Relationship between Formal and Real Authority in Interorganizational Networks
The Case of Joint Ventures
Patrick Hippmann
Center for Business Studies
University of Vienna
Brünner Str. 72, A-1210 Vienna, Austria
Josef Windsperger
Center for Business Studies
University of Vienna
Brünner Str. 72, A-1210 Vienna, Austria
Abstract
We apply the concept of authority developed by Aghion & Tirole (1997) to interorganizational networks, and provide the first empirical evidence on how formal and real authority authority are allocated in joint ventures. Specifically, we show that intangibility of knowledge and uncertainty impact the allocation of authority in joint ventures, via formal and real authority. Moreover, we provide evidence that formal authority and real authority function as complements in the joint venture relationships.
1. Introduction
Authority is a fundamental concept in understanding organizations and networks. Going back to Coase (1937) and Simon (1951) contractual incompleteness due to uncertainty and intangibility of assets is the reason for establishing authority relationships. More recently, Grossmann and Hart (1986), Hart and Moore (1990) and Hart (1995) have defined authority as the residual right of control over the use of assets{Formatting Citation}. Aghion and Tirole (1997) extend this property rights view by differentiating between formal and real authority in intraorganizational relationships. An agent, for instance an employee in hierarchical relationships or a joint venture partner or franchisee in network relationships, has real authority when he/she has effective control over decisions and he/she has formal authority when he has the actual right to decide. Consequently, the allocation of authority in interorganizational networks refers not only to the design of formal decision making procedures but also to the network partner’s effective control over decisions.
Although there is a huge literature in organizational economics that deals with decision making and authority in organizations (Acemoglu, et al., 2007; Aghion & Tirole, 1997; Baker, et al., 1999; Dessein, 2002; Grossman & Hart, 1986; Harris & Raviv, 2005; Hart & Moore, 1990; Nagar, 2002; Rajan & Zingales, 1998; Simon, 1951; Van den Steen, 2010; Stein, 2002; Vazquez, 2004; Williamson, 1975; Zabjonik 2002) and interorganizational networks (Arruñada et al., 2001; Baker, et al. 2008; Elfenbein & Lerner, 2003; Young & Tavares 2004; Higgins, 2007; Hu & Hendrikse, 2009; Lerner & Merges, 1998; Windsperger, 2004; Windsperger, et al., 2009), only Li et al. (2011) test the Aghion & Tirole view in internal hierarchies. However, no prior study examines the allocation of formal and real authority in interorganizational networks. Starting from this deficit, the aim of this study is to apply the authority view of Aghion and Tirole to joint ventures and to provide empirical test of the determinants of formal and real authority in joint venture relationships.
In line with the property rights theory, we argue that allocation of formal and real authority depends on noncontractibility of knowledge due to uncertainty and intangibility (Grossman, Hart 1986; Aghion, Tirole 1997, Stein 2002). The less contractible the knowledge of the network partners, the more decision rights as formal and real control must be transferred to the partners. In addition, based on the complementarity view of organization design (Milgrom & Roberts, 1990, 1995), we argue that formal and real authority function as complements in joint ventures. Our empirical evidence from joint ventures in CEE-countries supports the theoretical predictions that formal and real authority should be delegated to the network partners who has highly intangible knowledge and whose business environment is characterized by high uncertainty. We also find evidence of complementarity between formal and real authority.
Overall, this study makes the following important contribution: We apply the the Aghion & Tirole view on formal and real authority to interorganizational networks (such as joint ventures). To the best of our knowledge this study is the first one to empirically show how JV-companies allocate formal and real authority between the JV partners. Furthermore, compared to Li, et al. (2011), we develop more valid measures for real authority.
The rest of the paper is organized as follows: Section 2 applies the AT-view in JV-relationships and develops the hypotheses. Section 3 presents the results of the empirical study on Austrian joint ventures in CEE. Section 4 discusses the results and concludes.
2. Formal and Real Authority: Theory and Hypotheses
Aghion & Tirole (1997) specify and delineate authority by defining it either as formal authority as “an explicit or implicit contract allocating the right to decide” or real authority.[1] The person with real authority is the person who has effective control over decisions because he/she possesses the relevant intangible knowledge that cannot be easily transferred to another person. For instance, JV-partner 1 (JV1) would accept and approve a decision, which has been taken by JV-partner 2 (JV2), and consequently rubberstamp it, as JV2 has more decision making capabilities to take a decision in the first place. In this case, JV2 has no formal authority but real authority. Accordingly, formal authority and the possession of the relevant knowledge to take the best decision in a specific situation may not be co-located within an organization. This is due to the fact that authority is exercised by a person who has an ex ante specified right to decide (formal authority), but also by someone who was not specifically assigned the right to decide but has the possession of the relevant intangible knowledge to take a decision (real authority).
