5. Technology Transfer

Note that this is only in an ex ante sense. There may not be much of any ex post variation in output over time for any one joint venture.

This variance is across different firms ex ante. Information asymmetry may therefore make an MNC choose an inefficient firm while forming a joint venture.

As Arora (1996, p. 235) put it, “transfer of chemical technology will typically involve training the licensee in a variety of issues such as how to handle and store chemicals, how to control the production process and return it to operation after (an) unscheduled breakdown caused by (an) accident or impurities in the feedstock.”

It will be assumed that this is the cost of using the capital equipment per unit of time to facilitate the static analysis that follows. Note, however, that capital costs can be fully recovered only if the integrity of the joint venture can be sustained over a sufficiently long time.

Technological development by the MNC will not generally pay attention to the variable costs in its implementation under various production conditions. Hence, substitution between capital and variable factors will not be acknowledged explicitly.

It can be shown that allowing substitution between capital and variable factors does not yield royalty rates commensurate with the stylized facts if randomness is acknowledged.

The fixed costs are assigned to P and the variable costs are borne by F. Hence, sharing output is the only relevant contract parameter.

The a priori expectation would have been one of relatively greater risk aversion of P for the risks associated with information asymmetry make it difficult to recover sunk investments. It can be easily verified that such a modification of the KM model yields similar results. However, the basic theme of this study is that P can modify the effects of randomness through his actions. Hence, the risk will primarily impinge on F if such choices are efficient.

Clearly, P must be compensated for the additional expenditure. The obvious mechanism is to adjust p suitably. Some authors suggest that P will claim a fixed amount upfront for the transfer of informal knowledge. See, for example, Brickley (2002). However, a change in p is more realistic if the expenditure by P depends on the skill level of F. This approach will be adopted in the sequel.

The context of liquidity constraints is somewhat analogous. Postulate that P makes an a priori judgment that the randomness is due to liquidity constraints and not the shortage of tacit knowledge. Assume that F is experiencing liquidity constraints primarily because his skills and collateral are inadequate. One approach available to F is to locally obtain finances at a higher interest rate. On the other hand, P may agree to raise finances in its parent country if some saving is possible. Suppose, P incurs an extra cost me ² and expects F to accept the variable cost e ²/2δ as before. Or, alternatively, P may allow F to raise the requisite finances and reimburse me ² of expenditure. The greater the value of m offered, the lower the σ ² due to the randomness created by the liquidity constraints. Hence, the optimal choice of m will be exactly the same as before. Once again, it is evident that the endogenous randomness specification compensates for the lack of skill on the part of F to raise the requisite finances. However, note that the basis for this formulation will be lost if the liquidity constraints are external to the operation of F.