Institutional Influence : the impact of institutional distance on the equity commitment of MNEs and the moderating effect of prior experience

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Institutional Influence

The Impact of Institutional Distance on the Equity Commitment of MNEs and the Moderating Effect of Prior Experience

Cécile van Rijn 6214657 28 June 2015

Master Thesis (Final Version) Niccolò Pisani Master Business Administration International Management Track University of Amsterdam

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Statement of originality

This document is written by Student Cécile van Rijn 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

Previous research argues there is a need for greater understanding how institutional distance influences internationalisation strategies of MNEs. The present study takes a closer look at the relationship between institutional distance and equity commitment. It aims to fill gaps in the current body of literature on institutional distance by adding prior experience as a moderator and decomposing the institutional distance concept. Based on previous research it is expected that institutional distance has a negative effect on the equity commitment in the foreign affiliate and that prior experience has a negative

moderating effect on this relationship. By focusing on the 120 largest Dutch multinationals retrieved from the ORBIS database as listed in 2013, we did not find solid support for the proposition that institutional distance influences the level of equity commitment in the foreign affiliate. Only the economic sub-index of institutional distance is positively related with the degree of ownership in the affiliate. We did conclude that prior experience

diminishes the effect of economic, legal and regulative distance on the level of equity commitment in the foreign affiliate. Thus, MNE’s managers that want to internationalise should consider economic distance and know that prior experience plays a significant role in the internationalisation process.

Keywords: Multinational Enterprise; Internationalisation; Globalisation; Institutional Theory; Institutional Distance; Equity Commitment; Prior Experience.

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Figure

Figure 1. Conceptual model ... 27

List of Tables

Table 1. Correlation matrix: Means, minima, maxima, standard deviations and correlations ... 30

Table 2. Results OLS regression ... 34

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1. Introduction

Over the past few years, internationalisation has become more and more important to business. Due to on-going globalisation, other parts of the world have become more easily accessible for firms. As a consequence, the number and value of market entries have developed in a rapid manner. Multinational enterprises (henceforth: MNEs) are eager to move their operations overseas in order to benefit from opportunities emanating from operating across borders, which can enhance firm performance (Ruigrok & Wagner, 2003). An increase in productivity and experience, the ability to exchange knowledge and to tap into local, unknown markets are just a few examples of the endless possibilities

international business has to offer. By supporting or restricting these opportunities, a country’s institutions have the ability to enhance or diminish the internationalisation possibilities of MNEs (Oliver, 1997; Peng & Heath, 1996). Therefore it is self-evident that institutions are critical actors in the business environment (North, 1991).

Internationalizing operations automatically means that firms choose to serve multiple environments simultaneously. The MNE’s ability to gain competitive advantage, legitimacy and survival in the foreign market depends on the capacity to cope with the differences of the institutional environments it operates in (Eden & Miller, 2004; Hymer, 1960, Johanson & Vahlne, 2009; Xu & Shenkar, 2002). In order to manage these

differences, MNEs have to adapt their strategies to the requirements of local institutions (Johanson & Vahlne, 1977; Kogut & Singh; 1988; Kostova & Roth, 2002).

Adjusting to these foreign institutional environments leads to considerable

additional costs stemming from a lack of knowledge of the local context and its practices, customs and regulations, a concept referred to as “liability of foreignness” (henceforth: LoF) (Zaheer, 1995). A larger distance in terms of inequality in institutional context between the MNE’s home territory and host country has a big impact on the LoF.

According to various scholars a difference in institutional environments may increase the LoF and the costs associated with doing business across borders (Eden & Miller, 2004; Hymer, 1960, Johanson & Vahlne, 2009; Xu & Shenkar, 2002). Thus the more the

environment of the host country differs from that of the home country, and thus the larger the institutional distance, the more challenging it is to adjust to the local environment (Ionascu, Meyer & Estrin, 2004; Kostova, 1999).

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MNEs face multiple challenging choices that affect their overall strategy. Most of these key decisions relate to the choice of ownership strategies. First MNEs need to choose an entry mode; whether they want to enter the foreign market through their own firm or by investing in a local partner. When the latter is the case, the following decision that has to be made is regarding the level of ownership (Gaur & Lu, 2007). A higher equity

commitment equals higher risk for the parent MNE as a larger number of resources have to be attributed to the affiliate (Delios & Beamish, 2004). Both decisions are crucial for the survival and profitability of the foreign affiliate and were therefore thoroughly analysed in previous research (Eden & Miller, 2004; Ionascu et al., 2004; Kogut & Singh, 1988; Xu & Shenkar, 2002). However, Chan, Isobe & Makino (2008) suggest there is a greater

necessity to comprehend the impact of institutional distance on an MNE’s internationalisation strategies.

That institutional distance between the home and the host country influences equity investments of the MNE is nothing new to international business literature. Even though this study checks for this proposition, it also aims to contribute to the current body of literature on institutional distance in several ways. First, the concept of institutional distance is split into different sub-indices. The influence of each sub-indicator of institutional distance on equity commitment is checked. Secondly, the study enriches extant literature by shedding light on the moderation effect of prior firm experience on the relationship between the different types of institutional distance and the MNE’s equity commitment abroad. As over time the firm might learn how to optimally profit from operating in different environments, prior experience might help to mitigate these

challenges. This learning can lead to a reduction in operating-costs (Chao & Kumar, 2010, Johanson & Vahlne, 2009), which diminishes the risk of operating in unknown

environments. Third, in relation to the empirical setting chosen, while most prior literature focuses on FDI comes from the United States, this study focuses on analysing the Dutch outbound FDI stock. The Netherlands is the home country of some of the largest

multinationals in Europe like Ahold and Shell (Garretsen & Peeters, 2009). As a result the Netherlands is in the top 20 of the countries with highest inward and outward FDI flows, according to the UNCTAD World Investment report (2014). According to this report, the Netherlands is number nine on the list with countries with the highest FDI outflows in 2013, which makes it an interesting country to invest FDI outflows.

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Previous research expects a negative influence on institutional distance and the number of investments made in a certain market (Chao & Kumar, 2010; Kostova & Zaheer, 1999) and states that prior experience might have a moderating effect (Buckley & Casson, 1981; Chao & Kumar, 2010; Davidson, 1980; Pan & Tse, 2000). They suggest that prior experience might increase the ease of adjustment (Chao & Kumar, 2010) and decrease costs associated (Buckley & Casson, 1981).

Not in agreement with the theoretical arguments presented in this study, according to the results institutional distance does not seem to influence equity commitment. Only economic distance was found to influence equity commitment in the foreign affiliate, but not in the expected negative way. According to the results the higher the economic distance, the higher the equity commitment. Another important contribution of this paper is the moderating effect of prior experience. Prior experience proved to diminish the effect of economic, legal and regulative distance on the level of equity commitment.

