An upper echelons perspective on FDI in High-Risk countries.

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An Upper Echelons Perspective on FDI in

High-Risk Countries

Daniel de Leau

5767946

24 March 2014

MSc Business Studies: International Management

Final Version Master Thesis

Supervisor: Dr. Alan Muller

Second Reader: Dr. Niccolo Pisani

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Abstract

High-risk countries are becoming increasingly important for multinational enterprises (MNEs) to take into account. These countries can offer multiple untapped opportunities, which can yield profitable returns for the companies that are willing to take the risk. However, since doing business in high-risk countries requires a distinct approach, the findings concerning FDI in ‘traditional’ and well-known emerging markets can not be assumed to hold true. To assess which companies are more likely to engage in such risky foreign direct investments, this research builds on the upper echelons theory and researched which CEO factors are associated with high-risk FDI. Focusing on the multinational Fortune 500 companies and the 50 riskiest countries in the world as identified by the OECD, it has been found that a CEO’s work-gained international and functional output experience are positively associated with high-risk FDI activity. The present research has proven to be of academic relevance by filling the gap in the upper echelons theory that existed concerning the high-risk country context and by presenting multiple topics for future research. Furthermore, the findings of this research also have managerial implications and can be used for high executive recruitment decisions and strategic decision-making.

Keywords: Upper Echelons Theory; Chief Executive Officer; Multinational Enterprise;

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List of Tables and Figures

Table 1. Cases of high-risk FDI per year ……….. 32 Table 2. Distribution of high-risk FDI ……… 33 Table 3. Descriptive statistics: means, standard deviations and correlations …………. 36 Table 4. Binominal logistic regression ……….. 37 Figure 1. Conceptual model of hypotheses ……… 27

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1 Introduction

Over the last decades an increasing number of firms entered foreign countries for multiple reasons, causing the number of multinational enterprises (MNEs) to grow. China has been a popular location for MNEs to establish foreign business units because of the magnitude of its domestic market, its large pool of cheap labor and its economic development of the last decades. The fast pace of economic development in China and other developing countries has driven many MNEs to make the leap into these foreign markets to seek for new business opportunities. However, the growing interest of MNEs in these emerging economies also has its disadvantages. Namely, these markets have become more crowded and competitive and therefore fewer market opportunities exist, profit margins have decreased and it has become increasingly difficult for MNEs to achieve first mover advantages (FMAs).

To exploit new market opportunities and achieve profitable FMAs, some MNEs have started to seek their fortune in even riskier and poorer countries. Obviously these countries have more challenges such as political risk, the risk of expropriation and the risk of default of payments (Busse & Hefeker, 2007). However, when an MNE manages to overcome these difficulties doing business in such a country could be very profitable. For example, the multinational brewing and beverage company SABMiller entered the political unstable Southern Sudan in 2009 and managed to capture a 75 percent market share of the local beer market. Besides the positive financial return on this investment SABMiller used land lease-agreements with local farmers to ensure that the Southern Sudanese community also benefited from the company’s success (SABMiller.com). Evidently SABMiller’s decision to enter Southern Sudan turned out to be a successful investment. The company now benefits from higher profit margins and multiple FMAs, which helped SABMiller to establish entry barriers to hold off potential competitors from entering the Southern Sudanese market. On the other hand, one of SABMiller’s biggest competitors, the Dutch brewing company Heineken did not enter Southern Sudan and hence did not profit from Southern Sudan’s market opportunities. Cases like these raise the question why some MNEs make the decision to enter a high-risk country while its competitors do not.

Prahalad and Hammond (2002) also stress the opportunities that these countries have to offer. They state that the bottom of the pyramid (BOP) (countries where the

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inhabitants earn less than $1.500 a year) represents a vast market of 4 billion people and despite of the challenges that characterize these countries, they offer a lot of opportunities. Although some MNEs such as SABMiller, are already investing in these countries, the potential of these locations remains mostly untapped (Prahalad & Hammond, 2002). According to Perks et al. (2013) newly emerging markets is a topic that still needs to be explored. They state that findings concerning the traditional emerging markets (such as Brazil, Russia, India and China (BRIC countries)) cannot be generalized. Namely, the newly emerging markets are characterized by a different market-space and a less familiar business context and thus doing business in these countries differs from doing business in traditional and well-known emerging economies. Prahalad and Hammond (2002) agree and state that doing business in the bottom of the pyramid requires a distinct approach. One of the problems with the BOP is that some of these countries have very high-risk profiles. Country risk is determined by multiple factors but as will be explained in more detail later, can be generally defined as ‘the likelihood that a sovereign state or borrower from a particular country may be unable and/or unwilling to fulfill their obligations towards one or more foreign lenders and/or investors’ (Hoti & McAleer, 2004). This suggests that the general knowledge about FDI does not apply to FDI in these specific high-risk countries. These findings emphasize the need for more research on less developed and newly emerging economies and high-risk countries.

As mentioned before, the case of SABMiller raises questions about why certain MNEs undertake risky foreign direct investments (FDI) while its competitors do not. Former research by Hambrick and Mason (1984) argues that important organizational decisions can be declared by studying a company’s top managers because they have the ultimate responsibility over strategic decisions. The upper echelons theory depicts that an organization is a reflection of its top executives (Hambrick & Mason, 1984; Hambrick, 2007). This suggests that examining the characteristics and backgrounds of chief executive officers (CEOs) will provide us with more insight about what factors drive an MNE to enter a high-risk country through FDI. Little is known about the CEO factors that drive MNEs to make high-risk FDI decisions. Former researches found that CEO age, gender, tenure, education and different types of work-gained experience are associated with organizational outcomes related to risk-taking. This suggests that researching factors like these in the high-risk country context can potentially yield new insight into

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this research gap. To fill this gap in the literature this research will build on the upper echelons theory. The focus will be on the CEO as the person that has the ultimate responsibility over the overall course of a company and hence FDI location decisions. Besides the academic relevance of this research the findings will also be useful for MNEs and their top managers because it can be used in the conduct of recruitment, business planning and internationalization.

This research consists of several parts. First, in the following section the relevant literature will be discussed to elaborate on all the factors and variables that are related to the topic of this research and to find out where the stream of literature has brought us so far. Subsequently, the CEO factors that are expected to be from influence on high-risk FDI decisions will be identified and hypotheses will be developed. Thereafter, the data collection, the variables and the method that will be used to carry out this research will be discussed in the methodology section. Then, the findings that have emerged from statistical analysis will be presented in the results section and the interpretation and implications of the results will be discussed. Finally, the limitations of this research and suggestions for future research will be given and the research will be concluded.

