Chinese outward foreign direct investment and country risk : the effect of country risk on locational selection, investment and market entry

Chinese Outward Foreign Direct Investment and Country Risk

Master thesis, Business Studies Ischa G. Kamps

June 2014

Abstract

Motivated by the increasing importance of Chinese outward foreign direct investment and Chinese integration within the global economy, this study attempts to model Chinese pre-entry considerations and subsequent post-entry integration in relationship with country risk. It attempts to quantify how China’s relationship to risk diverges from that of Western countries. Western literature indicates that low risk indices have a positive influence on the attractiveness of an investment opportunity and the acquired level of equity ownership. However, China has a distinctive nature as a late developer with a dominant institutional framework in which organizations are able to benefit from distortions in the capital market and capitalize on relational assets. This environment inhibits the traditional risk reaction and points towards risk-seeking behaviour. The statistical results partially confirm an alternate risk perception and show that elevated political risk increases a country’s chance of being selected as a location for Chinese investment and increases the amount of money invested. However, the alluring nature of elevated economic and financial risk could not be statistically confirmed. In regards to post-entry integration, Chinese organizations are deterred from acquiring high levels of equity ownership in high-risk countries, confirming the reigning risk-averse reaction. In addition to current findings, suggestions are made for future studies, as severable viable topics remain unexplored.

JEL classification: C34, E02, F21, F23, G32, G34

Keywords: Foreign Direct Investment, country risk, entry strategy, China, Heckman, Tobit

Under supervision of: Dr R. M. Singh

Acknowledgements

The accomplishment of this research was not without challenges and I am grateful to those who offered their help and support in writing and finalizing the paper. I would like to express special gratitude to Dr Ranjita Singh, whose valuable insights and constructive criticism were an immense help in developing this research paper. I would also like to thank my family for their continuous support and encouragement throughout the process. Finally, I would like to thank the University of Amsterdam for providing such an excellent study programme.

1.

INTRODUCTION

1

2.

LITERATURE REVIEW

5

2.1. Foreign Direct Investment Literature Review 5

2.1.1. Foreign Direct Investment 5

2.1.2. Theoretical Developments within Foreign Direct Investment 6

2.1.3. The Eclectic Paradigm 7

2.1.4. Locational Selection of Foreign Direct Investment 9

2.1.5. Foreign Direct Investment and Market Entry Strategies 11

2.2. Market Entry Strategies Literature Review 11

2.2.1. Market Entry Strategies 11

2.2.2. Theoretical Development of Market Entry Strategies 14

2.2.3. Foreign Direct Investment, Market Entry Strategies and Country Risk 16

2.3. Country Risk Literature Review 17

2.3.1. Economic Risk 20

2.3.2. Financial Risk 21

2.3.3. Political Risk 23

2.3.4. Foreign Direct Investment and Country Risk 26

2.3.5. Market Entry Strategies and Country Risk 26

2.3.6. Chinese Addendums towards Foreign Direct Investment and Entry Strategy 28

2.4. Chinese Foreign Direct Investment Flows 29

2.4.1. China as a Late Developer 33

2.4.2. China’s Institutional Framework 34

2.4.3. Distortions within the Capital Market 40

2.4.4. Ownership Advantages Specific to China 40

3.

THEORETICAL FRAMEWORK

42

3.1. Chinese Foreign Direct Investment and Country Risk 42

3.2. Chinese Market Entry Strategies and Country Risk 45

4.

METHODOLOGY

49

4.2.1. Outward Foreign Direct Investment 54

4.2.2. Level of Ownership 57

5.

RESULTS

59

5.1. Outward Foreign Direct Investments 59

5.1.1. Descriptive Statistics 59

5.1.2. Probit Selection Regressions 60

5.2. Level of Ownership 64

5.2.1. Descriptive Statistics 65

5.2.2. Tobit Regressions 66

6.

DISCUSSION

68

6.1. Outward Foreign Direct Investments 68

6.1.1. Chinese Locational Selection 68

6.1.2. Quantification of Chinese Investments 71

6.2. Level of Ownership 75 6.3. Limitations 78 6.4. Future Research 79

7.

CONCLUSION

82

8.

REFERENCES

86

9.

APPENDICES

99

9.1. Appendix A, Components of Country Risk 99

9.2. Appendix B, Skewness and Kurtosis 100

9.3. Appendix C, Initial Heckman Model on oFDI 101

9.4. Appendix D, Non-Robust Predictive OLS Model on oFDI 104

9.5. Appendix E, Multicollinearity, Heteroskedasticity and Omitted Variable Bias 105

9.6. Appendix F, Robust Predictive OLS Models on oFDI 106

9.7. Appendix G, Robust Heckman on oFDI with Significance Indicator 108

9.8. Appendix H, OLS Models on Ownership 110

9.9. Appendix I, Robust Tobit Models on Ownership 112

9.10. Appendix J, Robust Tobit on Ownership with Significance Indicator 114

1.

Introduction

An increasing number of organizations are stepping outside their national boundaries and entering foreign markets in search of profitable opportunities. This process encompasses outward Foreign Direct Investment (oFDI). A remarkable case study can be found in China, where financial liberalization and strong capital flows have driven durable economic development. This process, which resulted in strong Chinese integration into the world economy, has been remarkable and can be divided into five key stages. The “open-door” policy provided the initial stepping stone for enhanced integration (Buckley et al., 2007) and this process was rapidly pushed forward when China joined the World Trade Organization (WTO) in 2001 (Buckley et al., 2008).

As described in Section 2.4, China’s inward Foreign Direct Investment (iFDI) increased from $57 million in 1980 to $115 billion in 2010 (UNCTAD, 2013), with an exponential compounded annual growth rate of 28.86%. It is therefore unsurprising that much of the literature about China has focussed on its role as a host country, while little attention has been paid to its role as an originator of oFDI. However, China’s integration within the global economy following its membership in the WTO has led to a change within Chinese capital flows during the past decade, characterized by strong growth and positive net FDI (Bouvatier, 2007).

The increasing oFDI flows stemming from China, with a compounded annual growth rate of 112.76% between 1980 and 2010 (UNCTAD, 2013), justify increasing interest in and academic attention paid to the internationalization and internalizing processes of Chinese organizations. Even the financial crisis of 2007 did not decrease China’s oFDI. This is especially interesting since global FDI flows declined significantly during 2008 and 2009. China’s role as an investor is therefore growing, as the country is becoming a leading oFDI investor (Buckley et al., 2007). As Besada et al. (2008) have noted, there has also been a significant increase in trade volume, given that annual growth rates of 30% have been reached. The information about Chinese oFDI is supplemented by data from the Chinese Ministry of Commerce (Statistical Bulletin, 2010), which stated that in 2010 domestic investors directly invested in 18,000 organizations in the non-financial sector in 124 countries. The combined investments totalled approximately $322 billion, a 1.8% increase compared to results from 2009. As The Economist (The Economist, 2013) and the

Financial Times (Anderlini, 2013) both reported, the surge of oFDI in China is expected to

continue increasing steadily in the foreseeable future.