The remainder of this paper is organised as follows; section 2 surveys the literature on institutional distance as it relates to equity commitment. In section 3 the hypotheses are formulated according to the theoretical model that is presented. Moreover, the moderator prior experience is discussed. The sample, data analysis, variables and methodology are reviewed in section 4. In the final sections the results are presented, the implications for this study are discussed and directions for future research are given.

2. Literature review

The multinational enterprise (MNE) is the main subject of this study. In this paper the MNE is considered as a “coordinator of a global system of value added activities that are controlled and managed by it” (Dunning & Lundan, 2008; p. 588). One of the most important characteristics of an MNE is its ability to decide on economic engagement with two or more countries from one single centre (Pultz, 1981). While an MNE operates across country borders, it often engages in FDI.

During the last few decades the complexity level of the MNE’s operations has increased significantly. The result is that between a quarter and a third of all world

production can now be attributed to MNEs (Kostova & Roth, 2002; Xu & Shenkar, 2002). As a result of operating in different countries, MNEs are faced with the challenges of

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interacting with different environments.

2.1. Challenges of doing business across borders

In 2000 – when compared to 1980 - MNEs had clearly expanded their international investments. When an MNE expands its operations through geographical diversification, the company opens up the possibility to tap from unknown markets and new consumer bases. In doing so, the organization may be able to enlarge its consumer base, which enhances firm production and therefore stimulates growth. Ultimately this can lead to a competitive advantage over other companies (Geringer, Beamish & DaCosta, 1989). On the other hand, when the activities of enterprises are not confined to one single location, the management of its resources becomes more complex and consequently more

challenging (Ionascu et al., 2004; Johanson & Vahlne, 1977; Kogut & Singh, 1988;

Kostova & Roth, 2002). Consequently, firms will have to adjust to the local environment in order to be successful and increase their chances of survival.

These adaptation processes might lead to additional costs that can lead to a reduction in benefits gained from the international scope (Geringer et al., 1989). The increased costs that MNEs might face when operating abroad, can create daunting entry barriers for the MNE. They inhibit MNEs from exploiting their resources and other firm specific

advantages across borders (Geringer et al., 1989) and gaining social acceptance from the local environment (Kostova, 1999). The physical and non-tangible distance between the organizational centre of the MNE and the host country can therefore prove to be a crucial factor in the international development of the MNE. It can either limit or increase the likelihood of an MNE’s internationalisation into a certain country (Arregle, Miller, Hit & Beamish, 2013).

2.1.1. Liability of foreignness and costs of doing business abroad

When MNEs start international operations in unknown markets, they can face multiple disadvantages compared to local companies (Eden & Miller, 2004). These disadvantages might results in additional “costs of doing business abroad” (henceforth: CDBA) (Chen, 2008; Hymer, 1976; Salomon & Wu, 2012; Zaheer, 1995). According to Hymer (1976) these extra costs can be caused by a number of factors; a lack of information about foreign markets, an unfavourable treatment by host governments, difficulties caused by the home

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government and by foreign exchange risks. To neutralize these costs, MNEs need one or multiple firm specific advantages that distinguish their company from others (Eden & Miller, 2004).

These firm specific advantages, that constitute an important part of the MNEs competitive advantage, are introduced by Dunning’s (1979) eclectic paradigm. This paradigm proposes that “distance” has a multidimensional nature and that some locations are preferable when it comes to transferring firm specific advantages (Bénassy-Quéré, Coupet & Mayer, 2007).

Zaheer (1995) approaches the concept of CDBA by dividing it into four categories; spatial distance, unfamiliarity with local environment, differential treatments by host countries and home country environments. Eden and Miller (2004) on the other hand, refer to economic and social factors as the two main catalysts of CDBA. Expenses linked to international business activities like commerce and manufacturing are specified as economic factors. Examples of social aspects are absence of knowledge, skills and information about the home country (Chen, 2008; Eden & Miller, 2004).

More recently, scholars have introduced a second concept related to CDBA, which affirms that MNEs face inherent disadvantages when operating abroad (Eden & Miller, 2004; Kostova & Zaheer, 1999; Zaheer, 1995). This concept named “liability of

foreignness” (LoF) defined as “the costs of doing business abroad that result in a

competitive disadvantage for the MNE subunit,” or in other words “all additional cost a firm operating in a market overseas incurs that a local firm would not incur” (Zaheer, 1995; p. 342-343). Broadly stated: when LoF is high, costs arise from unfamiliarity with the local market, customs and legislation. According to Eden and Miller (2004) LoF emphasizes the social costs of doing business abroad, whereas CDBA stresses both the social and

economic costs of doing business abroad. Social costs arise from a lack of knowledge of the parent MNE and differential treatment by and underdeveloped relationships with host country governments, buyers and suppliers (Eden & Miller, 2004; Hymer, 1976).

Another factor that might increase unfamiliarity costs is legitimacy. When engaging in business activities in foreign institutional environments MNEs are forced to gain

legitimacy (Yang, Su & Fam, 2012). This concept can be described as “the acceptance of the organization by its environment” (Kostova & Zaheer, 1999; p. 65). In other words: firms have to establish the right to do business in a new environment and thus gain social acceptance (Yiu & Makino, 2002). Kostova and Zaheer (1999) argued that legitimacy

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frequently foreign firms were expected to build their reputation and goodwill and to contribute to various supporting programs (Kostova & Zaheer, 1999).

In order to gain legitimacy MNE’s affiliates have to yield to pressures for local responsiveness from the local institutional environment (Eden & Miller, 2004; Davis, Desai & Francis, 2000). Establishing and maintaining legitimacy can also lead to

increasing costs since MNEs have to adapt to the new multifaceted environment; internal processes have to be adjusted, appropriate entry methods have to be chosen and the right organizational form has to be selected (Ionascu et al., 2004). As these costs can lead to a competitive disadvantage and the local institutions influence the ease of these adjustment processes, it is important for these firms to be accepted by actors in the domestic

environment (Kostova, Roth & Dacin, 2008).

In order to overcome these disadvantages and surpass additional costs, firms pursue different mitigating strategies. Local isomorphism is one of those strategies (Salomon & Wu, 2012). When pursuing the strategy of local isomorphism, firms become similar to other firms in the same organizational field by emulating practices of domestic firms (Kostova et al., 2008). Local firms provide examples of strategies compatible with the domestic institutional environment. By imitating these firms foreign MNEs mimic practices that are perceived as legitimate in the host country. If isomorphism takes place, subsidiaries may not only acquire increased legitimacy but also increased resources, survival methods and reduce their overall liability (Eden & Miller, 2004; Salomon & Wu, 2012).

2.1.2. Equity commitment

One of MNE’s main concerns when moving their operations overseas is “establishing effective boundaries for the firm” (Brouthers & Hennart, 2007; p. 395), in others words making a decision about the degree of commitment in the foreign affiliate. Deciding on the degree of foreign commitment is a trade-off between risks and financial return.

