Journal of Business Research 58 (2005) 1320 – 1329 When are international managers a cost effective solution? The rationale of transaction cost economics applied to staffing decisions in MNCs Jaime Bonache Péreza,*, José Pla-Barberb,1 a Universidad Carlos III, Madrid, Spain, Calle Madrid, 126, 28903 Getafe, Madrid, Spain Departamento de Dirección de Empresas, Universitat de València, Avd. de los naranjos s/n, 46022 Valencia, Spain b Received 1 November 2003; received in revised form 1 March 2004; accepted 1 May 2004 Abstract A common claim in the literature of expatriation is the one referring to the high costs of expatriation. In this paper, on the basis of transaction cost economics (TCE), we show how limited this approach is. In particular, we consider a set of costs that, although ignored in traditional expatriation literature, must be accounted for when a MNC is deciding on whether to recruit expatriates or local managers in its subsidiaries. These costs include selection, training, and performance evaluation costs. We also formulate a series of hypotheses around the situations in which the total costs of recruiting expatriates are lower than those generated by local managers. We then test these hypotheses in a sample of 96 Spanish MNCs. Findings may help explain the apparent paradox between the increasing pressures to reduce costs and the use of an apparently costly practice, such as expatriation. D 2004 Elsevier Inc. All rights reserved. Keywords: Expatriation; Transaction Cost Economics; International Human Resource Management 1. Introduction One of the key decisions that multinational companies must make is whether to select local or expatriate personnel to manage their foreign subsidiaries. Despite the alleged globalization of businesses, the predominant trend in MNCs seems to be ethnocentric (Mayrhofer and Brewster, 1996). This effectively is the case in Japanese companies, in which, according to a survey by Koop (1994), 75% of their subsidiaries’ directors are expatriates. But it is also the case in European and U.S. MNCs, in which expatriates occupy 54% and 51% of senior management posts, respectively. Although the ethnocentric orientation is predominant in MNCs, there are certain obvious problems associated with it. It is noted, for example, that it creates problems of * Corresponding author. Tel.: +34 91 624 95 78. E-mail addresses: bonache@emp.uc3m.es (J. Bonache Pérez)8 Jose.Pla@uv.es (J. Pla-Barber). 1 Tel.: +34 96 3828100x1662. 0148-2963/$ - see front matter D 2004 Elsevier Inc. All rights reserved. doi:10.1016/j.jbusres.2004.05.004 adaptability to foreign environments and cultures (Black et al., 1998; Shaffer et al., 1999; Caligiuri et al., 1998), leads to high failure rates (Tung, 1987), has a discouraging effect on local management morale and motivation (Min-Toh, 2003), and may involve high salary costs (Chen et al., 2002). With regards to the latter problem, international assignments seem to be an bexpensiveQ option for an enterprise. A survey of the Management Europe Center reports that the salary cost of an expatriate is approximately three times as high as a local employee’s. In some countries, such as China, expatriates have been estimated to earn between 20 and 50 times as much as local employees do (Chen et al., 2002). A thorough summary of these expatriation problems is provided by Bonache et al. (2001). If we focus only on costs, what is certainly surprising is why, within a business context, under unremitting pressure to keep costs down, MNEs should continue to implement such an apparently costly solution, such as expatriation. Explaining this apparent paradox will require more theoretical guidance than past work on expatriation has received. In J. Bonache Pérez, J. Pla-Barber / Journal of Business Research 58 (2005) 1320–1329 this study, we tested the viability of the transaction cost perspective as an explanation for firm’s reliance on expatriates to manage foreign subsidiaries. The remainder of this paper is organized as follows. The next section explains why this theoretical perspective is particularly suited to examining the central question of our paper. In the following section, we analyze the overall costs, above and beyond the purely salary-related costs to which traditional expatriate literature limits its attention, that are implicit in management personnel recruiting in subsidiaries. Then, we formulate a series of hypotheses around the situations in which the total costs of recruiting expatriates are lower than those generated by local managers. The data collection and measurement procedures are then described, followed by a report of the empirical results. The final section discusses the findings of the study, points out its limitations, and suggests directions for further research. 2. Transaction cost economics and expatriation Drawing on the seminal article of Coase (1937), transaction cost economics (TCE) has been simultaneously and independently developed in the 1970s by different authors, see, e.g., McManus (1972), Buckley and Casson (1976), Williamson (1975), and Teece (1982).2 The general rationale of these contributions is that bmarket imperfectionsQ are inherent attributes of markets, and firms are institutions for bypassing these imperfections. Markets experience bnatural imperfectionsQ due to the fact that implicit neoclassical assumptions of perfect knowledge and perfect enforcement are not realized (Hennart, 1991). As Buckley and Casson (1976) state, this rationale can be applied to any situation in which a transaction on intermediate products takes place. In fact, this theory has been applied to analyze a large number of exchange phenomena, such as vertical integration (Klein et al., 1978), corporate strategy (Teece, 1982), joint ventures (Hennart, 1991), or