Benito and Gripsud, 1992; Ghemawat, 2001; Hennert, 2001) about the FDI process has indicated that investments are made in search of internalizing opportunities in order to leverage acquired ownership advantages. The internalization is part of an attempt to add supplementary substance to the value chain by integrating relevant organizational markets through balancing the additional incurred costs and benefits of an enlarged controllable network. A maximizing trade-off between costs and benefits is crucial to this process. The definitive selection of a host country for investment is based on two factors: the interplay between the motives to invest abroad and the ownership and internalizing advantages an investment provides.

Location selection is of utmost importance within the oFDI process, as host country characteristics may significantly influence the costs associated with doing business abroad. Theories about FDI address both “why” and “where” organizations aim to invest, but often miss a critical piece of information: “how” organizations engage in oFDI, where an organization’s entry strategy is of prime concern. Therefore, in addition to selecting an investment location, searching for the optimum entry strategy within the preferred location is another critical strategic decision an organization must take during its internationalization process (Quer et al., 2007). The choice of an appropriate entry mode and the definition of the organizational perimeter are critical factors for the organization (Zhao, 2004; Brouthers and Hennart, 2007) and are therefore important aspects of the investment strategy (Agarwal and Ramaswami, 1992) governed by the concept of FDI.

Prior literature offers many theories about the concepts of oFDI and market entry. Within these constructs, every investment, whether domestic or international, bears a certain level of associated risk and requires a return in accordance with the risk of the investment made (Berk and DeMarzo, 2006). Therefore, when an organization engages in the process of oFDI and enters foreign markets, additional risks that influence the return on investment can be associated with factors relating to the host country. These risks are contained within the concept of country risk, which represents the accumulation of unique country-specific risk factors investors face when they choose to invest in a foreign location (Meldrum, 2000). Country risk refers to the perceived riskiness of the political, economic and financial environments in a given host location (Nordal, 2001). This risk cannot be ignored when entering a host market, because it has a major impact on locational selection and the form in which the organization will enter the host country. The relevance of country risk has become increasingly significant as more organizations invest outside their home countries.

According to Cui and Jiang (2009), organizations that encounter an elevated country risk require more flexibility and are looking for opportunities to minimize their exposure to this risk. High country risk not only impedes the organizational inclination towards high equity ownership, but

also impedes the organizational aspiration to invest in an uncertain environment. Low country risk levels can be said to indicate a relatively safe investment climate with an appropriate rate of return that in a standard and generalized global perspective, positively contributes to the attraction of cross-border investments (Meldrum, 2000).

A number of researchers (Matthews, 2002; Warner et al., 2004; Child and Rodrigues, 2005; Buckley et al., 2007; Buckley et al., 2008; Morck et al., 2008) perceive an intriguing connotation towards the traditional relationship between oFDI, market entry strategies and country risk. The authors have noted that these theories are primarily founded in the western perspective concerning cross-border investment, which disregards China as an actor within this framework. As an emerging economy with distinct relational assets and a challenging institutional framework, China might require several addendums to these theories (Child and Rodrigues, 2005; Buckley et al., 2007), which makes it an interesting case to investigate further. Prior research (Child and Rodrigues, 2005; Buckley et al., 2007; Morck et al., 2008; Ramasamy et al., 2012) indicates that China might have a perverse reaction towards risk, stemming from four addendums that are able to alter the importance of the determinants governing oFDI and the implemented entry strategy. The addendums, described in Section 2.4, leave open the possibility for Chinese cross-border investments that disregard the necessity of a maximum trade-off between risk and organizational return. However, none of the researchers have empirically investigated the effects of the full spectrum of country risk on the locational choice of oFDI.

Since globalization is increasing the importance of country risk and China is significantly contributing to this process, this paper aims to investigate the relationship between the perceived host country risk of China, its investment locations and its entry mode strategy between 2004 and 2010. The paper will attempt to provide an initial linkage between country risk, pre-entry contemplations and subsequent post-entry integration, therefore aiming to answer the following research question:

• What is the influence of country risk on China’s choices about foreign direct investment

locations, the amounts invested and the levels of acquired ownership?

An empirical analysis using a two-staged Heckman selection model will be used to quantify the effects of country risk on China’s location selection and the amount invested. Furthermore, a Tobit regression will be used to delineate the relationship between country risk and the level of ownership involved in the entry strategy. The analyses adopt data retrieved from several well-known sources, such as the 2010 Statistical Bulletin of China’s Outward Foreign Direct

Reuters’ mergers and acquisitions databases, the World Bank and the International Country Risk Guide. The data has been combined and used to construct a specific dataset that comprises observation from 124 countries, which will be used to study the research question.

To summarize, this paper will make a contribution to the literature by empirically investigating the effects of the full spectrum of country risk on locational choice related to Chinese FDI and their favourable entry strategy. Prior literature will be cited to give a valuable and profound theoretical understanding of the relationship between the concepts of country risk, FDI and level of ownership.

This paper is structured as follows. First, Section 2 will describe a literature review through which the constructs of FDI, country risk and market entry strategies will be discussed. From the literature review, several hypotheses will be brought forth in the theoretical framework of Section 3. Section 4 will elaborate on the acquired data and variables, as well as on the motivation and usage of different methodologies to test the hypotheses. Section 5 will give the results and Section 6 will interpret them. Finally, Section 7 will offer a general conclusion aimed at answering the research question.

2.

Literature Review

The literature review in this section has four aims. First, current literature about FDI will be discussed to clarify the primary organizational motives that guide the process of cross-border investment. This will answer “why” and “where” organizations invest. Second, entry modes and the attributable percentage of ownership organizations acquire when entering host countries via oFDI will be discussed; this will answer “how” organizations invest in a host location. Third, host country risk associated with entering a foreign market will be discussed. Country risk governs the choice of location for oFDI and the amount of equity ownership acquired. Fourth, China’s relationship to FDI will be considered, especially how its situation deviates from the prevailing FDI theories and market entry strategies. Assuming that China poses an alternate example within the overall concepts of FDI and market entry strategies a diverging theoretical perspective subsequently lays the foundation for the hypotheses in Section 3, which illustrate the theoretical framework of this research.

2.1.

Foreign Direct Investment Literature Review

2.1.1. Foreign Direct Investment

Before delving into theories about FDI, a proper definition of the concept is required. A foreign direct investment is defined as an investment in which an organization acquires an equity stock percentage within another organization (the affiliate) operating in a host country (World Bank, 2013), with the intention to durably manage the acquired asset (World Trade Organization, 2013; UNCTAD, 2012). The World Trade Organization (1996) defined three categories of FDI:

• Equity capital: the monetary worth of an investment as represented by the percentage of shares an organization acquires in another organization in a foreign country. The rule of thumb is that the acquiring organization needs a minimum acquired equity share percentage (or voting power) of 10% or greater with an intention to actively manage their shareholding, in order to have a controlling stake in the acquired organization. These investments include joint ventures, acquisitions and Greenfield investments.