Foreign MNEs have different possibilities when entering the target market. Brouthers & Hennart (2007) define these modes of entry as “different forms of operation firms use to enter foreign markets” (p. 395). Entry modes can be divided into two main types: equity modes and non-equity modes (Pan & Tse, 2000). Whereas equity modes demand an extensive commitment of resources by the foreign entrant in the new market (Pan & Tse, 2000), non-equity modes do not require any equity investments (Erramilli,

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Agarwal & Dev, 2002) or establishment of an independent organization (Dunning, 1988; Pan & Tse, 2000) in the overseas location. Non-equity modes include export and

contractual agreements. Contracts can be signed with different parties such as distributors, suppliers, licensees and franchisees (Brouthers & Hennart, 2007). Non-equity entry modes, however, are not within the scope of this research.

Pan and Tse (2000) view entry mode choice as a hierarchical process. In the early stage of international expansion, firms decide at first whether they want to invest via an equity- or non-equity mode (Chan & Makino, 2007; Dikova & Witteloostuijn, 2007; Pan & Tse, 2000). The subsequent decision is the main subject of this study: whether firms decide to extend their operations abroad by engaging in equity investments is a choice regarding the level of ownership of the company (Pan & Tse, 2000). The firm has the possibility to adopt a “wholly owned subsidiary” (henceforth: WOS) or a “joint venture” (henceforth: JV). A WOS is an affiliate that is completely owned by the parent company. A company can become a WOS by the acquisition of a local firm by the parent MNE or a spin off from the parent MNE. Differently, when the firm decides to enter by a JV, the ownership of the affiliate is shared with a domestic firm. In this case, the MNE has multiple possibilities (Blythe & Zimmerman, 2005). The MNE could equally share the stake in the affiliate with the local firm and decide on a 50-50 ownership structure. Hence, both companies have equal influence and share the risks. Another possibility for the parent MNE is to invest more money and resources and opt for a majority stake. The MNE then owns more than 50 percent of the foreign affiliate, which means it has control over the operations, but also faces higher risks (Blythe & Zimmerman, 2005). The firm could also opt for a minority mode, which requires lesser investments but does not grant control over the affiliate. In some countries this might be the only way to enter the market due to local institutional regulations (Blythe & Zimmerman, 2005).

Entry mode choice is seen as one of the most essential strategic decisions that MNEs have to make. The subject has been analysed broadly in international business literature

(Ionascu et al., 2004) and so is the level of ownership of the foreign affiliate (Anderson & Gatignon, 1986; Hill, Wang & Kim, 1990; Meyer, 2001). Most often scholars focused on the transaction cost theory when analysing entry mode choice (Brouthers & Hennart, 2007). Transaction cost theory suggests that the choice of entry mode, and thus level of ownership, is influenced by the costs of finding potential business partners (Brouthers, 2002). The

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engage in opportunistic behaviour when given the possibility (Brouthers & Hennart, 2007). Therefore, these entry mode studies emphasized the role of control over foreign operations (Anderson & Gatignon, 1986; Brouthers, 2002; Delios & Beamish, 1999).

The resource-based view is another theory that is used to analyse entry modes. This view argues that firms develop unique resources. These resources can either be exploited in foreign markets or acquired or developed in new, foreign markets (Brouthers & Hennart, 2007). Regarding entry modes, this view focuses on if alternative modes facilitate

processes to develop unique resources.

A different perspective that is frequently applied when studying entry modes is Dunning’s (1979) OLI framework. This paradigm argues that the choice for entry mode is a result of an overall evaluation of the firm’s international operations. These operations entail ownership, location and internationalisation advantages and should not be analysed separately (Hill et al., 1990; Agarwal & Ramaswami, 1992).

The present study uses another theory from business literature to approach the equity commitment: namely, institutional theory. According to this theory foreign entrants are bound by certain rules set by the local environment (North, 1991; Scott, 1995).

Differences between the home and host institutional environment are therefore crucial. According to this perspective choice of ownership structure is the degree to which the foreign affiliate has to conform to local pressures in order to gain legitimacy (Chan & Makino, 2007).

Even though different perspectives are used to analyse ownership structures, the literature on the subject agrees on one point: when MNEs choose to invest equity there is a

continuum of increasing resource commitment, control and risk (Brouthers & Hennart, 2007; Chu & Anderson, 1992; Pan & Tse, 2000). Compared to the non-equity mode, the equity mode grants more control, but also higher cost due to a higher level of resource commitment (Anderson & Gatignon, 1986). Investing in wholly owned subsidiaries offers the parent MNE the possibility to gain and keep the highest degree of control, but

consequently bears the costs and risks of full ownership. Sometimes, the parent MNE prefers a lower level of risk and costs, or it is impossible to acquire majority or complete control. In that case the parent MNE might opt for an affiliate or accomplice firm from which it can buy a minority stake to form a JV. A JV allows for shared control (Hill et al., 1990) and shared risks with local partners at the same time (Kogut, 1991).

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2.2. Institutions

Scholars began to argue and investigate the potential benefits and harm of international expansion of MNEs in the 1950s. According to different scholars, institutions play an important role in the international expansion of MNEs (North, 1991; Scott, 1995).

Adam Smith was the first to introduce institutions in his 1776 book The Wealth of Nations. Smith proposed that flourishing trade and production are only possible when there is a certain amount of trust in the operating government and law. Later North (1991)

pointed out the importance of institutions and how neoclassical economists ignored them. He was the first to introduce institutions as the drivers of the economy and important actors that shape rules and belief systems.

Institutions are defined as “the rules of the game in a society” or “the humanly devised constraints that shape human interactions” (North, 1991: p. 97). Ronald Coase (1960) was the first scholar to make the crucial link between institutions, transaction costs and neoclassical theory. He argued that neoclassical approaches were discounting the significance of institutions by suggesting that efficient markets are only obtained when there are no transaction costs. When there are transaction costs, institutions matter since they can lower the costs of transaction. In reality transaction costs play an important role, therefore neoclassical approaches failed to correctly predict market outcomes. It can be concluded that neoclassical models are not sufficient and institutions should be seen as crucial determinants that will affect market outcomes (North, 1991).

Different scholars argue that institutional structure consists of both formal and informal constraints (Dunning & Lundan, 2008; North, 1991). Formal constraints are described as laws, constitutions and property rights, while informal institutions are traditions,

conventions, codes of conduct, religion and culture (North, 1991).

Scott (1995), on the other hand, approaches institutions from a three-dimensional institutional context that consists of regulative, normative and cognitive pillars. The first pillar reflects North’s (1991) formal constraints in the form of rules and regulations that exist in society (Scott, 1995). Examples of these formal constraints are laws, rules and guidelines carried out by the government that promote certain behaviour. Regulatory or legal control often means additional direct and indirect costs for the MNE (Arregle et al., 2013). MNEs consent to these regulations to “avoid the penalty of non-compliance” (Chao & Kumar, 2010: p. 94). By intimidating people or companies with legal penalties, the

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regulatory environment provides supervision and guidance for management decisions. To sum up, this pillar defines what people are and are not allowed to do (Eden & Miller, 2004).

