The home region in the age of globalization : understanding how institutional diversity within region affects MNE’s international expansion

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The Home Region in the Age of

Globalization: Understanding How

Institutional Diversity within Region

Affects MNE’s International Expansion

Huimin Li

10379088

28 June 2015

Final Version Master Thesis

MSc in Business Administration – International Management Track

ABS, UvA

Supervisor: Dr. NiccolòPisani

Second Reader: Dr. IlirHaxhi

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Statement of Originality

This document is written by Student [Huimin Li], 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

Institutional diversity at the regional level is becoming a prominent aspect in Multinational Enterprise (MNE)’s international expansion process. Institutional diversity of MNE’s home region equals the average institutional distance between countries that belong to the region where the MNE is headquartered. This research investigates the relationship between the institutional diversity in the home region and the MNE’s scale and scope of internationalization. The obtained results, which are based on the Fortune Global 500 list of 2014, show that the institutional diversity of the home region is negatively related to firms’ internationalization. Furthermore, we also find that this negative association is weaker in case the focal firm possesses technological advantages.

Keywords:Globalization, Internationalization, Institutional Diversity,

Home

Region,

MNE,

Scale

of

Internationalization,

Scope

of

Internationalization, Technological Advantage

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List of Tables

Table 1. Descriptive Statistics: Means, Standard Deviations and Correlations…………31 Table 2. Results of OLS Regression……….32 Table 3. Results of OLS Regression……….…33

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1. Introduction

Some believe the world is becoming increasingly global, whereas others believe that it is still far from truly global. Ghemawat (2003) shows that the world is far from truly globalized. Even though the integration of markets is significant and reached highs unprecedentedly, he calls it ‘semi-globalization’. In line with Ghemawat’s (2003) view, Rugman and Verbeke (2004) point out that most of MNEs’ international activities are concentrated in their home region, therefore, markets are more regional-based than global.

Geographic expansion is one of the most substantial paths for firm growth (Lu & Beamish, 2001). Firms that decide to expand internationally face a number of challenges. During this international expansion process, the main challenge firms face is the ‘distance’ from the home country to the host countries to where they expand. This can be measured by four dimensions: cultural distance, administrative or political distance, geographic distance and economic distance (Ghemawat, 2001). These ‘distances’ are important in shaping MNEs’ internationalization patterns.

Since most of the MNEs are more active in their home region, home region plays a significant role. According toRugman and Verbeke (2004) and Rugman (2005), an average of 75% or more of the sales generated by the world’s 500 largest firms is within their home region. Furthermore, Rugman and Verbeke (2008) argue that among the world’s 500 largest firms both of the service MNEs and manufacturing MNEs are home region based. Rugman and Oh (2013) find out that home region effect outperforms the

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6 country effect, because risks arise with distance and institutional process. These risks drive an MNE to overcome costs of distance by operating within its home region, while the relative barriers in countries outside the home region are larger and hard to overcome.

Existing literature focuses on the fact that home region effect is more significant than country, firm and year effects (Rugman& Oh, 2013) and that the institutional diversity determines firms’ home region orientation (Benalieva&Dhanaraj, 2013).Seno-Alday (2009) states that home region market characteristics should bring influences in the internationalization process. However, no previous study has investigated how institutional diversity of MNE’s home region affects the internationalization process of firms based in these countries. To fill this gap, this study precisely examines whether home region institutional characteristics significantly influence the level of multinationality of MNEs.

This study is based on the world’s largest corporations, which have been ranked in the Fortune Global 500 2014. The sample of the Fortune Global 500 companies is appropriate for this study, because it offers great insight in the level of globalization, characteristics and performance of regions.

This research consists of several chapters. In the following chapter, we review the existing literature on all relevant aspects of this study and introduce the concepts that are of interests for the purposes of this study. The research gap is explained in more detail. Subsequently, the theoretical framework is presented and hypotheses are formulated. Afterwards, the research method chapter provides information regarding data gathering,

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7 the variables operationalized and methods of analysis used to test the hypotheses. This is followed by findings that have emerged in the analysis. The final chapter contains the managerial implications, the limitations of the research, the suggestions for future research and the conclusion.

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2. Literature Review

2.1 Globalization of MNEs

In the last fifty years, international business literature reached a more mature stage, with many important scholars studying in this field (Dunning, 2000; Johanson&Vahlne, 1977; Rugman, Verbeke, & Nguyen, 2011; Zaheer, 1995). Globalization is a noteworthy subject in international business, which is associated with the international integration of markets for goods, services and capital (Brune& Garrett, 2005; Ghemawat, 2003). A common assumption is that the national borders are fading, which makes the world more connected and that consumers from different countries can be served with standardized products and services (Levitt, 1983; Rugman&Verbeke, 2004). MNEs are considered as the key drivers of globalization (Rugman&Verbeke, 2004). MNEs can be defined as organizations that produce and/or distribute products and/or services across national borders (Rugman&Verbeke, 2004). Even though the international integration of markets is significant in the last few decades and recently reached highs without historical precedent, it is still far from complete globalization; it is in a state of ‘semi-globalization’ (Ghemawat, 2003). According to Rugman and Verbeke (2004), international activities of most MNEs are concentrated in their home region. Thus, markets are not global, but more regional-based. Ghemawat (2003) states that regionalization should be considered as a symbol of semi-globalization.