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2 Theoretical Background and Research Hypotheses

2.1 Foreign Direct Investment 2.1.1 FDI Defined

Multinational enterprises (MNEs) and FDI are important and central concepts in this study. In this section there will be further elaborated on FDI. An MNE is by definition a firm that uses FDI to establish or purchase income-generating assets abroad. FDI is a direct investment from a company into production or business in another country. This can either be done by buying a business unit or company in the host country or by expanding a current operation to another country (Goldar & Ishigami, 1999). FDI can be distinguished from foreign portfolio investment (FPI) by the fact that it entails a more than 10% equity stake in a foreign subsidiary and it involves the active management of foreign assets. FPI on the other hand is also known as foreign indirect investment because it entails a less than 10% equity stake in a foreign operation and it does not involve the direct management of assets (Peng, 2010). In this research the focus will solely be on FDI because this is associated with managing assets directly and it is expected that involvement of the CEO is higher in this process compared to foreign indirect investment.

Over the last decades the amount of FDI that was undertaken by corporations worldwide has increased substantially. The total amount of FDI has surpassed $1.4 trillion a year in 2012 (OECD). This increase of total FDI is accompanied by a growth in academic interest in this topic in the field of international business. Several scholars have focused on the drivers behind foreign direct investment. Dunning (2000) identified four main reasons why multinational enterprises undertake FDI: market-seeking reasons, efficiency-seeking reasons, resource-seeking reasons and strategic asset-seeking reasons. First, MNEs invest in foreign countries directly to tap into new markets. For instance China is a popular destination among MNEs because of the size of its home market. With a population of over 1 billion people it offers large potential for foreign companies that are striving to expand their customer base. A second reason to undertake FDI is to increase a company’s efficiency. For instance, various companies relocate their factories to countries that are characterized by lower labor costs in order to decrease overall operating costs. Third, companies also invest in foreign countries in

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search of (natural) resources because these cannot be obtained in the home country or because these resources are less expensive in the host country. Finally, some companies invest in foreign countries with the purpose of obtaining a particular expertise or valuable knowledge. MNEs from developing countries often invest in western economies with the purpose of tapping into a pool of expertise and knowledge that is unavailable in the home country and use this as a springboard to catch up with companies from further-developed economies (Gubbi et al., 2010). Agglomerations such as Silicon Valley in the US (for high-tech and internet companies) are well known for attracting companies for strategic asset-seeking reasons. These findings are complemented by Demirbag and Glaister (2010) who found that wage differences between home and host country, knowledge infrastructure differences between home and host countries, the science and engineering talent pool size and political risk are important determining factors for FDI-location decisions. At the firm level they found that a company’s experience of overseas projects and prior experience of research in the host country are important determinants of FDI location choice (Demirbag & Glaister, 2010).

In practice MNEs can engage in different types of FDI and a general distinction can be made on the basis of the amount of ownership and control an MNE has over its foreign subsidiary. On one hand there are joint ventures (JVs) where the MNE does not own the entire foreign subsidiary and collaborates with another company (often from the host country). On the other hand there are wholly owned subsidiaries (WOS) where the MNE owns the entire subsidiary (Pan & Tse, 2000). Within these two categories different strategies can be chosen that vary in amount of ownership right, control and speed of entry. Which form of FDI an MNE undertakes depends on multiple factors such as the speed of entry that an MNE desires, the amount of control an MNE wants to exert over its foreign subsidiary and home and host country legislation (Peng, 2010).

2.1.2 Theoretical Explanations for FDI

Over the years international business scholars have developed various theories that can be used to explain why MNEs engage in FDI. These include the OLI framework (Dunning, 2001), the Uppsala model (Johanson & Vahlne, 1977) and transaction-cost theory (Coase, 1937). Below, these different theoretical explanations will be discussed.

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Dunning (2001) states that engaging in FDI can bring an MNE three types of advantages; ownership, location and internalization advantages (OLI). Dunning (2001) argues that FDI is associated with many difficulties and therefore doing business abroad is only justified when the gains outweigh the costs. He describes these advantages on the basis of his eclectic paradigm and introduced the OLI framework. First, the benefit of ownership is a result of the combination of equity ownership rights and management control rights. A company can use its existing valuable, rare, inimitable and organizational embedded assets to lever their strength overseas to outperform foreign competitors. So in this case a company will use company specific advantages to exploit foreign business opportunities. Second, a company can exploit advantages that are specifically linked to a location by obtaining the control over assets that contain these location specific advantages (Dunning, 1998). Third, an MNE can replace external market transactions with internal transactions by obtaining foreign subsidiaries to keep production processes within the company. By doing this, external uncertainties and market failure can be reduced and transaction-costs can be decreased (Feinberg & Gupta, 2009).

A second well-known theory that describes why firms engage in FDI is the Uppsala internationalization process model, which was first introduced by Johanson and Vahlne in 1977. The theory depicts that firms choose to invest in culturally similar and geographically close countries and expand to cultural and geographic more distant countries when enough experience is gained. This results in a gradual expansion of investments in terms of market commitment and distance. For example, a company will first enter countries that are relatively close in terms of cultural and geographic distance and will start with low commitment in the form of export. When enough local market knowledge is gained, establishing subsidiaries and so on will increase the company’s commitment. Once enough market knowledge is gained and the commitment is increased the company will be ready to expand to cultural and geographic more distant countries. In other words, the internationalization process is based on learning and will be carried out in stages.

A third popular theory that is used to explain international business behavior is the transaction-cost theory. This theory dates back to 1937 and was first introduced by Ronald Coase. He states that firms exist when the transaction-costs of market exchange (external transaction-costs) exceed transaction-costs within a company (internal

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transaction-costs). In other words, when the opportunity arises of lowering transaction- costs by internalizing trade in the firm, entrepreneurs will establish businesses to exploit these opportunities. When applying this theory to international business it can be concluded that companies exist to replace expensive external trade between companies from different countries with internal trade. An influential theory that builds on transaction-cost economics is the internalization theory of Buckley and Casson (1976) and is often used to describe international business strategies. The internalization theory depicts that the boundaries of the firm are set at the point from which the benefits of further internalization are offset by the costs. Buckley and Casson (2009) state that firms engage in foreign direct investments to internalize overseas activities in order to exclude institutional and market risks of the host country. In other words, this theory as well as the traditional transaction-cost theory gives an explanation of why MNEs chose to own foreign subsidiaries instead of merely selling to foreign markets through export.

