBS archive of the past 20 years (1988 to October 2008) yields an impressive number of 116 separate, substantive entries referring to the opportunism concept.
Assessing the validity of critical behavioral assumptions, and refining these assumptions when describing variety, selection and retention of governance mechanisms, is fundamental to advancing management theory, including IB theory. Unfortunately, the empirical efforts to date to address the validity of the opportunism assumption, whether through testing it directly or through testing alternative behavioral assumptions with proposed higher relevance, have remained unsatisfactory (Tsang, 2006). The present paper performs such an assessment within IB research, with a specific focus on identifying the mechanisms explaining failed human commitments in internal MNE functioning. The importance of assessing the opportunism assumption cannot be understated, but approaching the topic has proven difficult in practice. Deciphering the nature of man, and assessing the various forms of self-interest (from weak to strong), has plagued philosophers (e.g., Hobbes, 1651; Plato, c. 375 BC), economists (e.g., Mill, 1867; Smith, 1776), and more recently social scientists (Axelrod, 1984; Ridley, 1998). Despite the broad treatment of the subject throughout the history of science, scholars in management and IB have rarely attempted to assess in a non-ideological fashion whether an assumption of opportunism is warranted. Management and IB scholars have mostly chosen to reject (Ghoshal & Moran, 1996), incrementally extend (Heiman & Nickerson, 2002), ignore (Conner & Prahalad, 1996), or view as relevant in only well-defined circumstances (Casson, 2000; Madhok, 2006a; Verbeke, 2003), Williamson's strong-form view of self-interest, without attempting to analyze more broadly the mechanisms underlying failed human commitments and critical to governance choices.
In an effort to advance TCE-based thinking, we propose the concept of bounded reliability (BRel)1 as a more appropriate behavioral assumption. We develop the bounded reliability concept by analyzing case studies of the nine truly global MNEs in the Fortune Global 500 (Rugman & Verbeke, 2004). These nine MNEs are firms with proven, successful global strategies, as measured by the balanced dispersion of their sales across the triad of North America, Europe and Asia. Our analysis suggests that while Williamsonian opportunism may sometimes be at play, there are more common reasons for the non-fulfillment of commitments inside the MNE. Bounded reliability, much like bounded rationality (BRat), suggests that economic actors may be reliable but only boundedly so (Simon, 1955).
The remainder of this paper takes the following form. In the next section we outline some key elements in the debate surrounding opportunism. The section following focuses on opportunism in the IB context, where we contrast the Williamsonian view on opportunism with the contemporary perspective of three IB scholars – Alain Verbeke, Mark Casson and Anoop Madhok – who have been particularly outspoken on this issue. We highlight the common conceptual weakness present in each of these three perspectives, and introduce bounded reliability as an envelope concept describing the limits of human reliability inside the MNE. We then attempt to define more precisely bounded reliability's substance, building upon case studies of nine global MNEs, and suggest a number of implications of BRel for MNE research and management.
OPPORTUNISM AND TCE
TCE proposes that economic organization aims to align transactions, which differ in their attributes (such as frequency, uncertainty, and asset specificity) with governance mechanisms (such as market contracts, various forms of organization inside a single firm and hybrids) in a discriminating, and mainly transaction cost economizing, way (Williamson, 1991). In managerial terms, TCE addresses three broad questions. First, what activities/transactions should be conducted within the firm's boundaries? Second, how should the linkages be governed with external actors that are relevant to the activities/transactions performed within the firm? Third, how should the activities/transactions conducted within the firm be governed? The general answer to each of these questions is that business firms – given a particular macro-level institutional context – will be driven mainly by joint efficiency/effectiveness considerations, meaning the goal of achieving the best attainable output–input relation given the available governance alternatives, each of which is associated with costs and benefits, and is subject to risks. Here, TCE relies heavily on the behavioral assumptions of bounded rationality (Simon, 1955) and opportunism, the latter being defined as self-interest seeking with guile (Williamson, 1985). Opportunism is considered core to TCE: absent opportunism, markets alone, through autonomous contracting, would be sufficient for handling most economic activities/transactions (Williamson, 1985; Williamson & Ouchi, 1981). For Williamson, managing the looming problem of opportunism is the key to understanding the micro-level institutions of capitalism (Williamson, 1996b). While opportunism is not assumed to be present all the time, bounded rationality constrains the ability both to write complete contracts and to identify ex ante possible occurrences of opportunism. In combination, these assumptions create hazards that need to be guarded against. Adopting appropriate safeguards in contracting reduces the occurrence of opportunism and mitigates its impacts when it occurs.
Opportunism manifestations, according to Williamson (1985: 47), include “calculated efforts to mislead, distort, disguise, obfuscate or otherwise confuse”. Inside the firm, shirking is a common expression of opportunism, whereas in the context of hybrid governance, opportunism often expresses itself as the deceitful appropriation of the partner firm's knowledge (Parkhe, 1993). However, various scholars have criticized the opportunism assumption, inter alia because of its limited conceptual grounding and the absence of analysis of its complexity (Wathne & Heide, 2000). Moreover, research that actually attempts to measure opportunism directly is scarce (Boerner & Macher, 2001).
From a conceptual perspective, at least four credible points of criticism have been voiced against the opportunism concept. First, Williamsonian opportunism reflects a dispositional (non-contextual) view of human nature, with a lack of detail provided on how opportunism develops or how it can be reduced. For example, Moran and Ghoshal (1996) have referred to a TCE schizophrenia, whereby opportunism is static and dispositional, yet safeguards against opportunism are dynamic and situational. Following the dispositional critique, these authors have criticized Williamson for not differentiating between opportunism as an attitude and opportunism as a behavior.
Second, opportunism has also been criticized for its potential influence on enacted societal and individual behavior: propagating the belief that opportunism reflects “standard behavior” (i.e., “this is to be expected”) is likely to reinforce any initial intentions to cheat, shirk, etc., and such intentions in turn will express themselves as actual opportunistic behavior. In other words, focusing on guarding against opportunism actually gives license to – and may even increase the levels of – the behavior one wants to safeguard against.
Third, the capabilities school (including the resource-based, knowledge-based and learning views of the firm) has argued that firms may exist for many reasons even absent opportunism in external markets (e.g., for the efficient and effective development, transfer and exploitation of knowledge, i.e., for its superiority in managing the innovation process in its entirety). The capabilities view has also suggested that inter-firm relationships offer value creation and knowledge-sharing opportunities that cannot develop if a prime focus is maintained on guarding against opportunism (Dyer, 1997; Dyer & Singh, 1998; Gulati & Singh, 1998; Madhok, 1995; Noorderhaven, 1994; Ouchi & Price, 1993). Conner and Prahalad (1996), in providing one of the first links between the knowledge-based view of the firm and TCE, have argued that even in the absence of opportunism, transaction costs will still exist in knowledge-based transactions. These costs arise because knowledge is often tacit, embedded in organizational routines, and learning may need to occur through direct observation (Afuah, 2001; Conner & Prahalad, 1996).
Fourth, Ghoshal and Moran (1996) have suggested that purpose plays the role in organizations that price plays in markets: the advantage of firms over markets may not lie in overcoming human pathologies through hierarchy substituting for price, but instead in the firm's purpose of leveraging the human ability to take initiative, to cooperate and to learn.
Trust, as a substitute or complement to opportunism, has probably generated the most interest. Trust centers on the trustor's vulnerability, and the trustee's reliability and perceived benevolence. Zaheer, McEvily and Perrone (1998) have argued that trust reflects the expectation that an actor can be relied upon to fulfill obligations and to behave in a predictable manner. Implicit in reliability is the notion of ability or competence (Nooteboom, Berger, & Noorderhaven, 1997), and this is viewed as an essential condition for trust (Mayer, Davis, & Schoorman, 1995). Benevolence is the extent to which a trustee is believed to want to do good or to cooperate with the trustor, owing to moral obligation or internalized norms (Delerue-Vidot, 2006; Mayer et al., 1995). The inclusion of benevolence in trust definitions highlights the difficulties in combining both trust and opportunism (strong-form self-interest) within a single theory. In choosing between the two constructs, many scholars find trust a more satisfying behavioral assumption than opportunism (Gambetta, 1988). From the trust perspective, the solution to the incentive loss problem associated with hierarchical coordination (meaning that incentives are arguably lower-powered in firms than in markets) lies not in firms emulating markets, but in firms creating a context of identification, commitment and benevolence that clearly differentiates them from markets (Ghoshal & Moran, 1996).
