The Effect of Home Country Environment Factors on
Firms’ OLI Advantages in Outward CBM&A
Master Thesis
2014 – 2015
Dual Award in Advanced International Business and Management (Faculty of Economics and Business, University of Groningen) Dual Award in Advanced International Business Management and Marketing
(Newcastle University Business School)
Hongbin Yuan
Student Number: S2450747 (RUG) B4017418 (NUB)
Word Count: 10260 Submission Date: 27th February 2015 Supervisors
Abstract:
This dissertation examines the effect of home country environment factors on outward CBM&A through discussing how firms’ OLI (Ownership, Location, and Internalization) advantages will be affected. According to Dunning’s IDP (Investment Development Path) theory, home country environment forms the foundations of domestic firms’ OLI advantages. Each of these three advantages will be indicated by some of the selected home country-specific factors, which are expected to have the effect to increase firms’ propensities of engaging in outward CBM&A. This dissertation uses the outward CBM&A transactions of 32 OECD countries1 across 24 years as sample points, and studies the effect of home country environment by adopting home country-specific factors as indicators, and discusses its effect on outward CBM&A. The data in period 1990 – 2013 is adopted and panel analysis is applied for analysing the relation between variables. The result indicates that technology, GDP per capita, and inflation rates have positive and significant effect of increasing firms’ propensity of engaging in outward CBM&A. While the expected effects of other factors (human capita, exchange rates, and interest rates) are not confirmed. Based on the current results, the research provides important implications of how to cope with the external environment of the country in which it operates to maintain OLI advantages and keep competitive in CBM&A.
Keywords: IDP, outward CBM&A, OLI advantages, home country environment
factors, macroeconomic factors
Acknowledgement:
Content
1. Introduction ... 1
2. Lite rature Review and Hypotheses ... 2
2.1 Research Gap ... 2
2.2 Theoretical Basis: OLI Advantages in IDP Theory ... 3
2.3 How Home Country Environment Affects Outward CBM&A Decisions... 5
2.4 Home Country Environment Factors and OLI Advantages ... 6
2.4.1 Conceptual Model and Theoretical Lens ... 7
2.4.2 Factors of Ownership Advantages ... 9
1. Technology ... 9
2. Human Capital ... 10
2.4.3 Factors of Location Advantages ... 11
1. GDP Per Capita ... 11
2. Inflation Rates ... 12
2.4.4 Factors of Internalization Advantages ... 13
1. Exchange Rates ... 13
2. Interest Rates... 14
3. Methodology ... 15
3.1 Sample Selection ... 15
3.2 Variables and Data Sources... 16
3.2.1 Dependent Variables... 16
3.2.2 Independent Variables ... 16
3.3 Data Process ... 19
3.3.1 Panel Data Analysis ... 19
3.3.2 Model Specification ... 20
3.3.3 Stationarity Test ... 21
3.3.4 Model Selection Based on Hausman Test ... 22
3.3.5 Fixed Effects Model ... 23
3.4 Results... 25
3.4.1 Factors of Ownership Advantages ... 25
1. Technology ... 25
2. Human Capital ... 26
1. GDP Per Capita ... 26
2. Inflation Rates ... 27
3.4.3 Factors of Internalization Advantages ... 27
1. Introduction
In terms of cross-border investments, Dunning’s IDP (Investment Development Path) theory indicates that home country environment grants firms the abilities and affects firms’ propensities to invest abroad. When making a strategic decision before investing abroad, it is vital to understand the environment, and make adjustments to assets portfolio accordingly. As each World Investment Reports2 indicated, countries with largest volumes of FDI on the ranking list always are the ones with best macroeconomic performances. It’s not simply a coincidence. Instead, a country’s macroeconomic performance certainly has influence on its FDI outflows, because, according to Dunning’s IDP theory, home country environment sets the foundation up for domestic firms’ OLI (Ownership, Location, and Internalization) advantages. Firms’ advantages are especially important to overcome the liability of foreignness and increase the competitiveness in CBM&A transactions. Therefore, it is necessary to take an insight into the effect of home country environment on firms’ OLI advantages.