• Reinvested earnings: the dividend on the shares possessed by the acquiring organization that are artificially reinvested in the affiliate.

• Other capital: short- or long-term borrowing between the acquiring organization and its affiliates.

investments made by the acquiring organization to the affiliate and from the affiliate towards the acquiring organization) added to the retained earnings of the affiliate, where a minimum of 10% equity ownership is acquired.

When an organization engages in the process of oFDI by acquiring at least 10% of equity ownership (UNCTAD, 2012), a multinational enterprise (MNE) is formed. Following the definitions put forth by Buckley and Casson (1976) and Dunning and Lundan (2008), an MNE is an organization that acquires a priori shareholder rights and voting power in order to exercise a notable influence over integrated value-adding activities in multiple host countries. The organization therefore has assets in at least one country besides their home country, where the individual organizations (parent and affiliates) are primarily centrally coordinated. Markusen and Maskus (2002) created a further distinction between vertical and horizontal organizations. They defined vertical multinationals as geographically disperse organizations whose activities can be divided based upon locational characteristics such as high- versus low-skilled labour. In contrast, horizontal multinationals replicate the parent organization in numerous host locations.

2.1.2. Theoretical Developments within Foreign Direct Investment

Prior literature has strived towards creating consensus about the identifying variables that govern decisions about oFDI. According to Nonnenberg and de Mendonça (2004) and Faeth (2009), Caves (1971) was the instigator of our current understanding of FDI. Another author worth mentioning is Hymer; his dissertation, published in 1976, signalled an initial shift away from using neoclassical trade theory to explain the existence of multinational enterprises. According to Hymer (1960), multinational enterprises are only able to exist and make cross-border investments through imperfect competition within the host country or extensive exertion of governmental influence, which is regarded as the market imperfection theory. Caves (1971) eventually proceeded to shift further away from neoclassical trade theory; his 1971 article argued that FDI primarily transpires when host market structures bear imperfections in order to mitigate the additional costs incurred when doing business abroad. He concentrated on the idea that

organizations engage in horizontal FDI (which can be distinguished from vertical FDI) in order to provide a differentiated offering to new markets as a means to increase profitability and achieve a positive return on investment.

The differences between horizontal and vertical FDI can be explained by making a distinction between market-seeking reasons and efficiency-seeking reasons for engaging in oFDI (Dunning, 1977, 1988, 1998, 2001; Beugelsdijk et al., 2008). An organization engages in horizontal FDI when it aspires to directly serve new foreign markets by exploiting ownership advantages

(Dunning, 1976). Organizations engaging in vertical FDI are primarily concerned with creating synergy and internal efficiency (Beugelsdijk et al., 2008) via forward or backward integration of the value chain. Horizontal FDI is therefore undertaken when product differentiation exists within the market, whereas vertical FDI will most likely be undertaken in undifferentiated product markets. Organizations can therefore only become truly international if they are able to mitigate these imperfections through comparative advantages (Caves, 1971; Hennert, 2001; Buckley et al., 2008).

Buckley and Casson (1976) were the first to extend the concept put forward by Caves (1971). They combined several ideas about FDI and stated that the organizational motivation to engage in the process of oFDI is determined by two underlying propositions, which are governed by the concept of internalizing transaction costs. First, oFDIs are made in search of internalizing and capitalizing on missing or imperfect intermediate external markets, in order to ensure a maximum trade-off in the costs and benefits relationship by ownership of valuable assets. Second, organizations make their locational choice on the premise of overall cost minimization as proposed by the Transaction Cost Analysis (TCA) theory (Williamson, 1985). Both propositions obviously focus on profit maximization.

2.1.3. The Eclectic Paradigm

Dunning’s (1977, 1988, 1998, 2001) OLI (eclectic) paradigm represents a renewed and profound advancement towards a complete theory of oFDI. It is constructed on three pillars: Ownership (O), Location (L) and Internationalization (I), which provide separate advantages and where the specific configuration influences all aspects of oFDI. These three constructs have an internal interplay and the configuration between them is dependent on the relevant context and prone to variation across countries (Dunning, 2001). This paradigm, which combines previous theories, provides a comprehensive perspective on why organizations engage in oFDI, where they aim their FDI and the extent and pattern of oFDI. The advantages stemming from ownership and internationalization are constructed through the use of firm-specific resources and internal capabilities, in order to minimize transaction costs in operations throughout the organization (Dunning, 1988). The choice of location is dependent on the motives for doing business abroad (Benito and Gripsud, 1992; Dunning, 1998).

The eclectic paradigm contends that ownership advantages relate to the portfolio of tangible and intangible resources attained by the organization (Nonnenberg and de Mendonça, 2004); the sustainable competitive advantages realized by the organization within one or multiple market structures stem from the ownership or availability of wealth-creating resources (Dunning, 2001).

According to Cantwell and Narula (2010), the OLI paradigm differentiates between competitive advantages stemming from two categories of ownership: 1) the ownership of Valuable, Rare, Inimitable and Non-substitutable (VRIN) resources (Barney, 1991), mainly intangible assets as exemplified by internal knowledge; and 2) the ownership of complementary assets in order to capitalize on transactional advantages, as exemplified by cross-border coordinating capabilities (Cantwell and Narula, 2010).

Internalization advantages refer to the idea that, given the ownership advantages, an organization will internalize certain markets as a result of detected market failure (Dunning, 1988) in order to strive towards effective management within the value chain in combination with rigid quality control (Faeth, 2009). Prior literature has defined several sources of market failures that are derived from elevated country risk and correlated uncertainty, economies of scale within imperfect markets or the incurrence of external cost (Dunning, 2001).

One identifiable failure is the existence of an oligopoly or monopolistic market. In that case, internationalizing will be instigated in response to the additional incurred (transactional) cost originating from market failure, in an attempt to add value to the value chain by integrating relevant organizational markets through the balancing of additional incurred costs and benefits of an enlarged controllable network (Cantwell and Narula, 2010). Hennert (2001) added that internalization and the coherent reduction in transaction cost provide significant organizational advantages through the increase of efficiency and effectiveness of interdependencies in the organizational network. The willingness of organizations to internalize is therefore greater when transactional costs are perceived to be high.

Locational advantages are related to the other two concepts within the eclectic paradigm. An organization searches for appropriate investment locations, where the appropriateness is based on the organization’s motives for investing abroad as well as the ownership and internalizing advantages an investment provides (Dunning, 1977). Locational advantages seem to be treated separately from ownership and internalization advantages in the eclectic paradigm, but the choice of location is not always made separately as market failures are as likely to govern the locational choice as reductions in coordinating cross-border activities do (Dunning, 2001). In his 1998 article, Dunning elaborated extensively on the third pillar of locational advantages, which have gained increased consideration in light of the geographical disparity of organizational activities in combination with the never-ending search for efficiency, effectiveness and competitiveness.

