Firm, industry and home country effects on multinationality : a multi-level analysis of the 2014 global fortune 500

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FIRM, INDUSTRY & HOME COUNTRY EFFECTS ON

MULTINATIONALITY

A MULTI-LEVEL ANALYSIS OF THE 2014 GLOBAL FORTUNE 500

MSc Business Administration University of Amsterdam

Final Version Master Thesis June 28th, 2015

Lisa Doedel (5893410) Supervisor: Dr. Niccolò Pisani Second Supervisor: Francesca Ciull

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Statement of Originality

This document is written by Lisa Doedel who declares to take full responsibility for the contents of this document. I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.

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Abstract

This research focuses on the influence of firm-, industry- and home country-characteristics on the level

of multinationality. Existing research has focused on one level of analysis at a time, this study fills this

research gap by offering a comprehensive framework that integrates firm-, industry- and home

country-factors and examines how these factors influence multinationality. By focusing on the world’s

largest multinationals, as ranked by the 2014 Global Fortune 500 list, this paper reports that the level

of innovation of a firm positively influences the scale and scope of multinationality. Furthermore,

evidence is found that this positive association is weaker in the case of high levels of innovation of a

firm in combination with a high level of institutional development of the home country.

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Abbreviations

COE Country-of-origin effect

EMMNE Emerging market multinational enterpise FSA Firms-specific advantage

MNE Multinational enterprise RBV Resource Based View R&D Reseach & Development

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List of Tables & Figures

Table 1. Distribution of Companies – Home Countries 26 Table 2. Standard Deviations & Correlations 32

Table 3. Results of OLS Regression 33

Table 4. Results of OLS Regression – Continued 34

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1

Introduction

Firms nowadays are increasingly diversifying into foreign countries or across regions, and many of the

world's largest and most successful firms are multinational enterprises (MNEs). The global Fortune

500 list consists of companies that together account for approximately 90% of the world’s stock of

foreign direct investment and represent about 25% of the world’s trade (Rugman & Verbeke, 2004;

Rugman & Oh, 2008). Internationally diversified firms enjoy cost advantages and more diversified

access to tangible and intangible resources such as natural resources and specialised knowledge (Hitt

et al, 1997). However, multinational companies are also faced with costs stemming from a lack of

foreign market knowledge, increased coordination and higher risk due to uncertain environments (Hitt

et al, 1997). Given the benefits and disadvantages of multinationality, this paper aims to determine

what factors influence the level of international diversification, i.e. the degree to which a firm is

extended beyond the borders of its home-market into new markets in order to pursue value-adding

activities (Hitt et al., 2006).

A large body of research has focussed on the antecedents, outcomes and moderators of

multinationality (Hitt et al., 2006). Three levels of analysis can be distinguished, namely analysis on

the firm-, industry- and home country-level. The majority of multinationality research has focused on

the influence of firm-level characteristics, in particular the influence of firm-specific advantages, firm

age and firm size. Firm-specific advantages, e.g. R&D and superior management skills, can be

employed as strategic resources that lead to a competitive advantage (Lu & Beamish). The

idiosyncratic nature of firm-specific advantages provides the MNE with a safeguard against costs from

market imperfections (Buckley & Casson, 1976). Subsequently, internalization of firm-specific

advantages generates high levels of multinationality (Delgado-Gomez et al., 2004). In addition to

firm-specific advantages, firm size and firm age are variables commonly identified in the literature to

influence the level of multinationality. Firm size influences the ability to successfully operate in foreign

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2 management skills, and economies of scale and scope (Kirca et al., 2012). Firm age, however, mainly

influences multinationality through variables such as previous international experience and

managerial capabilities (Kirca et al., 2012). Hence, older firms do not face the liabilities of newness as

younger firms do (Autio et al, 2000). Young firms, however, are less likely to be constrained by

organizational inertia or bureaucratic constraints when diversifying internationally (Kirca et al., 2012).

Scholars investigating the influence of industry-level factors have identified industry growth and

industry rivalry to be of influence on a firm’s decision to diversify internationally. The influence of

industry growth on multinationality is explained by the fact that prospective growth is usually seen as

a sign of an attractive industry (Porter, 1980). Consequently, high growth industries positively

influence multinationality due to the potential increase of prosperity when diversifying into high

growth markets (Kirca et al., 2012). The influence of industry rivalry on multinationality can be

explained by the opportunity to reduce the level of competition for key resources or markets (Hitt et

al., 2006). Thus, when diversifying internationally firms are better able to guard themselves from

industry rivalry (Kirca et al., 2012). Hence, when industry rivalry is high, firms are more likely to

diversify internationally.

Researchers studying the influence of the home country have drawn upon two theories; the culturalist

and institutionalist theory (Noorderhaven & Harzin, 2003). The culturalist theory relies heavily on the

work of Hofstede (1980) and the indices of national value dimensions in order to explain differences

in internationalization strategies. The second theory, the institutionalist approach, explains that, in

addition to differences in cultural backgrounds and production factors, e.g. land, labour and capital,

multinationality is influenced through the political, legal and societal institutions of a country

(DiMaggio & Powell, 1991; Wan & Hoskisson, 2003). More specifically, multinationality is influenced

through transactional efficiency and the development of capital markets of the home country. High

transactional efficiency allow firms to substitute as well as fully utilize their home country factors

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3 from a relatively unfavourable capital environment may diversify as a mean to create a more

favourable capital environment (Li & Yeu, 2008).

Although prior research has explored the relationships between firm-, industry- and home

country-characteristics and multinationality, scholars have mostly focussed on one level of analysis at a time.

This has resulted in a collection of small and disparate streams of research (Hitt et al., 2006; Kirca,

2012). As firms operate and originate from a certain environment and are thus largely influenced by

industry- and home country-characteristics (Wan & Hoskisson, 2003; Li & Yue, 2008; Gimeno et al.,

2005), there is a need for a more in-depth investigation on the determinants of multinationality.

Hence, this study conducted a multi-level analysis on the influence of firm-, industry- and home

country-characteristics on multinationality based on the 2014 Global Fortune 500.

