THE EFFECT OF MSTITUTIONAL DISTANCE ON MULTINATIONAL ENTERPRISE STRATEGY

DEAN XU

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York University Toronto, Ontario

July 200 1

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THE EFFECT OF INSTITUTIONAL DISTANCE ON MULTINATIONAL ENTERPRISE STRATEGY

a dissertation submitted to the Faculty of Graduate Studies of York University in partial fulfillment of the requirements for the degree of

DOCTOR OF PHILOSOPHY

O Permission has been granted to the LIBRARY OF YORK UNIVERSITY to lend or seIl copies of this dissertation. to the NATIONAL LIBRARY OF CANADA to microfilm this dissertation and to lend or seIl copies of the film, and to UNIVERSITY MICROFILMS to publish an abstract of this dissertation. The author reserves other publication rights. and neither the dissertation nor extensive extracts frorn it may be printed or othewise reproduced without the author's written permission.

ABSTRACT

This dissertation centers on a newly deveIoped concept in the Iiterature of

institutional theory, institutional distance, in explaining the behavior of the

multinational enterprise (MNE). Institutional distance is defined as the

difference/similarîty between the regulative, cognitive, and normative institutions of

two countries (Kostova, 1996). The fhmework of the dissertation involves multiple

levels. The first part of the fiamework is mainly at the MNE parent firm level. I

discuss factors that may have an impact on the MNE's choice of host country dong

the dimension of institutional distance. These include the cornpetitive advantages of

the MNE, its level of global integration, and its level of £irm diversity. The second

part focuses on the effect of institutionaï distance on subsidiary level MNE strategies,

including entry mode, level of equity ownership, and expatriate strategy. in the third

part, 1 develop the concept of host-country diversification strategy and examine the

effect of institutional distance on this country-level strategy. Furthemore, the

performance implications of institutional distance for the MNE are also discussed.

Scott ( 1 995) defined the institutional environment in terms of three "pillars" -

the regulative, normative, and cognitive domains. The regulative and nonnative

dimensions are derived here based on two "factors" ("institutions" and

"manage~nent'~) in the Global Competitiveness Report (World Economic Forum,

1997). Selected sub-items comprising these two factors are combined to form the

regulative and normative scales, respectively. The two scales are then combined to

tom a partial institutional distance measure in a way simiIar to Kogut and Singh's

(1988) approach to deriving the cultural distance index. Hypotheses are tested

utilizing a large-sample database covering thousands of Japanese foreign subsidiaries

in over fifiy countries (Toyo Keizai, 1997). Statistical results indicate that some

attributes of the parent finn may influence the MNE's preference for some host

counûies over others and, once a host country has been chosen, the institutional

distance of the host country will have an impact on MNE subsidiary level sîrategies,

as well as MNE diversification strategy, in that country. The results dso suggest that

a good "fit" of institutional distance and expatriate strategy can lead to higher

subsidiary performance in the host country.

Keywords: multinational enterprises, institutional distance, entry mode, expatriate strategy, product diversification.

ACKNOWLEDGMENT

This dissertation originally grew out of a term paper for Professor Christine

Oliver's doctoral serninar on Organization Theory. Over the pst three years this

work developed into several papers that 1 presented at the Academy of Management

and the Acaderny of International Business annual meetings, and finally, this

dissertation. In the process 1 have benefited enormously fiom Professor Oliver's

continuous guidance and encouragement. The same can be said of the other members

of my corrimittee - Professor Yigang Pan, who took over as my committee chair after

rny former supervisor had Iefi York, and Professor Bernie Wolf, who has provided

consistent support for me since 1 took my comprehensive examination. After the oral

defense, I received invaluable statistical assistance fiom Professor Mike Ornstein of

the Institute for Social Research for the final version of this dissertation. The final

version also benefited fiom helpful comments and suggestions by the other two

examination committee members, Professor Lorna Wright, and Professor Nailin Bu

of Queen's University.

1 could not have completed this work without the support of Professor Paul

Beamish of Ivey School of Business, fiom whom 1 took a doctoral seminar on

International Management. It was his idea to use the valuable Ivey database on

Japanese FDI for my dissertation topic. The database was compiled with a Social

Sciences and Humanities Research Council (SSHRC) of Canada Grant (#411-98-

0393) to Professor Beamish. My first empincal work was done and presented in bis

class. 1 am greatly indebted to his generosity and intellectual stimdation.

Throughout the last four years 1 benefited from continuous financial support

within and outside the SchuIich School of Business. These include a Seymour

Schulich Entrance Scholarship and an SSHRC Doctoral Fellowship. I am also

indebted to Professor Phi1 Phan, my former supervisor, who provided generous

financial support for me out of his research funds while he was leaving for the

Rensselaer Polytechnic Institute.

vil

TABLE OF CONTENTS

ABSTRACT ................................................................................................................. iv

ACKNOWLDEGMENT ........ .... .......................................................................... vi

. . * TABLE OF CONTENTS ............................. ,., ........................................................... viii

LIST OF FIGURES AND TABLES ............................................................................. x

1 . INTRODUCTION .................................................................................................. 1

2 . REVIEW OF LITERATURE ON THE MNE .......................................................... 5

2.1 . Two Prominent Paradigms of MNE Research ................................................. 5

2.2. Country Difference and the Intemationalization Process Mode1 ................... 10

2.3. The Resource-Based View of Intemationalization and Transfer of Organizational Capabilities ................................................................................... 13

2.4. The International Diversification Literaîure .................................................. 15

2.5. Literature on Foreign Entry and Ownership Modes ...................................... 18

3 . INSTITUTIONAL THEORY AND THE EFFECT OF INSTITUTfGiiAL DISTANCE ................................................................................................................. 22

3.1. Review of Lnstitutional Theory ...................................................................... 22

3.2. Institutional Distance and MNE Strategies .................................................. 26

3.2.1. Institutional distance as indicator of host-country choice ..................... 27

3.2.2. Institutional distance and subsidiary-level MNE strategies ............... ... 37

3.2.3. Institutional distance and M'NE diversification in the host country ...... 46

4 . DATA SOURCES. MEASURES. AND SAMPLE CHARACTERISTICS .......... 55

4.1 . Data Sources .................................................................................................. 55

4.2. Development of the Institutional Distance Measure ....................... .. .......... 56

3.3. Variables ...................................................................................................... 61

4.3.1 . Variables for parent firm level analyses .......................................... 61

4.3.2. Variables for subsidiary level analyses ................................................ 66

4.3.3 . Variables for host country level analyses ................... ... .................. 69

4.4. Sample Characteristics ................................................................................. 70

4.4. I Sarnple characteristics of Japanese foreign subsidiaries ........................ 70

4.4.2 . Sarnple characteristics of Japanese parent fims .......... .. ....................... 73

4.4.3. Sample characteristics of the host countries ......................................... 75

5 . ANALYSES AND RESULTS ................................................................................ 79

5.1. Parent Firrn Level Analyses and Results ....................................................... 79

5.2 . Subsidiary Level Analyses and Results ........................................................ 83

5.3. Host Country Level Analyses and Results ............ ... .................................. 94

5.4. Comparing the included and Excluded Sarnples ....................................... 101

5.5. Summary ........................ ............................................................................ 105

6 . DISCUSSION AND CONCLUSIONS ................................................................ 108

......................................................................................................... REFERENCES 121

APPENDIX 1 . Components of the institutional Distance Measure and Their Respective Factor Loadings ...................................................................................... 141

APPENDLX 2 . Correlation Matrix for Parent Firrn Level Analyses ........................ 143

APPENDIX 3 . Correlation Matrix for Subsidiary Level Analyses .......................... 144

APPENDIX 4 . Correlation Matrix for Host Country Level Analyses ...................... 145

LIST OF FIGURES AND TABLES

FIGURE 1 . An Illustration of Basic Hypothesized Relationships ............................. 28

TABLE 1 . Profile of Foreign Subsidiaries ................................................................ 71

TABLE 2 . Profile of Parent Firrns ............................................................................. 74

TABLE 3a . Countries included in Analyses: Regulative and Normative Scores ....... 76

TABLE 3b . Host Countries included in Analyses: Distance fiom Japan and ........... -77

TABLE 4 . Results of Parent Firm Level Analyses based on Sales ............................ 80

TABLE 5 . Results of Parent Firm Level Analyses based on Capitalization .............. 82

TABLE 6 . Results for Entry Mode Analysis .............................................................. 84

TABLE 7 . Results for Ownership Level Analysis .................................................... 86

TABLE 8 . Results for Subsidiary Expatriate Analyses .............................................. 89

TPLBLE 9 . Results for Subsidiary Performance Analyses .......................................... 93

TABLE I O . Results for Diversification in Host Country by Sales ............................. 95

TABLE 1 1 . Results for Diversification in Hast Country by Capitalization ............... 97

TAI3 LE 12 . Performance Implications: Diversification by Sales ............................... 99

TABLE 1 3 . Performance Implications: Diversification b y Capitalization ............... 100

TABLE i 4 . Mean Cornparison for Parent Firm Groups ........................... ... . . . . . 102

TABLE 1 5 . Mean Cornparison for Subsidiary Groups ............................................ 103

TABLE 1 6 . Mean Cornparison for Parent - Host Country Groups .......................... 105

TABLE 17 . Sumrnary of the Results ........................................................................ 106

TABLE A l . Correlation Matrix for Parent Firm Level Analyses ............................ 143

TABLE A 2 Correlation Matrix for Subsidiary Level Analyses .............................. 144

TABLE A3 . Correlation Matrix for Host Country Level Analyses .......................... 145

1. INTRODUCTION

This dissertation centers on a newly developed constmct in the literature of

institutional theory, institutional distance, in explaining the behavior of the

multinational enterprise (MNE). As such, it is theory-onented, as opposed to issue-

oriented. The focus is on testing theory, and more specifically, on testing the

relationship of institutional distance to MNE strategy. In so doing 1 did not

concentrate on one particula. issue or develop one model. Instead, severai issues are

discussed, and many tests conducted, with institutional distance as the focal constmct.

Institutional distance has been defineci as the differencdsimilarity between the

regdative, cognitive, and nonnative institutions of two countries (Kostova, 1996).

While previous research has related this concept to two aspects of the MNE, namely,

MNE legitirnacy in the host country (Kostova & Zaheer, 1999) and the ansf fer of

strategic organizational practices within the MNE system (Kostova, 1999), the

relationship between institutional distance and MNE stlategy has not b e n explored.

As I will argue in the next two chapters, the introduction of institutional distance will

provide an alternative perspective for research on the MNE, thus changing the narrow

focus on efficiency-based explanations in the field.

Specifically, this dissertation addresses the following research questions: a)

what is the role of institutional distance in MNE's choice of host country? b) what is

the efi'ect of institutional distance on MNE's foreign entry mode and mode of

subsidiary control? and c) what is the effect of institutional distance on the MNE's

diversification strategy in a particular host country? The framework of this

dissertation involves mdtiple !evels. The first part of the framework is at the MNE

parent firm level. 1 discuss factors that may have an impact on the MNE's choice of

host country dong the dimension of institutional distance. These include fhn-specific

cornpetitive advantages of the MNE, its level of global integration, and its level of

firrn diversity. Institutional distance is treated here as a dependent variable indicating

host country choice. The second part focuses on MNE subsidiary level strategies. 1

examine the effect of institutional distance on MNE foreign entry mode, level of

equity ownership, and expatriate strategy, as well as the implications for subsidiary

performance. In the third p m I develop the concept of host-country diversification

strategy and examine the relationship of institutional distance to this country-level

strategy. 1 also EY to examine the moderating effect of institutional distance on the

relationship between diversification strategy and MNE performance in the host

country.

Corresponding to this multi-level fiamework, my literature review covers a

diverse body of issues and theoretical perspectives that are relevant to propositions

developed in this dissertation. These include discussion on the transaction cost theory,

the global strategy perspective, the internationalization process model, the resource-

based view, the international diversification literature, and the literature on entry

mode and subsidiary control. In the theoiy development section, thesc theoretical

perspectives are mainly used to support, rather than contrast, institutional

explanations.

The methodology of this dissertation relies heavily on a large sample database

on Japanese foreign direct investments (FDI) - the Toyo Keizai (1997) database. The

dataset contains subsidiary level, fhm level, and industry level information for over

18,000 Japanese overseas affiliates, combined with the country level institutional

distance index developed in this dissertation. This ensures rigorous testing of the

effect of institutional distance, with controls at four different levels - subsidiary, firm,

industry, and country. Furthmore, statistical tests conducted here take account of the

clustering of subsidiaries within each parent firm (Snidjers & Bosker, 1999), which

has been neglected in strategy and MNE research. Signifiant results were obtained at

the three levels of the theoretical fiamework. At the parent firm level, the tendency of

foreign direct investment, as represented by the h n ' s weighted average institutional

distance to al1 its host countries, was found to be related to its marketing ability and

its level of global integration. At the subsidiary level, institutional distance between

the host and home countries was found to have an impact on the MNE's entry mode,

level of ownership, and expatriate strategy. In particular, it was found that the nght

mix of institutional distance and expatriate presence could produce higher subsidiary

performance. At the country level, institutional distance was found to have an impact

on the MNE's level of product diversification within the host country.

This dissertation contributes to research on MNE strategy by introducing a

more comprehensive measure of cross-country diflerences, and by reveaiing its

strategic implications for the MNE. It contributes to institutionai theory by extending

the "strategic response" perspective of the theory (Oliver, 199 1 ) to the international

arena, and by attempting to test the performance consequences of such strategic

responses. It dso represents a first atternpt at operationalizing MNE product

diversification on a country-by-country basis, and exarnining the detemiinants of such

a host-country level diversification sirategy. Theoretical propositions developed here

have practical implications for the MNE, as they provide a new context, narnely

institutional distance, for developing effective strategia in the host country. Not only

researchers can now study FDI decision and MNE strategy fkom a new angle, but

managers can also compete with other firms by designing strategies that better match

the firm's institutional context.

The organization of this proposal is as follows. Chapter 2 provides a survey of

relevant literature on the MNE. Chapter 3 reviews institutional theory and develops

hypotheses. Chapter 4 discusses methodological issues. Chapter 5 presents statistical

results. And finally, Chapter 6 provides concluding rernarks.

2. REVIEW OF LITERATURE ON THE MNE

Literature on foreign direct investments and the MNE consists of a diverse

body of theoretical approaches and subject areas. These include, for instance, the

economic theones (Coase, 1937; Dunning, 1988, 1995, 1998; Hymer, 1970; Vernon,

1979), behavioral theories (Aharoni, 1966; Bower & Doz, 1979; Hofstede, 1983),

political theories (Boddewyn, 1 988; Fitzpatrick, 1983; Gilpin, 1987; Moran, l985),

networks (Ghoshal & Barlett, 1 990), joint ventures and alliances (Beamish & Banks,

1987; Buckley & Casson, 1996), and global strategy @oz & Prahalad, 1991 ; Harnel,

199 1; Kogut, 1991). For my purpose 1 will review six streams of research in this

chapter: the transaction costlinternalization theory, the global strategy perspectives,

the resource-based view, the diversification literature, the intemationalization process

school, and the literature on foreign entry mode choice.

2.1. Two Prominent Paradigms of MNE Research

A comrnon criticism of the field of MNE research, and more broadly of

international business in genaal, is its lack of one unifjmg or dominant paradigm

(Doz & Prahalad, 199 1 ; Toyne, 1989). Nevertheless, one may be l a s hesitant to state

that two prominent paradigms exist in the field: the transaction cost theory and the

global strategy perspective.

The transaction cost theory (Casson, 1982; Hemart, 1982; Teece, 1976, 1986)

is ofien used to refer to the economic theories of MNE research in generai. Indeed,

two other influentid economic theories, the intemalization theory (Buckley &

Casson. 1 976; Rugman- 198 1 ) and the eclectic theory (Dunning, 1977, 1988) are both

related to. and based on, this theory. They combine to f o m the transaction cost

paradigm.

The transaction cost paradigm in the field of international management is

influenced by two early versions of emnomic theories in the 1960s: the product life

cycle (Vernon, 1966, 1979; Wells, 1972) and monopolistic competition (Caves, 197 1 ;

Grosse, 1985; Hymer, 1960; Kindleberger, 1969) theories. Until then, research in

international business had mostly focused on international trade, reflecting the field's

roots in classic microeconornic theories and, particularly, in the theory of comparative

advantage (cf. Barlett & Ghoshal, 199 1). Beginning wiîh Hymer's (1 960) seminal

thesis, however, the focus gradually shifted to patterns of FDI and explanations of

these patterns in terms of oligopolistic competition among fïrms, which is in essence

an application of the neo-classicd micro-economic mode1 to the international setting.

Meanwhile, Vernon's international product cycle th- removes the classical

assumption that factors are immobile internationally, focusing on the firm's decision

on trade and investment based on both cost and revenue conditions (cf. Grosse &

B e h a n , 1992). The theory proposes a dynarnic sequence of domestic production,

export, foreign direct investment, and production abroad.

Onginating from the works of Coase (1937) and b h e r developed by

Williamson (1975), the transaction cost theory began to be used to explain the

existence and behavior of MNEs by the late 1970s. The basic presumption of the

theory is that a fim's hierarchy exists. and expands, to reduce costs of transactions

that would otherwise be incurred in the externa1 market, The theory was extended to

the internationai arena to explain the interna1 functions of large fims, which remove

many and varied activities from the market and place thern within the hierarchy of the

firm, hence the intemalization theory. Dunning ( 1 97 7, 1 980) M e r incorporated

intemdization theory into his eclectic theory, making it one of the three components

(dong with ownershipspecific factors and location-specific factors) of his theory.

S till, transaction cost theory constitutes the core of the two latter theories. Together

they represent the major economic explanations of FDI and MNE. Therefore, 1 refer

to al1 these three, combined, as the transaction wst paradip. Other ecunomic

theories, such as agency theory (E-g., Roth & O'Donnel, 1995), are less influentid in

international management research.

The global strategy perspective has its roots in strategic management. Its

domains large1 y correspond to those of polic ylstrategy: the environment, cornpetitive

advantage and strategy, and organizational process (cf. Barlett & Ghoshal, 199 1 ).

This perspective is an extension of strategic management theories or approaches -

industry and environment analyses based on industrial organization (IO) economics

(Kogut, 1 99 1 ; Porter, 1986, 1 990), the resource or capability-bas4 view (Collis,

199 1 : Prahdad & Hamel. 1990; Tallman, 1992), and the "process schooI" (Barlett &

Ghoshal. 1989; Doz & Prahalad, 1987; Prahalad & Doz, 1987), each focusing on one

of the three dornains mentioned above. These streams of research al1 followed earlier

studies that extended Chandler's work ( 1962) to examine the strategy and structure of

MNEs (cf. Barlett & Ghoshal, I991), e-g., Dyas and Thanheiser (1976), Franko

(1976), and Stopford and Wells (1972). The historical evolution of the global strategy

perspective, therefore, is parallel to the historical evolution of the policy/strategy field

in general, namely, from the strategy-structure issue, to the process, to the domination

of industry analysis, and then to the challenge of the intemal perspective (resource-

based view ) to extemal, industry and country-level environmental analyses. Despite

the differences in theoretical roots arnong these perspectives, especially between 10-

based industry analysis and the resource-based view, they share a cornmon theme -

the competitive advantage of the MNE, be it at the country level, industry level, iïrm

level, or subsidiary Ievel.

It is difficult to compare and contrast the transaction cost and global strategy

paradigms since the latter contains theories with different assumptions and is almost

as diverse as the strategy field at large. As discussed earlier, however, a cornmon

theme within the global strategy perspective is the emphasis on the competitive

advantage of the MNE. As such, it has some fûndamental differences fiorn the

economics-based iransaction cost theory, which 1 will now discuss in more detail.

