The costs of governance in international companies Sverre Tomassen, Gabriel R.G. Benito * Department of Strategy and Logistics, BI Norwegian School of Management, N-0442 Oslo, Norway 1. Introduction The ever-rising use of foreign direct investment (FDI) as a way of expanding internationally has been a striking development for several decades. However, going abroad through FDI has implications for the costs of internationalization. In addition to expenses associated with staffing, housing, land, machinery, etc., more subtle costs are generated in the daily management of the subsidiary. Before entering a foreign market, such costs are, for many companies, unclear and often underestimated, and in some cases perhaps even ignored. Nevertheless, when the structure is set and the day-to-day foreign business develops, these costs, which in correspondence with Demsetz (1993, pp. 161–162) 1 are labeled ‘‘governance costs’’ in this paper, become more manifest and may play a significant role for multinational companies’ (MNCs) assessment of the performance of their subsidiaries. Careful analysis of these costs and the resulting performance of the foreign direct investments should be of major importance. A better understanding of the relationship between governance costs and performance requires that the relevant governance costs are identified and properly measured, and that the notions of subsidiary performance and its antecedents are adequately clarified. The first has to some extent been done within the framework of transaction cost economics (TCE) (Dahlstrom & Nygaard, 1999; Masten, 1993; Masten, Meehan, & Snyder, 1991; Noordewier, John, & Nevin, 1990). Regarding the latter, a growing number of studies have in recent years been dealing with various aspects of performance (Aulakh & International Business Review 18 (2009) 292–304 ARTICLE INFO Article history: Received 1 December 2006 Received in revised form 22 May 2008 Accepted 13 February 2009 Keywords: Foreign subsidiaries Governance costs Multinational companies Performance ABSTRACT Using foreign direct investment as a governance mechanism has a cost side that goes beyond mere production and input costs. The governance costs of foreign operations are often vague and underestimated, and sometimes even ignored by companies entering a foreign market. The effects of these costs have also largely been neglected in former empirical research. This study examines the governance cost effects on foreign subsidiary performance. Using data from a survey of 160 Norwegian multinational companies the study shows that there are significant and negative relationships between bargaining, monitoring, and maladaptation costs and subsidiary performance. Conversely, costs incurred due to bonding activities are positively associated with performance. Overall, this study indicates that governance costs play a significant role in explaining the performance of foreign subsidiaries: close to 40% of the variation in performance can be attributed to such costs. Dealing with such costs is hence of utmost importance for the management of multinational companies. ß 2009 Elsevier Ltd. All rights reserved. * Corresponding author. Tel.: +47 46410455; fax: +47 46410451. E-mail address: gabriel.r.g.benito@bi.no (Gabriel R.G. Benito). 1 Demsetz (1993, pp. 161–162) prefers to use the word ‘‘transaction costs’’ when describing the costs of organizing resources across markets and ‘‘management costs’’ when organizing resources within firms. He suggests however that those who do not like this distinction can substitute the two expressions with ‘‘governance costs’’. Contents lists available at ScienceDirect International Business Review journal homepage: www.elsevier.com/locate/ibusrev 0969-5931/$ – see front matter ß 2009 Elsevier Ltd. All rights reserved. doi:10.1016/j.ibusrev.2009.02.005