The present research builds on the upper echelons theory and will assess CEO factors and thus uses a more behavioral approach to explain the actions of international businesses. This research is therefore more in line with the Uppsala internationalization process model than with the efficiency approach that is used in the transaction-cost theory.

2.2 The Upper Echelons Theory

This research builds on the upper echelons theory to assess why some companies engage in risky FDI activities while their competitors do not. Below, the upper echelons theory will be discussed in more detail to gain insight about what this theory depicts and about why it is fruitful and appropriate to use in this research.

Hambrick and Mason introduced the upper echelons theory in 1984 and argue that the background and characteristics of the highest managers influence strategic choices and performance levels of a company. The theory depicts that the choices a CEO makes are influenced by his or her experiences, values and personality (Hambrick, 2007). This implies that if one desires to understand why organizations take the actions they take or why they perform the way they do, one must consider the biases and

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limitations of the most powerful actors, the top executives. The upper echelons theory is thus built on the premise of bounded rationality. Especially when making strategic decisions the decision-maker faces a situation that is complex and consists of more phenomena than one can comprehend (Hambrick & Mason 1984). The decision-making process is influenced by many factors. First, the decision-maker is influenced by his or her cognitive base and values, which result in a limited field of vision. This implies that the decision-maker cannot view every aspect of the organization and its environment (Hambrick & Mason, 1984). Second, this limited field of vision results in a selective perception of the situation. Finally, the interpretation of the information is also influenced by one’s values and cognitive base. These three processes make up a manager’s perception of a situation and strongly influence the choice that the manager will ultimately make. These strategic choices, which are influenced by upper echelons characteristics are in turn from influence on a company’s performance (Hambrick & Mason, 1984). In the upper echelons theory, performance is defined in terms of profitability, variations in profitability, growth and survival. These findings underpin the notion that also FDI decisions into high-risk countries can be better understood by analyzing the management team of an MNE. More specifically, using the upper echelons theory in a high country risk context will likely give more insight into which CEO factors drive certain companies to make direct investments in risky countries.

In the upper echelons literature there is no universal definition about what the upper echelons includes. Some researchers have studied the chief executive officer (CEO) (Barker & Mueller, 2002) who is the highest ranked employee, while others have researched entire top management teams (TMTs) (Amason, 1996; Carpenter et al., 2001; Kor, 2003). Studies that focused on top management teams also differ in the definition and composition of the team. For instance, Carpenter et al. (2001) defined the TMT as ‘all the executives above the level of vice president while Amason (1996) defined the TMT as the ‘top managers involved in strategic decision-making identified by the CEO’. In this study the focus will be on the CEO because this person has the ultimate responsibility over the strategic decisions of a company. It is therefore expected that the influence of a CEO’s characteristics and background on organizational outcomes will be the greatest.

The background and characteristics of a CEO have already been linked to FDI decisions. Herrmann and Datta (2006) state that there is an association between a CEO’s

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background and experience and his or her strategic decisions. Herrmann and Datta (2006) focused on the management of a firm and assessed the relationship between the experience of newly selected CEOs and their choice of FDI entry modes. They found that CEOs with less firm experience prefer acquisition and greenfield investments over joint ventures and older CEOs were more likely to choose joint ventures over greenfield investments. It was also found that CEOs with functional experience prefer acquisitions over JVs and greenfield investments. Finally, it was found that the international experience of a CEO was associated with a preference for greenfield and acquisitions instead of joint ventures. These findings suggest that the upper echelons theory is able to declare FDI decisions and this justifies the use of the upper echelons theory to get more insight into high-risk FDI decisions.

2.3 The Role of Country Level Risk on FDI

Now that the concepts of foreign direct investment and the upper echelons theory are elaborated on, the attention will be directed to the concept of country risk. Country risk is influenced by various factors and is an important factor for MNEs to take into account when doing business abroad. Especially when operating in foreign locations there are multiple factors that can increase the uncertainty of organizational outcomes. Below, the concepts of country risk and the institutional framework will be elaborated on. Subsequently, the effect of multiple dimensions of distance on doing business and its consequences will be discussed.

2.3.1 Country Risk

Country risk is an important and central concept in this research. Country risk has been discussed by a number of scholars and a substantial part of these researchers have focused on the country level and identified home and host country factors that induce risk and influence FDI flows. Country risk can be defined as ‘the likelihood that a sovereign state or borrower from a particular country may be unable and/or unwilling to fulfill their obligations towards one or more foreign lenders and/or investors’ (Hoti & McAleer, 2004). Country risk consists of three major components, namely economic, financial and political risk (Hoti & McAleer, 2004). These three factors are interrelated

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and therefore difficult to measure individually. According to Busse and Hefeker (2007) FDI inflows are influenced by political risk. They state that political risk can be divided into three subcategories namely government stability, religious tension and democratic accountability. They found that countries with lower political risk and better institutions related to the three indicators have received more FDI inflow per capita. This claim is confirmed by Vijayakumar et al. (2009) who found that country risk is a good predictor of FDI inflow and that this effect is stronger for FDI that is undertaken by firms from the United States. Jensen (2008) found that the presence of democratic regimes reduces the overall risk for multinational investors. Henisz (2000) developed the POLCON index to measure a country’s institutional environment on the basis of political constraints. He found that the POLCON variable has a statistical and economic significant impact on the growth rate of a country. This indicates that political constraints is an important contributor to country risk and can be used to make growth predictions.

The literature suggests that MNEs are more likely to engage in FDI in countries with relatively low country risk and perhaps that is the reason why there is little research in the high-risk country context. This research strives to address this unexplored area of the business environment of countries that are characterized by high risk and the MNEs that invest in these countries. Therefore high country risk will be treated as a given and in that context the influence of CEO factors on FDI activity will be analyzed.

2.3.2 The Institutional Framework

Country risk is often a result of the underdevelopment of the institutional framework of a country. Weak institutions result in more uncertainty and thus more risk. With respect to economic actions, more uncertainty increases the transaction-costs because more ambiguity exists concerning the outcome of a certain investment (Peng, 2010).