The crux of transaction cost theory is that an organization exists because it can

mediate economic transactions at a lower cost than a market mechanism can. In the

international arena, firms choose the l e s t cost location for each activity they perfom

and grow by ïnternalizing markets up to the point where the benefits of M e r

internalization are outweighed by the costs (Buckley, 1988). Like al1 economic

theories, this mode1 also suggests uniform behavior among sirnilar firms in a given

indusûy, with little provision for firm-specific managerial choices (Tallman, 1992).

Because the theory is concerned with expIaining why firms exist, and hence, the most

efficient governance structure - market or hierarchy, it has been most extensively

applied to research on entry mode choice (Anderson & Gatignon, 1986; Beamish &

Banks, 1987; Buckley & Casson, 1976)-

The global stmtegy perspective, on the other hand, centers around the way to

compete in the international setting, be it industry positioning, raource and capability

building, or through other foms of managerial discretion. A prominent topic in this

Stream of research, for instance, is strategic and structural issues centering around

coordination mechanisms within the MNE, and more specificdly, the global

integration versus local orientation dimension (Westney, 1993). The emphasis,

therefore, is not why MNEs exist, but how competitive advantage can be achieved

through strategic and stxuctural design or managerial process.

The relationship between the transaction wst paradigm and global strategy

paradigm, in my view, is somewhat similar to the relahonship between IO economics

and sîrategic management (Porter, 198 1). As an economic theory, transaction cost

theory is the dominant paradigm in the broader field of "international business". It is

a "borrowed" theory within international management. It provides a strong

disciplinary foundation, as welI as theoreticai rigor. for the field, and is supported by

a large quantity of empirical research. Just like IO economics as used in strategic

management, however, it suffers from obvious economic determinisrn: it suggests

that fims in the same industry or national environment will have the same conduct,

and probably the same economic performance. The cornmon cornpla.int against the

economic theories that they treat the firm as a "black box" is also valid here. The

global strategy perspective, on the other hand, is rooted in traditional strategic

management and, therefore, has more Iegitimacy within strategy-oriented research

streams. It focuses on the traditional firm-level andysis and managerial decision-

making, but suffers fiom tkagmentation of theory and a lack of ngor (Foss, 1996).

2.2. Country Differences and the Internationaikation Process Mode1

Country differences have been an important subject in international business

theories. In (Ricardo's) classic international economics, for instance, this concept

takes the form of national differences on productivity, on which comparative

advantage is based. in transaction cost theory, the difference is in the form of

location-specific advantages of the MNE (Buckley & Casson, 1986; Dunning, 1980,

1995; Hemart, 1982; Hill & Kim, 1988). Within the strategy-based literature,

Porter's (1990) premise is that certain industries are more likely to prosper in

particular countries. These conceptualizations of the national environment al1 focus

on the economic aspect. Kogut (1991), on the other hand, attributes national

competitiveness to differences in organizing principles and societal institutions across

nations. Research in this direction, however, is rather scarce.

One research strearn that does acknowledge the impact of societai differences

on MNE behavior is the intemationalization process model, or ''Uppsala School"

(Johanson & Vahlne, I977, 1990). Nthough not a dominant perspective in the MNE

literature, this Stream has exerted significant influence on the field (e.g., Bakema,

Bell, & Pemings, 1996; Chang, 1995). The model was first based on ernpirical

evidence fiom the field of international operations (Honell, Vahlne, & Wiedersheim-

Paul, 1 972; Johanson & Wiedersheim-Paul, 1 975; Luostarinen, 1970). The authors

then sought theoretical explanation through the behavioral theory of the firm (Cyert &

March, 1963). Internationalization is seen as the product of a series of incremental

decisions. These decisions reflect a process of iricrernentd adjusîments to changing

conditions of the firm and its environment (Aharoni, 1966). The key variables here

are market knowledge, market cornmitment, and psychic distance. Leaming through

gaining expenential knowledge about foreign markets is necessary in order to

overcome the psychic distance (Melin, 1992). Only then can cornmitment to the

foreign market be increased.

Johanson and Vahlne ( 1977: 24) loosely defined psychic distance as "the sum

of factors preventing the flow of information fiom and to the market". Their examples

included differences in language, education, business practices. culture, and industrial

development. After Hofstede ( 1980) had turned the vague concept of national culture

into four rneasurable dimensions, and especially after Kogut and Singh (1 988) had

operationalized cultural distance based on these four dimensions, cultural distance has

become the most cited form of national difference and psychic distance. A large

arnount of research has bea. done on the effects of cultural characteristics of different

countries, and of cultural distance between countries, on the MNE (Barkerna, et al.,

1996; Brouthers & Brouthers, 2001; Davidson, 1980; Hemart & Larimo, 1998;

Hofstede, 1983; Kedia & Bhagat, 1988; Li, Lam, & Qian, 2001). This cultural

perspective, however, still lacks a strong theoretical foundation and involves many

"illusions" (see Shenkar, forthcoming, for a review and critique). The concept of

national culture was originally operationalized by Hofstede at the level of individuals

in the organization. How it becomes a firm-level influence deserves further

theoretical clarification.

Delios (1998: 29) noted that while the psychic distance argument obtained

much support fiom ernpirical evidence, first among Swedish fixms and then in some

other countries, there are also mixed results. For exarnple, Benito and Gripmid

(1 992) did not find that more experience in a culturally distant country increased that

country's share of FDI from a firm. Other researchers observed that h s may skip

various stages of the intemationalization process (e.g. Hedlund & Kverneland, 1984;

Engwall & Wallenstal. 1988: Calof, 199 1). Finally, Johnson and Mattson (1984)

stated that in highly intemationalized settings, this mode1 of expansion rnight not

hold.

23. The Resource-Based View of Internationalization

and Transfer of Organizationai Capabiiities

For a long time the field of strategic management was dominatecl by the IO

economics approach represented by Porter's works (1 980, 1985, 1990). The emphasis

of this school is on the external (product market) aspect of the firm, or the

oppominity-threat side of the SWOT framework developed by Andrews (1971). A

paradox inherent in this extemal approach is performance variations among firms

situated in the same industry environment. As earIy theorists within the resource-

based Stream pointed out, managerial discretion in terms of resource positioning and

development is a critical explanation for these variations (Wemerfelf 1984).

The resource-based view originated fiom Penrose (1959) and became

acknowledged as a new theoretical perspective in the mid-1980s (Barney, 1986%

1986b; WernerfeIt, 1984). It takes an intemal (or factor market) approach by viewing

firms as bundles of heterogeneous resources and emphasizing the importance of rare,

valuable, and inimitable resources (Bamey, 1986% 199 1 ; Brumagim, 1994; Reed &

DeFillippi, 1990). A related concept here is capabilities, which refer to a fûm's

capacity to deploy resources, usually in combination, using organizational processes,

to effect a desired end (Arnit & Schoemaker, 1993). These processes can best be

described by Nelson and Winter's concept of organizational routines (Grant, 199 1 )

and involve developing, carrying, and exchanging information through the firm's

human capitaI (Arnit & Schoemaker, 1993).

The resourcekapability-based view has implications for international

management and the MNE. According to Penrose (1959), it is rare for ail units of a

fim to be operating at the same speed and capacity, and this phenornenon creates an

intemal inducement for firm growth. Excessive capacity due to indivisibility, and

cyclical dernand, to a large extent drives the diversification process (cf. Mahoney &

Pandian, 1992). In other words, slack resources provide motivation for firm growth,

including, of course, expansion across the national border. On the other hand, unique

resources, as a source of competitive advantage, are inherently immobile, sticky, and

costly to accumulate (Collis, 1991). They produce path dependence for the firm

(Dosi, Teece, & Winter, 1990) and are difficult to apply outside the existing business

context (Delios, 1998: 11). The MNE, therefore, is facing the paradox of utilizing

existing, parent-firm resources and routines across its subunits versus developing

unique and embedded resources and capabilities at each of these subunits.

A large body of research has studied the transfer of capabilities and

knowledge tiorn the parent firm to organizational subunits (Chang, 1995; Kogut &

Zander, 1993; Kostova; 1999; Zaheer, 1995). Although not al1 of these researchers

used the resource-based view as their theoretical rationale, the central issues here are

whether knowledge and capabili ties can b r transferred successfull y fiom the parent

firm to subsidiaries, and how the transfer can be carried out successfulIy. Others, on

the other hand, have focused on the local accumulation of subsidiary-specific

resources and capabilities (Birkinshaw & Hood, 1998; Birkinshaw, Hood, & Jonsson,

1998; Zaheer, 1995). Results fkom these two streams are mixed. For instance, while

intra-firm transfer of capabilities within the MNE system proved to be important for

the foreign subsidiary to overcome the Lability of foreignness (Chang, 1995; Kogut &

Zander, 1993; Zaheer, 1995), the success of such transfer is restricted by the

discretion of the transfming firm's managers (Chi, 1994) and by the ability of the

recipient firm to absorb and replicate the knowledge or organizational processes (cf.

Delios, 1998: 1 8). Furthermore, there are also indications that locally-accumulated

knowledge and capabilities are critical for subsidiary performance (Makino & Delios,

1996) and may even be inversely transferred to f o m firm-specific cornpetitive

advantage (Birkinshaw, et al., 1 998).

2.4, The International Diversification Literature

Diversification research has been one of the central components of strategic

management research in general . Earl y studies on diversification foIiowed an

industrial organization economics tradition. The central theme was that diversification

increases market power, and therefore enhances firm performance (Caves, 1981;

Miller. 1973). There was, however, little empiricai evidence to support this argument

(Amould, 1969; Gort, 1962; Markham, 1 973).

The strategy-based diversification literature following Chandler ( l962), on the

other hand, has centered on factors such as core skill, relatedness, and synergy

(Rumelt, 1974, 1 982: Teece, 1982; Wrigley, 1970). From a resource-based

perspective, the key to higher corporate performance resulting fiom diversification is

utilizing excess resources (Mahoney & Pandian, 1992; Peteraf, 1993; Teece, Pisano,

& Shuen, 1997) rather than reducing risk (a finance perspective). Related

diversification, therefore, is preferred to unrelated diversification, as the former

allows for the leverage of strategic resources and h-spec i f i c capabilities across

product lines (Geringer, Tdlman, & Olsen, 2000).

A related issue is the cost resulting fkom diversification. According to the

transaction cost theory, increasing levels of diversification will raise the cost of

governing the fim (Jones & Hill, 1988). A firm will diversifi only if the benefits

resulting fiom the reduction in transaction costs exceed incrernental bureaucratic

costs of governing an expanded firm (Williamson, 1975). In this sense related

diversi fication incurs higher bureaucratic costs, because it requires a higher level of

coordination among the related product lines (Hill & Jones, 1998). Combining the

resource-based view and transaction cost theory (Conner, 1991), therefore, the key

issue becornes at what level of diversification will economies of scope outweigh

bweaucratic costs (D' Aveni & Ravenscrafi, 1993).

Researchers in international management have been interested in two types of

diversification - product market diversification on a global scale, and geographical

market diversification of the MNE (Barkema & Vermeulen, 1993; Delios & Beamish,

1999a; Geringer, Beamish, & dacosta, 1989; Geringer, et al., 2000; Kim, Hwang, &

Burgers, 1989, 1993; Tallman & Li, 1996). The former is an extension of the product

diversification literature in the international area. Research in the latter Stream

generally suggests that the sarne benefits of shared capabilities should occur across

national markets as across product markets (Geringer, et al., 2000; Fladrnoe-Lindquist

& Tallman, 1994). Furthermore, it is also believed that international or geographicai

diversification enables a firm to use market power, to spread its markets risks, and to

seek less expensive inputs and less pnce-sensitive markets (Kim, et al., 1993). These

researchers have O ften examined the effects of product and geographical

diversification simultaneously as weI1 as their interactions (e-g., Barkerna &

Verrneulen, 1 998; Tallman & Li, 1 996).

The above literature, however, only deals with diversification at the firm level.

Research on MNE diversification strategy in a given host country is scarce. Virtually

no attempt has been made to investigate the determinants of a host-country-level

corporate strategy, if there is one, and the effect of such a strategy on MNE

performmce in that country. One such discussion appeared in a recent issue of

Harvard Business Review (Khanna & Paiepu, 1997). The authors propose. that in

emerging markets, diversification may be preferred because it enables the MNE to fil1

the 'institutional voids'. i-e., creating a supportive institutional structure that is

typically lacking in those markets.

2.5. Literature on Foreign Entry and Ownership Modes

Foreign entry and ownership modes comrnonly refer to the choices between

acquiring an existing firm and establishing an entirely new foreign subsidiary (so

called greenfield investment), and between a joint venture and a wholly owned

subsidiary. There are, however, also studies that focus on the choice between

acquisition and joint venture (e.g., Hennart & Reddy, 1997). Research on foreign

entry and ownenhip modes has largely followed two lines of argument: the

transaction cost - intemalization theory (Anderson & Gatignon, 1986; Beamish &

Banks, 1987; Buckley & Casson, 1976; Delios & Beamish, 1999b; Rugman, 1982;

Williamson, 1975, 1985) and the experiential or leaming perspective (Barkema, et al.,

1996; Barkema & Vermeden, 1998; Delios & Beamish, 1999b; Makino & Delios,

1996). Also there are others who have taken an eclectic approach (Hill, et al., 1990)

or focused on cultural distance as a major detexminant (Kogut & Singh, 1988).

The transaction cost - internalization theory is concerned with the most

efficient form of govemance. Williamson (1 975, 1985) suggests that the most

efficient f o m of govemance should be able to minimize transaction costs. The choice

is among the market (ranging from exporting to licensing contracts), hierarchy

(wholly owned overseas subsidiaries) and something in-between (e-g., international

joint ventures). The first mode, which is non-equity-based, is considerd of l e s

interest (cf. Contractor & Kundu, 1998). The choice between wholly owned

subsidiary and joint venture can also be seen as a question of to what extent a finn

should intemalize its activities in order to minimize transaction costs. The main

. . detmmmng variables include asset specificity, bounded rationality, and opportunism.

Empirical studies have generally supported transaction cost-bas4 explanations of

mode choice (Gatignon & Anderson, 1988; Gomes-Casseres, 1 989; Hennart, 1 99 1 ).

From the experiential or learning perspective, the biggest disadvantage facing

the MNE in a host country is its lack of local knowledge, as well as the difficulty in

transferring £km-specific know-how to the foreign subsidiary. Modal choice,

therefore, should be aimed at optimizing leaming and knowledge tramfer. To

facilitate the tram fer of firm-speci fic knowledge to the forei gn subsidiary, for

instance, the MNE stiould ideally establish start-ups by sending over expatriates who

carefidly select and hire local employees (Hofstede, 199 1) and gradually build up the

business (Simmonds, 1990; Teece, 1982). To obtain knowledge of local business

institutions and practices, however, the MNE needs to cooperate with local partners

(Beamish, 1984, 1988) in the form of joint ventures, or acquire an existùlg firm with

local staff (Barkema & Venilulen, 1998). Based on this principle, international

experience and product and multinational diversity are among the factors that

influence rnodai choices (Barkema & Verrnulen, 1998; Makino & Delios, 1996).

The transaction cost and leaming perspectives also constitute the theoretical

basis for those who focus on culture as a detenninant of modal choice.

Understandably, cultural distance is an important barrier to leaming (Barkerna, et al.,

1996) and makes it difficult for MNEs to manage their foreign subsidiaries by

themselves or to enlist the help of a local partner efficiently (Hennart & Larimo,

1998). It therefore increases transaction costs. Besides these, cultural differences also

influence the perception of managers regarding the costs and uncertainty of

alternative modes of entry into foreign markets. Certain cultural values, such as

uncertainty avoidance, may tend to favor the greenfield over acquisition mode (Kogut

& Singh, 1988).

2.6. Summary

From the above review of literature, one weakness and one gap cm be

identifiai. The one weakness is the lack of a comprehensive m a u r e of cross-country

differences that can explain MNE strategy. It is a weakness, rather than a gap,

because measures of national differences do exist, for example, cultural distance and

psychic distance. As 1 argued earlier, however, the former is too nmow a concept

(when used to explain phenornena as diverse as FDI and MNE strategies) and still

lacks theoretical clarity, while the latter is basically non-theoretical. This weakness

reflects a more general probIern in the field of international management, namely, a

narrow focus on efficiency-based explanations of MNE behavior (e-g., economic

theories. the global strategy perspective, and the resource-based view). As Davis. et

al. (2000) pointed out. concerns have been raised about the limitations of the

assurnptions underlying these efficiency-based hmeworks. Strategic behavior of the

MNE, therefore, needs to be re-examined from a different perspective. Although not a

wmprehensive constmct itself, institutional distance, which 1 will focus on in this

dissertation, will help correct such a narrow orientation.

The one gap re fm to the lack of research on a host-country-level, as opposed

to firrn-level, MNE corporate strategy. There is little discussion on MNE

diversification within a host country, except for perhaps some case studies (e.g., Li,

Li, & Tan, 1998) and ernpincal studies focusing on one single country (e.g., Khanna

8i Pa!qu- 2000a, 2000b). The problem, 1 believe, is partly attriiutable to the

weakness discussed above. Diversification within the host country has not been

extensively researched, perhaps because an important aspect of the host-country's

charactenstics, its institutional environment as compared to that of the home comtry,

has not been empirically rneasured, with the exception of Kostova's (1996) initial

attempt on a limited set of countries. The introduction of the institutional distance

measure employed here will facilitate the examination of within-the-country

diversification strategy as associated with the institutional context of the hast country

of interest.

3. INSTITUTIONAL THEORY AND THE EFFECT

OF INSTITUTIONAL DISTANCE

The theoretical framework presented here is aimed at understanding the

patterns and strategies of FDI, mainly from the perspective of institutional theory

(DiMaggio & Powell, 1983; Scott, 1995). Institutional theory is a non-efficiency-

based theoretical perspective (DiMaggio & Powell, 199 1). It views the institutional

environment as a major determinant of finn structure and behavior. Recent research

on the MNE has shown "a growing appreciation of the importance of the institutional

context and of the pattenis in the way MN(E)s respond to that context" (Westney,

1993). Institutional theory has often been seen as a complement to, rather than

substitute for, other thwretical perspectives. For instance, Eisenhardt (1988) used

variables fiom both agency and institutional perspectives to explain retail sales

compensation. Oliver (1997) combined institutional theory and the resource-based

view into one integrative model. As the development of my theoretical h e w o r k

will be based on institutional theory as well as literature on the MNE discussed

previously, a brief review of literature in institutional theory is pertinent here.

3.1. Review of Institutional Theory

The 'hew institutionalisrn" f h t developed as a deterministic theory that

comprised, among other things, "a rejection of rational-actor models" (Selmick,

1996: 273). Acmrding to this theory, organizations have to conforrn to the des and

belief systerns prevailing in the environment in order to survive (DiMaggio & Powell,

1983 : Meyer & Rowan, 1977), because institutional isomorphisrn, both structural and

procedural, will earn Iegitimacy for the organization (Dacin, 1997; Deephouse, 1996;

Suchan, 1 995). This model has been applied in unitary, domestic environments and

with relatively smdl or young organizations such as public schools (Rowan, 1982)

and day care centers (Bawn & Oliver, 1992). It has received somewhat less empirical

evidence, however, in more complex environments where multiple institutional

demands exist (Meyer, Scott, & Strang, 1987) and where strategic choice becornes

important (Oliver, 199 1, 1997).

in a study of d m g abuse treatment units, D'Aunno, Sutton, and Price (1991)

found that organizations in an environrnent of conflicting institutional pressures could

only gain legitimacy fiorn some sources, depending on which practices they adopted.