Deng (2004), Cai (1999) and Dunning (1998) have clearly stated four separate motives that govern locational choice:

• Foreign market seeking: influenced by the search for primary, large, increasing domestic markets, where potentially interesting locations can be found in adjacent regional markets. The availability and cost of skilled, professional labour is important, but the presence and competitiveness of related firms also bears weight.

• Efficiency seeking: factors related to the cost of production, the availability of specialized clusters and investment incentives stemming from the host country.

• Resource seeking: influenced by the availability of natural resources within the host country.

• Strategic asset seeking: influenced by the availability of knowledge-related assets necessary to protect or enhance ownership advantages.

The locational advantages described by Dunning (1977, 1988, 1998, 2001) can be distinguished from the factual location because the location pillar internally encompasses the three pillars of the eclectic paradigm. Therefore, this paper provides additional consideration towards the host location as an isolated, tangible factor of oFDI.

2.1.4. Locational Selection of Foreign Direct Investment

Aharoni (1966) stated that the primary variables governing the decision to invest in a certain location are dependent on prior internal knowledge and previous exposure to the host country. Homogeneous locations reduce uncertainty and, therefore, expenditures in operational activities. Benito and Gripsrud (1992) added their perspective in which augmented knowledge of the host location is of prime concern, as it provides both a deduction in cost as well as a reduction in the levels of uncertainty involved in the investment process. This, in turn, results in a greater return on investment for the organization. Johanson and Vahlne (1977) introduced this concept using the term “psychic distance” to describe a determinant of locational choice for oFDI. They suggested that the choice of geographical location for an investment is influenced by both physical and psychological closeness, in an organizational attempt to reduce the uncertainty and risk associated with an investment.

Ghemawat (2001) supplemented the literature regarding locational choices by proposing a delineated four-dimensional framework that describes the different factors governing the distance between home and target locations. His CAGE framework consists of Cultural, Administrative, Geographical, and Economic distance. Each of these four dimensions has a different influence on the locational selections made by organizations in their cross-border expansion and comprises

many related factors.

Hofstede (1994) defined culture as the consolidated programming of the collective mindset, which distinguishes citizens of one country from those of other countries. Schein (1988) related the concept of culture to the validated pattern of presumptions that are developed over time to deal with external adaptation and internal integration. The pattern of presumptions is transferred to new entrants; they are made aware of these assumptions as the appropriate and reigning values, beliefs and action. Although culture is primarily vested in people’s individual and collective mindsets, it also takes form through establishment in institutions, where culture bolsters validated patterns of presumptions (Hofstede, 1994). Ghemawat (2001) described cultural differences as the distance between the multiple cultural aspects and attributes of one country and those in another. These differences might arise from alterations to the norms and values or religion and language that govern the manners in which people collaborate and cooperate with other individuals, organizations and institutions.

Although geographical distance can easily be interpreted as the factual distance between two countries, it is only a part of the concept. According to Ghemawat (2001), several other geographical factors should be analyzed: for example, a country’s size, climate and access to (and transport to and from) water. Furthermore, synthetic geographical characteristics (e.g. a country’s infrastructure) should be considered in the process. An increase in geographical distance contributes to an increase in uncertainty and therefore leads to rising expenditures for doing business abroad. Grosse and Trevino (1996) added to the concept of geographical distance by stating that increasing distance has proven to be a prime factor leading to a decrease of control between a parent company and its subsidiaries, as well as elevated complexity in the internal organizational coordination process.

Ghemawat (2001) defined political distance as the difference in the political structure and past experiences in combination with the reigning relationship among countries. However, political distance can also be enlarged through one-sided actions as governments separately enforce their own policies within their sovereign territories, which poses restrictions, risks and additional costs for new organizational entrants. Nordal (2001) substantiated this claim by arguing that a negative difference between political climates increases the transactional cost of doing business within a host country as seen from the perspective of the potential entrant. A poor political climate will therefore allay cross-border investments. The extent to which several individual policies are integrated at the national level affects the administrative and political distances between countries; diminishing these effects has a positive impact on locational choice.

Finally, Tsang and Yip (2007) defined economic distance as the relative comparison between the economic advancements in the target and home countries. The outcome of this comparison is reflected by varying levels of income, costs of production and quality of tangible and intangible national resources that constitute to the economic distance.

2.1.5. Foreign Direct Investment and Market Entry Strategies

The underlying criteria for engaging in oFDI are the result of extensive deliberation on, and evaluation of, the potential organizational expenditures and earnings when investing abroad and internalizing activities. Locational motives are of prime concern in this process, as host country characteristics can significantly influence the costs associated with doing business abroad. However, as Section 2.1 indicates, just knowing “why” and “where” an organization aims to invest leaves out a critical piece of information: “how” an organization engaging in oFDI enters a host country. Therefore, Section 2.2 will discuss market entry strategies.

2.2.

Market Entry Strategies Literature Review

2.2.1. Market Entry Strategies

Internationalization driven by increasing globalization within the economic frontier pressures organizations to invest abroad. The choice of an appropriate entry mode is a critical factor for the establishment and definition of the organizational perimeter (Zhao, 2004; Brouthers and Hennart, 2007). It is therefore an important aspect of the investment strategy (Agarwal and Ramaswami, 1992) governed by the concept of FDI. As discussed in Section 2.1, organizations have several motives for instigating and exploiting cross-border activities. The organizational method of entry is of prime concern for successfully carrying out these activities. The literature about entry strategies describes several possible methods of entering foreign markets and different entry strategies offer alternate strategic effects for an organization (Chang and Rosenzweig, 2001).

Pan and Tse (2000) theorized that an organization’s selection of entry mode follows a hierarchical model. On the first hierarchical level, a selection is made between entering via a non-equity mode or equity mode. The distinction is based on whether an investment of organizational equity is required (Pan and Tse, 2000). This selection differentiates between multinational and non-multinational organizations (Peng, 2012). Kumer and Subramaniam (1997) described the second level of hierarchical classification: non-equity modes consist of contractual agreements and exporting goods and services, while equity modes are constructed of wholly owned subsidiaries (WOS) or joint ventures (JV). Since the focus of this research is on oFDI, which revolves around

the acquisition of at least 10% equity ownership in order to exercise a notable influence over integrated value-adding activities, non-equity entry mode strategies will not be considered further within this research.

Chang and Rosenzweig (2001) argued that organizations that engage in oFDI must take two strategic decisions within the framework of equity entry modes that further delineate the concepts of WOS and JV. Dikova and Witteloostuijn (2007) illustrated that the first decision revolves around the establishment mode of cross-border activities. According to Peng (2012), the second decision is related to the degree of equity ownership, as the organization has to determine whether to individually invest or combine resources with an organizational partner.