This dissertation uses the outward CBM&A transactions of 32 OECD countries across 24 years as sample points, and studies the effect of home country environment by adopting home country-specific factors as indicators, and discusses its effect on outward CBM&A. The research question is: how do home country environment factors affect firms’ OLI advantages in outward CBM&A? Therefore, the real explanatory power of each home country environment factor under each OLI advantage needs to be tested. I will perform the test by panel data analysis. Many studies have focused on the role of host country in stimulating the FDI transactions, but only a few studies made their efforts to explain the relations between home country environment factors and the number of outward CBM&A (Boateng et al. 2013). Moreover, current studies on this issue are more about which home country environment factors may affect the outward CBM&A of firms in a particular country. This dissertation discusses home country environment factors concerning outward CBM&A based on firms’ OLI advantages theory proposed by Dunning. Most
importantly, by using the method of analyzing panel data, this dissertation reveals the relations between firms’ propensity of engaging in CBM&A and each environment factor.
The dissertation is meant for providing implications for firms about how to respond to the external environment of the country in which they operates, and helps investors to understand the effect of environment to improve their portfolio to be in tune with the home country’s environment and build up their firms’ competitive advantages in investing abroad by making strategic decisions. The remainder of the dissertation is structured as follows. Next section will introduce research gap, theoretical basis, the relation between home country environment and outward CBM&A, conceptual model, and key home country environment factors in the form of literature review. Based on the knowledge of literature review, I will propose 6 hypotheses about each factor following the literature review. The research method and the results will be given in the third section. Following the results, the discussion is presented to provide better understanding of this study. Finally, the dissertation ends with the conclusion and limitation of this research.
2. Literature Review and Hypotheses
2.1 Research GapThe research gap that this dissertation would like to cover is the discussion about home country environment factors that affect domestic firms’ OLI advantages and increase firms’ propensities to engage in CBM&A regardless the differences between countries. The real explanatory power of each home country factor is revealed.
rates, technology, and human resources, favor domestic CBM&A activities between the US and European countries. In the study of the relation between home country environment and the value of FDI outward flows, Kyrkilis & Pantelidis (2003) discovered that country specific characteristics, such as income, exchange rates, technology, and human capital, have varying explanatory abilities in the case of European countries and non-EU countries. However, all the earlier studies above either merely focused on the outward CBM&A of one country, or only discussed the matter by analyzing the CBM&A between the selected and known countries, or specifically tried to explain how country environment factors affect the value of FDI outward flows.
I intend to increase the number of research units from one country to a group of OECD countries, and use the outward CBM&A transactions of 32 OECD countries across 24 years as sample points. I also d iscuss the outward CBM&A of the selected countries without the restriction of focusing on the CBM&A transactions between the selected countries only. The home country factors in each selected country will not be directly compared with the same home country factors in other countries. Instead, I will integrate the data of key factors of all the sample points for panel analysis, and review the effect of the home country factors via cross-sections. Therefore, the interferences of the home country throughout the selected period will be eliminated, and the real explanatory power of each factor across those countries will be observed.
2.2 Theoretical Basis: OLI Advantages in IDP Theory
advantages that a firm overcomes liability of foreignness by using the current resources; location advantages refer to the advantages generated from location in which a firm operates; internalization advantages refer to the advantages that a firm trades off the savings in transactions or controlling costs of a wholly-owned subsidiary.
According to the IDP theory, there are five stages of investment development for each country. In Stage 1, inward and outward investments are barely existent due to small domestic markets, inadequate infrastructure, poorly educated work force, and undeveloped institutional frameworks (Buckley & Castro 1998). In Stage 2, outward investment remains low, because domestic firms lack ownership advantages. In Stage 3, the growth rate of outward investment surpasses that of inward investment, as domestic firms become stronger in ownership advantages and more competitive in domestic market, and explore foreign countries under the resource-seeking and asset-seeking motives. In Stage 4, NOI (net outward investment, defined as: gross outward direct investment minus gross inward direct investment) breaks through 0 level and grows positively (Gorynia et al. 2007). In this stage, the location advantages utterly rely on the created assets that are currently available. The ownership advantages that are created by managing and coordinating geographically assets become more critical than the ownership advantages that are derived from country-specific characteristics (Buckley & Castro 1998). In Stage 5, NOI tends to fluctuate around 0. This is actually what is happening currently, especially when countries are in the transition from Stage 4 to Stage 5.
for a wide range of theoretical and empirical studies (Narula & Guimón 2010). These advantages are the fundamental driving forces, which are derived from environment, for firms’ investment activities and development.