Trust has sometimes been interpreted as a complement to conventional restraints on opportunism, and therefore as a component of an interrelated bundle of governance mechanisms (Alvarez, Barney, & Bosse, 2003; Nooteboom et al., 1997). It has even been argued that, beyond Williamson's contractual coercion (legal ordering) and self-interested incentives (private ordering), trust constitutes a significant addition to governance (Madhok, 1995; Nooteboom et al., 1997). Trust's ability to reduce opportunism operates through reducing the likelihood of negative interpretations of a partner's actions, allowing for the benefit of the doubt. Such allowance facilitates openness in sharing knowledge, and reduces unwarranted fear of opportunistic behavior by partners (Krishnan, Martin, & Noorderhaven, 2006).
However, viewing trust as a governance mechanism to curb opportunism remains ultimately unsatisfactory, since trust may reduce the alertness needed when economic actors such as alliance partners or even loyal employees respond to environmental change. Krishnan et al. (2006) have suggested that reduced alertness may stem from trust's encouragement of economic actors to minimize redundancies in the search process as they rely on the partner's purported expertise to engage in specialized search. From a cognitive-heuristic perspective, trust may also be dangerous, since it may produce systematic biases, and even strategic blindness, resulting in significant errors (Ferrin & Dirks, 2003; McEvily, Perrone, & Zaheer, 2003). Jap and Anderson's (2003) findings illustrate this point: when all is well, the confidence that two individuals place in each other may allow their relationship to perform better in every respect, but these positive performance effects may diminish, even evaporate, as ex post opportunism mounts. In this situation, it is actually the prior trust that allows opportunism to come to fruition.
Williamson (1993b) has argued that most, if not all, economic trust can be reduced to calculative trust. Williamson further contends that calculative trust is a contradiction in terms, and therefore the study of economic organization should refrain from adopting trust as an analytical construct (Williamson, 1993a). Williamson's focus on farsightedness also conflicts with the trust perspective. Farsightedness suggests that when looking forward and identifying the danger of opportunism materializing, economic actors should give and receive credible commitments (in a cost-effective manner) (Williamson, 1996b). In contrast, myopic parties must rely on altruism when a bad state of affairs materializes, and then suffer from having neglected to introduce ex ante proper safeguards in the exchange and to contemplate the contracting process in its entirety. Williamson has suggested that the concept of “credible commitments” provides an effective response to the substantive challenge of effective contracting, and eliminates the need for references to trust (Williamson, 1993a: 100).
Another key to the opportunism concept is found in Williamson's statement that to concede opportunism is not to celebrate it (Williamson, 1996a). The main purposes of recognizing the possibility of opportunism are that it avoids contractual naiveté when a contract as a mere promise (unsupported by credible commitments) is put forward, and invites identifying, making explicit, and mitigating hazards that have their origins in opportunism. This view does not imply that all economic actors are mean spirited or immoral, nor should it promote opportunism (Williamson, 1996b).
The above offers a brief outline of various key elements in the debate surrounding opportunism within the TCE context. In the following section we turn our attention to modern IB theory, which – while similar to the general TCE perspective – offers a departure from conventional TCE regarding the opportunism assumption.
TRANSACTION-COST-BASED REASONING IN INTERNATIONAL BUSINESS THEORY
Infusion of Williamsonian Behavioral Assumptions in IB
Modern IB theory (especially internalization theory or TCI) shares with Williamsonian TCE a Coasian foundation (Safarian, 2003).2 IB theory essentially describes the MNE as an internal market that operates across national boundaries. For example, as with conventional TCE, IB theory suggests that MNE foreign entry mode choices will vary depending upon the nature of the transactions at hand, for example, as a function of the risk of proprietary knowledge dissipation, the risk of negative effects on brand name reputation, the probability that the required complementary knowledge of economic actors can (or cannot) be accessed, etc. Here, the focus is more on the complex and dynamic process of efficiently transferring, deploying, augmenting and exploiting firm-specific advantages (FSAs), linking these with complementary assets of local partners and coordinating the resulting internal and external networks, rather than on merely assessing the potential redeployment without loss of economic value of narrowly defined assets involved in a particular transaction. To put it differently: the MNE as an entity is itself a governance mechanism specialized in resource recombination, meaning that a joint capability perspective and TCE perspective, as provided by internalization theory, is required to analyze properly decisions such as entry mode choices and subsequent network governance. Consistent with TCE logic, when penetrating foreign markets MNE managers must align efficiently and effectively entry mode characteristics (such as the characteristics of a subsidiary or a licensing agreement with a foreign partner) with the attributes of the cross-border transaction, but taking into account the MNE's extant resource basis (Verbeke, 2009). Given this resource base, the ultimate choice is guided by the relative efficiency and effectiveness of internalization vs the use of external markets.
As regards the use of the opportunism concept in the empirical IB literature, we revisited comprehensively all 38 empirical studies included in the meta-analysis performed by Zhao, Luo and Suh (2004), which addressed the TCE determinants of ownership-based entry mode choice, and complemented this analysis with a further study of five more recent empirical articles, which in our view satisfied the requirements for inclusion in the meta-analysis (Brouthers, Brouthers, & Werner, 2003; Chen, 2007; Chen & Mujtaba, 2007; Quer, Claver, & Rienda, 2007; Yiu & Makino, 2002). Importantly, many of the papers briefly mention the opportunism concept or expressions thereof (such as shirking), but only one of these papers, namely Brouthers et al. (2003), came close to actual measurement of the concept. These authors used a “behavioral uncertainty” measure, reflecting the dangers of free-riding, information dissipation and shirking. Behavioral uncertainty was assessed on the basis of answers to five Likert-type questions, including three items about monitoring performance related to product/service quality, one item about monitoring/safeguarding proprietary knowledge, and one item about the costs of search, contracting, and enforcement. Many of the other papers (26 of the 43) propose asset specificity or a special form thereof, namely R&D intensity, as a variable expected to influence entry mode choice, and the rationale for this is regularly couched in traditional TCE terms, including references to opportunism, but no effort was undertaken to assess directly whether safeguarding against opportunism was actually instrumental to governance choices. The general assumption is that high asset specificity in terms of difficult asset redeployment and high value losses associated with such redeployment, or perhaps more to the point the easy dissipation of FSAs in the form of the proprietary (knowledge) resources’ value creating features, will lead MNEs to favor internalization, so as to avoid the possibility of cheating (reneging on contractual terms or not abiding by the spirit of these terms) by external contracting parties.
On the issue of internal MNE governance choices there is an even greater paucity of empirical research in terms of directly measuring the potential for opportunism. However, three well-known IB scholars have recently put forward new conceptual approaches, which are all similar in terms of underlying behavioral assumptions, but ultimately fall short in providing an acceptable “behavioral envelope” for capturing fully failed human commitments inside the MNE.
Alain Verbeke's (2003) Perspective on Opportunism
limited managerial information processing capacity;
multifacetedness of information, with different economic actors inside the MNE selecting different information facets as the basis of their biased decision-making, thereby typically triggering head office–subsidiary conflicts (this is an issue of selectively picking items from the same overall information sets);
divergence in judgment when contemplating identical information, as an outcome of a differential functional/educational background and experience in the MNE.
As regards the latter two points, common manifestations of bounded rationality within the MNE appear to be the head office managers’ choice of different information facets than those selected by foreign subsidiary managers, and the more negative assessment of autonomous projects arising in foreign subsidiaries, as compared with the choices and assessments made by the foreign subsidiary managers themselves. Various best practices, such as giving seed money to subsidiaries, formally requesting subsidiary proposals, allowing some subsidiaries to act as incubators for new ideas, and developing intra-MNE subsidiary networks, have been shown to alleviate bounded rationality challenges, but obviously subject to the constraint that implementing these best practices comes with a cost tag attached to them (Birkinshaw & Hood, 2000; Verbeke, 2009).
Verbeke (2003) argues that the closest link between opportunism and value creation may be the intrinsic value arising from a reputation for not acting opportunistically, whether in the context of internal or external contracts (cf. Hill, 1990). A reduced role for opportunism in MNE internal governance is also suggested by the fact that opportunistic managers in the Williamsonian sense seldom continue to work in large, modern MNEs over prolonged periods of time (Rugman & Verbeke, 2003). The problem with Verbeke's view, however, is that proposing a hierarchy among behavioral assumptions in terms of relevance to managers (bounded rationality being the primary managerial challenge, and opportunism only a secondary one), while perhaps useful for managerial purposes, hardly constitutes a proper foundation for general IB theory, unless it could be convincingly demonstrated that failed human commitments beyond those triggered by BRat systematically disappear after internalization has taken place.
