Choosing misaligned governance modes when offshoring business functions: A prospect theory perspective

Research Summary: Transaction cost economics (TCE) holds that multinational corporations (MNCs) should select governance modes based on associated transactional hazards. However, MNCs often adopt theoretically misaligned governance modes. Applying a prospect theory (PT) perspective, we use the context of business-process offshoring to explore why firms choose misaligned governance modes. We argue that theoretically misaligned governance modes are regarded as riskier than aligned governance modes, and we suggest that prior experiences of failure in an international context—especially in business functions that are relevant for the internationalization of a firm—prompt decision-makers to choose theoretically misaligned governance modes. We enhance discussions on governance-mode decisions with important behavioral perspectives on how such decisions materialize. Managerial Summary: Experience with underperforming investments provides decision-makers with an important motivation to search for riskier, nontraditional solutions, such as governance modes that do not necessarily comply with conventional logics. We show that such decisions, which have traditionally been conceived as managerial mistakes, are driven by behavioral insights found in the fields of human and organizational psychology. While we explore this idea in the context of international governance-mode decisions, we believe such a behavioral perspective on international decision-making is generalizable to other relevant contexts.