Some scholars point out that home region effect is as important as industry effect, which explain most of the geographical expansions of MNEs, while country, firm and

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9 year effects are very minor (Rugman& Oh, 2013). Benalieva and Dhanaraj (2013) argue that institutional diversity determine firms’ home region orientation. Seno-Alday (2009) states that home region characteristics should bring influences in the internationalization process. Extant studies suggest that MNEs prefer to place their foreign operations in host countries that are more proximate and similar to their home country (Flores & Aguilera, 2007).

Thus, the link between MNEs’ home region institutional characteristics, namely, the home region institutional diversity, and the level of internationalization is recognized as one of the great interests in the international business literature.

2.2 Distance by CAGE Model and the Importance of the Institutional Environment

Distance, broadly defined to encompass cultural, administrative, geographic, and economic dimensions (Ghemawat, 2001),is a fundamental subject in international business theory, which many of the subfields are built upon. Implicitly, it is in Hymer’s discussion of the MNE’s distinctive international aspect (Hymer, 1976), also in Buckley and Casson’s conceptualization of the MNE as a means to internalize markets across national borders (Buckley &Casson, 1976). Furthermore, it is at the heart of more current conceptualizations of the MNE as a mechanism for knowledge transfer over distance (Kogut& Zander, 1993). These theories explain the existence of the MNE, as well as the opportunities and challenges it faces as a result of distance.

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10 According to Ghemawat (2001), the four types of distance influence different businesses in different ways. Cultural distance mainly refers to how a country’s cultural attributes determine the way people interact with each other and with companies and institutions. Differences in social norms, religious beliefs, race, and language, are different aspects that are capable of creating cultural difference between two countries. Among these cultural attributes, some are much more subtle, like social norms, than some attributes, language and race, for instance. Social norms are invisible, deeply rooted to the people who abide by them with unspoken principles that guide individuals in everyday life.

Various studies point out that cultural distance is a predominant factor that influences the choice of entry mode (Dubin, 1975; Davidson, 1980). The greater the cultural distance between the MNE’s home country and host country, the more likely a firm in home country will choose a wholly owned greenfield over an acquisition or a joint venture (Barkema, Bell &Pennings, 1996).Firms entering through a wholly owned greenfield or through a joint venture or an acquisition both face cultural barriers. However, the barriers are not exactly the same. Wholly owned greenfields require the expending firm to adjust itself to a foreign national culture. When a firm expands through a joint venture or an acquisition, this adjustment involves ‘double layered acculturation’. The expanding firm has to accommodate both national and corporate cultures of the target firm.

Geographic distance refers to not only the physical distance between two countries in miles or kilometers, but also the physical size of the country, average

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11 within-country distance to borders, across to waterways and the ocean, and topography. In addition, man-made geographic attributes, a country’s transportation and communications infrastructures, for example, also need to be taken into consideration. Obviously, geographic distance affects the transportation costs of tangible products. Interestingly, intangible products or services can also be influenced by information infrastructure, which belongs to geographic attributes. The farther the geographic distance between two countries, the slower the cross-border transaction flow (Ghemawat, 2001).

In international business literature, two approaches have been used to explain firms’ geographic expansion: the Uppsala internationalization process model (Johanson&Vahlne, 1977) and the Penrosian capability model (Penrose, 1995). The Uppsala model suggests that MNEs face liability of foreignness, when operating abroad. MNEs increase their commitment to foreign countries in small steps as they learn the new markets. Commonly, MNEs internalize incrementally from proximate and familiar to distant and new locations (Barkema et al., 1996; Benito &Gripsrud, 1992; Johanson&Vahlne, 1977, 2009). The Penrosian model compensates the Uppsala model by emphasizing the increasing constraints in managerial resources, when MNEs expand internationally (Penrose, 1995). Managerial resources that can be adapted to the complexities of internationalization is scarce, therefore, MNEs are likely to grasp proximate and familiar opportunities in order to minimize the cost of dynamic adjustment (Hutzschenreuter, Voll&Verbeke, 2011; Meyer, 2006; Tan & Mahoney, 2005).

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12 One of the most important economic attributes that create distance between countries is the wealth or income of consumers. Rich countries tend to engage more cross-border economic activities compared to poorer countries. Other economic attributes include differences in costs and quality of natural resources, financial resources, human resources, infrastructure, intermediate inputs and information or knowledge (Ghemawat, 2001).

The level of home country economic development, as operationalized by Gross Domestic Product (GDP) per capita, is a major indicator of levels of international expansion to host countries. Generally, the higher levels of economic development will lead to the higher levels of foreign expansion (Tallman, 1988). Furthermore, market size of the home country is also an important factor. Hennart (2007) argues that if the home country market size is large enough for the firm to gain economies and profitability, there is no reason for the domestic firm to expand to a large extent.

