Unbalanced Institutions in Market Transition: How Do They Matter for Firm Strategic Choices and Performance in Emerging Economies?

VerfasserLiu, Weiping

1 Introduction

Institutions are the humanly devised rules and constraints that structure human interactions (North 1990), and they include both formal rules and informal constraints. Institutions, including the economic and legal dimensions, establish norms, rules, and procedures for economic and social activities, and constitute a society's basis for production, exchange, and distribution (North 1990). Following prior literature, we define economic institutions as the structural arrangements through which a society produces, distributes, and consumes goods and services (Khanna and Palepu 2000). Economic institutions generally involve market intermediaries (Khanna and Palepu 1997; North 1990) and supporting infrastructures (Porter 1990). They provide needed infrastructure and systems to allow for business activity and exchange, and influence production and transactions by shaping resource availability and access to opportunities within a region (Khanna and Palepu 1997, 2000; North 1990). We define legal institutions as the existence of laws, regulations, and written rules that define the 'rules of the game' of market competition (Acemoglu and Johnson 2005; Acemoglu et al. 2005). They constitute and define an established order within which businesses operate (North 1990) and set constraints on practices that considered unfair or socially harmful.

The institutional transition process under way in many emerging economies has attracted the attention of scholars in a wide range of disciplines, including economics, sociology, international business, and business strategy (Boisot and Child 1996; Hoskisson et al. 2013; Li 2013; Nee 1992; Wright et al. 2005). Emerging economies are defined here as those undergoing institutional transition towards a market-based system, a process which normally involves building various market-supporting institutions (Hoskisson et al. 2000). The institutional transition normally involves "fundamental and comprehensive changes introduced to the formal and informal rules of the game that affect organizations as players" (Peng 2003, p. 275). Business scholars have developed an institution-based view of firm strategy which emphasizes the dynamic interaction between institutions and firms, and considers strategic choices as a reflection of the prevailing economic, legal, and political systems (Peng 2003). According to the institution-based view, emerging economies often lack the stable institutional structure which facilitates economic exchange, and thus tend to suffer from high costs. Organizations pursue strategies that take advantage of opportunities while accommodating the constraints imposed by the underdeveloped institutions.

Such an institution-based perspective has been widely adopted by scholars in strategic management. Most of them adopt a simple dichotomy that divides the world into emerging and developed economies, and emphasize the underdeveloped nature of institutions in emerging economies, such as deficient capital market structures, poor legal infrastructure, weak property rights protection, or high institutional uncertainty. More recently, Hoskisson et al. (2013) go beyond the simple dichotomy to consider firms in mid-range economies, i.e., economies that are positioned between traditional emerging economies and those considered fully-developed. These economies have more developed market infrastructures, but their development is often unbalanced.

Institutional transition is a dynamic process in which different institutions develop in different ways at different speeds. As a result, institutional transitions in different economies may manifest diverse patterns which may have different impacts on firms (Jackson and Deeg 2008; Lundan and Li 2019). When the multiple dimensions of institutions transit simultaneously, they could interweave, support, and reinforce each other. Better synchrony promotes their reaching some sort of equilibrium, which in turn facilitates development (Hall and Soskice 2001) and economic performance (Yang et al. 2015). When the development of institutions is unbalanced, however, the misfit can lead to conflicts and frictions, which trigger uncertainties in, for example, transferring critical information, accessing opportunities and resources, or safeguarding intellectual property. In leveraging institutions to their competitive advantage, firms need to adjust and coordinate their business activities, which may lead to inefficiencies and high transaction cost, hampering market transactions.

China and India, for example, are two economies which are reforming their market infrastructures (Hitt and He 2008; Kapur and Ramamurti 2001; Patibandla 2002). In both, the development of legal institutions has so far failed to keep pace with that of economic institutions. The law has lagged behind, the enforceability of contracts is weak, and competition has been relatively slow to develop (Rawski 1994; Yang 2002). Some other countries such as Poland have been able to foster better legal institutions after the breakup of the Soviet bloc (Hoskisson et al. 2013). The Polish government has revised the laws that regulate economic activity, reaffirming private ownership and enhancing the efficiency of the law enforcement. In Poland, however, economic institutions have not changed commensurately. Some of the central planning infrastructure remains despite being outdated. Figure 1 shows data on the development of economic and legal institutions in several emerging and developed economies (published in the IMD World Competitiveness Report) for selected recent years.

The figure shows that in China, India and Russia, the development of institutions is unbalanced: somewhat developed in terms of economic institutions but less developed in terms of legal institutions. Other economies, like Hungary and Poland, are unbalanced in a different way: with relatively developed legal institutions but underdeveloped economic institutions.

The unbalanced development of institutions prevails in many economies, but has so far received inadequate scholarly attention. The literature on institutional transition in emerging economies has mainly treated it as a two-stage model and emphasized the underdeveloped nature of institutions in the transition process while predicting an eventual evolution to a full development (Peng 2003). But the transition process could be more complex than such models imply. In particular, the unbalanced development of institutions and its impact on firm strategies have been largely overlooked (Hoskisson et al. 2000, 2013).

This study built upon an institution-based view of firm strategy and investigated how imbalances in the development of institutions can influence market competition, firms' strategic choices and firm performance. With a major foundation in the new institutional economics, this approach emphasizes the actual functions that the different dimensions of institutions perform in the effective functioning of markets. Institutions work as both constraints and facilitators under this perspective. Specifically, this research focused on the development of economic and legal institutions, holding the development of other dimensions constant (Hitt et al. 2006; Khanna and Palepu 1997; North 1990). The aim was to investigate how imbalances in the development of economic and legal institutions in an emerging economy can influence its markets, firm strategies and firm performance. Figure 2 illustrates two unbalanced development paths (Path 1 and Path 2) at an intermediate stage (Stage II) in the market transition process.

2 Theoretical Framework

2.1 The Institution-Based View of Economic Development

The traditional institutional perspective emphasizes the embeddedness of organizations in the institutional environment, and has its roots in both sociology (Scott 1995) and economics (North 1990). The sociological approach of institutional analysis emphasizes the legitimacy-defining roles of institutions, which are composed of cultural-cognitive, normative, and regulative elements (Scott 1995). These institutions, as widely shared beliefs, shape the way people in a society think and behave, and exert significant pressure on firms (Scott 1995).

Alternatively, the institutional economics view, as represented by North (1990), focuses on the actual functions that institutions perform for the effective working of markets. It considers institutions--as reflected in laws, regulations, or capital markets--to be both constraints and facilitators, and contends that, institutions determine transaction and production costs, define the incentives of individuals and organizations, and thus influence firm activities and performance (North 1990). This perspective places little emphasis on the legitimation processes and the process of institutionalization in explaining firm actions (Zucker 1987). But there is also an emergence of explanations based on institutions 'behaving' as actors in their own right (Zucker 1987).

With a main foundation in institutional economics, an institution-based view of firm strategy has been developed that accounts for the impact of institutions on firm strategy and on organizational and economic outcomes. This view emphasizes the dynamic interaction between institutions and firms, and considers strategic choices as the outcome of such interactions (Peng 2003). As Ingram and Silverman (2002, p. 20) point out, "institutions directly determine what arrows a firm has in its quiver as it struggles to formulate and implement strategy, and to create competitive advantage".

In the past few years, the institution-based view has been a leading perspective in strategic management (Wright et al. 2005), especially in research on emerging economies (Hoskisson et al. 2000; Xie and Li 2018). This discussion will be based on the institution-based view, especially the institutional economics perspective (North 1990). It will emphasize the distinct roles of...

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