Figure 1. Entry mode strategies (Peng, 2012)

Figure 1 shows four distinctive entry mode strategies, distinguishing between establishment modes (source of growth) and entry modes (degree of equity control). It shows two establishment modes: a Greenfield investment and an acquisition. The difference between them is that a Greenfield investment offers organic growth for the organization: it is an initial start-up that does not involve the acquisition of an existing organization. An acquisition (an external source of growth) is the opposite: it involves acquiring an existing organization in the host location. If the investing organization opts to exclude the involvement of a partner, the organization acquires full equity control rights, leading to the constitution of a WOS or the full acquisition of an existing organization. If an organization prefers to collaborate with a partner, a subsidiary with a split in ownership level is founded, indicating an international joint venture (IJV) or a partial acquisition. The definitive decision to establish a foreign subsidiary via an acquisition or a Greenfield investment and the desired level of ownership has great significance, which stems from the characteristics of each variant and the characteristics within the host country.

The establishment of a WOS via a Greenfield investment offers the opportunity to gain complete managerial control and full ownership. It also provides the ability to duplicate the organization abroad, instilling similar norms, values and technology as the subsidiary is established from the ground up. This contributes towards avoiding friction in the integration process. However, according to Peng (2012), one disadvantage lies in the notion that wholly owned subsidiaries are time consuming to establish. Organizations acquiring a WOS often also lack a local network due to the absence of prior experience that can be crucial when investing in unknown markets (Meyer et al., 2009). This can potentially lead to additional costs attributed to the concept of liability of foreignness (i.e. the cost of doing business abroad) where a lack of experience leads to significant organizational expenses (Zaheer, 1995).

In contrast, an acquisition with full equity ownership presents an organization with complete managerial control and provides it with a relatively quick establishment in the selected host location (Brouthers and Hennart, 2007; Peng. 2012). Additionally, a full acquisition provides the acquirer with a previously established local network and the opportunity to immediately increase attributed returns (Anderson and Gatinon, 1986). Disadvantages can be found in the post-acquisition integration process, where friction might be caused by operational, cultural and technological differences (Dikova and Witteloostuijn, 2007).

Figure 1 also shows that the degree of equity control can vary: an organization can make either a full or partial acquisition. Both deliver access to resources previously owned by the domestic organization that enters into an agreement with an acquiring organization (Meyer et al., 2009). International joint ventures are a common type of full acquisition. According to Meyer et al. (2009), IJVs are newly established subsidiaries owned by at least two parent organizations. This entry mode is used to reduce capital investments and share the risk of operating in the host country (Anderson and Gatinon, 1986). However, an IJV creates the possibility for risk stemming from cooperating with other organizations that have different interests. Furthermore, this type of entry mode is usually associated with a lack of control (Peng, 2012). Kogut and Singh (1988) defined a partial acquisition as the acquisition of a certain number of company shares in order to gain a predetermined level of influence in a jointly operated organization. In both establishment modes, partial equity ownership offers the possibility to incorporate organizational resources available to the domestic firm within the resource base of the foreign entrant (Das and Teng, 2000).

Following the reasoning of Anderson and Gatinon (1986), entry modes are grouped by the preeminent control that can be exerted on the subsidiary. Brouther and Hennart (2007) noted that the choices between establishment modes and entry modes are not sequential and can be seen as two distinctive, separate strategic decisions. Due to the predetermined partial research objective of

this paper, which is focussed on uncovering additional information about the acquired level of ownership of Chinese investors when investing abroad, only the degree of equity control (partial or full) will be considered. The motive for this selection is based on the assumption that the degree of equity control represents the proper consideration with respect to investing in a host country. Hill et al. (1990) argued that different levels of equity ownerships are distinguished on the premises of the desired degree of managerial control, the level of resources committed towards the entry mode and the manner through which investment risks are diffused. Brouthers and Hennart (2007) agreed and noted that equity ownership revolves around a trade-off between the resources an organization is willing to commit and its willingness to bear additional organizational risk. The strategic entry modes we discuss (IJV and partial acquisition) are combined on the basis of partial degree of equity control; the same principle applies to the wholly owned subsidiary and full acquisition, which are combined on the premise of full equity control. Therefore, this paper distinguishes between two entry mode strategies: full and partial acquisition. Reynold and Snapp (1986), Mjoen and Tallman (1997) and Brouthers and Hennart (2007) have all indicated that the main difference between full and partial equity control lies in the discrepancy between individual internalization and joint internalization with a strategic partner.

In accordance with the discussed theory involving motives for engaging in oFDI, several theories emerge from the literature about factors the influence the choice of entry mode strategy and the acquired level of ownership.

2.2.2. Theoretical Development of Market Entry Strategies

Buckley and Casson (1976) have argued that an organization that engages in cross-border investments must contemplate various factors when selecting an entry mode strategy: they must internalize the acquired foreign resources and capitalize on their resources to ensure a maximum trade-off between costs and benefits through ownership of valuable assets. Williamson (1985) offered a foundation for advancing Buckley and Casson’s theory by introducing the Transaction Cost Analysis theory.

Within the TCA theory, Williamson (1985) defined organizational decisions as bounded by rationality, where prime attention is given to minimizing transaction costs. Anderson and Gatignon (1986) were the first to create a direct link between TCA theory and entry mode strategies. Malhotra et al. (2003) viewed TCA theory, which is founded on the premises of bounded rationality as well as opportunism (Williamson, 1985), as an explanation of organizations’ incentives to capitalize on their investments by selecting the most suitable governance structures to minimize costs. Zhao et al. (2004) agreed and noted that TCA theory

pays great attention to continuous reduction of organizational cost via the selection of the most appropriate governance structure for the organizational environment. Quer et al. (2007) added that the ratio between organizational (i.e. monetary) benefits and transactions costs is key to the internalization process.

In combination with Williamson’s TCA framework, Anderson and Gatignon (1986) distinguished between two relevant constructs, where each has an influence on the degree of equity control taken in foreign investments:

• Asset specificity: this refers to the organizational assets and capabilities that differentiate an organization’s strategic direction and product offering from that of their competition (Zhao et al., 2004). Following Dunning (1977, 1988), asset specificity is primarily exemplified in assets and capabilities founded on tacit knowledge as well as intangible organizational assets embedded in employees. The concept and relative importance of asset specificity stems from the Resource Based View (RBV) (Peng, 2002) and primarily comes into play through an instigated collaborative relationship between organizations. Within this relationship, one organization possesses VRIN assets specifically tailored towards a successful investment or transaction, implying that future and alternate adaptations of these assets are likely to be limited (Brouthers, 2002). A potential threat is found in collaborative transactions or investments with intermediate control over the assets, as the possibility of opportunism exists (Zhao et al., 2004). Following Chang and Rosenzweig (2001), the concept of asset specificity is governed by both informational asymmetry and the protection of VRIN resources.

