ENTREPRENEURIAL EXPORTING STRATEGIES:
CONTRACTUAL CONSIDERATIONS

Andrew L. Zacharakis
Babson College

Babson Park, MA

Abstract

The best opportunity for growth is often overseas, even for smaller entrepre-
neurialfirms. However, resource constrained smaller firms do not have as many
available entry strategies as do larger Multinational Corporations (MNCs).
Smaller firms frequently must ally themselves with partners in order to make
international expansion feasible. The alliance of two distinct parties central to
these entry strategies lends itself to an Agency Theory (AT) perspective. AT
illuminates the underpinnings of these relationships; in particular, highlighting
problems and risks that the respective parties face when entering into the part-
nership. The paper develops these problems within the entrepreneur/export agent
realm and suggests contractual methods for overcoming these problems.

Introduction

Betsy Seabert, International Manager of Spyder Active Sports Inc., recently
observed ...

"[Our Norway Distributor] is only selling the racing
pants, sweaters, and a couple of jackets. We have this great line
for which the agent does not even purchase samples. We know
that there has to be people in Norway that would be interested
in [our entire line]."

"[We] receive reports on what they have ordered, but I
do not have copies of orders or to whom they have sold. I could
go over there and research each shop if I wanted to, but I do not
have the time...also a company our size has to really watch
[expenses]."

"There have been problems in the past with collecting
money long distance. We were not reimbursed for products
shipped... .!t is not usually worth the expense [to enforce our
contracts]."

The above observations exemplify the difficulty of international operations,
especially for small entrepreneurial firms. The small firm often worries about
whether its foreign agents are acting in the firm's best interest. Small firms are



74 Journal of Business Strategies Vol. 15, No.2

likely to suffer some broken contracts and they do not have the resources to either
do more of the work themselves or keep tabs on their foreign operations. Never-
theless, the potential opportunities of international expansion may outweigh the
risks, even for small businesses. In fact, international expansion by small entre-
preneurial organizations, or what Oviatt & McDougall (1994) call International
New Ventures (INVs), is increasing (Brokaw, 1990) which suggests that these
firms perceive international opportunities. The number of smaller firms export-
ing goods has increased by over 22 percent since 1987 - 150 percent increase in
the dollar value of those goods (Brown, 1995) - to the point where 96 percent of
all U.S. exporters are firms with less than 500 employees (Prosak, 1993). Al-
though entrepreneurs are exploring opportunities overseas more frequently, the
research related to this topic has been somewhat ignored (Oviatt & McDougall,
1994).

This paper explores the potential difficulties that smaller entrepreneurial
organizations face when entering the international environment; particularly fo-
cusing on the partnerships that entrepreneurs often use for entry. Since entrepre-
neurial firms are typically resource constrained, they must leverage their re-
sources in order to successfully enter an international market. Utilizing a partner
with some knowledge of the target market, or what Oviatt & McDougall (1994)
call hybrid entry strategies (Le. export agent, licensing, joint ventures, strategic
alliances - see appendix for definitions of these terms), can help leverage the
entrepreneur's resources. The real issue for the entrepreneur is picking the right
party with which to ally. Does the party possess the necessary skills to facilitate
successful expansion? Will the party perform as promised? How can the entre-
preneur ensure that performance? In sum, the entrepreneur may be susceptible to
informed partners who mayor may not share the entrepreneur's goals.

Recognizing and managing the information discrepancy (i.e. the entrepre-
neur does not know enough about the potential partner to ensure that they have
the same goals and work ethic), or information asymmetry, is a cornerstone of
Agency Theory (Rumelt, Schendel, & Teece, 1991). The primary objective of the
Principal-Agent branch of Agency Theory is to highlight the discrepancies in
knowledge between the two parties and derive a proper governance structure to
minimize problems (Eisenhardt, 1989). Agency Theory highlights the diverse
goals between entrepreneurs and their partners; it also suggests how such diver-
sity can be managed. Moreover, depending upon which country the entrepreneur
is interested in expanding, Agency Theory can illustrate how the relationship
might be structured.