Administrative or political distance consists of attributes that can create distance, such as, absence of colonial ties, absence of shared monetary or political association, political hostility, government policies and institutional weakness. Colonial ties are historical and political associations shared by countries, which bring a great influence on trade between them. Administrative and political distance can also be created through unilateral measures, where policies of governments pose barriers to cross-border competition. In addition, individual governments can also raise their barriers to foreign competition through tariffs, trade quotas and restrictions on FDIs; hereby, protecting domestic industries. Finally, a country’s institutional infrastructure greatly affects the

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13 cross-border economic activity. It is attractive to outsiders, when the institutional infrastructure of the target country is strong, while companies will try to avoid doing business in the target country, where the institutional infrastructure is weak (Ghemawat, 2001).

One important factor, under administrative or political distance in affecting home country’s international expansion, is political risk. Political condition plays an important role in internationalization process together with bilateral international political relationships. A cooperative home country political environment attracts domestic investment, in turn, reducing outward direct investment (Tallman, 1988).

Another key factor is government support. Luo, Xue and Han (2010) state, “Companies complying with requirements have preferential treatment concerning funding, tax collection, foreign exchange, customs and others” (p. 74). These authors also indicate that companies, which comply with these guidelines, enjoy beneficial financial support, exchange rates, taxation and other favorable treatment. This resource protects domestic companies to buffer potential risks and uncertainties, when investing in a specific country. As prior international experience can be used to overcome these risks and uncertainties, government support might be able to reduce its marginal benefits (Cui & Jiang, 2012). Thus, home government support reduces the importance of prior entry experience and significantly increases the likelihood of international expansion (Lu, Liu, Wright &Filatotchev, 2014).

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14 Furthermore, institutional distance also significantly influences home country’s international expansion. Institutional distance is rooted in one of the institutional traditions, that of Scott (1995). Scott (1995) views institutions as consisting of regulative, cognitive and normative components. The institutional profiles of the countries in which MNEs operate can vary substantially (Kostova& Roth, 2002).Berry, Guillen and Zhou (2010) analyze various types of institutional distances and their influences on the foreign entry decision. The literature suggests that MNEs prefer to place their foreign operations in host countries that are more proximate and similar to their home country (Flores & Aguilera, 2007).

Witt and Lewin (2007) state that some firms escaped from the home country through outward FDIs due to perceived misalignments between firms’ needs and home country institutional environments. One key source of the misalignments is the informal institutions, which is embedded in the business system. Firms are assumed to not only comply with the institutional constrains offered by the business system (Whitley, 1999; Hall & Soskice, 2001; Redding, 2005), but also respond to economic pressures coming from the extra-institutional environment, namely, demographic changes and technological advances (Porter, 1990; Lewin, Long & Carroll, 1999). Over time, the needs of firms alter with the changes in the extra-institutional environment. However, the misalignment can be created, when formerly useful elements of the business system lose their utility, or become an impediment for the firms to respond to the new conditions in the extra-institutional environment.

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15 As the institutional environment of the MNE’s home region becomes less harmonized and more complex, the pressure on the MNE becomes more cumbersome and needs for restructuring the organization arise, if the MNE wants to maintain its legitimacy abroad (Banalieva, Santoro & Jiang, 2012). The diverse political systems upraise the cost of operating abroad and increase the uncertainty in the relationship between MNEs and governments due to a poor prediction regarding local governments and/or other organizations (Dow &Karunaratna, 2006). Rangan (2000) confirmed it by arguing that during the foreign expansion, MNEs have to go through “a process of search and deliberation” (p. 206), which includes two types of costs. Although expanding in the home region would help to reduce the search costs of possible partners due to spatial proximity, institutional diversity would increase the deliberation costs of assessing these partners, because there would be a lack of common similarities between them.

Institutional diversity of MNE’s home region equals the average institutional distance between countries that belong to the region where the MNE is headquartered.

2.3 Importance of Home Region

Dunning (1998) believes that the eclectic diagram paradigm, which includes ownership (O), location (L) and internalization (I), determines Foreign Direct Investment (FDI). Ownership (O) specific advantages refer to the competitive advantages, which are specific to the ownership of the investing enterprises in seeking to engage in foreign investments. MNEs prefer to engage in foreign production, when they have greater competitive advantages relative to those of other firms. Location (L) stands for locational

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16 attractions of a country compared to alternative countries or regions, for undertaking the value adding activities of MNEs. MNEs will choose to exploit their ownership (O) advantages by engaging FDIs when their resources in a specific country are immobile, natural and created. Internalization (I) offers a framework for evaluating alternative ways of firms in organizing the creation and exploiting the core competencies, based on the locational attractions of different countries and regions. A firm is more likely to engage in foreign production itself, when the net benefits of internalizing cross-border intermediate product markets are great. The three variables need to be evenly balanced for foreign expansion to start and grow smoothly. He mentions that the L (location) and O (ownership) of production are becoming more geographically dispersed, but mainly within a region. He puts emphasis on the growing importance of geographical distance, the role of regional governments and development agencies in MNE’s market-seeking activities in the 1970s and 1980s. In the 1990s and 2000s, the importance of distance and the home region remained the same. As a result, firm-level evidence shows that the geography of MNE’s activity is largely determined by distance and home region (Cantwell, 2009). It has also been shown by Rugman and Verbeke (2004), Rugman (2005) and others that an average of 75% or more of the sales generated by the world’s 500 largest firms is within their home region. In addition, Rugman and Verbeke (2008) argue that among the world’s 500 largest firms both of the service MNEs and manufacturing MNEs is home region based, even though the largest MNEs in service have a much stronger home region orientation than manufacturing MNEs. They operate mainly within the home region of the Triad of the EU, North America, or the Asia Pacific.