• Uncertainty: a distinction must be made between internal and external uncertainty. Internal uncertainty relates to the organizational inability to evaluate performance and output delivered from the internal organizational boundaries (Anderson and Gatignon, 1986); external uncertainty is related to volatility within the external environment in which the organization must thrive. External uncertainty inhibits an organization’s ability to predict and anticipate future contingencies, since the market is too volatile. Various researchers; (Anderson and Gatignon, 1986; Hill et al., 1990; Quer et al., 2007) have argued that country risk is the prime variable within external uncertainty and has a major impact on entry strategy.

The TCA theory, including Brouthers and Hennart’s (2007) research, is the predominate perspective currently used in literature about entry modes. Zhao et al. (2004) confirmed the viability of the TCA theory as a predictor of level of ownership. Brouthers (2002) added that transaction cost variables are primarily attentive towards the organizational integration of

activities with respect to the relative expenditures related to the transactions. However, in order to create a comprehensive overview of perspectives about entry strategies, TCA theory must be extended with several arguments. Hill et al. (1990) proposed combining it with organizational strategic decisions, which indicate alternate levels of intended and required control; this depends on the pursuit of a global or multi-domestic strategy.

Aharoni (1966) and Johanson and Vahle (1977) added the concept of internationalization, which proposes that an internationalizing organization prospers from previous experience in cross-border investments. This arguably leads to a reduction in psychological distance as prior internal knowledge and previous exposure to the host country reduce uncertainty. The result is a diminished liability of foreignness and related operational costs, leaving less uncertainty and the subsequent opportunity to obtain a higher level of ownership. Furthermore, international experience has the potential to increase the likelihood of opportunity recognition, assigning higher value to the capitalization of these opportunities (Agarwal and Ramaswami, 1992). In addition, various researchers (Delios and Beamish, 2001; Brouthers, 2002; Yiu and Makino, 2002) have extended TCA theory by not only applying transaction cost variables, but by integrating cultural and institutional variables in order to explain entry mode strategies.

When the TCA theory is supplemented by strategic related factors (which are founded in the theoretical framework governed by the RBV (Malthotra et al., 2003), the concept of psychological distance and the institutional framework within a country, it provides a similar narrative to that of the eclectic paradigm proposed by Dunning (1977, 1988, 1998, 2001) and described in Section 2.1.3. Slightly rephrasing the eclectic paradigm to direct it towards the provisional clarification governing entry mode strategies and the level of equity ownership allows the TCA theory and the proposed addendums to be implemented within the internalization pillar. The eclectic paradigm therefore provides an indication of the motives for cross-border investments (ownership pillar), the determinants of the locational selection (locational pillar) and the entry strategy and acquired ownership level in the host country (internalization pillar).

2.2.3. Foreign Direct Investment, Market Entry Strategies and Country

Risk

An organization’s decision to invest in foreign countries is governed by motives stemming from the OLI paradigm (Dunning, 1977, 1988, 1998, 2001) and other important locational factors (Hofstede, 1994; Ghemawat, 2001; Buckley et al., 2007). It is also influenced by external uncertainty (Hill et al., 1990; Chang and Rosenzweig, 2001; Quer et al., 2007; Brouthers and Hennart, 2007). The overall concept of oFDI therefore encompasses investment motives and

locational choice as well as the entry strategy, where organizational investments are made in search of positive internal and external returns on investment. Investment decisions are made by comparing the relative advantages of various investment opportunities available to an organization at a particular moment in time. However, every investment, whether domestic or international, bears a certain level of associated risk and a consistent return. Therefore, when engaging in the process of oFDI, additional risks influencing the return on investment can be allocated towards factors related to the host country. These factors potentially influence both the oFDI flows as well as the entry strategy, since organizations constantly strive for a maximum trade-off between risk and return (Berk and DeMarzo, 2006) as they aim to minimize risk while maximizing return.

One difficulty that organizations face when investing in heterogeneous locations is described by the concept of country risk. It is related to the eclectic paradigm, TCA theory and the proposed addendums. A number of previous researchers have stated that country risk is one of the most influential variables within the investment relationship (Anderson and Gatignon, 1986; Hill et al., 1990; Meldrum, 2000; Nordal, 2001; Brouthers and Hennart, 2007; Buckley et al., 2007). This will be discussed in Section 2.3 in order to establish a theoretical relationship with oFDI (Section 2.3.3) and market entry strategy (Section 2.3.4).

2.3.

Country Risk Literature Review

Although the focal point of this research is risk associated with the host country, it is perhaps appropriate to provide a more extensive perspective on risk. Miller (1992) and Gregorio (2005) stated that the risk and uncertainty organizations encounter in their activities consists of internal and external aspects. Internal risks primarily come from the collaboration between and within different internal organizational levels; external risks come from a variety of sources.

External risks can be distinguished into three categories of exogenous risk. First, risk associated with market competition is fully dependent on the uncertainty arising from the behaviour of the competition, which can be defined as unpredictable (Porter, 1980). Second, (and somewhat broadening the notion of risk) risk can stem from the industry in which the organization aspires to act; encountered uncertainty and risk fundamentally stem from advancements in technology and changes in the prices of both intermediate and final goods and services (Gregorio, 2005). Third, risk in the external environment refers to the risk an organization is confronted with when it engages in activities in foreign environments through cross-border investment (Gregorio, 2005). Meldrum (2000) and Bouchet et al. (2003) added that all cross-border investments entail a certain

amount of risk, which can be attributed to significant national differences in economic, political, societal, geographical, natural and financial structures.

Prior literature (Meldrum, 2000; Nordal, 2001; Oetzel et al., 2001) has defined the additional risk associated with cross-border investments as country risk, which represents the accumulation of unique country-specific risk factors investors face when investing in a foreign location as opposed to investing in other opportunities. Country risk can therefore be further defined as interference due to uncertainty within the external environment that reduces the predictability of organizational performance in alternate national structures when the organization establishes, controls and operates affiliates within an international context (Meldrum, 2000; Bouchet et al., 2003). Hoti and McAleer (2004) and Hoti (2005) distinguished themselves by referring to country risk as a reflection of both the willingness and the ability to fulfil financial requirements within a host country; Harvey (2004) agreed and added that the willingness to pay is related to political risk within a host country, whereas the ability to pay can be divided into economic and financial risks. Both notions of country risk can be seen as complementary given their explanations.

According to Sambharya and Rasheed (2012), risk bears numerous connotations, as three types of risks can be identified: risk as a variance within the possible outcomes, risk as a downside (sunk) loss and risk as a profitable contingency. Nordal (2001) claimed country risk should only be used to describe the probability of downside risk and the probabilistic opportunities it can provide. Bouchet et al. (2003) followed this argument by stating that country risk is dependent on the type of foreign investment made. Three separate classifications of investments are shown in Figure 2: lending, equity and FDI (Nordal, 2001).

