What is a foreign subsidiary strategy?
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Abstract This study extends agency theory to explain the design of compensation strategy in foreign subsidiaries competing within global industries. Results from 100 subsidiaries in five countries indicate that compensation strategy is influenced by the agency problem, defined by the subsidiary's cultural distance from its headquarters market, lateral centralization, and senior management's commitment to the parent. In addition, the association between the overall design of the compensation strategy and perceived subsidiary effectiveness was examined. An incentive structure aligned to the agency state was positively related to subsidiary effectiveness. Journal Information The Academy of Management Journal presents cutting edge research that provides readers with a forecast for new management thoughts and techniques. All articles published in the journal must make a strong empirical and/or theoretical contribution. All empirical methods including (but not limited to) qualitative, quantitative, or combination methods are represented. Articles published in the journal are clearly relevant to management theory and practice and identify both a compelling practical management issue and a strong theoretical framework for addressing it. For more than 40 years the journal has been recognized as indispensable reading for management scholars. The journal has been cited in such forums as The Wall Street Journal, The New York Times, The Economist and The Washington Post. The journal is published six times per year with a circulation of 15,000. Publisher Information The Academy of Management (the Academy; AOM) is a leading professional association for scholars dedicated to creating and disseminating knowledge about management and organizations. The Academy's central mission is to enhance the profession of management by advancing the scholarship of management and enriching the professional development of its members. The Academy is also committed to shaping the future of management research and education. Founded in 1936, the Academy of Management is the oldest and largest scholarly management association in the world. Today, the Academy is the professional home for more than 18290 members from 103 nations. Membership in the Academy is open to all individuals who find value in belonging. Rights & Usage This item is part of a JSTOR Collection. A standard practice in global expansion is to establish a new business entity. Global businesses may form a foreign subsidiary to take advantage of local technical skills or participate in regional economic activities. While the advantages of foreign subsidiaries may help you expand into new markets and niches with minimum liability to the parent company, the disadvantages of foreign subsidiaries may result in increased compliance costs in the foreign country. A thorough understanding of foreign subsidiary pros and cons will help you decide whether to set up a subsidiary or use an alternative, such as a global Professional Employer Organization or ‘global PEO‘. Things to Consider Before Setting Up a Foreign SubsidiaryConsider the following criteria before setting up a subsidiary in a foreign land. Stability of foreign governmentThe following aspects determine the stability of the local government and its authority when reviewing overseas business options.
It is sensible to seek the services of local consultants over the political and business environment before deciding on any overseas expansion. Your business requirementsYour business cases need to respond to the challenges, adversity, and rewards of expanding overseas. Some strategies to consider are:
The legal structure of the subsidiaryWhen a company decides to register a subsidiary, representatives of the legal and tax departments can determine among common types of entities to choose from -
LLCs are usually the ideal business structure for small businesses as it promises personal liability protection, flexible tax options, management flexibility, less paperwork, and are inexpensive. Eventually, the management chooses the type of legal entity depending on the purpose of the subsidiary, the composition of its interest holders, local jurisdictional requirements, and tax implications. Minimum capital, FDI limits, & business visas in foreign countriesAfter the legal structure of a subsidiary is fixed, parent companies must pay heed to the minimum capital requirement of that particular structure. The minimum capital necessary to form an entity varies by country. For example, forming a foreign subsidiary in several European jurisdictions requires a fixed capital. Most developing countries in Asia & South America base capitalization on reasonableness, operating costs, or practical considerations. Before setting up a subsidiary, it is also essential to evaluate the sectors of the economy ready for foreign direct investment (FDI) without any prior approval from the local government. Additionally, consider the business visa requirements for shareholders/directions of subsidiaries in the proposed jurisdiction. Post-incorporation of a subsidiaryEven after a foreign entity is