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17 Rugman and Oh (2013) find out that home region effect outperforms the country effect, because risks arise with distance and institutional process. These risks drive an MNE to overcome costs of distance by operating within its home region, while the relative barriers in countries outside the home region are larger and hard to overcome.

Home country effects partially determine geographical tendency. Thus, country-level scope metrics are misleading; it needs to be augmented by a regional-level scale metric (Rugman& Oh, 2013). Arregle, Beamish and Hébert (2009) also consider that the regional experience is much more important than the country experience. Furthermore, Benito, Grøgarrd and Narula (2003) find that due to the environmental factors affecting deep integration in the region, being on the outside of a region leads to loss of firm competency in the region.

Given the possible home region factors, it is interesting and valuable to see whether home region institutional characteristics indeed matters for level of multinationality of the MNEs. The purpose of this thesis is to clarify the role of home region institutional diversity in the internationalization process of the MNEs.

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3. Theoretical Framework

As discussed in the previous chapter, the aim of this research is to analyze whether institutional diversity of MNE’s home region matters in the process of foreign expansion. According to Goerge, Wiklund and Zahra (2005), foreign expansion is composed of both internationalization scale and internationalization scope. Internationalization scale refers to the degree to which a firm relies on foreign markets in its operations, for instance, manufacturing, marketing and R&D. International scope indicates the international geographic reach of the firm in its operations.

The institutional environment is a critical factor in internationalization costs, as “institutions directly determine what arrows a firm has in its quiver as it struggles to formulate and implement strategy and to create competitive advantage” (Ingram & Silverman, 2002: p. 20). MNEs operate in a diverse institutional environment (Kostova& Roth, 2002; Rosenzweig& Singh, 1991). When MNEs start establishing value-creating activities abroad in new sociocultural, political and legal environments, these MNEs may be confronted with institutional hazards (Delios&Henisz, 2003; North, 1990; Zaheer, 1995). The potential negative consequences of institutional hazards for MNEs have been found to bring important influences on these MNEs’ foreign investment decisions (Slangen&Beugelsdijk, 2010).

The institutional diversity at regional level is the variation in the institutional environments across the countries within the home region (Benalieva&Dhanaraj, 2013). Subsequently, institutional diversity is important for the MNEs all through their

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19 existence. For instance, government hazards restrict the MNEs from the pursuit of business opportunities and can create disaster, not only in a particular country operation, but also at a regional network level (Zhou &Poppo, 2010). As the variance across the different institutions within the home regions decreases, firms can exploit valuable knowledge created and gained in one country within the region to another country within the region to create a competitive advantage (Chan, Isobe& Makino, 2008). According to Arregle et al. (2009), when regional institutional diversity is discussed, the regional considerations play a more important role than the country-to-country considerations.

Extant studies have found that MNEs are less likely to expand their operations in countries characterized by a greater cultural distance or a more deficient governance system (Flores & Aguilera, 2007; Henisz&Delios, 2001; Kim & Kim, 1993), as many restrictions may impede firms to pursue expansion strategies. It is more likely for these MNEs to expand to countries with a smaller cultural distance or a more efficient governance structure for FDI. As a result, countries with less institutional distance compared to other countries have more likelihood to receive FDIs; countries with larger institutional distance have less likelihood to receive FDIs and hence own less foreign-owned activity (Bevan, Estrin& Meyer, 2004; Globerman& Shapiro, 2003; Loree&Guisinger, 1995; Sethi, Guisinger, Phelan & Berg, 2003).

To put it in the MNEs home regional level, on one side, if the institutional distance between countries in the home region is similar, which means that there is a similar cultural background between countries and an efficient government system in which the FDI takes place, it is easy for the MNEs to expand. Consequently, the MNEs in

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20 home regions, where the institutional distance between countries is similar, are inclined to rely more on the foreign markets, since foreign markets offer great opportunities for them to leverage core competencies across a broader range of markets. On the other side, if the institutional distance between countries in the home region is diverse, which means that there is a big difference of institutional background between countries, the institutional environment within this region will be more diverse as well. Due to these perceived impediments, the MNEs will find it more problematic to expand internationally. Therefore, the MNEs in home regions, where the institutional distance between countries is diverse, tend to rely more on domestic markets and cling less on the foreign markets for growth. From this, the following hypothesis is formulated:

H1: The institutional diversity of the home region is negatively related to the firm’s scale of internationalization.