• Lending: direct lending or the purchase of bonds from the state, government or private organizations in a specific country. Figure 2 shows two types of borrowers: government and private organizations. Whenever a loan is extended to a government, the associated risk is described as sovereign credit risk. Meldrum (2000) formulated the concept of sovereign risk as the unwillingness or inability to conform to the financial requirements attached to the loan. Lending to governments is different from lending to private organizations, where the latter is governed by risk denoted as generalized country risk. • Equity: investments in organizations vested in foreign countries, which according to

Figure 2 relate to generalized country risk. Equity distinguishes itself from Nordal’s (2001) definition of FDI, as equity relates to investments made in non-listed organizations. • FDI: investments in country-specific resources and organizations. According to Figure 2,

Figure 2. Adoption of country risk (Nordal, 2001)

As the subject matter of this paper is cross-border organizational investments, no further attention will be paid to sovereign credit risk and the influence of country risk in regards to lending. However, both equity and FDI currently fall within the scope of this research.

Although Nordal (2001) drew a distinction between equity investment and FDI, the World Trade Organization (1996) and the World Bank (2013) described these two concepts as interchangeable and assert that they encompass the same activities governed by one concept: FDI. Given the concept of country risk in relation to oFDI, this paper uses the general term country risk to include both risk as a downside (sunk cost) and risk as an opportunity (Sambharya and Rasheed, 2012). Country risk can therefore be characterized as the correlating effect investing within a country has on the return on investment (Meldrum, 2000) in both equity and asset (Miller, 1992) governed by the concept of FDI (Bouchet et al., 2003) in both listed and non-listed organizations (Nordal, 2001).

Following the reasoning of Schneider and Frey (1985), the expected return from an organization’s investment in foreign countries is susceptible to both economic and political risk variables. Those authors were among the first to investigate the correlation between several economic and political variables in order to explain the determinants of FDI flows; earlier research primarily focussed on either economic or political determinants. Schneider and Frey (1985) concluded that there was significant evidence that both economic and political variables influence FDI flows simultaneously. Prior literature (Schneider and Frey, 1985; Cosset and Roy, 1991; Nordal, 2001; Hoti and McAleer, 2004; Li et al., 2012) agrees that general country risk (excluding sovereign risk) is constituted and substantiated through the following versatile main categories: economic, political and financial risks. Through analyses focussed on the risks associated with operating and

investing in a foreign country, organizations attempt to identify the main risk factors that could decrease their return on investment (Bouchet et al., 2003).

2.3.1. Economic Risk

The financial crisis of 2008 is a prime example of globalization and worldwide economic interconnectedness. The crisis pointed out the increasing vulnerability of organizations around the availability of credit (Sambharya and Rasheed, 2012) and mutual trust, which resulted in stagnant economic growth. Bouchet et al. (2003) distinguished between two types of economic risk: 1) macroeconomic country-related risk, which affects all foreign organizations, and 2) microeconomic risk, which only affects specific industries and organizations. Where macroeconomic risk is described as the alteration of the economic environment, microeconomic risk comprehends all localized events and comprises the organizational business environment.

Given that division of economic risk, this paper describes a host country’s economic risk as an encapsulation of all the drastic alterations and shifts in a country’s economic structure and policies, compared to those in the parent company’s country, which could impact the return on investment (Meldrum, 2000). The concept of economic risk therefore pertains to the vitality and vulnerability of a country’s economic structure, as this significantly influences organizational sustainability and competitiveness. Economic risk can be exemplified as well as constituted by the macroeconomic advancement of the host country (Nordal, 2001), reflected by the monetary and fiscal policies instigated by government, which include rules that govern FDI, the stability of the banking sector (Sambharya and Rasheed, 2012) and the openness of the economy (Bouchet et al., 2003; Hoti and McAleer, 2004). In addition, according to Meldrum (2000), economic risk includes quantifiable alterations in a country’s comparative position relative to other countries, exemplified by resource depletion or a changing demographic (e.g. aging).

In short, economic risk can be visualized as the risks a multinational organization faces that stem from the business transaction costs attributed to the requirement and attainment of the necessary resources to operate affiliates as well as the possibility to distribute their products. Ferson and Harvey (1991) found a negative relationship between the elevation of the economic risk variable (governing a host country’s economic state) and the level of FDI within a country. These findings indicate that countries with a low economic risk should attract more cross-border investments. Prior literature has acknowledged numerous variables, which individually or in combination provide a quantifiable measurement of economic risk (shown in Table 1).

Table 1. Economic Risk

2.3.2. Financial Risk

Hoti and McAleer (2004) described financial risk as a host country’s ability to fulfil its financial obligations, which is related to the notion of a government’s ability to service its debts (World Bank, 2012). This is an important risk indicator, as a government’s willingness and ability to service its debts reflects heavily on the reigning investment climate for organizations (Buckley et al., 2007). Financial risk can therefore be derived from instability within financial markets that act in a host country, the interconnected financial global market, and the influence this has on the country’s financial abilities. A host country’s financial risk can therefore be seen as the risk and

uncertainty associated with financing (i.e. the frequency of loan default or expropriation) an organization operating within a host country, since financial losses may be incurred.

Nordal (2001) argued that the concepts of transfer risk and exchange risk are two main components of financial risk. Meldrum (2000) described transfer risk as risk pertaining to alterations in the restriction or expansion of capital movement within a host country as decided by the government. Since governments can alter policy about capital movement at their own discretion, this imposes new constraints on repatriating affiliated profits, dividends and remaining retained earnings. Financial risk therefore influences a country’s ability to attract foreign investments (Erb et al., 1996), which means that countries with a low financial risk should attract more cross-border investments.

Exchange risks are associated with fluctuations in the exchange rate, which are stimulated by alteration in the maintained currency regime (Meldrum, 2000). When an exchange rate lacks stability, both imports and exports will most likely diminish (Berk and DeMarzo, 2006) as organizations might overpay for imported products or be underpaid for exports, depending on the strength of the currency. This represents a lack of certainty, which constitutes additional organizational risk. Prior literature has acknowledged numerous variables, which individually or combined provide a quantifiable measurement (shown in Table 2).

Table 2. Financial Risk

2.3.3. Political Risk

Political risk is arguably the most important construct of country risk (Robock, 1971; Korbin, 1979; Erb et al., 1996; Harms, 2002). However, it is difficult to formulate a clear, definite and quantifiable definition of political risk as it lacks solid figures to substantiate the incurred risk. This issue is not relevant to economic risk and financial risk, which are constructed by quantifiable figures at the national level. As each host country is a distinct political entity, their respective governments impose their own unequivocal rules and regulations about direct and indirect foreign investments and organizations acting with their sovereign territory.