The second pillar, the normative component of institutional environment, consists of norms and values. These norms and values reflect the desired behaviour and maintain stability in the way this behaviour is implemented (Scott, 1995). This component defines “what is the right thing to do” (Eden & Miller, 2004). The need to conform to social norms and the professionalism of these procedures determine whether they will actually influence organisational activities. As an illustration: gifts and bribes are frequently accepted in rising economies like India and China (Chao & Kumar, 2010), whereas it is absolutely not generally agreed upon in Western countries.

The last pillar, the cognitive component, is a reflection of shared beliefs and perceptions on established social reality in society (Scott, 1995). It suggests actions are influenced by meanings that people attach to their behaviour. These meanings are socially created through communication and interaction with others. Therefore, in order to understand actions not only the objective meaning is important, but the subjective interpretation also has to be taken into account. In short this pillar tells society what can be done, and what cannot be done (Eden & Miller, 2004). Scott’s normative and cognitive pillar can be compared to North’s informal institutions, since they both serve to maintain social stability and prevent opportunistic behaviours.

2.2.1. Institutional theory

Different theories in the international business field have approached the question what strategy will lead to successful business. In international business literature there are two perspectives that are commonly used to answer this question. The first is the industry-based view, which addresses industry conditions as crucial factors of a firm’s strategy (Porter, 1980). The second, the resource-based view, argues that the competitive advantage of a firm is determined by the efficient application of the various resources the company has at its disposal (Peng, 2001). Instead of looking at the competitive environment, like the industry based view suggests, the resource based view proposes that to find the sources of competitive advantage, the company has to look inside the firm.

Although both theories are widely accepted in international business literature, neither of them include the institutional context in which MNEs are operating (Peng, Wang & Jiang, 2008). As stated earlier, institutions play an important role in the

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organization (North, 1991; Peng et al., 2008). Institutions set the rules of the game; they shape behaviour, perceptions and choices by determining the rules and belief systems dominating the environment (Di Maggio & Powell, 1983; North, 1991). Institutional theory is described as “a non-efficiency perspective in which institutional environment is seen as the key determinant of firm structure and behaviour” (Chao & Kumar, 2010; DiMaggio & Powell, 1983; Scott, 1995; Xu & Shenkar, 2002). In addition to previous literature it argues that the MNE not only has to focus on international sources, but also take in account

external sources, the institutions. The theory implies that companies that operate in

different environments might face multiple institutional contexts (Xu & Shenkar, 2002). It recognizes that the MNE faces dual pressures for global integration and local

responsiveness. These pressures sometimes have the ability to lead the MNE to be directed by legitimated aspects. If MNEs want to sustain a competitive advantage, it is crucial to establish legitimacy and thus to confirm to the norms and beliefs dominant to the

environment (Di Maggio & Powell, 1983; Zucker, 1983). Enactment of these legitimated features creates isomorphism with the institutional environment, which increases an MNE’s chance of survival.

These pressures created by local institutions are a big problem MNEs face when operating abroad (Xu & Shenkar, 2002). They can play a crucial role in shaping the opportunities for MNEs to move their operations to an unknown, foreign environment (DiMaggio & Powell, 1983; Rugman, 2001). For that reason, institutional theory has become an increasingly used and powerful tool to explain both individual and

organizational activity (Dacin, Goodstein & Scott, 2002).

2.2.2. Institutional distance

The past decades, scholars have used the concept of distance to analyse differences in strategies and activities across countries (Ionascu et al., 2004). Johanson & Vahlne (1977) were the first do address this problem by creating the concept of “physical distance,” which mainly focuses on the cultural differences between countries. Overtime, however, different scholars pointed out that more than cultural aspects shape an organization’s strategies and actions (Ghemawat, 2001). When entering a foreign country an MNE is confronted with certain “rules of engagement” that differ from country to country and are essential to the investment decision. Literature points out that local institutions play an essential role in this process (North, 1991; Scott, 1995). Their proximity to business has a

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major impact on the modes of coordination of the MNE and its choice of allocation of resources (Dunning & Lundan, 2008).

In order to efficiently address contextual differences between the home and the host country, Kostova (1996) constructed a concept to measure the differences or dissimilarities between the institutional environments drawing on all three of Scott’s (1995) components. This concept, called institutional distance, has been described as “the level of dissimilarity in formal and informal institutions of the home and the host country” (Eden & Miller, 2004; Kostova, 1996; Kostova & Zaheer, 1999; Xu & Shenkar, 2002). It contributes to the

explanation how differences between countries affect international business decisions (Ionascu et al., 2004). According to Kostova and Zaheer (1999) it is harder for MNEs to establish legitimacy in the host country environment as well as transferring strategic patterns to subsidiaries overseas when the institutional distance is larger.

2.3. Institutional distance and equity commitment in the foreign affiliate

In this study an institutional approach has been used to approach the equity commitment of the MNE in the foreign affiliate. Because of the on-going internationalisation process, an increasing number of firms invest in an environment in which the institutional context is completely different from its original habitat (Dikova & Witteloostuijn, 2007). Local markets vary in terms of the institutions that dominate the industry environment and social arrangements (Chao & Kumar, 2010). As multiple institutional environments are faced at the same time, MNEs are confronted with different institutional pressures. For example; governments of emerging economies often strictly regulate their economies by controlling capital, labour and production markets. They try to maintain a low level of international competition by for example restricting import and inward foreign direct investment and by imposing licensing requirements in different sectors (Chao & Kumar, 2010).

By restricting or facilitating international business, institutions influence the

attractiveness of a certain market. Institutions can thus be an explanation why regions with similar production factors still strongly differ in the received amount of FDI. Bénassy-Quéré et al. (2007) discovered that a solid institutional framework could appeal to cross-border investments. Examples are: low levels of corruption, governmental and economic freedom, sufficient protection of property rights, little uncertainty, high confidence and adequate engagement of government institutions.

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(LoF) (Ghemawat, 2001; Hymer, 1960; Kostova & Zaheer, 1999). Institutional distance impedes a firm’s understanding of the local market and makes it more difficult to interact with customers, suppliers, and other agents. Likewise, it is also hard for local actors to understand foreign firms. As a consequence foreign firms from more distant institutional contexts are seen as less legitimate (Kostova & Zaheer, 1999). Since MNEs are in particular need for legitimacy in the host country in order to survive, liability of

foreignness is especially important in institutionally distant countries (Xu et al., 2004). Additionally, the more institutional distance increases, the more the costs of doing business abroad rise (Eden & Miller, 2004; Kostova & Zaheer, 1999; Salomon & Wu, 1999). When the distance is small, LoF is not likely to be an issue and no or little learning has to be done. Consequently costs will be low as well (Gaur & Lu, 2007). Costs increase when the

differences between the home- and the host country increase (Eden & Miller, 2004; Kostova, 1999; Xu & Shenkar, 2002).