Mark Casson's (2000) Perspective on Opportunism
Casson (2000) has suggested an ambitious new agenda for research on the MNE, focused on information cost economizing, in line with Egelhoff's (1988) classic work, thereby moving away from conventional TCE and resource-based theories: “Transaction cost analysis … explains the boundaries of the firm extremely well … What lies inside the boundaries of the firm is not explained so well, however, because this is not the focus of the theory” (Casson, 2000: 118). He further argues that the main challenge for companies is the efficient integration of activities ranging from procurement to marketing “through the structuring of information flow”, thereby “dictating the internal organization of the firm” (Casson, 2000: 118). Casson's perspective is one that allows for opportunism, particularly as regards transactions for intermediate product flows, which have been the traditional focus of internalization theory (though even there, some transaction costs, such as determining intermediate product specifications, may be incurred without opportunism being present). However, MNE theorizing needs to refocus on the role of information costs, especially the information costs that are “independent of any specific transaction … [and] … can only be attributed to large sets of transactions” (Casson, 2000: 122). Casson's perspective implies, inter alia, that some types of information are more costly to communicate than others. Communication costs are incurred even when information is truthful, again if no party to a transaction would benefit from providing false information (i.e., absent opportunism).
The problem with Casson's perspective is similar to Verbeke's (2003): opportunism is presented as a critical behavioral assumption in the realm of determining firm boundaries (e.g., entry mode choice in the MNE context), but then largely disappears from the analytical picture when studying internal MNE governance: “lying would normally be self-defeating in activities [related to the information-processing demands of procurement and marketing]. The key to success is to process information efficiently, and not to invest at great expense in checking that every item of information supplied by other people is true” (Casson, 2000: 125). Casson then proposes a number of useful principles of efficient information processing inside the firm, especially the principle of sequential information collection, meaning that “a sequential investigation strategy confers option value. The option value arises from the costs that are saved from avoiding the collection of unnecessary information” (Casson, 2000: 135). In addition, Casson (2000: 145) argues that over time the more established firm (with a focus on market-making companies) may need skill sets different from those that led to its original, entrepreneurial success: the diagnostic skills required (e.g., processing information on unexpected cost increases or slumps in demand) are different from the initial prospecting skills (e.g., processing information on new market opportunities). Here, the information processing challenges faced by MNEs are typically more severe than those found in domestic contexts, given the presence of, for example, cultural differences and the higher number of sources of environmental volatility.
Casson's analysis is based largely on the behavioral assumption of meta-rationality, meaning that decision-makers take into account information costs when deciding how to come to a decision (e.g., they adopt standard procedures in a succession of similar situations characterized by uncertainty) (Casson & Wadeson, 2000). In this context of information cost economizing, Casson implicitly rejects the importance of failed commitments and the need for preventive or mitigating action against such failure. The key types of costs relevant to internal MNE decision-making are “the costs of handling information which is believed to be honest. The information may not be entirely accurate because of measurement error, and errors may be aggravated by the incompetence of those who are responsible for making observations. Nevertheless, the quality of the information will not be improved significantly by altering incentives, because those involved have no particular reason to lie.” This last statement is particularly important, because it assumes, save simple human error/functional incompetence, that failed commitments will normally occur only when there are reasons to lie, that is, when substantial benefits would accrue to the individual(s) providing false information. In practice, however, it is our view that there may be not only good reasons to lie, but also other reasons than opportunism explaining (beyond functional incompetence) why failed commitments may occur, thereby negatively affecting firm-level performance.
Anoop Madhok's (2006a) Perspective on Opportunism
Madhok (2006a), while not focused on the issue of information costs per se, provides an original storyline with a starting point and conclusion similar to those of Verbeke and Casson above. The common starting point is that TCE-based analysis may be particularly useful when the firm emerges (following a Coasean logic), but much less so when studying management inside the firm that is concerned with improving value creation (Madhok, 2006a: 116). Madhok accepts the presence of Williamsonian opportunism inside the firm, but views it as “relatively less important” as compared with the need for knowledge management: “In spite of the (occasional) acts of opportunism, building trust relations may have a greater general payoff” (Madhok, 2006a: 119). Here, individuals are viewed as having “at their core” the potential for both opportunistic and trusting behavior, with managerial action capable of influencing which side will prevail inside the firm. Firms incur both Type A costs to manage opportunism and Type B costs required to manage knowledge flows. Type B costs are essentially the same as Casson's information processing costs that cannot be attributed to individual transactions or Verbeke and Yuan's (2005) suggested investments in bounded rationality economizing, but with an emphasis on intra-MNE, relationship-building elements such as the fostering of “greater cognitive alignment … so as to ‘lubricate’ the coordinating interface and increase actors’ receptivity toward one another” (Madhok, 2006a: 112). Madhok's useful contribution to the scholarly literature is that a relatively greater focus on Type B costs vis-à-vis Type A ones, especially in knowledge-intensive firms facing strong pressure to innovate, will lead to increased value creation over time, and may, through the infusion of trust elements, actually reduce the propensity for opportunistic behavior.
The above perspective is similar to Madhok's (1995) celebrated exposition on trust in international joint ventures. In reflecting on his JIBS Decade Award winning 1995 article, Madhok (2006b) proposed that if opportunism is assumed to be rare, then non-opportunism (trustworthiness) is the more likely condition. He suggested that the value creation from assuming trust can outweigh the costs associated with the occasional cases of partner opportunism. Madhok (2006b: 9) specifically argued that “a more holistic approach towards trust and opportunism, and perhaps a re-examination of deep-seated and implicit assumptions may change firms’ attitudes and behavior towards their international partnerships.”
Importantly, the same conceptual problem arises as observed in Verbeke's (2003) and Casson's (2000) approaches described above. Opportunism inside the firm is viewed largely as a constraint, and is perceived as having been given too much attention in mainstream TCE theory. Managers should therefore focus more on bounded rationality economizing/value creation, with the substance of bounded rationality being somewhat extended so it can address the specific knowledge management challenges in large organizations, thereby also reducing opportunism problems. No alternative behavioral assumption is introduced, and the outcome is one whereby only an extended (and improved) version of bounded rationality is assumed. This outcome is thus similar to the ones proposed by Casson, who built upon the meta-rationality concept and focused on information processing cost optimizing, and by Verbeke, who attempted to extend the bounded rationality concept to cover more adequately the information processing challenges specific to MNEs (see especially Verbeke and Yuan, 2005). Madhok (2006a: 114) argues in this context: “what if the failure to perform may be not for self-interested reasons but, rather, due to cognitive limitations of a genuine nature to do with bounded rationality, which results in different understandings, different interpretations of internal and external developments and the like?”. He then concludes: “management plays a dual function in guarding against dissipation of the rent stream, both checking opportunistic behavior and coordinating knowledge flows.” Here, investments in trust play an important role as a moderating variable between managerial costs and firm-level performance. Investments in trust do not merely allow reducing Type A costs in the firm, but also provide the seeds for future value creation through better knowledge management, that is, they improve the return on Type B expenditures, with the manager being “an orchestrator of knowledge flows … in order to generate surplus value through the cooperative efforts of individuals and teams” (p. 117).
The Unsolved Verbeke–Casson–Madhok Puzzle
Verbeke, Casson and Madhok, though criticizing the opportunism concept in terms of the alleged excessive weight given to it in TCE-based work, actually endorse the concept, but mainly in the context of setting the firm-level boundaries and selecting entry mode choices, rather than in the context of management inside the MNE. What occurs inside the MNE is then driven largely by sophisticated information processing and knowledge management considerations. Such considerations allow economizing on (extended and contextually relevant forms of) bounded rationality. Madhok contends that this approach inside the firm may have further value-creating properties. In Casson's case, meta-rationality may not be consistent with Simon's definition of bounded rationality (see also Casson, 1999), but if one moves away from Simon's notion of mere satisficing, and bounded rationality is viewed as an envelope concept describing the various challenges of managing information faced by decision-makers given their limited information processing capacity, and the complexity, uncertainty and geographic dispersion characterizing relevant information, meta-rationality (which reflects calculative/optimizing behavior rather than satisficing) can probably be subsumed within a BRat-envelope, as Casson's (1999: 115) interpretation of imitation in business strategy illustrates.
