International Business Alliance under Asymmetric Information: Technology Vis-a-Vis Information Advantage

[Author Affiliation]Chifeng Dai, , , , daic@siu.eduSajal Lahiri, , , , lahiri@siu.edu; corresponding author[Acknowledgment]We are grateful to two anonymous referees for extremely helpful comments and suggestions.1. IntroductionInternational inter-firm business cooperation as a means to reach a foreign marketplace has been rapidly increasing in popularity and has been growing hand in hand with the overall process of globalization. Business collaborations in general take different forms. Licensing/franchising and joint venture (JV) are two important forms of this collaboration. The exact nature of the contract between firms can also take different forms involving one or more of the following: up-front licensing fees, equity investments, annual maintenance fees, milestone payments, and royalties.1 For example, under the JV agreement between Generex Biotechnology (Canada) and Sejong Capital (Korea), Sejong agrees to invest $25 million in the JV as a non-refundable license fee paid to Generex and to purchase $5 million of Generex's equity. Under the JV agreement between Cambridge Biostability (United Kingdom) and Panacea Biotec (India), Panacea purchased £1.935 million of Cambridge's equity up front and signed a long-term licensing agreement that provides gross royalty income to Cambridge over the agreement period.2Apart from the contractual arrangements, another important issue in international business cooperation is the question of transfer or adaptation of technology for the international alliance (IA), and this has received a lot of attention in the literature (see, for example, Katz, Rebentisch, and Allen 1996). It is generally agreed that the technology adaptation issue is a rather complicated engineering and economic issue and often requires significant efforts.There are four broad research questions here. First, why do firms from developing and industrialized countries form an alliance? Miller et al. (1997) studied 76 IAs in six developing countries. They found that more than 65% of the foreign companies chose domestic partners because of their knowledge of local politics, government regulations, local custom, and local markets, and more than 70% of the domestic firms in developing countries sought collaboration with multinationals based on their superior technology.The second question involves why IAs have diverse contractual arrangements. The third question involves how each firm's advantage and disadvantage in technology and market information affect their profits in IAs. Do firms in the alliance always prefer more market information and better technology? The final question has to do with whether technology spillover hinders the formation of an IA.3In order to answer some of the research questions outlined above, we consider a simple model consisting of two firms: a multinational corporation (MNC) and a domestic firm. The firms operate under uncertain market demand. The MNC possesses a production technology that is superior to that of the domestic firm. However, the domestic firm has an information advantage in the sense that with costly and non-contractable efforts it can predict demand conditions with some probability.We start with the case in which the credit market is perfect and the technology adaptation in the IA is exogenous and costless. We show that in the IA, the MNC optimally charges the domestic firm a lump-sum payment but offers it the entire profits of the IA. Under the contractual arrangement, market uncertainty and the domestic firm's ability to gather information increase the domestic firm's profits but not the MNC's profits in IA. However, the MNC prefers duopoly competition to IA if the technology adaptation is imperfect and the domestic firm's production technology is exceedingly inferior.We then deviate from the benchmark case in two different directions, but one at a time. …