According to institutional theory there is a way to alleviate liability of foreignness and gain legitimacy. By giving up on some strategic control - thus lowering the equity commitment by, for example, joint venturing with a local partner - it is more likely that the subsidiary will be perceived as less “foreign” by domestic institutions (Xu et al., 2004). Higher involvement of a local associate will help the MNE mitigate threats and legitimacy by benefiting from knowledge of local institutions and from reputation in the domestic market (Yiu & Makino, 2002). This way a local partner can help the foreign affiliate to gain the right to do business and thereby smooth the transition from a “foreign” firm to a locally accepted subsidiary (Xu et al., 2004).

Larger institutional distance increases CDBA, which in its turn increases the risks for MNEs to engage in business overseas. A higher degree of risk and increased resource commitment are linked to greater control of the parent MNE in the foreign affiliate (Delios & Beamish, 1999). The higher the equity commitment, the more attention the affiliate needs from the parent MNE to be managed. When the level of equity commitment is high, the affiliate is important to the parent MNE, since the impact of the MNE’s return on investment on the MNE’s overall benefits is higher (Ionascu et al., 2004). When

differences between countries are high, higher levels of equity commitment from domestic firms might be required to lower CDBA and LoF and gain legitimacy (Argawal &

Ramaswami, 1992, Anderson & Gatignon, 1986; Xu & Shenkar, 2002).

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while good governance infrastructure may attract cross-border investments. Examples are: absence of corruption, little uncertainty, high confidence and adequate engagement of government institutions.

2.4. Research gap and research question

The growing internationalisation of economies has increased the interest in the process and criteria by which MNEs expand to foreign markets. Accordingly, different scholars have researched different internationalisation decisions like the MNE’s entry mode decision in the foreign market and the decision regarding the level of ownership in the foreign affiliate (Eden & Miller, 2004; Ionascu et al., 2004; Kogut & Singh, 1988; Xu & Shenkar, 2002). Having said that, recent research suggests there is a need for greater understanding of how institutions influence these internationalisation decisions (Chan et al., 2008).

Accordingly, this study addresses two different gaps in the existing body of

research. First of all, there is little knowledge about the influence of the different types of institutional distance on the foreign equity commitment of MNEs. Moreover, the effect of prior experience deserves more attention as little is known about the influence it has as moderating variable on the relationship between institutional distance and foreign equity commitment. Therefore, the central research question of this thesis will be as follows;

To what extent does the institutional distance between the home and the host country influence the location choice of MNEs?

3. Theoretical framework

3.1. Influence of institutional distance on equity commitment

Business activities in institutionally distant markets require conformity to local rules and norms that conflict with those of the home country (Xu & Shenkar, 2002). This will affect the subsidiary’s ability of understanding and the interpretation of local institutional

requirements (Adrich & Fiol, 1994; Kostova & Zaheer, 1999). It will also hinder the foreign affiliate from gaining legitimacy (Kostova & Zaheer, 1999). Therefore, it is expected that the CDBA rise when the institutional distance between two countries

increases (Xu & Shenkar, 2002). MNEs try to adapt their business strategy when investing in these institutionally distant environments to avoid higher risk and uncertainty (Xu &

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Shenkar, 2002).

This is nothing new to the literature on institutional distance. Earlier research had already discovered that MNEs enter these markets, but generally opt for a lower degree of control and commitment of resources (Argarwal & Ramaswami, 1992; Anderson & Gatignon, 1986; Hill et al., 1990; Xu & Shenkar, 2002). In support of this conclusion, Delios and Beamish (2002) stressed that strict regulations on equity involvement in local affiliates will generate lower equity commitments in the foreign plant. By adjusting ownership structure, the MNE can possibly avoid institutional conflict between the local environment and the familiar context of the home country (Xu & Shenkar, 2002). Joint venturing with a local firm and not opting for full ownership will smooth the new

affiliate’s transition from “foreign” to “accepted” by the local institutions (Xu & Shenkar, 2002). The affiliate will find it easier to be accepted by local consumers and buyers (and thus increase legitimacy), to understand the domestic culture, to cope with the legal system and to integrate managerial practices from the home plant into the subsidiary.

It stands to reason that these different aspects of the new business environment greatly influence the transaction costs the MNE is confronted with and consequently the competitiveness of the new venture. Regarding the extensive amount of previous research on this subject, it can be expected that institutional distance has a direct impact on MNE’s level of ownership in the host-country affiliate. We therefore check the perception that institutional distance negatively influences equity commitment in the foreign subsidiary, by hypothesizing the following:

Hypothesis 1: The higher the institutional distance between home- (X) and host-country (Y), the lower the equity commitment in the affiliate in the host country (Y).

While the hypothesis above is just a check of previous literature, the real contribution of this study to the existing body of literature on institutional distance and equity commitment starts by splitting the concept of institutional distance. As institutional distance involves various facets of the regulatory environment (Estrin, Ionascu & Meyer, 2007) and contains different dimensions that should be analysed separately (Kostova, 1996), every component is analysed in isolation in order to check the individual impact on equity commitment.

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3.1.1. Influence of governmental distance on equity commitment

Home- and host-country governments have a serious impact on trade between countries. Political associations can considerably affect business by diminishing or creating distance between countries (Ghemawat, 2001). Governmental distance relates to dissimilarities in political associations like political stability, democracy and enrolment in a trade block (Berry, Guillén & Zhou, 2010). Barriers for trade are often created by restrictions set by governments. By, for example, prohibiting blackmail or setting strict regulations on health, safety and the environment, a country’s government can impede inward direct investments. Weak government institutions are often defined by institutional constraints, while strong established political institutions with clear rules provide support for profitable business activity.

Most often the host country’s government is the one that wants to suppress

international competition (Ghemawat, 2001). Local governments want to be able to control and manage the FDI-flow, so that political and economic concerns in countries are

addressed. They fear that they have very little power over large, foreign MNEs that try to enter their market. By regulating trade, governments try to gain more control over those MNEs.

In this study a factor that is assumed to influence the degree of foreign equity commitment (Agarwal & Ramaswami, 1992; Kim & Hwang, 1992) and governmental distance, is considered a political risk. A political, or governmental, risk refers to “the likelihood of an unfavourable change in the governmental regime of a country or in the policies used by this regime” (Slangen & van Tulder, 2009; p. 279). Governmental risk increases the

uncertainty of doing business in a certain country (Argawal & Ramaswami, 1992; Delios & Beamish, 1999; Delios & Henisz, 2000). Previous literature agrees that MNE’s strategic decisions regarding the level of equity commitment rely upon the degree of uncertainty an MNE faces when entering the target country (Slangen & van Tulder, 2009).