Institutions can be defined as the formal and informal “rules of the game”. More formally institutions are “the humanly devised constraints that structure human interaction” (North, 1990). For companies that engage in foreign direct investment it is essential to take the formal as well as the informal institutions of the host country into account (Peng, Wang & Jiang, 2008). Formal institutions are laws and legislation and are supported by the regulatory pillar. This means that people act according to the formal institutions on the basis of rewards and punishments. Informal institutions are formed

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by values, believes and actions and result in norms, culture and ethics. These aspects are supported by the normative (norms) and cognitive (values and beliefs) pillar, which implies that actions are guided by moral pressure.

Peng (2010) states that institutions have the purpose of reducing uncertainty and risk by clarifying the range of acceptable actions. For economic players in an institutional framework, uncertainty and risk can result in higher transaction-costs. In a weak institutional framework the incentive structures are absent, arbitrary or ambiguous and therefore these societies are based on relationships and networks. In strong institutional frameworks the rules are more transparent and predictable and therefore these societies are rule-based (Peng, 2010). This indicates that doing business in a country with weak institutions requires a distinct approach compared to doing business in a country with strong institutions. Therefore it is harder for MNEs to operate in institutional distant countries and for firms that originate from countries with strong institutional frameworks doing business in a weak institutional context can bring multiple difficulties. A well-known source of transaction-costs that is caused by weak institutions is opportunism, which is self-interest seeking with guile. Examples of opportunism are misleading, cheating and confusing other parties involved in transactions. All these actions will result in higher transaction-costs and thus have a negative impact on MNEs that are doing business in foreign countries (Peng, 2010). Institutions are not static and can change over time. Countries with a weak institutional framework can move from a relationship-based structure with personalized transactions to a rule-based structure with impersonal and more transparent transactions. Economies that are undergoing such a change are called transition economies (Peng, 2003). Because this research assesses the high-risk context in international business, it is important to consider the institutional framework since it has been shown that institutional development is influencing the risk of doing business abroad.

2.3.3 The CAGE Framework

Risk can be the consequence of or can be increased by distance. However, as will be shown below, distance does not only consist of geographic distance. For an MNE, doing business abroad is accompanied by more uncertainties compared to operating in the home country. Ghemawat (2001) confirms this and argues that there are four

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dimensions of distance and that these can affect different types of businesses in different ways. The four dimensions of distance are cultural, administrative, geographic and economic distance (CAGE) (Ghemawat, 2001). First, a country’s cultural attributes influence how people interact with each other. Some aspects of culture can be very obvious and easy to observe such as language and religion. Other aspects however, are more difficult to observe and understand, such as social norms and principals. The bigger the differences between two cultures are, the bigger the cultural distance is. Second, the formal ties between countries determine the administrative or political distance. Important aspects of this dimension are governmental policies, colonial ties and legal systems. An example is the European Union (EU) where formal ties are strong, which decreased trade barriers and improved the economic development of this region. Third, not only the distance in kilometers or miles from one country to another constitutes the geographic distance but also the size and accessibility of a country has an influence on the geographic distance. The geographic distance can be decreased by developed infrastructure and the accessibility to waterways. For example, landlocked countries (countries with no access to seas) are disadvantaged when it comes to international trade (Ghemawat, 2001). Finally, the economic distance is defined by the wealth of the inhabitants of a country. Research shows that rich countries (countries with inhabitants with a high per capita income) engage in foreign trade more often. These four dimensions of distance can make it increasingly difficult for companies to do business abroad (Ghemawat, 2001). When choosing a location for foreign direct investment, MNEs should weigh the costs that are accompanying the different types of distances and the potential benefits that a location has to offer. As mentioned before, the different dimensions of the CAGE distance framework affect different sorts of companies. For example, when a company ships heavy goods, the geographic distance is an important dimension while for a company that sells luxury goods, the economic distance would be more important to take into account. In contrast, a company that sells food should take into account the cultural distance to assess dietary habits.

2.3.4 Liability of Foreignness

The differences in institutions between the home and host country and the four dimensions of the CAGE distance framework all contribute to the inherent disadvantage that foreign firms experience in host countries because of their nonnative status, also

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known as the liability of foreignness (LOF) (Zaheer, 1995). Zaheer (1995) found that MNEs could often offset the LOF by importing their organizational capabilities to their foreign subsidiaries. However, the author adds that this is not applicable to every organization. It is possible that in some industries local adaption may be more useful to overcome the liability of foreignness. Peng (2010) argues that the primary weapon against the LOF is employing overwhelming resources and capabilities. Besides offsetting the LOF this strategy also results in a significant competitive advantage. Not all scholars agree with this notion. Petersen and Pedersen (2002) argue that instead of striving to offset the LOF, firms should think about reducing it. They found that the effort to learn how to conduct business in a foreign context varies significantly between companies and that the adoption of standardized international business practices is associated with low learning engagement (Petersen & Pedersen, 2002). This suggests that local responsiveness could be a superior strategy over global standardization and can result in a lower LOF. In sum, with respect to overcoming the liability of foreignness there does not seem to be a universal best practice. In fact it is often context and practice dependent. The liability of foreignness is an important factor to discuss in this research because it is closely associated with doing business in a foreign economy and especially in the case of high-risk countries it can be expected that MNEs are experiencing a higher LOF.

2.4 CEO Factors and High-Risk FDI

As mentioned before, this research focuses on the chief executive officer of a company because it is expected that he or she has the most influence over FDI decisions. This is based on the notion that the CEO has the final responsibility over a company’s strategic decisions. Below, the CEO will be discussed in more detail and on the basis of the relevant literature the CEO factors that will most likely have an effect on FDI into high-risk countries will be identified. Subsequently these factors will be elaborated on and hypotheses will be developed that will guide the statistical analysis of this research.

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2.4.1 The Chief Executive Officer

The chief executive officer (CEO) is the highest-ranking corporate officer within an organization and the leader of the top management team. He or she has the ultimate responsibility over every decision and action of all the employees of a company (Farkas & Wetlaufer, 1996). A CEO has influence over the flow and allocation of assets and can in this manner influence the course and performance of a company (Roth, 1995). Daily et al. (2000) argue that it is specifically useful to focus research on the CEO because he or she is the most uniquely organizational resource that a company possesses. Additionally, the CEO exceeds the other top management team members because he or she has achieved the “pinnacle” of the organization (Norburn, 1989). Another reason why the CEO transcends other organizational members is the fact that he or she has the unique responsibility over the performance of the firm (Vance, 1983). These researchers all underpin the fact that a CEO is the most important member of an organization. On the basis of these former findings it is expected that studying CEO factors will give more insight into FDI decisions and therefore the upper echelons focus of this research will be on the CEO.

