Do Environmental Policies Affect MNEs' Foreign Subsidiary Investments? An Empirical Investigation.

VerfasserZilja, Flladina

1 Introduction

How do countries' environmental policies affect multinational enterprises' (MNEs) foreign subsidiary investments? Climate change and the need to reduce greenhouse gas emissions (GHGE) have become a major focus of governments (Guest, 2010) and MNEs (Bull & Miklian, 2019; Perez-Batres et al., 2012). Motivated by the need to address climate change and pollution, to create jobs, and to improve competitiveness (Bass & Gr0gaard, 2021; Holburn, 2012), many countries have enacted environmental policies to encourage transition into more sustainable energy sources (Bass & Gr0gaard, 2021). These policies require changes in MNEs' behavior; they may, for instance, require MNEs to measure their carbon footprint, innovate products and processes, and adopt environmentally friendlier production processes. Studies show that such institutional pressures affect MNEs' activities (Penna & Geels, 2015; Porter & Van der Linde, 1995) by increasing the cost of operations (Berman & Bui, 2001; Dowell et al., 2000; Li & Zhou, 2017). This alters the national business climate and appeal for foreign investments (Guest, 2010; Hamprecht & Schwarzkopf, 2014; Shinkle & Spencer, 2012).

However, while national environmental sustainability policies may affect the foreign investments of MNEs, empirical evidence of the impact of countries' environmental policies on MNEs' foreign investments is scarce. Few papers (e.g., Dowell et al., 2000; Li & Zhou, 2017) studied the issue empirically at the firm level, where decisions to determine firms' efforts to address climate change and pollution levels are made. On the one hand, conceptual work predicts that environmental regulations increase compliance costs for MNEs and may lead to market exit (Berchicci & King, 2007; Jaffe et al., 1995). Consistent with this argument, empirical studies show that MNEs avoid countries with stringent environmental regulations by shifting polluting operations from such countries to those with lax regulations (Dowell et al., 2000; Taylor, 2005). On the other hand, MNEs cannot avoid environmental regulation entirely, as such policies are increasingly supranational (Bass & Gr0gaard, 2021; Grubb et al., 2018) and present an opportunity for being an early mover in obtaining green advantages (Gao & Bansal, 2013; Rugman & Verbeke, 1998). The purpose of this study is to shed light on the unclear association between countries' environmental policies and MNEs' foreign subsidiary investments.

Building on institutional theory (North, 1990, 1991), we argue that environmental policies increase institutional pressure to achieve two important outcomes: reduce GHGE and increase reliance on renewable energy (RRE). We follow prior work on GHGE and the Kyoto Protocol (Kumazawa & Callaghan, 2012) and hypothesize that countries that adopt stringent environmental regulations decrease GHGE and increase RRE. This, in turn, affects the attractiveness of the country as a foreign investment destination. This is so because countries with effective institutions (North, 1991)--that align formal institutions (i.e., environmental policies) with tangible institutional outcomes (i.e., reductions in GHGE, increases in RRE)--reduce uncertainties by providing a reliable and efficient framework for economic transactions. This attracts MNE subsidiary investment, as MNEs perceive countries with tangible and predictable institutional outcomes to be more fertile investment locations (Cuervo-Cazurra, 2008; Georgallis et al., 2020). We test our hypotheses on a sample of 882 US firms and their ties to 102 host countries from 2000 to 2015. We find that countries that signed and ratified the Kyoto Protocol experience greater increase in RRE and decreased GHGE. Further, we find that RRE positively mediates the relationship between the adoption of the Kyoto Protocol and MNEs subsidiary investments. Yet, this relationship is stronger for countries with greater institutional quality. For firms, the relationship is weaker for those that are in capital-intensive sectors. This supports our argument that countries that align institutional pressures with tangible outcomes (i.e., reduce uncertainty) are attractive to MNE, thereby receive more subsidiary investments. We do not find evidence for a mediating effect of GHGE. We later discuss why such different findings persist.

