Transnational Corporations and Transnational Governance

‘“Transnationalism” is a term which suffers from being “in” in social science’ (Huntington, 1973, p. 334). Although this opening quote is from 40 years ago, it could just as well have appeared in a publication this year. It was written in the aftermath of a global energy crisis, when there was a need to redefine the role of some of the key actors and their relative position in the global (political) system. Transnationalism continues to be popular in the social sciences, at least in part because four decades of globalization have resulted in a world economy that presents a mixture of public and private governance, where new actors continue to emerge, but where state borders still matter. In this context, transnational organizations and transnational corporations (TNCs), in particular, continue to exert a powerful influence on the world economy, but the world economy they are operating in is in some important ways quite different from the economy that was shaping up in the 1970s.

Business firms, along with nation states, are crucial agents in today’s advanced economies. Transnational corporations (TNC) are business firms with activities in more than one nation state,¹ and although they are but a small subset of all business firms, they play a dominant role in the world economy. According to UNCTAD (2009), there were some 82,000 TNCs in 2008 owning more than 800,000 foreign affiliates. Ten years earlier, their internal trade was estimated to already account for as much as three-quarters of world exports (UNCTAD, 1999: 232).

Transaction cost economics (TCE) has fast become one of the most influential theories within the social sciences (Carroll & Teece, 1999; Carter & Hodgson, 2006). Its applications in the international business (IB) context have shown its relevance not only to explaining and predicting a wide variety of IB phenomena, including, inter alia, the existence of multinational enterprises (MNEs) (Buckley & Casson, 1976; Rugman, 1980; Teece, 1981; Hennart, 1982), MNE foreign entry mode decisions, and interactions with external parties (Beamish & Banks, 1987; Hennart, 1988; Buckley & Casson, 1998a; Chen, 2005), but also to MNE internal governance choices (Hennart, 1993; Verbeke & Kenworthy, 2008).

At some time during their lives, approximately 10–15 per cent of the people in the world will experience significant problems related to gastric acid secretion, with duodenal ulcers being the most common affliction. In 1988, the Swedish pharmaceutical group Astra (now AstraZeneca) introduced a new type of drug, called Losec, which revolutionized the treatment of ulcers. By 1991, 8.9 million patients had been treated with Losec, and the product was marketed all over the world. Losec became one of the most sold drugs in history (Johanson & Vahlne, 1993).

The first great unbundling (Baldwin, 2006) took place during the industrial revolution, when it first became possible to produce goods in a location that was different from where they were consumed. This process facilitated economic agglomeration and led to the development of large cities, which in turn allowed for more specialization within specific regional areas. The process of specialization was based on local advantages, some of which were geographical in origin, while others developed more by accident, dependent on the location of individual entrepreneurs.

Multinational companies (MNCs) have an international reach by definition. They combine components which are manufactured in far-away countries, they produce in manifold subsidiaries set up and dispersed around the globe, and they serve the world market. Research, development and innovation follow suit and take place in dispersed settings where cost of space and time is negligible. The fact that foreign direct investment (FDI) amounted to US$ 1.24 trillion in 2010 shows how internationalised our modern economy is, especially if we take into account that this FDI turnover had been even higher before the economic downturn (UNCTAD, 2011). It seems logical to conclude that space is getting more and more irrelevant, or, to phrase it differently, ‘the world is fat’ and geography is dead (Ohmae, 1990; Friedman, 2006).

The European Union (EU) is characterised by significant economic and technological disparities (Fagerberg & Verspagen, 1999; Midelfart-Knarvik et al., 2004; Verspagen, 2010). Even though these regional disparities within the enlarged EU have been decreasing since the early 1990s following post-socialist transformation and the European integration processes, economic and technological disparities between the most and the least advanced European regions remain very high — for example, between Brunswig with a research and development (R&D) expenditure of 7.9 per cent of the regional GDP and Lubuskie with 0.1 per cent (2009). These disparities represent a major reason behind the continuing economic inequalities and, consequently, also threaten the monetary and political integration of the EU. Technological capabilities are strongly concentrated in just a few Western European regions and cities. In 1995 the research intensity in the most advanced regions was nearly 14 times higher than the expenditures of the lowest decile and in 2009 it was still 12 times higher. The disparities between the business R&D expenditures and patent applications of the highest and lowest deciles were even higher (38 and 47 times higher, respectively; see Table 7.1).