The puzzling outcome of the Verbeke–Casson–Madhok approaches is that the presence of Williamsonian opportunism (whether in its dispositional or its situational form) is accepted as an accurate behavioral foundation for scholarly work explaining – or militating against – failed human commitments in the context of establishing firms or redrawing firm-level boundaries, but at the same time economizing on opportunism is viewed as a rather minor challenge inside the firm, in spite of substantial empirical evidence suggesting otherwise, especially in the contemporary accounting and finance literatures that focus on agency and economic entrenchment challenges, but also in the rich scholarly work on the historical growth patterns and functioning of the world's largest enterprises: see, for example, Chandler, Amatori and Hikino (1997) on the rise of large firms and MNEs worldwide, and Chandler (1994) on the restructuring of American industry between 1960 and 1990. The governance challenges identified cannot be reasonably reduced to bounded rationality problems only, even if BRat's substance is extended in the ways contemplated by Verbeke–Casson–Madhok, thereby making it an envelope concept to which new components can be added, as the situational context changes over time and space. In our view, the systematic occurrence of failed human commitments makes it essential to studying MNE internal governance (as a general case for developing a theory of the firm, in line with Casson, 1987) using an appropriate behavioral assumption addressing the sources of failed commitments, in addition to the bounded rationality envelope concept accepted by most scholars. Casual observation of real-world problems in IB allows three points to be made regarding failed commitments inside the firm beyond bounded rationality.
First, Chandler (1994: 17–18) powerfully describes the excessive commitment of senior management in large American firms towards unrelated diversification in the 1960s, fueled by fast historical growth and an overrating of the “potential of their enterprises’ product-specific organizational capabilities. The information revolution reinforced a belief in the new view of management as a set of skills unrelated to specific products or industries.” In a number of cases, the outcome of this lack of importance attached to domain knowledge was a failure to achieve the expected growth rates and profitability promised to shareholders. In part this undoubtedly reflected a bounded rationality problem, since “the top managers often had little specific knowledge of, or experience with, the technological processes and the markets of many of the businesses they had acquired” (p. 18), and these new businesses “created an extraordinary demand for decision making that overloaded the corporate office.” (p. 18). Here, Chandler observes that most large, diversified US MNEs managed maximum 10 divisions before World War II and only a few firms had 25 divisions, whereas in 1969 several US MNEs managed between 40 and 70 divisions. However, there is more going on here than imperfect information availability or imperfect information processing, as the mere presence of such information problems should have led to the rapid shedding of difficult-to-manage, unrelated activities, once the performance effects proved unsatisfactory. The real source of the failure towards making good on promises to shareholders was the perhaps good faith – but certainly exaggerated – self-confidence in the senior management teams’ organizational capabilities, a belief that was reinforced rather than moderated by the possibilities offered by modern information and communications technology. This exaggerated self-confidence led to organizational overcommitment, which then had to be scaled back at a later stage. The scaling back sometimes came in the form of hostile takeovers by short-term oriented raiders and financial intermediaries, who prevented the required investments in R&D and capital equipment to sustain growth. As a result, many extant stakeholders, sometimes including the original shareholders, suffered the consequences of the broken promises by the senior management teams involved.
Second, senior management in large MNEs nowadays often publicly voices commitment towards decentralized entrepreneurship, but then falls short on making good on such commitment. This common phenomenon has been demonstrated in a large body of literature on the challenges faced by enterprising subsidiaries that identify new market opportunities downstream or develop innovative solutions upstream in the value chain, but must then confront a corporate immune system that appears at odds with head office management's promises towards decentralized entrepreneurial initiatives: see Birkinshaw (2000) for an overview. The point is not only that head office managers face bounded rationality problems when trying to distinguish between valuable subsidiary initiatives and initiatives that can best be pursued outside the company boundaries, especially when head office managers face information problems resulting from high cultural, economic and administrative distance. The point is that corporate managers’ support expressed toward decentralized entrepreneurship may actually not be implemented when (especially peripheral) subsidiaries attempt to gain head office attention and resources for their initiatives. The “let a thousand flowers bloom” philosophy is a powerful driver of variety generation in MNEs, but one that appears difficult to implement in practice when one arrives at the stage when head office management must actually select “winners” and weed out “losers”. Bouquet and Birkinshaw (2008) provide an overview of various governance design elements to facilitate peripheral units escaping from head office management's tendency towards de facto subsidiary initiative neglect, such as fostering successful representatives from the periphery being promoted to the head office, or creating formal and informal opportunities for subsidiaries to showcase their capabilities. Unfortunately, it is clear from their analysis that the promise of decentralized entrepreneurship as a tool to serve long-term, corporate objectives is often replaced by the pursuit of “local” goals, paradoxically established at the head office level rather than the foreign affiliate level, since the MNE “involves a cacophony of competing initiative attempts, with actors at all levels pushing for issues of particular importance to their own strategic agendas” (Bouquet & Birkinshaw, 2008: 490). Here, actual resource allocation then typically favors established businesses and managers with a long track record of success, which implies a reversal of the promised focus on decentralized entrepreneurship.
Third, though the two above points demonstrate that broken promises are common, even in the absence of opportunism, this concept remains of some relevance. A large literature describes the negative effects of managerial discretion in large firms, whether domestic firms or MNEs, with alleged managers’ motivations ranging from Marris's (1964) growth maximization goals to Bertrand and Mullainathan's (2003) preference for a “quiet life”. Here, information asymmetries might allow deviations from effort to increase shareholder profits, and introducing new governance mechanisms, such as better financial disclosure and oversight, may curb such discretionary behavior. In addition, information processing requirements may be particularly severe in the MNE context (Tihanyi & Thomas, 2005). Managers supposedly committed to serving shareholders’ interests are often observed failing on their commitments and pursuing other objectives. Luo (2005) enumerates several distinct components of MNE corporate governance design that should be considered as MNEs become more internationally diversified, in order to avoid collapses resulting from various forms of intentional deceit (Luo, 2005: 37). Useful governance design measures include inter alia larger and more culturally diverse board structures, more outside directors on corporate boards, and more specialized committees within the corporate boards. In other words, opportunism in the sense of intentional deceit, resulting in failure to make good on commitments, actually is a common phenomenon, even at the highest levels in the MNE.
The three above elements suggest the importance of various sources of broken promises inside firms, including inter alia promises made to shareholders, top-down promises made to affiliates, and bottom-up promises made by affiliates. The observation of broken promises resulting from what is ultimately imperfect effort towards actually fulfilling commitments is obviously not new, and has been studied in great depth by many scholars, for example in the context of managerial incentive problems and discretionary behavior. Particularly notable is the work of the late Harvey Leibenstein (1966, 1976), a Harvard economist. The problem with Leibenstein's oeuvre, however, is that his conceptualization of X-inefficiency requires assessment/measurement of observed performance vis-à-vis a theoretical optimum suggested by perfect competition in neoclassical economics. A more actionable approach is to compare the performance of real-world alternatives, that is, discrete governance choices, each with particular bounded reliability economizing properties. In addition, Leibenstein viewed the “personality” of economic actors as the ultimate source of X-inefficiency, with little analysis of the linkages between personality traits and observed inefficiency. In contrast, we view the occurrence of imperfect effort (whether by head office managers, subsidiary managers, non-managerial employees, etc.) as a behavioral phenomenon that can inform comparative institutional analysis in well-defined situational contexts. Specific promises, whether in the context of individual transactions or of large sets of transactions, may not be kept, and such failures may arise to a greater or lesser extent with different, discrete governance alternatives in place. In the next section, we present the results of an analysis of 30 MNE case studies, leading to the development of a new envelope concept complementing bounded rationality, namely bounded reliability or BRel, against which economizing action can be undertaken so as to avoid failed commitment or mitigate the effects of such failure.
CASE STUDY ANALYSIS
We draw on existing case studies to describe tentatively the potential mechanisms underlying failed human commitments, and the managerial actions undertaken to avoid or mitigate such failures, within the MNE context. We explore why managers fail on commitments, asking the question whether such failure results solely or partly from a strong-form self-interest, that is, intentional deceit, or whether other mechanisms can trigger failure. To put it differently: what are managers actually safeguarding against when making governance choices affecting the MNE's internal functioning?
To answer the above questions we adopted a largely inductive design (though building upon the insights presented above) that utilized purposive or theoretical sampling (Eisenhardt, 1989; Yin, 1994), thereby selecting 30 case studies for our analysis. We selected case studies that focused on the nine global MNEs identified in Rugman and Verbeke (2004). These nine global MNEs, namely Canon, Coca-Cola, Flextronics, IBM, Intel, LVMH, Nokia, Royal Philips Electronics and Sony, are the only MNEs in the Fortune Global 500 with over 20% of total sales revenues coming from each of the triad regions (North America, Europe and Asia). These MNEs, though having varying administrative heritages, all operate as differentiated networks, and are appropriate subjects for our analysis because of the size and scope of their operations as well as their observed success in addressing the complexities of major operations in all three triad regions, as demonstrated by the balanced geographic distribution of their sales.