Different scholars have investigated the effect of political risk and instability on the entry mode decisions. As entry mode research also includes the level of ownership, these studies are also relevant for the current paper. Henisz and Delios (2002) are two scholars that investigated the influence of the host country’s institutional environment on foreign operations. They agree with previous research and conclude that government policies affectively alter the level of ownership of the parent MNE in the foreign affiliate. Legal and political pressures in the host country are likely to curtail the level of foreign equity

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Likewise, Slangen and van Tulder (2009) argue that MNEs should opt for a JV with a local firm, and thus lower equity commitment of the parent MNE, when the political risk in the host country is high. JV partners often possess knowledge about the unfamiliar country’s practices, norms and values (Agarwal & Ramaswami, 1992; Barkema & Vermeulen, 1997). Further shared-equity partnerships generally require fewer resources from the MNE than wholly owned affiliates (Anderson & Gatignon, 1986; Hill et al., 1990). Along these lines collaboration with a domestic firm can help the local affiliate to

overcome LoF and reduce uncertainty.

Hill et al. (1990) stressed that MNEs should decrease liabilities when political instability and risks are low in the host country context. MNEs should decrease their vulnerability by lessening their resource commitments and simplifying the opportunity of a quick market exit. Hill et al. (1990) agree with Slangen and van Tulder (2009) by

concluding that entry modes involving lower commitment are preferable when political risk is high.

Based on previous literature it can be expected that higher levels of political distance and risk make MNEs opt for a lower level of equity commitment in the foreign plant. By doing so, they have the ability to export their products and thus minimize their risk, or joint venture with a local firm to overcome LoF and reduce risk and uncertainty.

Hypothesis 1a: The higher the governmental distance between home (X) and host country (Y), the lower the equity commitment in the affiliate in the host country (Y).

3.1.2. Influence of economic distance on equity commitment

The traditional factors of institutional distance, the economic factors, still matter when it comes to cross-border investments (Ghemawat, 2001). Berry et al. (2010) describe economic distance as differences in economic development and macro-economic characteristics between two countries. In international business literature economic

distance is built around the purchasing power of consumers, macro-economic stability and openness of the economy to international business (Berry et al., 2010).

The most important determinant of economic distance is the level of consumer income. The wealth of the inhabitants of a country, also known as the economic size of a country, has a severe influence on the types of trade partners and on the levels of trade between countries (Ghemawat, 2001). According to the gravity theory of trade, the larger

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the economic size, the larger the amount of trade and the larger the distance the lower the amount of trade (Ghemawat, 2001). Additionally, empirical research points out that poor countries engage in less cross border activity relative to their economic size than richer countries. Also, a high correlation between the GDP per capita and trade flows indicate that most economic activities of rich countries are with other richer countries (Ghemawat, 2001).

The impact of economical distance on entry mode is no new subject to international business literature (Campa & Guillén, 1999; Zaheer & Zaheer, 1997). Various scholars investigated the ownership strategies of MNEs in economically distant countries (Campa & Guillén, 1999; Henisz & Delios, 2002; Mellahi, Demirbag & Riddle, 2011). In general, the foreign investments in these studies are derived from parent MNEs from countries in which the economic development is relatively high. Mellahi et al. (2011), for example, analysed United States MNE’s investments in the Middle East and stressed that MNEs from the United States often had lower equity commitment in foreign affiliates so JVs with local companies were possible. Henisz and Delios (2002) add to this statement that the similarity between the home and the host country is enhanced when the host country has a higher income, as the home country’s income is often relatively high as well. When the level of economic development between the home and the host country is more similar, risks and uncertainties are decreased (Tsang & Yip, 2007) and companies are more prone to opt for full ownership of the foreign affiliate. In reliable and secure economies with high incomes teaming up with a domestic firm brings no additional benefits to the foreign MNE (Benito, 1996).

The outcomes of Erramilli et al.’s (1997) research strengthen these results. They found that when the MNE discovered a market with high potential, it sufficiently increased the chance it would select a higher level of ownership in the foreign subsidiary. Campa and Guillén (1999) found support of these arguments by concluding that the higher the

economic development, and thus the lower the economic distance, the higher the commitment of the parent MNE in the foreign plant.

Previous research states that the higher the difference between the economics within host and the home country of the FDI, and thus the higher the economic distance, the lower the equity commitment of the MNE in the foreign market will be. The same outcomes are expected in the present study.

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Hypothesis 1b: The higher the economic distance between home (X) and host country (Y), the lower the equity commitment in the affiliate in the host country (Y).

3.1.3. Influence of legal and regulative distance on equity commitment

Regulatory institutional distance alludes to “differences in legal institutions and prevalent rules, and regulations in an MNE’s home country and the host country” (Arslan & Larimo, 2010; p. 182). According to Scott’s (1995) framework the regulatory component either regulates or enforces certain types of behaviour by setting laws and other rules.

Organizational actions are bound by these rules and influenced by the penalties and risks that follow from not obeying to them. The behaviour of foreign MNEs trying to enter a new market can thus be influenced by the host country’s regulatory powers (North, 1991). By interfering with the freedom of engaging in international exchange, regulations can restrict market entry. Host country governments may want to do so in order to protect domestic firms from international competition.

Previous research has argued that regulatory distance might discourage investing in wholly owned subsidiaries (Gaur & Lu, 2007) and that it might be associated with lower equity control in the foreign affiliate (Xu & Shenkar, 2002; Xu, Pan & Beamish, 2004). MNEs are likely to opt for low equity commitment when the regulatory environment in the host country contrasts with the one in the home country (Xu & Shenkar, 2002; Xu et al., 2004). However, when the environment in the host country is more comparable, there is a chance the MNE will prefer full ownership. Yiu and Makino (2002) set forth that the extent to which the affiliate conforms to the local regulatory environment influences the entry mode decision. Additionally, they concluded that when the host environment had strict regulations, the MNEs were more prone to choose for shared-ownership instead of a wholly owned affiliate.

Delios and Beamish (1999) observed a similar effect regarding protection of intellectual property. They discovered that equity commitment in the foreign affiliate was low when there was a low degree of intellectual property safeguarding, and thus high regulative distance. Vice versa, if the protection of property rights was high, the equity commitment of the parent MNE was higher and the regulative distance between the home and the host country was lower.

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LoF and lacking legitimacy (Xu & Shenkar, 2002; Xu et al., 2004; Yiu & Makino, 2002). Companies that do not conform to local business practices, laws and other regulations, may lack social acceptance. Legitimate firms are those that are set up by and operate according to legal rules (Scott, 2001). A market leader in the home market may lack legitimacy in the host country because of strict regulations due to regulative distance. Investing in a local firm and lowering the MNE’s level of commitment might alleviate the effects of LoF, as it will help the MNE to gain knowledge of new environments. Another option to overcome these complexities is hiring local managers and other personnel as a vehicle to learn local rules and norms (Xu et al., 2004).

