Joint Ventures

Kogut (1991) discussed that joint ventures should be seen as options to expand. The importance of market signals was emphasized. There are certain hazards with respect to acquisition decisions after a joint venture – a temporal agreement – has reached its end. The statistical results “indicate that unexpected growth in the product market increases

the likelihood of acquisition; unexpected shortfalls in product shipments have no effect on the likelihood of dissolution. This asymmetry in the results strongly supports the interpretation of joint ventures as options to expand.”150

Inside a joint venture it might be argued that the partner also places a bet on future market developments. Costs and benefits are shared; therefore joint ventures represent an attractive option to expand in risky markets. The special problem associated with joint ventures is that exercising the option requires further capital commitments, thereby urging the need of renegotiations. “The exploration of the link in the timing of

the acquisition of joint ventures and of the exercise of the option to expand is the focus of the following empirical investigation.”151 In a real option sense joint ventures are a

possible way of both exploiting and buffering uncertainty.

At first, the concepts of real options in this very specific context shall be explained: in our framework real options are the right to buy and sell equity in the joint venture. As stated above, when it is decided to exercise the option, one party is likely to divest of the joint venture, because the value added arising from exercise of the real option to expand to one entity might be very different from the value added to another entity. These are differences in option valuations due to “potential spill-over effects of the

venture's technology complement the product portfolio of one partner more than the other.”152

Therefore joint ventures can be interpreted as being real options: there are two extremes in our framework: In the first case, it is valuable to wait with investments, because it pays off before committing more resources. In the second case, investment

commitments are necessary to retain the right to exercise the option to expand in future. What is important to emphasize is that the financial burden of establishing a joint venture is sometimes not only dividing the overall sum, but reducing it, because total investment costs can be lowered due to complementary skills. The motivation divesting is the realization of capital gains or the absence of additional technology to launch a market product.

150 _{Kogut, B. (1991), p. 19} 151 _{Kogut, B. (1991), p. 20} 152 _{Kogut, B. (1991), p. 21}

Arguably one of the most delicate issues when thinking about options is the timing of exercise. In our joint venture context exercising means acquiring the venture. It represents a long call option; consequently, “acquisition is justified only when the

perceived value to the buyer is greater than the exercise price.”153 There are mainly

two reasons for exercise: First, if further investments are not made, the future cash flows would be inevitably lost. Secondly, if capitalization needs to be increased, normally renegotiations are required, often leading to termination of the joint venture. To buy the partner out of the venture is common business practice, because

opportunities are perceived in different ways. In the spirit of this argument, Kogut (1991) set up the hypothesis that “The venture will be acquired when its valuation

exceeds the base rate forecast.”154

In our framework a special market valuation problem arises, because there are no prevalent markets that would indicate changes in the value of the option. It is practically impossible to collect objective data. Parameters vary over time and

decisions are contingent on estimates. The motivations for forming a joint venture may be heterogeneous as well. Besides of developing an option to expand in new markets also the sheer benefits of sharing assets in the current use could be decisive. A further property of joint ventures is that “a joint venture serves as a vehicle of managerial and

technological learning.”155

The author’s statistical results show that the hypothesis is confirmed: joint ventures are regularly used as an intermediate stage to complete acquisition. Concerning

governance, an interesting result is that “a decision by managers whether to acquire or

divest the joint venture is more significantly sensitive to annual departures from a long- term trend than to short-term indices of industry growth.”156 Management decisions

therefore are “cued” by market signals and acquisitions often occur when an industry is performing superior with respect to historical trends. Those decisions are imperatively based on managerial interpretations – especially the recognition that short term market

153 _{Kogut, B. (1991), p. 23} 154 _{Kogut, B. (1991), p. 24} 155 _{Kogut, B. (1991), p. 26} 156 _{Kogut, B. (1991), p. 30}

fluctuations may be outliers is often misjudged. One concluding statement is that “Once

the capital is committed, the downside risk is low, especially if there is a market for the acquisition of the assets and operating costs are not high. The selling of the venture means that one firm puts a higher value on the assets; it does not mean the venture is unprofitable.”157 This strongly supports the opinion that joint ventures can be designed

as real options.

Citing a closing assertion: “This article has investigated the proposition that joint

ventures are designed as options that are exercised through a divestment and acquisition decision.”158