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Journal of Economic Behavior and Organization 18 (1992) 265-271. North-Holland

Transaction costs, technology transfer,

and in-house R&D

A study of the Indian private corporate sector

N.S. Siddharthan*

institute of Economic Growth, Delhi, India

Received January 1990, final version received September 1990

This paper deals with the determinants of in-house R&D, and the impact of technology transferon R&D expenditures for a sample of firms belonging to the Indian private corporate sectorlisted with the stock exchanges in India. Using the transactions costs frame work it considerstwo modes of technology transfer, the first through the market, namely armslength purchasesagainst lump sum payments and the second through foreign direct investments. The resultsindicate a complementary relationship between import of technology and R&D.

1. Introduction

Recent works have been considering the role of technology imports in

influencing in-house R&D expenditures in addition to other determinants.

Most firms simultaneously import as well as export technology against

royalty and lump sum payments. Dosi (1988, p. 1132) considers in-house

R&D units as a must to ‘recognise, evaluate, negotiate and finally adapt the

technology potentially available from others’. Many earlier empirical works

have found a complementary relationship between in-house R&D and

technology imports. However, while considering the impact of technology

imports on R&D, most of the works [Odagiri (1983), Katrak (1985) andSiddharthan (1988)], considered only one form of technology import, namely

transfer through lump sum or royalty payments. Technology transfer could

also occur through foreign direct investments and equity participation. This

aspect, by and large, has been ignored in the literature dealing with the

dete~inants of R&D. This study will consider among other things, the

impact of both modes of technology transfer in analysing the firms’ R&D

intensities.

Co~~e~~o~de~ce to: Dr. N.S. Sid~arthan, Institute of Economic Growth, University Enclave,

Delhi 110 007, India.*I am grateful to Mr. Ashis Toru Dev and Miss Madhumita Lodh for their statisticalassistance.

0167-2681/92/$05.~ @ 1992-Elsevier Science Publishers B.V. All rights reserved



266 N.S. Siddharthan, Transaction costs, technology transfer and in-house R& D

Section 2 is devoted to a discussion of technology transfer through direct

investments and licensing. In particular it refers to the transaction costsframe work and spells out the internalisation advantages in transferring

technology to the affiliates as distinct from transfer through the market.

Section 3 presents the empirical model and section 4 is devoted to a

discussion of the regression results. The main conclusions are presented in

section 5.

2. Technology transfer: Direct investments and licensing

International technology transfer could take place internally (between the

parent and the affiliate) through foreign direct investments or through theexternal markets via licensing or both [Robinson (1988)]. There is more or

less a consensus in literature that direct investments would be preferred when

transaction costs are high. The nature of intangible assets to be transferred,

of course, also influences the mode of transfer [Dunning (1979), Buckley and

Casson (1976), Rugman (1981), Teece (1977), Caves (1982), La11 and

Siddharthan (1982) and Kumar (1987)].

Transaction costs are likely to be high in cases where the technology that

is to be transferred is not standardised, cannot be easily codified and

transmitted through design and drawings or involves a large tacit and firm

specific component. Transaction costs could also be high in cases character-ised by information asymmetry, and where brand names are involved. In all

these cases firms would prefer equity participation in order to exercise some

control over the host country firm, to the outright sale of technology or the

patent along with the brand name.

On the other hand, firms would prefer to transfer technology through

licensing or armslength sale in cases where brand names are not involved,

which are in the nature of pure process technologies, and in particular where

it could be transferred through sale of design and drawings. In the Indian

case, most of the foreign firms transferring technology through the market

prefer to transfer it against lump sum payments to transferring againstroyalty payments. Even where royalties are involved, the foreign firms tend

to insist on a major share being paid as lump sum. This could be due to the

high transaction costs involved in collecting information regarding the

market, reputation and credit worthiness of the Indian firms. Hence, in this

study lump sum payments will be used to denote technology imports

through the market.