2.1. Determinants of Formal and Real Authority
Our analysis examines two key variables that impact the allocation of formal and real authority, namely uncertainty and intangible knowledge. It is proposed that uncertainty rooted in the local environment of the JV-partner, as well as due to cultural differences, impacts the allocation of real and formal authority. Furthermore, JV-partner’s as well as JV-parent’s intangible knowledge is expected to influence the allocation of formal and real authority. This expectation rests upon the assumption that knowledge needs to be matched with the appropriate authority.
(i) Intangible knowledge
According to the property rights perspective, the governance structure is determined by the intangibility of knowledge. Intangible knowledge, or “soft” information, will be transmitted and used differently than tangible, easily transferrable knowledge (“hard”information) (Stein, 2002; Agarwal & Hauswald, 2010). These characteristics therefore impact the governance structure via the allocation of formal and real authority. If the knowledge is intangible (noncontractible), decision rights must be transferred to the person with the intangible knowledge (soft information). In this case, potential agency costs due to divergent preference structures are more than compensated by the residual income-increasing effect of lower information loss under delegated decision rights (Dessein 2002). If the knowledge is contractible, more explicit knowledge (hard information) will be transferred to the person with the decision rights. In this case, the formal decision maker can acquire the relevant knowledge, because communication results in low knowledge transfer costs, and potential agency problems can be easily controlled by the decision maker. Accordingly, we can formulate the following proposition: The delegation of formal and real authority increases with increasing intangible knowledge.
(ii) Uncertainty
According to the adaptation view of the organization (Gibbons, 2005; Simon, 1951; Williamson, 1991) higher environmental uncertainty requires more adaptability and local responsiveness. This view suggests that more decentralized decision structures are more effective under high uncertainty. This is compatible with Dessein (2002) who argues that delegation will generally lead to better results in situations of high environmental uncertainty. Similarly, Acemoglu, et al. (2007) argue that firms delegate authority to managers when the environment is more heterogeneous. Applied to JVs, under a highly uncertain foreign market environment, the JV-parent will delegate a higher proportion of decision rights to the foreign JV-partner. By having more decision authority, the JV-partner can react more quickly to the changes in the market and retain the necessary flexibility. Hence we can formulate the following proposition: The delegation of formal and real authority increases with uncertainty.
(iii) Complementarity between formal and real authority
Since the governance structure of organizations and networks refers to the structure of formal and real authority, the question to ask is which relationship exists between formal and real authority. Based on the complementarity view of organization design, an efficient organization design requires the use of complementary organizational practices (Milgrom & Roberts, 1995). Complementarity means that companies choose a bundle of practices that fit together (Bloom, et al., 2010). Applied to the relationship between formal and real authority, complementarity means that formal authority increases the residual income-increasing effect of real authority, and real authority increases the residual income-increasing effect of formal authority. Applied to the decision structure in joint ventures, the JV-partner will be motivated to use his intangible knowledge in decision-making more efficiently if he also has the formal authority, and the JV-partner with the formal authority will take more efficient decisions if he also has the decision making capabilities and hence the real authority. Complementarity is particularly important in the context of uncertain environmental conditions with respect to the application of specific and intangible knowledge (Agarwal & Hauswald, 2010; Van den Steen, 2010). We formulate the following proposition: Formal and real authority function as complements.
2.2. Hypotheses
We empirically investigate the relationship between formal and real authority in international joint ventures, where Austrian companies (joint venture partner 1 – JV1) enter the CEE markets with a foreign partner (joint venture partner 2 - JV2). Based on results in 2.1.,we can derive the following hypotheses:
H1. JV1’s formal and real authority decreases with environmental and cultural uncertainty in the foreign market.
H2. JV1’s formal and real authority increases with his/her intangible knowledge and decreases with the JV2’s intangible knowledge. .