Oliver (1991) proposed a model of firm responses to institutional processes that

accommodated strategic choice, thus providing a basis for convergence between

institutional and rational, strategic perspectives. Oliver's detemiining factors for

con fo rmi ty incl uded perceived social legitimac y, perceived economic gain, extemal

dependence, and consistency of institutional noms. This model has been

operationalized and applied to situations ranging fkom work- family issues (Goodstein,

1994; ingram & Simons, 1995) to environmental strategies of the MNE (Tsai &

Child, 1997). Later studies also modeled organizational discretion in responding to

institutional practices on the basis of context uncertainty. Goodrick and Salancik

(1 996)- for example, hund that hospitals exercised such discretion when uncertainty

was hi@, Le., when patient risk was at an intemediate levef. A more recent study

(Deephouse, 1999) suggests that where there is competition, a balance between

strategic similarity and strategic differentiation rnust be achieved in order to have

higher performance.

Researchers within institutional theory have also focused on industry creation

and on fhms facing a new institutional environment. Aldrich and Fi01 (1994), for

instance, examined strategies that founders can pursue in seeking sociopolitical

legitimacy and reshaping institutional environments. Haveman (1993) tested the

hypothesis that organizations will follow similar and successful organizations into

new markets. Ln an earlier study, the lack of institutional support experienced by

young organizations was found to be an important reason underlying the "liability of

nemess" (Singh, Tucker, & House, 1986). These studies provided a b a i s for

extending institutional theory to the international scene.

In recent years, institutional theory has been shown to have the potential to

make a signifiant contribution to research on MNEs. Given the fact that the MNE

operates in multiple institutional environments across nations, the theory may be able

to explain one of the fundamental issues in the field - the conflicting demands of

global coordination and local orientation (Westuey, 1993). Rosenzweig and Sin&

(1 99 l), for instance, provided an institutional perspective on the relationship between

the environment and the MNE. They specifically addressed the issue of conflicting

pressures for conformity facing the MNE, and hypothesized the relative influence of

home- and host-country institutiond environrnents on the MNE as dependent on a set

of contextual, strategic, and structural variables. Empirical testing for some of these

predictions was conducted in subsequent studies on MNE human resource

management (Rosenzweig & Nohria, 1994), organizational practices of international

trading rooms (Zatieer, 1999, and M'NE entry mode choice (Davis, et al., 2000).

While most studies in institutional theory have focused on sub-national levels,

such as the industry (Baum & Oliver, 1992; Dacul, 1997; Holm, 1995), line of

business (Tsai & Child, 1997), professionltask (Gupta, Dusmith, & Fogarty, 1994),

and inter-organizational relations (Galaskiewicz & Wasserman, 1989; Oliver, 1 98 8),

some of the authors have also conceptdized the institutional environment at the state

or national level (e.g., Dacin, 1997; Rowan, 1982). It is conceivable that a fïm may

be situated in multiple institutiond fields (Hoffman, 1999) and thus operate under

multiple institutional pressures (D' Aunno, et al., 199 1 ; Oliver, 199 1). Some of these

are locd in ongin; others are at the national level (Thomas & Meyer, 1984; Zucker,

19871, develop as a result of the rise of the elaborated state and other institutions, and

lead to the "collective action" (Meyer & Rowan, 1977: 360) of ail organiziiîions in

the nation.

Further breakthrough was made in two recent articles (Kostova, 1999;

Kostova & Zaheer, 1999). The authors defined the institutional environment in terms

of Scott's (1995) three pillars - the regulative, normative, and cognitive domains of

the environment, and developed a key concept, institutional distance, for differences

between the host and home countries of the MNE in terrns of the above three sub-

dimensions. The regulative pillar refers to explicit regulative processes - rule-setting,

monitoring, and sanctioning activities (1995: 35). The normative pillar refers to

values and norrns that govem people's behavior (1995: 40). The cognitive pillar

refers to the cognitive d e s îhat constitute the nature of reality and the hunes through

which meaning is made (1995: 40). Institutional distance was defined as the

difference/similarity between the regulative, cognitive, and normative institutions of

two countries (Kostova, 1996). Their propositions, relevant here, are that the larger

the institutional distance, the more difficult for the MNE to establish legitimacy in the

host country (Kostova & Zaheer, 1999) and to transfer strategic organizational

practices f?om the parent firm to the foreign subsidiary (Kostova, 1999). They

stopped short, however, of M e r suggesting the strategic implications of

institutional distance for the MNE and its internationalization process.

3.2. Institutional Distance and MNE Strategies

The propositions developed by Kostova (1999) and Kostova and Zaheer

(1 999) have direct bearings on FDI decisions and strategy. If, as they have suggested,

institutional distance has implications for the MNE in tenns of establishing

legithacy in the host country and transferring organizational routines h m the parent

fim to the foreign subsidiary, then where and how to invest dong this dimension

become important strategic choices. First, where to invest m u t be influenced by firm-

level attributes. The choice of host country. in tems of institutional distance, should

be matched to fim-level attributes in such a way that the legitimacy of the foreign

subsidiary can be ensured in the host country, and the transfer or maintenance of

cornpetitive advantage can be carried out successfully. Second, after a host country

has been chosen, the choice of subsidiary-level strategies m u t be matched to the

condition of that particula. country, in ternis of its institutional distance, in order to

mitigate the negative impact of a large institutional distance or e h c e cornpetitive

advantage resuiting from a mal1 institutional distance. Third, the MNE may

coordinate activities of its subsidiaries within a particular host country to f o m either

a focused or a multi-product strategy. This host-country-level strategy is also affected

by the institutional distance. Figure 1 illustrates the strategic implications of

institutionaf distance for the MNE at these three levels. The following sections

introduce theoretical hypotheses that sonstitute this multi-level Gramework.

3.2.1. Insîïtutionai Distance as Indicaîor of Hosi-Counîry Choice

In this section, I examine factors that may have an impact on the MNE's

choice of host country dong the dimension of institutional distance. By definition, the

institutional distance between any two countries is not "detemiined" by parent fhm

level factors or attributes. The MNE, however, rnust decide which countries to invest

in. This decision is partly reflected in the institutional distance between the home

country and the chosen host country, and is influenced by parent fixm level factors. 1

have previously reviewed institutional theory and some infiuentiai theoretical

perspectives in international management, which can help identie these parent level

factors. They include the level of firm-specific competitive advanîages of the MNE

(mainly supported by the internalization theory and the resource-based view fiom

different angles), the level of global integration of the MNE (mainly supported by the

global strategy perspective), and the level of diversity of the MNE (maidy supported

by organization theory, but also by the resource-based view and in the diversification

literature) .

Fir m-specific CO mpetitive advantage

It has long been argued that MNEs operating overseas face costs beyond those

incurred by their domestic counterparts (Hymer, 1976; Kindleberger, 1969), and that

MNEs must overcome this "liability of foreignness" (Zaheer, 1995) either by

transfenuig firm-specific cornpetitive advantages to the foreign subsidiary (Dunning,

1 98 1, l988), or b y utilizing host-country-specific advantages of the foreign subsidiary

(Kogut, 199 1 ; Porter, 1 990). The review of literature on the resource-based view has

indicated that excess resources provide motivation for fims to expand internationally.

These resources and capabilities are of value and constitute the MNE's competitive

advantage. The transferability of these resources and capabilities, therefore, is critical

for the MNE to compete on a global basis. This view is, in fact, also implicitly

supported by the industrial organization paradigm in strategy (Porter, 1980, 1990),

which suggests that the MNE should transfer its competitive advantage, in terms of

the generic business strategies of differentiation and cost leadership, fiom the parent

Company to the subsidiaries (Porter, 1986).

Institutional theory has now incorporated this line of reasoning. EarIier

research based on institutional theory emphasized the influence of local isomorphism

on MNE subunits (Rosenzweig & Singh, 199 1 ; Rosenzweig & Nohna, 1994). With

Kostova (1999), however, isomorphic pressures within the MNE system have been

recognized. Kostova mgued that because organizational practices are shaped by the

institutional environment in which organizations function, successful transfer of these

practices fiom the parent fkn to the foreign subsidiary depends on the institutional

distance between the home and host countries. The larger the institutional distance,

the harder the transfer. Hypothesis 1 below is built directly on this assumption. If a

large institutional distance makes the transfer of routines difficult, then MNEs that

have to make such a transfer, Le., MNEs that have strong, home-country-based, f%m-

specific cornpetitive advantages, will prefer to invest in host countries with a sirnilar

institutional environment to the home environment. (For purpose of this dissertation, 1

do not make a distinction between firm-specific and home-country-based competitive

advantages, and will use these terms interchangeably.) MNEs that do invest in

institutionally distant markets, on the other hand, are those that do not enjoy strong

firrn-specific cornpetitive advantages and intend for their subunits to copy local

practices (Rosenzweig & Nohria, 1994; Zaheer, 1995). For instance, McDonald's has

standardized products, name recognition, and managerial skills that it can îransfer to a

foreign market (Hill & Jones, 1998). In contrast, an unknown company may spread its

marketing activities in different countries in an attempt to exploit advantages

embedded locally: the account managernenï guru is based in Stockholm, business

intelligence and customer loyalty measurement in London, and database marketing in

Paris (Moore & Birkinshaw, 1998).

Among the many types of h - s p e c i fic competitive advantages, technologicai

intensity and marketing ability have received wide attention. UnderstaudabIy,

transnationai tramfer of technological capabilities is an important aspect in the

operations of the MNE (Dunning, 1 98 1, 1 988; Kindlebergm, 1984; Wolf, 1 977). That

is why R&D intensity, which is a surrogate for technological intensity in general, has

often been a focus in various studies (e.g., Erramilli, Agarwal, & Kim, 1997;

Gatignon & Anderson, 1988; Shrader, 2001 ; Stopford & Wells, 1972; Zaheer, 1995).

Another important aspect of competitive advantage is marketing ability of the MNE,

or the ability to achieve product differentiation through, for example, various

marketing promotions, including advertising (Allen & Pantzalis, 1996; Erramilli, et

al., 1997; Gatignon & Anderson, 1988; Shrader, 2001; Wells, 1983). Therefore, 1

hypothesize the following:

Hypothesis la. W E s with higher b e l s of technological intensity tend

to invest in host countries where institutional distance is smaller;

MNEs with Iower ievefs of technofogical intensity rend fo invest in host

countries where institutionai distance is larger.

Hypothesis lb. MNEs with higher marketing ability tend to invest in

host countrïes where institutionai distance is srnalier; MNEs with

Iower marketing ability tend to invest in host countries where

institutional distance is larger.

Global integration

Different measures have been developed for global integration strategy in the

literature, for instance, ethnocentric vs. polycentric (Perlmutter, 1969), global vs.

multidomestic (Porter, 1 98 6), global vs. multinational (Barlett & Ghoshal, 1 989), and

global rationalization vs. lateral centralization (Roth & O'Donnell, 1996). In essence,

al1 these authors treat the global integration strategy as a dimension ranging fiom

bbglobal" to "multidomestic". The former requires the MNE to concentrate its

production and administrative activities in one location in order to reap the cost and

control advantages of economies of scaIe. With the latter strategy, foreign

subsidiaries focus on their local markets, carry out production and marketing

activities locally, and have a significant measure of autonomy from the headquarters

(Ghoshal & Westney, 1993). Hill, et al. (1 990) also discussed the conbrol implications

of MNE strategies. A global strategy is associated with high control, while a

multidomestic strategy is associated with low control.

These two kinds of strategy actually represent two conceivable motivations of

foreign expansion: market expansion and value chain expansion. The former suggests

a locally oriented strategy that caters to host market demand and consumer needs. The

latter requires that the host country sub-units be integrated into the MNE7s global

value chain. Rosenzweig and Singh (1 99 1 ) argued that foreign subsidiaries with a

multidomestic strategy are more dependent on local resources and therefore have a

greater need to gain legitimacy locally, while MNEs with a global strategy are more

dependent upon other units in the MNE to provide managerial know-how,

technology, capital, and key personnel, and consequently, more subject to

institutional pressures from the parent firm. A logical extension of tbis argument is

that MNEs with a gIobal strategy, or hi& level of global integration, will tend to

invest in host counûies where institutional distance is small; otherwise, they will

encounter difficulties in the parent-subsidiary cooperation due to conflicting

institutional rules and noms. MNEs with a mu1tidomestic strategy, or low level of

global integration, on the other hand, do not have such a restriction. They have the

latitude of investing in institutionally distant markets since they do not rely as heavily

on the parent-subsidiary coordination and are less concerned about institutional

conflict.

It should be noted that the above institutional theory based explanations are

not fblly consistent with transaction cost arguments. The latter would suggest that

firms with a multidomestic strategy, or a low integration level, prefer a host

environment sirnilar to the home environment, because the transactional costs of

dealing with local partners and customers can be minimized this way. O n the other

hand, firms with a globa! strategy, or a high integration level, do not incur high

transactional costs since they have relatively fewer interactions with the local market.

Consequently, these h s are willing to invest in institutionally distant countries.

However, as discussed in the next section, f?om an *htitutional perspective, local

legitirnacy is important in any event regardless of the industry the fïnn is in. Before

1985, for instance, MEA succeeded in selling Swedish-designeci products in the same

manner across Europe, with a highly integrated strategy. When it expanded to

institutionally more distance North Amerka, however, the emphasis on its Swedish

roots caused serious legitimacy problem for the company. Under this circumstance,

the company had to either withdraw fiom the market or redesign the entire strategy.

En IKEA's case, the company switched to a more locally-oriented strategy (Hill &

Jones, 1998). For a locally-responsive h, internai integration would be not an issue

in the first place. And the firm shouId operate where there is a market, and cater to

local needs, regardless of the institutional distance.

Hypothesis 2. MNEs with higher levels of global integration tend to

invest in host countries where institutional distance is smaller; MNES

with lower levels of global integration rend to invest in host countries

where institutional distance is larger.

Firm diversity

Firm diversity can be reflected in many forms, including corporate culture and

values, number of shareholders and creditors, decision-making process, personnel

composition, source of input, and most commonly, product markets. A diversified

organizational structure suggests that the finn is not dependent on one single source

for resources, and that the firm is more easily subject to influences fkom multiple

institutional constituents (Oliver, 199 1 ). It also points to a lower degree of consensus

within the firm as to what institutional d e s and noms to abide by. These suggest

that the aggregate influence of those multiple institutional constituents will be less

clear.

Kondra and Hinings (1998) suggested that organizations within an

institutional field may undertake coercive (or mimetic) responses to firms that deviate

fiom noms of the institutional field, and they speculated that the stronger the

institutional pressures, the less fiequently will such deviation be observed. The MNE

system has been regarded as an institutional field that exerts institutional pressures on

its subunits (Kostova & Zaheer, 1999; Rosenzweig & Singh, 199 1 ; Westney, 1993). It

can be argued that a high level of h diversity across the MNE system reduces the

level of institutional pressure that the M'NE, as an institutional field, can impose on a

foreign subsidiary. In other words, a high level of diversity raises the MNE's level of

tolerance towards different institutional rules and noms exhibited at the foreign

subsidiary. MNEs with a less diversified structure, on the other hand, will not be as

tolerant towards deviations from home-country-based institutional noms and

organizationai practices. In order to avoid institutionai confiict, therefore, the Iatter

will only invest in markets where the institutionai rules and noms are similar to those

of the home country, namely, in markets where institutional distance is small. Many

multinational companies, for instance, tried to increase i n t e r m diversity by forming

global strategic alliances (GSAs) with other firms in an attempt to adapt themselves

to foreign investment environrnents. These GSAs also rqresent an emerging

institutional field (Parkhe, 199 1 ). In 1990, two companies with substantial differences

in management style - Daider Ben . and Mitsubishi - held secret talks in Singapore

to foxm sirategic alliances in overseas markets (Business Week, 1990). The former

had an orderly Gexman corporate structure, while the latter was known for its

leaderless group management approach. This diversity was necessary for the two

companies to absorb the cultural and institutional shocks when going to an

"unfâmiliar" host country.

Hypothes& 3. MNEs with higher Zevels ofJm diversity tend to invest

in hosr counhies where institutional distance is larger; MNES with

Iower bels of firm diversity tend to invest in host counrries where

institutional distance is srnaller.

3.2.2. Institurionai Distan ce and Subsidiary-Level MNE Strategies

In this section. 1 examine the effect of institutional distance on the choice

between joint ventures and wholly owned subsidiaries, on the level of equity

ownership, and on the presence of expatriates in foreign subsidiaries. The first two

questions are about strategic control over the foreign subsidiary. The third question

reflects the level of operational control that the MNE has in the foreign sub-unit. A

high level of control naturally leads to a high level of intemal conformiW. It also

implies, however, that the foreign sub-unit may be l a s atnined to the Iocal

environment.

Once a host country has been chosen, the first priority for the M'NE is to

overcome the liability of foreignness (Zaheer, 1995; Zaheer & Mosakowski, 1997). It

needs to acquire local legitirnacy in order to survive in the host environment. This

requirement is particularly salient in host countries where the institutional

environment differs substantially from that of the home country. Therefore, my basic

proposition is that MNEs will first try to mnfom and adapt to the local institutional

environments, thus rnitigating the Iiability of being foreign in countries with a large

institutional distance. This means that they will have to give up some of the demand

on sirategic and operational control over the sub-unit. Specifically, 1 hypothesize that

in institutionally distant countries, MNEs are more likely to give up sorne strategic

conml over their sub-units by formuig joint ventures with local partners and by

taking a Iowa ownership position. They are also more likely to give up some

operational contro! by sending fewer expatriates to overseas sub-units.

A second theme in this section is that the level of control is associated with

levek of resource cornmitment and risk (Delios & Beamish, 1999b). To achieve

higher control over the foreign subsidiary, either through increased equi ty

involvement or by sending more expatriates to the sub-unit, the MNE has to commit

more financial and human resources, and hence faces a higher risk exposure, As a

large institutional distance represents a higher level of risk, therefore, the MNE will

iry to alleviate this nsk by reducing its resource cornmitment and by opting for a

lower level of control in institutionally distant countries. These will be elaborated in

more detail below.

Enîry mode

Establishing a joint venture with a local partner is an important mechanism by

which the MNE can obtain local knowledge (Hennart, 1988; Inkpen & Beamish,

1997; Makino & Delios, 1996), secure local legitimacy (Zaheer, 1995), and share

resources and risks (Beamish & Banks, 1987; Inkpen & Bearnish, 1997). In

institutiondl y distant countries, these benefits provided by a local partner are crucial

for the MNE.

MNEs face challenges in institutionally distant foreign markets due to

differences in the exteniai environment (Delios & Beamish, 1999b). They have to

make srnse of, and abide by, complex local laws, rules. and regulations, and deal with

various re-datory institutions. They also have to establish and support business

relationships including clients, suppliers. and cornpetitors in different value and

cultural systems. A local partner may greatly d u c e the time and cost involved in

achieving these objectives. It is generally accepted that greater cross-counw

differences will require higher levels of cooperation in the form of equity

involvernent by local partners (Contractor & Kundu, 1998; Kim & Hwang, 1992;

Kogut & Singh, 1988). Moreover, a large institutionai distance is associated with the

difficulty the MNE faces in obtaùiing local legitimacy (Kostova & Zaheer, 1999). A

local partner certainly may help overcome this disadvantage.

Investment in an institutionally distant country is also inherently ris@ because

of differences in political, cultural, and market systems (Kogut & Singh, 1988;

Madhok, 1997). OAen incremental involvement in such foreign markets is advised

(Johanson & Vahlne, 1977). The transaction cost perspective suggests that MNJ3

need to baIance the cost/uncertainty of investment with the level of intemalization

(Agarwai & Ramaswami, 1992; Erramilli & Rao, 1993; Gatignon & Anderson,

1988). Given the disadvantages and risks of operating in institutionally distant

markets (Kostova, 1999; Kostova & Zaheer, 1999), it is desirable for the MNE to

share equity investment with local partners (Bearnish & Banks 1987; Hennart 1 988;

Kogut 1988) in order to lower the risk level. When China just opened its market, for

instance, the dominant mode of entry was joint venture, not o d y because there were

strict restrictions in some industries, but also because China was institutionally (in

terms of regulations and business noms) "distant" to the rest of the world. The joint

venture mode was considered as a safe and efficient way of sharing risks, gaining

experience, and building networks in China (Beamish, 1988)- For example, the well

established "guanxi" networks of China Postal and Telecornmunication Corp. (CPTC)

have given a tremendous boost to the growth of Shanghai Bell Telephone Equipment

Manufacturing Co., one of the most profitable Sino-foreign joint ventures in China

(Luo, 1998). Therefore, 1 hypothesize,

Hypothesis 4. MNEs will fmor local-partner joint ventures over

wholly owned subsidiaries in imtiiutionally distant host countnes.