relationships with clients. Within the HR literature, transaction costs perspective has also been applied to explain the decision to subcontract certain positions or tasks (Masters and Miles, 2002). Yet, as far as we know, it has never been used to explain the use of expatriates within multinational corporations. In this study, we will show that this perspective can shed some light on this issue. In the case that interests us here, the transaction is the MNC’s decision concerning whether to fill a given subsidiary position using outside local labor (local managers) rather than internal labor (expatriates). In both cases, a permanent employment contract will be chosen to govern the transaction. As existing evidence shows (Koop, 1994), the management of subsidiaries is not the sort of job to be 2 In fact, the label btransaction cost economicsQ seem to be more appropriate to reflect the wide range of transaction costs approaches. 1321 externalized. Thus, it is not an issue of analyzing when and why a given position will be internalized within the governance of an MNC or externalized to the governance of market forces. Rather, our focus is on the set of costs involved in filling a permanent employment position. In this vein, it will be argued that these costs are different, depending on whether the manager is local or expatriate. This focus on costs of traditional employment arrangements builds on existing transaction costs theorizing about HR decisions (e.g., Jones and Wright, 1992). It is worth noting that TCE is only one of a number of theories needed to explain this type of international business decisions. Other approaches have important contributions to make here. In fact, the question analyzed in this paper could be conceptualized as a classic principal–agent problem that occurs when parties in a transaction have different goals and division of labor (Jensen and Meckling, 1976). The issue is how best to ensure that managers of foreign subsidiaries respond effectively to the commands or directives of the parent company. The focus of the theory is on determining the most efficient contract governing the principal (headquarters)–agent (subsidiaries managers) relationship, given assumptions about people (self-interest, bounded rationality, risk aversion). However, not surprisingly, the agency theory has many similarities with the transaction cost perspective used in this paper. As Williamson (1988, p. 569) asserts, bthese two theories share assumptions of self-interest and bounded rationality, they are very similar in their managerial discretion and efficient contracting orientations, and their behavioral assumptions are substantially identicalQ. Even assuming the consistency between both theories, there is one reason to base our analysis on a transaction cost rationale: the agency theory is merely concerned with the creation of appropriate incentives structures before contract completion, whereas TCE explicitly analyzes contracting in its entirety (i.e., ex ante and ex post), an endeavour we attempt in this paper.3 3. Transaction cost economics and staffing decisions in MNCs Following Williamson (1975), transactions can differ according to three dimensions: (a) frequency and expected duration of the exchange; (b) uncertainty to which it is subject; and (c) the specificity of the assets associated with the exchange. How do these dimensions operate in the employment relationship that we are interested in? Regarding the first dimension, international assignments vary in duration and frequency. Staff members may sometimes be sent abroad to carry out a very specific and technical task, which, once it is finished, there is no need for them to stay any longer (e.g., the setting up of a certain IT 3 We thank an anonymous reviewer for this interesting insight. 1322 J. Bonache Pérez, J. Pla-Barber / Journal of Business Research 58 (2005) 1320–1329 system in a subsidiary). In other cases, such as the one we wish to refer here, the assignment takes longer because it involves taking over the subsidiary’s management (or any of its functional areas) for a lengthy period of time, usually a two- to four-year stay, on average (Bonache et al., 2001). With regards to the second dimension, the decision to appoint managers is a rather complex one, and the conditions under which this decision is taken have a high degree of uncertainty. Many contingencies may arise during the relationship. The company requires to know whether the candidate will be able to overcome any setback which might come up. However, a selection mistake is always possible. Such a possibility is due to the confluence of two factors regarding human behavior: bounded rationality and opportunism (Williamson and Ouchi, 1981; Williamson, 1993). With regards to the first factor, human agents are assumed to be bintendedly rational, but only limitedQ (Simon, 1961). In the case we are analyzing here, this means that the company’s decision making body has access to limited information and also limited ability to process that information. In addition to this, candidates have the potential to behave opportunistically. By this term, Williamson refers to a type of behavior, such as lying, stealing, cheating, and making calculated efforts to mislead, distort, disagree, obfuscate, or otherwise confuse (Williamson, 1985). This behavior, which results from the combination of limited rationality and self-interest (Alchian and Woodward, 1988), occurs when people are driven by self-interest, no matter how detrimental their attitude can be to others, and whenever such a behavior is not easy to detect by the other party. According to Williamson and Ouchi (1981), not all candidates will necessarily have opportunistic behaviors, but some will. The problem stems from the great difficulty in