2.3 How Home Country Environment Affects Outward CBM&A Decisions
A firm engages in outward CBM&A as a result of the firm’s growing capability of acquiring and utilizing internally income yielding assets that generate value or profit, and these assets are both country-specific natural and created endowments, on which the firm relies to produce efficiently and supply its market both home and abroad and change the firm’s ability to serve and the propensity to invest abroad over time (Kyrkilis & Pantelidis 2003). In the study of outward foreign direct investment of IDP theory, the mixed OLI advantages of a country’s firms vary with the development of the country’s economy (Dunning & Lundan 1993). Due to the differentiated policies and idiosyncratic development courses, each country’s endowments differ from those of others. Therefore, a firm’s CBM&A activities are affected by its environment on the country level. However, the dissertation is not here to compare the OLI advantages derived from the differentiated environment. There might be home environment factors exerting common effect on firms’ OLI advantages regardless that firms are based in different countries. The purpose of this dissertation is therefore to find out the effect of these factors by revealing their explanatory power in explaining the variations of outward CBM&A, and understand it within the framework of OLI advantages.
relation between home country environment and firms as that home country environment grants firms the abilities and affects firms’ propensity to invest abroad. However, firms’ propensity to engage in CBM&A not only depends on the effect of home country environment, but also depends on firms’ internal conditions, such as the capability of management and financial conditions.
Second, country effects are not able to perfectly predict the behavior of individual firms. The effect of an environment factor doesn’t necessarily and equally work on the individual firms, and the abundance of an environment factor doesn’t necessarily equal to that an individual firm is abundant in the factor. It is not realistic to expect all the firms have the same capability and capacity to benefit from the effect of the same home country environment factor to the same degree. This study focus on the relation between home country effects and firms’ collective behavior of making CBM&A decisions in a statistical sense, and provides individual firms with implications of the pattern of collective behavior. In this way, the importance of home country environment factors to individual firms can be oberved and explained. This clarification is important for understanding the following discussions.
2.4 Home Country Environment Factors and OLI Advantages
inflation rates, technology, and human capital (Kyrkilis & Pantelidis 2003; Tolentino 2010; Wei & Alon 2010).
Of course, there are other relevant factors from earlier studies. Such as stock prices (Erel et al. 2011), political support from domestic government (Holtbrügge & Kreppel 2012), pre-acquisition performance of a company (Changqi & Ningling 2010), state owned shares (Changqi & Ningling 2010), etc., are expected to positively related to the propensity of engaging in outward CBM&A. However, these factors will not be included in my discussion. The most important reason is that most of these factors work in a way on firm level. For example, stock prices, pre-acquisition performance of a company, and state owned shares are very firm specific not exactly the indicators of home country environment. Besides, factors like political support or culture differences require a separate discussion, because these factors can hardly be quantified in time series, and thus require a distinct research model, which is beyond this dissertation. Because Euro zone countries are included in my sample countries, and the data of the amount of broad money supply of each Euro zone country is not statically published, broad money supply will not be included in my study.
Based on the reason mentioned in last paragraph, in Ann McDonagh Bengtsson’s proposal, and in the earlier studies, I particularly focus on studying external environment – home country environment, and choose technology, human capital, GDP, inflation rates, exchange rates, and interest rates as indicators, which are expected to contribute to the effect on firm’s decisions of engaging in outward CBM&A by affecting the advantages of OLI of firms. To be specific, among all the factors, technology and human capital affect ownership advantages most, because these two factors can be owned and controlled by firms; GDP and inflation rates contribute to the location advantages most, because these factors affect the foundation of a country in which a firm operates; exchange rates and interest rates influence internalization advantages most, in that they influence the value of assets and the costs in CBM&A transactions.
After the home country environment factors are decided, and based on OLI advantages, the conceptual model is constructed as follow.
(Chart 1: Conceptual Model)
Chart 1 illustrates the logic relations between home country environment factors
and firms’ OLI advantages in CBM&A. Due to different attributes of different factors in CBM&A, and in order to explain how each factor is related to firms’ propensity to engage in CBM&A, different theoretical lenses are applied.
TCE, transaction costs include the costs other than money price that occur in a transaction. Both factors are closely related to the costs in the CBM&A transaction. Besides, in order to be more convincing, COP is also applied to discuss exchange rates. The detailed effect of each factor and hypothesis will be given in the following section.