Agency Theory

Agency Theory is closely related to Transaction Cost Economics (Mahoney,
1992a; Williamson, 1988). Transaction Cost Economics has been widely used in
studying international business (e.g. Contractor, 1990; Hennart, 1988, 1990;



Fall 1998 Zacharakis: Entrepreneural Exporting Strategies 75

Rugman & Verbeke, 1992; Shane, 1992, 1993), Both theories address gover-
nance in the face of opportunism (i.e. one party seeks self interested gains "with
guile" at the expense of the other [Williamson, 1988]). Each theory posits that
opportunism can be controlled via contracting. Whereas Agency Theory focuses
on ex ante alignment of incentives, Transaction Cost Economics is concerned
with ex post governance issues such as dispute resolution (Mahoney, I 992b).
Although there are many subtle differences between the two theories, the differ-
ence of central importance to the current paper is that of information asymmetry
(Rumelt, Schendel & Teece, 1991). Agency Theory focuses on the individuals
involved in the partnership (versus the transaction) and how different knowledge
(asymmetric information) may allow one party to take advantage of the other
party. Asymmetric information is especially problematic when the two parties
have conflicting goals or desires (Eisenhardt, 1989).

Agency Theory as a Framework for International Entrepreneurial
Expansion

Agency Theory provides insight and guidance for entrepreneurs considering
international expansion. Given the relatively small size of most entrepreneurial
firms (versus larger MNCs) and the subsequent scarcity of excess resources
possessed by these firms, the entrepreneurial firm may need to leverage its avail-
able resources in order to make international expansion plausible. Thus, entrepre-
neurial firms (or INVs) typically resort to one of the hybrid entry strategies
(McDougall, Shane & Oviatt, 1994) mentioned earlier. I The unifying denomina-
tor between each of these entry strategies is that entrepreneur's (principal) ally
themselves with a partner (export agent) in order to leverage their resources and
make international expansion more affordable, as well as increasing the likeli-
hood of successful entry.

Information Asymmetry
In order for both parties to benefit from the relationship, each must contrib-

ute some specialized knowledge that the other is lacking; or as Lawless & Price
(1992) assert, each party must possess asymmetric information. For example,
Spyder - the ski clothing manufacturer introduced at the beginning of the paper
- possesses the knowledge and skill of designing and producing highly desir-
able ski accessories. The export agent contributes an in-depth knowledge of the
target market. Each party possesses valuable information that the other party can
utilize; the export agent wants a good product to sell and the entrepreneur wants

I Agency Theory can apply to any relationship where the principal delegates responsibil-
ity to an agent. Within the international context described in this paper, Agency Theory
could apply to any of the hybrid entry strategies (licensing, joint ventures, strategic
alliances, etc.) described by Oviatt and McDougall (1994). In an effort to simplify and
focus the discussion, the current paper focuses on an entrepreneur/export agent scenario.



76 Journal of Business Strategies Vol. 15, No.2

a knowledgeable and skilled salesperson. Thus, as Lawless & Price (1992) point
out, asymmetric information can have positive implications. If each party pos-
sesses the requisite skill and each party's asymmetric knowledge complements
that of the other party, entry success is apt to be greater.

Proposition I a: All else equal, each party's special knowledge
(information asymmetry) increases the overall chances of entry
success.

However, asymmetric knowledge (as the majority of Agency Theory litera-
ture highlights) also provides the basis for opportunistic activity that may be
detrimental to the other party. Opportunistic behavior may so damage the partner-
ship, that it is dissolved. Even if the relationship remains intact, the lost "trust"
may impede the two parties from effectively working together to the point where
entry success is diminished. Thus, each party prefers that the relationship be
structured in a manner such that opportunistic behavior is dissuaded.

Proposition 1b: All else equal, opportunistic behavior on the
part of either party will decrease the chances for successful
entry.

Conflict of Interest
Eisenhardt (1989) highlights two major problems associated with the agency

relationship. First, the principal and agent generally have conflicting goals. More-
over, it is often difficult and expensive for principals to verify that agents are
complying with the entrepreneur's goal. For example, Spyder wants its full line
sold in Norway while the export agent prefers only to sell the popular (and higher
margin) ski pants. The verification problem is exemplified by two behaviors
discussed in Agency Theory - adverse selection and moral hazard. Adverse
selection occurs when one party misrepresents their abilities to the other (Bergen,
Dutta & Walker, 1987; Eisenhardt, 1989). Moral hazard occurs when one party
does not put forth the level of effort agreed upon (Bergen, Dutta & Walker, 1987;
Eisenhardt, 1989). The potential threat of these behaviors leads each party to a
differing structure preference for the partnership.