To sum up, on the basis of previous research regarding the regulative distance and equity commitment, the following is hypothesized:

Hypothesis 1c: The higher the legal distance between home country (X) and host country (Y), the lower the equity commitment in the affiliate in the host country (Y).

Hypothesis 1d: The higher the regulative distance between home country (X) and host country (Y), the lower the equity commitment in the affiliate in the host country (Y).

3.2. Moderating effect of prior experience

According to Johanson and Vahlne’s (1977) Uppsala model of international expansion, international expansion is viewed as an increasing development. In the case of Swedish firms they noticed that these MNEs expand their foreign commitment in small steps; first firms start exporting to a country via a local agent, then they establish a local sales unit before moving their production facilities abroad. Through this incremental process, MNEs have the ability to keep control of their foreign operations by gradually improving their knowledge of the local context. Pan and Tse (2000) support this view and state that low resource commitment entry modes are often preferred when entering a new market; in time firms are likely to increase the degree of their commitment.

Thus, the Uppsala model states that knowledge of foreign markets is a crucial factor for firms that want to internationalise. Acquiring knowledge of local markets, becoming active in these markets and learning by doing, creates experience. Experience in a certain market that has a similar institutional environment of that of the new host country,

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will help to reduce uncertainty and costs of operating in an unknown market (Buckley & Casson, 1981; Davidson, 1980; Pan & Tse, 2000). Delios and Beamish (2002) discovered that experience could increase the ability of the MNE to transfer firm specific advantages and other practices to foreign markets. Experience also adds to the knowledge of the foreign affiliate’s managers and helps them to notice and exploit opportunities emerging in the domestic market (Johanson & Vahlne, 1977) and to deal with risks and uncertainties (Henisz & Delios, 2002; Pan & Tse, 2000).

In order to operate successfully firms need extra information and expertise of the local environment to gain social acceptance. In order to be accepted in the local

environment, firms need to adapt to a country’s institutional profile. MNE’s familiarity with such a profile determines the progress of adjusting to a foreign institutional

environment (Xu & Shenkar, 2002; Xu et al., 2004). In other words, ease of adjustment will be higher when the country already has experience with a similar institutional profile. Experience can provide the information needed to gain acceptance and smooth the process of adjusting (Gatignon & Anderson, 1988; Brouthers & Brouthers, 2001).

Various scholars argue that LoF can lower when an affiliate acquires more knowledge of the local environment and becomes an insider in the host country (Eden & Miller, 2004; Zaheer & Mosakowski, 1997). As a consequence, the foreign affiliates will gain legitimacy and accordingly experience also diminishes the urge for local isomorphism (Salomon & Wu, 2012). The importance of imitating local firms diminishes and as firms are not as reliant on these strategies as they used to be, hence, their flexibility increases.

To sum up, experience can be expected to alleviate the effect of institutional distance on equity commitment by closing the legitimacy gap quicker (Salomon & Wu, 2012). For this reason, our second hypothesis is as follows:

Hypothesis 2: Prior experience positively moderates the relationships hypothesized in H1,

H1a, H1b, H1c and H1d.

3.3. Research design

In this study we argue that institutional distance has a negative effect on equity

commitment in a foreign market. Prior experience moderates this relationship. When an MNE has more experience in a foreign market, we expect that the influence of institutional

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distance has a smaller impact on the equity commitment of the MNE. But when the parent company has little or no prior experience it is likely that there will be a larger influence of institutional distance on the equity commitment of the MNE in the foreign market. These relationships are visualized in the conceptual framework (Figure 1).

Figure 1: Conceptual framework

4. Methodology

In the following part of this thesis the relationship between institutional distance, equity commitment and prior experience is analysed. The hypotheses proposed in the previous section will be tested using an OLS regression analysis. In this section the sample and dataset are discussed. At the end the different variables and how there are measured will be discussed.

4.1. Sample and data collection

This thesis adopts a quantitative research design. It focuses on gathering numerical data and analysing them using statistical techniques to generalize the data across groups of people, or in this case companies, to explain a particular phenomenon (Saunders, Lewis & Thronhill, 2011). Given that the data are measured at one point in time, it is a cross-sectional dataset.

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For a valid and reliable measurement of the relationship between variables, a descriptive study usually needs a large sample (Saunders et al., 2011). In order to observe the effects of institutional distance on the location choice of Dutch FDI decisions in this thesis, the most recent data on 120 different Dutch MNEs are being analysed. The sample of multinational companies is selected from the ORBIS database, an extensive database that provides information on companies all over the world. The data gathered from the 120 different Dutch MNEs are the most recent published data as revenues from the year 2013 are used. At the moment of data gathering, numerous companies have not yet rolled out their 2014 report. The information from the ORBIS database is complemented with firm specific data from annual reports obtained from online sources.

The 120 selected MNEs make a total of 10510 investments. Only international equity affiliates are considered, therefore the national investments were ruled out, after which 2397 FDIs remained. These investments were made in over 100 different host countries. In order to measure institutional distance, the Fraser Index of Economic Freedom of the World, published by the Fraser Institute, is used. This index contains information on over 120 countries across the globe on four different dimensions of institutional distance.

4.2. Measurement

4.2.1. Dependent variable

The dependent variable of this research is equity commitment. Equity commitment is measured by a newly constructed variable. The new variable combines the companies’ direct stake and the total stake in the affiliate. The commitment is measured on a scale from 0-100, with 0 being no commitment at all and 100 being a wholly owned subsidiary. A commitment around 50 indicates that the MNE is opting for a joint venture-relationship with a domestic firm that operates in the target market.

4.2.2. Independent variable

The concept of institutional distance is measured by using the Fraser Index of Economic Freedom of the World, published by the Fraser Institute. The index consists of four different elements: governmental, economic, legal and regulatory distance (Gwartney & Lawson, 2014). The data on institutional distance were gathered in the year 2012, which

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does not align with the data from the annual reports and ORBIS, which were gathered in 2013. However, this does not jeopardize the quality of the analysis performed, given that institutional data do not tend to change drastically from one year to the other.

First the three letter ISO codes used in the Fraser index were converted to two letter ISO codes used in the rest of the gathered data. Then five new variables were created to compare all four sub-indices and the summary index, which combined the scores of the sub-indices with the home country; the Netherlands. In order to create these scores, the values for each country were deducted by the Dutch value on the Fraser score. The higher the score on the new variables, the higher the distance on the selected element of the index compared to the Netherlands. An overview of the different components of institutional distance based on the Fraser index is given in the Appendix.