The structure of this paper is as follows. The first chapter, the literature review, focusses on relevant

literature regarding the topic of multinationality, i.e. the level and the determinants of international

diversification. Subsequently, we build on these theories by developing hypothesis in the theoretical

framework. The methodology section then discusses the data collection process, the variables used

and the method of analysis. Finally, we present the findings and discuss the academic relevance,

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4

Literature Review

Both international diversification (Hitt et al., 2006) and multinationality (Contractor, Kundu & Hsu,

2003) are used in the literature to describe the extent to which firms are operating on an international

level. This study uses both terms interchangeably to describe the degree to which a firm is extended

beyond the borders of its home-market into new markets in order to pursue value-adding activities

(Hitt et al., 2006). The topic of multinationality is well covered in the international management and

business literature (Hitt et al., 2006). The large stream of research on the topic is a result of the fact

that multinationality involves a central process, one that interacts with the structure, functioning and

performance of a firm (Kirca et al, 2012). A large number of studies have focussed on the relationship

between multinationality and performance (Rugman and Oh, 2007). In this study we do not focus on

the relationship between multinationality and performance but on the influence of firm-, industry-

and home country- factors on multinationality. Several measures of multinationality, however, have

been developed in studies investigating the influence of multinationality on performance (Rugman

and Oh, 2007). These metrics can be divided into two categories, i.e. the scale and scope of

multinationality (Rugman and Oh, 2007). The scale of multinationality refers to the foreign

involvement (Qian, 1996) and includes measures such as foreign to total sales and foreign to total

assets (Rugman and Oh, 2007; Oh, 2009). The scope of multinationality refers to a firm’s expansion

into different geographic regions or markets (Hitt et al., 1997) and is often measured based on the

number of foreign countries or number of foreign subsidiaries (Rugman and Oh, 2007; Oh, 2009).

Rugman and Verbeke (2004) explain that it was long believed that MNEs were global as they are the

key drivers of globalization. Recent research, however, has provided evidence that MNEs operate on

a regional level instead of a global level (Rugman, 2000; Rugman and Verbeke, 2004). Other scholars,

however, have questioned the validity of these results (Inkpen & Ramaswamy, 2007; Flores & Aguilera,

2007). This inconsistency in results may be due to the use of incorrect or ambiguous metrics of

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5 2009). We will therefore first elaborate on the globalization versus regionalization debate and the

methodological issues in the measurement of multinationality. After which the remainder of this

chapter will focus on the drivers of multinationality, i.e. firm-, industry- and home

country-characteristics.

Globalization versus Regionalization

It was long believed that as MNEs are the key drivers of globalization, they were global themselves

(Rugman & Verbeke, 2004). This belief has resulted in strategies shaped to meet the global

environment, in which serving the global market with globally oriented product has been the main

message (Levitt, 1983). The start of the globalization versus regionalization debate was caused by the

publication of Rugman’s (2000) ‘The End of Globalization’. Rugman (2000) argues that globalization,

as previously envisioned, never existed. More specifically, Rugman (2004) argues that the majority of

the world’s largest MNEs operate regionally instead of globally. Meaning, the world’s largest

companies are not global but regionally based, in terms of the depth, i.e. the scale of multinationality,

and breadth, i.e. the scope of multinationality, of their market coverage (Rugman & Verbeke, 2004).

Following Rugman’s (2000) aforementioned publication, Rugman and Verbeke (2004) extended

Rugman’s (2000) study from the country- to the firm-level by using sales data of the 500 world’s largest

firms. Rugman and Verbeke (2004) find that the world’s 500 largest firms mainly operate within the

triad, consisting of the United States, the European Union and the Asia-Pacific region, as defined by

Ohmae (1985). Rugman and Verbeke (2004) measure the level of multinationality by classifying each

company based on their developed sales distribution framework. This framework consists of four

different classifications; Home-region oriented, Bi-regional oriented, Host-regional and Global

companies. The first, home-region oriented, reflects firms that derive at least 50% of its sales in the

home region of the triad. Continuously, a company that derives at least 20% of its sales in at least two

legs of the triad, but less than 50% of its sales in the home region, is classified as a bi-regional company.

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6 regions other than its home region. Finally, in order to be seen as a truly global company, a company

must have sales of at least 20% in each of the three regions of the triad but no more than 50% in any

region. By classifying 380 of the world’s largest companies according to this framework, 320 were

assigned to the home-region classification, 25 to the bi-regional oriented class, 11 companies to the

host-oriented classification and only 9 companies were assigned to the global category (Rugman &

Verbeke, 2004). In addition, Rugman and Verbeke (2004) find that the weighted average of

intra-regional sales for the home-region reached 80.3%, 43% in the bi-intra-regional category, 30.9 % in the

host-regional class and 38.3% in the global-classification. Based on these empirical findings Rugman and

Verbeke (2004) conclude that most companies are regionally based as opposed to operating on a

global level.

Following Rugman’s (2000) publication, many scholars have shown the robustness of the

regionalization argument. Scholars, such as Ghemawat (2005) and Rugman and Oh (2012), provide

more foundation for the regionalization argument by presenting longitudinal data whereas others

contribute to the debate by focussing on particular industries. Grosse (2004), for example, focusses

on the financial sector whereas Filippaios and Rama (2008) investigate the scale and scope of

multinationality of the food and beverage industry. Both Grosse (2004) and Filipaios and Rama (2008)

provide evidence in favour of regionalization. Friedman (2005) and Inkpen and Ramaswamy (2007),

however, provide arguments in favour of globalization. In addition, Flores and Aguilera (2007) point

out that the capital investments of 100 large US MNEs in Asia and Europe increased by respectively

52% and 12% in 2000 when compared to the same country scope data 20 years prior. This result seems

to contradict the empirical evidence as provided by Rugman and Oh (2007) who state that the regional

orientation of MNEs remained stable over time. Oh (2009) notes studies contradicting the

regionalization argument often use incorrect or ambiguous scale and scope metrics. Flores and

Aguilera (2007), for example, use a country scope metric. In order to capture the geographic scope,

Flores and Aguilera (2007) simply counted the number of countries. By using this metric, Flores and

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7 Instead of simply counting the number of countries it is necessary to evaluate the level of foreign

direct investment in each country as well as by country (Rugman & Oh, 2007). This is supported by Oh

(2009) who investigated the reliability of multinationality measurements. In doing so, Oh (2009)

reports that the regionalization argument is supported when using the right scale and scope metrics;

metrics based on sales and assets instead of metrics based on country count. Hence, we can conclude

that the empirical evidence is certainly more in favour of the regionalization argument.