A second major problem generated by principal/agent structures is that the
principal and agent are quite likely to have different attitudes towards risk. Tradi-
tional Agency Theory suggests that agents are more risk averse than principals
because they cannot diversify their employment (Eisenhardt, 1989). Principals,
by extension, are risk neutral (Eisenhardt, 1989). Within the international sce-
nario, the traditional interpretation of risk differences may not be applicable. For
instance, entrepreneurs (principal) may offer their agents an "exclusive" for any
particular target market which precludes entrepreneurs from diversifying their
risk (i.e. using other agents in the target country). The agents, on the other hand,



Fall 1998 Zacharakis: Entrepreneural Exporting Strategies 77

may be able to represent several organizations (thereby becoming risk neutral).
Regardless of each participant's risk attitude, the agency relationship is one of
dependency where each party can be adversely affected by the actions of the
other. Therefore, each party wants to structure the relationship in such a way as to
limit their risk exposure.

Divergent goals and different risk preferences increase the cost of the rela-
tionship between the principals and agents because each respective party wants to
structure the relationship in a manner that best meets their needs while reducing
risks to an acceptable level. Agency Theory suggests that these problems are
handled via a "nexus of contracts" (which Jensen & Meckling define "as a multi-
tude of complex relationships ... between [the firm] and ... labor... " 1976, p. 311). 2

Further, the theory suggests a continuum of contract types, ranging from behav-
ior-oriented to outcome-oriented (Eisenhardt, 1989).

Outcome-oriented contracts focus on the principal's (entrepreneur's) desired
outcome. For example, the entrepreneur (principal) may contract for the sale of
200 ski jackets in Europe. The outcome-oriented contract is based on the end
result and not the method of selling the jackets. Since the end result is the same
for both parties (sell 200 jackets), outcome-oriented contracts align the principal's
and the agent's interest. Aligning interests reduces the threat that agents will
misrepresent themselves (adverse selection) or shirk (moral hazard) because do-
ing so exposes agents to losses (i.e. they eat the cost of the 200 ski jackets).
Outcome contracts are favored by entrepreneurs because these contracts shift the
risk and uncertainty of meeting a certain outcome to the export agent.

Behavior-oriented contracts focus on the "means" of achieving the
entrepreneur's goal. Thus, a behavior-oriented contract might emphasize the num-
ber of outlets, price level, or some other factors affecting the method of selling
jackets. To ensure that the agent puts forth the effort agreed upon, the entrepre-
neur must monitor the agent's behavior. If the agent does not sell the targeted
level of jackets, the agent is not liable as long as (s)he conformed to the behaviors
outlined in the agreement (e.g. met with 50 retail outlets during the year). Agents
prefer behavior based contracts because they are not exposed to risk from outside
factors that might impede their efforts (e.g., downturn in the economy, below
average snow fall, etc.). Unfortunately, from a managerial perspective, the princi-
pal generally incurs the cost of verifying the agent's actions in this type of
contract. However, monitoring costs may be offset to the extent that agents wish
to protect their reputation (Donaldson, 1990; Larson, 1992). The reputation effect
assumes either that the principal and agent will conduct business in the future or

2The term "contract" should be thought of as a metaphor; contracts describe relationships
in which one party delegates responsibility to another (Rugman & Verbeke, 1992). The
contract is not necessarily a formal, written contract, but may be a set of expectations
between the parties that are not necessarily verbalized, let alone documented (Brown,
1995).



78 Journal of Business Strategies Vol. 15, No.2

that the principal can diminish the agent's reputation to other potential principals.
In order to reduce monitoring costs, principals also may attempt to bond the agent
via guarantees, third party auditing, contractual limits on the agent's authority,
and compensation agreements if the agent does take certain liberties (Jensen &
Meckling, 1976). The next section further explores the issues and why they are
particularly relevant for an entrepreneur considering international expansion.

The Agency Costs to Entrepreneurs of International Expansion

The agency issues raised by this relationship stem directly from the risks
inherent in the expansion decision, and from the likelihood of divergent goals
between the entrepreneur and the international agent. Differing goals and desires
as outlined above frequently cause problems between entrepreneurs and agents;
in particular, the aforementioned adverse selection and moral hazard.

Adverse Selection
Adverse selection is problematic because agents have asymmetric informa-

tion regarding their own abilities. Conlon & Parks (1988) find that the principal's
typically strong information network (or capability to verify an agent's ability)
favors a behavioral based contract. However, Conlon & Parks' (1988) research
focuses on large organizations (retailers) and their ability to gain information
about their salespeople (agents). Unlike principals in the majority of Agency
Theory research, relatively resource constrained entrepreneurs may find it diffi-
cult to obtain good information about their agents. Therefore, entrepreneurs may
be more likely to favor outcome based contracts.

