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 transfer
on R&D expenditures for a sample of firms belonging to the Indian private corporate sector
listed with the stock exchanges in India. Using the transactions costs frame work it considers
two modes of technology transfer, the first through the market, namely armslength purchases
against lump sum payments and the second through foreign direct investments. The results
indicate 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) and
Siddharthan (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 statistical
assistance.

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 costs
frame 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 the
external 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 against
royalty 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 imports
In 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 through
the 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, that
merely 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 relationship
between 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 the
two.

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&D
could 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 some
of 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 on
capital 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&D
ventures. 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 dummy
variable 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 Stock
Exchanges 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 Official
Directory 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 technology
imports 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 a
different resource endowment needs certain modifications to suit the Indian
210 N.S. Siddharthan, Transaction costs, technology transfer 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 0.2779
R2 0.2990 0.3310
F 4.409 6.233
“t-values are given in the brackets. *denotes
significant 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 foreign
equity 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 are
complementary and one aids the other. Indian R&D intensities are very low
 N.S. Siddharthan, Transaction costs, technology transfer 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 be
imported. 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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