The 30 cases describing various aspects of the internal functioning of the nine MNEs were also selected through purposive sampling, to ensure the quality of the description of managerial decision-making and intentions. The cases were drawn exclusively from four recognized case producers and distributors, namely the Harvard Business School, Stanford University, the Ivey School of Business, and the International Institute for Management Development (a list of the cases is provided in the Appendix). These case studies were typically crafted to offer insight into managerial responses to business opportunities and to the potential of failure associated with these opportunities, including the potential for failed human commitments. The objectivity of such cases can be debated, as they may stretch information to make a particular point or to appease company management, who often must sign off on the final product (thereby making it less likely that intentional deceit is discussed). While this limitation poses a challenge to theory testing, the cases do offer a rich source of real-world examples useful to theory development regarding the mechanism(s) underlying failed commitments.
Our analysis of the cases focused on the underlying intentions involved in managerial decision-making and commitments. We started from our casual observations described in the previous section that MNE managers often fail to make good on their commitments, and that other mechanisms appear to be in play than opportunism as intentional deceit. Within this context, we searched for emerging themes within the aggregate of all the cases (Glaser & Strauss, 1967). Upon identifying themes from the aggregate, we looked across the cases on the nine MNEs for within-group similarities and inter-group differences (Eisenhardt, 1989). This process followed the four iterative stages of the constant comparative method, which begins with comparing incidents applicable to each category, integrating categories and their properties, focusing the theory, and writing the theory (Shah & Corley, 2006).
Finally, we note that qualitative research often lacks robust reporting techniques, which leaves readers wondering how the conclusions were drawn from the data (Eisenhardt, 1989). Thus we utilized a summary theme support table and summary vignettes to illustrate the linkages between our propositions and the data (a theme quote support table, consistent with Sharma and Vredenburg, 1998, is available from the authors upon request).
RESULTS AND DISCUSSION
A number of themes emerged from our analysis of the global MNE cases, much in line with our prior casual observations. These themes suggest a plurality of mechanisms, including but not limited to opportunism as intentional deceit, that underlie both realized failed commitments and the adoption of safeguards against the potential for failed commitments. We suggest that these individual mechanisms can be conceptualized under the broad envelope concept of bounded reliability (BRel). Bounded reliability reflects the fact that expressed (or reasonably expected) commitments to achieve a particular outcome do not always result in the promised outcome, owing to a variety of factors (but excluding elements such as technical error, functional incompetence or exogenous circumstances, e.g., unpredictable environmental change). Thus, whereas bounded rationality reflects the scarcity of mind, bounded reliability reflects the scarcity of making good on open-ended promises.
that are not fulfilled;
because of identifiable mechanisms;
attributable to specific economic actors;
resulting in a dysfunctional consequence for the MNE (loss of efficiency/effectiveness).
Prevalence of bounded reliability examples in MNE CSEs
Benevolent preference reversal: reprioritization
Benevolent preference reversal: overcommitment
Opportunistic Bounds on Reliability
In line with traditional TCE-based thinking, opportunism as intentional deceit or the threat of opportunistic behavior was an emergent theme in a number of the cases. One example of opportunism as a bound on reliability is found in the case discussing IBM's emerging business opportunity (EBO) program. While this was an important program, the then newly appointed CEO Lou Gerstner was concerned that managers might attempt to “game the system” by reclassifying horizon 1 businesses as horizon 2 or 3 ones (horizon 1 businesses being traditional, established operations subject to standard performance targets, whereas horizon 2 and 3 ones are new and emerging businesses), thereby avoiding the requirement to meet specific targets. Here, the scenario was contemplated that employees/managers might act opportunistically by advancing their private interests through obfuscating the true nature of their operations.
Benevolent Preference Reversal: Reprioritization
A second emerging theme revolved around failed commitments stemming from benevolent preference reversal associated with good faith reprioritization. This bound on reliability captures instances whereby managers make ex ante commitments in good faith (with benevolent intent), but whereby the importance of that commitment diminishes over time (preferences are reordered). This theme is consistent with a substantial body of literature in psychology that has identified two main reasons for the occurrence of good faith reprioritization. First is the psychological phenomenon of preference reversal over time (Tversky, Slovic, & Kahneman, 1990). The relevance to the bounded reliability concept is that a manager may make ex ante commitments to a particular course of action, for example, based on a high probability of at least some payoff. In carrying out the commitment, however, other opportunities may arise with a higher payoff, at least in terms of net benefit categories perceived relevant by this manager, and therefore be valued more positively, causing a reversal in the original commitment. The relevant point here is not uncertainty reduction as time goes by (making the second course of action comparatively more attractive), which would make it a mere bounded rationality issue, but the fact that an original commitment was made to a contracting party to implement the first course of action (e.g., by a subsidiary manager to the MNE's head office), and that this contracting party with a continued preference for the original course of action may now suffer from the managerial reprioritization towards pursuing the second course of action. Obviously, a dysfunctionality negatively affecting the firm results only if the new course of action focuses too much on “local” goals rather than “global”, firm-level goals, in spite of the manager believing the new course is in the best interest of the firm.
The second major cause of reprioritization is the cognitive bias known as the time discounting bias. This bias suggests that individuals place a lower value on future events than on more proximate events. Time discounting broadly encompasses any reason for caring less about a future consequence, and the associated preference for immediate utility over delayed utility (Frederick, Loewenstein, & O’Donoghue, 2002). Within the bounded reliability context, such discounting can cause managers to postpone fulfilling commitments (i.e., to procrastinate) to the point where such commitments can no longer be fulfilled. Again, this is not a bounded rationality problem in terms of incomplete information about the future or limited information processing capacity, but rather a systemic source of individuals being unreliable, and engaging in procrastination over and over again, though knowing full well, based on past experience, that such behavior endangers making good on commitments (Steel, 2010).
Within the internal MNE context, this type of benevolent preference reversal in the case studies typically took the form of refocusing on local priorities, at the expense of head office priorities or global priorities, which ultimately was detrimental to the firm. Refocusing on local priorities is particularly salient within MNEs, as distance in time between a promise and its expected fulfillment can be further exacerbated by various other dimensions of distance (cultural, economic, institutional, geographic, etc.). For subsidiary managers, bona fide local economic opportunities not condoned by the corporate head office may arise with rewards perceived as more immediate, while managers may also be insulated from some of the head office's monitoring apparatus by cultural and geographic distance. The cultural and spatial separation between head office and subsidiaries may also contribute to the cognitive distance between head office and subsidiary managers, thereby increasing the likelihood of a reordering of preferences after an original commitment is made.
However, local reprioritization does not imply that the problem of failed commitment always arises at the subsidiary level; it may also have its source at the head office. As one example, prior to IBM's emerging business opportunities (EBO) program noted above, commitments made to fund new business projects would dry up if the division overseeing the project came under financial pressure. IBM typically made an initial commitment to new business ventures in terms of large-scale funding. Over time, the priority of this commitment would change because of a reordering of priorities, whereby typically a focus on success in traditional business activities would replace the initial priority on developing the new business. This preference reversal resulted in the whittling away of the new venture's resource allocation, and possibly the complete abandonment of the commitment to the new venture. The dysfunctional consequence of such failed commitments was that IBM senior management appeared unable to capitalize on emerging business opportunities.
Several successful cases illustrated the potential governance mechanisms for economizing on bounded reliability, in terms of reducing good faith local reprioritization. We acknowledge the difficulty in making causal inferences based on the absence of a failed commitment. Nonetheless, the following three examples illustrate this point. First, the eventual implementation of IBM's EBO program suggests a useful mechanism for economizing on this expression of benevolent preference reversal. The EBO program utilized both milestones and frequent project reviews to ensure fulfilled commitments. These reviews did not have to be extensive or formal, as suggested by one IBM executive's comment that just a 30-min conference call would typically help keep the discipline. Such frequent reviews, though coming with a cost, imply an increase in fulfilled commitments through keeping these commitments cognitively proximate. In general terms, the use of milestones allows the decomposition of large, temporally distant commitments (e.g., profitability of business operations) into smaller, more temporally proximate components (e.g., market feasibility, prototype development, production, monthly sales growth). Temporally proximate commitments are less prone to preference reordering, as the commitments remain “top of mind” (cognitively proximate), in this case with IBM's business unit managers.