Level of Ownership

in addition to modal choice, the decision on the appropriate level of equity

ownership in the foreign subsidiary is also a crucial one (Delios & Beamish, 1999b;

Gatignon & Anderson, 1988; Gomes-Casseres, 1989). Equity ownership detennines

the level of control the parent firm has over the sub-unit, through either the

appointment of board members or the placement of key managerial personnel (Child

& Faulkner, 1998). Even though it can be argued that other means of control, such as

placing expatriates in key positions, can ensure control over daily operations in the

new entity, equity ownership is an effective means of acquinng strategic contrai

(Hennart, 1988; Pan, 1996). Choosing a Iow level of equity invoIvexnent may mean

that the M N E is giving up a substantial part of strategic control to the local partner

and allowing the latter to play a larger or even leading role in the joint venture.

Although it may be every firm's desire to keep a high level of strategic control

internally, there is a greater need for the MNE to conform to the externd institutional

environment in order to sunive and succeed. These intemal and extemal pressures

may not constitute conflicting demands on the subsidiary where institutional distance

is small. When institutional distance is large, however, the need for the subsidiary to

conform and adapt to the local environment will arguably take precedence over the

desire of the MNE to keep intemal confomiity and control. A Iarger roIe on the part

of the local partner will enable the joint venture to secure legitirnacy and compete

well in the complex regdative, normative, and cognitive environments of the host

country.

Equity ownership also determines the arnount of resource contribution (Child

& Fadher , 1998; Harrigan, 1985). Following previous reasoning leading to the

choice of entry mode, 1 argue that the MNE will choose low resource cornmitment

and low sû-ategic control in host countries with a large institutional distance. Existing

literature suggests that the greater the differences between two couniries, the lower

the level of equity involvement chosen by the MNE in the host country (Contractor &

Kundu, 1998; Hill, et al., 1990; Kogut & Singh, 1988). An important reason for this is

that the MNE will assume a low equity ownership when there is a high Ievel of nsk

associated with the host market (Delios & Beamish, 1999b). Institutional distance is

an indicator of such risk. By assurning a low level of equity ownership, and hence a

lower level of resource cornmitment, the MNE will be less exposed to the risks and

uncertainty of doing business in an institutionally distant country. In MarcWApril,

2000, for instance, two joint ventures were formed in the petroleum industry in China.

One of them was between PetroChina Co. and Cheung Kong Infhstructure Holdings

of Hong Kong, the other between PetroChina Co. and BP Arnoco of the United

Kingdom. While Cheung Kong had a 51 percent stake in the former, BP Arnoco had

only 20 percent equity in the latter (China Business Review, 2000). The larger

institutional distance between the United Kingdom and China probably played a role

in this difference. Taken together, 1 hypothesize,

Wypothesis 5. MNEs will favor a lower latel of equity ownership in

subsidiaries Iocated in institutionally distant host couniries.

Presence of Expatriates

Apart fiom exerting strategic control through ownership, MNEs may also try

to secure control over a foreign subsidiary's daily operations through their expatriate

workforce overseas (Beamish & Inkpen, 1998). A primary motive of keeping

expatriates abroad is to ensure that the subsidiary adheres to corporate goals and

objectives of the parent firm (Beamish & Inkpen, 1998; Boyacigiller, 1990). As

discussed earlier, when the institutional distance is large, the MNE has a p a t e r need

to adapt to the locai environment. in such instances, it would be wise to rely more on

local personnel in the daily operations of the sub-unit. Local employees bring in locai

expertise, local networks. and a way of doing business that is consistent with local

customs (Wong & Law. 1999). These will facilitate the process of establishing

legitimacy for the MNE in the host country.

Heavy reiiance on expatriates, on the other hand, puts the sub-unit at a

disadvantage in institutionally distant locations. Expatriates do not know the local

market as well as local employees. It will take extra tirne and resources for them to

leam and acquire the necessary knowledge to compete effectively in an unfamiliar

environment. Furthemore, the desire of expatriates to uphold interna1 conformity

may be perceived as a threat to the way of doing business by local employees due to

differences in institutional noms and perceptions. Differences in educational

background, corporate training, sotietal values and d e s between expaîriates and

local emplo yees are breeding grounds for intra-organizational con flicts (Davis &

Rasool, 1988; Doucet & Jehn, 1997). To ensure smooth operations at the foreign

subsidiary, therefore, the MNE has to rely more on local employees to avoid these

potential problems in institutionally distant locations. in an extreme case, Lotus

Development Company appointed a team of local executives in their Japanese

subsidiaries with idiocentric cultural values (i.e. individualists within a collectivist

culture) in order to reduce such potential conflicts (Gomez-Mejia & Palich, 1997). In

contrast, it is h o w n that Japanese managers lacked responsiveness, hence legitimacy,

in culturally distant countries, which affected their performance (DeNero, 1990).

in short. the costs and nsks of maintaining a large expatriate workforce are

particularly hi& in institutionally distant locations. As discussed earlier, the MNE

will try to minimize its resource cornmitment and opt for a low control mode when

facing high nsks and uncertainty. Taken together, 1 hypothesize,

Wypothesis 6. MNEs will favor a srnuller exputriate worworce in su&

units Iocated in institutionally distant host countries.

While this relationship holds with both joint ventures and wholly owned

subsidiaries, 1 argue that it will be stronger among wholly owaed subsidiaries than

among joint ventures. Although the choice of wholly owned subsidiary is often

motivated by the desire of the MNE to maintain internai control and confonnity

(Davis. et al., 2000), the MNE can still rely on local personnel to establish extemal

legitimacy when institutional distance is large. When institutionai distance is srnail,

however, legitimacy is no longer a big issue. The MNE can rely more on expatriates

fiom the home country. These expatriates can function effectively in an environment

that is sirnilar to their home environment, and are in a better position than their local

counterparts to uphold control and conformity within the MNE system.

in cornparison, 1 have argued earlier that the motive for setting up a joint

venture is for the attainrnent of local expertise and local legitimacy, probably at the

cost of losing some interna1 control. Even in situations where institutional distance is

small and the need for local p e r s o ~ e l is not as strong, the number of expatriates

placed in key positions in the joint venture is more likely to be determined through

negotiation with the partners rather than solely by the MNE's desire to maintain

intemal control and conformity. Thus, 1 expect that institutional distance affects the

nurnber of expaîriates to a lesser degree in joint ventures than in wholly owned

subsidiaries.

Nypothesis 7. The negative effect of institutional distance on the

presence of expaîriates wilZ be sRonger among whoZ4 owned

subsidiaries than anzong local-parmer join t ventures.

Performance implications

Oliver's (1991) proposition that h n s respond to institutiond processes

strategidly and in accordance to their self-interests suggests that there shodd be

positive performance consequences of strategic behavior following this pattern. It has

long been argued in strategic management that the effect of strategy on £bm

performance is contingent on the context, or in other words, there m u t be a "fit"

between strategy and context in order to achieve higher performance (Prescott, 1986;

Venkatrarnan, 1989; Venkatraman & Prescott, 1990). In the international area, if the

MNE chooses a certain ownership or expatriate strategy in response to the

institutional context of the host country, then we can expect to see a positive effect of

such a strategy on the performance of the MNE at the subsidiary level. Ln other

words, if firm behavior is consistent with what is predicted in the preceding

propositions in this section. firm pwformance will be higher. Here 1 propose the

following:

Hypothesis 8a Subsidiaty pe$ormnce will be higher if the MATE

t a k a high ownership position where institutional distance is srnuII,

or a low ownership position where institutional distance is large.

Hypothesis 86. Subsidiary petfiormance will be higher ryrhe MNE send

more expatria tes to subsidiaries where institutional distance is sml l ,

or send faver expatriates to subsidiaries where institutional distance

is large.

3.2.3. Instr'tutional Distance and M7\rE Dntersijiiation in the Wost Country

The logic for a host country level diversification strategy

As discussed in Chapter 2, diversification is a heavily researched area. A

widely held belief is that firms diversi@ to reduce risk or uncertainty. Total fim-

specific risk can be reduced if cash flows h m the firm's separate business units are

not perfectly correlated (Markham, 1973). This view was criticized by researchers

f?om both finance (Levy & Samat, 1970) and strategy (Teece, 1980' 1982)' who

argued that nsk-reduction shouid not be the motive since investors can divers@ their

own portfolio. Yet there are counter arguments. Amihud, Dodd, and Weinstein

( 1986). for example, suggested that diversification through individual portfolios can

not achieve the same result as firm diversification- Others also argued that firm

diversification can lower employment nsk to managers (Hoskisson & Turk 1990)

and attract quality managers without inordinate increases in compensation (Marshall,

Yawitz, & Greenberg, 1984). As Hoskisson and Hitt (1990) commented, this is

relevant to strategic management because it suggests that managers can have an

impact on risk that can not be obtained through individual podolio management.

Product diversification, however, can only reduce firm-specific risk due to

industry or segment variability. It does not reduce systernatic risk affecting dl h s

within a national market. International or geographical diversification, on the other

hand, can achieve the latter objective. Researchers in internationd management have

focused on global product diversification and examined the effects of both product

and geographical diversification (Barkema & Vermeden, 1 998; Delios & Beamish,

1999a; Geringer, et al., 1989; Geringer, et al., 2000; Kim, et al., 1989, 1993; Tailman

& Li, 1996). As many researchers have argued, the one general reason for

international diversification is risk spreading (Caves, 1982; Hisey & Caves, 1985;

Reuer & Leiblein, 2000; Rugman, 1 979; Wolf, 1 977). Global market diversification

can, arnong other things, allow firms to minimize the effect of adverse changes in a

country's interest rates, exchange rates, wage rates, and commodity and raw material

prices by providing the added option to more readily shift production and sourcing

sites to other more favorable national markets (Kogut, 1983. 1985; Porter, 1986). It

also releases firms fiom supply and demand fluctuations of any one nationai market,

smoothing the peaks and troughs of firms' revenue Stream (Kim, et al., 1993). Based

on real options theory, multinational diversification has b e n seen as providing a

portfolio of options that enable a firm to reduce downside nsk by shifting value-chain

activities across national borders in response to environmental contingencies (Allen &

Panlalis, 1996; Reuer & Leiblein, 2000). The combinecl effect of product and

geographical diversification, therefore, is that both industry-specific and country-

specific risks are reduced.

When examining international product diversification, however, none of the

above-surveyed studies addresses product diversification within each geographical

market, or geographical diversification within each product category. In fact,

reduction of industry-specific risk and reduction of country-specific nsk c m not be

simultaneousl y achieved if these two kinds of diversification do no t overlap perfectI y.

In the simplest case, suppose a fin can achieve fidl industry-specific risk-reduction

by diversifjmg evenly into two industries, A and B. Also suppose the firm can

achieve full country-specific risk-reduction by diversimg evenly into two countries,

X and Y. If, for example, the firm has only exposure to industry A in country X and

industry B in country Y, then any adverse change in country X would also negatively

impact industry A, disrupting the "product balance" of the h. Similady, any

adverse change in industry B would also affect country Y, disrupting the "country

balance" of the firrn. The firm, therefore, can only achieve total risk-reduction (of

both risks) by having exposure to both industries in both counûies.

In addition to the above corporate level consideration, managers at the

headquarters (if any) in a host country may have motives to diversi@ within the host

country that are sirnilar to those of the corporate level managers. Just as corporate

managers cannot diversify their jobs (Hisey 22 Caves, 1985), managers at country

headquarters cannot diversi@ theirs, either. Therefore, they may be risk averse and

try to build a diversifiai operating portfolio within the country.

Institutional distance and product diversification in host country

The motivation for diversifjmg away industry-specific risk within a country,

however, should be negatively related to the country-specific risk. If risk specific to a

particular country is hi& then the proportion of industry risk to the total risk within

that country is relatively low. Consequently, the benefit that can be obtauied from

reducing industry-specific risk in that country becornes less significant. This

consideration also applies from the perspective of the country managers. If total risk

in a country mainly coma from uncertainties that affect al1 industries in that country,

then managers in that country wiIl not be better off by pursuing diversification

regardless of their risk preference. Generally speaking, there exists a risk-retum

performance tradeoff for firms (Amit & Livnaf 1988). Expansion into hi&-risk

national markets, therefore, is motivated more by profit incentives than by risk

spreading. Correspondingly, corporate strategy in high-risk markets should be a

focused one, as opposed to a diversified one.

Whiie country-specific nsks are rnany, including, for example, political risk of

the country, here 1 argue that institutional distance represents risk or uncertainty

arîsing fkom business operations in an unfamiliar or unfavorable institutional

environment. The regulative distance (distance dong the regulative dimension), for

instance, reflects the extent of uncertainty due to a different regulatory and legal

environment. The normative distance, on the other hand, represents the social aspect

of such uncertainty.

This line of reasoning is also consistent with previous hypotheses based on

resource commitment. Diversification usually requires a high level of corporate

cornrnitrnent in the form of interna1 funding, especially at the host country/subsidiary

level, where equity funding is not available. If, as argued earlier, a large institutional

distance will lead to low resource commitment in the host country, then it will also

lead to less intensive diversification activities.

Ln addition to the above nsk-based rationale, recent literature has also linked

diversification to building institutional support. in a series of publications, Khanna

and Palepu (1997, 2000a, 2000b) proposed that in emerging markets, diversification

may be preferred because it enables the affiliated fhns to fil1 the 'institutional voids',

Le., creating a supportive institutional structure that is typically lacking in those

markets. Empirical results based on data from locaI firms in ChiIe and India have

supported their hypotheses. Khanna and Palepu (1 997) suggest that diversified

business groups can irnitate institutions that are lacking in emerging markets, such as

capital, labor, and product markets, as well as goverrunent regulations and contract

enforcement.

For MNEs operating in emerging markets, however, the benefits of building

up institutional support intemally among diversified sub-units may not be as great as

for the local firms. Some of these benefits are not available to the same degree to the

MNEs. For a long tirne, for instance, China has maintained a tight control over the

labor market by enforcing a resident identification (hukou) system. Movement of

labor, even within the same MNE, was not easy until vwy recentiy. More

importantly, the "liability of foreignness" (Zaheer, 1995; Zaheer & Mosakowski,

1997) is particularly heavy for MNEs diversimg into the emerging markets. These

firms may encounter serious legitimacy problems in countries where the institutional

environment is very different from their own (Kostova & Zaheer, 1999).

Diversification in those muntries may help build up some institutional suppoa within

the business group, but it can not solve legitimacy problems for the group as a whole.

On the contrary, diversification can exacerbate the extent of legitimacy problems for

the MNEs. This is because by adopting a diversified strategy, the MNE is creating

institutions of its own, which are substantially different or even contradictory to the

host institutions. The MNE is not adapting to, but challenging, the existing

institutions. This strategy is particularly risky in the emerging markets, where

nationalist sentiments are common, and IocaI political and economic institutions are

jealously guarded.

Based on the above reasoning, 1 believe that Khanna and Palepu's (1997)

proposition will not apply to MNEs operating in the emerging markets. On the

contrary, the level of institutional support in a host country is an important constraint

on the MNE's diversification strategy in that country. The lower the level of

institutional support (as in many emerging markets), the more likely a focused

strategy will prevail over a diversifiecl strategy.

The essence of Khanna and Palepu's proposition, however, is not about the

emerging markets. It is really about markets that have a substantially different

institutional environment from the home institutions. For instance, even in developed

markets, a foreign firm can experience the lack of "institutional support" because of

different institutional noms and niles. The United States is an extreme example of a

country where there are few "institutional voids" (Khanna & Palepu, 1997). But we

don? see many Taiwanese firms diversi@ in the US. (Acer will probably never sel1

soft drinks), because they lack the legitirnacy to do su, even though there is good

institutional support in the US. In contrast, people wouldn't be surprised to see a

Canadian fhn diversiS. south of the border. "Khanna and Palepu's proposition,

therefore, c m be tested using institutional distance as the explanatory variable. It c m

be expected that MNEs will have substantial institutional support in their home

countries. and less support in host countries. The level of institutional support that a

foreign subsidiary can obtain is negatively correlated to the institutional distance

between the host and home countries. Combining above arguments:

Hypothesis 9. The MNES b e l of product diversification in a host

country wifZ be negatively reZuted to the institutional distance of that

host country.

Performance implications

A logical extension of the above arguments is that a focused strategy where

institutional distance is large, or a diversified strategy where institutional distance is

small, will lead to higher MNE performance in the host country. This is consistent

with the "fit" argument (Prescotî, 1 986; Venkatraman, 1 989; Venkatraman &

Prescott, 1990) discussed earlier, Le., the contingency relationship of context,

strategy, and firm performance. In the diversification case, the level of diversification

is the "strategy", and institutional distance is the "context". It is somewhat surpnsing

that when studying diversification, researchers have not paid much attention to the

moderating effect of the host country context on the relationship between

diversification strategy and performance in that country. It is inconceivable that there

is a universal diversification strategy that fits al1 countries, because such a proposition

would be against some basic principles of strategic management. Theories developed

in this section suggest that the effectiveness of a diversification strategy depends on

the institutional distance between the host and home countries. This relationship can

be summarized in the follo wing hypothesis:

Wypothesis 10. A high level of product diversification where

instimtional distance is srnall, and a Zow b e l of product

diversification where institutional distance is large. wiZ1 both lead to

higher MNE peflormance in the host country.

4. DATA SOURCES, MEASURES, AND SAMPLE CHARACTERISTICS

4-1- Data Sources

The main source of subsidiary level data used here is Kaigai Shimhum

Kigyou Souran, Kuni-Betsu (Japanese Overseas investments - By Country) published

by Toyo Keizai inc., a large Japanese compiler and publisher of business-level,

statistical, and economic information. The data were based on responses to a large-

scale, annual survey sent to top-level managers in Japanese foreign subsidiaries. It

was reported that this annual survey covers close to the population of overseas

affiliates for the Japanese companies included (Yamawaki, 199 1). The main source of

parent firm uiformaîion is the Analysrs' Guide @aiwa hstitute of Research, 1996),

which reports fim-level data gathered in a 1 996 survey of 1,124 companies listed on

the first section of the Tokyo Stock Exchange, and aggregates of industry-level

information based on a survey of 1,5 15 fimis. Additional parent level information

was gathered f?om the GlobalVanrage database and the Japan Company Handbook,

both of which comparable to the Analysts Guide, and Principal International

Business: The World Marketing Directory, which is compiled b y Dun and Bradstreet.

A database was built combining these sources by the Richard Ivey School of Business

under Professor Paul Bearnish. The 1997 edition of the database, on which this study

is based, contains information on 18,206 Japanese foreign subsidiaries.

The importance of this database is being increasingly recognized, and its

reliability well accepted by the academic community, as evidenced by a growing

number of studies piiblished in reputable journaIs, including the Academy of

Management Journal (Delios & Henisz, 2000), Journal of International Business

Studies (Anand & Delios, 1997; Makino & Delios, 1996; Woodcock, Bearnish, &

Makino, 1994), and Strutegic Management Journal (Delios & Beamish, 1999%

1999b; Lu & Beamish, forthcoming), based on this information. It has been seen as

an expansion of, and improvement over, the Harvard Multinational Enterprise

Project, which stopped in 1975 (Vernon, 1997).

Final1 y, country-level data are main1 y from the Global Competitiveness

Report (World Economic Forum, 1997), which will be discussed in more detail

below.

