Transnationality and financial performance in the era of the global factory.

Author:Buckley, Peter J.
Position:RESEARCH ARTICLE - Report
 
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Abstract Drawing on the core notions of knowledge augmentation and rational choice in internalization theory, the paper develops a theoretical framework to examine the relationship between transnationality and financial performance in the era of the global factory, and tests hypotheses against recent experience of leading transnational enterprises. The paper rejects a direct relationship between transnationality and financial performance, and supports a mediation model in which knowledge-based assets mediate the relationship between transnationality and financial performance conditional on R&D intensity. In making decisions on the transnationality of a firm, managers should not focus on whether it helps the firm achieve direct financial benefits because these are quickly offset by the costs in a competitive environment. Instead, they should focus on whether it helps the firm enhance knowledge-based assets and, through it, financial gains that can be longlasting, and whether it is supported by R&D to augment such assets.

Keywords Internalization theory . Transnationality . Performance . Global factory

1 Introduction

Transnationality is defined as the extent to which a firm engages in value-creating activities across national borders. Faced with accelerated globalization, managers often make decisions to expand a firm's transnationality in order to enable the firm to effectively compete with rivals on a global scale. Increasing transnationality has become a prominent feature of the world's leading firms in recent years, as shown in the transnationality index of top 100 transnational enterprises (TNEs) published by the United Nations Conference on Trade and Development (UNCTAD 2014). Famous global brands, such as General Electric, Shell, Toyota, Exxon Mobil, and British Petrol, have been on the top of the transnationality index for years. The relationship between transnationality and financial performance (hereafter T--P relationship) thus became a focus of research. (1) The research reached, however, little consensus on the nature of the T--P relationship. Some found a positive T--P relationship (Grant 1987) while others found a negative T--P relationship (Siddharthan and Lall 1982; Kumar 1984). The findings were so divergent that many characterized them as "inconclusive" (Tallman and Li 1996, p. 180), "mixed" (Doukas and Lang 2003, p. 154; Gomez-Mejia and Palich 1997, p. 310), "decidedly mixed" (Hitt et al. 1997, p. 772), "inconsistent" (Ruigrok and Wagner 2003, p. 65), "conflicting" (Annavarjula and Beldona 2000, p. 48), "contradictory" (Geringer et al. 2000, p. 51), and "disappointing" (Hennart 2007, p. 424). The confusing findings offer little guidance to managers who have to make decisions on the transnationality of a firm, and need to know whether and how the decisions may help enhance firm performance.

The present paper contends that a major problem in extant research lay in the focus on the direct financial benefits and costs of increasing the transnationality of a firm. The direct benefits were said to include reduction in financial risk due to geographic diversification of investment (Markowitz 1959; Shapiro 1978; Kim et al. 1993), arbitrage of differentials in location-based endowments (Delios and Beamish 1999), profiting from linkage, leverage and learning in cross-border cooperations (Mathews 2002, 2006), and cost-savings through scale economies (Hitt et al. 1997). The direct costs were believed to include operation costs related to the liabilities of foreignness (Zaheer and Mosakowski 1997), learning costs associated to the liabilities of newness (Caves 1971), and coordination costs in managing dispersed value chain across the globe (Hitt et al. 1997; Bartlett and Ghoshal 1989; Sundaram and Black 1992; Tomassen and Benito 2009; Richter 2014). In particular, Richter (2014) was among the first who have actually attempted to measure these costs. The focus on direct benefits and costs eventually led to the formulation of a "three-stage or S-shaped general theory" of the T--P relationship (Contractor 2007, p. 453; also see Contractor et al. 2003, 2007; Lu and Beamish 2004; Thomas and Eden 2004; Contractor 2012). According to this theory, the T--P relationship changes with the incremental benefits and costs incurred to a firm at different stages of transnational expansion. The T--P relationship is negative at the early stage of transnational expansion, when substantial initial costs exceed benefits; positive at the mid stage of transnational expansion, when growth benefits surpass its costs; and then negative again at the late stage of transnational expansion, when increasing coordination costs outstrip the benefits. Guided by the theoretical focus on direct financial benefits and costs, extant research almost exclusively estimated the direct T--P relationship through regression analysis in which a firm's profitability was directly regressed on its transnationality index (Yang and Driffield 2012).