Our study makes three contributions to the international business (IB) literature. First, we add to research on institutions, particularly research on the effects of formal institutions, such as government environmental policies enacted to control or constrain firms' behavior (Hartmann & Uhlenbruck, 2015; Kolk & Pinkse, 2005, 2008). A recurring criticism of institutional theory has been its assumptions of firms' passivity to institutions (Lawrence et al., 2009; Oliver, 1991). We show that while MNEs react to institutional pressures, they often do so when institutional pressures are accompanied by tangible outcomes, which must be realized to make institutional development legitimate. Second, we contribute to IB research on environmental sustainability by highlighting MNEs responses to government emission policy, focusing on firm-level decisions. Understanding MNEs' investment decisions to comply with countries' environmental programs is important, as MNEs have an essential role in addressing climate change given their influence on smaller firms and consumers (Christmann, 2004; Dowell et al., 2000; Perez-Batres et al., 2012). However, most of the extant IB literature has paid limited attention to government emission policies and their role at the firm level (Bass & Gr0gaard, 2021; Li & Zhou, 2017). Our study seeks to fill this gap, responding to the call by Bass and Gr0gaard (2021, p. 814) for IB scholars to do more to generate "novel insights into global grand challenges" such as the long-term energy transition. Finally, our study contributes to research on the environmental strategies of MNEs (Li & Zhou, 2017; Perez-Batres et al., 2012) by examining how MNEs respond to host countries' investments in and adoption of renewable energy as compared to efforts in reducing greenhouse gas emissions. For MNEs, understanding the regulatory cost of non-compliance and the potential reputation risks of environmental disasters is crucial to assess the challenges and opportunities of the global effort to combat climate change.

2 Theory

2.1 Effective Institutions and Foreign Investment: The Case of Sustainability Regulation

IB scholars have long considered institutions essential in influencing MNEs' subsidiary investments (Alvi, 2012; Dorobantu et al., 2017; Garcfa-Canal & Guillen, 2008; Liu & Li, 2019). In analyzing the institutional contexts--that produce strict or lax environmental regulations--the IB literature has adopted various perspectives, such as sociological institutionalism (Scott, 2001), historical institutionalism (March & Olsen, 1983), new institutional economics (North, 1990, 1991), among others (for a review, see Aguilera & Gr0gaard, 2019; Cuervo-Cazurra et al., 2019). New institutional economics is a strand of institutional theory that argues that firms and individuals have objectives and strive to achieve them within the constraints imposed by institutions (Aguilera & Gr0gaard, 2019; Cuervo-Cazurra et al., 2019). The theory depicts institutions as limitations on market activities that are more conducive to market transactions if they are predictable (North, 1990; Williamson, 2000). In this paper, we rely on new institutional economics (North, 1990, 1991) for two reasons. First, in contrast to other streams of institutional theory, this perspective emphasizes formal institutions (Aguilera & Gr0gaard, 2019; Cuervo-Cazurra et al., 2019) and policy contexts (Garcia-Canal & Guillen, 2008; Henisz, 2000). This makes it an appropriate perspective for our study, as we study the effects of host government (environmental) policy adoption on MNEs' subsidiary investments. Second, new institutional economics is the most frequently adopted perspective by IB scholars (Aguilera & Gr0gaard, 2019; Georgallis et al., 2020). This allows us to contribute to the broader debate in the IB literature on the role of institutional contexts in relation to MNEs' foreign subsidiary investments.

Following the new institutional economics perspective of institutional theory, we consider host country environmental policy as the "rules of the game" (North, 1990, p. 3) that through formal controls force MNEs behavior to conform to national goals that seek to alter industry behavior (Andreou & Kellard, 2021; Backman et al., 2017). Institutions may be informal (e.g., norms, customs, and values) or formal (e.g., laws, regulations, and policies). We focus on formal institutions such as government policies enacted to control business conduct because such formal policies define what economic activities are permissible and profitable in a host country (North, 1991). Thus, we examine a set of institutional mechanisms targeted at national sustainability efforts. Prior work in IB has studied how environmental policies affect foreign MNEs investments (Bu & Wagner, 2016; Georgallis et al., 2020). They find that policy efforts decrease (Eskeland & Harrison, 2003; Taylor, 2005) as well as increase (Garcia-Quevedo & Jove-Llopis, 2021; Holburn, 2012) MNEs foreign investments. They propose various explanations for why some firms either react positively or negatively to stricter environmental regulations but find no uniform explanation (Bu & Wagner, 2016). Eskeland and Harrison (2003) show that MNEs "flock" to countries with weak environmental regulations. Bu and Wagner (2016) argue that MNEs with environmental capabilities prefer to invest in countries with stricter environmental policies. Georgallis et al. (2020) argue that MNEs engage in "jurisdiction shopping" by investing in countries with more generous environmental policies.

In line with prior work, we posit that institutional...

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