4.2. Development of the Institutional Distance Measure

Kostova and Zaheer's conceptualization of institutional distance is usefül

when very specific issues are involved, and when the number of corntries under

examination is very small. Kostova (1 997) measured the "institutional profiles" of ten

nations (and implicitly, the institutional distance between each two of the ten

countnes) in tenns of one particular domain, i.e. quality management in business

organizations, using a survey instniment. This domain-specific and issue-specific

measurement ( H o f i a n , I999), however, would be less practical when the

institutional environment under exarnination is one that is in the general sense,

affecting many aspects of FDI and the MNE.

Quantifjmg the institutional environment in such a general sense would

probably involve a large-scaie s w e y similar to that in Hofstede's (1980) study on

national culture, which is beyond the scope of this research. There are, however,

existing sources that can serve as acceptable substitutes. One such source is the

Global Compeririveness Report series published annual1 y b y the Geneva-based World

Economic Fonim. The 1997 edition of the Report includes 170 variables that are

believed to contribute to the competitiveness of nations. These variables are grouped

Uito eight factors: openness, government, finance, infiastructure, technology,

management, labor, and institutions. The 6th and 8th factors, management and

institutions, are based excIusiveIy on survey data and correspond to the normative and

regdative pillars of the institutional environment, respectiveIy, as defined by Scott

(1995). They are the Ieast weighted contributing factors to national competitiveness

arnong the eight, each accounting for 1/18 of the total weight (World Economic

Forum, 1997). The survey data were collected through the World Economic Forum's

1997 Executive Survey, which was an upgrade from previous surveys. The

questionnaire was sent out to 58 countries in every continent. Over 3,000 completed

questionnaires were received, thanks to the strong support of the Forum's corporate

constituency and the efforts of partner institutes and collaborative govenunent

agencies in many countries (World Econornic Forum, 1997: 85). Responses to the

survey questions were obtained on a scaie ranging fiom 1 (strongly disagree) to 7

(sirongly agree). The country scores on each item are aggregate scores representing

the average of responses fiom that country.

The "institutions" factor consists of nineteen sub-factors (survey items) that

describe a country's civil systerns. Each of the sub-factors has an item nurnber.

Arnong these 1 selected items that deal directly with the Iegal and regdatory aspects

of the civil institutions. The criteria are based on Scott's (1 995: 35) conception of

regulative processes - de-setting, monitoring, and sanctioning activities. They can

be characterized as coercive, instrumental, and legally sanctioned. "Market

dominance", for instance, is not considered part of these processes and therefore is

excluded, while the 'kpartiality of arbitration" in the country £ 3 ~ the definition and

is included. As a result, seven items are selected, covering many aspects of the legal

and regdatory environment surrounding the multinational enterprise. These include

anti-trust laws, legal systems, impartiality of arbitration, settle of disputes,

institutional stability, effectiveness of police force, and product liability. Factor

analysis confirmed a one-factor solution. Al1 items except one (product liability) have

a factor loading of -70 or greater. Factor loading on product Iiability is .45. The

s w e y question reads "Legal claims for product Iiability are not an important cost of

business in your country". Subsequently, this item was dropped. The six remaining

items have a Cronbach's alpha of -93. The simple numerical average of these six

items was taken as the country's score on its regulative dimension. Appendix 1

provides a description of these items as well as their respective factor loadings.

From the "management" factor, which consists of eighteen survey items that

descnbe a country's managerial practices, 1 selected those items that suggest

managerial attitudes and noms. Acmrding to Scott (1995: 37), norms speciQ how

things should be done; they define Iegitimate means to pursue valued ends.

Normative systems define goals or objectives but also designate the appropriate ways

to pursue them (e.g., conceptions of fair business practices). Based on Scott's

conception, seven items were selected. They include product design, customer

orientation, staff training, willingness to delegate, performance-related pay,

professional managers, and effectiveness of corporate boards. Factor loadings on al1

these items are -79 or greater, and the Cronbach's alpha is -94. The simple numerical

average of these seven items for each country was taken as the counîry's score on its

normative dimension. Descriptions and factor loadings of these items are also

provided in Appendix 1.

Unfortunately, there is not a factor in the Global Cornpetitiveness Report that

can be used as a proxy for Scott's third pillar, the "cognitive" aspect of the

institutional environment. 1 expect, however, that the cultural distance measure

commonl y used in international business research (Kogut & Singh, 1988) will have

effects similar to those of cognitive distance since culture, as "mental programming"

(Hofstede, 1980, 1997), is closely related to cognitive systems. I treat cultural

distance as a separate variable, instead of integrating it into the institutional distance

measure. This will also enable us to see if institutional theory and the cultural

perspective support each other.

A "distance" index for each of these two aspects is derived using Kogut and

Singh's (1988) approach to cultural distance. Kogut and S i n a used the following

formula to calculate the cultural distance between the United States and a host

country:

Co, = Pi=, ((4 - I*)* / Y;) /4

where 2, stands for the index for the ith cultural dimension and jth country, 6 is the

variance of the index of the ith dimension, u indicates the United States, and CDj is

culturd distance of the fi country fiom the United States. The formula is now

modified to take Japan (instead of the United States) as the home country, and

accommodate two institutional dimensions, regulative and normative, instead of four

cultural dimensions. The regulative distance (distance dong the regulative dimension)

between Japan and a host country is calculated as follows:

REG-D1STi = ((, - 1d2 / Vr

where REG-DISZ is the regulative distance of the ith country fiom Japan, I,+ and I,

are the index scores of the host country and Japan, respectively, on the regulative

dimension, and V, is the variance of the regulative index. Similarly, the normative

distance (distance between Japan and a host countxy dong the nonnative dimension)

can be derived as follows:

NOR-DIST; = (4; - ln.' / Vn

where NOR-DIST, is the normative distance of the ith country fiom Japan, 1, and In,

are the index scores of the host country and Japan, respectively, on the normative

dimension. and I.',, is the variance of the normative index.

The correlation between the regulaîive distance and normative distance

indices is -64. In order to eliminate potential multicollinearity problems in regression

analyses, therefore, these two indices are combined by taking the average of the two.

Underlying these two indices, however, are two distinctive concepts. A similar

argument was made by Hofstede (1983), who divided an empincally derived factor

into two (individudism/collectivism and power distance) based on theoretical

grounds. The combined scale represents a partial institutional distance index, not

including variations dong the cognitive dimension. Empirically, therefore,

institutional distance involves only two sub-dimensions throughout this dissertation.

A list of host corntries involved in this study, dong with comesponding scores

of institutional distance, regulative distance, normative distance, cultural distance,

and the nurnber of Japanese subsidiaries in each country, is provided in Table 3b in

Chapter 4.4.3.

43. Variables

4.3.1. Variabks for Parent F h Level Analyses

Weighted Institutional Distance. In addition to serving as a detexmining

factor for MNE strategy, institutional distance is also an indicator for host country

choice in my fiamework. To avoid potential mode1 specification problerns,

institutional distance, as a dependent variable, is operationalized as the weighted

average of institutional distance for al1 host countnes in which the MNE has foreign

direct investments. A weighted institutional distance measure reflects the MNE's

overall FDI position dong the institutional distance dimension. The weight is

assigned in two ways: 1) by the proportion of the MNE's sales in a particula. host

country to its totai FDI sales, and 2) by the proportion of the MNE's capitalization in

a particular host country to its total FDI capitalization. The following fonnula is used:

WNS-DIST = Zni=, lN"SDIS~ * (Si /SJ, or

IUALS-DIST = Eni= NS-DISZ * (Ci / CJ

where WTNS-DIST is the weighted average institutional distance for the MNE,

INS-DISTi is the institutional distance (the average of regdative and normative

distance) of the ith country, Si is total sales of the MNE in the ith country, Sr is total

FDI sales of the MNE, Ci is total capitalization of the MNE in the ith country, and C,

is total FDI capitdization of the MNE. As the Toyo K e i z . database contains

information on subsidiary sales, capitalization, and equity shares for the parent firm,

the sales and capitaiization figures for tbe parent firm can be easily calculated For

instance, if the annual sales of a fifty-fifty joint venture amounted to % 1,000,000, the

sales volume of the parent h n of interest in that nibsidiary will be $500,000. This

method applies to al1 aggregated data based on subsidiary sales or capitalization

throughout this dissertation.

Technological intensity. As discussed in Chapter 3, R&D intensity is a

surrogate for technological intensity in general (ErramiIli, et al., 1997). The Toyo

Keizai database contains information on R&D intensity at both the firm and industry

levels. Although not strictly ''firm-specific", industry R&D intensity is also "home-

country-based" and contributes to firm advantages vis-a-vis host-country-based

advantages. Empirical research has shown how industry level technical know-how led

to international expansion and domestic diversification (e-g., Wolf, 1977). It can be

considered as '%m-specific7' for the purpose of this study. Industry R&D intensity

was measwed as the ratio of R&D expenses to sales revenues for the parent fïrm's

industry in Japan. Parent finn R&D intensity was calculated as the ratio of R&D

expenses to sales revenues for the parent firm divided by the same ratio for the parent

firm ' s industry,

Marketing ability. A widely used proxy for marketing ability is advertising

intensity (Allen & Pantzalis, 1996; Erramilli, et al., 1997; Shrader, 2001). Similar to

R&D intensity, it was rneasured at two levels: industry and hn. Industry advertising

intensity was measured as the ratio of advertising expenses to sales revenues for the

parent h ' s industry in Japan. Parent firm advertising intensity was calculated as the

ratio of advertising expenses to sales revenues for the parent firm divided by the same

ratio for the parent hm ' s industry. High R&D and advertising intensity levels

indicate strong home-counî~y-based, fimi specific cornpetitive advantages.

Global expatriate ratio. The level of global integration c m be measured in

many ways. For instance, Harzing (2000) used four dimensions - global and domestic

cornpetition, national responsiveness, and economies of sa le , whiie Johansson and

Yip (1994) provided a Iist of ten variables. In essence, global integration implies

dependence of subsidiaries on the multinational system for information, technology,

management, b d s , and products. Based on this logic, Kobrin (1991) used intrafirm

trade as a proportion of d l international sales as an index of integration. Similady, in

this research a global expatriate ratio, i.e. Japanese expatriates as a percentage of d l

overseas employees of the MNE, serves as an indicator for the level of global

integration. The rationale is similar to that of Hypothesis 6, i.e. the use of expatriates

reflects the extent the MNE controls and coordinates its overseas operations (Beamish

& Inkpen, 1998; Boyacigiller, 1990; Kobrin, 1988; Taylor, 1999). The variable is an

aggregate measure calculated as the sum of Japanese expatriates in al1 foreign

subsidiaries divided by total overseas employment of the MNE. It reflects the extent

the parent b. exercises global coordination and integration throughout the entire

MNE.

Global diversification. Because Toyo Keizai is an archival data source, some

common measures of firm diversity, such as cultural and ethnical diversity, are not

available. The diversity measure used here is a modified entropy method (Jacquemin

& Berry, 1979; Palepu, 1985) to combine both product and multinational

diversification (Kim, et al.. 1993). Suppose an MNE operate in N geographic market

areas or host countries (a):

DZI'ERS-G = zNa=, I3,, Ph ln ( l / P h )

where DIVERS-G is total product diversity of the MNE on a global basis (referred to

as global diversification), and P, is the proportion of the size of the ith business

segment in the ath market area to a firm's total size of operations in terms of sales. In

cornparison to the more traditional classification scheme by Rumelt (1974), this

measwe involves not only the number of business segments (either three- or two-digit

SIC codes), but also the relative importance of each business segment and national

market for the MNE. In addition, it provides a degree of relatedness among the

various product segments (Palepu, 1985).

While the entropy method based on sales data is well accepted in the

diversification literature, this measure has a potential shortcoming when it cornes to

data drawn fiom MNE foreign subsidiaries. A foreign subsidiary may be established

for the purpose of supporting another subsidiary, either in the same country or in

another, e.g. senice centers, R&D divisions, etc. A sales-based entropy measure,

therefore, may not represent the whole picture of firm diversification. On the other

hand, 1 believe capital invested in a subsidiary points to the MNE7s level of

cornitment to the country and industry segment involved. It is an important

indicator of FDI activity. Throughout this study, therefore, 1 use both sales-based and

capital-based entropy methods for various kinds of diversification measures involved.

For global diversification, the capital-based entropy measure is derived using the

above formula, but with Ph representing the proportion of the size of the ith business

segment in the ath market area to a finn's total size of operations in tems of

capitalization.

Log parent sales. Parent firm size is measured in terms of mean domestic

sales (in yen million) of the parent h n in the 1992- 1996 period. Its natural logarithm

form is included in the andysis as a control variable.

Log parent firm FDI orientation. FDI orientation measures the relative

weight of FDI sales to the domestic sales of the parent fbm. It is calculated as the

ratio of al1 foreign sales (in US dollars) in 1997, not including exports, to mean

annual sales of the parent f h (in yen million) in the 1992- 1996 period. The natural

logarithm form is included as a control variable.

4.3.2. Variables for Subsidiury Level An aiyses

Joint venture with local partner. This is a binary variable coded 1 if the

foreign entry was made through a joint venture involving one or more local partners,

and O if through either a wholly owned subsidiary or a joint venture not involving any

local partrier (for simplicity, referred to as a wholly owned subsidiary in this

dissertation). 1 divided the groups this way because 1 was mainly concerned with the

effect of institutional distance on the choice of a local-partner joint venture, as

opposed to other forrns of joint venture. Only local partners are relevant to the

attainment of local knowledge and legitimacy.

Ownership level in the subsidiary. This is a four-category variable coded O

if the parent firm held minority ownership in the subsidiary, 1 if equal (50 percent)

ownership, 2 if majonty ownership, and 3 if 100 percent ownership.

Equity shares in the subsidiary. This refers to the actual equity shares the

parent firm held in the foreign subsidiary (including joint ventures and wholly owned

subsidiaries).

Subsidiary expatriate ratio. Unlike the global expatriate ratio, which is an

aggregate rneasure, the subsidiary expatriate ratio measures the level of control

through Japanese expatriates at a particuiar subsidiary. It is operationalized as the

number of Japanese expatriates divided by total ernployment at the subsidiary.

Subsidiary performance. The variable is a managerial assessrnent of the

subsidiary's pdomance. It has three levels: loss (coded O), break-even (coded l),

and profit (coded 2).

Cultural distance. Cultural distance is calculated using the Kogut and Singh

(1 988) formula introduced earlier, with Japan substituting the United States as the

home country. The variable is included not only for control purposes, but also to

provide evidence of discriminant validity for institutional distance. Discriminant

validity is the extent to which a measure is indeed novel and not simply a reflection of

some other variables (Churchill, Jr., 1979). It is indicated by "predictably low

correlations between the measure of interest and other measures that are supposedly

not measuring the same variable or concept" (Heeler & Ray, 1972). A possible

objection to the institutional distance constmct is that the concept is too similar to

cultural distance and therefore does not constitute an important theoretical

contribution. in addition to the theoretical argument that these two concepts are

indeed different, the lack of correlation between the two (r = -.22 and insignificant)

indicates that these are two empirically distinctive concepts. Including cultural

distance in regression analysis rnay prove that these two constructs have different

effects on MNE strategy.

Log parent fmm international expenence. International experience is

measured as years of FDI experience of the parent fixm at the tirne the subsidiary was

formed. It is computed as the total number of subsidiary years of experience

accumulated in al1 foreign subsidiaries at the tirne of investment. The logmithm form

is included in the analysis as a control variable.

Log subsidiary sales. Subsidiary size is measitred as the logarithm of the

subsidiary's 1997 sales volume in US dollars.

In addition to the above. 1 also include the R&D and advertising intensity

measures, log parent firm sales. and log parent finn FDI orientation as control

variables. Development of the main independent variable, institutional distance, has

been discussed in Section 4.2.

4.3.3. Variables for Host Country Level Analyses

Host-country diversification. This variable is derived by using a modified

entropy formula:

DIVE- = zNj= 1 Pi ln ( I / Pi )

where DIVERS-N refers to total product diversity in the host nation, N is the number

of industry segments the MNE operates in within that host country (based on either

three- or two-digit SIC codes), and Pi is the proportion of the ith segment to the total

sales or capitalization of al1 subsidiaries of the MNE within that country. Four

measures are thus created, based on sales in two- and three-digit SIC categones, and

based on capitalization in two- and three-digit SIC categones, respectively.

Log GDP. The natural logarithrn of the country's nominal GDP is included as

a control for market size.

MNE performance in host country. Traditional measures of firm

performance, such as ROE and ROA, are difficult to attain at the host country level,

since information on these rneasures is typically suppressed in consolidated financial

statements. The Toyo Keizai database, however, contains a three-category subsidiary

level performance measure (profit, break-even, and loss) discussed earlier. Based on

this information, I operationalized MNE performance within a host country as the

percentage of profitable subsidiaries of the MNE out of aI1 its sub-units in that

country.

As well, the R&D and advertising intensity meastues, log parent fïxm sala,

and log parent FDI orientation are inctuded as control variables. The institutional

distance measure used here is the same as in subsidiary level analyses.

4.4. Sample Charac teris tics

4.4.1 Sample Characteristics of Japanese Foreign Subsidiaries

Table 1 provides a profile of the Japanese foreign subsidiaries in the 1997

edition of the Toyo Keizai database. Descriptive statistics for some key variables at

the subsidiary level are iisted in the table. These include sales and capital sizes,

nurnbers of Japanese expatriates and total ernployees, entry mode, equity shares, and

subsidiary performance.

Of the 18206 foreign subsidiaries, information on entry mode and equity share

is the most complete, with only one missing value, followed by capitaiization and

employee information. Sales and performance have the most missing entries, but stilt

with a respectably large sample of over 7,000. The average performance score of the

Japanese subsidiaries is 1.42 on a O - 2 scale. About 60 percent of them made a profit,

18 percent had a loss, and the remaining 22 percent achieved break-even. These

Japanese firms operated in a total of 3 17 three-digit SIC segments and 74 two-digit

SIC industries.

Table 1. Profde of Foreign Subsidiaries

Number Minimum Maxirnurn Mean Standard of Cases Deviation

Capital invested 17335 .O 1 8.8E+09 1.9E+07 1.8E+08 W W

Sales volume 7899 -04 (US$) Log subsidiary 7899 -3.26 sales

Number of total 14407 1 ernployees

Number of Japanese 14085 O emplo yees

Equity share of primary 18205 O Japanese parent (%)

Joint venture with Iocal 18205 O partner (0- 1 )

Subsidiary performance 7070 O (0-2)

Beamish, Delios, and Lecraw (1 997: 1 1 1) pointed out that Japanese

subsidiaries included in the Toyo Keizai database tend to have srnaller size than their

US counterparts fiom other sources, in temis of both capitalization and ernployment

levels. They conjecturai that this was because the Japanese foreign subsidiaries were

mostly "screw-driver" tacilities that imported components fiom Japan and merely

assembled thern in the host country, as opposed to full production operations. On the

other hand, they also acknowledged that this might be partly due to more efficient

production technologies on the part of the Japanese firms.

As to enûy modes, about 34 percent of d l subsidiaries are joint ventures with

at ieast one local partner. The remaining 66 percent are either wholly owned

subsidiaries or joint ventures not involving a local partner. The average equity share

held in the subsidiary across the whole sample is 73.68 percent, while the average

equity share in the joint venture group is 51.14 percent. When divided into four

ownership levels, wholly owned subsidiaries account for 46.8 percent of the sample

(8518 cases), majority ownership accounts for 22.7 percent (4125 cases), and

minority ownership accounts for 25.1 percent (4562 cases). There are dso 1000 cases

(5.5 percent) in which the Japanese parent held exactly 50 percent ownership.