Firm-Level Factors

Now that we have elaborated on the regionalization versus globalization debate and the importance

of using the right multinationality metrics, the remainder of this chapter will focus on the

determinants of multinationality. Hitt et al. (2006) note that the majority of multinationality research

has focussed on firm-level characteristics. In this section we focus on three commonly identified

factors, namely firm-specific advantages, firm size and firm age.

As noted, much of the multinationality research has focused on firm-level characteristics, among

which a large body of research has investigated the influence of firm-specific advantages (FSAs). The

literature commonly draws upon both the Resource Based View (RBV) (Barney, 1991) and

internalization theory (Buckley & Casson, 1976) in order to explain the influence of FSAs on

multinationality. The RBV consists of two fundamental assumptions regarding a firms resources, i.e.

bundle of all assets, knowledge and capabilities (Priem & Butler, 2001). The first assumption is that of

rarity and value. Meaning, resources that are both rare, i.e. not widely available or held, and valuable,

i.e. resources that contribute to firm efficiency or effectiveness, can produce a competitive advantage

(Prahalad & Hamel, 1990; Barney, 1991). The second assumption is that of inimitability,

non-substitutability and non-transferability. When valuable and rare resources are also simultaneously

inimitable, i.e. they are not easily replicated by competitors, non-substitutable, i.e. other resources

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8 they might produce a sustainable competitive advantage (Barney, 1991). In other words, rarity and

value are necessary but not sufficient conditions for a competitive advantage whereas inimitable,

non-substitutable and non-transferable are all necessary but not sufficient conditions for a competitive

advantage (Priem & Butler, 2001). Where the RBV explains multinationality based on idiosyncratic

resources and capabilities, the internalization theory posits that organizations diversify internationally

in order to internalize operations when the cost of using the market are higher than the internal

governance costs (Rugman et al., 2011). In doing so, the emphasis switches from foreign direct

investment at the country level to the level of the MNE, the ‘institution’, making the investment

(Rugman et al., 2011). MNEs attempt to minimize transaction costs and therefore prefer internalizing

operations up to the point where the benefits equal the costs, i.e. the internal governance costs are

higher than the costs of market imperfections (Buckley & Casson, 1976). Integrating both the RBV and

internalization theory helps providing clarity regarding the nature and role of FSAs. As detailed

previously, a firm’s proprietary assets, e.g. technological or marketing know-how, research and

development (R&D) and superior management skills, can be employed as strategic resources that lead

to a competitive advantage in the international marketplace (Lu & Beamish, 2004). Consequently, by

diversifying internationally firms are able to employ their strategic resources on an international level

(Lu & Beamisch, 2004; Morck & Yeung, 1991). Along this line of reasoning, numerous studies suggest

that a firm’s intangible non-location bound FSAs provide ownership advantages that offer firms

opportunities of internal control and expansion to new geographic areas (Hitt et al., 2006;

Delgado-Gomez et al., 2004).

In addition to the influence of intangible non-location bound FSAs, e.g. superior management skills or

R&D, firm size is another variable commonly identified in the literature to influence the level of

multinationality (Dass, 2000). Tihanyi, Ellstrand, Daily and Dalton (2000) note that firm size influences

the ability of a firm to operate successfully in foreign markets. Large firms not only have the abundant

resources needed for doing business abroad, but also have the intangible resources such as

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9 (Kirca et al., 2012). In addition, large firms also benefit from scale and scope economies. Hence, large

firms are capable of pre-emptive moves that might limit or prevent late entrants from gaining access

to suppliers, markets, customers or other production related assets (Kirca et al., 2012). Other benefits

that are a result of large firm size are the ability to invest heavily in innovations, pursue aggressive

expansions and to bear risks commonly associated with international diversification (Cohen, 1996).

The ability to reduce risks is explained by the fact that large firms have access to privileged learning

channels, have larger product portfolios or a stronger bargaining power than smaller firms when it

comes to host country institutions and governments (Kirca et al., 2012). Thus, firm size influences firm

behaviour as well as the response of a firm to environmental situations.

A third variable commonly identified to influence multinationality on the firm-level is that of firm age.

The literature on the relationship between firm age and multinationality provides conflicting

arguments and findings (Kirca et al., 2012). On the one hand, firm age positively influences

multinationality because older firms do not face the liabilities of newness in industries or foreign

markets as younger firms do (Autio et al., 2000). Older firms are also likely to have the experience and

managerial capabilities necessary to diversify internationally, even if this entails expansion into risky

and uncertain markets (Autio et al., 2000; Kirca et al., 2012). This is supported by Burt et al. (2003)

who add that more experienced firms are more likely to successfully enter foreign markets. On the

other hand, older firms are less likely to diversify internationally because of organizational inertia or

bureaucratic constraints (Kirca et al., 2012). Thus, more research is needed in order to investigate the

relationship between firm age and multinationality.

Industry-Level Factors

As previously noted, much of the existing literature has focused on the relationship between

firm-level characteristics and international diversification (Hitt et al., 2006). Less research has focussed on

the influence of industry- and home country-factors. As previously explained, FSAs are reported to

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10 a safeguard against costs from market imperfections (Buckley & Casson, 1976). The extent to which

these FSAs actually enable firms to benefit from them, however, depends on the nature of the

environment in which the MNE operates (Buckley & Casson, 1976). Industry- and home country-level

factors are therefore of crucial importance when investigating the determinants of multinationality.