Geographic expansion is an important step for MNEs to grow. According to Porter (1990) and Ramaswamy (1995), MNEs are pursuing competitive advantage through diversifying the geographic scope of their activities. There are attendant benefits (Geringer, Beamish, &daCosta, 1989) and costs (Tallman & Li, 1996) of geographic expansion. Firms can attain a higher level of production and then grow by widening customer bases through entering into other countries. Moreover, the market conditions across different geographic areas are different (Lu & Beamish, 2001). Geographic diversification enables a firm to achieve economies of scale and scope (Caves, 1996). It helps firms to decrease fluctuations in revenue by spreading the risk of investment over different countries (Kim, Hwang, & Burgers, 1993). In addition, it helps lower costs and

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21 increase profits by raising a firm’s market power over its suppliers, distributors, and customers (Kogut, 1985). It also helps reduce costs by enabling the realization of arbitrage difference in input and output markets (Hennart, 1982). Finally, through leveraging resources in different areas, firms are able to exploit market imperfections and achieve higher returns on their resources (Zahra, Ireland &Hitt, 2000).

Next to the potential benefits of geographic diversification, there are also costs related to it. The liability of newness and foreignness (Hymer, 1976) is one of the costs. When making a foreign investment, many challenges, for instance, purchasing and installing facilities, staffing and establishing external business networks, can put a new subsidiary in a disadvantageous position. As a firm’s subsidiaries build and improve reputations and legitimacy in the host country in which they operate, these liabilities can diminish (Barkema, Bell, &Pennings, 1996). Moreover, as internal transactions increase with growing foreign subsidiaries, governance costs can rise rapidly to exceed the internationalization benefits (Hitt et al., 1997; Tallman & Li, 1996) due to challenges in coordination difficulties, information asymmetry, and incentive misalignment between headquarters and divisional managers in multidivisional firms. Similar to this prospective, Rangan (2000) mentions that when MNEs decide to expand to countries outside the home region, MNEs face two types of costs, which are included in “a process of search and deliberation” (Rangan, 2000: p. 206). Even though Benalieva andDhanaraj (2013) argue that firms will find alternative global countries that are more attractive and similar to avoid the growing regional institutional complexity as regional institutional diversity increases, the ‘search costs’ of possible partners increase due to spatial

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22 remoteness. Therefore, MNEs face different types of challenges in the foreign expansion process, liabilities of foreignness and information searching costs.

Similar to the relationship between the institutional diversity of home region and the scale of internationalization, when the institutional environment within the home region is similar, it is relatively easier for the MNEs to expand beyond the home region due to the encouraging government system for FDI. Therefore, the MNEs in home regions, where the institutional distance between countries is similar, tend to rely more on global markets, since global markets enable economies of scale and scope, lower costs and higher returns on resources. On the contrary, if the institutional distance between countries in the home region is diverse, which means that there is a big difference of institutional background between countries, the institutional environment within this region will be more diverse as well. Because of these perceived obstacles, the MNEs will find it harder to expand globally. Consequently, the MNEs in home regions, where the institutional distance between countries is similar, tend to depend more on domestic markets and rely less on the global markets for returns on resources.This leads to the following hypothesis:

H2: The institutional diversity of the home region is negatively related to the firm’s scope of internationalization.

Technology advantage stands for proprietary knowledge developed by an MNE through R&D and embodied in the firm’s processes and products. It is considered as the most valuable asset MNEs own (Caves, 1996; Dunning, 1980). Kirca, Hult, Roth,

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23 Cavusgil, Perry, Akdeniz, Deligonul, Mena, Pollitte, Hoppner, Miller and White (2011) consider technology advantage as “the most commonly used proxy available in the literature to denote the existence of internationalization advantage, implying that high degrees of R&D intensity indicate the presence of intangible assets that lead to competitive advantage in international markets” (p. 32). In addition, it is a non-location-bound firm specific advantage (FSA) that propagates firms globally (Anand&Delios, 2002; Meyer, Wright &Pruthi, 2009; Nocke&Yeaple, 2007; Rugman&Verbeke, 2008). Rugman and Verbeke (2008) argue that MNEs can penetrate foreign markets only if they can develop non-location-bound FSAs, which are transferrable and deployable in a profitable way in a host country.

Technology offers competitive advantages to a firm to access global markets and overcome the challenges of increasing distance from the home market (Morrison, Ricks & Roth, 1991; Roth & Morrison, 1992). Leaders in technology become trail blazers, since they set new trends for other firms to follow (Arthur, 1996; Nocke&Yeaple, 2007). Additionally, increasing technological advantage accelerates productivity of managerial attention in international expansion at an increasing rate (Bouquet, Morrison &Birkinshaw, 2009; Bouquet &Birkinshaw, 2011). Based on the theories mentioned above, the following hypothesis is formulated:

H3: The technological advantage of the firm positively moderates the relationship hypothesized in H1 and H2.

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4. Research Methods

4.1 Sample and Data Collection

This study is based on the Fortune Global 500 companies, which have been ranked in the Fortune Global 500 2014 list according to their revenues from large to small. Despite the fact that these companies are on the 2014 list, it represents the largest worldwide organizations of 2013. Hence, the analysis of this study is relative to the year 2013. Generally, the world’s largest 500 corporations belong to multinational corporations, which means that they produce and/or distribute products and/or services across national borders (Rugman&Verbeke, 2004). Additionally, these companies within the sample participate in all kinds of industries. The sample of the Fortune Global 500 companies is appropriate for this study, because it offers great insight in the level of globalization, characteristics and performance of regions.