separating ex ante those who are opportunist from those who are not. In our context, these two factors create a framework leading to two potential problems: wrong selection, when prospective employees conceal some revealing information, which would otherwise evidence their lack of knowledge, experience, and abilities required for the position; and moral hazard, which occurs once the successful candidate has been appointed and is driven by self-interest, regardless of the level of congruence with the objectives of the organization. This kind of behavior arises when the company cannot easily detect it in advance. This is the situation that MNCs have to face. In the international scene, there exists a large number of circumstances (distance, cultural changes, different market structures, etc.) that may impair the headquarters’ (HQ’s) ability to gauge the potential (when appointing the candidate) or the competence (once appointed) of the manager’s working performance. Finally, specific assets are those whose value in its present use is higher than the value they would have in any alternative use (Klein et al., 1978). Let us think, for example, of company-specific knowledge, such as knowl- edge of the company procedures, policies, and culture. Once specific assets are locked into a relationship, there is a situation of dependency, which could favor opportunistic behaviors, called hold up in the literature, both on the company’s side and on the employee’s. Opportunism on the employee’s side is the one we wish to focus on. How does it operate? In the hypothetical case of selecting a local manager and training him in the values and procedures of the company (acquiring, thus, the human capital specific to the company), the employee could become highly productive because he would not only know the business idiosyncrasy of the host country but also the operating ways of the company. Without him, the organization will not achieve the same results. This might be a potential incentive for him to exploit the situation and, under the threat of leaving or changing companies, renegotiate his terms and conditions to appropriate the rents. How this situation is to be tackled will only depend on the degree of mutual dependency (see Alchian and Woodward, 1988). What we would like to stress here is that if specific assets exist, then this type of opportunism, leading to the renegotiation of the original terms and conditions of the agreement, is a possibility that should not be overlooked. To increase the efficiency of the exchange and/or to prevent opportunistic behaviors, the organization will have to incur transaction costs. By this term, we refer to the costs of planning, adapting, and monitoring task completion (Williamson and Ouchi, 1981). Following Jones and Wright (1992), we can distinguish four main types of transaction costs: (1) Selection and recruitment costs. The costs incurred in overcoming a wrong selection. This item also includes the costs of gathering information about the candidate as well as costs associated with negotiation and final drawing-up of the contract with the appointed candidate. (2) Training and socialization costs. These are costs associated with the development of the subsidiary managers’ skills and abilities, together with their acquisition of the company policies and cultural standards. (3) Monitoring and evaluating subsidiary’s managers. The costs incurred in safeguarding the organization against moral hazard. These will include costs of HQ managers and managerial time spent on supervising, as well as costs associated with the implementation of appraisal and feedback systems. (4) Enforcement. The organization will have to take actions in the event of a breach of contract on the part of the subsidiary’s manager. This will obviously originate new costs for the company. The basic premise of TCE is that transactions will tend to take place in a form that minimizes the combined costs of the transaction. Applying this argument to our reasoning, we J. Bonache Pérez, J. Pla-Barber / Journal of Business Research 58 (2005) 1320–1329 can state that, when deciding whether to recruit a local manager or an expatriate, the organization will have to consider the total transaction costs associated with each alternative and opt for the most efficient one, i.e., the one that minimizes such costs. The question can therefore be formulated in the following terms. When are the transaction costs of using expatriates lower than those of using local nationals? As we have seen, the supposition that people may behave opportunistically is at the root of transaction costs. If this prejudice could be replaced for a higher degree of trust in the parties’ integrity to fulfil their obligations, costs would certainly be reduced (Baron and Kreps, 1999). Trust is thus a nuclear notion. Such a concept was introduced by Williamson (1993) in terms of a calculative economic reasoning. He described it within a contractual schema where exchange is defined as a triple ( p, k, and s): p refers to the price at which the trade takes place, k refers to the hazards that are associated with the exchange, and s denotes the safeguards within the exchange is embedded. Three possible situations arise: (a) a classical market exchange, where there are no hazards; (b) a low-trust exchange, where there is a contractual hazard but the buyer is unable to provide a safeguard; and (c) a high-trust exchange, where the contractual hazard is similar to (b), but contractual safeguards are provided. Several authors (Boyacigiller, 1990; Nohria and Ghoshal, 1994; Yan et al., 2002) have stated that expatriates are very frequently regarded as btrustworthyQ employees sent abroad to represent the interests of the company. In terms of the above framework of Williamson, they would