Relational Contracts and Foreign Managerial Distribution
By Stephanie Policastro
Entering a business into an overseas market is no small feat for foreign (or immigrant) entrepreneurs. From limited knowledge of the local environment to cultural differences in management practices and local buyers’ lack of familiarity with international products – the costs associated with the “liability of foreignness” can be high.
One of the most significant challenges when taking a business abroad is the difficulty enforcing formal contracts with local employees, suppliers and customers – a practice that is often downplayed by foreign firms – and one that can be particularly difficult, given the vulnerability of business owners in foreign courts. Navigating these challenges is what often leads immigrant business owners to the vital decision of managing the new business venture themselves or delegating responsibilities to a local agent.
It is a topic that Elena Kulchina, Poole College associate professor of strategic management, and Joanna Oxley, University of Toronto professor of strategic management, have studied extensively over the years. A paper of their findings, titled “Relational Contracts and Managerial Delegation: Evidence from Foreign Entrepreneurs in Russia,” was recently published in Organization Science.
Foreign firms often downplay official contracts with local business associates, and instead, rely on informal agreements that are not bound by law.
“Foreign firms often downplay official contracts with local business associates, and instead, rely on informal agreements that are not bound by law – which can be attributed to cultural factors and the fact that foreign firms litigate at a much lower rate than their domestic counterparts” says Kulchina.
In their study, Kulchina and Oxley adopt the lens of relational contract theory to develop six hypotheses linking managerial delegation decisions to local institutional and economic conditions associated with self-enforcing agreements, and test them in the context of post-Soviet Russia. They argue that immigrant entrepreneurs will be more likely to hire an agent-manager in the local market when they are confident that a self-enforcing agreement aligns with the managers’ incentives.
Kulchina and Oxley find that delegation to local agent-managers is most common in industries and regions where product market competition is low, revenue growth is high, profits are stable and agents’ outside employment options are limited – which contrasts with the pattern observed for domestic (Russian) entrepreneurs, whose managerial delegation decisions are influenced by the density of the local entrepreneurial network.
The study contributes to the understanding that contracts are just one of many important aspects in the delegation decision-making process, and ultimately points to several additional opportunities for research contributions on relational contracts.
The study abstract follows.
“Relational Contracts and Managerial Delegation: Evidence from Foreign Entrepreneurs in Russia”
Authors: Elena Kulchina, Ph.D., NC State University and Joanne Oxley, Ph.D., University of Toronto
We examine the managerial delegation decisions of foreign entrepreneurs and assess how these decisions are shaped by characteristics of the local product and labor market environment. We argue that actual or perceived home bias in court proceedings leads foreign entrepreneurs to place little reliance on formal contracts in their dealings with local agent-managers. Adopting the lens of relational contract theory, we develop hypotheses linking managerial delegation decisions to market conditions associated with stable self-enforcing agreements and test the hypotheses in the context of post-Soviet Russia. Consistent with our arguments, we find that foreign entrepreneurs are more likely to hire an agent-manager in local markets where industry growth creates a substantial “shadow of the future,” where managers’ outside employment options are relatively limited, and where competition and the variability of returns are not so high as to induce defection from an informal agreement. Similar observations on a sample of Russian-owned entrepreneurial firms suggest that these delegation decisions are relatively insensitive to local market conditions but that they are influenced by the density of local reputation networks. Our study thus contributes to understanding of the distinctive features of foreign entrepreneurs’ managerial delegation decisions and reinforces the view that contracting impediments constitute one important aspect of the “liability of foreignness” for entrepreneurial firms.