Former research found that CEO characteristics are from influence on a firm’s investment decisions (Barker & Mueller, 2002; Daily et al., 2000; Elsaid & Ursel, 2011). For instance, it has been found that R&D spending is greater at firms where CEOs are younger, have greater wealth invested in firm stock and have significant career experience in marketing and/or engineering and R&D (Barker & Mueller, 2002). Another interesting finding was that when a female CEO succeeds a male CEO, this is associated with a decrease in firm risk-taking (Elsaid & Ursel, 2011). Again, this indicates that the influence of these CEO factors on risk-taking is worth studying.

Herrmann and Datta (2006) argue that although this topic has received academic attention, still gaps in the literature exist. For instance, the relationship between CEO experience and strategic choices in an international context has been relatively unexplored. And besides, the effect of CEO characteristics and background on FDI decisions must be researched in other contexts. In sum, there is still a gap in the upper echelons literature with respect to the international and high-risk country context. Up till now, the upper echelons theory in a high-risk country context remains unexplored. And as it was shown before, high-risk countries are characterized by different institutional frameworks and doing business in such countries requires a distinct

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approach. Therefore it is important that this context will be researched using the upper echelons theory.

This research strives to fill the aforementioned gap by assessing the link between the characteristics and background of a CEO and the FDI decision to enter high-risk countries. It would be useful for the theoretical field and have managerial implications to research whether findings from previous researches hold true or deviate in a high country risk context. The research question that this research strives to answer is as follows:

Research question: How do the characteristics and the background of a CEO affect the likelihood of a firm undertaking FDI in high-risk countries?

2.4.2 An Upper Echelons Perspective on Risk-Taking and FDI in High-Risk Markets

Now that a thorough look into the literature indicates that it is relevant to research how the characteristics and background of a CEO matter in a high country risk context, the next step is to determine which factors could be from influence on FDI decision-making. Since the high country risk context is a specific topic within the upper echelons theory it is possible that some factors are from more influence than others. Over the years numerous upper echelon factors have been used to study different organizational outcomes. By examining the literature, the CEO factors that are expected to be most relevant for this specific topic will be determined. This will be done by assessing which factors have been shown to be associated with organizational outcomes that are considered to be comparable to risky FDI decisions.

When Hambrick and Mason (1984) introduced the upper echelons theory they only included observable demographics in their study because they stated that it is very difficult to examine top executives on a psychological level. Over the years this ‘black box’ has not been opened completely (Carpenter et al., 2004) and this notion still holds true for the present study. Since it is not feasible to obtain psychological data about high executives this study will focus on observable characteristics and attributes. Besides, former research shows that assessing observable demographics of a CEO can yield very fruitful information about corporate decision-making and organizational outcomes.

As mentioned before, several scholars have found that organizational outcomes can be explained by a CEO’s background and characteristics. Factors that have been

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associated with organizational outcomes in an international context are age, education and functional experience of top management team members (Magnusson & Boggs, 2006). These scholars also state that international experience of a CEO is an important factor because companies have the increased need to compete effectively in an international context. Tihanyi et al. (2000) also identified factors that are from influence on a firm’s international diversification and are therefore interesting to research in a high-risk international context. It has been found that the TMT’s average age, TMT’s average tenure, TMT’s educational background, TMT’s international experience and TMT tenure heterogeneity are associated with a firm’s international diversification. Since these factors matter for the process of internationalization they will be included in this research and will be applied to the CEO. TMT tenure heterogeneity will not be included in this research because this factor does not apply to an individual. Kitchell (1997) researched the influence of CEO characteristics on organizational outcomes in a Canadian context and identified age, education, tenure and international experience as important factors. This provides additional confirmation that these factors matter and therefore these will be included in the present research. Mischel (1977) linked several industries with firm globalization and found that the heterogeneity of TMT tenure, educational background and functional work experience were all positively related to firm globalization. Earlier it was already mentioned that these factors were also found to be associated with risk-taking (Elsaid & Ursel, 2011) and FDI entry mode decisions (Herrmann and Datta, 2006). In other words, these CEO factors are found to be from influence in contexts (international diversification, firm globalization, risk-taking and FDI entry mode decisions) that are deemed to be comparable to the high-risk country context. The reason that it is expected that findings in these contexts are likely to yield fruitful findings in the high-risk country context is because on one hand international diversification, firm globalization and FDI entry mode decisions are associated with the international context of this study. On the other hand, risk-taking is associated with the high-risk context of this study. This provides more support for the notion that these factors are relevant to include in this research and matter specifically in the context of high-risk countries.

In short, based on the literature four CEO characteristics and two CEO work-gained experiences have been identified that are expected to be from influence on internationalization and the ability to cope with environmental complexities. The six

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factors that are expected to be relevant in the high-risk country context and will be analyzed in this research are: CEO age, CEO gender, CEO education, CEO tenure, CEO international experience and CEO functional experience. In the following section these factors will be elaborated on and it will be discusses why these specific factors are expected to matter in a high-risk country environment. On the basis of former research, hypotheses will be developed for each factor.

2.4.2.1 CEO Age

The first demographic factor that will be assessed is CEO age. Age is a simple and straightforward attribute of a CEO. Former research found that the age of a CEO is associated with several organizational outcomes. It has been found that a lower average age of the top management team resulted in more organizational changes concerning the strategy (Wiersema & Bantel, 1992). In an international context, Tihanyi et al. (2000) state that a higher average age of the top management team is negatively correlated with a firm’s international activity. Datta and Rajagopalan (1998) found that a CEO’s age is associated with the firm’s strategic direction. They explain that age influences a CEO’s underlying psychological base of knowledge and orientation. Age has also been identified as an indicator of firm risk-taking by various other scholars. For instance, Bantel and Jackson (1989) found that managers become more rigid when age is increasing and this results in a manager’s preference for less-risky strategies. Grimm and Smith (1991) found a similar relation, namely that older managers tend to rely on more conformist strategies and place more emphasis on security. Because the age of a CEO has been linked to risk-taking as well as international activity, this factor is expected to especially matter in the high-risk country context of this study. No research has been carried out that assesses the relationship between CEO age and firm risk-taking in a high-risk country context. This research strives to shed more light on this particular matter. As mentioned before, findings of former research show a negative relationship between CEO age and different forms of risk-taking. These findings suggest that younger CEOs do not have experience to rely on and therefore are more likely to engage in more out of the box and nonconformist strategies than older CEOs. In the context of this research that implies that younger CEOs are more likely to undertake high-risk FDI decisions. On the other hand, older CEOs are more likely to choose more conformist strategies that have proven to work in the past. Because of the fact that