be a high-trust node. Similarly, locals would be a low-trust node, as no safeguards have been provided ex ante. Building these safeguards implies incurring in transaction costs. Our point is that the higher salary cost of expatriates might be lower than those additional transaction costs that the firm needs to incur to create safeguards.4 Hence, we should have to specify the situations in which this trust factor plays a decisive role and the extent to which it can be undertaken by expatriates. To determine the situations in which trust is a crucial factor and, consequently, the use of expatriates a more efficient option, we will have to distinguish between those situations emerging from organizational factors (such as international expansion of the company, degree of technological innovation, and international strategy of the company) and those situations emerging from institutional factors, such as the culture of the host country. A similar conceptual framework was specified by Buckley and Casson (1976, 1985). They show that incentives to internalize depends on the interplay of (i) industry-specific factors, such as degree of technological 1323 innovation, (ii) region-specific factors, namely, the cultural distance between the regions involved, and, finally, (iii) firm-specific factors as, e.g., the extend of foreign expansion or the international strategy. If we analyze these situations, we will find that trust is a key factor in all of them. 3.1. Extent of foreign expansion Several advantages have been highlighted in the literature about the use of local managers, among which we wish to emphasize the following: (1) They can speak the language, they are familiar with the culture and the local political system; (2) They ensure continuity in the subsidiary’s management, avoiding in this way the frequent substitutions of expatriates, often accompanied by unjustified managerial changes in the subsidiary; (3) They represent significant savings on salary costs, yet allowing for a margin to offer monetary incentives to attract the best local candidates; (4) Motivation and career opportunities of local staff are enhanced in this way because managerial positions are not kept for HQ’s employees; (5) Local acceptance of the MNE is also favored (Grosse and Kujawa, 1988). Let us imagine a company which, persuaded by such advantages, wishes to recruit a local manager. How does it go about it? If the company’s arrival at the international scene is only recent, the task might turn risky and uncertain due to the company’s ignorance of the local labor market and the fact that it lacks a pool of local candidates already working for them. To overcome wrong selection and prevent potential opportunism, the company will have to spend a longer period of time, as well as more resources, in the selection process. Simultaneously, as we shall see in our next section, local candidates might have to familiarize themselves with the company products and procedures, which will force the company to invest in training and socialization, incurring the corresponding costs. Finally, to prevent moral hazard from people who the company bdoes not knowQ, it will also have to incur higher control and assessment costs. However, this set of costs can be drastically reduced by recruiting trustworthy employees already working for the company, or else, as the company acquires a higher level of international expansion. Because the costs of employing local managers tend to decrease as the level of a company’s international expansion increases, we propose the following hypothesis: H1. The lower the level of a company’s international expansion, the more it will use expatriates. 3.2. Degree of technological innovation 4 A good explanation on building safeguards in terms of TCE is provided by Baron and Kreps (1999). From the standpoint of TCE (Buckley and Casson, 1976; Rugman, 1981; Hennart, 1991), it could be expected 1324 J. Bonache Pérez, J. Pla-Barber / Journal of Business Research 58 (2005) 1320–1329 that the degree of technological innovation is, in some way, associated with a greater use of expatriates because they help to mitigate the perceived risk of possible opportunistic behavior by non-company-people hired from local markets. Nevertheless, in a recent work, Baron and Kreps (1999) explain how an organization’s degree of technological innovation heavily influences the predominant type of jobs in the organization. These authors distinguish between star and guardian jobs and claim that star jobs predominate in very innovative companies. These are the jobs in which bad performance is not too critical, but a good performance is excellent for the firm. A star job would be one held by a manager who runs a subsidiary that has very little dependence on the HQ’s products, brand image, and procedures and where the essential thing is to develop new products or management processes highly tailored to the local market. A guardian job is one in which a good performance is only slightly better for the firm than an average performance is, but a bad performance is a disaster. A guardian job would be one held by a manager of a subsidiary whose function is to represent the organization before a series of global customers and in which the organization’s reputation is a valuable asset. Subsidiary managers in the financial industry typically belong to this category. The type of position to be occupied affects the time and resources invested in the selection and assessment process of candidates. For a star job, the costs of a hiring error are small relative to the upside potential from finding an exceptional individual. Therefore, the organization will be less concerned about the problems that information asymmetries and opportunism may cause in the recruitment phase and will thus be prepared to assume higher risks in the decision-making process. On the other hand, for guardian jobs, it is essential for candidates to have the required qualifications to make sure that their performance will not be detrimental to the company’s image or global reputation in any way. The higher salary costs incurred by the company in recruiting trustworthy employees might compensate for the costs that a selection error may cause in these cases. Because the costs of employing local managers tend to decrease as a company’s degree of technological innovation increases, we propose the following hypothesis: H2. The higher a company’s focus on innovation, the less it will use expatriates. 