Several factors make adverse selection especially troublesome for entrepre-
neurs. First, entrepreneurs are relatively resource constrained (Stinchcombe, 1965,
Vesper, 1990) compared with larger MNCs that operate internationally. Thus, the
entrepreneur may be less able to verify the agent's credibility. The small organi-
zation often relies on the agent's resume, referrals, and the "grapevine" (i.e., talk
at international trade shows) to judge the agent's ability and trustworthiness.
However, these sources of information may not be nearly as reliable as those
possessed by larger MNCs. MNCs, for example, are more likely familiar with the
agent's reputation, because the MNC is tuned into the industry's "gossip circle
that tells who is honorable, tough, sleazy and so on" (Pratt & Zeckhauser, 1985,
p. 13). The entrepreneur in the current paper's scenario, on the other hand, is
likely new to the international arena and, by extension, less connected to the
industry's "gossip circle."

Second, the distance between the home market and the target market also
impedes verification because it increases the cost of communication and travel.
Differences in language and culture further affect understanding about goals,
risks and the development of adequate contracts. The principal and agent may not
be able to achieve or maintain a "meeting of the minds." Again, the principal



Fall 1998 Zacharakis: Entrepreneural Exporting Strategies 79

bears the risk of incurring extra costs to overcome any potential misunderstand-
ings. These extra costs can be especially burdensome to smaller entrepreneurial
organizations.

Finally, entrepreneurs, as relatively small players, can rely much less on the
reputation effect (Donaldson, 1990; Larson, 1992) than larger firms, because
their power over agents is limited. Therefore, "trust" relationships (Lawless &
Price, 1992), while the ideal, may subject the entrepreneurial firm to a heightened
level of risk. For example, the agent may enter into a contract for a quick profit,
realizing that the entrepreneur will not be able to adequately monitor or enforce
the contract. Thus, entrepreneurs are likely to favor an outcome based contract
because of the protection it provides.

Moral Hazard
Agency theory posits that agents shirk, or do not live up to their contracts

where possible. Moral hazard relates to information asymmetry in that the entre-
preneur cannot easily obtain information about the export agent's performance.
Eisenhardt (1985) and others (e.g., Brickley & Dark, 1987) find that the more
difficult it is to monitor the agent's behavior, the more likely the principal will
use an outcome contract. Several of the issues raised with respect to adverse
selection apply to moral hazard as well. Since entrepreneurs are resource con-
strained, the costs involved of adequately monitoring the agent's behaVior may
be overwhelming, especially considering the distance between the two parties. In
addition, different cultural norms may lead entrepreneurs to believe that agents
are shirking, but in reality, the agents are performing within the expected norms
of their culture. For example, completing deals in Japan can be time consuming
since Japanese business people value relationships. Thus, the amount of time that
Japanese export agents spend making small talk might surprise American entre-
preneurs. To impatient Americans, the small talk and dinner appointments that
can literally take days during the initial contact between two new business part-
ners can seem like a huge waste of time and money. An American entrepreneur
unfamiliar with Japanese cultural norms might assume her/his Japanese agent is
shirking. Yet, the development of a personal relationship is crucial to long term
success in Japan. Therefore, American entrepreneurs would likely prefer to con-
tract on an outcome basis versus a behavior basis because such contracts focus on
the end result rather than how business is conducted. Moreover, outcome-ori-
ented contracts reduce the need for monitoring and align the interests of princi-
pals and agents (Jensen & Meckling, 1976). Thus, entrepreneurs are apt to prefer
outcome-oriented contracts.

Risk Aversion
Each party anticipates benefits from a joint relationship, but recognizes that

there is risk in the endeavor. Thus, each would like the other to shoulder as much
of the risk as possible (i.e., the entrepreneur wants the export agent to shoulder



80 Journal of Business Strategies Vol. 15, No.2

most of the risk and vice versa). Eisenhardt (1985) finds that agents prefer behav-
ioral based contracts because such contracts reduce their risk. Likewise, entrepre-
neurs likely favor outcome based contracts. As mentioned earlier, principals
(entrepreneurs) are more risk averse because it may be difficult to diversify their
use of agents in anyone market. Additionally, Brickley & Dark (1987) find that
franchising (using an agent) is preferable when environmental uncertainty is high
(just as it might be in the international area). A franchise can be viewed as an
outcome contract, because the franchisee's interests are aligned with the
franchiser's ("sell as many units as possible"). It is likely that international ex-
pansion causes entrepreneurs additional concern due to their unfamiliarity of the
target market and their added reliance on others for S1A:cess.