2.4.2 Factors of Ownership Advantages
1. Technology
Technology, as a form of intangible firm resource, is a key element to maintain a firm’s competitive advantages, and plays a crucial role in spurring outward FDI. It is a vital ownership competitive advantage for a firm to have the ability to organize and undertake the production of technological inputs; the ability of firms varies across countries, since each country differs in the availability of necessary inputs and skills for the technology production, market structure, legal and patent systems, education, the ability of R&D, etc. (Kyrkilis & Pantelidis 2003). Also, in order to competing with rival players, CBM&A is a quick and easy measure to react to competitors and access to needed technology (Kang & Johansson 2000). Hence, other than obtaining the benefit from economy of scale, firms nowadays engaging in CBM&A are also aiming for the acquisitions for superior or complementary technology. It has been theoretically supported that outward FDI can be affected by the technolo gical achievements of a country, because a country’s technological efforts and absorptive capacity influence technology efforts and absorptive capacity (Das 2013). With more available technology within a country, firms in the country are more likely to be able to catch up with and assimilate advanced or complementary technology.
From the perspective of RBV, firms are encouraged to engage in CBM& A by the motivation of seeking for complementary technology to be competitive. In the research of outward FDI, Kyrkilis & Pantelidis (2003) found that firms in need of technological intermediate product tend to internalize it via FDI. As concluded in
Section 2.2 (Theoretical Basis), when countries are in the transition from Stage 4 to
coordinated assets than relying on country-specific characteristics. It’s understandable because when countries are relatively abundant in the possession of technology, and with abundant available technology, firms in these countries are able to generate technological inputs, and in need of larger capacity. They are more inclined to geographically integrate complementary technology to secure the supply of their intermediate product for lower costs or higher efficiency, and becoming more competitive. Moreover, Ann McDonagh Bengtsson’s (1992) proposal of CBM&A explained well about this. She suggested that factors contributing to gaining back-up products will motivate firms to engage in CBM&A. In this case, technology is the factor that motivates firms.
Therefore, given more technology available in a country, domestic firms will more likely to benefit from the abundance of technology to have greater ability to generate technological inputs and larger capacity, and are more inclined to geographically integrate complementary technology to sustain back- up products by CBM&A.
Hypothesis 1: Technology in home country is positively related to outward CBM&A of domestic firms.
2. Human Capital
In addition to technology, human capital is another powerful firm resource to build up ownership advantage, granting possessing firms the ability to acquire competitive advantages of another type (Kyrkilis & Pantelidis 2003). Human capital is defined as the education, skills, abilities and knowledge of an individual.
Based on the RBV (resource based view), the quality of the workforce is vital in providing a competitive advantage over competitors (McDonnell 2008). But why does human capital increase firms’ propensity to engage in CBM&A as an ownership advantage?
France), he suggested that a key force behind these transactions is human resource. He reasoned that when firms fall behind in the level of human capital, it’s difficult for firms to compete efficiently in an industry.
Second, competent human capital is imperative for foreign operations. In fact, there are empirical studies based on the research of a few countries showing that human capital intensity is significantly and positively associated with MNEs’ activities (Tolentino 2008). According to the research of determinants of a country's international business activities, FDI was found more likely to happen in skill-intensive sectors (Jeremy Clegg 1988).
Human capital is, ergo, a driving force of outward cross-border investments. I develop a hypothesis as follows:
Hypothesis 2: Human capital in home country is positively related to outward CBM&A of domestic firms.
2.4.3 Factors of Location Advantages
1. GDP Per Capita
GDP per capita is often used to represent the level of economic development (Hyung-Suk Byun et al. 2012). It’s a key factor affecting location advantages. GDP affects the supply of as well as the demand for outward investment, and economic expansion in home countries boosts earnings and equity prices and hence the pool of capital available for investment abroad (Kang & Johansson 2000).
There are some other studies showing that GDP positively affects outward investment, and higher GDP per capita results in higher FDI (Vasconcellos & Kish 1996; Das 2013; Boateng et al. 2013). The possible explanation is that higher GDP enables firms to keep more cash at their disposal, which encourages them to merge or acquire firms abroad (Boateng et al. 2013). In light of the discussions above, it is hypothesized that:
Hypothesis 3: The GDP per capita of home country is positively related to outward CBM&A of domestic firms.