3.3. International strategy There are two basic ways for multinationals to compete on the market: country to country or on a global basis. In the latter case, the presence of an MNE in foreign markets is frequently justified by its set of company-specific knowledge, which gives it a competitive advantage over local companies (Teece, 1982; Dunning, 1988) and compensates for the disadvantage of being foreign (MNEs are comparatively less familiar with the national culture, the structure of the local industry, and other aspects of doing business in a given country). Where company-specific knowledge is required, expatriates can be a more efficient recruitment option. Such knowledge and skills are often only obtainable within the company and after a long time. If a local manager is recruited, the company will have to incur a number of training costs, which could otherwise have been saved if an internal employee had been chosen. Such training costs are high. In fact, the level of knowledge about the firm, its operations, its personnel, its traditions, etc., required for the higher level positions considered in our case is likely to be much higher and, therefore, more costly to acquire (Baron and Kreps, 1999). Consequently, the company will obviously try to recover the training costs incurred in training its national employees instead of training new local managers in those skills. Additionally, a trained local manager might threaten to transfer this knowledge to the company’s rival, or renegotiate his terms and conditions and appropriate the rents that are generated from this knowledge, evidencing thus the type of opportunism already defined as holdup. On the other hand, expatriates, as long as they are trustworthy employees, are less likely to show this type of opportunistic behavior (Yan et al., 2002), which will save the company monitoring and enforcement costs. Finally, management jobs in interdependent units generally require making decisions that span other units of the corporation. Therefore, the costs of error of those higher up in the hierarchy are very high. This implies both a higher reluctance to recruit staff that they are not well acquainted with and an increase of uncertainty due to potential opportunistic behavior. Under these circumstances, the higher costs associated with expatriates may also compensate for the lower selection, training, and assessment costs. Therefore, because the costs of employing local managers are higher in global strategies, we propose the following hypothesis: H3. Companies with a global strategy will make more use of expatriates than will companies that compete country to country. 3.4. Cultural distance Multinational companies make use of two main mechanisms, different but complementary to each other, to control their subsidiaries’ performance: centralization and formalization. Centralization refers to the degree that decisions (i.e., introduction of new products or changes in the managerial processes) are taken in the HQ. Formalization depends on the existence of a well-defined set of 1325 J. Bonache Pérez, J. Pla-Barber / Journal of Business Research 58 (2005) 1320–1329 rules and procedures regulating the tasks and the ways to proceed in different situations. Although this mechanism limits the subsidiary’s autonomy, it also reduces the HQ’s direct involvement because direct control is replaced by rules and procedures. However, when a great cultural distance separates the HQ from the subsidiary, none of these mechanisms have proved to be efficient enough because they represent some sort of straitjacket acting as a deterrent for the subsidiary to confront political, legal, economic, or cultural complexities specific to its environment (Nohria and Ghoshal, 1994). Within the problem of control mechanisms in units with great cultural distance, we can discuss recruitment options. Cultural differences between HQ and subsidiaries increase information asymmetries and opportunist potential, thus, in the case of recruiting local managers, the company will have to incur higher selection, training, and control costs. These costs aiming to prevent wrong selection and moral hazard could otherwise be reduced by sending a trustworthy manager to the subsidiary. The function of these employees is to act as interpreters and to represent the interest of the HQ in the subsidiary. As the company acquires experience in the host country and considering that trust is the result of repeated relationships (Williamson, 1975), distrust and uncertainty are reduced, and local managers can eventually be trusted. Because the costs of employing local managers tend to increase as the cultural distance between HQ and subsidiary increases, we propose the following hypothesis: H4. The greater the cultural distance, the more the organization will use expatriates. Table 1 Dependent variable E=% of expatriates N % Mean S.D. E=1. Between 0% and 50% E=2. Between 51% and 90% E=3. More than 90% 35 21 40 36.5 21.9 41.7 2.25 0.87 real response rate of 19.2%.5 Based on various t tests for independent samples, there is no evidence that our final subset of 96 firms is biased in any consequential way when compared with the population of 498 firms. 