Firm-specific intangible assets and subsidiary profitability: The moderating role of distance, ownership strategy and subsidiary experience

Abstract

How does distance attenuate the value of MNC parent intangible assets on affiliate profitability? Beyond the basic assumption of internalization theory about the positive relationship between parent intangibles and foreign affiliate performance, we test how this relationship, is contingent on ownership strategy, subsidiary experience, and is moderated by the distance between home and host economies, in terms of differences in technological capacity, intellectual property regimes, economic development, language and geography. Based on newly-available accounting data on intangible assets, we test hypotheses on a sample of over 2000 multinationals and 5000 of their overseas affiliates in 45 home and host economies.

Introduction

Internalization theory has long proposed that the profitability of a multinational company’s (MNC) foreign affiliate should correlate positively with the intangible assets of its parent (Buckley & Casson, 1976; or Dunning’s, 2001 OLI framework). But so far, MNC parent intangible value has mainly been tested by using proxies such as the all-company, or parent R&D/Sales ratio or marketing intensity. Recently however, more detailed accounting information has become available, where parent MNC intangible value is available as an actual financial number. This newly available financial data has not yet been used to test the hallowed assumption of internalization theory that parent intangible assets constitute the key competence of modern firms and that therefore we should expect a positive association between parent intangibles and subsidiary performance (Villalonga, 2004). We contribute to the literature on subsidiary performance by directly testing the link between parent intangibles and subsidiary profitability.

We build on this to focus on a more novel research question about the contingent value of parent firm’s intangible assets: “how does the degree of difference between the home (MNC parent) and host (subsidiary) country, ownership strategy of the parent firm and subsidiary experience attenuate, or augment, the link between parent intangibles and foreign affiliate profits?” Recent academic literature operationalizes these differences as institutional, or cultural or geographical “distances” between the nation of the MNC parent and the country location of its subsidiary (e.g. Berry, Guillen, & Zhou, 2010; Malhotra & Gaur, 2014). The literature on country location distances, more often than not, takes a negative view of country differences, arguing that distance increases the liability of foreignness and creates greater obstacles in transferring ownership-specific (parent intangible asset) advantages to distant locations.

This view emanates from traditional thinking on MNCs, where it was assumed that the value of intangible assets of a MNC diminishes or attenuates as the psychic distance between the home and host country increases. However, this assumption is becoming increasingly invalid since (a) MNCs may invest in another similar or dissimilar country, and (b) MNCs from emerging and less developed economies are expanding internationally, and establishing subsidiaries in countries more institutionally and culturally advanced than their own, in search of resources and capabilities (Luo & Tung, 2007). Hence the measurement of distance has to take into account the directionality of the foreign direct investment (FDI), or how the destination (host) nation compares with the location of the parent. Setting up a subsidiary in a distant country may augment, or diminish, the parent firm’s intangible assets (internalization advantage) depending on the directionality of the movement. Given that much of the extant literature treats distance bi-directionally neutral (Shenkar, 2012), we make an important contribution by examining the effect of directionality in the distance construct.

While distance is an exogenous factor, the value of parent intangibles may also be affected by the ownership strategy of the parent firms and the subsidiary experience. Accordingly, we argue that the parent intangibles − subsidiary performance relationship is likely to be also contingent on these parent and subsidiary specific factors. We test our theoretical arguments on data from a sample of 5010 foreign affiliates belonging to 2301 MNCs over a 12-year time period from 1996 to 2007. Past studies on subsidiary performance have often used subsidiary survival as a measure, due to limited availability of financial data at the subsidiary level. Other studies have used surveys to measure subsidiary CEO’s perception of subsidiary performance. We contribute to this literature by using detailed, actual subsidiary and parent level financial data, which overcomes the limitations of relying on survival or perceptual measures.