This study uses a cross-sectional dataset to examine the effect of home region characteristics on companies’ globalization process, because it allows the researcher to compare different variables at the same time among different organizations. Another reason to choose this research method is that the time frame the research has is limited. The annual reports of 2013 and Orbis database are used together as primary data sources. In the annual reports of 2013, information such as selling and general administrative expenses, advertising expenses, labor expenses, R&D expenses, domestic sales, international sales, regional sales, global sales and sales in different geographical regions are providedfor the majority of the corporations. Data that is not available in the annual

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25 report was obtained via Orbis database. Orbis is a database provided by Bureau van Dijk, which is one of the most comprehensive and inter-temporal databases containing detailed information regarding public and private companies all over the world (De Jong & Van Houten, 2014). The following information is provided by Orbis: total turnover of 2013, company year founded, major sector, SIC code, number of employees including percentage of employees in the home country and foreign country, national legal form, shareholders funds, non-current liabilities, total shareholders funds and liabilities, gearing, profit of 2013, profit or loss before tax, return on assets (ROA), return on equity (ROE) and detailed information of current shareholders and subsidiaries. A few strengths of this research need to be addressed. First, the Fortune Global 500 companies represent the world’s largest corporations, which appear to be the most relevant regarding internationalization process. Second, most of these 500 companies make the financial information available in their annual reports; thus, the data can be gathered relatively easy.

4.2 Dependent Variable

The firm’s scale of internationalization is the first dependent variable that correlates with the level of the institutional diversity of the home region, as assumed in this study. In order to capture the firm’s scale of internationalization, we rely on the measure of foreign sales divided by total sales (Banalieva&Eddleston, 2011; Delios& Beamish, 2005; Li,

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26 2005; Rugman&Verbeke, 2008), following prior research. The foreign sales and total sales were determined by the information available in the annual reports or other secondary sources of information.

The second dependent variable is the firm’s scope of internationalization. The breath of the internationalization is captured through global sales divided by total sales. The same sources used to determine a firm’s scale of internationalization have been used to determine a firm’s scope of internationalization; the global sales were determined by the information available in the annual reports or other secondary sources of information.

The scale of internationalization measures the degree to which the firm is dependent on foreign sales, whereas the scope of internationalization measures the degree to which the firm is dependent on global sales. Other measures concerning firm’s level of internationalization used in previous research focused on equity affiliates (Kaczmarek&Ruigrok, 2013), assets (Rivas, 2012), employee data (Kim, Hwang, & Burgers, 1989; 1993) and country scope (Tallman & Li, 1996; Tihanyi, Ellstrand, Daily & Dalton, 2000).

4.3 Independent Variables

The independent variable of this study is the institutional diversity of the home region. To measure the institutional diversity, we rely on the Fraser Index of Economic Freedom of the World published by the Fraser Institute. This index consists of several other

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27 sub-indexes: government, legal, economic and regulatory (Gwartney, Lawson, Hall, McMahon, Soysa&Vadlamannati, 2014).

In order to measure institutional diversity of the home region, countries from the Fraser Index have been divided into categories corresponding to their home regions as denoted by the United Nations (UN) geographic based country mappings (Banalieva&Dhanaraj, 2013). Subsequently, the coefficient of variation of the Fraser Index has been computed for the home region of the MNE. To calculate this coefficient of variation, first, the home country of the respective MNE has been excluded from the home region. Consequently, the standard deviation of the distribution is divided by its mean (Banalieva&Dhanaraj, 2013). A higher coefficient of variation can be interpreted as a greater diversity in the institutional environment.

4.4 Moderating Variable

The technological advantage of the firm is captured with the ratio of R&D expenditures to total sales, which is a widely used measure of firm’s innovation input (e.g., Anand&Delios, 2002; Kirca ,Hult, Roth, Cavusgil, Perry, Akdeniz, Deligonul, Mena, Pollitte, Hoppner, Miller & White, 2011; Meyer, Wright &Pruthi, 2009).

4.5 Control Variables

At the firm level, there are three factors that are controlled for. Firm size is the first control variable that is commonly used, due to its influence on firm performance

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28 (Gomez-Meji&Palich, 1997). The size of the firm brings impact on its behavior and response to environmental circumstances. Larger firms tend to involve more frequently in international activity and are better prepared to uncertain situations. Nevertheless, smaller firms can be more flexible and open to change (Tihanyi et al, 2000). Gross annual revenue in millions of US dollar is used to measure the size of the firm. The natural logarithm of the variable is used in this study to explain the skewness in the data. The second control variable is firm age. The number of years since the firm was founded until the year of reference for this study, 2013, is used to measure firm age. The third and final control variable is firm performance. It has been argued that firm internationalization relates to firm performance, since well-performing MNEs have necessary resources to expand internationally (Geringer, Beamish, &daCosta, 1989; Hitt, Hoskisson& Kim,1997; Kim, Hwang & Burgers, 1989). Well-performing MNEs are also more stable and prone to risky decisions. Firm performance is operationalized as ROA at the end of 2013 financial year.