4.2. Variables measurement 4.2.1. Dependent variable To determine the extent to which a company is using local or expatriate managers in managerial positions, the questionnaire included the following question: bWhat percentage of managers in charge of international operations are Spanish?Q The dependent variable is E=1 if the firm uses a percentage of expatriates below 50% (the company has a pronounced propensity to hire managers in the local market following a polycentric orientation), E=2 if it operates with a percentage of expatriates between 51% and 90%, and E=3 if it is operating on a percentage higher than 90% (a percentage of 90% or more means that this function is largely internalized in the company following a ethnocentric orientation). The dependent variable E is therefore a polytomous ordinal measure that implies higher levels of control through the use of expatriates as its level increases. These cut-off points are in line with the rationale of several studies of strategy by multinational companies (Pelmutter, 1969; Bartlett and Ghoshal, 1989). Table 1 shows the descriptive statistics for the dependent variable in the sample.6 4. Methodology 4.3. Independent variables 4.1. Target population of study and final sample The population studied was the Spanish multinational companies currently active in international markets. These companies were selected from the international files of a database set up by Dun and Bradstreet. This database included 498 multinational companies whose head offices were 100% Spanish owned. These companies can be considered as the most active Spanish enterprises in international markets. A postal survey was the instrument used to gather information. Questionnaires were sent to the selected companies, either addressed to the company presidents or, in some cases in which their names were not available, to the head executives. The first mailing to all selected companies was made in June 1997. Within three months, we received 74 replies, after which we again mailed the questionnaires to those companies that had not responded. The process was concluded with a total of 96 valid replies, which amounts to a 4.3.1. Level of foreign expansion (FEXP) Although foreign expansion is a multifaceted concept, most previous studies have used simple proxies. The approach taken here is somewhat more elaborate and arguably better. Following the same methodology than Benito (1996), foreign expansion was measured by two 5 The sample was spread across the following industry groups that represents a broad variety of commercial activity in accordance with the structure of the Spanish economy: construction and contracting (2), food and kindred products (6), textile mill products, apparel, and other textile products (5), lumber, wood products, furniture, and fixtures (7), publishing (4), chemicals (6), rubber and plastic products (7), leather (6), stone and glass products (4), metal products (2), industrial machinery (15), electronic equipment (6), transportation equipment (4), instruments (4), communication and public utilities (2), retailing (6), finance, insurance, and real estate (5), and other services (5). 6 As it can be seen, 40 (41.7%) of the firms prefer to use expatriates. As we noted in the Introduction, this high percentage of expatriate use is consistent with results obtained in studies on other nationalities. 1326 J. Bonache Pérez, J. Pla-Barber / Journal of Business Research 58 (2005) 1320–1329 Table 2 Descriptive statistics (total sample, N=96) Variable Mean S.D. FEXP INNV ISTR 0 2.10 0.71 0.35 CULTD 1.66 1.033 3.68 1.26 2.65 1.307 SIZE IEXP Distribution % Multidomestic Global European Union OECD Latin America Rest of the world Less than 25 employees Between 26 and 50 employees Between 51 and 250 employees Between 251 and 500 employees More than 500 employees Less than 10 years Between 11 and 20 years Between 21 and 30 years Between 31 and 40 years More than 40 years 39.6 60.4 67.7 5.2 19.8 7.3 10.4 10.5 27.1 18.8 33.3 19.8 35.4 21.9 7.3 15.6 indicators: (1) the number of firm’s subsidiaries and (2) the level of manufacturing abroad. To arrive at a single measure for foreign expansion, an index composed of both indicators was constructed. Because the indicators have different scales, standardized scores (mean=0, S.D.=1) were used. 4.3.2. Degree of technological innovation(INNV) Based on Kim and Hwang (1992), the innovation variable was measured on a three-item scale (INNV) constructed in a way similar to the previous case: (1) ability to develop new products, (2) the volume of investment in R+D; and (3) the innovative level of products/services or processes involved in international operations. 4.3.3. International strategy (ISTR) To measure the global or multidomestic nature of the international strategy guiding company operations (ISTR), and following a methodology similar to the one used by Leong and Tang (1993), a dichotomous variable was introduced that very concisely reflected the role that foreign subsidiaries play in the company. Managers had to choose one of the following two statements: (0) In my company, subsidiaries can operate and innovate in their local markets with considerable independence from central HQs (multidomestic); (1) In my company, activities, and innovations developed in subsidiaries are controlled to a large extent from central HQs (global). 