2.1. The main determinants of in-house R&D

2.1 .I. Technology importsIn analysing the relationship between technology transfer (imports) and in-



N.S. Siddharthan, Transaction costs, technology transfer and in-house R&D 267

house R&D, the earlier works ignored intra-firm technology transfer through

foreign equity participation and considered only technology imports throughthe market. In the Indian case, the Government does not allow foreign direct

investments in the absence of technology transfer; further it, permits equity

participation only in high technology areas or where the technology trans-

ferred is of a sophisticated kind. Hence in analysing the impact of technology

imports on in-house R&D, both modes of technology transfers ought to be

considered. Katrak (1985) assumed and hypothesised a complementary

relationship between technology transfer (through the market) and in-house

R&D expenditures. This is based on his observation that very few Indian

firms do innovative research which results in the creation of new products

and processes. They, on the other hand, do mostly adaptive research, thatmerely makes minor modifications in the imported technology to suit Indian

resource and other conditions. Odagiri (1983) found a positive relationship

between R&D and technology imports only among non-innovative Japanese

firms. The relationship was not significant for the innovating Japanese firms.

Thus for the innovators, it is quite possible that import of technology will

stand in the way of spending more on R&D. Siddharthan (1988) also found

a strong positive relationship only for the Indian private sector firms. The

Indian public sector firms spent more on R&D and had much larger R&D

establishments. It is possible that they were also involved in innovative

research and therefore the absence of a statistically significant relationshipbetween these two technology expenditures. However, in this paper the

sample will consist only of firms belonging to the Indian private corporate

sector whose equities are listed in the stock exchange. Most of these firms

spent less than 2% of their sales turnover on R&D, and none of them spent

more than 4% of the sales on R&D. Given this very low R&D intensity,

innovative research that could compete with import of technology is not

possible. Under these conditions imported technology (both intra-firm and

through the market) would be an important input and to some extent a base

for in-house R&D efforts. Hence a positive relationship is predicted between

R&D and imported technology implying a complementary role between thetwo.

2.1.2. Firm size and capital intensity

The role of size in explaining R&D intensity is a complex one and the

empirical evidence in this regard is very mixed. Most of the empirical works

found a non-linear relationship between firm size and R&D intensity. They

also found a high R&D intensity among both small and large firms,

indicating the difference in the nature of the R&D being performed by these

two sets of firms. [Acs and Audretsch (1987, 1988), Siddharthan (1988)]. The

conflicting results in explaining the relationship between firm size and R&Dcould be partly because of the nature of the size variable. Size happens to be



268 N.S. Siddharthan, Transaction costs, technology transfer and in-house R&D

a catch-all variable that could capture capital intensity, multinationality

(most MNCs have a larger size than their local counterparts, although someof the Indian firms could also be large) etc. In this paper, in the equations,

capital intensity and multinationality as seen by foreign equity participation

are being separately introduced, to see whether size per se is important after

taking into account these factors.

2.1.3. Age of the R&D unit

In the Indian context, the age (in terms of number of years) of the R&D

unit would also indicate long run and sustained commitments of the units to

R&D. There is evidence to show that the expenditure patterns of new and

old units are also different. While the new ones spend a larger proportion oncapital equipment and building, the older ones spend more on scientists and

raw materials for experiments. The current expenditures of the older units

were found to be higher than those of the new ones. A positive relationship

is expected between age of the R&D unit and R&D intensity.

2.1.4. Past achievements

Firms that had a better record of R&D achievements in terms of R&D

output could be enthused and therefore expected to spend more on R&D in

the current period compared to those who had less success in their R&Dventures. Most studies consider patents to be the most important representa-

tive of R&D output. However, the use of patents as a measure of innovative

output has been questioned in recent times. Pakes and Griliches (1980), Acs

and Audretsch (1988) in particular, consider it a flawed measure as not all

new innovations are patented and patents also differ in their economic

impact and value. Data relating to the value of the patents is not available.

In its absence the number of patents might not make much sense. In

addition, some firms merely state that they hold patents without giving their

number or value. Many of the sample firms did not patent their products.

Under these conditions it was considered preferable to introduce a dummyvariable with a value one for the firms that ever patented and zero for those

that did not patent at all.

3. Empirical model

Around 200 units reported their R&D activities to the Ministry of Science

and Technology as reported in their publication ‘Compendium on in-house

R&D centres, 1987’. Of these many were pure research laboratories belong-

ing to the Government and to non-profit making organisations. Only 69 of

them belonged to the private corporate sector listed with the StockExchanges in India. The sample covers all the 69 firms that reported their



N.S. Siddharthan, Transaction costs, technology transfer and in-house R&D 269

R&D activity to the Ministry during the period 1985-1987, and which were

listed in the stock exchange directory.The dependent variable RD, refers to research and development expendi-

tures as a percentage of sales.