H3: JV1’s formal authority and real authority are positively related
3. Empirical Analysis
3.1 Data and Measurement
The data was collected from Austrian companies that established joint ventures with partners in Slovakia, Poland, Hungary, or Slovenia. The questionnaires were sent to 250 executives of Austrian JV-parent companies, of which 60 were returned (i.e. 24% response rate). In order to test the hypotheses, we included the following variables in our multivariate regression model (see Table 1):
Variable / N / Mean / Std. DeviationFormal authority / 54 / 0.4830 / 0.31965
Real authority / 60 / 1.4417 / 1.98707
Environmental uncertainty / 60 / 3.2389 / 0.80055
Cultural distance / 59 / 2.5763 / 0.89449
JV-parent Knowledge / 60 / 5.0816 / 1.05224
JV-partner Knowledge / 57 / 3.5806 / 1.14471
Experience / 59 / 4.5847 / 0.68325
Age / 58 / 9.4828 / 4.16013
Sector / 60 / 0.38 / 0.490
Formal and real authority. We use the following measures for formal and real authority: (a) Formal authority refers to the extent to which management positions are assigned to the joint venture partners (JV1, JV2). Our questionnaire included questions regarding the following management positions: General manager, deputy general manager, production and logistics, marketing, financing, strategy, organization, and human resource management. The more these positions are filled by the JV1 compared to JV2, the higher the formal authority of the JV1. Thus we summed up and averaged all eight items to construct an index measuring formal authority. Cronbach Alpha is 0.824. (b) Real authority is operationalized by the relative influence of the JV1 compared to JV2 on decision making in the JV regarding the following value chain activities: Joint venture strategy, organizational form, product program, personnel recruiting, personnel remuneration, personnel training, production program, product prices, marketing activities, advertising activities, selection of suppliers, investment projects, selection of outside creditors, investment funding, deployment of accounting and controlling systems, and selection of cooperation partners. We then calculated the difference of the resulting scores between the JV-parent and the JV-partner, to obtain relative influence score. Cronbach Alpha is 0.869.
Uncertainty. Uncertainty refers to environmental and cultural factors in the foreign country. It is measured on a 5-point Likert scale. Environmental uncertainty refers to JV1’s perception of uncertainty of the foreign market concerning variation of market prices, number of competitors, product development and predictability of demand. Cronbach’s Alpha is 0.683. Cultural uncertainty refers to JV1’s perception whether the cultural distance between Austria and the foreign country is high.
Intangible Knowledge. It is measured on a 7-point Likert scale. JV-partners’ intangible knowledge refer to the know-how contribution of JV1 and JV2 regarding the following value chain activities: Production and logistics, procurment, marketing, personnel recruitment, sales, services, corporate planning, controlling, funding, research and development, organization design, strategic planning, local market knowledge, and relations with local authorities. Cronbach Alpha for JV1- knowledge is 0.867 and for JV2-knowledge is 0.899.
Control variables. Experience is a measure for the international experience of the Austrian JV-partner. It refers to the number of years of general experience, and the number of years of foreign experience in the country of the JV2. Age refers to the year of the foundation of JV in a foreign market. Sector refers to the industry of the JV, and differentiates between service industries, and manufacturing industries.
4.2. Results
To test our hypotheses (H1, H2), we carried out a multivariate generalized linear model (GLM) which has the advantage of simultaneously analyzing two correlated dependent variables (i.e. formal and real authority) among the same set of independent variables (Hair, et al., 2006).
Table 2: Multivariate GLM results tests (right)Independent variable / Wilks Lambda / Partial eta² / Dependent variable / Partial eta² / β coefficients
Intercept / F(1.863) = .913 / .087 / Formal authority / .086 * / 1.007
Real authority / .034 / 2.768
Environmental uncert. / F(4.499) = .813 ** / .187 / Formal authority / .001 / 0.012
Real authority / .124 ** / -0.589
Cultural distance / F(3.233) = .858 * / .142 / Formal authority / .080 * / -0.086
Real authority / .137 ** / -0.520
JV-parent knowledge / F(5.958) = .765 *** / .235 / Formal authority / .044 / 0.058
Real authority / .228 *** / 0.651
JV-partner knowledge / F(17.724) = .524 *** / .476 / Formal authority / .143 ** / -0.098
Real authority / .470 *** / -1.014
Experience / F(4.117) = .826 ** / .174 / Formal authority / .031 / -0.077
Real authority / .058 / 0.480
Age / F(0.428) = .979 / .021 / Formal authority / .017 / 0.010
Real authority / .000 / 0.006
Sector / F(0.106) = .995 / .005 / Formal authority / .000 / -0.008
Real authority / .005 / -0.170
N=48
Adj. R2 (formal authority) = 0.139
Adj. R2 (real authority) = 0.570
All F statistics for Wilks' Lambda were exact
***p<0.01; **p<0.05; *p<0.1
Table 2 summarizes the results of the multivariate regression model. First the data provides support for impact of uncertainty (i.e. environmental uncertainty and cultural distance) and JV-partners’ intangible knowledge on the allocation of real authority in JV. Second, consistent with our hypotheses cultural distance and the foreign JV-partner’s intangible knowledge vary negatively with JV1-formal authority. However JV1’s intangible knowledge and environmental uncertainty do not significantly influence the allocation of formal authority. Finally, we tested the complementarity hypothesis (H3) by caluculating the partial correlation between the two depended variables, formal authority and real authority. Using the partial correlation allows us to control for the effect of all other variables in our regression model (Hitt & Brynjolffson 1997). The correlation of 0.565 (p=0.000) is highly significant and thus provides strong evidence for a positive relationship between formal and real authority.