This section discusses the influence of industry growth and industry rivalry after which the next section

will elaborate on the influence of home country-factors.

International business scholars have argued that both industry growth as well as rivalry influence a

firm’s decision to diversify internationally (Hymer, 1976). Porter (1980) explains this by detailing that

prospective growth is usually seen as a sign of an attractive industry. High growth industries attract

firms both from the domestic market as well as firms from foreign countries because of the potential

to increase the prosperity of those firms (Kirca, 2012). Industry growth therefore positively influences

multinationality.

In addition to the influence of industry growth, industry rivalry is also reported to influence the level

of multinationality. Fuentelsaz, Gomez and Polo (2002) state that high domestic rivalry encourages

firms to look for opportunities in different geographical markets because the higher the industry

rivalry, the lower the profit margins of the home market are likely to be. A firm’s incentive to diversify

internationally based on industry rivalry can therefore be explained by the opportunity to reduce the

level of competition for key resources or markets (Hitt et al., 2006). This resource-seeking motivation

was found to be most influential in information-intensive industries; market seeking and export

seeking were dominant motivations in less information-intensive industries (Hitt et al., 2006). In

addition to high domestic rivalry, foreign rivalry also seems to influence the level of multinationality

(Sarkar, Cavusgil & Aulakh, 1999). Firms diversify internationally to guard themselves against the

increased rivalry due to the presence of foreign competition in the home market (Kirca, 2012). When

diversifying internationally, the domestic firm is likely to become more competitive and efficient due

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11 efficient, the domestic firm is more capable to face challenges posed by foreign competition as well

as operate and compete at a global level (Kirca et al., 2012).

Home Country-Level Factors

As noted, industry- and home country-characteristics are of crucial importance as they largely

influence the environment in which firms operate. Sethi and Elango (1999) explain the influence of

home country-factors by explaining that firms originating from different countries draw from different

sets of factor endowments, cultural backgrounds and socio-political infrastructures. This in turn

provides companies with unique competitive advantages, of which they will benefit in the

international market place, compared to firms originating from countries that are not as hospitable in

the aforementioned areas (Sethi & Elango, 1999). In this section we therefore focus on the influence

of home country-characteristics, also known as the country-of-origin effect (COE), on multinationality.

Before discussing the COE into more detail, we first clarify the issue of ‘what country can be assumed

to be the country-of-origin’. The country of origin might not necessarily be the same as the location

of the MNCs headquarters (Ghemawat, 2007). In some instances, firms locate to countries other than

those of their founding, to pursue tax advantages or to achieve legitimacy (Ghemawat, 2007;

Noorderhaven & Harzin, 2003). Although, as Ghemawat (2007) points out, most firms, more than 90%,

are headquartered in the home country. We therefore, for the purpose of this paper, assume that the

location of the MNCs headquarter is the same as its country-of-origin.

In this paper we define the COE based on a definition as provided by Noorderhaven and Harzin (2003,

p. 14), who describe the country-of-origin effect as ‘differences in internationalization strategies and

international control strategies of MNEs that can be ascribed to the different national origins of these

MNEs, rather than to variations in their task environment’. The literature on the topic can be divided

into two schools of thought, i.e. the culturalist and the institutionalist orientation (Noorderhaven &

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12 indices of national value dimensions in order to explain differences in internationalization strategies.

The underlying assumption of the culturalist approach is that individuals become mentally

programmed by the environment in which they grow up, e.g. parents, educational institutions

(Hofstede, 2001). Hence, individuals adopt preferences for certain states of affairs that are similar to

other people who have grown up in comparable environments (Hofstede, 2001). Literature on the

topic demonstrates that issues such as leadership and management correlate significantly with

Hofstede’s cultural indices (Noordhaven & Harzin, 2003). As we do not focus on the influence of Top

Management Teams on multinationality, we will concentrate on the second school of thought; the

institutionalist approach.

The institutionalist approach views the institutional environment, in addition to production factors,

e.g. land, labour and capital, as the key determinant of organizational characteristics (DiMaggio &

Powell, 1991). Institutions refer to the political, legal and societal institutions within a country (Wan

& Hoskisson, 2003). Home country institutions influence multinationality through transactional

efficiency (Wan & Hoskisson, 2003), the financial development of the home country (Li & Yue, 2008).

Wan and Hoskisson (2003) explain that high levels of institutional development contribute to

transactional efficiency as institutions allow firms to conduct business with unfamiliar but more

efficient parties. As home country institutions enable firms to conduct business with more efficient

parties, firms are able to achieve a significant competitive advantage over their competitors by

diversifying internationally in order to substitute for factors, e.g. raw materials or low labour costs,

otherwise unavailable to them (Wan & Hoskisson, 2003; Porter, 1991). Strong home country

institutions also allow firms to fully utilize factors available in the home country environment with the

goal of improving their competitiveness in the international marketplace (Wan & Hoskisson, 2003;

Porter, 1991). Thus, home country institutions allow firms to substitute factors otherwise unavailable

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13 In addition to the influence of home country institutions on transactional efficiency, differences in

home country institutions account, to a large extend, for differences in the development of capital

markets (La Porta et al. 1997). Legal systems, i.e. common and civil law, differ in terms of property

rights and protection of corporate investors (Li & Yeu, 2008). The common law system evolved to

protect private property owners against the crown and thus facilitates financial development and

private contracting (Li & Yeu, 2008). The civil law system, however, focusses more on the rights of the

government and less on private property rights (Li & Yeu, 2008). Thus, corporate shareholders in

common law countries benefit from more legal protection than corporate shareholders in civil law

countries (Li & Yeu, 2008). Hence, countries offering less legal protection to investors are likely to have

less developed capital markets than countries offering more protection to investors (Li & Yeu, 2008).

Thus, faced by a relatively unfavourable legal and capital environment, MNEs may diversify

internationally as a way to create substitutes for a lack of legal support (Li & Yeu, 2008).

