Institutional distance and foreign subsidiary performance in emerging markets: Moderating effects of ownership strategy and host-country experience.
| Verfasser | Shirodkar, Vikrant |
| Posten | RESEARCH ARTICLE |
Abstract Institutional distance has been known to be an important driver of Multinational Enterprises' strategies and performance in host countries. Based on a large panel dataset of 10,562 firms operating in 17 emerging markets and spanning 80 home countries, we re-examine the relationship described by Gaur and Lu (J Manage 33(1):84-110, 2007) between regulatory institutional distance and subsidiary performance. We extend this research by (1) examining this relationship in the context of emerging markets, (2) examining the moderating effects of ownership strategy and host-country experience within the context of emerging markets and (3) accounting for a greater variety of institutions by including a large number of home and host countries. We find that institutional distance negatively affects subsidiary performance in emerging markets. Our findings also show that the negative effects of institutional distance on subsidiary performance are lesser for subsidiaries with partial ownership (than for subsidiaries with full ownership) and for subsidiaries with greater host-country experience. We discuss our findings with respect to Gaur and Lu's model, which explores the relationships between these variables in a general context.
Keywords Institutional distance * Subsidiary performance * Emerging markets * Multinational enterprises
1 Introduction
Institutional distance, defined as the difference between the regulatory, cognitive and normative environments (Scott 1995) of the home and host countries of multinational enterprises (MNEs), has been known to be of great importance to international business scholars and managers (Kostova and Zaheer 1999; Xu and Shenkar 2002). Formal (or regulatory) institutional distance increases MNEs' costs associated with learning the 'rules of the game' (North 1990) of new environments. Such liabilities of foreignness (Zaheer 1995) are likely to act as sources of competitive disadvantage to MNEs (Eden and Miller 2004; Miller and Eden 2006). Although, in some industries, the increasing standardisation of practices has been argued to reduce the effect of cross-country institutional differences (Brunsson et al. 2012; Larsen and Manning 2015), institutional distance has been argued to affect various important decisions such as MNEs' choice of location (Xu and Shenkar 2002), entry mode (Schwens et al. 2011), and ownership strategy (Eden and Miller 2004), and it remains an important concept in the analysis of foreign subsidiaries' performance (Gaur and Lu 2007).
Gaur and Lu (2007) argue that although there are disadvantages to operating in countries with different regulatory institutions, distant regulatory environments provide opportunities for institutional arbitrage. For example, in the United States, many MNEs from weaker institutions establish research and development centres to benefit from superior intellectual property protection regimes. However, at high levels of institutional distance, Gaur and Lu (2007) argue that the scope of such arbitrage becomes narrower, resulting in declining advantages. As regulatory institutional distance increases, subsidiaries face greater 'unfamiliarity and relational hazards' that negatively impact subsidiary performance. In line with this argument, Gaur and Lu (2007) have found an inverted-U-shaped relationship between regulatory institutional distance and foreign subsidiary survival.
In our paper, we first suggest that emerging markets provide unique and important contexts for re-examining the effect of regulatory institutional distance on foreign affiliates' performance. The reason is that in comparison to developed countries, emerging markets have lesser developed, complex and changing formal institutions that pose greater challenges for MNEs from distant institutions (Ionascu et al. 2004; Meyer et al. 2009; Meyer and Nguyen 2005). However, over the past decade, many emerging markets have shown significant development in institutions that minimise bureaucracy in foreign direct investment (FDI), increase transparency in business-government communication, protect intellectual property, and minimise corruption in business transactions (Hoskisson et al. 2013; Luo 2007). Simultaneously, over the past decade, investments by other developing countries in emerging markets have substantially increased, alongside continuing investments by developed countries (1) (UNCTAD 2015). As emerging markets continue to develop their institutions, MNEs from countries with weaker formal institutions are likely to face greater institutional differences while operating in emerging markets. Examining the link between regulatory institutional distance and the subsidiary performance of MNEs within the specific context of emerging markets can therefore add valuable insigts to the existing research in this area.