4.6 Data Analysis and Results

The initial sample size of this study consisted of 500 companies. However, only 170 companies provided complete data on each variable required. Hence, the final sample size is 170. The descriptive statistics of the control, independent, dependent and moderating variables are shown in Table 1. The variables were tested on multicollinearity by conducting a bivariate correlation analysis. All variables were retained, since they have values below 0,7 (Pallant, 2011).

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29 The mean values of both the scale and scope of internationalization are 40,83 and 39,82 respectively, which suggest that the MNEs examined are fairly international. Therefore, the sample is suitable for this study. The mean value for the institutional diversity of the home region is 0,09 with a standard deviation of 0,03. Since scores closer to 1 indicate diversity, the institutional difference between countries in a region is not very large. As mentioned before, firm size is described as the natural logarithm of the total turnover of the firm. The average turnover in this sample is 10,78 with a standard deviation of 0,75. This information states that the sample is consistent in terms of a firm’s total turnover. Similar results are found for firm performance. The mean value is 4,94 with a standard deviation of 6,04, which denotes a greatly diverse sample in terms of performance.

For testing the hypothesis, a hierarchical regression analysis was used in order to test the sequential relationships with the explanatory variables. As the dependent variables have continuous values and we assume a linear relationship between the dependent and explanatory variables, the most suitable model is the Ordinary Least Squares (OLS). The regression analysis was performed in two steps. In the first step, the control variables were introduced to observe their effects on the dependent variables. Afterwards, the independent variable and interaction terms were added one at a time to observe their additional explanatory effect. Correspondingly, we run five models in total. In both Table 2 and Table 3, the control variables were used in Model 1. Model 2 and 3 in Table 2 test the hypothesis 1 and 3. Finally, Model 2 and 3 in Table 3 test the hypothesis 2 and 3. The significance indicates whether the results are reliable to support the hypothesis. The Beta

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30 standardized coefficient represents the change in the dependent variable relative to the explanatory variables. The sign of the Beta standardized coefficient defines the direction of the change. In addition, the R-squared indicates how good the model fits and to what extent it explains the variance.

Hypothesis 1 states that the institutional diversity of the home region is related to the scale of internationalization. The coefficient of the institutional diversity is significant (b=-0,271, p=0,000) and negatively related to the scale of internationalization. The R-squared increases from 0,027 in the first model to 0,100 after the independent variable was included in Table 2 Model 2. From this, one can conclude that this model fits the data better. Hypothesis 2 is also supported as significant results are found in Table 3 for the relationship between the institutional diversity and the scope of internationalization (b=-0,245, p=0,005). The institutional diversity of the home region is negatively related to the scope of internationalization. Similar to the result of Model 2 in Table 2, the R-squared improves from 0,037 in the first model to 0,092 after the independent variable was included in Table 3 Model 2, which indicates that this model is a better fit for the data. When testing the moderating factor, the technological advantage, Model 3 in both Table 2 and Table 3 bring support for hypothesis 3. The technological advantage has a significant effect on the scope of internationalization (b=3,420, p=0,018) with a significant term (b=-27,850, p=0,036); it also brings significant effect on the scale of internationalization (b=-0,628, p=0,059) with a significant interaction term (b=11,917, p=0,037).

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31 Variables Mean S.D. 1 2 3 4 5 6 1. Firm Age 59,05 50,15 2. Firm Size 10,78 0,75 -,01 3. Firm Performance 4,94 6,04 -,09 ,19* 4. Institutional Diversity ,09 ,03 -,28** -,01 ,09 5. Scale of Internationalization 40,83 32,91 ,07 ,15 -,03 -,22** 6. Scope of Internationalization 39,82 26,71 ,11 ,12 ,11 -,24** ,40** 7.Technological Advantage 2,86 6,87 ,01 -,06 ,02 ,06 ,06 ,10 Table 1. Descriptive Statistics: means, standard deviation and correlations

*. Correlation is significant at the 0.05 level (2-tailed). **. Correlation is significant at the 0.01 level (2-tailed).

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5. Discussion

This study analyzed the relationship between institutional diversity of home region and international expansion. The results show that home region’s institutional diversity is a strong influencing factor in both scale and scope of internationalization. This confirms the first two hypotheses based on the “process of search and deliberation”. Even though expanding in host countries, that are more proximate and similar to their home country, would help to reduce the search costs of potential partners, institutional diversity would increase the deliberation costs of evaluating these partners, due to a lack of similarities between them. Specifically, significant negative relationships between institutional diversity of home region and the scale and the scope of internationalization have been found. This implies that MNEs are more likely to expand to countries that share similar institutional backgrounds as they do.

Furthermore, the findings show that the relationship between institutional diversity of home region and the scope of internationalization is positively moderated by the technological advantage of firms. The findings partially confirm Hypothesis 3, which is based on the argument that technology offers competitive advantage to a firm to enter foreign markets and helps the firm to overcome the challenges of increasing distance from the home market. This research did not find significant evidence for the moderating effect of technological advance on the relationship between the institutional diversity of home region and the scale of internationalization.

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5.1 Academic Relevance

The present study adds new insights to the existing literature by addressing the gap concerning the institutional diversity of MNE’s home region and internationalization process. Although this is an increasingly important topic to research, there is a lack of research, which combines institutional diversity and internationalization patterns. More specifically, no previous research has integrated both the scale level and the scope level to measure internationalization. Thus, this research has academic relevance, as it is the first study to examine how institutional diversity influences both the scale and the scope of internationalization process.