Entrepreneurs entering foreign markets may tend to be risk averse for several
reasons. First, entrepreneurs are entering an unfamiliar market. It is far more
difficult for the entrepreneur to derive accurate estimates of future outcomes in
the new international market than in the entrepreneur's existing areas of opera-
tion. Thus, the "uncertainty" of future events (Ring & Van de Ven, 1994) is
compounded by unfamiliarity of the target market. The foreign market's prefer-
ences are likely to vary dramatically from the entrepreneur's home market due to
culture, language, political, and environmental differences. This unfamiliar mar-
ket raises the entrepreneur's uncertainty. The agent, on the other hand, is highly
familiar with the target market. Therefore, the export agent does not perceive the
same level of risk in relation to the market as does the entrepreneur.

Another reason that the entrepreneur may be risk averse is that entrepreneurs
are typically relatively smaller in comparison to other international players; which
implies relatively limited resources. Thus, they tend to be cautious when explor-
ing different uses for their resources. Limited resources in conjunction with
geographical distance makes the control and monitoring of any international
relationship more tenuous.

Since the entrepreneurial firm may be risk averse and susceptible to adverse
selection and moral hazard, the entrepreneur prefers an outcome-oriented con-
tract. The outcome-oriented contract shifts risk to the agent (Eisenhardt, 1989).
The preceding discussion leads to the following proposition:

Proposition 2: All else being equal, the added uncertainty of
operating inforeign markets, in combination with the threat of
adverse selection and moral hazard involving an export agent,
encourages entrepreneurial firms to negotiate for outcome-
based contracts (versus behavior-based contracts) in order to
shift risk to the agent.

Export Agent Preference
The export agent faces many of the same issues as the entrepreneur -

adverse selection, moral hazard and risk aversion. In order to secure the agent's



Fall 1998 Zacharakis: Entrepreneural Exporting Strategies 81

services, the entrepreneur may misrepresent the product's true potential (a case of
adverse selection). Just as the entrepreneur lacks complete knowledge about the
agent, the agent lacks complete knowledge about the entrepreneur, especially
since it is often difficult to get good secondary information about relatively new
entrepreneurial organizations (versus larger more established MNCs). Thus, agents
are assuming substantially more risk in aligning themselves with relatively smaller
entrepreneurial organizations than if they aligned themselves with larger MNCs.
Once the relationship has been established, the entrepreneur may fail to execute.
For example, the entrepreneurial firm may not meet the agent's orders in a timely
fashion which could adversely affect the agent's reputation (a case of moral
hazard).

The foreign agents that entrepreneurs are likely to deal with may also tend to
be risk averse. Just like the entrepreneur, the agent may also face the problems of
geographical distance, and a different language and culture from the entrepre-
neur. In addition, the agent is likely to be relatively small. The smaller the princi-
pal organization is, the smaller the volume of business conducted between the
principal and agent, which suggests small scale agents will dominate. Since the
agent is likely to be relatively small, the agent also tends to be resource con-
strained and relatively cautious. These circumstances raise the agent's uncer-
tainty.

The risk averse agent likely prefers a behavior-oriented contract, because the
agent is not obligated to reach a certain outcome. Instead, the agent is only
required to perform in a certain manner (e.g., meet with thirty perspective clients
in a month, etc.) versus achieving some end specified in an outcome contract (e.g.
sell 3000 ski gloves a month). Thus, risk is shifted to the entrepreneur. The above
discussion leads to the following proposition:

Proposition 3: All else being equal, the added uncertainty ofdeal-
ing with a foreign entrepreneur, in combination with the threat of
adverse selection and moral hazard encourages the agent to nego-
tiate for a behavior-based contract (versus an outcome-based con-
tract) in order to shift risk to the entrepreneur.

The difference in contract desires means that it costs entrepreneurs more to
shift the risk to the agent, especially since entrepreneurs lack power to enforce
their will. Therefore, the entrepreneur has to weigh the added monitoring costs
associated with a behavior-oriented contract against the added cost to shift the
risk to the agent associated with an outcome-oriented contract. A common method
of solving this contract dichotomy is bonding.

Bonding
Bonding (the use of appropriate incentives to dissuade agents from acting

opportunistically) makes behavior-oriented contracts more closely represent out-



82 Journal of Business Strategies Vol. 15, No.2

come-oriented contracts, because it shifts monitoring costs to the agent (Jensen &
Meckling, 1976). As the quotations from the example cited at the beginning of
this paper illustrate, entrepreneurs may have difficulty enforcing international
contracts. Bonding empowers the entrepreneurial firm by enabling it to more
easily and efficiently enforce its contracts. There are several possible bonding
avenues available for international transactions, including forum selection clauses,
arbitration agreements, letters of credit, and escrow accounts.