incorporated, consider additional items like license applications, taxation issues, obtaining payroll and customs numbers, and opening a permanent bank account. Companies also need to take care of the work visas and permits of the foreign employees. Why Should You Establish a Foreign Subsidiary Company?Establishing a subsidiary in a foreign country can be beneficial for a company for several reasons like brand image, access to the market, reduced tax liabilities, etc. The advantages of foreign subsidiaries are discussed in the following paragraphs by identifying the pros and cons of establishing a legal entity in specific regions. Better access to local technical talent in AsiaSome Asian countries, particularly India, Singapore, China, and Japan, have qualified human resources in technical fields and better access to advanced technology. Pros:
Cons:
Taking advantage of free trade zones in UAEThe parent company can establish its foreign subsidiaries in Free Trade Zones without facing extensive barriers to entry. Pros:
Cons:
Enter the most sophisticated markets in the European UnionThe interlocked countries and the closely integrated market makes setting up a foreign subsidiary in the European Union highly lucrative. Pros:
Cons:
Companies prefer the USA to build brand valueAlmost any technology-driven company wants to associate with the USA. Companies form a subsidiary or acquire one in the USA to expand their brand’s reach. Pros:
Cons:
Leveraging local economic opportunitiesAny company can use local economic opportunities in a foreign land to build a profitable business out of it. Pros:
Cons:
Cost-effective productionStarting a subsidiary in a country like China helps companies manufacture cost-effective products. Pros:
Cons:
Does the Global Minimum Tax Impact Foreign Subsidiaries?Previously, the foreign subsidiary advantages and disadvantages depended entirely on the host country’s tax rates. It was a ‘race to the bottom’ with tax competition between governments to attract foreign investment. It may now end with 136 countries signing a deal to ensure global companies pay global minimum tax. The countries behind the global minimum tax rate collectively account for over 90% of the global economy. Economists expect that this global minimum tax rate deal will encourage multinationals to repatriate capital to their country of headquarters, boosting those economies. Multinationals will continue to establish a separate foreign entity and measure the foreign subsidiary’s pros and cons based on business factors as discussed above. Advantages of Establishing a Foreign SubsidiaryForming a new entity or acquiring an established entity in a new market is beneficial for international expansion only after validating all the possible foreign subsidiary pros and cons. Listed are some of the advantages a company gets while establishing a foreign subsidiary: Foreign subsidiaryPros:
The parent company remains protected from business risksThe significant advantage of foreign subsidiaries over a representative or branch office is that it is recognized as a separate legal entity from its parent company. Even though the parent company may hold majority shareholding rights, and the liabilities and risks associated with the failure of the subsidiary are generally kept isolated. This also means that both companies can share liabilities and will separate in terms of tax or regulations. Establish market presenceEstablishing a subsidiary in a foreign country establishes a legal entity in that country. These entities can then market their products to local people and participate in import and export. A local client may prefer to engage and contract with a locally established company. Setting up your legal structure in any target country can gain valuable market perception, adding to your overall brand value and profits. For instance, an American company establishing its subsidiary in the Netherlands will be called a Dutch company and is more likely to attract the local clientele. Protection under local lawsEstablishing a foreign subsidiary means having a legal entity recognized by the local government. Therefore, the enforceability of employment contracts or any legal matter is under the relief of local court systems. High compliance with tax regulationsForming a foreign subsidiary company in any target country will automatically kick in tax regulations and bilateral tax treaty requirements, ensuring the highest levels of compliance in that country. It would automatically cover the risk spectrum usually associated with cross-border trade. Access to a global talent poolOne of the significant advantages of foreign subsidiaries is giving the parent company unlimited access to new markets. Besides, the parent company can hire full-time employees abroad directly based on their skill set. New business relationsEstablishing a legal entity also helps parent companies form business relations with local partners in foreign countries. They can, in turn, utilize localized knowledge and set up joint ventures. This will help boost the company’s revenue. Flexibility of investmentSince the parent company controls a foreign subsidiary's assets, it may invest as much or as little into the subsidiary. The level of investment depends on risks associated with the new market location or the business niche. Not just that, if a foreign subsidiary company fails to achieve its desired outcomes, the parent or the holding company can choose to sell it and get its investment back. Physical asset acquisitionEngaging the services of foreign independent contractors, BPOs, or even an Employer of Record (EOR) is usually preferred for quicker global expansion. However, establishing a foreign subsidiary protects your manufacturing or any other business requiring real estate acquisition or other physical assets. Disadvantages of Establishing Foreign SubsidiariesSubsidiaries also have certain disadvantages. Foreign subsidiaryCons:
