Relationship with Headquarters and Divestments of Foreign Subsidiaries: The Hysteresis Perspective

Abstract

This paper examines the conditions under which foreign subsidiaries of multinational corporations (MNCs) are less prone to divestments. In the study, we examine the importance of foreign subsidiaries to MNCs based upon (1) product-level vertical integration, (2) human capital investments, and (3) technological investments in the subsidiaries. Given that we examine the probability that a subsidiary divestment will occur under the condition that all other subsidiaries are also at risk during the same time period, we employ a Cox proportional hazard rate model as a commonly used statistical method in the event history analysis. For empirical testing, we utilized a sample of Korean 439 MNCs and its 5306 foreign subsidiaries over a period of 1990-2011. We find that even under hostile host market demand conditions, MNCs are less likely to divest their foreign subsidiaries when those subsidiaries are vertically integrated with their headquarters, benefiting from a top management team dispatched from their headquarters or other affiliates, or possessing technological knowledge shared by their headquarters. These findings imply that relationship-specific investments with headquarters cause a hysteresis effect that deters these subsidiaries from being divested, even during times when divestments seem most likely because of unfriendly economic conditions in their host countries.