4.3.4. Cultural distance (CULTD) The questionnaire identified the first three countries where the company had begun its international venture and also the three most significant countries at the present time. In most cases, it is observed that on entering a specific area, the second and third targeted markets are concentrated in the same area. Furthermore, in most cases, these initial markets are currently still the most significant ones. Therefore, following the same methodology than López-Duarte and Garcı́a-Canal (2002), we grouped countries in homogenous blocks in such a way that they present a similar liability for Spanish investors due to their cultural distance from Spain, their degree of economic development, and/or their country risk. The first group comprehends the European Union countries. As the countries integrated in the European Union share a common economic and political framework, Spanish firms face the lowest liability when investing in this area. The second group—OECD countries—includes the remaining countries that are integrated in the OECD. These countries are characterized by their political stability and their medium-to-high level of economic development. These group implies a greater disadvantage for Spanish investors than the previous one does, although lower than other regions. The third group includes Latin American countries. These countries show a lower degree of economic development and greater political instability than Spain does. However, they are very close in terms of cultural distance due to a common language and historical ties. As before, the liability faced by Spanish firms when inventing in this region is higher than in the European Union, but not as high as that of the next block. Finally, the fourth group comprises other countries, non-OECD, as well as non Latin American nations (i.e., former centralized-economy European countries and the Asian and African continents). These countries present the greatest liability for Spanish firms, as these are culturally and economically distant countries. 4.3.5. Controlling variables: Size (SIZE) and international experience (IEXP) Finally, we also controlled the potential effect that the size of the firm (number of employees) and the international experience (number of years abroad) may have on the choice of expatriates versus local managers. Table 2 shows descriptive statistics for the independent variables in the model. 4.4. Statistical analysis and discussion of results The correlation matrix of the independent variables, reported in Table 3, does not reveal severe multicollinearity problems. However, the table shows that the correlation between FEXP and SIZE are relatively high. Therefore, in Table 3 Correlations among independent variables (total sample, N=96) FEXP FEXP INNV ISTR CULTD SIZE IEXP ** *** INNV ISTR CULTD SIZE IEXP 1
.076
.130 .013
.049 1
.159 .075 .083 1 .096 .032 1 .164 1 1 .144
.202** .122 .498*** .074 Pb.05. Pb.01. J. Bonache Pérez, J. Pla-Barber / Journal of Business Research 58 (2005) 1320–1329 addition to regression results for the complete model, specifications of the model including only one of the variables were also explored. As the dependent variable is ordinal, the analysis used to verify the effect of the independent variables on the dependent variable is the ordinal logistic regression (OLR). For an ordinal response variable in categories E=1, 2, and 3, the following model is appropriate: LogitðPE1 Þ ¼ logðPE1 =ð1
PE1 ÞÞ ¼ logðPE1 =ðPE2 þ PE3 ÞÞ ¼ a1 þ bX LogitðPE1 þ PE2 Þ ¼ logððPE1 þ PE2 Þ=ð1
PE1
PE2 ÞÞ ¼ logððPE1 þ PE2 Þ=PE3 Þ ¼ a2 þ bX This model is known as the proportional-odds model because the odds ratio of the event is independent of the category E. The model examines the sign of the regression coefficients of the statistically significant variables. Given our definition of the dependent variable, a positive coefficient indicates an increased chance that a firm with a higher score on the independent variable will use expatriates. A negative coefficient implies an increased probability that the firm will hire local managers (Table 4). Judging by the model chi-square values, it seems that the model performs rather well. All regressions are significant for the total sample. However, the model that does not include FEXP give far worse fit to the data than do regressions with this variable. Therefore, FEXP has a higher Table 4 Ordinal logistic regressions Variable Description Intercept 1 Intercept 2 FEXP INNV ISTR CULTD SIZE IEXP N
2 Log likelihood v2 * Pb.1. ** Pb.05. *** Pb.01. Foreign expansion Innovation International strategy Cultural distance Size International experience Parameter estimate (Wald chi square) 1 2 3
1.342 (0.813)
0.269 (0.033)
0.884*** (6.000)
0.862* (2.291) 0.879** (4.284) 0.329 (1.228) 0.258 (1.677) 0.146 (0.864) 96 184.051
1.757 (1.490)
0.700 (0.239)
0.647*** (4.531)
0.829* (2.076) 0.990*** (5.597) 0.349 (1.412)
1.266 (0.743)
0.260 (0.032) 0.167 (1.130) 96 178.952
0.956** (2.782) 1.145*** (7.781) 0.272 (0.920) 0.000012 (0.006) 0.137 (0.785) 96 188.532 20.559*** 18.617*** 13.196** 1327 explanatory power than the control variable SIZE does. In fact, the two control variables (SIZE and IEXP) are not significant in any of the models. An inspection of the parameter estimates in the regressions shows that all significant variables have the predicted sign. As was expected, a higher level of foreign expansion is associated with a greater use of local managers. The FEXP coefficients (
.884,