Earlier literature has proposed several related concepts and definitions of political risk. Robock (1971) was among the first to distinguish between two notions of political uncertainty (political instability and political risk) in recognition that the political environment is vivid and dynamic. Therefore, if a change does not have a significant impact on the organizational environment, it is described as political instability rather than political risk. Following Harms (2002) and Bouchet et al. (2003), political risk is further defined as societal risk that stems from anticipated or factual alteration within the national political structures through both internal and external influences. Delios and Henisz (2003) added that a significant impact for potential or current investing organizations in regards to political risks lies in the government’s willingness to alter its unequivocal rules and regulations. Robock (1971), who discussed political risk as a concept that solely impacts the organizational environment, found that the notion of political risk is only present when it provides a prolonged disruption for an organization, derived from an unanticipated alteration in the national political structure. As an additional requirement, Root (1972) asserted that the alteration in the organizational environment should be able to substantially affect the organization’s earnings. The interpretation of Butler and Joaquin (1998) was similar: political risk governs the concept of an unanticipated alteration within competitive business structures that has a substantial impact on activities stemming from multinational organizations within a host country. The impact can be attributed to the notion of volatility. As the national political structure is susceptible to sudden and unexpected alterations, the uncertainty and the risk this potentially brings forth will affect the multinational organization’s return on investment (Berk and DeMarzo, 2006). Korbin’s (1979) view is similar: political risk is best described as the host government’s impedance within the political climate governing business transactions.

It can therefore be argued that political risk within a host country is the result of current conditions (as well as willing alterations to these conditions) under which foreign organizations establish, operate and behave. These conditions stem from political processes (e.g. political dissidence and war) or changes in the enforced governmental policies. In addition, Busse and Hefeker (2007) and Harms (2002) have shown that an elevated political risk index (where a high risk indicates a feeble national political structure) has a significant, negative effect on the number of foreign investments being made in a host country. This indicates that countries with a low political risk should attract more cross-border investments. This is supplemented by information from Fatehi-Sedeh and Safizadeh (1989) and Diamonte et al. (1996), who noted that alterations within national political structures have a more pronounced influence on developing countries, something worth noting given the research scope of Chinese oFDI. The relative prominence of political risk as an index within the construct of country risk is therefore an important part of this paper. As noted, the political variable is hard to quantify in a definitive way. Therefore, Table 3 shows many factors used to measure political risk.

2.3.4. Foreign Direct Investment and Country Risk

As a weighted average encompassing the three components, country risk can be seen as an important factor in locational selection and the level of oFDI. The importance of country risk has been corroborated in literature; for instance, Ramcharran (1999) and Harvey (2004) demonstrated that a model that incorporates the three risk components has the potential to forecast FDI flows between countries. Low risk indices imply higher iFDI flows, which is especially important in a global, interconnected economy (Bouchet et al., 2003). Lankes and Venable (1996) performed a qualitative study among management teams responsible for foreign investment at Fortune 500 companies and found that roughly four out of five respondents preferred to invest in low-risk locations. Furthermore, the preference for a certain location decreased exponentially when the perceived country risk increased. Alfaro et al. (2004) agreed and empirically proved that organizations choose different locations for oFDI based on any additional costs and inferior organizational performance associated with an elevated host country risk. Given the notion that organizations are in search of performance, measured through the return on assets or equity (Berk and DeMarzo, 2006); low-risk countries will be preferred. Low-risk locations offer a stable and advantageous environment for attaining higher levels of organizational earnings (Meldrum, 2000). Furthermore, Lankes and Venables (1996) found that perceived country risk is a compelling attribute when making investment decisions in combination with the nature of the investment being made (Meldrum, 2000; Tsang and Yip, 2007).

Low country risk levels can therefore be seen to indicate a relatively safe investment climate with an appropriate rate of return that, at a minimum, covers the return required by investors (Erb et al., 1996). Country risk level influences both the host location, as well as the height and nature of the amount invested (Meldrum, 2000). The three distinguishable components of country risk individually indicate that an elevation in their risk component decreases the probability and the level of iFDI a country will attract. In a standard and generalized global perspective, a low risk index positively contributes to the attraction of cross-border investments. Low-risk countries are therefore seen to obtain a higher absolute amount of FDI inflow (Albuquerque, 2003). In contrast, elevated country risk indices have a significant and negative effect on the level and likelihood of FDI in a particular country. This assumption remains strong for country risk as a weighted average of the components.

2.3.5. Market Entry Strategies and Country Risk

As proposed by prior literature, the concept of entry mode strategy is governed by country risk. The optimal form of entry flows from external uncertainty within the host country location. However, the literature often mentions a first requirement regarding internalization and the level

of ownership: the concept of asset specificity (Zhao et al., 2004). It is therefore reasonable to discuss this concept and the implications it bears, based upon initial organizational ownership advantages. In order to protect VRIN assets and overcome informational asymmetry within an investment location, different governance structures have been proposed (Malhotra et al., 2003). These governance structures allow for different degrees of equity ownership, in order to ensure control over organizational assets and capabilities, and to ensure cost-effective operations within the host country (Brouthers, 2002). Chang and Rosenzweig (2001) have provided the most comprehensive view; they argue that an organization’s strategic objective is the determining factor with respect to the overall concept of asset specificity. The objective relates to either the protection of an exclusive asset (through internalization via high equity ownership in order to minimize the risk of expropriation of VRIN intangible assets) or the acquisition of knowledge (to overcome informational asymmetry via lower equity ownership and a collaborative governance structure).

Based on the premises of an investment made as well as the willingness and the necessity to leverage VRIN resources and potentially overcome informational asymmetry, non-ambulatory investments are a logic consequence within this connotation (Erramilli and Rao, 1993). Quer et al. (2007) indicated that country risk is perceived to be the prime variable dictating the relationship between the level of the invested resources and the level of ownership. Malhotra et al. (2003) confirmed this and noted that the three constructs of country risk (economic, financial and political conditions) impose restrictions upon organizations with respect to organizational commitment of resources and capabilities. Quer et al. (2007) added that elevated country risk is associated with diverging entry strategies among organizations within a certain host country. Based on this idea, researchers (Delios and Henisz, 2003; Feinberg and Gupta, 2009) have asserted that there is abundant empirical documentation to prove that an elevation in perceived country risk makes an organization that is engaging in oFDI likely to acquire a lower ownership share in the subsidiary.

Following Meyer et al. (2009), low-equity ownership in a subsidiary diminishes the amount of resources invested in a host country. Organizations see this as beneficial, because they have fewer resources and capabilities at risk at any given moment (Feinberg and Gupta, 2009). Furthermore, a partial equity stake provides the foreign organization with a strategic partner able to reduce the liability of foreignness and a weak institutional framework through which the organization can capitalize on local knowledge, capabilities and connections (Meyer et al., 2009). Kim and Hwang (1992) agreed and contended that organizations have a higher inclination towards full equity ownership when country risk is deemed low, as internalizing a subsidiary offers maximum internal value creation. Prior literature (Brouthers and Hennart, 2007) primarily indicates an organizational