Though research on the topic is limited, it is important to note that the influence of home country

institutions differs for firms originating from emerging markets. Emerging markets are often

characterized by high government intervention and weak legal systems, which in turn has resulted in

underdeveloped factor markets, e.g. financial capital and marketing know-how (He et al., 2013). Home

country networks therefore often function as a substitute for adequate legal frameworks and stable

political structures (Khanna & Palepu, 1997; Khanna & Rivkin, 2001). Yiu et al. (2007) notes that there

are two types of home country networks; business network ties and institutional ties. The first,

business network ties, can be described as linkages among parties involved in a business deal (Yiu et

al., 2007). Business network ties influence the likelihood of international diversification because

emerging market MNEs (EMMNEs) are often vertically integrated with home country partners, e.g.

suppliers (Yiu et al., 2007). In addition, belonging to a business network can help gain information on

international diversification which helps the EMNE overcome liability of foreignness (Guillen, 2002).

The second, institutional network ties, refer to linkages with domestic institutions, e.g. government

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14 government approval when they plan to diversify internationally (Yiu et al., 2007). Thus, institutional

network ties are of crucial importance in emerging countries such as China when diversifying

internationally. In conclusion, as these studies suggest, home country influences may differ

systematically for firms originating from emerging countries as opposed to firms originating from

developed countries based on the lack of strong legal frameworks and stable political structures.

Now that the construct of multinationality as well as the different factors relating to the firm-,

industry- and home country-level have been discussed it is clear that previous research has

contributed to our understanding of the drivers of international diversification. The literature on the

topic of international diversification, however, has mostly focussed on one level of analysis at a time.

This has resulted in a collection of small and disparate streams of research (Hitt et al., 2006; Kirca,

2012). This study fills this critical gap by offering a comprehensive framework that integrates firm-,

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15

Theory & Hypotheses

This chapter builds on the theories as described in the literature review and will propose 3 hypotheses

that will be used in order to test the relationship between firm-, industry- and home country-level

factors and the scale and scope of multinationality. This chapter is structured as follows. We first

theorize the relationship between innovation and multinationality after which the relationship

between a focus on manufacturing versus a focus on service and multinationality is elaborated upon.

Finally, the proposed moderating effect of home country institutional development on the positive

relationship between the level of innovation of a firm and the scale and scope of multinationality will

be discussed

The influence of Innovation on Multinationality

The purpose of this study is to test the influence of firm-, industry and home country- characteristics

on multinationality. In our effort to do so, we first focus on the relationship between firm-factors,

innovation in particular, and multinationality. As elaborated upon in the previous chapter,

internalization of FSAs generates high levels of multinationality. This is caused by the idiosyncratic

nature of FSAs which provides the MNE with a safeguard against costs from market imperfections

(Buckley & Casson, 1976). Research suggests that innovation, i.e. the effort to create purposeful and

focused change in a firm’s economic and social potential (Acs et al., 2002), is critical for creating and

maintaining a competitive advantage in the international market place (Hitt et al., 1994; Hoskisson et

al., 1997; Porter, 1990). In addition, Franko (1989) provides strong evidence on the importance of R&D

investments in order to compete in today’s increasingly competitive marketplace. The need to

innovate is explained by the fact that competitors will outperform firms that fail to improve and

update their competitive advantage (Hitt et al., 1994). Thus, the only way to sustain a competitive

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16 As innovations can be costly, international diversification provides a useful mechanism for firms to

spread the costs of innovations and benefit from their investment on a larger scale. Expansion into

different geographic markets allows firms to spread the cost of innovations and thus lower the risk of

investments in innovations, i.e. technological, organization and managerial improvements (Hitt et al.,

1994). Firms only operating in domestic markets may find it difficult to recuperate investments in

innovations and the investment may not pay off before the innovation becomes out-dated, thus

providing incentives to diversify internationally (Kotabe, 1990). In addition, diversifying internationally

is likely to increase the return on investment based on the fact that innovations can be applied in

multiple markets (Hitt et al., 1994). Therefore, international diversification provides a useful

mechanism to spread the risk of innovation investments and benefit from an increased scale. Thus,

we articulate the following as to establish the relationship between innovation and multinationality:

H1: The level of innovation of a firm positively influences the scale and scope of multinationality

The influence of a Manufacturing Focus vs a Service focus on Multinationality

Past research has shed a light on the influence of industry-level factors, in particular the influence of

industry growth and industry rivalry, on multinationality. Prospective high growth industries are

usually seen as attractive industries and therefore attract firms both from the domestic market as well

as foreign firms looking to increase their prosperity (Kirca et al., 2012). High industry rivalry, on the

other hand, encourages firms to look for opportunities in different geographical markets. In doing so,

firms are able to reduce the level of competition for key resources or markets. However, as Hitt et al.

(2006) point out, the resource-seeking motive was found to be most influential in

information-intensive industries whereas the market-seeking motive was found to be dominant in less

information-intensive industries. This finding implicates the need to differentiate between

information- and less information-intensive industries when investigating the influence of

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17 even though information-intensive industries, i.e. service industries, and less information-intensive

industries, i.e. manufacturing industries, might have similar motivations, e.g. economies of scale and

low labour costs, the unique characteristics of information-intensive industries are likely to increase

the difficulty of diversifying internationally. This can be explained by the fact that services supplied by

multinational firms to local consumers may need more adaptations than manufactured products due

to differences in languages or cultures (Capar & Kotabe, 2003). More internationally diverse service

firms, especially those offering services that require intensive customer contact or a lot of cultural

adaptations (Knight, 1999), may therefore be faced with relatively higher costs than manufacturing

firms offering more standardized products. Another reason that service industries face more

difficulties than manufacturing firms when diversifying internationally is the fact that many services

require simultaneous production and consumption (Capar & Kotabe, 2003). The simultaneous

production and consumption of services makes it necessary for a firm to have a local facility

(Boddewyn et al., 1986). This in turn causes a service firm to undertake considerably higher

investments than manufacturing firms when diversifying internationally. Therefore, we expect the

following relationship:

