Kellogg School Corner | The power of the pyramid

Kellogg School Corner | The power of the pyramid

When conducting international business, firms have more than a language barrier to navigate.

Cultural differences, legal frameworks and taxes—all influence strategic decisions. But, something not typically at the forefront of a company’s strategy is


According to research by Susan Perkins, Kellogg assistant professor of management and organizations, the differences in ownership that exist around the world can make or break a firm’s success if its leaders are unaware of such variations and the potential risks inherent to partnership. Perkins’ recent research paper, Innocents Abroad: Failure Rates of International Joint Ventures with Firms in Pyramidal Groups, addresses some of the consequences of not understanding those dynamics. This research is a collaboration with Randall Morck, distinguished chair and professor of finance at the University of Alberta School of Business, and Bernard Yeung, professor of global business, economics and management at New York University’s Stern School of Business.

The typical ownership structure of a US or UK company, where owners and managers are separate entities, is not common elsewhere, Perkins explains. With the exception of these two countries and others such as Canada, Australia, Germany and Singapore, the dominant ownership structures are business groups in which owners and managers are often the same. Therefore, the core agency problem is one of shareholder protection for outside investors or joint venture partners. In Brazil, the focal country of this research, and throughout Latin America, these pyramidal ownership structures are called ‘grupos’.

One of the distinguishing features of grupos is their ability to leverage control of lower-tiered firms within their overall portfolio of firms. They achieve this through an extraordinarily disproportionate amount of “voting stakes" compared with “equity stakes" in the partnering firms. For example, in 2005, the ultimate owners of all Brazilian-listed firms retained 85% of the voting rights with only 51% of the equity stakes in the company. Insiders who control firms with these pyramidal structures are able to siphon resources between the various companies they control, to further their own agendas rather than those of outside investors or the joint venture partnership.

“In thinking about the expropriation risks of joint venturing with a grupo, this paper attempts to illuminate the pitfalls and provide strategic insight on how to avoid falling into expropriation traps," says Perkins.

She and her research colleagues examined 96 companies that have entered the Brazilian telecommunications industry as joint ventures. They found that the Brazilian ownership structures combine with a foreign company in one of three ways: with a stand-alone firm, with another pyramidal structure, or with another form of business group (e.g. the Japanese keiretsu or South Korean chaebols). “We measure the success rates of these corporate governance and ownership structure combinations and find a strong and significant relationship between market failure and having differing types of ownership structures," Perkins says.

Her research shows that 27% of partnerships between stand-alone firms and those with pyramidal structures fail. “However, we find that pyramidal groups that partner with other pyramidal groups have only an 8% likelihood of failure," says the Kellogg professor. “And if we compare that to the best form of foreign entry, which is a wholly-owned subsidiary, those firms only have a 4% failure rate, which is not statistically different than the 8% failure rate of the pyramidal joint ventures."

In other words, how the different governance and ownership structures interact will have an impact on the success of these joint ventures. Perkins says that firms with pyramidal structures know how to manage and mitigate risk against one another better.

For example, she says, when pyramidal groups Portugal Telecom and Telefónica from Spain formed a partnership, they created strategies of reciprocity by purchasing cross-holdings in each other’s companies. Other pyramidal firms have also used strategies of multiple point competition to pose a credible threat of retaliation for expropriation, thus reducing this risk. “If it looks like, instead of maximizing the joint venture, I’m starting to maximize my own wealth by siphoning out of the joint venture, my partner can retaliate by competing against me in other markets," Perkins says.

The research team also found evidence that companies originating from a home country market where pyramids are dominant function better in host countries that also are dominated by pyramids because the players are more aware of how pyramidal grupos behave. Conversely, firms which are from home countries that do not have pyramids are at increased risk when entering pyramidal environments.

“The timing of this study is exciting given global trade and its importance to economic growth and development of nations," says Perkins. “When we think about world economies and strategies to enable trade flows or foreign investment between nations, much of this challenge falls at the bedrock of figuring out what are the most effective alliance strategies to enable nations and firms within nations to work together."

These strategies require conducting due diligence within local markets to learn about potential partners before forming an alliance, she says. Equally important is thinking about non-market strategies,which Perkins says are often overlooked. Questions of how one will navigate the ‘rules of the game’ in a given corporate governance arena and the direct impact of those decisions on one’s shareholder agreement are critical for managers to answer.

Perkins will continue to explore research related to market volatility driven by institutional difference and understand the strategic implications for managing against such risks.

“I have an interest in foreign investment and what drives economic development and growth, particularly in emerging market economies," she says. “Where opportunities are the largest comes the greatest chance of risk."

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Based on the research of Kellogg School assistant professor of management and organizations, Susan Perkins, in collaboration with Randall Morck, chair and professor of finance at the University of Alberta School of Business, and Bernard Yeung, professor of global business, economics and management at New York University’s Stern School of Business. Adrienne Murrill is a staff writer at the School.