2. Inflation Rates
Inflations rates are often used to indicate the health status of an economy (Schneider & S. Frey 1985), therefore it’s closely related to the location advantages provided by an economy. When explaining the effect of external environment on firms’ FDI pattern, Hyung-Suk Byun et al. (2012) discovered that inflation rates disturb macroeconomic stability and political stability, and therefore exert strong effect on CBM&A.
ROI and COC explain the relation between inflation rates and CBM&A well. Inflation rates affect the return on investment as well as the costs of capital and thereby affect a firm’s acquisition decision (Boateng et al. 2013). When a firm’s return on its capital exceeds the costs of capital, the firm tends to acquire more assets in form of capital investments or acquiring other firms (Gugler et al. 2012). Home country’s high inflation rates discourage domestic acquisitions, in that the ratio of return on capital to the costs of capital is negatively affected, and the firm will choose investing abroad instead, where the low inflation rate s raise the ratio and increase the volume of acquisition activities (Boateng et al. 2013).
rates by shifting the production location between home and foreign countries. Based on the discussions above, I formulate a hypothesis as follow:
Hypothesis 4: The inflation rates in home country are positively related to outward CBM&A of domestic firms.
2.4.4 Factors of Internalization Advantages
1. Exchange Rates
For the M&A between two firms from two countries using different currencies, exchange rates become the key factors that inevitably have direct influence. Even in the case of Euro area countries, the real effective exchange rates of each country are different from those of other countries due to different levels of CPI in these countries. Exchange rate is closely related to internalization advantages, because it directly affects the CBM&A transaction costs.
From the view of TCE, exchange rates affect the relative price of the domestic firm’s assets compared to the price of the target firm in CBM&A transaction. By studying firm-specific assets and the link between exchange rates and FDI, Bruce A. Blonigen (1997) concluded that the movements of exchange rates affect M&A, because M&A involves firm-specific assets that generate returns in currencies other than the one used for purchasing. When the exchange rates are favorable, it’s cheaper to engage in CBM&A, and the costs of CBM&A will be lower.
The view of COP (costs of production) also helps to explain: the exchange rates move with the changes in the relative production costs across countries, without offsetting the increase in the wages and the COP accompanied in the target market for investment capital; the exchange rates can’t be anticipated (Goldberg & President 2005). When a domestic currency appreciates, the wages and the COP become relative higher than those in foreign countries (Klein & Rosengren 1996). Therefore, a real depreciation of the domestic country results in more acquisitions to the country (Bruce A. Blonigen 1997).
acquisitions or mergers. There are two kinds of theoretical arguments of volatility: production flexibility and risk aversion. In the production flexibility theories, the extent to which exchange rates’ variability influences foreign investment depends on the extent of investment irreversibility, the competitive structure of the industry, and the convexity of the profit function in prices; in the risk aversion arguments, outward FDI reduces with the expected investment value declines due to the high volatile exchange rates (Goldberg & President 2005; Takagi & Shi 2011; Jin 2013; Boateng et al. 2013).
In this dissertation, exchange rates are the real relative prices of a currency to US dollar. Therefore, a rise of exchange rates indicates the appreciation of a currency, resulting more outward CBM&A transactions. According to the discussions above, the following hypothesis is developed:
Hypothesis 5: The movements of real effective exchanges are positively related to outward CBM&A of domestic firms.
2. Interest Rates
Interest rate is considered to be a factor affecting internalization advantages, because it’s an indicator of the financial cost, which is one of the most important transaction costs to be concerned in CBM&A. The role of interest rates in the home country in stimulating cross-border investment has been recognized both financially and internationally (Boateng et al. 2013). Ahmed Gad Kamaly (2007) studied the M&A flows from G7 countries to developing countries, and discovered that interest rates play a critical role as external determinants for M&A.
synergy and increases the likelihood of acquisitions (Uddin & Boateng 2011). Capital opportunity costs explain the effect of interest rates from another perspective. The level of interest rates indicates the capital abundance or scarcity of a country, and low interest rates associated with a home country’s capital abundance reduce the opportunity costs of capital and enhance the profitability of investment abroad (Tolentino 2010). Given the lower interest rates, the ability and propensity of a firm to engage in CBM&A are enhanced (Pablo 2009).
Therefore, I hypothesize the relation between interest rates in home country and outward CBM&A:
Hypothesis 6: The interest rates in home country are negatively related to outward M&A of home country.