Second, Canon's new product development guidelines provided a mechanism for the regular and ongoing review of each innovation project's progress (e.g., new fax scanning technology). These guidelines broke long-term commitments into smaller, more temporally proximate commitments (milestones), and this undoubtedly helped reduce the occurrence of local reprioritization. The case of Canon also usefully illustrates the role of expectation alignments with and within development teams as a bounded reliability economizing mechanism. The ex ante alignment of expectations (as opposed to the simple alignment of incentives to curb opportunism) increased goal clarity and buy-in from the parties involved. The Canon example suggests there were few failed commitments from the head office to development teams and vice versa.
Third, still in the realm of expectation alignment, it is worth noting that many of the MNE cases (e.g., Philips, Nokia, Canon and Sony) suggest the use of expatriates in foreign subsidiaries as a mechanism to develop and sustain a unified MNE vision. Expatriates’ understanding of – and informal connections with – the head office offer the ability to align the subsidiaries’ and headquarters’ expectations better. Thus expatriates can serve as a bounded reliability economizing mechanism by bridging the cognitive distance between the head office and geographically distant affiliates. In doing so, subsidiary commitments to the head office are less likely to suffer from benevolent preference reversal, and thus are more likely to be fulfilled.
Benevolent Preference Reversal: Scaling Back on Overcommitment
A third major theme that emerged was the tendency for managers to fail, owing to benevolent preference reversal, in the form of ex ante overcommitments that had to be scaled back ex post. Overcommitment reduces reliability, and stems from the behavioral phenomena of impulsivity and an unrealistic belief in one's own abilities. There is a vast psychology literature on the personality, cognitive and behavioral aspects of impulsivity. The two types of impulsivity usually distinguished include dysfunctional impulsivity, that is, the tendency to act with less forethought than most people of equal ability, with this tendency acting as a source of subsequent difficulties, and functional impulsivity, that is, the tendency to act with relatively little forethought when such a style is optimal (Dickman, 1990). Dysfunctional impulsivity as a bound on reliability suggests that economic actors may commit themselves ex ante with little forethought, thus bringing into question their ability to fulfill the commitment made. From a more dynamic perspective, impulsivity as a bound on reliability can also occur when subsequent commitments are made with little reflection on the impact thereof on current commitments.
The planning fallacy also contributes to overcommitment, and has been studied in the planning fallacy biases literature (Buehler, Griffin, & Ross, 1994; Tversky & Kahneman, 1974). The planning fallacy means that planners rely on their best-case plans for a project (transaction), even though similar tasks in the past have typically run late. The planning fallacy leads managers to pursue initiatives that are unlikely to come in on budget, or on time, or to ever deliver the expected returns (Lovallo & Kahneman, 2003). The planning fallacy was observed in Durand's (2003) study, which found that a high illusion of control increases positive forecast bias. This bound on reliability is also evidenced by economic actors’ propensity to overlook failures because organizational learning produces a biased history: “As learners settle into those domains in which they have competence and accumulate experience in them, they experience fewer and fewer failures. Insofar as they generalize that experience to other domains, they are likely to exaggerate considerably the likelihood of success” (Levinthal & March, 1993: 104). Here, an ex ante misconception of one's own abilities to fulfill a commitment results in an increased likelihood of failing to meet that commitment and to scale back.
Similar to what was noted in the context of good faith reprioritization, the above sources of overcommitment cannot be simply reduced to bounded rationality problems, because sufficient objective information is usually available to assess correctly ex ante which commitments can be fulfilled and which ones reflect overcommitment. In addition, there is no conventional problem of limited human information processing capacity, because past experience actually allows identifying with a high probability (and again ex ante) when an overcommitment is being made. Here, psychological biases lead to a neglect of both the objective information and the outcome of the rational processing of this information, in terms of what can actually be achieved and what cannot.
As one example, Flextronics made a commitment to Microsoft to manufacture the X-box game console with aggressive requirements such as a DVD port, ethernet port, 733 MHz processor, and high-end graphic chips, with a size no larger than a standard video cassette, that could be sold for under $400 and be on the shelves by October 2001 for the holiday season. Flextronics further committed to provide all this in conjunction with a simultaneous launch in Europe and North America using two separate manufacturing facilities. This already aggressive target was further complicated by Flextronics’ lack of computer and coordinated global production experience. While Flextronics was able to produce the Xbox, early shipments of the console did not meet expectations, and Flextronics’ inability to adopt a unified shop floor system for the North American and European manufacturing plants became a stumbling block for the successful fulfillment of the firm's original commitment. For Microsoft this delay had the dysfunctional consequence of lost revenue due to insufficient product availability. While one could argue that Flextronics was merely acting opportunistically by knowingly overcommitting to Microsoft (i.e., engaging in intentional deceit), evidence from the case suggests that good-faith overcommitment represents the more likely bound on reliability. For example, the description of the Flextronics’ entrepreneurial culture and the firm's history of success probably increased benevolent overcommitment by allowing impulsivity and self-evaluation bias to influence the scope of top management commitment made to Microsoft. Flextronics’ CEO (at that stage Michael Marks) disliked both formal processes and large teams requiring several weeks before making decisions. He preferred a culture whereby individuals were allowed to make strong commitments, a culture he viewed himself as somewhat chaotic. While there are advantages to such an entrepreneurial culture, the combination of employee empowerment and lack of formal process within the firm allowed for individual impulsivity, and in its dysfunctional form this triggers overcommitment, to be scaled back at a later date. Flextronics was also subject to a self-evaluation bias stemming from the firm's rapid global expansion and growth in developing manufacturing competencies (including building keyboards and joysticks for Microsoft). These past successes reduced Flextronics’ senior management's desire to assess properly the extent of the commitment that was being made.
As a second example, Coca-Cola provides another illustration of good faith overcommitment. As CEO, the late Roberto Goizueta consistently set bold targets, for example, a commitment to the board and shareholders to increase earnings by 18% and volume by 7% annually. As with the example above, this could be simply interpreted as a case of opportunism on the part of Goizueta, so as to increase his power and personal financial rewards. The case, however, suggests that Goizueta truly believed Coke's global market potential was enormous, and Goizueta correctly stated the firm had yet to overpromise. It is likely that, in this case, self-evaluation bias and a high illusion of control were creating a positive forecast bias. Goizueta's reliance on Coke's past successes influenced his desire to assess properly the extent of the commitment he was making. This benevolent overcommitment set him and Coke's entire senior management up for subsequent failure. It later became apparent that Coke's senior management reverted to balance sheet maneuvers to hit many of these targets, and by the time Douglas Daft took over as CEO, these commitments had to be scaled back considerably. In the end, Goizueta's overcommitment to the board and shareholders, and the resulting failure, damaged Coke's reputation and had a negative impact on overall shareholder value.
IMPLICATIONS OF BOUNDED RELIABILITY
Illustrations from our case analysis combined with findings from the extant psychological and economics literature suggest that bounded reliability as an envelope concept includes the following three main components, within the context of global MNE internal governance: opportunism as intentional deceit, benevolent preference reversal as local reprioritization and benevolent preference reversal as scaling back on overcommitment, with both expressions of benevolent preference reversal resulting from decisions made in good faith, but ultimately with negative (dysfunctional) consequences for the firm.
Assessing Bounded Reliability
The adoption of behavioral envelope assumptions such as bounded rationality and bounded reliability, while managerially relevant, comes with the threat of reducing the parsimony of a theory. However, bounded reliability replacing the opportunism assumption does not detract from the parsimony of TCE/internalization theory, or more generally comparative institutional analysis. The multifacetedness of the bounded reliability envelope concept is also consistent with other TCE constructs. For example, in the MNE context we argued earlier that four dimensions of bounded rationality are critical, rather than merely the two conventional dimensions. We should also remember that Williamson distinguishes among six forms of asset specificity – site, physical, human, dedicated, brand name capital, and temporal (see, e.g., Williamson, 1996a) – and acknowledges various forms of uncertainty: behavioral, technological and demand related (Williamson, 1985).