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companies have only recently engaged in FDI into high-risk countries it is expected that the conformist strategies that older CEOs tend to rely on do not involve risky FDI. This expectation is formulated in the following hypothesis:

Hypothesis 1: The age of a CEO is negatively associated with high-risk FDI activity. 2.4.2.2 CEO Gender

The second CEO factor that will be researched is gender. Research has shown that gender is associated with different leadership styles, which indicates that the gender of a CEO does have an influence on organizational decision-making (Krishnan & Park, 2005). CEO gender has been linked to risk-taking but different scholars have brought forth contradicting findings. Mainiero (1994) argues that female managers are more likely to be comfortable with change. She found that female managers show more initiative, have a more entrepreneurial-minded attitude and have the ability to solve issues in innovative ways. This is confirmed by Paton and Dempster (2002) who found that female managers are more often found to successfully cope with change and uncertain situations. However, Elsaid and Ursel (2011) found a contradicting relation and state that when a male CEO is succeeded by a female CEO this is associated with a decrease in firm risk-taking. Because the former findings are related to innovativeness and change and the latter are directly related to firm risk-taking it is likely that the latter have more predictive value in the context of this research. It has been shown that there is a relation between gender and risk-taking and therefore the gender of a CEO is deemed to be an essential factor to include in this research to get more insight into which CEO factors affect high-risk FDI activity. With the findings of former research in mind it is expected that female CEOs are less likely to favor a high-risk strategy. In the context of this research this implies that female CEOs are less likely to engage in high-risk FDI and are more likely to choose less-high-risky strategies. This expectation is formulated in the following hypothesis:

Hypothesis 2: CEO gender is associated with FDI into high-risk countries. More specifically, male CEOs will be more likely to engage in high-risk FDI compared to female CEOs.

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2.4.2.3 CEO Educational Background

The third CEO factor that will be assessed is educational background. The educational background of a CEO is a factor that has proven to be from influence on a firm’s performance. Jalbert et al. (2002) found surprisingly that on average, firms that have a CEO without a university degree are outperforming firms that have a CEO with a university degree. In addition, CEO’s without a degree are earning more than CEO’s with a degree. Although this finding is surprising, it is supported by Mintzberg and Lampel (2001) who state that the greater part of business failures is among corporations that are managed by CEOs holding an MBA degree. A possible explanation could be that CEOs that are university-educated are taught to assess a situation and make strategic decision within a certain paradigm while CEO’s that were not educated are more likely to think out of the box. Finkelstein and Hambrick (1996) report similar findings regarding the connection between CEO education and risk tolerance. They state that in particular MBA programs attract risk-averse and conservative students. Furthermore, they argue that during MBA programs students are taught analytical skills that are focused on avoiding big mistakes or losses. These findings indicate that the education level of a CEO has an influence on organizational outcomes and particularly matters with respect to risk-taking. The fact that the education of a CEO has been found to be associated with out of the box thinking and risk-averseness makes this CEO factor a vital factor to include in this research and is expected to yield fruitful results. The findings of former research bring us to the expectation that this relation will also be found with respect to FDI into high-risk countries. In other words, it is expected that a CEO that does not possess a university degree is more likely to engage in high-risk and out of the box investments. This expectation is formulated in the following hypothesis:

Hypothesis 3: CEOs without a university degree are more likely to enter high-risk countries through FDI compared to CEOs with university degrees.

2.4.2.4 CEO Tenure

The fourth CEO factor that will be researched is CEO tenure. Tenure is the duration that a CEO has been fulfilling his or her role as highest executive for a certain company. Several authors have found an influence of CEO tenure on multiple organizational outcomes. For instance, longer-tenured CEOs generally have more conservative

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attitudes towards organizational changes. This is the result of CEOs becoming more committed to their familiar paradigm of leading a company and this causes CEOs to avoid information that opposes this paradigm (Hambrick & Fukutomi, 1991). Concerning the high-risk environment Keck (1997) found that shorter-tenured top management teams are more suitable to address environmental complexities and the productivity of these teams will be higher in turbulent environments. Furthermore, it was found that commitment to the status quo is related with longer executive position tenure (Hambrick et al., 1993). These findings suggest that longer-tenured CEOs will be less suitable to cope with the environmental complexities that one encounters in the high-risk country context. The association of CEO tenure and risk-taking is not yet researched in a high-risk country context and Musteen et al. (2006) pointed out that additional research is needed. This research will fill this gap in the academic literature. The fact that CEO tenure has been linked to the ability to cope with environmental complexities and the attitude towards change makes this factor logical to include in this research. The findings of former research suggest that longer-tenured CEOs are less open towards change and are less suitable to deal with environmental complexities. Given the fact that change is accompanied by more uncertainties it is expected that similar findings will be derived in the high-risk country context. In line with the CEO age hypothesis, the literature suggests that shorter-tenured CEOs do not have the experience to rely on and therefore are more likely to engage in out of the box and riskier strategies. Longer-tenured CEOs on the other hand, can rely on conformist strategies that have proven to work. Given the fact that companies only recently have been engaging in FDI into high-risk countries it is expected that these conformist strategies do not involve these types of FDI decisions. This expectation is formulated in the following hypothesis:

Hypothesis 4: CEO tenure is negatively related to the likelihood of this same CEO undertaking FDI into high-risk countries.