3. Methodology
3.1 Sample SelectionAccording to IDP theory, home country environment affects the outward CBM&A by changing the advantages of OLI firms through dynamic home country conditions. Therefore, the research units of this dissertation are countries. In order to make the results more convincible, I study the factors that will affect the outward CBM&A by analyzing 32 OECD countries (see the table below).
(Table 1: 32 Countries in The OECD)
I choose the OECD countries out of the following reasons: first, OECD is a group formed by a cluster of countries that are relatively developed, and generates at
least more than 80% of global M&A deals, providing considerable recorded information for research; second, many OECD countries have been leading the volume of both inflows and outflows of FDI according to previous annual World Investment Reports, and it is wise to study the pattern of effect of home country environment by choosing these samples, which have considerable and reliable data.
3.2 Variables and Data Sources 3.2.1 Dependent Variables
Although several existent studies have exerted their efforts on explaining the possible effect of home country has on outward FDI, most work quite often focused on the value of outward FDI. The existent studies ignore the necessity of measuring the effect of home country environment factors on firms’ propensity to engage in outward CBM&A. Due to the limited availability of data and the intention to study firms’ propensity, I adopt the number of CBM&A transactions as an indicator of the propensity of engaging in outward CBM&A.
I use the outward CBM&A data of 32 OECD countries from 1990 – 2013 published by UNCTAD (United Nations Conference on Trade and Development). The data is available on it’s website under the section named World Investment Report 2014: Annex Tables. The data presents 148,544 outward CBM&A transactions by region/economy of purchaser from 1990 – 2013. According to the description of UNCTAD, the CBM&A deals have the following characteristics:
1. All the mergers and acquisitions must be outward cross-board transactions. 2. All the CBM&A transactions must be completed. Any rumor or claim about
having a transaction will not be included.
3.2.2 Independent Variables
2013) of each independent data of each country will be collected for analysis. Each variable is described below, and the data source is presented in Table 2.
Indicator Source Citation
Technology OECD (2015), Triadic patent families (indicator). doi: 10.1787/6a8d10f4-en Human Capital OECD (2015), Researchers (indicator). doi: 10.1787/20ddfb0f-en
GDP per capita OECD (2015), Gross domestic product (GDP) (indicator). doi: 10.1787/dc2f7aec-en Inflation Rates OECD (2015), Inflation (CPI) (indicator). doi: 10.1787/eee82e6e-en
Exchange Rates OECD (2015), Exchange rates (indicator). doi: 10.1787/037ed317-en
Interest Rates OECD (2015), Long-term interest rates (indicator). doi: 10.1787/662d712c-en (Table 2: Data Sources of Indicators)
Variables of Ownership Advantages:
Technology: This indicator will be approximated by the number of Triadic patent
families issued in each country. A triadic patent family is defined as a set of patents registered in various countries (i.e. patent offices) to protect the same invention. The number of patents in a country approximates the ability of firms in the country to generate technological inputs (Kyrkilis & Pantelidis 2003).
Human capital: As Kyrkilis & Pantelidis (2003) suggested, the preferred
the management of the projects concerned. This proxy directly indicates the capability of R&D and management of firms in each country.
Variables of Location Advantages:
GDP per capita: GDP will be measured in the form of real GDP per capita of
each country. According to Dunning’s IDP theory, GDP per capita indicates the real level of economic development, and is an important determinant of outward FDI (He & Lyles 2008). In order to eliminate the influence of inflation and minimize the unexpected interferences, the raw GDP per capita data is adjusted into real GDP per capita based on the 2010 price index (index 2010 = 100).
Inflation rates: I adopt CPI inflation rates (index 2010 = 100) from the OECD
Database.
Variables of Internalization Advantages:
Exchange rates: In order to measure the effect of exchange rates on FDI, real
effective exchange rate is most often used in various researches (Kyrkilis & Pantelidis 2003; Tolentino 2010). Before applying the data into the formula for testing, I transformed the representative exchange rates into real effective exchange rates based on the 2010 price index (index 2010 = 100). Therefore, the effect of inflation on exchange rates is eliminated. As a consequence, even in each of Euro zone countries, the real effective exchange rates are discriminated due to the different inflation rates of each country.
Interest rates: I acquire the long-term interest rates of each country as the data
to make all the data positive. It’s a common method in statistics, because the adjusted data indicates the real interest of each 1 unit of money or investment.