Forum selection clauses enable the entrepreneur to specify where any dis-
putes should be settled. Thus, if the entrepreneur is aU.S. firm, it might stipulate
that all disputes be settled in the United States. Similarly, an arbitration agree-
ment specifies that any dispute be heard by an arbitrator instead of a court.
Arbitration ideally saves both parties considerable legal expenses. The entrepre-
neur can also demand a letter of credit through a bank in its home country; if the
agent organization balks on fulfilling its obligations, the entrepreneur can enforce
the letter of credit. Since the letter of credit is through a home-country bank, the
entrepreneur can avoid any uncertainty or misunderstanding that might result
from different legal standards in the international country. Again, such an ar-
rangement reduces the entrepreneur's costs. Another alternative might be an
agent escrow account. An escrow account accomplishes similar objectives as the
letter of credit, but increases the agent's bonding costs. Thus, an escrow account
will probably be used only if the agent is unable to obtain a letter of credit.

Since the entrepreneur lacks the power to dictate a purely outcome-oriented
contract, bonding helps reconcile the entrepreneur's desire for an outcome-ori-
ented contract and the agent's desire for a behavior oriented contract. Bonding
effectively moves a behavior based contract towards an outcome based contract.
Regardless of the method, bonding can reduce the entrepreneur's monitoring
costs. The bonding discussion leads to the following proposition:

Proposition 4: Since entrepreneurs and agents have different
contract desires, most contracts will include bonding stipula-
tions which reconcile a behavior-oriented contract with an out-
come-oriented contract.

Cultural Differences Among Target Markets
While the simplified Agency Theory framework provides direction to the

entrepreneur considering international expansion, it may not provide the best
basis for establishing a long-term, efficient, equitable and productive relation-
ship. The basic Agency framework assumes that the relationship is one of oppor-
tunism as a function of information asymmetry. In other words, the parties to the
relationship (especially the agent) take advantage of their position to the detri-
ment of the other party. While this most certainly does happen, it is not cast in
stone. Trust mitigates opportunism (Ouchi, 1980). Moreover, if both parties enter
the relationship assuming the worst, it may have negative effects on the overall



Fa111998 Zacharakis: EntrepreneuraL Exporting Strategies 83

performance ofthe relationship (Bazerman & Carroll, 1987; Neale & Northcraft,
1991). The entry is more likely to succeed if the entrepreneur and export agent
trust each other and, by extension, demonstrate that trust during the establish-
ment of the relationship. Unfortunately, the entrepreneur cannot blindly demon-
strate trust in all target markets by automatically using behavior based contract-
ing; such a move would be dangerous. Thus, the basic Agency Theory framework
should be modified to account for potential differences in the threat of opportu-
nistic activity.

Possibly a good place to start might be to adjust the basic framework based
upon the target country's culture or aptitude to be more opportunistic or altruistic.
If an export agent is from a culture which dissuades opportunistic behavior, then
the entrepreneur can negotiate a behavior based contract without greatly increas-
ing the risk. In essence, people from trusting cultures automatically align their
own interests with that of the entrepreneur because agent's from these cultures
are less apt to misrepresent themselves (adverse selection) or shirk (moral haz-
ard). Therefore, behavior based contracts may approximate outcome based con-
tracts. In essence, entrepreneurs may adjust their contract desires based upon the
target market's trustworthiness. The more trustworthy the target country, the
more likely the entrepreneur will prefer a behavior contract and vice versa. The
question is how do resource-constrained entrepreneurs identify which countries
are more trustworthy?

Shane (1992, 1993) uses Hofstede's (1980) power distance index as a gauge
of cultural trustworthiness. The power distance index represents the degree that
members of a particular society expect power to be equally distributed in organi-
zations (Hofstede, 1980). Stated differently, power distance is the degree to which
inequality exists in a society (Hofstede, 1980). Hofstede notes that inequality
exists on a number of different dimensions, such as prestige, wealth and power.
For example, if a society has a large disparity between the wealthiest and poorest
citizens, it has a high power distance. Subordinates naturally try to reduce the
power distance (or inequality) between them and their superiors. Likewise, supe-
riors try to increase the power distance. The societal average is the point of
equilibrium where subordinates and superiors are comfortable with the power
distance.