A previous study reported that Japanese fimis tend to assume higher equity

shares in joint ventures than their US counterparts in certain markets (Pan, 1997). On

the other hand, Chang (1945) pointed out that unlike Western MNEs, which o h

make big investments strategically in a short period of time and mainly through

acquisitions, Japanese firms tend to enter foreign markets sequentially due to their

unique culture. They also tend to use a higher percentage of joint ventures as their

eniry strategy (Beamish, et al., 1997: 240). Of the entire Toyo Keizai sample,

acquisitions account for only 3.3 percent of al1 Japmese entries. That is why when

discussing entry mode, 1 have focused on the choice between joint venture versus

wholly owned subsidiary, rather than that between acquisition and greenfield

investrnent. Finaily. close to two-thirds of the foreign entries were made in the last ten

years (Le., in or after 1987).

As shown in Table 1 , capital, sales, and ernployment figures are al1 highly

skewed, with standard deviations substantially greater than the means. A conventional

approach to transfomiing skewed distribution is to take the logarithm values of the

variable. Among these variables, only subsidiary sales is an independent variable in

the analyses. Therefore, 1 took the natural logarithm of subsidiary sales in order to

reduce the skewness of its distribution.

4.4.2. Sample Characteriktics of Japanese Parent F h s

Table 2 provides a profile of the Japanese parent h s involved in the study.

Descriptive statistics for the key variables are listed in the table. These include sales

volume (raw figure and naturd log), FDI orientation (raw ratio and natural log), the

number of foreign subsidiaries, the number of host countries, and the numbers of

three- and two-digit SIC segments.

Of the 901 Japanese parent fims, the average domestic sales voiume is

41 5,122.50 million yen, and the average FDI ratio is 1793.62 dollar/million yen.

These two variables are highly skewed, as indicated by the large standard deviations.

Their natural logarithm foms. on the other hand. exhibit a nomal distribution, as the

ranges are largely within three standard deviations fiom the means. The average

number of overseas subsidiaries is about 1 2, and the average number of host corntries

the MNE operates in is just above 6.

Table 2. Profde of Parent Firms

Number Minimum Maximum Mean Standard of Cases Deviation

Parent sales 830 3925.20 1.7E+07 415122.5 1414366 (yen million) Log parent 830 8 -28 16.66 1 1.84 1.26 Sales

Parent FDI orientation 650 O 194 178.8 1793.62 8755.9 1 (dollar/million yen)

Log parent FDI 615 -2.96 12.18 5.68 2.18 orientation

Number of 90 1 1 334 11.91 25-57 subsidiaries

Number of host 90 1 1 55 6.17 6.80 nations operating in

Number of 3-digit 90 1 O 96 5.17 8.23 SIC categories

Number of 2-digit 90 1 O 44 3.66 4.08 SIC categories

The average numbers of t h e - and two-digit SIC segments are 5.17 and 3.66,

respectively, representing a ratio of about 1 -4: 1. In other words, within each two-digit

industry, the M'NE operates in only 1.4 three-digit segments. Notice that this ratio is

much larger for the subsidiary sample (3 1 7 : 74 = 4.3 : 1 ). Because two-digit industries

are generally seen as unrelated to one another, a preliminary conclusion here is that

for the Japanese parent firms. unrelated diversification is the major form of

diversification. in cornparison, Chang (1 992: 154) reported that US firms participated

in 1 1.8 three-digit SIC segments. This observation conformed with Li and Taliman's

(1996) expectation that Japanese firm had a narrower and more focused scope as

compared to a similar sarnple of US firms (Delios, 1998: 103). One possible reason

for this is that, on average, the institutional distance between Japan and another

country is larger than that between any two other countries due to Japan's unique

institutional and cultural environments. As Hypothesis 9 suggests, this larger average

institutional distance has limited the scope of Japanese operations overseas.

4.4.3. Sample Characteriifics of the Hust Counmès

Table 3a lists al1 countries incIuded in the various analyses, dong with

curresponding regulative and normative scores. Japan is ranked 2 1 st on the regulative

dimension and 1 2 ~ on the normative dimension. Table 3b displays four distance

indices: regulative, normative, institutional, and cultural. The list was sorted by

institutional distance. In addition, the total number of Japanese subsidiaries in each

country is also displayed, with the United States, China, Thailand, Hong Kong,

Singapore, and Britain having the largest shares of Japanese subsidiary distribution.

Obviously, cultural distance does not exhibit sirnilar patterns to the other three

distance measures, an indication that these are two substantially different constructs.

Thus culturaily similar countnes, such as China and Taiwan, may have substantially

different institutional distant scores from Japan. Conversely, some countries that are

culturally distant from Japan, such as Luxembourg and Belgium, are institutionally

close to Japan. This is not surpnsing as in this study institutional distance m e m e s

specifically the regulative and normative differences between two countries. These

regulative and normative aspects are more relevant to business operations. They are

not as intuitive to us as cultural elements.

Table 3a, Countries included in Analyses: Regdative and Normative Scores

Host Regulative Host Normative Count~y Score Country Score

c c2 Nonvay German y Canada Netherlands Finland United Kingdom Switzerland Ausiria Ireland Singapore Sweden Denmark New Zealand Luxembourg Australia United States France Israel Portugal Hong Kong Japan Chile Malaysia Belgium Spain I ~ ~ J Y

Sweden United States Cana& Netherlands Finland New Zealand Denmark S wi tzerland Singapore United Kingdom Norway Japan Hong Kong Luxembourg Ireland Australia Gerrnan y Taiwan Belgium Austria Malaysia Chile France Spain Israel Philippines

Taiwan India Zimbabwe B razil China EgYPt Korea Greece H ~ P ~ Y Slovak Thailand Turkey Argentina Peru Philippines Jordan South Afica Indonesia Czech Poland Vietnam Mexico Ukraine Venezuela Columbia Russia

Brazil Italy China South Afica Indonesia Mexico Thai land Portugal Czech Korea Argentina H w F Y Turkey Slovak Columbia Zimbabwe Vietnam Russia Greece Peru EIzYPt india Poland Venezuela Uluaine

3.08 Jordan 2.82

Table 3b. Host Countries included in Analyses:

Distances from Japan and Number of Japanese Subsidiaries

Host Regulative Normative Institutional Cultural Number of Country Distance Distance Distance Distance Suhidiaries Hong Kong 0.00 0.00 0.00 3 -36 1153 Luxembourg 0.19 0.02 O. 10 2.02 47 Australia 0.15 0.06 0.10 2.79 515 Belgium 0.06 0.15 0.1 1 1.77 157 Malaysia 0.04 0.20 0.12 4.66 79 1 Chile 0.0 1 0.27 O. 14 3.83 49 New Zealand 0.20 0.12 0.16 3.03 104 Denmark 0.24 0.12 O. 18 8.27 21

Ireland 0.35 France 0.02 Singapore 0.30 United Kingdom 0.42 Israei Spain Taiwan Switzerland Finland Austria Gerrnany Norway Netherlands United States Italy Sweden Canada Brazil Portugal China Philippines Korea Thailand H W F Y South Afiica Argentina Zimbabwe Lndonesia Slovak Turke y Czech Mexico India Greece E ~ Y P ~ Peru Vietnam Poland Columbia Russia Venezuela Jordan

5. ANALYSES AND RESULTS

5.1. Parent Fim Level Analyses and Results

To test Hypotheses 1 through 3, both measures of weighted institutional

distance (based on saies and capital) are treated as the dependent variable in

respective OLS regression analyses. The R&D and advertising intensity measures,

global expatriate ratio, and global diversification are the independent variables of

interest, while parent firm sales size and parent firm FDI orientation 00th in natural

Iogarithm) are included for control purposes. They are designed to see if certain

features of the parent firm will help overcome the hurdles caused by institutional

distance. The Toyo Keizai dataset includes 901 primary Japanese parent fhns. After

excluding missing values list-wise, the final sample size is reduced to 394 parent

firrns. Descriptive statistics and correlations for al1 variables are provided in

Appendix 2.

Table 4 displays hdings fiom regression analysis for institutional distance

weighted by sales. The two columns of results are for global diversification in three-

and two-digit SIC segments, respectively. Because the two measures of global

diversification (across three- and two-digit segments) are highly correlated, results

displayed in these two columns are highly consistent.

Table 4. Results of Parent Firm Level AnaIyses based on Sales

Constant

Parent advertising intensity

Parent R&D intensity

industry advertising intensity

Industry R&D intensity

Global expatriate ratio

Global diversification by sales across 3-digit SIC categories

Global diversification by sales across 2-digit SIC categories

Log parent sales

Log parent FDI orientation

R~ Adjusted R~

-.

Weighted institutional Distance by Sales .841 ** -847 ** (.30 1) (-30 1) .O39 ' .O39 ' (.O2 1 ) (.O2 1) -.O06 -.O06 (0.01 1) (.O1 1) -4.649 * -4.650 * (2.305) (-2.3 05) - 1 .584 -1 -589 (1 .lm) (1.104) -.423 ** -.422 ** (. 160) (. 160) -.O57 - (-043) - -.O58

( -045) .O04 .O04 (-022) (.022) -.O30 * -.O3 1 * (.O 15) (.O 15) .O77 .O77 .O58 .O57

N 394 394 Al1 two-tailed tests. Standard errors are in parentheses. t pC.10

Hypothesis 1 predicts that institutional distance will be negatively related to

technological intensity and marketing ability of the parent h. Of the four intensity

measures, three are negatively signed as expected in Hypothesis 1. Among these

three, however, only industry advertising intensity is significant at the p < .O5 level.

On the other hand, parent advertising intensity is signifiant at the p c .10 level but

positively signed. Hypothesis 1 b, therefore, received weak and mixed results, while

hypothesis la is not supponed. The different results for technological intensity and

marketing ability seem to suggest that these two kinds of competitive advantage have

different strategic implications. Marketing ability is perhaps more routine-based and

more market-specific than technological ability, thus more heavily influenced by

institutional factors.

Hypothesis 2 predicts that institutional distance will be negatively related to

the level of global integration of the MNE. The variable for global integration used

here is the global expatriate ratio. This variable is negatively signed and significant at

the p < .O 1 level. Hypothesis 2, therefore, is supported.

Hypothesis 3 predicts that institutional distance will be positively relate. to

firm diversity. The diversity variables used here are global diversification measured

in t m s of sales in three- and two-digit SIC segments. In both columns, global

diversification is negatively signed and insignificant. Hypothesis 3, therefore, is not

supported. Among the two control variables, log parent sales is insignificant, while

log parent FDI orientation is negative and signifiant at thep < -05 level.

Table 5 displays findings from regression analysis for institutional distance

weighted by capital. Sirnilar to Table 4, the two colurnns correspond to global

diversification measured by capitalization in the - and two-digit SIC segments,

respectively. None of the four intensity measures in this table is signiticant, although

three of them are negatively signed as predicted in Hypothesis 1. Results for

Hypotheses 2 and 3 and the cuntrol variables are consistent with those in Table 4, The

adjusted R' is significantly lower in this analysis (-035 versus .077).

Table 5. Results of Parent Firm Level Analyses based on Capitalization

~ e i g h t e d In&tutional Distance by Capital Constant -954 *** -960 ***

(-287) (-285) Parent advertising intensity -.O 1 O -.O 1 O

(-020) (-020) Parent R&D intensity .O07 .O07

(.O 1 0) (.O1 O) Industry advertising intensity -2.887 -2.895

(2.191) (2.19 1) Industry R&D intensity -.384 -.385

(1 -054) ( 1.054) GlobaI expatriate ratio -.411 ** -.410 **

(. 154) (. 1 54) Global diversification by capital -.O37 - across 3-digit SIC categones (.039)

Global diversification by capital - -.O37 across 2-digit SIC categories (.o‘w Log parent sales -.O06 -.O07

(.023) (-022) Log parent FDI orientation -.O23 -.O23

(.O 12) (.O 1 2) R ' .O35 .O35 Adjusted R~ .O1 5 .O1 5 N 394 394

Al1 hvo-tailed tests. Standard errors are in parentheses. t p -c -10 * * p -= .O1 ***p < .O01

5.2. Subsidiary Level Analyses and Results

Entry mode (H4)

Testing Hypotheses 4 through 8 involves using country. industry, parent, and

subsidiary level variables to predict subsidiary level strategy and performance.

Subsidiarïes within each parent fim share certain common charactenstics. In other

words, these subsidiaries fonn "clusters". Therefore, treating thousands of

subsidiaries as independent observations violates the randomness assump tion.

Statistical analysis m u t take such clustering into account in order to obtain correct

standard errors and signiiicance levels (Snidjers & Bosker, 1999). This procedure was

performed using the STATA software for al1 subsidiary level analyses. The 1997

edition of the Toyo Keizai dataset includes 18,206 Japanese foreign subsidiaries.

After excluding cases with missing values list-wise, the final sarnples for various

analyses at the subsidiary level are in the 2,200 - 2,600 range except for the

performance analysis (N = 1,365). Descriptive statistics and correlations among

variables included in al1 subsidiary level analyses are provided in Appendix 3.

Hypothesis 4 was tested with binary logistic regression. Previous research on

entry mode and ownership has included international experience, parent firm and

subsidiary sizes, R&D intensity, and advertising intensity as explanatory variables

(Contractor & Kundu, 1998; Gatignon & Anderson, 1988; Pan & Li, 2000). Statisticai

results are displayed in Table 6 below. The dependent variable here is a binary

variable coded 1 for joint ventures with local partners, and O if otherwise. institutional

distance h a . a significant and positive effect, at the p < 0.001 level, on the modal

choice. The larger the institutional distance between the home and host countries, the

more Iikely the local-partner joint venture mode will be chosen over wholly owned

subsidiq. H 4 is strongly supporteci.

Table 6. Resdts for Entry Mode Analysis

Joint Venture vs. Wholly Owned

institutional distance 1.583 ***

Cultural distance

hdustry advertising intensity

Indusûy R&D intensity

Parent advertising intensity

Parent R&D intensity

Log parent sales

Log parent international experience

Log parent FDI orientation

Log subsidiary sales

Log likelihood Wald Chi-squared Pseudo R-squared N 2339

Dependent variable: Joint venture = 1, others = 0. Al1 two-tailed tests. Robust standard errors are in parentheses. * p < .O5 *** p < .O01

Cultural distance is also positively correlated with the joint venture mode of

entry and is signiticant at the p < -05 level. Among the four intensity measures, o d y

industry R&D is significant @ < -10). And among the other four control variables,

only parent FDI orientation is significant. Parent size and international experience do

not influence modal choice, neither does subsidiary size. The negative signs of

industry R&D and parent FDI orientation suggest that MNEs with higher ownership

advantage and higher focus on overseas sales may tend to choose wholly owned

subsidiaries over joint ventures. The sample size of this regression is 2,339

subsidiaries.

Level of equity ownership (H5)

Level of equity ownership by the MNE in the foreign subsidiary was analyzed

using ordered logistic regression with the same set of variables as in the entry mode

test. Afier accounting for the clustering effect mentioned earlier, results are displayed

in Table 7. The sample size for this analysis is 2,339 foreign subsidiaries, including

1,076 wholly owned subsidiaries, 573 majority ownership, 1 10 equal ownership, and

580 minority ownership cases. Institutional distance had a negative effect on the level

of equity ownership. The larger the institutional distance, the lower the level of equity

shares that the Japanese parent held in the sub-unit, ranging fiom 100 percent to

minority ownership. This relationship is significant at the p < -001 level, strongly

supporting Hypothesis 5. The results not o d y c o n h Hypothesis 4 about modal

choice, but also indicate a negative effect of institutional distance on ownership level

in joint venture cases (fiom majority to minority ownership).

Table 7. Results for Ownership Level Analysis

Level of Ownership in the Subsidiary

Institutional distance -1-193 *** (. 132)

Cultural distance -.O32 (-037)

Industry advertising intensity 1 S2 1 (4.140)

Industry R&D intensity 6.193 * (2.427)

Parent advertising intensity .O30 (.085)

Parent R&D intensity .O04 (-037)

Log parent sales -. 047 (-045)

Log parent international experience -.O37 (.033)

Log parent FDI orientation -281 *** (.@w

Log subsidiary sales -.O48 (.027)

Log likelihood -2532.382 Wald Chi-squared 260.30 *** Pseudo R-squared .O9 1 N 2339

All two-tailed tests. Robust standard errors are in parentheses. t p < -10 * p < .O5 ***p < .O01

Among other variables, cultural distance has a negative sign but is

insignificant. Al1 four intensity measures are positively signed, but only industry

R&D is significant at the p < -05 level. Parent firm international orientation is also

positive and significant at the p < .O01 level, suggesting that firms with higher

overseas sales tend to choose a higher equity position. These findings are consistent

with and supportive of those in Table 6. Parent sales and international experience are

negatively signed but insignificant. Subsidiary size is negatively signed and

significant at thep < -10 level in this test.

Expatriates (H6 and H7)

Hypothesis 6 predicts that the presence of Japanese expatriates in the foreign

subs id iq will be negatively related to institutional distance. This test can be

conducted using OLS regression, with the subsidiary expatriate ratio as the dependent

variable, and institutional distance as the main independent variable. Hypothesis 7, on

the other hand, suggests a cmtingency relationship, namely, the relationship between

the expatriate ratio and institutional distance will be more evident among wholly

owned subsidiaries than in joint ventures. Testing this hypothesis requues that an

interaction t e m of institutional distance and entry mode be included in the regression.

This interaction term, however, rnay potentially cause the multicollinearity problem,

as the term will be highly correlated with its two component variables. A cornmon

procedure to deal with this potential problern is to create a mean-adjusted measure for

the continuous component variable(s) before creating the interaction temi (e-g.,

Errarnilli, et al., 1997). The interpretation of statistical results will remain unchanged.

A mean-adjusted institutional distance measure was created by making its value

equivalent to the unadjusted value less its mean. The product of this new measure and

the entry mode variable einary with joint venture coded as 1) was then taken as the

interaction term and included in the regression. Table 8 displays the results. in order

to make sure that the multicollinearity problem has indeed been eliminated, 1 checked

the variance inflation factor (VIF) for each variable included in the analysis. As

suggested by Neter, Wasserman, and Kutner (1990: 409), a maximum VIF value in

excess of 10 is often taken as an indication that serious muiticollinearity may be

unduly influencing the least squares estimates. The highest VIF value in al1

subsequent analyses involving the mean-centering procedure is substantidirl y lower

than 10.

The sample size for the expatriate regression is 2,199. Institutional distance is

significant at the p < .O0 1 level and negatively signed, indicating the larger the

institutional distance, the lower the expatriate ratio in the subsidiary. Hypothesis 6 is

supported. The other "main effect" term, joint venture, is also significant at the p <

-001 level and negatively signed. This is consistent with the expectation as the

expatriate ratio certainly will be lower in joint ventures than in wholly owned

subsidiaries. The interaction term is positive and significant at the p < -10 level. This

indicates that the expatriate ratio will be higher if the two component variables move

towards the same direction. in order to further investigate the combined influence of

the "main effécct" and the interaction terms on the expatriate ratio, the regression

function is rearranged as follows:

Table 8. Results for Subsidiary Expatriate Analyses

Expatriates as a % of Total Employment in Subsidiary

Constant -466 *** (-085)

Institutional distance -.O38 *** (mean-cen tered) (O0 1 O)

Joint venture with local firm -. 103 *** (-009)

InstitutionaI distance (mean- .O16 centered) x Joint venture (.O 1 O)

Cultural distance .O04 (-003)

Industry advertking intensity -.853 * (-345)

Indusûy R&D intensity -066 (-220)

Parent advertising intensity -.O16 * (. 007)

Parent R&D intensity .O05 (-004)

Log parent sales -002 (-006)

Log parent international experience -.O07 (.O041

Log parent FDI orientation -.O1 8 *** (-004)

Log subsidiary sales -.O1 1 *** (-002)

F 15.61 *** R- squared O. 128 N 2199

Al1 two-tailed tests. Robust standard mors are in parentheses. f p < .10 * p < .O5 * * p < 0.1 ***p < .O01

Subsidiary Expatriate Ratio = -.O3 8 x Institutional Distance-. I03xJoint Venture +.O 16x Institutional DistancexJoint Venture+. . .