The explanatory variables include AGE, the age of the R&D unit

expressed in number of years; FE, the percentage of foreign equity participa-

tion in the total equity, a variable reflecting the extent of foreign direct

investments and multinationality; MT or MT- 1, the current or lagged

import of technology, lump sum payments paid during the last three years as

a percentage of sales turnover; SIZE, the size of the firm as seen from the

sales turnover; KSR, the capital sales ratio; PAT, patents, a dummy variable

with value 1 for firms that ever registered patents and zero for the rest.All the variables refer to 1985-1986, and the lagged variables refer to the

previous year. Technology imports through lump sum payments refer to

three year averages for the period 1983-1984 to 1985-1986. Since firms do

not make lump sum payments every year a three year average was preferred

to a single year data. Data on RD, AGE, PAT and FE are derived from the

publication ‘Compendium on in-house R&D centres’. Lump sum payments

are calculated from the publication ‘National register of foreign collabor-

ations’. Both these publications are brought out by the Ministry of Science

and Technology. Data on KSR and SIZE are taken from the balance sheets

and profit and loss accounts of the companies reproduced in the OfficialDirectory of the Bombay Stock Exchange.

In the model all the variables are in the form of ratios and are deflated by

size factor, except the SIZE variable which is taken in its logarithmic form.

4. Regression results

Table 1 deals with the determinants of R&D intensity, RD. The results

presented in the table show the importance of technology imports in

determining R&D intensity. The coefticients of FE and MT are positive and

significant indicating a complementary relationship between technologyimports and R&D. The results indicate that the affiliates of MNCs in India

do more in-house R&D than other firms given other things as equal. It

could be argued that MNCs do most of their R&D in their home

establishments and not in the third world, hence FE could even be negatively

related to in-house R&D intensities. The results reject this line of explana-

tion. They confirm the line of reasoning advocated in the previous sections of

this paper, namely, that foreign equity participation, in the Indian case in

particular, would reflect technology transfer internally (this is one of the

important preconditions set by the Government for permitting equity

participation). However, technology developed by the parent firms for adifferent resource endowment needs certain modifications to suit the Indian



210 N.S. Siddharthan, Transaction costs, technology t ransfer and in-house R& D

Table 1

Dependent variable RD.”

Equation no.

Explanatory variables (1) (2)

Intercept 1.502 0.959(1.710) (1.157)

AGE 0.0573* 0.0613*(2.647) (2.937)

PAT 0.2543 0.1819(0.889) (0.649)

FE 0.0105* o.OOs7*(2.433) (2.078)

KSR -0.0910

(-0.363) -Log SIZE -0.1027 - 0.0627

(- 1.488) (-0.925)MT 0.2782* -

(2.739)MT-, _ 0.3117*

(3.222)

fi* 0.2312 0.2779R2 0.2990 0.3310F 4.409 6.233

“t-values are given in the brackets. *denotessignificant at 5% level by two tail test.

resource and other environmental conditions. This is done by the in-house

R&D units. Hence the positive relationship between the two variables.

The age of the R&D unit turns out to be an important determinant of the

current R&D intensity. Established and older R&D units that enjoyed a

tradition of R&D activities spent more on R&D compared to the newer

ones. Size and capital intensity are not important in explaining RD. The

patent dummy is also not statistically significant in determining the current

R&D expenditures. The size variable was also tried in its quadratic form but

was not important. It is possible that multinationality as seen by foreignequity participation also captured the size effect, hence the size variable was

not important.

5. Conclusion

The results presented in this paper have implications for the current debate

in India and the other developing or newly industrialising countries on

technology imports. In some quarters the question is posed as one of

technology imports versus in-house R&D. The results presented in this

paper indicate that they are not in conflict with each other, rather they arecomplementary and one aids the other. Indian R&D intensities are very low



N.S. Siddharthan, Transaction costs, technology t ransfer and in-house R& D 271

and they ought to be stepped up considerably, as without a good R&D

setup, it is not possible to identify and evaluate the technologies to beimported. The recent spurt in the Indian in-house R&D activities in the last

two or three years is partly related to the liberalisation trends in technology

imports.

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