The Effects of Transaction Costs on the Performance of Foreign Direct Investments: An Empirical Investigation

The multinational companies’ (MNCs) use of foreign direct investments as a governance mechanism in the globalization of businesses has a cost. Together with expenses linked to production processes, additional costs are also generated in the governance of the foreign subsidiaries. These costs, defined as transaction costs in this study, are in many cases underestimated, unclear, or to a certain extent ignored by the companies before entering a foreign market. Unfortunately, studying the effects of these costs have also, to a certain extent, been neglected in former empirical research. Hence, as a response to the shortcomings, this study has investigated the transaction costs effects on foreign subsidiary performance. In addition, the moderating role of two different modes of entry on this transaction cost – performance relationship has been examined. By using a transaction cost economics (TCE) approach, four different types of ex post transaction costs are identified and measured within a setting of 160 Norwegian MNCs and one of their foreign subsidiaries. In addition, subsidiary performance are identified and measured in various ways. The foreign subsidiaries were established as either greenfield operations or as acquisitions. The construct validity of the different measures was examined in LISREL. Excellent fit indices, as well as satisfactory reliability measures are observed. The main effects were tested by using multiple regression analysis, and the findings provide support to three out of four hypotheses. There is a significant and negative relationship between bargaining costs and subsidiary performance, as well as between monitoring costs and performance, and maladaptation costs and performance. Moreover, this study also shows that different entry modes create different transaction costs effects on subsidiary performance. It is also worth emphasizing that this study shows that transaction costs play a significant role in explaining the performance of foreign subsidiaries. According to the findings, close to 35 percent of the variation in performance can be attributed to such costs. This is an important observation and strengthens the idea that there is a strong relationship between transaction costs and performance, and that reducing such costs must be important for the management of MNCs.