Various factors have been argued to moderate the relationship between institutional distance and MNEs' subsidiary performance. These include entry mode or subsidiary ownership strategies (Gaur and Lu 2007), host-country experience (Carlsson et al. 2005; Delios and Beamish 2001; Gaur and Lu 2007), and MNE's international diversity (Chao and Kumar 2010). Among these, subsidiary ownership strategies and host-country experience have been argued to be the most important. Gaur and Lu (2007) argue that in distant regulatory environments, tightly controlling subsidiary operations via full ownership increases the probability of subsidiary survival. In this context, our second argument is that the moderating effect of ownership strategy can be different in the case of emerging markets. In emerging markets, the importance of embedding in socio-political circles, production networks, and business-government communication channels allows MNEs to gain important intangible resources such as local legitimacy and local reputation (Meyer et al. 2009) and is thus likely to reduce the negative effects of institutional distance. Extending prior research (Gaur and Lu 2007) on the moderating effect of subsidiary ownership in the context of emerging markets can therefore provide new insights. We also suggest that there has been limited prior research on the moderating effect of host-country experience on the institutional distance-subsidiary performance link. Because emerging markets are characterised by a large informal/extra-legal economy and a greater variety of external stakeholders that affect MNEs' operations, we suggest that greater host-country experience is an important aspect of the organisational learning process (Johanson and Vahlne 1977). Accordingly, with greater experience, subsidiaries will be better able to overcome the disadvantages of institutional distance.
Third, we argue that, in general, research on the institutional distance-subsidiary performance relationship can benefit from accounting for firm-level observations from a larger cohort of home and host countries. Recent research highlights that by focusing on a single home (developed) country, the validity of the institutional distance construct can be undermined due to a greater conflation between 'institutional distance' and 'institutional profile effects' (van Hoorn and Maseland 2016), where 'institutional profile' relates to the institutional environment of a particular home or host country where firms are deeply embedded and face distinct opportunities and challenges (Meyer et al. 2009). In their study, Gaur and Lu (2007) consider MNEs from a single (developed) home country, i.e., Japan, and therefore, the variation in institutional distance between Japan and the selected host countries is tantamount to variation in the institutional profile of the host countries. The reason is that because institutional distance is calculated as the difference between home and host countries' institutional profile scores, the use of a single developed home country makes a low institutional profile score for the host country correspond to a high institutional distance with Japan, which makes it impossible to determine whether the observed effects are due to weaker institutions in the host country or due to the dissimilarity of the institutions between the host country and the home country. In response to recent calls (van Hoorn and Maseland 2016) to include a diverse group of countries in institutional distance research, our study also aims to re-evaluate the existing findings on the institutional distance-subsidiary performance relationship by including a wider array of home and host countries.
Reflecting these limitations in prior research, our paper aims to address the following important questions: (1) What is the effect of formal (regulatory) institutional distance on the performance of MNEs' foreign subsidiaries in emerging markets? and (2) What are the moderating effects of ownership strategy and host-country experience on the link between formal institutional distance and subsidiary performance in the context of emerging markets?
We believe that by testing our hypotheses on the linkages among formal institutional distance, ownership strategy, host-country experience and subsidiary performance within the context of emerging markets, we make the following contributions. First, we partially replicate Gaur and Lu (2007) model of the effect of formal institutional distance on the performance of MNEs' foreign subsidiaries and the moderating effect of ownership strategy on this link. By doing so, we contribute to a greater generalisation of the institutional distance-subsidiary performance link within their model by using observations of subsidiaries of MNEs from 80 home countries operating in 17 emerging market countries. As explained above, in contrast to Gaur and Lu (2007) sample, our sample enables us to address an important discussion related to the methodological construct of institutional distance (van Hoorn and Maseland 2016) and to re-evaluate the existing findings on the institutional...
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