.647) are negative and statistically significant at the .01 level. Therefore, the likelihood of using expatriates decreases as the number of subsidiaries and foreign production increase. In addition, all coefficients for the INNV variable are negative and statistically significant, suggesting that the probability of using expatriates decreases when innovation is important for the firm. It seems that when innovation is a major competitive advantage for the company, it tends to be more culturally heterogeneous, and greater importance is attached to local managers, not only so that they can better address market needs, but also to contribute new ways of thinking and understanding the company. This result is consistent with that for the strategy followed by the company. If the subsidiaries depend on and innovations are centralized in the head office, there is a tendency to use expatriates (positive, statistically significant signs). On the other hand, if the strategy is multidomestic, whereby the subsidiaries have a certain degree of independence and innovations are usually generated in any part of the organization, the proportion of local managers used is higher. Therefore, the type of strategy pursued is seemingly a relevant predictor of the degree of internalization of the managerial function in local markets through the use of expatriates. Finally, the geographical area where the company has most of its operations does not influence the decision to use expatriates or local managers. In accordance with these findings, we consider that cultural distance may be relevant in early investment decisions—where to invest and with what amount of resources, etc.—but once a certain amount of experience has been gained, this effect diminishes. 5. Conclusions A common claim in the literature on expatriation refers to the high costs of expatriates. In this paper, on the basis of TCE, we have shown how limited this approach is. In particular, we have considered a set of costs that, although ignored in traditional expatriation literature, must be accounted for when a MNC is deciding on whether to recruit expatriates or local managers in its subsidiaries. These costs include selection, training, and performance evaluation costs. We have also defended the premise that, in companies with a lower level of international expansion, a lower degree of technological innovation, a global strategy, and operations in very culturally distant environments, expatriates can be a cost-effective solution. This explains 1328 J. Bonache Pérez, J. Pla-Barber / Journal of Business Research 58 (2005) 1320–1329 the apparent paradox, formulated at the beginning of this paper, of how it is possible, in a business context defined by the need to reduce costs, that companies continue to make intensive use of such an apparently costly solution. The empirical investigation supports three of our four hypotheses, which illustrates the viability of our approach. That expatriates are more extensively used in companies with a global strategy and a low level of international expansion, two of our study’s findings, is consistent with the findings obtained by Edstrom and Galbraith (1977) in the late 1970s. In contrast, the third supported hypothesis in our study, i.e., that expatriates are used less in multinational companies with a higher level of technological innovation, is a finding that, as far as we know, has not resulted from any previous studies on this subject. In view of this, the TCE not only makes it possible to confirm findings already obtained from other theoretical perspectives, but also results in new findings that provide sound arguments for defending their potential and interest in this area. Our data did not support the hypothesis concerning a diminished use of expatriates when companies operate in increasingly culturally distant environments. Instead, we have found that, at least in Spanish multinationals, the target country has no influence on the recruitment option. A possible reason for this is that the importance of cultural distance starts decreasing as the company acquires a solid international presence. In this case, and consistent with our line of reasoning, information asymmetries and opportunism, two of the factors that generate higher or lower employment costs, are reduced. Companies with a solid international base have already acquired information on how to operate in local job markets, and they also have a local personnel base in their subsidiaries to select the more trustworthy individuals. The study has some limitations. First of all, we recognize that our framework may be incomplete. Other transaction costs that have not been identified may also be significant to the employment relation in a subsidiary of a MNC (e.g., the costs of enforcing contracts). Second, the existence of transaction costs associated with the recruitment decision in multinationals helped us formulate the hypotheses tested in the empirical investigation, but they were not specifically measured. In this respect, we understand that this study is of a merely exploratory nature and should be complemented by other future studies to fill this gap. Finally, the study has not measured how staffing decisions, based on transaction cost considerations, influence the future performance of the company’s subsidiary, depending on which candidate was chosen. Future research on this issue is clearly needed. Despite these limitations, we consider that the study points to some interesting elements that do more than shed some light on the apparent contradiction mentioned above. In the first place, the study establishes and explains, from a sound theoretical perspective, an area of management (i.e., expatriate management) that tends to be criticized as being a merely descriptive field lacking in analytical rigor. Second, it not only integrates a specific international human resource management decision with the company’s international strategy, but also jointly considers different human resources policies or decisions; in particular, it demonstrates the influence that other human-resource decisions, such as training, compensation, and performance evaluation, have on the selection decision. Therefore, it involves the two types of integration (external and internal) that are usually attributed to human resource policies for them to be considered strategic. 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