H2: The focus on manufacturing (versus services) is positively related to the scale and scope of

multinationality

The Moderating Role of Home Country Institutional Development

Based on the institutional theory, home country institutions influence multinationality in that they

facilitate transactional efficiency and influence the development of capital markets. However, based

on the comparative capitalism theory, home country-institutions also affect the development of

capabilities of firms in specific economies (Jackson & Deeg, 2006). The embeddedness of a firm in a

certain institutional environment represents a basis for the creation of distinctive organizational

capabilities, e.g. managerial capabilities and innovation skills. In particular, researchers have

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18 These studies are based on the notion that innovations are risky and when the costs of innovations

become too high, firms are likely to refrain from innovating (Waarden, 2001). The legal system in turn

provides regulations with the goal of reducing uncertainty (Waarden, 2001). Much of the work on the

influence of home country institutions focusses on two legal systems; common and civil law systems

(Waarden, 2001). As previously explained, these legal systems largely differ on the protection of

property rights and protection of corporate shareholders (Li & Yeu, 2008). Common law systems

protect property owners whereas in civil law systems property rights are not given any special

privileges (Judge et al., 2015). Thus, MNEs originating from civil law countries benefit less from legal

protection over newfound skills and knowledge than their counterparts originating from common law

countries, which in turn increases the risk and uncertainty of innovations. This is supported by recent

research which suggest that the lack of innovation and technological entrepreneurship in Eastern

Europe is due to the lack of property protection offered by the civil law system (Todorovic & Ma,

2010). Hence, we theorize that the level of institutional development of the home country positively

moderates the positive relationship between the level of innovation of a firm and the scale and scope

of multinationality. We therefore expect the following;

H3: Ceteris paribus, the level of institutional development in the home country positively moderates

the relationship as hypothesized in H1.

The relationships as hypothesized in this chapter result in the following conceptual framework:

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19

Methods

This study used a multi-level analysis design to examine the effect of firm-, industry- and

home-country-factors on international diversification. Multi-level analysis can be used to examine relations

between variables measured at different levels, i.e. at the firm-, industry- and home country-level, of

the multilevel data structure (Hox, 2010). As elaborated upon in the previous chapter, the general

concept is that firms are influenced by the context in which they operate. Thus, by employing

multi-level analysis one can investigate the question at hand, that of the effect of firm-, industry and

home-country-characteristics on the level of international diversification. However, before doing so, we will

first elaborate on the sample after which the variables are discussed into more detail.

Sample

The research setting of this paper is that of the 2014 Global Fortune 500. The Global Fortune 500

consist of the 500 largest companies ranked by revenues (Global 500 2014, n.d.). Together the Fortune

500 companies account for a total revenue of $31.1 trillion (Global 500 2014, n.d.). The majority of

the Global Fortune 500 companies are multinational companies in that they produce and distribute

products or services across national borders (Rugman & Verbeke, 2004). Also, the Global Fortune 500

belong to a wide variety of industries. This sample therefore provides great insights into the influence

of firm-, industry- and home country-factors on international diversification. The sample consists of a

total of 500 companies, stemming from 37 different countries and 21 different industries. Most Global

Fortune 500 companies originate from North America (25.6%), followed by China (19%) and Japan

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20 Data on the individual companies was obtained from ORBIS. This database, created by Bureau van

Dijk, provided us with an extensive amount of information on companies worldwide, i.e. annual

reports and information gathered from the internet. Data on firm size, domestic and foreign sales as

well as industry information was collected. Due to the fact that some companies, mostly companies

from China or Japan, did not publish annual reports written in English, some companies were excluded

from the sample. This resulted in a final sample of respectively 231 and 152 Companies.

Dependent Variables

The dependent variable of this study is the degree of multinationality. In order to assess the scale of

international diversification this study relies on the measure of foreign sales divided by total sales

(FSTS) (Rugman & Verbeke, 2004). To capture scope of international diversification this study relies

on the measure of global sales divided by total sales (GSTS) (Rugman & Verbeke, 2004). Both

measurements have been proven to be reliable measures of the scale and scope of multinationality

(Rugman and Oh, 2007; Oh, 2009). Contrary to the research as conducted by Rugman and Verbeke

(2004), this study has included all six continents instead of three continents, also known as the triad

of Ohmae (1985). In doing so, the classification system encompasses all countries of the world instead

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21 Ohmae (1985). Even though the ‘expanded triad’ as proposed by Rugman and Verbeke (2004),

includes a bigger part of the world, it still excludes many countries and continents, such as Africa and

South America (Aggarwal et al., 2011). The continent-based regions as proposed by Aggarwal et al.

(2011) therefore provides a valuable framework for examining international diversification of firms

headquartered in countries both in the triad as well as outside of the triad. Additionally, a classification

based on continents is not as sensitive to political changes. A classification of regions based on

geographic instead of political lines, i.e. North America and Central America instead of NAFTA are

stable and not subject to political change.

Independent variables

The first independent variable of this study is that of the level of innovation of a firm. This is captured

by using R&D expenditure as a proxy for the level of innovation of a firm, a common used empirical

proxy in the literature (Rugman & Sukpanich, 2006). R&D expenditure was measured in ratio with firm

revenue as to account for differences in firm revenue.

The second independent variable of this study is that of a manufacturing versus a service focus. This

was captured by using dummy variables. Firms belonging to manufacturing industries were coded 0

whereas firms belonging to service industries were coded 1.

Moderating Variables

As noted in the previous chapter, it is important to take into account the context in which firms

operate when investigating international diversification. Based on this notion this study investigates

the moderating effect of institutional development of the home country on the relationship between

the level of innovation of a firm and the scale and scope of multinationality. Institutional development

is captured through the Fraser index of Economic Freedom of the World published by the Fraser

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22 ownership investment restrictions. Where most of these sub-categories are certainly of great

importance to international trade in general, they are beyond the scope of this paper. As explained in

the theoretical framework this thesis focusses on the influence of the institutional development of

the home country, we therefore use the data regarding the home country legal system and property

rights. The home country legal system and property rights are measured on a scale from 1-10, with

higher values meaning better legal quality.