In wholly owned subsidiaries (Joint venture = O),

Subsidiary Expatriate Ratio = -.O38 x Institutional Distance+. . .;

In joint ventures (Joint venture = 1 ),

Subsidiary Expatriate Ratio = -.O38 institutiona al Distance-. 1 O3 +.O 1 6 x institutionat Distancet. . . , or

Subsidiary Expatriate Ratio = -. 103-.022xInstitutional Distancet.. .

In both wholly owned subsidiaries and joint ventures, there is a negative

correlation between subsidiary expatriate ratio and institutional distance. The absolute

value of the coefficient, however, is greater for wholly owned subsidiaries than for

joint ventures, supporting Hypothesis 7. Notice that the constant values in these two

regressions are O and -. 103, respectively. This is because the institutional distance

measure used in the analysis is mean-adjusted. The unadjusted institutional distance

measure should have a positive constant value.

In this test, cultural distance is not significant, and its sign is different f?om

that of institutional distance. Of the four intensity measures, parent and industry

advertising intensities are both negatively signed and significant at 'Jie p < -05 level.

My initial expectation was that stronger home-country-based cornpetitive advantages

will lead to lower reliance on local staff, and thus an higher expatriate ratio. The

results obtained here contradict this expectation. One possible explanation for this is

that the transfer of some particular foms of advantages or skills (in this case, brand

name image) do not require physicai human participation at the subsidiary level. On

the contrary. Japanese firms with higher fim-specific cornpetitive advantages rely

more on these particular foms of resources in foreign countries, and therefore

commit less human resources in those markets. The negative signs of international

experience (significant at the p < -10 level) and FDI orientation (significant at thep <

-001 level) may be consistent with this explanation: As the MNE gains more

international experience and becomes more internationdly oriented, there is less need

to send expatriates overseas as the MNE has learned to maintain subsidiary control

more efficiently without keeping a large expatriate force. The negative sign for

subsidiary size @ < -001) is consistent with the negative effect of subsidiary size on

ownership level in Table 7. Both indicate that tocal involvernent will be higher when

subsidiary size is larger, either due to risk-sharing considerations or because of host

country regulations.

Subsidiary performance (88)

The last subsidiary level tests are for Hypotheses 8a and 8b, which predict

positive performance implications for Hypotheses 4, 5 and 6. As the perfomance

measure used here is a three-category variable, I used ordered logistic regression to

accornplish this purpose. Two interaction tenns, institutionai distance x equity share,

and institutional distance x subsidiary expatriate ratio, were created, with al1 "main

efTect" and component terms being mean-adjusted measures discussed earlier. The

equity share variable used in the first interaction term is a continuous variable for the

actual equity shares the parent firm held in the foreign subsidiary, including 100

percent for wholly owned subsidiaries. Thus the performance effect of both

Hypotheses 4 and 5 can be tested with this terrn- The results are displayed in Table 9.

The sample size for this analysis is 1,365. Al1 the three "main effect" terrns

are negatively signed. Institutional distance is negatively correlated with subsidiary

performance in the host country. This relationship, however, is not significant. Equity

share is significant at the p < -0 1 level. The negative correlation suggests that a joint

venture mode of entry and higher equity involvement by the local partner(s) will lead

to higher subsidiary performance in the host country. The same can be said about

expatriates. The expatriate ratio is significant at the p < .10 level. The negative sign

indicates that a high expatriate ratio does not contribute to high performance. On the

contrary, relying on local managers may have a positive effect on subsidiary

performance. These results are consistent with the general arguments for involving

local partners and local staff in the operations of the MNE (e.g., Beamish & Banks,

1987; Beamish & *en, 1998; Pan & Chi, 1999; Pan, Li, & Tse, 1999). The two

interaction terms are both negatively signed, which is consistent with Hypotheses 8a

and 8b. However, the first interaction term, institutional distance x equity share, is

insignificant. The second interaction term, institutional distance x expatriate ratio, is

significant at the p < .O5 level. The interpretation is that subsidiary performance will

be higher if the expaûiate ratio is high where institutional distance is small, and if the

expatriate ratio is low where institutional distance is large. Hypothesis 8b, therefore,

obtained acceptable support.

Table 9. Results for Subsidiary Performance Analyses

Subsidiarv Performance 4

Equity shares in subsidiary -.O08 ** (mean-centered)

Expatriate ratio in subsidiary (mean-centered)

Institutional distance (m-c) x

Equiiy share (m-c) Institutional distance (m-c) x

Expatriate ratio (m-c) Cultural distance

Industry advertising intensi ty

Industry R&D intensity

Parent advertising intensity

Parent R&D intensity

Log parent sales

Log parent international experience

Log parent FDI orientation

Log subsidiary sales

Log likelihood Wald Chi-squared Pseudo R-squared N 1365

Al1 two-tailed tests. Robust standard errors are in parentheses. + p < .10 * p c .O5 * * p < .O1 *** p < .O01

Most of the control variables in this analysis are insignificant, including the

four intensity measures. Parent international expenence h a . a negative and significant

@ < -10) efièct on performance. This is surprising, as experiencc was expected to

make a positive contribution to performance (Makino & Delios, 1996). Also

unexpected is the positive and significant @ < -05) sign for cultural distance. One

would expect that culturd distance had a negative effect on subsidiary perfonnance

(Barkema, et al., 1996). The positive and significant effect of parent FDI orientation

(p < .IO) and subsidiary sales @ < .001) fa11 within nomal expectations.

53. Host Country Level Anaiyses and Results

Institutional distance as a determinant of MNE diversification (Hg)

Hypothesis 9 predicts that the level of MNE product diversification within the

host country will be negatively correlate. with the institutional distance between the

host and home countries. 1 used sales- and capital-based diversification measures,

respectively, as the dependent variable, and in both cases, included three- and two-

digit operationalization. This resulted in four regression analyses. institutional

distance is the main independent variable in these analyses, with some wntrol

variables that have been used in previous analyses - the four intensity measures,

parent size, and parent FDI orientation. Also included is a market size variable

rneasured in terms of the logarithm of nominal GDP of the host country. Statistical

results based on sales data are presented in Table 10 below (Descriptive statistics and

correlations for variables included in al1 host counrry level analyses are provided in

Appendix 4).

Table 10. Results for Diversification in Host Country by Sales

Parent diversification Parent diversification in host nations by sales in host nations by sales

in 3-digit SIC codes in 2-difit SIC codes Constant -.885 *** -.718 ***

(-077) (-066) Institutional distance -.O18 ' -.O16 '

(.O 1 O) (-008) Log GDP .O38 *** -031 ***

(-004) (-004) Indusiry advertising intensity -.664 -.625

(.543) (.468) Industry R&D intensity -.325 -.406

(.288) (-248) Parent advertising intensity .O10 .O07

(-007) (-006) Parent R&D intensity -.O02 -.O0 1

(-004) (.003) Log parent sales .O52 *** .O42 ***

(.005) (-004) Log parent FDI orientation .O22 *** .O18 ***

(.004) (.003) R~ 1 07 .O99 Adjusted R~ .IO3 .O95 N 1729 1729

Al1 two-tailed tests. Standard errors are in parentheses. t pc.10 ***p < -001

The sample size for this analysis is 1,729 parent firm - host country

combinations, reduced fiom 5,653 entries after excluding missing values list-wise.

They represent 400 Japanese parent firms operating in 44 countries. For both three-

and two-digit diversification by sales, institutional distance is negativeiy sikmed and

significant at the p < -10 level. Hypothesis 9 received weak support in this analysis.

Among the control variables, the four intensity measures are insignificant. The

remaining variables - market size, parent fïrm size, and FDI orientation - are al1

positively signed and significant at the p < .O01 levei. It is reasonable tkiat both the

market size in the host country and the size of the parent firm will contribute to a

higher level of product diversification in that country. Parent FDI orientation may

also propel the MNE to engage in diversification activities.

Table 11 displays results for diversification analysis based on capitalization

data. Institutional distance is again negatively signed, but this time signifiant at thep

c .O5 level for three-digit SIC codes, and at thep < .O1 level for two-digit SIC codes.

Hypothesis 9 received stronger support in this analysis. The control variables exhibit

the same pattern as in Table 10, with market size, parent size, md parent FDI

orientation being positive and significant at the p < -00 1 level. Also notice that the

capital-based analysis has a larger sample size than the sales-based analysis (2,613

versus 1,729), and the R~ has been irnproved fiom about .10 to the .13 - .15 range.

The stronger results obtained in this analysis suggest that operationalization of

product diversification based on capital information is probably prefmed than that

b a s 4 on sales information for MNEs.

Table I I . Results for Diversification in Host Country by Capitalization

Parent diversification in Parent diversification in host nations by capital host nations by capital in 3-digit SIC codes in 2-digit SIC codes

Constant -1.257 *** - 1 .O26 *** (.075) (.066)

Institutional distance -.O19 * -.O20 ** (.008) (-007)

Log GDP .O56 *** .O47 *** (-005) (-004)

industry advertising intensity -.639 -.456 (-560) (.490)

industry R&D intensity .O19 -.2 12 (-27 1) (.23 7)

Parent advertising intensity .O06 .O05 (-005) (-004)

Parent R&D intensity -.O02 -.O02 (-003) (-003)

Log parent sales .O84 *** -067 *** (-005) (-004)

Log parent FDI orientation .O10 *** -010 *** (-003) (.003)

R' -150 -134 Adjusted R~ -147 .131 N 2613 2613

Al1 two-tailed tests. Standard errors are in parentheses. * p < .O5 ** p < .O1 ***p < .O01

Performance in host countries @IO)

The last set of tests are for Hypothesis 10, which predicts a contingency

relationship similar to Hypothesis 8. More specifically, it States that MNE

performance in the host country depends on the right mix of context and strategy -

either a high level of product diversification in host countnes where institutional

distance is srnaIl, or a low level of product diversification in host countnes where

institutional distance is large. As in previous tests for Hypotheses 8a and Sb,

interaction terms of institutional distance and product diversification were created,

with the component and "main effect" terms being mean-adjusted measures. Again, 1

created four measures of product diversification: using sales and capitalization data,

and based on three- and two-digit SIC codes, respectively. The control variables are

the same set as included in the diversification anaiysis above. In al1 four tests, VIF

values revealed no multicollinearity problems.

Table 12 displays results based on sales data. As in the previous performance

test at the subsidiary level, institutional distance has no effect on performance at the

host country level. The other "main effect" tem, product diversification within the

host country, is negatively signed and significant at the p < -05 and p < -01 levels for

three- and two-digit SIC codes, respectively. The negative effect of diversification on

performance is supportive of arguments made by the resource-based view against

diversification, especially unrelated diversification, as diversified sub-units across

two-digit industries are considered urrrelated to each other. The interaction tem,

however, is insignificant in both columns, although the negative sign is consistent

with what is predicted in Hypothesis 10. Among the control variables, market size is

negatively related to the percentage of profitable subsidiaries in host country. This

correlation is significant at the p < -001 level. As in previous tests, the four intensity

measures are insignificant. The other two control variables are significant. Parent FDI

orientation contributes positively to performance, while parent size has a negative

eftèct on performance. The sample size for this analysis is 1,247.

Table 12. Performance Implications: Diversification by Sales

% of Profitable Subsidiaries Constant

Institutional distance (mean-centered)

Diversification by sales across 3- digit SIC codes (mean-centered)

institutional distance (m-c) x

3-digit Diversification (m-c) Diversification by sales across 2- digit SIC codes (mean-centered)

Institutional distance (m-c) x

2-digit Diversification (m-c) Log GDP

hdustry advertising intensity

Industry R&D intensity

Parent advertising intensi ty

Parent R&D intensity

Log parent sales

Log parent FDI orientation

RL Adjusted R' N

Al1 two-tailed tests. Standard errors are in parentheses. * p < .O5 * * p < .O1 ***p < .O01

Table 13. Performance Impücations: Diversification by Capitalhotion

% of Profitable Subsidiaries -825 *** .870 ** * Constant

Institutional distance (mean-cen tered)

Diversification by capital across 3- digit SIC codes (mean-centered)

Institutional distance (m-c) x

3-digit Diversification (m-c) Diversification b y capital across 2- digit SIC codes (mean-centered)

Institutional distance (m-c) x

2-digit Diversification (m-c) Log GDP

[ndustry advertising intensity

Industry R&D intensity

Parent advertising intensity

Parent R&D intensiîy

Log parent sales

Log parent FDI orientation

Al1 two-tailed tests. Standard errors are in parentheses. t p < -10

Table 13 presmts hdings based on capitaiization daîa. These are largely

consistent with those in Table 12, with diversification now significant at the p < .O01

level in both columns. The interaction term is insignifiant. giving no support for

Hypothesis 10. Except market size and parent FDI orientation, however, al1 other

variables are insi-gificant. The sample size of this analysis is 1.375. R' is improved

from -054 in the last analysis to above 0.064.

5.4. Comparing the Included and Excluded Samples

The above analyses on the three different levels al1 involve the exclusion of

missing values list-wise. Final sample sizes for the various regressions are respectably

large - ranging fiom 1,247 to 2,613 for subsidiary and host country levels, and by

aggregating infoxmation fkorn thousands of subsidiaries to achieve a sarnpIe of 394 at

the parent firm level. Still, these final samples represent only a fraction of the 18,206

Japanese subsidiaries included in the entire Toyo Keizai (1 997) dataset. Exclusion of

large proportions of missing cases may potentially cause selection bias if the excluded

sample is substantially different fkom the included sample. Therefore, a comparison

of means between the included and excluded samples is warranted here in order to see

if there is indeed such a difference. The next three tables provide such a comparison

at three different Ievels.

In Table 14, characteristics of the 394 parent firms included in the analyses

are compared to the 500 or so excluded firms. Arnong the key characteristics of these

firms, those included in the analyses have an evidently lower global expatriate ratio

(7.39% versus 12.54%). They also have a consistently higher global diversification

Ievel (in average, about 30% higher than the exclude sample).

Table 14. Mean Comparison for Parent Firm Groups

Weighted institutional distance by sales

Weighted institutional distance by capital

Industry advertising

Industry R&D

Parent advertising

Parent R&D

Global expaûiate ratio

Global diversification by sales in 3-digit SIC

Global diversification by capital in 3-digit SIC

Global diversification by sales in 2-digit SIC

Global diversification by capital in 2-digit SIC Log parent sales Log parent FDI

Included Excluded Included Excluded included Excluded hcluded Excluded hcluded Excluded included Excluded included Excluded included Excluded Included Excluded Included Excluded IncIuded Excluded Included Excluded Included

Variables Groups Sample Mean T-value for Mean Size Difference 394 -5994 1.825

- -

orientation Excluded 22 1 5.4058 Al1 two tailed tests. i p < -10 * p < .O5 * * p < .O1 ***p < -001.

Table 15. Mean Cornparison for Subsidiary Groups

Variables Groups Sarnple Mean T-value for Mean S ize Di fference

Institutional distance

Cultural distance

Industry advertising

Industry R&D

Parent advertising rate

Parent R&D rate

Log parent sales

Log parent FDI experience

Log parent FDI orientation

Log subsidiary sales

Joint venture mode

Ownership level

Equity shares

Subsidiary expatriate ratio

Included Excluded Included Excluded included Excluded Included Excluded included Excluded Included Excluded Included Excludea Included Excluded Included Excluded Included Excluded Included Excluded Included Excluded Included Excluded Included Excluded .1385

Al1 two tailed tests. t p < -10 * p < -05 *** p < .O0 1

in Table 1 5, the 2,199 subsidiaries included in the analyses (except for the

performance test) are compared to the 16,000 or so excluded cases. The average

institutional distance in the included sample is significantly @ < -001) smaller than

the excluded sarnple. But the difference (-62 versus -68) doesn't seem striking, given

the range of institutional distance (O - 6.72) in Table 3b. The two samples do not have

substantial differences in texms of entry mode and ownership level. The difference in

mean equity shares (73.9% versus 73.5%), although signifiant at the p < .O5 level,

should not cause any concern. As at the parent fim Ievel, the included subsidiaries

have a lower expatriate ratio (10.9% versus 13.8%). The included sarnple is lower on

parent sales and international experience but higher on parent FDI orientation and

subsidiary sales.

Finally, in Table 16, the 2,682 parent firm - host country combinations

involved in the analyses (except for the performance test) are compared to the 3,000

or so excluded entries at the host country level. The included sample here has Iowa

parent sales and higher FDI orientation. The included firms also have a lower level of

product diversification when measured in terms of sales. Across the three tables, the

included samples generdly have higher industry R&D, higher parent FDI orientation,

and lower parent sales. These differences, while statisticall y signi ficant, are not

intuitively substantial given the ranges of these variables displayed in Chapter 4.4.

The more substantial differences are in the expatriate ratios (lower for the included

sample) and in product diversification Oower for the included sample at the host

country level, and higher for the included sample at the parent 6rm IeveI). These

should be taken into consideration when discussing the generalizability of this study.

Table 16. Mean Comparison for Parent - Host Country Groups

Variables Groups Sarnple Mean T-value for Mean S ize Difference

Institutional distance

Cultural distance

Parent R&D

Parent advertising

Industry R&D

Industry advertising

Log parent sales

Log parent FDI orientation

Diversification in host country by sales in 3-digit SIC codes

Diversification in host country by capital in 3digit SIC codes

Diversification in host country by sales in 2-digit SIC codes

Diversification in host country by capital in 2-digit SIC codes

Al1 two tailed tests.

Included Excluded Included Excluded Included Excluded IncIuded Excluded Included Excluded Included Excluded Included Excluded included Excluded IncIuded Excluded Included Excluded Included Excluded hcluded Excluded

5.5. Summary

Table 17 provides a summary of the results obtained in various analyses.

Arnong the three parent firm level hypotheses, only Hypothesis 2 received relaîively

strong support- Hypotheses 1 a and 3 were not supported. Hypotheses l b received

weak and mixed results in one test, but no support in the other. Generally speaking,

findings at this level are not strong, and the explanatory power of each mode1 is not

ideal.

Table 17. Summary of the Results

Level of Hypo- Relationships R e d ts Anal ysis theses

Parent firrn

Parent finn

Parent firm

Parent f inn

Subsidiary

Subsidiary

Subsidiary

Subsidiary

Subsidiary

Subsidiary

Host Country

Host Country

Institutional distance and technological intensity (negative) Institutional distance and marketing ability (negative) Institutional distance and global integration (negative) Institutionai distance and firm diversity (positive) Entry mode and institutional distance (positive) Ownership level and insti tutional distance (negative) Expatriates and ins titutional distance (negative) Expatriates, institutional distance, and entry mode (positive) Equity share, institutional distance, and pdonnance (negative) Expatriates, institutional distance, and performance (negative) Diversification and institutional distance (negative) Diversification, institutional

No support

Weakhixed results

Strong support

No support

Strong support

Strong support

Strong support

Weak support

No support

Moderate support

Moderate support

No support distance, and performance (negative)

Stronger results are achieved at the subsidiary level. Institutional distance has

1 O6

a clear effect on the strategy variables: entry mode (H4). ownership level (HS), and

the expatriate ratio (H6). The interaction hypothesis (H7) also received weak support.

For subsidiary performance. the fit behveen institutional distance and expatriate ratio

(H8b) received moderate support, whereas the institutional distance - equity share

alignrnent (H8a) is insignificant but "correctly" signed.

At the host country level, the effect of institutiona1 distance on diversification

strategy (Hg) has received moderate support, whereas the contingency hypothesis

(H 1 0) regarding institutional distance, diversification, and MNE performance within

the host country, is not supported, although the interaction ternis are also "mrrectly"

signed.

Generally speaking, results for the control variables (especially the fou.

intensity measures when used as control variables) are neither clear nor consistent.

The effect of each variable has to be discussed in each particuiar case. As these

effects are not the central issues being studied in this dissertation, 1 have focused only

on those tests that are relevant to the hypotheses.

