International joint venture with double-sided moral hazard: payment arrangements and credit constraints

Abstract

We analyse the formation of an international joint venture (IJV) between a multinational corporation (MNC) and a domestic firm with double-sided moral hazard. The MNC can imperfectly adapt a superior production technology, and the domestic firm can reduce set-up costs, for the IJV. We examine how set-up costs interact with borrowing constraints and different payment arrangements. Our findings include: (i) a better access to credits can make the domestic firm worse off, (ii) under credit constraints, a reduction in set-up costs has a smaller positive effect on both partners' profits, (iii) under moderate credit constraints, whereas either a better access to credits or a higher set-up costs increases the domestic firm's share of profits with ex ante payments, the effect can be the opposite with ex post payments, and (iv) profit-sharing always occurs with ex ante payments, with or without credit constraints, but not so with ex post payments. Copyright 2012 Oxford University Press 2011 All rights reserved, Oxford University Press.