This paper argues that the T--P relationship is far more complex than envisaged in the direct benefit-cost approach. A third variable may influence the transnationality of a firm on the one hand and profitability of the firm on the other, and thereby has an impact on the T--P relationship. Hitt et al. (1997) noted, for instance, that transnational expansion enhances a firm's innovation capabilities to augment knowledge. However, Hitt and colleagues did not go further to investigate the indirect financial gains from transnational expansion through knowledge augmentation. To distinguish indirect financial gains through knowledge augmentation from direct financial gains, it is necessary to develop a mediation framework to model the T--P relationship on a solid theoretical base and apply techniques of mediation analysis in empirical tests.

The lack of mediation analysis was recently noticed by a group of scholars who developed mediation models that take into account knowledge-based assets, also named firm-specific advantage or firm-specific assets. They maintained that knowledge-based assets such as proprietary technology and management know-how profoundly influence both transnationality and profitability, and the relationship between them. However, scholars in the group disagreed on which variable is the mediator in the mediation framework. Some proposed a 'T-mediator model', arguing that transnationality is the mediator between knowledge-based assets and profitability. Rugman and Verbeke (2008, p. 169) noted that transnationality is really "an intermediate variable, not an independent variable", and that "the true independent variable" that influences performance is knowledge-based assets. Kirca et al. (2011, p. 51) further postulated that transnationality "mediates the relationship" between knowledge-based assets and financial performance. Others proposed a 'K-mediator model', arguing that knowledge-based assets are the mediator between transnationality and financial performance. Verbeke and Forootan (2012, p. 335) proposed that knowledge-based assets "act as mediator", qualifying any observed linkage between transnationality and financial performance. Both sides believed that their mediation models were based on internalization theory. However, neither side explicated the difference in theoretical rationales between the two mediation models.

The present paper argues that the two mediation models represented alternative theoretical explanations about the relationship between transnationality and financial performance. The T-mediator model focused on the role of knowledge-based assets in determining transnationality and, through it, profitability. The K-mediator model focused on the role of transnationality in enhancing knowledge-based assets and, through it, profitability. Both mediation models need to be assessed against core notions of knowledge augmentation and rational choice in internalization theory in the light of the transition from vertically integrated TNE to "the global factory" (Buckley 2009, p. 229). Both models need to be subjected to empirical tests against recent experience of TNEs to see how well they help explain the new international business reality.

The contribution of the paper is threefold. It applies the notions of knowledge augmentation and rational choice to the new international business reality of the global factory, and develops a coherent internalization theory framework to examine the relationships between transnationality, knowledge-based assets, R&D, and profitability. Moreover, it tests the two mediation models against a dataset of leading TNEs from 2004 to 2011, provides robust evidence in support for a model in which knowledge-based assets mediate the relationship between transnationality and financial performance conditional on R&D, and helps resolve the T--P relationship puzzle in current discussion. Based on the findings, furthermore, it draws implications for managers in making decisions on transnational boundary and R&D to enhance knowledge-based assets and, through it, financial gains that can last long.

2 Theoretical Framework and Hypotheses

Since the pioneering work of Coase (1937), internalization theory has analysed firms in relation to imperfect markets, and become the theoretical foundation for research on TNEs. A number of scholars applied internalization theory to the transnationality of a firm, including Buckley and Casson (1976), Hennart (1982), Hymer (1976), McManus (1972), Swedenborg (1979), and Rugman (1981). Consequently, there were different interpretations, if not branches, of internalization theory in the research on TNEs. In the meantime, internalization theory has experienced substantial development in recent decades in integrating with theoretical perspectives from other disciplines in order to embrace the changing international business reality (Buckley and Casson 2009; Teece 2014). It is beyond the scope of the paper to trace the...

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