6. DISCUSSION AND CONCLUSIONS

This dissertation extends institutional-theory exphnations of legitimacy-

seeking processes to the global setting. ResuIts of this study have supported the

majority of the hypotheses. Of the twelve hypotheses (including sub-hypotheses) in

Table 17, six obtained strong or moderate support, two received weak or mixed

support, and four were unsupporte-. These results provided evidence that institutional

factors influence the MNEs' choice of host country, and that MNEs respond to

variations in the institutional environment by designing appropnate strategies in the

host country. An important constnict that captures these environmentai variations is

institutional distance. Following Scott's (1 995) conceptudization, 1 integrated the

regulative and normative dimensions of institutional differences. This measure has a

broader scope than the one developed by Kostova (1996), which is issue-specific. It

also involves a much larger scale of investigation. In cornparison to Kostova's (1996)

survey of 10 nations, the present index includes over 50 counaies, and is based on

more than 3000 survey responses. Furtherrnore, 1 combined this index with a large-

sample archival database c o v e ~ g thousands of Japanese foreign subsidiaries. In the

following paragraphs, 1 discuss the implications of research findings at three different

levels.

Discussion of Parent Firm Level Hypotheses and Results

At the parent firm level, my theoretical h e w o r k proposes that the MNE's

preference for the host country is influenced by some firm level attributes, including

the level of firm-specific competitive advantase (H 1 a and H 1 b), the ievel of global

integration (Hz), and the level of firm diversity (H3). Among these, only H2 received

strong support, indicating the importance of global strategy in making FDI decisions.

H lb received weak and mixed results. When used as control variables in subsequent

analyses, the four intensiv measures were also largely ineffective. This is typical of

empirical studies invotving advertising or R&D intensity measures (e.g., Kogut &

Singh, 1987, 1988). One explanation for this is that advertising and R&D intensities

reflect different types of competitive advantage, and therefore, have different effects

in each cases (Allen & Pantzalis, 1996).

H3 received no support in the test. Little research has been done to investigate

the reIationship between MNE product diversity and the preference for certain host

countries over others. Assuming theoreticai arguments leading to H3 are correct, then

two possibilities may partly explain the result. Firsf those arguments may better

apply to other forrns of firrn diversity, such as cultural and ethnic diversity. Second,

the global diversity measure has not incorporated domestic saledcapitalization data,

which may account for a disproportionally large share for the MNE. Consequently, it

does not tmly reflect a firm's diversity level.

Whatever the reason, results obtained at the parent firm Ievel are not strong, as

evidenced by the lack of significance for some key variables and the low R-squares

for the models. It seems that, in general, parent firm level factors do not have strong

influences on the choice of host country, or rather, institutional distance is not the

most important dimension on which host countries are chosen. This is

understandable, as FDI decisions are most likely motivated by the profit potential of

the host countries, or sometimes int'luenced by transaction cost considerations as

discussed in the paragraph preceding Hypothesis 2. For instance, an MNE may have

strong firm-specific cornpetitive advantages, and therefore, prefer to invest in

countries with an institutional environment similar to its home institutions. This does

not mean, however, that the MNE will r e h i n £iom investing in the ernerging markets

with high growth and profit potential, even though there may be institutional bamiers

for the MNE in those markets (Hyrner, 1960; Khanna & Palepu, 1997).

Discussion of Subsidiary Level Hypotheses and Results

Compared to the weak results at the parent tirm level, results for subsidiary

level analyses are relatively strong. While managers may tend to neglect institutional

factors in favor of economic incentives when choosing host countries, they have

consciously designed subsidiary level strategies that address those institutional

factors. in recent years, researchers have staried considering the impact of

institutional processes on the choice of entry mode (Davis, et al., 2000), and have

discussed the implications of institutional distance for the MNE in t m s of

legitimacy-seeking behavior (Kostova & Zaheer, 1999). 1 have ernpirically shown in

this shidy that institutional distance influences Japanese MNEs' choice of entry mode

(H4, level of equity ownership (H5), and the presence of expatriates (H6 and H7) in

their sub-units abroad. 1 argue that these strategic choices are made in such a way that

the MNE can maintain an optimal level of strategic and operational control over its

foreign subsidiaries, and maximize the benefits provided by local partners and

personnel in terms of local knowledge and legitimacy. Results for these hypotheses

are supportive of this line of reasoning.

As to the two hypotheses for subsidiary performance, although one of them

(H8a) was not supported, the other one (H8b) received moderate support. The result

indicates that an expatriate swategy that has a good fit with the institutional cuntext

will have a positive effect on subsidiary performance. Although studies on the effect

of institutional distance started with an effectiveness test - the success of

transnational transfer of organizational practices within the MNE (Kostova, 1996),

the test conducted here represents a first successfi11 attempt to empirically examine

the interactive effect of institutional distance and strategy on f k n performance. While

institutional distance per se does not seem to have a negative impact on subsidiary

performance, a link between institutional distance and performance has been

established here in that appropriate expatriate strategies have to be adopted to match

the institutional distance of a particular host country in order to achieve higher

performance resul ts.

Performance tests of this kind are a logical extension of the "strategic

response" perspective within institutional theory. If, as Oliver ( 199 1) suggests,

managers respond to institutional processes in accordance to their self-interests, then

they certainly will do so with finn performance in mind. Thus, firm behavior is no

longer the result of "taken-for-granted" responses to environmentai pressures. It must

be based on a rational, caiculated decision to achieve certain performance objectives.

Future research might benefit, therefore, fkom greater convergence of institutional and

efficiency-based theories in explaining finn behavior.

Empincal tests in this study took account of the clustering of subsidiaries in

parent firrns. As discussed earlier, each parent finn has an impact on its own

subsidiaries. Therefore, there are implicit *'clusters" within the population of

subsidiaries, violating the randomness assurnption. Previous studies on subsidiaries

using the same database (e.g., Delios & Beamish, 1999b) have not paid adequate

attention to this issue. Statistical results obtained here are based on standard mors

and significance levels that have been adjusted for such a clustering effect. A

cornparison of results shows that without such adjustments, standard mors would be

underestimated, and significance levels incorrect.

Another important finding fiom the subsidiary level tests is that, generally

speaking, cultural distance has similar but weaker effects on MNE strategy than

institutional distance. This result is in line with the numerous studies in international

management involving cultural distance (Bakema, et al., 1996; Contractor & Kundu,

1998; Delios & Bearnish, 1999b; Kogut & Singh, 1988; Markoczy, 2000). Moreover,

the effect of cultural distance is not consistent. For instance, cultural distance has a

positive and moderately signifiant impact on subsidiary performance, which

contradicts the conventionai wisdom. In the ps t , cultural distance has taken center

stage in cross-country research in international business. It is a useful and valid

construct. Yet, reliance on culturai distance alone as a proxy for cross-country

differences tends to over-simplifjr complex environmental variations, especially

ignoring the diverse differences in societd institutions across nations. While it is

important for the MNE to adapt to the unique culture of a host country, there may not

be a one-to-one correspondence between an organization's cultural adaptation and the

way it is perceived by other constituents of the local institutional environment

(Kostova & Zaheer, 1999). Thus, it is possible for an MNE to be culturally adapted,

but still lacking legitimacy in a particular host country. Furthemore, the cultural

distance index was constructed using Hofstede's cultural data collected three decades

ago. It's usefulness when matched to current firm data is increasingly questionable

(Shenkar, 200 1 ).

The institutional distance consû-uct enriches our understanding of cross-

country differences. Instead of negating the role of cultural distance, 1 have shown

that institutional distance covers at least two domains not previously addressed by

cultural distance, i.e., the regdative and normative dimensions. The institutional

distance index has a low and insignificant correlation with cultural distance (r = -

0.239). This provides evidence of discriminant validity for institutional distance,

indicating that it is a distinct construct.

On the other hand, 1 suspect that cultural distance may be a form of cognitive

distance that has not been incorporateci into our institutional distance constnict. To

anthropologists, cognition certainly represents one aspect of culture (Casson, 1981).

Institutional theorists ais0 have related cultural elements to cognitive systems

(Hofihan, 1999: 353; Scott, 1987: 498). Thus, it is possible that cultural distance can

be fully integrated into a broadened measwe of institutional distance in future

research.

1 also followed Kogut and Singh's (1988) analysis of entry mode in a separate

test. I found that in institutionally and culturally distant countries, MNEs favored joint

ventures, wholly-owned greenfield operations, and wholly owned acquisitions, in that

order. Although not a part of my formal hypotheses, I suspect that this is because a

large institutional distance forces the MNE to place local conformity and adaptation

as its first priority, and interna1 control and conformity as a second priority. As

previous research has indicated, the greenfield mode of foreign inveshnent will

enhance the MNE7s control over its sub-units, whiIe acquired firms may have

difficulty in integrating into the MNE system (Barkema, et al., 1996; Kogut & Singh,

1988).

Discussion of Host Country Level Hypotheses and Resutts

At the host country Ievel, this dissertation atternpts to contribute to the

diversification literanire by filling a noticeable gap in the area, Le., MNE

diversification within host countries, as well as the pedormance effect of such

diversification on a country-b y-country basis. Results of this research are supportive

of Hypothesis 9 about the relationship between product diversification in the host

counby and the institutional context of that particular country. While market size has

a positive effect on product diversification - an indication of ecunomic incentives,

institutional distance constitutes an institutional b k e r to diversification in the host

country.

Generally speaking, countries with a large institutional distance kom Japan

represent less developed or irnperfect markets. Even with a developed country, a large

institutional distance would suggest that the institutional environment of that country

is distinct f?om that of Japan, and therefore, there would be less institutional support

for Japanese firms in that country. The negative effect of institutional distance on

product diversification, therefore, contradicts Khanna and Palepu's (1997)

proposition as appiied to the MNE. While local f ims in imperfect markets may be

able to fil1 institutional voids by forming business groups, the same benefits can not

be achieved by MNEs adopting a diversified strategy .in those markets. Institutional

theory-based MNE research has examined the dual pressures of global integration and

local adaptation upon the MNE, and found that the latter force g e n d l y exerts

stronger influences on firm behavior ( R o s e m e i g & Nohria, 1994; Zaheer, 1995;

Zaheer & Mosakowski, 1997). In host countries where the institutional environment

is substantially different f?om that of the home country, the need for the MNE to

adapt to, and secure legitimacy in, the local environment, probably outweighs the

benefits that can be obtained from intemal institutional support from affiliated group

units. Based upon data f7om 400 Japanese MNEs operating in over 40 host countries,

results obtained here have sîrengthened this argument.

Unfortunately, the performance test at this level (H10) did not receive

significant results, and the R-squares were very low. One reason for the failure may

be the performance measure used in this study (percentage of profitable subsidiaries

in the host country). Ideally, a country-level profitability measure (ROA or ROE)

should be used. One argument against using my measure is that some overseas

subsidiaries rnay serve as cost centers, therefore always having negative profitability.

It is rather difficult, however, to obtain accurate corporate performance data in each

host country.

Limitations and Directions for Future Research

This study has several limitations. An obvious weakness of the institutional

distance measure developed here is the absence of the third, cognitive domain of the

institutional environment. This deficiency, of course, is due to the reliance on

secondary data sources. To develop a more comprehensive definition of the country-

level institutional environment, and hence institutional distance, future researchers

might use a procedure similar to the one employed by Hofstede (1980) in developing

the cultural dimensions. A carefûlly designed s w e y may furrher prove validity for

the regulative and normative constructs developed in this study. Alternatively, the

cultural distance measure usai here as a control variable might be modified in funire

research to tap into the cognitive aspect of institutional distance noted above.

As discussed in Chapter 5.4, statistical results in this dissertation are based on

list-wise exclusion of missing values. Tables 14, 15, and 16 have displayed the mean

differences in key characteristics between the included and excluded samples.

Generally speaking, f ims included in the various analyses tend to have a higher

industry R&D level, higher parent FDI orientation, and lower parent sales. While

these differences are not striking given the range of these variables, the included

sample does have a substantially Iowa expatriate ratio and a diffaent product

diversification level. When drawing conclusions h m this study, therefore, these

factors should be cautiously taken into consideration.

The current research involves o d y one home country, Japan. As discussed in

Chapter 4.4, Japanese firms have some unique characteristics. For instance, they tend

to use a higher percentage of joint ventures as their entry strategy, while at the same

time assume a higher equity position in joint ventures. With a non-Japanese sample,

therefore, the effect of institutional distance on entry mode and ownership level rnay

not be as clear since, for instance, the joint venture mode is simply not an option, just

as acquisition is generally not an option for Japanese firms. Also as mentioned earlier,

Japanese fims have a narrower product sape, and tend to diversi@ into unrelated

areas instead of related ones. Firrns fiom other home countries that pursue related

diversification, therefore. might exhibit a weaker institutional distance -

diversification relationship since higher diversification intensity in related areas rnay

not be motivated by risk considerations discussed in this dissertation. Future research,

therefore, rnay examine the effects of institutional distance in a range of other

contexts to determine whether these effects are globally generalizable. The validity of

this study can be examined by applying the institutional distance approach in this

dissertation to a non-Japanese dataset.

It is also discussed in Chapter 4.4 that Japanese subsidiaries tend to be smaller

in size, r e k t i n g the fact that most Japanese foreign investments rnay be "screw-

driver" facilities rather than full operations. Fimi-specific goals and strategies in

overseas operations will certainly influence country choice and subsidiary level

strategies. Although such differences have been partly captured by the global

integration construct (H2), differences in goals and strategies dong other possible

dimensions, as well as differences in industry-specific factors, rnay affect the results

of this study. Furthemore, these differences may cause the firm to be more easily

affected by some institutional dimensions than others. Future research, therefore, rnay

incorporate these firm and industry differences while adopting an "issue-specific" and

"domain-specific" approach suggested by Kostova (1996) to examine which

institutional dimension has a larger impact on what type of firms.

In examining the effect of institutional distance on entry mode and equity

ownership, it should be noted that both entry mode and equity ownership may be

restricted by laws and regulations in the host cowtry. One can argue, of course, that

these legal and regulatory variations are partly captured by the institutional distance

constnict. Ideally, however, future research should incorporate policy controls in

order to differentiate institutional factors fiom evolving policy effects.

Although not an objective of this dissertation, institutional effects resulting

fkom parent-organizaîion differences might also be examined in future research. For

example, parent corporations within the sarne home country, while sharing a country-

level institutional environment, may still differ in behavior and structure because of

sub-nationd institutional influences. It may be that some particular parent-

organization differences exacerbate the efiects of institutional distance in determining

MNE strategies. Future research needs to examine how these esects interact with

institutional characteristics of individual parent firms in detemiining international

expansion strategies. Furthemore, while previous research has examined the effects

of both cultural distance and specific cultural values on MNE behavior (Hennart

Larimo, 1998; Kogut & Singh, I988), this study focuses on the aggregate bbdistance7'

measure only. Future research may examine the effects of institutional charactenstics

of the home and host counîries on MNE strategy.

Conciuding Rernarks

In conclusion, this dissertation has made several important contributions.

First, It introduces a broad measure of institutional distance, and combines this index

with a large-sample archival database, so that many areas of MNE behavior can be

examined here. A broad measure of institutional distance also dlows for cornparison

across studies in the future, so that its generalizability can be examined. Second, it

extends the "strategic response" perspective of institutional theory to the global

setting by examining not only the effect of institutional distance on MNE subsidiary

level strategies, but, for the first time, the performance consequences of these

strategic responses as well. Third, it also, for the k t tirne, atternpts to provide a

rationale for, and identifi the determinants of, a host country level MNE product

diversification strategy. Results obtained here indicate that institutional distance has

an impact on MNE foreign entry mode, ownership level, and expatriate strategy, as

well as on MNE product diversification in the host country. Furtherrnore, the results

provide evidence for the moderating effect of institutional distance on the relationship

between MNE expatriate strategy and subsidiary performance in the host country.

The practical implication for these is that managers of the MNE can now pursue

cornpetit ive advantages in a new 1 y de fined context, namel y institutional dis tance, and

design strategies that better match this institutional context.

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APPENDIX 1

Components of the Institutional Distance Measure

and their Respective Factor Loadings

1. Normative Distance (alpha = .937):

Product design (-815)

Product design capability is heavily emphasized.

Customer orientation (.903)

Firms in your country generally pay close attention to customer satisfaction.

Staff training (.887)

Staff training is heavil y emphasized.

Wiliingness to delegate (-934)

Willingness to delegate authority to subordinates is generally high.

Performance-related pay (-833)

Compensation policies link pay closely with performance.

Professional managers (.785)

It is more cornmon for owners to recmit outside professional managers than to

appoint their children or relatives.

Effectiveness of corporate boards (.833)

Corporate boards are highly effective at monitoring management performance and

representing shareholder interests.

2. Regulative Distance (alpha = .929):

Anti-trust laws (-706)

Anti-tmst or anti-monopoly policy in your country effectively promotes competition.

Legal system (.899)

The iegal system in your country is effective in enforcing commercial contracts.

Impartiality of arbitration (.886)

Private business can readily file suits at independent and impartial courts if there is a

breach of trust on the part of governrnent.

Settlement of disputes (.919)

Citizens of your country are willing to accept Iegal means to adjudicate disputes

rather than depending on ph ysical force or illegal means.

Institutional stabillty (-83 1)

The chance that the legal and political institutions in your country will change

drastically in the next five years is low.

Effectiveness of police force (.903)

Your country's police are effective in safeguarding personal security so that this is an

important consideration in business activity.

Product liability (-451; removed after factor analysis)

Legal claims for product liability are not an important cost of business in your

country.

APPENDIX 3: TABLE A2. Correlrtion Matrix for Subsidiary Lcvcl Analyses

Mean Std. 1 2 3 4 5 6 7 8 9 10 1 1 12 13 14 15 Dev.

.675 .700 1.00 1 . Institutional distance

2. Cultural distance

3. Industry adveriis- ing intensity

4. Industry R&D intcnsity

5. Parent advertising intensity

6. Parent R&D intensity

7. Log parent sales

8. Log parent int'l experience

9. Log parent FDI orientation

10. Log subsidiary sales

1 1. Joint venture W.

local partner 12. Ownership level

in subsidiary 1 3. Equity shares

in subsidiary 14. Subsidiary

expatriate ratio 15. Subsidiary

performance Valid N = 1365 (list-wise). Al1 two-tailed tests; values untransfomed. * p < .05; ** p < .01.

APPENDIX 4: TABLE A3. Correlation Matrix for Host-Country Level Analyses

Mean Std. I 2 3 4 5 6 7 8 9 1 0 1 1 1 2 1 3 Dev.

Percentage of profitable ,516 .443 1 .O0 subsidiaries in host nation Diversification by sales across 3-digit SIC codes in host nation Diversification by capital across 3-digit SIC codes in host nation Diversification by sales across 2-digit SIC codes in host nation Diversification by capital across 2-digit SIC codes in host nation Institutional distance Log GDP Industry advertking intensity Industry R&D intensity

10. Parent firm advert ising 1.187 1.209 -.O4 .O4 .O1 .O4 .O1 -.O1 .O0 -.O3 -.O2 1.00 intensity *

1 1. Parent firm R&D 1.501 1.867 -.O2 .O2 .O1 .O3 .O1 .O1 .O1 .O0 -.22 ,22 1.00 intensity * i ~ +*

12, Log parent 12.63 1.601 - , I l ,23 .29 -22 .27 .16 -.16 -.15 -.17 -.O0 .Io ],O0 sales ** ** ** ** ** ** ** ** ** * *

13. Log parent firm FDI 5.975 2.237 .O9 .O7 -,OS .O6 -.O4 -,O7 .O4 .O8 . i 4 - . ] 3 4 3 -JO 1 ,()O

orientation ** ** ** ** * ** * ** ** ** * * Valid N = 1242 (list-wise). Al! two-tailed tests; values untransformed. * p < -05; ** p < -01.