Hofstede (1980) directly links the index to trust. Countries with high power
distance "exhibit less interpersonal trust and a greater need for organizational
controls on the behavior of individuals" (Shane, 1992, p. 299). Moreover, Shane
asserts that countries with more per capita lawyers are less trustworthy, because
these countries need to write contingent claim contracts (Shane, 1993). Indeed,
the power distance index significantly correlates with per capita lawyers (r=:.51,
p<O.025 [Shane, 1993]). Although this relationship is significant, it is not per-
fectly correlated. For example, India has relatively few lawyers per capita (~
Economist, 1992) in spite of its high power distance. Other factors come into play
such as the huge population, the relatively lower level of economic activity per



84 Journal of Business Strategies Vol. 15, No.2

capita, other types of activities that lawyers might partake (e.g., politics), etc. On
the other hand, the United States has relatively high number of lawyers per capita
(The Economist, 1992), yet a relatively low power distance (ranks 11 - see Table
1). Nonetheless, the relationship between lawyers and the power index is signifi-
cant.

The concept of equality and power distance has implications for the entre-
preneur/export agent relationship. High power distance countries may be less
stable. Subordinates may try to enact changes in the power distance via violent
means. Thus, high power distance countries more frequently suffer sudden changes
in form of government (i.e., revolutions [Hofstede, 1980]). Similarly, agents
from these cultures may act covertly to equalize the entrepreneur/agent relation-
ship; they are likely to act opportunistically. Thus, entrepreneurs should seek
strong outcome based relationships in these countries to limit their risk exposure.
On the other hand, "a smaller power distance leads to the feasibility of control
systems based on trust in subordinates; in larger power distance countries such
trust is missing" (Hofstede, 1980, p. 384). Therefore, entrepreneurs entering low
power distance countries can risk behavior oriented contracts because there is
less danger of opportunistic behavior by the agent.

Shane (1992) adeptly demonstrates that the power distance index correlates
highly with trust attributes. Basically, Shane finds that MNCs are apt to engage in
foreign direct investment versus licensing when entering countries which are less
trustworthy. It is more effective to internalize (even if it increases initial ex-
penses) than rely on opportunistic licensers. Conversely, licensing is more effec-
tive if the culture is trustworthy, because the MNC does not have to worry about
opportunistic behavior and licensing reduces the initial expenses of establishing a
presence in the target country (Shane, 1992).

Table 1 ranks a number of countries on Hofstede's (1980) power distance
index. If a country is ranked towards the bottom of the list (high power distance),
its culture breeds opportunistic behavior. Thus, when negotiating with an export
agent from the Philippines (ranked number 31 on Hofstede's list), entrepreneurs
should negotiate for strong outcome based contracts (if they decide to enter the
country at all). However, entrepreneurs can feel pretty confident in behavior
based contracts with agents from Austria (ranked number 1), because members of
this culture are apt to be more trustworthy.

Unlike the large MNC, the smaller entrepreneurial firm typically does not
possess the resources to internalize into the target market. Smaller organizations
must leverage their relatively constrained resources by reducing up-front expen-
ditures. The export agent strategy can greatly reduce the entrepreneur's initial
expenses. The implications of Hofstede's (1980) and Shane's (1992, 1993) work
is that the entrepreneur should (1) structure the agency relationship with the
target country's trustworthiness in mind and (2) possibly avoid those countries
with the lowest trustworthiness. If entrepreneurs fail to acknowledge a country's
propensity for trustworthiness, they may inappropriately structure the relation-



Fall 1998 Zacharakis: Entrepreneural Exporting Strategies

Table 1
Ranking of Countries on the Power Distance Index

(the higher the rank, the lower the power distance)
Country Rank

85

Argentina
Australia
Austria
Belgium
Brazil
Canada
Chile
Colombia
Denmark
France
Germany
Great Britain
Greece
Hong Kong
Indonesia
India
Italy
Japan
Korea
Malaysia
Netherlands
Norway
New Zealand
Philippines
Portugal
South Africa
Singapore
Spain
Sweden
Switzerland
Taiwan
Thailand
United States
Venezuela

12
9
1

23
27
11
20
24
2
25
7
7
18
25
29
28
14
15
18
31
10
4
3

31
20
12
27
16
4
6
17
22
11
30

Adaptedfrom Hofstede (1980)

ship such that they bear too much risk. Likewise, it may be wise for entrepreneurs
to avoid entering countries with the lowest trustworthiness because it would
require a tight outcome oriented contract. Although such a contract may bring the



86 Journal of Business Strategies Vol. 15, No.2

risk to acceptable levels, a contract entered with such negative stipulations often
results in poor performance (Bazerman & Carroll, 1987; Neale & Northcraft,
1991). The above discussion leads to the final propositions:

Proposition 5a: All else being equal, entrepreneurs should ne-
gotiate for a behavior-oriented contract in countries with a
high power index ranking (high trustworthiness) and for an
outcome-based contract in countries with a low power index
ranking (low trustworthiness).