Working problems in a foreign countryA foreign subsidiary is a local legal entity in its place of incorporation. However, any legal or financial action could have implications for the parent companies. Thus, the usual problems of working in a foreign country also apply. As a foreign subsidiary is not developed organically in that country, it may have to face cultural and political issues. These could negatively affect the foreign subsidiary’s growth. Following local procedures and regulations to mitigate may increase compliance costs. Not suitable for a cost-plus approachThe significant disadvantage of foreign subsidiaries comes into play when it sells products based on cost-plus pricing. Since the subsidiary is now contracting and invoicing locally, it increases local maintenance costs, adds tax complexities, and requires local signatories. Usually, the cost-plus pricing strategy involves adding a fixed percentage on top of a unit cost and arriving at the selling price. Regulatory complianceIn the past few decades, the rise of global trade has forced national governments to open doors for foreign companies to set up their subsidiaries. Subsequently, several employment law violations, corporate malpractices, and international banking frauds have also made headlights. In the context of the ever-changing regulatory landscape, a foreign subsidiary must stay updated on changes to national/regional/local tax laws, payroll withholdings, employment law changes, and banking regulations, to name a few. Bureaucratic hurdles within the parent companyTaking decisions on a company level can become demanding for both the parent and the daughter company. It would mean that the decision-making process will take significantly longer and thus will involve more people. Finally, both companies might have to hire a legal team to navigate the legislation differences in both countries. Resource curseAs established already, one of the advantages of foreign subsidiaries is to tap into the local technical talent. However, practical difficulties in finding the right talent will always be a challenge. Hence, we refer to it as a resource curse. There are optimized solutions available for staffing. Outsourcing the talent acquisition to trained professionals who are well versed with local laws and customs in the host country can choose the best candidates for any job opening in the subsidiary company. Wrapping UpAfter an elaborate discussion on the advantages and disadvantages of foreign subsidiaries, we recommend hiring an experienced team to aid your expansion efforts. Companies must be aware of all government rules and tax regulations to hire local employees and set up a subsidiary in another country. The procedure to set up a foreign subsidiary is time-consuming and expensive. Global businesses can switch to new-age EOR/PEO business solutions like Multiplier. Our SaaS-based platform allows companies to pass setting up a new business entity when entering global markets. Partnering with the latest international EOR/PEO solutions from Multiplier can reduce costs for your company by taking over your global HR functions in over 150+ countries so that you can concentrate on your business. What does foreign subsidiary mean?A foreign subsidiary is a company that does business abroad, owned by a larger company based in another country — also known as a parent company or holding company.
Why would a company set up a sales subsidiary in a foreign market?Companies primarily open foreign subsidiaries to establish a corporate foothold in a specific overseas economy, primarily to boost revenues, generate tax benefits and diversify company assets to better manage risk.
What factors should be considered while setting up a subsidiary in a foreign country?Factors to consider include: the level of taxation for both corporations and individuals, government incentives, employer overhead in the form of social costs, local labor laws regulating the number of hours that employees work and the general motivation, reliability and commitment of the local workforce.
Why American companies set up subsidiaries in the country?Access to New Markets for Your Products and Services
Legal entities can market their products and services to the local population. They can also import and export goods. Additionally, companies with a local presence can expand their brand recognition to new markets so that they can potentially increase their profits.
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