Control Variables

This study adopts a total of four control variables. Firm size, measured by the number of employees,

is controlled for based on the fact that firm size largely influences a firm’s ability to operate

successfully in foreign markets (Dass, 2000; Gomez-Meija & Palich, 1997).

We include firm age as a control variable based on the proposed influence of a firm’s international

experience (Kirca et al., 2012). Prior research has indicated that international experience increases

with age. Firm age is therefore an excellent proxy for a firm’s international experience (Pennings et

al., 1994). Firm age is measured as the number of years since the firm was incorporated until the year

of reference of this study, 2014.

Another control variable included in this study is that of firm profitability. Firm profitability has been

reported to influence multinationality as well performing firms are likely to have the resources

necessary to successfully diversify internationally (Hitt et al., 2006). Firm performance is captured

through Return on Assets (ROA), an often used measurement to capture firm profitability (Thomas &

Eden, 2004)

The final control variable of this study is that of privately held versus public ownership. This variable

was captured by using a dummy variable. Privately held companies were coded 0 whereas public

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23

Statistical Analysis & Results

The descriptive statistics and correlations between the variables are detailed in Table 2. The main

concern was whether any of the correlations would have a value above 0.7 since this would indicate

the presence of problematic constructs (Pallant, 2011). We also tested if the multicollinearity

consumption was met, this was done by calculating the VIF scores and by checking if they were all

below 10, as they should be. After checking for correlations and testing for multicollinearity, all

variables were used in this study.

The mean value of the scope of multinationality is 0.44, suggesting that the sample is, on average,

quite international in terms of sales spread out over different regions. The mean value of the scale of

multinationality is 0.5, suggesting that the sample, on average, has a relatively strong sales dominance

in specific regional markets.

In order to test the hypotheses, a regression analysis was used in order to determine the relationships

between the scale and scope and explanatory variables. An Ordinary Least Squares (OLS) regression

method was used based on the fact that the dependent variable consists of continuous values and a

linear relationship between the dependent and explanatory variables was assumed. When

investigating the possible relationship of the moderating variables on the dependent and independent

variables we made use of interaction terms. The interaction terms were created by multiplying the

moderating and independent variables. The first step of the regression analysis was that of the

introduction of the control variables, firm size, firm age, firm profitability and privately held versus

public ownership. This enabled us to observe the effect of the control variables on the dependent

variables, scale and scope of multinationality. The next step of the regression analysis introduced the

independent variables after which the interaction term was added. This resulted in a total of 8 Models.

Models 1 and 5 investigated the effect of the control variables on the dependent variables, scale and

scope of multinationality. Models 2 and 6 test the relationship between the level of innovation of a

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24 firms that have a manufacturing versus a service focus on the scale and scope of multinationality.

Finally, models 4 and 8 test for the presumed moderating influence of the home country institutional

development on the hypothesized relationship between the level of innovation of a firm and the scale

and scope of multinationality. Table 3 and 4 present the results of the OLS regression analysis.

When analysing the results, we took a close look at three different values. The first value is that of

significance. Significance is an important value since it indicates the reliability of the results and thus

if they can be used to support the hypotheses. The second value, the Beta standardized coefficient,

indicates the change in the dependent variable that is a result of the explanatory, also called

independent, variable. A negative Beta indicates a negative relation between the explanatory

variables and dependent variables whereas a positive Beta indicates a positive relation between the

explanatory variables and the dependent variable. The third and final value, R2, measures the

goodness of fit of the model used and the degree to which it explains the variance observed.

Based on the results of the OLS regression, not all of the included variables have addition explanatory

power as not all are significant. The results show support for hypothesis 1. This hypothesis states that

the level of innovation positively influences the scale and scope of multinationality. In addition, the R2

slightly improves from .045 to .087 in model 1 and from .035 to .065 in model 5. This indicates that,

after including the independent variable, the data fits the model better. The results are insignificant

for hypothesis 2, which states that a manufacturing focus, versus a service focus, is positively related

to the scale and scope of multinationality. Thus, whether a firm belongs to a manufacturing industry

as opposed to a service industry does not significantly influence the scale and scope of

multinationality. As with the first hypothesis, the R2 improves slightly from .045 to .055 in model 2

and from .035 to 0.049 in model 6. When testing for a moderating effect, partial support for hypothesis

3 is found. The R&D variable as well as the institutional development of the home country variable

have a positive significant effect on the scale (b=.294, p=.006, & b=-.185, p=.007) and scope (b=.230,

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25 scale of multinationality (b=-.185, p=.079). As for the control variables, support is found for the firm

age (b=.137, p=0.050) and public versus private held company (b=.133, p=.059) variables in model 1.

This result suggest that firm age influences the scale of multinationality. This finding also suggests that

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29

Conclusion

This study offered a comprehensive framework integrating firm-, industry- and home country-factors

and examined how these factors influenced multinationality. This study therefore provides interesting

insights regarding the determinants of multinationality. Prior research has mainly focussed on one

level of analysis at a time when investigating the influence of determinants on multinationality. As

firms operate and originate from a certain environment and are thus largely influenced by industry-

and home country-characteristics, there was a need for a more in-depth investigation on the

determinants of multinationality. Hence, this study conducted a multi-level analysis on the influence

of firm-, industry- and home country-characteristics on multinationality.

The findings support the proposed relationship between the level of innovation and the scale and

scope of multinationality. However, the level of institutional development of the home country was

shown to have a negative moderating effect on the positive relationship between the level of

innovation of a firm and the scale and scope of multinationality. This negative moderating effect

suggests that high levels of institutional development of the home country in combination with high

levels of innovation of a firm reduce the positive relation between the level of innovation of a firm

and the scale of multinationality. Finally, no evidence was found on the proposed relationship

between a manufacturing versus service focus and the scale and scope multinationality. The following

sections of this chapter will discuss these results into more detail by highlighting the academic

relevance and the managerial implications. Finally the limitations and suggestions for future research

will be discussed into more detail.