Proposition 5b: All else being equal, entrepreneurs should tar-
get countries with a high power index ranking (high trustwor-
thiness) for entry.

Discussion

As the above dialogue demonstrates, there are a variety of factors that
influence the entrepreneur/agent relationship. Optimally, the entrepreneur
prefers an outcome-based contract, because it aligns the entrepreneur's and
agent's interests (Jensen & Meckling, 1976). The agent organization is less
likely to misrepresent itself (adverse selection), because it is obligated to
reach some specified outcome. Furthermore, entrepreneurs are not subjected
to the costs of moral hazard since agents are only rewarded for outcomes of
their performance. Large geographical separation favors outcome contracts
to the extent that outcome-based contracts avoid monitoring costs. However,
the entrepreneur may have difficulty finding an agent who will accept an
outcome-based contract. Moreover, the negative tone that such a contract
conveys may lessen the chance for entry success. Therefore, the entrepreneur
needs to assess cultural values in determining the best contracting method. If
the culture is one of trust, the entrepreneur can confidently employ a behavior
based contract without incurring additional risk.

When entrepreneurs negotiate for a behavior-based contract, they should be
aware of possible bonding methods. Adeptly bonding the agent via a letter of
credit or some other mechanism may reduce the entrepreneur's monitoring costs
associated with a behavior-oriented contract. In fact, adroit bonding mechanisms
may reduce the entrepreneur's monitoring costs to the point where it would offset
any concessions that the entrepreneur would have to make for the agent to accept
an outcome-based contract. Under such a scenario, the behavior-based contract
might be more cost effective than an outcome-based contract, especially since it
may enhance the trust within the relationship thereby improving the chances for
success.

While the pitfalls for a small company seeking international outlets are
many, as the U.S. domestic market continues to mature, the best growth opportu-



Fall 1998 Zacharakis: Entrepreneural Exporting Strategies 87

nities may reside internationally. If an expansion opportunity arises, the entrepre-
neur should be cognizant of the agency issue; failure to recognize the agency
problem might even affect the entrepreneur's survival. The agency model pre-
sented in the current paper illustrates ideal contract desires, the conflict in con-
tract desires between entrepreneurs and export agents, and how these conflicts
might be reduced via bonding. Additionally, the concept that behavior oriented
contracts lead to greater entry success and, as a result, entrepreneurs should first
consider "trustworthy" countries (all else equal) provides powerful suggestions
to entrepreneurs about "how to" and "what" countries to enter.

Although Agency Theory provides an excellent basis for evaluating interna-
tional expansion, an important weaknesses of this perspective needs to be recog-
nized. Agency Theory assumes that the two parties act in a rational, opportunistic
way. Thus, agents are assumed to shirk unless they are properly monitored, or
obligated under an outcome-oriented contract, or fear reputation repercussions.
Other factors currently exogenous to this theory may, however, come into play.
For instance, people generally refrain from shirking, because of social norms.
While Doz & Prahalad (1991) rightfully stress the importance of including psy-
chological and social factors into the agency model, it is especially difficult for
an entrepreneur investigating a potential international relationship to gauge the
agent's psychological or social biases, except at the broadest levels (i.e.. cultural
biases). Thus, agency prescriptions may still provide a realistic basis for structur-
ing the relationship to maximize survival in a different context.

This paper guides entrepreneurs in contract structuring. The paper applies
Agency Theory to a specific application, the entrepreneur's entry into foreign
markets. Practitioners may find the paper illuminating when structuring their
international relationships. The Agency perspective clarifies the pluses and mi-
nuses of different contract options, which might help entrepreneurs decide if
foreign expansion is advisable. and ensure that they negotiate for the most effec~
tive contract possible. In conclusion, the Agency perspective provides a sound
theoretical basis for exploring entrepreneurial international entry strategies and
their consequences.

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Appendix
Definitions of International Entry Modes

Export - firm maintains its home production facilities and sells same good!
service that firm sells in domestic market through a contractual agent that gains
access to foreign distribution channel.

Licensing - arrangement that allows a foreign firm to purchase the right to
manufacture and sell the firm's product within a host country or set of countries.
Franchising is a form of licensing.

Joint Venture/Strategic Alliance - entrepreneur joins with another firm to share
the risks and resources required to enter international markets; usually with a
firm from the host country.

Foreign Direct Investment - direct acquisition and ownership of facilities within
host country.


	Entrepreneurial Exporting Strategies: Contractual Considerations