Sources of bounded reliability and economizing mechanisms
Sources of BRel (leading to failed commitments)
Specific examples of economizing
Ex ante intentional false commitments, and ex post malevolent reneging on commitments (strong-form self-interest)
• Contractual safeguards
• Institutionalizing the importance of reputation
Benevolent preference reversal as reprioritization
Good faith reordering of commitments over time (time discounting bias and changes in preference ordering)
• Expectation alignment
• Joint goal development
• Continued cognitive proximity
• Goal segmentation/milestones
• Frequent communication
Benevolent preference reversal as scaling back on overcommitment
Good faith overcommitment (overconfidence bias and impulsivity)
Organizational routines for reducing individual evaluation bias and impulsivity
Multilevel decision processes
A conceptual focus on the firm's ability to economize on both bounded rationality and bounded reliability offers a number of advantages. First, it allows TCE (and more generally comparative institutional analysis) to operate as a dynamic theory, one that invites analysis on how bounded reliability develops in particular situational contexts. This is in sharp contrast to blindly accepting Williamson's (1993a) limited view of man, which pushes the case for systematic (and costly) safeguarding against worst-case scenarios, and basically shuts down any appetite for further in-depth analysis of the phenomenon, as shown above by the Verbeke–Casson–Madhok perspectives on the concept. Our approach also invites serious study of the reasons why opportunism as intentional deceit may be stronger in some situational contexts, whether at the firm level or societal level, than in others. For all the emphasis on the need for adapting to changed environmental circumstances, Williamson's approach remains largely timeless (Slater & Spencer, 2000). Introducing elements into the theory that capture dynamics is a matter of urgency (Buckley & Casson, 1998b). While Buckley and Casson suggest that looking at costs over time or at the direction taken by the entrepreneur might be the appropriate way forward, we suggest a focus on economizing on bounded reliability and bounded rationality, which is a dynamic process in and of itself.
Second, Holt (2004) has argued that managers act from a complex set of motives, and rather than adopting standard modes of judgment or selection, remain responsive to the dynamics of an evolving set of cognitive and social influences. Bounded reliability captures the dynamic nature of managerial decision-making through the inclusion of benevolent preference reversal. As a result, we eliminate the danger voiced by Ghoshal (2005) that a wrong message is being sent to students, scholars, managers and society at large, when governance mechanisms in organizations are described as serving merely to protect against strong-form self-interest.
Third, through introducing governance mechanisms economizing on bounded reliability, the net benefits of internal organization vis-à-vis markets, for example, in terms of the former's ability to see through innovation processes in their entirety, may be increased further, whether opportunism mitigation is a prevailing consideration or quasi-absent. Some of the bounded reliability economizing mechanisms might, with effort, also be replicated in hybrids. Most TCE hybrid governance research has focused on equity vs non-equity joint ventures, with equity ventures approximating what occurs inside the single firm (Beamish and Banks, 1987; Geyskens, Steenkamp, & Kumar, 2006; Hennart, 1988; Poppo & Zenger, 1995). TCE runs into problems, however, when attempting to explain cooperative behavior in the absence of credible commitments. Thus much of the literature in these areas has identified inter-organizational trust as a key factor in contributing to hybrids’ success, the general view being that trust has a positive effect on hybrids’ performance (Krishnan et al., 2006). Bounded reliability provides an alternative explanation for the attractiveness of hybrid governance. For example, the trust literature suggests that frequent interaction between contracting parties increases trust and therefore levels of cooperation. An alternative interpretation, however, is that frequent interactions allow economizing on bounded reliability by increasing cognitive proximity (commitments are kept top of the mind) thus reducing the likelihood of preference reordering and time discounting bias.
Fourth, within both single firms and hybrids, economizing on benevolent preference reversal as reprioritization can also be activated through the ex ante alignment of the transacting parties’ expectations. By crafting a shared vision of the future, parties will become less likely to reorder their preferences over time. To assist in this process, milestones or frequent contact also ensure that parties’ preference orderings remain consistent with the original commitment. In this regard, the role of the “contract” extends beyond enforcing transactions towards ensuring all parties understand future expectations. Economizing on bounded reliability inter alia through ex ante expectation alignment, frequent communication, sub-goals and milestone specification, etc., also allows for hybrid governance forms to be applied in transactions involving highly specific assets. In line with Ghoshal's (2005) perspective: the main outcome of bounded reliability economizing may be to articulate better – and to reinforce – the common purpose shared by the transacting parties.
Bounded Reliability and MNE Research
We now very briefly explore the implications of bounded reliability for MNE research. For clarity of exposition, we distinguish among three key areas of research, namely location, internalization, and management of proprietary knowledge (see Dunning's 1988 eclectic paradigm).
First, on the issue of location advantages, bounds on reliability are likely to be influenced by the distance (e.g., cultural, economic, institutional, geographic) between the MNE's home and host countries. Opportunism as intentional deceit can be expected to increase when crossing borders, owing to the divergence in national institutional structures that make enforcement of open-ended commitments more difficult, especially if intentional deceit can take advantage of latent societal xenophobia vis-à-vis foreign business interests in a host-country environment, leading macro-level institutional safeguards (including the application of the rule of law by the judiciary) to break down. Informal safeguards such as reputation effects may also be diminished as the MNE becomes more geographically diversified, and moves towards higher-distance host-country environments where the firm's reputation is largely unknown. Benevolent preference reversal as local reprioritization can increase owing to cross-border economic and institutional differences that make ex ante expectation alignment more difficult. Cultural and geographic distance can also increase the cognitive distance between actors inside the MNE. As described earlier, greater cognitive distance suggests that original commitments are no longer “top of mind”, thus allowing for preference reversals. Finally, overcommitment may also increase, for example, as head office managers make commitments based on previous successes of operations in low-distance countries that do not necessarily transfer to new, higher-distance target countries. The scale of potential opportunities in the international context may also offer more “temptations”, thus magnifying impulsivity's influence on overcommitment (e.g., large commitments to new opportunities jeopardizing the ability to fulfill current commitments). The general implication of bounded reliability for location advantages is thus that expansion into higher-distance countries is likely to amplify reliability problems, both inside the MNE and in transactions with third parties, thereby increasing the vulnerability of the MNE when it attempts to access and exploit host country location advantages, whether in the sphere of input markets or of output markets. From an MNE network perspective, the prediction is that bounded reliability will become more of a problem in cases of unrelated as compared with related geographic diversification.
Bounded reliability can also inform research on the regionalization phenomenon. The majority of the world's largest companies are home region oriented (Rugman & Verbeke, 2004). The various distance components with host regions are likely to increase at the micro level the cognitive distance between home region head office and host region subsidiaries, thereby increasing benevolent preference reversal challenges. If bounded reliability levels are systematically higher when expanding to host triad regions, the question arises whether this higher propensity towards unfulfilled commitments of subsidiaries to the head office, and vice versa, should trigger limits on FSA transfers and on the allocation of subsidiary charters in host regions. The question also arises whether the strong likelihood of higher bounded reliability across regions implies that the nine global MNEs covered in our case studies have developed superior bounded reliability economizing routines as compared with their single-region counterparts.
Still in the realm of location, countries that facilitate bounded reliability economizing are likely to be more attractive to MNE entry and expansion. Bounded-reliability-economizing country-specific advantages (CSAs) include institutions that promote fulfilling commitments and punish reneging on them. While legal institutions such as stringent property rights protection rules obviously make it possible to economize on opportunism as intentional deceit, other institutions, such as industry groups and associations open to foreign investors, may serve to align expectations of members (e.g., through the development of industry standards), thereby reducing preference reversals (e.g., in the realm of local subsidiary management being expected to enforce stringent product health and safety controls). Public institutions can also be instrumental to bounded-reliability-economizing CSAs if they introduce policy routines that limit the possibilities for single actors (such as a country's head of state) or small groups in the executive branch of government to overturn prior government commitments towards foreign investors. For example, a layer of civil servants and bureaucracy just below government-level decision-makers limits the impulsivity and overconfidence bias found in individuals and small groups (as in “let's nationalize the oil industry and redistribute the wealth it creates to our citizens”), and thus increases the likelihood of a fulfilled commitment. From a normative perspective the question arises, in the context of government–MNE relations: what governance mechanisms provide the best bounded reliability economizing outcomes? For example, beyond legal institutions, what other steps can emerging market countries take to facilitate bounded reliability economizing in their country?
Second, as we indicated at the outset of this paper, the intellectual stimulus for developing the bounded reliability concept was born out of internalization theory (TCI) thinking, in part owing to the theory's reduced emphasis on opportunism. The internalization perspective has provided great insight into MNE entry mode choice (see inter aliaBuckley & Casson, 1998a), and adopting the bounded reliability concept should influence this area of research. For example, if benevolent preference reversal challenges are greater in more distant host-country contexts, the question arises as to the impact on internalization levels, with unified governance probably better at economizing on this form of bounded reliability than alternative entry modes. As regards international joint ventures with culturally, economically, institutionally and geographically distant partners, we should see success being more dependent upon explicit ex ante communication to encourage expectation alignment and alignment of preference ordering, and increased use of subgoals and milestones to reduce the time discounting bias.