2.4.2.5 CEO International Experience

The next factor that will be included in this research is the international experience of a CEO. The relation of executive characteristics and background with organizational outcomes has been the focus of numerous studies. An important factor that has received

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increasing attention over the last years is the international experience of top executives. This can also be declared by the aforementioned increasing interest that companies show in foreign markets. A CEO’s international experience is defined as ‘having overseas organizational assignments in their portfolio of professional experiences’ (Hoffman & Gopinath, 1994; Neff et al., 1997). Researchers have found a variety of associations between the international experience of top executives and firm internationalization. It was found that the international experience of the top management team is positively associated with a firm’s degree of internationalization (Reuber & Fischer, 1997; Carpenter et al., 2004; Sambharya, 1996). With respect to international performance of an MNE, a positive relationship between the international experience of top executives and international performance was found (Carpenter et al., 2001). When focusing on a firm’s CEO, a positive relationship was found between CEO international experience and the degree of firm internationalization (Daily et al., 2000). To my knowledge, the effect of a CEO’s international experience on FDI in the high-risk country context was not researched and since it has been shown that doing business in high-risk countries is different than just doing business internationally it is interesting to research whether CEOs with international experience are more likely to engage in high-risk FDI. The fact that international experience of top managers has been linked to firm internationalization and international performance makes it an essential factor to include in the present research. The findings from former researches suggest that international experience has a positive influence on FDI and therefore it is expected that this relation will also be found in the high-risk country context. In other words, CEOs that have international experience in their portfolio of professional experiences will be more likely to choose for high-risk FDI strategies because they can build on their gained international experience. On the other hand, CEOs that do not possess international experience are expected to be less comfortable choosing high-risk FDI strategies which will result in a lower likelihood of these managers engaging in risky FDI. This expectation is formulated in the following hypothesis:

Hypothesis 5: The international experience of a CEO is positively associated with a firm’s high-risk FDI activity.

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2.4.2.6 CEO Functional Experience

The last factor that will be assessed in this research is the functional experience of a CEO. Functional experience stands for the type of experience that a CEO has acquired during his or her career. This factor is believed to have an effect on the strategic decisions that a CEO makes. Multiple studies have found that a CEO’s attitude and cognition is affected by the different reward systems, goals and issues that were encountered in the functional area in which the CEO has spent his or her career (Finkelstein & Hambrick, 1996; Beyer et al., 1997). More specifically, Hambrick and Mason (1984) argue that CEOs with a more output-oriented specialization (marketing, sales or product R&D) are more open to new ideas and innovation. In contrast, CEOs with a more internal-oriented specialization (production or process engineering) are more conservative towards new ideas and innovation. This is caused by the fact that internal-oriented specializations are focused on maintaining control (Hambrick & Mason, 1984). Thomas et al. (1991) support this claim and state that in the computer industry, firms with more innovative strategies were often managed by CEOs with output functional experience. More specifically, these studies suggest that CEOs with functional output experience are more willing to take innovative strategies and are more open to change. This suggests that CEO functional experience is a decisive factor in risk-taking and it is expected that it has an influence on high-risk FDI decisions and will therefore be included in this research. This factor has not been researched in the high-risk country context and therefore this research will assess the potential influence of the functional experience of CEOs on high-risk FDI activity. The types of strategies that involve high-risk FDI are accompanied by more uncertainty and risk compared to conformist strategies. When taking the findings of former research into account it can be expected that CEOs with more output-oriented functional experience are more likely to think out of the box and engage in nonconformist and riskier strategies. On the other hand, CEOs with more internal-oriented functional experience will be more likely to maintain control and choose more conformist strategies. Based on the assumption that companies only recently started to engage in high-risk FDI it is expected that conformist strategies are less likely to involve high-risk FDI. Therefore it is expected that CEOs with output-oriented functional experience are more likely to undertake FDI into high-risk countries. This expectation is formulated in the following hypothesis:

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Hypothesis 6: A CEO with output-oriented functional experience is more likely to engage

in high-risk FDI compared to a CEO with more internal-oriented functional experience. Figure 1. Conceptual model of hypotheses

Dependent

Variable

FDI in

high-risk country

Control Variables

- Firm Size

- Profitability

- Year of Investment

- Company Age

- Industry

Independent

variables

- CEO Age

- CEO Gender

- CEO Education

- CEO Tenure

- CEO International

Experience

- CEO Functional

Experience

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3 Research Methods

3.1 Sample and Data Collection

The sample of this study consists of the 2010, 2011 and 2012 Fortune 500 companies, which are the largest companies from the United States measured by gross revenue. The companies from this sample that do not engage in foreign direct investment were excluded from the sample because this allows us to focus on the difference between ‘standard’ FDI and high-risk FDI in the international context. This resulted in a sample size of 1050 cases. The sample is appropriate for this study because the companies are from a variety of industries and the companies share the same home culture, which eliminates potential differences stemming from industrial or cultural differences and different institutional backgrounds. In addition, because the Fortune 500 firms are public the organizations are required to make financial and internationalization information that is needed for this study publicly available in an annual report. A list of the multinational Fortune 500 companies that are included in this research can be found in Appendix 1.

The data about the Fortune 500 companies was obtained from the Fortune 500 website which is published by Fortune Magazine on a yearly basis. The data about the CEO characteristics was obtained from the Business Week website which is published by Bloomberg and contains all the information about the top managers of the Fortune 500 companies including age, gender, education, tenure, international experience and functional experience. Data about FDI activity in the given years was drawn from the annual reports that the companies from this sample are required to disclose on a yearly basis.

3.2 Variables

3.2.1 Dependent Variable

The dependent variable in this study is high-risk foreign direct investment. To determine which countries are characterized by high risk, country risk data by the Organization for Economic Co-operation and Development (OECD) was used. The OECD assesses the country risk of over 200 countries and publishes this list annually. The risk

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of a certain country is shown by a risk classification ranging from 0 to 7, 0 being the least risky and a score of 7 meaning the highest risk. Because this study focuses on FDI in high-risk countries the sample of countries was drawn from the countries that received the highest risk classification of 7. On the basis of the country risk classifications that were published on the 25th_{of January 2013 a sample of 50 countries}

is used that received the highest risk assessment of 7. A list of these 50 countries can be found in Appendix 2 and a graphic view of the distribution of the 50 countries included in this research can be found in Appendix 3.

To determine whether the Fortune 500 companies from the sample engaged in FDI in one of these 50 high-risk countries, the annual reports were searched for mentions about FDI activities in these specific high-risk countries. This was then noted as a dummy variable (0 = no high-risk FDI and 1 = high-risk FDI). In some cases the annual reports were inaccessible or non-existent. This resulted in a final sample of 956 cases (305 in 2010, 322 in 2011 and 329 in 2012).