4.2.3. Moderator

As stated before, the moderator variable in this analysis is prior experience of the MNE. As a proxy for prior experience, the age of the firm is used. In order to measure the firm’s age, a new variable is created that subtracts the number of years since the firm was founded from the year of reference for this study, 2013. This proxy does not measure the amount of international experience, but the two are correlated. The longer a firm has existed, the more time the management and the other employees had to acquire knowledge. According to Zucchela, Palamara and Denicolai (2007) the older a firm is - and therefore the more experience the firm has gained – the earlier it is likely to internationalise.

4.2.4. Control variables

In this research different control variables are included to make sure they are not driving the results or the regression analyses by influencing the level of the MNE’s equity commitment. At firm level there are different factors that are controlled. As Kogut and Singh (1988) argue that firm size has a significant impact on the FDI decisions of MNEs, firm size was included as the first control variable. Large firms that employ more people are expected to have more experience. These firms have the opportunity to distribute their resources and to establish economies of scale and scope across operations. That way the costs of a new entry are lowered, and consequently firm size, is likely to enable higher equity commitment (Anderson & Gatignon, 1986). Firm size is operationalized as the

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The degree of internationalisation of the MNE is the second control variable. The level of internationality is captured by a measure that divides foreign sales with total sales of the MNE. Companies that are internationally diversified have various benefits.

Examples of these benefits are: economies of scale and scope and experience (Geringer et al., 1989). Correspondingly, companies might change their FDI strategies and the level of their equity commitments in foreign affiliates.

The third control variable that is included is firm profitability. Firm profitability can be linked to the degree of internationalisation of the firm, as MNEs that are performing well, and are thus profitable, have the means to expand internationally (Geringer et al., 1989; Hitt et al., 1997). Firm profitability is controlled by the return on assets (ROA) of the MNE at the end of 2013.

Different types of industries can have different reasons to expand globally and to operate individually. To check if the overall measure is not influenced by these differences, the last control variables are on industry level. The two main industries were chosen by checking what industries were most common. Both the Chemical industry and the Other Services industry were coded into a dummy variable.

5. Data analysis and results

5.1. Data analysis

Before testing the model by OLS, a check of the quality of the data and the applicability of a parametric test was done. The data were tested for normalcy, independence,

homoscedacity and linearity (Field, 2013).

A check was performed for missing cases by excluding cases list wise. Very few missing cases were found, only in Model 4 120 missing values were discovered. Due to the limited impact of these missing values, no replacements have been done.

In order to describe the variables and to be able to draw conclusions, the means, minima, maxima and standard deviations of all variables were calculated. These

descriptive statistics and correlations are presented in Table 1. This table contains the correlation coefficients for all the combinations of variables in the analyses. The

correlations show limited but significant relations between the independent variable and each of the predictor variables. Only two predictor variables, governmental distance and legal distance, correlate very highly (above 0.7) (Field, 2013). This however, brings no harm to the quality of the analysis since both variables are analysed in different models.

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The mean value of equity commitment of the MNE in the affiliate is 62.21 on a scale from 1 to 100. Thus on average, the level of equity commitment of the MNEs in the foreign country is quite high. Apparently MNEs prefer to joint venture with a local company but own a majority stake in the affiliate located in the target country.

Additionally, the descriptive statistics indicate that institutional distance has a mean of .03 on a scale from -1.53 to 3.56. Therefore it can be concluded that the institutional distance between the Netherlands and the affiliate countries is on average relatively small. Having said that, this outcome makes it even more interesting to review the differences in

institutional distance between the various sub-indices.

Table 1. Correlation matrix: means, minima, maxima, standard deviations and correlations

5.2. Results

To test the hypotheses, different OLS regression models are used to determine the relationship between the variables. As the significance of the factors of the regression analysis were under the .05 threshold, all factors have explanatory power.

5.2.1. Effect of institutional distance on equity commitment

Hypothesis 1 suggests that the lower the overall institutional distance, the greater the equity commitment in the affiliate in the host country. The models in Table 2 show the magnitude of the relationship based on the first hypothesis. The outcome of the regression analysis in Model 2 shows that the relationship between institutional distance and equity commitment is significant (F (6, 2390 = 379,325, p = .000) and positive (b = .039, p < .05). While a negative relationship was expected in the hypothesis, no support for hypothesis 1 has been found.

In hypotheses 1a to 1d the combined Fraser index is replaced with the four sub indicators. The hypotheses check the individual sub components’ effect on the dependent variable equity commitment in the affiliate. The results of all these four hypotheses are

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significant. The most notable outcome is that in only one of the models the coefficient of the dependent variable was significant. This significant result was found in Model 5, which investigated the relation between economic distance and equity commitment. The results of the analysis show a statistically significant relationship (F (6, 2354) = 404,717, p = .000) while its R2 amounts to .508. Because this relationship is positive as well (b = .114, p = .000), hypothesis 1c is not supported either.

5.2.2. Moderating effect of prior experience on the relationship between institutional distance and equity commitment

According to hypothesis 2, the prior experience of an MNE should have a moderating effect on the relationship between institutional distance - and its four sub-indices - and equity commitment in the foreign affiliate. This hypothesis is assessed by model 3 and models 8 to 11. Model 3 focuses on the moderation of prior experience on the relationship between the overall institutional distance variable and the equity commitment. When testing for the interaction effect, model 3 does not support hypothesis 2. The regression analysis shows that the moderation analysis in model 3 is significant (F (8, 2388) =

291,263, p = .000) and explains 49,4% of the variance of the model (R2 _{= .494). However,}

the interaction effect is not significant (p = .102). Because the interaction is not significant, there is no proof of a moderation effect.

Models 8 to 11 evaluate hypothesis 2 by using the various sub components of the Fraser index to examine the moderation effect of prior experience. When testing for the first sub indicator, governmental distance, model 4 shows a significant moderation (F (8, 2388) = 293,028, p = .000). The interaction shows a positive, significant result (b = .085, p = .000). As the expected moderation is negative, the result does not align with the

expectation set out in the hypothesis. On the other hand, the outcomes of models 9 to 11 show results that are consistent with the expected relationships. Economic, legal and regulative distance have a significant moderation effect (p = .000) and the interaction effect of each indicator is negative (b = -.039, b = -.065, b = -.054). Out of the five models, three models found interaction effects that support the second hypothesis. In conclusion, hypothesis 2 can only be partially supported and thus has to be rejected.

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5.2.3. Impact of control variables

For all the control variables strong support was found. Model 1 shows negative effects for the firm size (b = -.389, p = .000) and the firms’ degree of internationalisation (b = -.423, p = .000), whereas the other variables showed significant and positive effects. Firm

profitability is the control variable with least impact (b = .156), but still shows a significant result (p = .000). Both industry-dummy variables are significant at .000 and show strong effects (b = .653, b = .528). This means that when firms are part of either the Chemicals or Other Services industry, this raises the height of the equity commitment.

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Institutional Influence : the impact of institutional distance on the equity commitment of MNEs and the moderating effect of prior experience