Academic Relevance

Previous research reports evidence of a positive relationship between the level of innovation of a firm

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30 present study reinforces these findings and thus adds the level of innovation of a firm as an important

determinant of multinationality.

In addition, this study relied on the measure of global sales divided by total sales as to capture the

scope of multinationality, whereas the aforementioned studies used a scope measure based on the

number of countries. As noted by Oh (2009) multinationality metrics based on the number of countries

disregard the fact that countries largely differ in size and therefore produce unreliable results. Even

though this study reinforces the findings as reported by the aforementioned authors, we add to the

existing literature by confirming these results while using reliable measures of multinationality.

In addition to using reliable multinationality metrics, the environment of the MNE is of crucial

importance to take into account when investigating the determinants of multinationality as the MNE

is largely influenced by its environment (Buckley & Casson, 1979; Sethi & Elango, 1999). Which is why

we conducted a multi-level analysis incorporating firm-, industry- and home country-level factors.

Consequently, we found evidence that the effect of the level of innovation of a firm is dependent on

the level of institutional development of the home country. Interestingly though, the moderating

effect of the level of institutional development of the home country on the proposed positive

relationship between the level of innovation of a firm and scale of multinationality was found to be

negative. This finding indicates that the level of institutional development of the home country acts

as a double-edged sword. On the one hand, the level of innovation is influenced by the level of

institutional development of the home country, which can be explained by the fact that strong

institutional frameworks allow firms to acquire, develop and protect innovations (Wan & Hoskisson,

2003; Li & Yeu, 2008). On the other hand, home countries with high institutional development are also

characterized by regulations (Waarden, 2001). A lot of regulation can kill incentives to innovate due

to decreased freedom and flexibility to develop and try new innovations (Waarden, 2001). Therefore,

the higher the level of innovation of a firm in combination with higher levels of institutional

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31 Building or arguments as provided by Capar and Kotabe (2003) we theorized that having a

manufacturing focus, versus a service focus, would lead to a higher level of multinationality. However,

this study does not support this proposition. Capar and Kotabe (2003) argue that firms with a service

focus have to bear higher costs when diversifying internationally due to the need to adapt to

differences in local languages or cultures as well as the need to have local facilities due to the

simultaneous production and consumption of services. However, as the proposed relationship is not

supported, it might be that the benefits of international diversification actually outweigh the

aforementioned costs.

Managerial Implications

The study at hand includes three important managerial implications. Firstly, this study reports a

positive relationship between the level of innovation of a firm and the scale and scope of

multinationality. This confirms that when companies invest in innovations they are more likely to

diversify internationally. Thus, companies looking to diversify internationally may use this information

to their advantage.

Secondly, as the relationship between the level of innovation and the scale of multinationality is

moderated by the level of institutional development of the home country, companies need to take

into account the environment in which they operate. In particular, companies should analyse the legal

system and property rights of their home country. It seems that home country institutional

development acts as a double-edged sword. On the one hand, highly developed home country

institutions protect a company’s property rights (Wan & Hoskisson, 2003; Li & Yeu, 2008), e.g.

technological innovations, while on the other hand limiting the company’s freedom and flexibility to

develop and try out innovations (Waarden, 2001). Therefore, companies originating from highly

regulated, i.e. institutionally developed, home countries have to take into account that although the

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32 flexibility and freedom to develop innovations. This information is valuable for managers as it shows

that the value of investments in innovations will decrease after a certain point. Managers therefore

have to decide up till which point it makes sense to invest in innovations.

Thirdly, companies can use the findings of this study to analyse future strategic moves of their

competitors. By looking the amount spend on innovations and the institutional development of

competitor’s home country one can make an educated guess whether rivals are likely to increase their

scale and scope of multinationality. Anticipating rival’s strategic strategies is vital in today’s

competitive marketplace where first mover advantages can be crucial (Rugman & Verbeke, 2008).

Limitations & Suggestions for Future Research

Even though, this study certainly adds to the existing literature on the drivers of multinationality, there

are limitations that need acknowledgement. Firstly, it would be interesting to perform a longitudinal

study in order to further investigate the relationship between the level of innovation of the firm and

the scale and scope of multinationality. A longitudinal study would help scholars analyse the influence

of the level of innovation on multinationality over a longer period of time and thus observe whether

any changes occur. In addition, a longitudinal study could improve the reliability of the results.

Secondly, more attention should be directed towards the influence of industry-level factors. Up till

now, little is known about the influence of industry-level factors on multinationality. This study has

highlighted that environmental factors, i.e. industry- and home country-factors, are of great

importance as they large influence the environment in which the MNE operates. However, we did not

find evidence supporting the proposition that manufacturing firms are more likely to diversify

internationally than service firms. It is therefore worthwhile to investigate whether other factors

influence the level of multinationality.

Third, although this study reports a negative moderating effect of the level of institutional

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33 firm and the scale and of multinationality, it does not incorporate factors other than the legal system

and property rights of the home country. As MNEs are heavily influenced by their environment, which

consists of factors other than the legal system and property rights of the home country, it might be

interesting to include more environmental factors in future research. Future research could include

factors such as physical infrastructure, comparative factor advantages and the quality of the financial

subsystem or national resources (Kirca et al., 2012). Such a detailed investigation, unfortunately, was

not possible in this study but future research might benefit from adding these factors as it may lead

to extra explanatory power and provide interesting insights on the influence of home country-level

factors on multinationality.

Finally, future research could differentiate between developed and emerging countries. As elaborated

upon in the literature review, the influence of the home country may differ for firms originating from

emerging countries as opposed to firms originating from developed countries. As emerging markets

are often characterized by high government intervention and legal system, which has resulted in

underdeveloped factor markets, they rely more on home country networks (Khanna & Palepu, 1997;

Khanna & Rivkin, 2001; Yiu et al., 2007). Thus, differentiating between firm originating from emerging

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34

Acknowledgement

I would like to thank Dr. Niccolò Pisani for his feedback and structured guidance throughout the

process of writing this thesis. His comments and suggestions were highly valuable and helped me to

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35

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