3.2.2 Independent Variables

As mentioned before, the independent variables about CEOs were obtained from the Bloomberg Business Week website which is published by Bloomberg. This website is considered to be a renowned and a reliable source of information concerning business, corporations and investments. Other researchers have also used CEO data that was published by Business Week in the past (e.g., Baker and Mueller 2002, Guthrie and Datta 1998 and Ward et al. 1995), which confirms the suitability of the source for this research. The first CEO factor, age, was measured in years and the variable was centered which has the purpose of removing undesirable fluctuations. The second CEO factor, gender, was coded into a traditional dummy variable (0 = female and 1= male). The third CEO factor, education, was measured using a four-point scale showing the highest degree that a CEO obtained (0 = no college degree, 1 = a bachelor’s degree, 2 = a master’s degree, 3 = a PhD degree). This four-point scale was also used by other researchers that assessed CEO demographics (Barker and Mueller, 2002; Daellenbach et al., 1999), which confirms the appropriateness of this measure of CEO education. In the analysis the first category (no college degree) was used as a reference category to which the other categories were compared. The fourth CEO factor, tenure, was measured in years since the highest executive was appointed CEO and this variable was centered. The fifth CEO

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factor, international experience, was measured as a dummy variable (0 = no international experience and 1 = international experience). For international experience a dummy variable was used because the source reported the duration of the international assignments unclearly. However, whether a CEO possessed international experience or not was clearly stated. The last CEO factor, functional experience, was also measured using a dummy variable. Building on research of Hambrick and Mason (1984) and Musteen et al. (2006) the functional experience was divided into two groups based on a CEO’s resume. A value of 1 was noted when the greater percentage of the CEO’s career was spent in output functions (marketing, sales and R&D or similar) and a value of 0 was noted when the CEO spent a greater percentage of his or her career in a internal function (production, process finance or accounting or similar).

3.2.3 Control Variables

In the present research it is argued that the characteristics and background of a CEO are associated with the likelihood of MNEs performing FDI in high-risk countries. To test this argument there must be controlled for several firm and industry factors that have been identified to influence FDI activity. By doing this the role of CEO factors will be assessed more fully because the factors that may influence the hypothesized relationships are controlled for. Below, each of the identified control variables and the way in which these are measured in this study will be discussed.

The first variable that is controlled for is firm size which is a common control variable and has been linked to organizational outcomes more often (Daily et al. 2000 and Gomez-Meji & Palich, 1997). Small firms may behave differently than large firms and therefore a control variable measuring firm size will be included. Henderson and Fredrickson (1996) found that a large firm size is related to extensive international activity and indicates the capability of dealing with complex situations. Firm size is measured by annual gross revenue in millions of US dollars. This is also the way in which Fortune measures firm size to construct the Fortune 500 list. This variable was centered and the log of the variable was used to account for skewness in the data. The second variable that is controlled for is profitability. Profitability was measured using the profit ratio, which is calculated by dividing the annual profit by the annual gross revenue of a company. This variable was standardized and the outliers were excluded by removing data with a Z value smaller than -3 or a Z value greater than 3. In other

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words, cases with values that exceeded three times the standard deviation were excluded. Again, profitable firms may behave differently than less profitable firms and may have more financial strength to undertake FDI. Therefore profitability will be controlled for in this research. This control factor has also been used in other researches that have focused on CEO characteristics and risk-taking (Elsaid & Ursel, 2011), which confirms the appropriateness to use profitability as a control variable in the present study. The third control factor that has been included is the year of investment. It may be possible that in the aftermath of the financial crisis in 2008 the risk tolerance of companies have changed over time. Therefore there will be controlled for the fact whether the risky FDI activity was performed in 2010, 2011 or 2012. In the analysis 2010 was used as a reference category to which the other categories were compared. The next variable that is controlled for is company age, which is measured in years since the founding of the company and was centered. Older companies may behave differently than younger companies and therefore this is a relevant control factor to include in this research. This variable was found to be from influence in the international investment context (Magnusson & Boggs, 2006). Finally, there is controlled for the type of industry because as mentioned before, the literature shows that companies can have different reasons to enter a country through foreign direct investment. It may therefore be possible that firms from different industries behave in different ways. The type of industry was coded as a dummy variable from 1 to 12 indicating 12 different industries. The data about the subdivisions was drawn from the Fortune 500 list and merged into twelve different categories. The classification into 12 categories is carried out to create groups with similar amounts of cases, which makes the data more suitable for statistical analysis. The dummy numbers corresponds with the industries as follows: 1 is the apparel retailer industry, 2 is the automotive and motor industry, 3 is the food and beverage industry, 4 is the building and construction materials industry, 5 is the health care industry, 6 is the banking and financial services industry, 7 is the computer and electronics industry, 8 is the utilities industry, 9 is the entertainment industry, 10 is the telecom industry, 11 is the mail and packaging industry and 12 is miscellaneous. In the analysis the first industry category (the apparel retailers industry) was used as a reference category to which the other categories were compared.

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3.3 Statistical Analysis and Results

The descriptive statistics of the independent and control variables used in this research are presented in table 3. The variables were tested for multicollinearity by assessing the bivariate correlations between all the independent variables. According to Pallant (2011) only correlations above .7 will be problematic. All bivariate correlations are below .7 and therefore all variables were retained. Also a collinearity diagnostic test was performed to check for possible multicollinearity that is not evident in the correlation matrix. All the tolerance values of the independent variables were calculated. The tolerance value indicates how much of the variability of a specific independent variable is not explained by the other independent variables. A low tolerance value (less than .10) indicates that the multiple correlation with other variables is high, suggesting possible problems with multicollinearity (Pallant, 2011). All the tolerance values for the independent variables in this study were above .7, which indicates that multicollinearity is not problematic.

The mean value of the foreign direct investment dummy variable is .45, which indicates that the number of companies undertaking FDI into high-risk countries is representing almost half of the sample. This even distribution makes the sample suitable for comparison. A more detailed description of the number of cases of high-risk FDI per year can be found in table 1. It can be seen in table 1 that the percentage of high-risk FDI versus no high-high-risk FDI is relatively comparable for each year. A more detailed assessment of amount of FDI decisions per company over the three measured years shows that most companies either invest in all three consecutive years or do not invest at all. This suggest that the observed companies tend to stick to a foreign investment strategy for multiple years. The totals can deviate due to partial missing data.

Table 1. Cases of high-risk FDI per year

Investment Year High-Risk FDI No High-Risk FDI Total

2010 135 (44%) 170 (56%) 305

2011 139 (43%) 183 (57%) 322

An upper echelons perspective on FDI in High-Risk countries.