What is intra-firm trade law? In this article we propose that intra-firm trade law is a branch of transnational commercial law. Transnational commercial law, in turn, is a concept related to interdisciplinary legal studies which focuses on the question of how modern trade is institutionally organised in practice, and what role law plays in this context (Calliess et al., 2007). The formulation of this question contains a number of implications for the analysis of commercial law: First, following New Institutional Economics (Furubotn & Richter, 2005; Williamson, 2008) instead of the legal concept of contract, the generic term of transaction, as known also from the US Uniform Commercial Code, takes centre stage. Second, the main emphasis is on the analysis of cross-border transactions since the foreign trade-to-Gross-Domestic-Product (GDP) ratio of Germany, for example, reached an all-time high of 75.9 per cent in 2012.¹ And third, in terms of methodology a functional-empirical approach to the topic includes, apart from legal, also alternative forms of governance as being of paramount importance (Calliess & Zumbansen, 2010).

Overcoming trade-off like constellations has been a core challenge in business and management in the last years. Mass customization is one example in this regard; the debate on organizational ambidexterity (March, 1991) is another. Overcoming the ‘glocalization’ challenge is the trade-off debate relevant to this chapter. ‘Glocalization’ (Rugman & Brain, 2003; Rugman & Verbeke, 2004) is a neologism for the coeval need to standardize on a global scale and to access location-specific advantages by adaptations on a local scale.

In recent decades, many of the barriers to conducting international business have disappeared due to globalization, including the abolishment of trade barriers (e.g., WTO) and, as a consequence, internationalization of services, the development of modern information technology, innovations in logistical flows, the use of English as a global lingua franca and the introduction of international accounting standards. However, at the same time many barriers continue to persist such as national boundaries, local language and psychic distance between cultures. The result is a paradox of globalization.

The market for auditing services is dominated by four accounting firms that operate worldwide: Deloitte & Touche (Deloitte), Ernst & Young (E&Y), KPMG and PriceWaterhouseCoopers (PwC). The so-called Big 4 offer auditing services, tax advisory and consulting. In 2011, each of the Big 4 was represented in at least 145 countries. Altogether the Big 4 employ more than half a million people and have realised a turnover of more than 100 billion USD in all three service lines. These numbers make them comparable with international corporations from other industries. However, the Big 4 accounting firms differ in three important ways from most global players. First, they belong to the group of professional service firms (Suddaby et al., 2009). Characterised by high knowledge intensity, low capital intensity and a professional workforce (Von Nordenflycht, 2010), their business model differs systematically from that of most other corporations. Second, they mainly use the corporate form of a professional partnership (Greenwood & Empson, 2003). Third, they entertain intense reciprocal relationships with their regulatory environments (Eberle & Lauter, 2011). This applies in particular to accounting and auditing standards.

The debate on the legal and ethical responsibilities of multinational enterprises (MNEs) to respect human rights has become one of the most significant recent developments in the wider field of corporate social responsibility (CSR). That debate has been fuelled by the Guiding Principles on Business and Human Rights (Guiding Principles) endorsed in June 2011 by the UN Human Rights Council for implementing the UN ‘Protect, Respect and Remedy’ Framework (UN Framework).¹ This instrument can be said to constitute, ‘the first global standard for preventing and addressing the risk of adverse human rights impact linked to business activity’² It is the purpose of this chapter to develop a specific theme in the wider debate, namely, the role of the due diligence concept in formulating and making operational the second pillar of the UN Framework, the corporate responsibility to respect human rights.

During the past decades business firms have started to engage in activities that have traditionally been regarded as actual governmental activities (Margolis & Walsh, 2003; Matten & Crane, 2005; Scherer & Palazzo, 2008a). This is especially true for multinational corporations (MNCs). They engage in public health, education, social security, and protection of human rights while often operating in countries with failed state agencies (Matten & Crane, 2005); address social ills such as AIDS, malnutrition, homelessness, and illiteracy (Margolis & Walsh, 2003; Rosen et al., 2003); define ethics codes (Cragg, 2005); protect the natural environment (Hart, 2005; Marcus & Fremeth, 2009); engage in self-regulation to fill global gaps in legal regulation and moral orientation (Scherer & Smid, 2000); and promote societal peace and stability (Fort & Schipani, 2004).