In terms of internal MNE governance, a specific area of IB research to be influenced by the adoption of bounded reliability is the analysis of head office–subsidiary relationships. As our analysis has indicated, the use of expatriates in subsidiaries may facilitate expectation alignment between subsidiary and head office. Expatriates also offer informal network linkages with the head office that guarantee frequent communication and keep commitments more cognitively proximate. The prediction is therefore that subsidiaries with expatriates are more likely to fulfill commitments to the head office. If so, the question arises whether this effect will be magnified in more cognitively distant environments.
Bounded reliability and the subsidiary context also suggest a number of interesting questions surrounding subsidiary initiatives (Birkinshaw, 1997). In most cases, economizing on bounded reliability would be desired in order to ensure fulfilled commitments from head office to subsidiaries, and vice versa. Reducing overcommitment (e.g., keeping impulsivity and overconfidence bias in check), however, may actually imply setting limits on autonomous subsidiary initiatives, resulting in missed opportunities for the MNE. Interesting questions in this area include: Do higher levels of autonomous subsidiary initiatives correspond with more severe challenges of bounded reliability in subsidiaries? Do MNEs differentiate bounded reliability economizing mechanisms imposed on their subsidiaries depending upon these subsidiaries’ role or charter in the internal network?
Third, as regards ownership advantages (or FSAs), or more broadly the management of proprietary knowledge, the main point to be remembered from the above analysis is that continuous attention devoted to mechanisms to economize on bounded reliability, such as knowledge management routines, may itself become one of the MNE's core FSAs. The key question then arises which types of MNEs with which types of knowledge assets are most likely to specialize in developing FSAs in bounded reliability reduction. Given that investment in bounded reliability reduction is costly, the additional question is how much investment might be optimal, and how this optimal level of investment might affect both the scale and the scope of the MNE's international diversification efforts, and the management of the resulting internal network.
Bounded reliability or BRel as an envelope concept captures the mechanisms underlying and linking failed human commitments. Bounded reliability is dispositional, as is the case with bounded rationality (BRat): in any managerial context, one can always assume some level of intrinsic scarcity of effort to making good on open-ended promises, just as one can always assume some intrinsic scarcity of mind. However, the observed types of bounded reliability and the losses in efficiency and effectiveness these engender, as well as the remediating governance mechanisms, are largely situational, as is also the case with bounded rationality. In other words, an ex ante comparative institutional assessment is always required to assess whether economizing on bounded rationality and bounded reliability can reasonably be achieved, given the presence of real-world, discrete governance alternatives.
We identified two broad sources of bounded reliability inside the MNE, namely opportunism as intentional deceit, and benevolent preference reversal in the form of local reprioritization and overcommitment requiring subsequent scaling back of promises. The bounded reliability concept offers a more complete behavioral understanding – as compared with Williamson's view – of the reasons why economic actors inside the MNE fail to fulfill commitments. Bounded reliability as a behavioral phenomenon can affect performance at various levels inside the MNE: it can therefore influence the relative efficiency and effectiveness of alternative governance mechanisms, assuming these alternatives have idiosyncratic BRel-economizing properties.
Williamson's behavioral assumptions suggest a view of human nature whereby failed commitments need not occur all the time, but because of bounds on rationality it is difficult to assess ex ante who might act opportunistically. As a result, all transacting parties should be treated assuming the worst-case scenario could transpire. Importantly, if such worst-case scenario did materialize, the probability of amicably resolving the conflict at hand and sustaining the extant relationship would appear remote: few people would choose to work again with a party that had knowingly and willingly put a knife in their back. In other words, contracting parties are asked to focus on safeguarding against actions the occurrence of which would de facto terminate their relationship, and the risks associated with such actions largely determine governance choices. But in the context of MNEs (and for that matter in many other governance contexts), most failures to expend sufficient effort to fulfill a commitment do not lead to automatic relationship termination. Rather, such failures lead to feedback/attribution of why they occurred, to a dialogue on how to improve performance, to corrective action so as to avoid similar failures in the future, etc. In other words, save the case of intentional deceit, which might lead the guilty party to be expelled from the firm (or more generally the relationship to be terminated), the first assumption is that wrong courses of action were probably pursued in good faith, and the question then becomes whether governance redesign can prevent this problem from occurring again with the same parties being involved. In this context, the joint adoption of bounded rationality and bounded reliability as behavioral assumptions in management research suggests that all individuals have the propensity to fail on commitments, without the need to focus exclusively on the probability that self-interest seeking with guile might materialize. Here, the optimal mix of governance elements to reduce bounded reliability problems is fully situational, meaning that one need not necessarily prepare for the worst-case scenario (i.e., to invest heavily in ex ante opportunism avoidance and ex post opportunism mitigating measures).
The concept of bounded reliability offers a non-ideological view of human nature: human beings do not need to be assumed intrinsically trustworthy vs non-trustworthy, or as having a strong inclination to do good or bad. They just have a propensity towards imperfect effort to make good on commitments. Optimal governance as well as governance redesign precisely result from past experience with such imperfect effort, and are achieved through a combination of trial and error and emulating best practices observed inside and outside the organization (“rights from wrongs”).
Our new perspective should benefit future MNE research, but the current paper is not without limitations. Most notably, our inductive approach with case studies, though informed by some prior, casual observation of various forms of bounded reliability, is merely a first attempt to identify broad classes of the sources of failed commitments inside MNEs. Future research is needed to further delineate the core facets of bounded reliability and the corresponding economizing governance mechanisms. While the current paper is but a first step, the rationale for developing the bounded reliability concept is to capture, in a comprehensive and testable fashion, the critical mechanisms underlying failed human commitments. As research into bounded reliability progresses, the potential for objective measures and scale development of the construct will be realized. As we noted in our review of the opportunism papers in IB, the direct measurement of opportunism is currently missing in most empirical work that assumes opportunism. The development of clear bounded reliability measures will not only refine the concept, but will also allow for empirical testing of the interaction levels with more established TCE measures such as asset specificity, uncertainty and frequency. The adoption of more accurate behavioral assumptions should improve MNE theory, in terms of predicting the selection and retention of specific governance mechanisms in particular contexts, and in terms of normative implications, and by doing so should make theory more relevant to MNE managers. In many cases, the core TCE predictions might remain valid, such as the predicted positive impact of asset specificity (or R&D and advertising expenditures) on internalization levels, but the underlying explanation of this phenomenon should be more accurate than the Williamsonian one, thereby also improving TCE's legitimacy in the social sciences.
Finally, the development of bounded reliability in the IB context should spill over to the more general management literature. It is fitting that the study of the MNE as the general case – that is, the case whereby distance always does matter – in this instance grappling with the foundational assumptions of human nature, may inform the broader theory of the firm, and may result in a new dialogue between TCE scholars and researchers in other management and organization subdisciplines. Ultimately, the key point for managers – especially for those faced with high distance situational contexts – is simple: do not attribute to malevolence what can more reasonably be explained as good-faith reversal of preference.
The authors presented a first version of this paper at the Academy of Management 2004 Meetings in New Orleans, and have been refining the ideas presented there since that date, including a revised version presented at the Academy of Management 2007 Meetings in Philadelphia. Verbeke (2009) and Verbeke and Kenworthy (2008) also refer to the BRel concept, but build on earlier drafts of the present paper.
Dunning (2003) notes that from the citations in Buckley and Casson's (1976) classic book, The Future of the Multinational Enterprise, it would appear that the authors did not draw (or did not think they needed to draw) upon the writings of organizational theorists such as Williamson to expound or justify their own particular theoretical model of the MNE.
Another recurring theme associated with failed commitments was the influence of changes in the external environment on managers’ ability to fulfill commitments. Such factors, however, are already largely captured within TCE through the concepts of uncertainty and bounded rationality, and thus do not contribute directly to the development of the bounded reliability concept, though it can be argued that environmental changes can act as the trigger for a variety of preference reversals, whether benevolent or not.
Ideally, we would also like our analysis to provide examples in the form of theoretical replication, wherein contrasting results are found for predictable reasons (Yin, 1994). While some examples from the cases provide evidence of bounded reliability reducing processes and associated fulfilled commitments, the nature of the cases studied did not allow us to conclude definitively whether the absence of processes to reduce BRel would in fact lead to more unfulfilled commitments. We thank an anonymous reviewer for pointing out this limitation.
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