This research shows that the institutional diversity of home region and internationalization are strongly related. The more diverse the home region’s institutional environment, the less intensions the MNEs have to expand abroad. Most prior researches measure internationalization only on the basis of the scale level, this research also includes the scope of internationalization to provide more insights into the relationship between institutional diversity and internationalization. Most importantly, it shows that the technological advantage is of great influence on the relationship between institutional diversity and the scope of internationalization process. This means that the negative relationship between institutional diversity and the scope of internationalization is stronger when the firm has technological advantages over other firms.

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5.2 Managerial Implications

The present study conveys important managerial implications. First, MNEs that are to pursue an expansion strategy into international markets can assess the institutional diversity of the home region and evaluate MNEs’ readiness of expansion based on the relationship between the institutional diversity and the internationalization process.

Second, MNEs that possess technological advantages can use these advantages to overcome the institutional distance to expand internationally; MNEs that do not possess technological advantages should try to develop technological advantages. Having advanced technology does not only help overcome the institutional distance, but also offers competitive advantages, when expanding globally.

5.3 Limitations and Suggestions for Future Research

There are important limitations that need to be acknowledged. First, a certain number of companies on the list do not have their annual report available for the public and are therefore not included in this research. Mainly the annual reports of Chinese companies are not available. Compared to companies from Western Europe and the United States, it is remarkable that firmsfrom these regions provide extensive information in annual reports. Second, the research does not provide insights on a longitudinal base, since it is only focused on 2013. By analyzing how home region characteristics affect level of multi-nationality of companies over a longer period, it will provide more confirmative explanations. Moreover, this study uses percentage of foreign sales to stand for firm

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37 internationalization. In order to obtain a more comprehensive image of firm internationalization, future studies could combine foreign sales with other variables, for instance, number of foreign affiliates and the level of FDI. Finally, the sample is drawn from the world’s largest 500 companies, because of the fact that these corporations are highly internationalized. However, the findings do not necessarily apply to smaller companies. Therefore, future research needs to expand the study to smaller organizations to find out whether home country indeed matters for the globalization process on a larger scale.

The limitations provide opportunities for future research. First, this study is a cross-sectional study, thus the longitudinal approach is not taken into account. Future research can analyze the proposed relationship over a period of several years to observe whether any changes take place. The purpose of adopting the longitudinal approach is to improve the reliability of the results.

Moreover, technological advantage is the only moderator in this study. Including other moderating factors between institutional diversity and internationalization could provide additional insights into this relationship. These factors can be at company level, industry level or country level. Incorporating multiple factors that influence this relationship could shed more light on this relationship.

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6. Conclusion

The purpose of this study was to contribute to the academic literature by analyzing the relationship between the institutional diversity of home region and the internationalization. Institutional distance significantly influences home country’s international expansion. Expanding in host countries, that are more proximate and similar to their home country, would help to reduce the information-searching costs of potential partners.However, institutional diversity would increasethe deliberation costs of evaluating potential partners, due to a lack of similarities between them. The institutional diversity in this study is on the regional level, as home region effect outperforms the country effect and is therefore more important. Despite the importance of institutional diversity of home region and internationalization process, there is no research, which analyzes the relationship between home-regional level institutional diversity and internationalization patterns. More specifically, no previous research has measured internationalization using both the scale and the scope levels in relation to the institutional diversity.

This study ventured in filling this gap and investigated the relationship between the institutional diversity of home region and the level of multinationality of the MNEs. In order to do this, Fortune Global 500 companies of 2014 have been analyzed. The dataset was constructed by collecting data from the annual reports (2013) of the corresponding companies together with the data obtained from Orbis database.

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39 The hypotheses were tested by OLS hierarchical regression analysis. It was shown that the institutional diversity of home region is a great influential factor of internationalization process. The institutional diversity variable added significant explanatory power to the first model, which only contained control variables. The results confirmed that institutional diversity of home region is negatively related to both the scale and the scope of internationalization. Moreover, it was found that the technological advantage positively moderates the negative relationship between institutional diversity and the scope of internationalization.

This study contributes to academic literature by addressing the identified gap and investigating the relationship between the institutional diversity and the internationalization process. This study provides a new perception to the existing international business literature by showing that institutional distance between countries within a region matters for MNE’s international expansion.

The findings of this study have managerial implications. MNEs that are pursuing an expansion strategy into international markets can use the findings of this research to assess their readiness for expansion. In addition, MNEs should try to develop technological advantages to overcome the institutional distance. Future research could concentrate on other factors that moderate the effect of the institutional diversity on internationalization. Finally, future research could adopt a longitudinal approach to analyze the proposed relationship, in order to improve the reliability of the results.

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7. Acknowledgement

I gratefully acknowledge the supervision, valuable comments and feedback provided by my thesis supervisor Dr. NiccolòPisani, Assistant Professor of International Management at the Faculty of Economics and Business, University of Amsterdam.

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The home region in the age of globalization : understanding how institutional diversity within region affects MNE’s international expansion