3.3 Data Process
3.3.1 Panel Data Analysis
Panel data is also known as longitudinal data, which tests a given group of samples over a certain period, and observes the characteristics of the samples at one time point as well as the characteristics of the samples over the whole period.
This method is frequently used to in earlier studies for researching the relation between multiple variables in multiple countries for a certain period. For example, when studying the effect of macroeconomic determinants (such as economy’s size, openness, governance, and human development index) on the choices between CBM&A and greenfield investments, Neto et al. (2008) used the panel data of 53 countries for the period of 1996 – 2006. Another example is that when empirically assessing the effect of various host country-specific factors that influence inflows of FDI to emerging countries, Hyung-Suk Byun et al. (2012) employed the panel data set consisting of 40 emerging countries over a period from 1990 – 2009.
Why is panel data analysis applied in this dissertation? The fact that I have to use several sets of multiple variables offers me multiple choices of models. I searched many kinds of methods to test the data with the purpose of properly verifying my assumptions in this dissertation. I finally decided to use panel data analysis for 2 reasons:
Second, by mixing time series data and cross-section data, panel data analysis provides more valuable analysis. It increases the variability and decreases colinearity between variables, and improves the DOF (degree of freedom) and validity. Panel data analysis is suitable for studying the dynamic process over a period, because it repeatedly tests the cross-section data.
Third, considering the limited data and the purpose to design one model for all the samples, I have to adopt annual data. Only annual data of all the variables is available, and monthly data is only available for some of the variables. By adopting annual data, the time period is shortened. Therefore, the accuracy of other methods, such as SEQ model and VAR model, can‘t be secured.
Nevertheless, panel data analysis has its limitations. Because panel data analysis is constructed by two dimensional data (time series and cross-section data), if the model is not designed correctly or the data collected is flawed, there will be severe discrepancy between the estimated result and the reality. Besides, a classic panel data analysis requires that the number of cross-sections must be more than the number of time series. Therefore, I include 32 cross-sections (32 countries) and 24 time series (a period of 24 years) in this dissertation. The data is tested by the statistical software: EViews 8.
3.3.2 Model Specification
Before processing the data in the panel data analysis, I transformed all the variables into logarithmic form, so that the data will be more stable, and the heteroscedasticity and colinearity of the model can be weakened. Each variable is listed as follows:
lnM&A Natural logarithm of the number of outward CBM&A from each country
lnTEC Natural logarithm of the number of patents issued in the home country
lnHUM Natural logarithm of the number of researchers per 1000 employees
lnGDP Natural logarithm of real GDP per capita
lnIFR Natural logarithm of consumer price index
lnREER Natural logarithm of the real effective exchange rates
Considering the possible effect of previous CBM&A activity itself on the firms’ propensity of engaging in CBM&A, I add 𝑀&𝐴𝑖𝑡−1 in the model as a control variable. Therefore, the model is designed as follow:
𝑙𝑛 𝑀&𝐴𝑖𝑡= 𝑐 + 𝛼𝑖+ 𝛽1𝑙𝑛 𝑇𝐸𝐶𝑖𝑡+ 𝛽2𝑙𝑛 𝐻𝑈𝑀𝑖𝑡+ 𝛽3𝑙𝑛 𝐺𝐷𝑃𝑖𝑡+ 𝛽4𝑙𝑛 𝐼𝐹𝑅𝑖𝑡 + 𝛽5𝑙𝑛 𝑅𝐸𝐸𝑅𝑖𝑡+ 𝛽6𝑙𝑛 𝐼𝑁𝑇𝑖𝑡+ 𝛽7𝑙𝑛𝑀&𝐴𝑖𝑡−1+ 𝑒𝑖𝑡
where:
c = the common mean for all the sample countries 𝛼𝑖 = the country-specific effects
𝑀&𝐴𝑖𝑡 = the number of CBM&A in country i in year t 𝑀&𝐴𝑖𝑡−1 = the number of CBM&A in country i in year t-1 𝑇𝐸𝐶𝑖𝑡 = the number of patents in country i in year t
𝐻𝑈𝑀𝑖𝑡 = the number of researchers per 1000 employees in country i in year t 𝐺𝐷𝑃𝑖𝑡 = real GDP per capita in country i in year t
𝐼𝐹𝑅𝑖𝑡 = inflation rate in country i in year t
𝑅𝐸𝐸𝑅𝑖𝑡 = real effective exchange rate in country i in year t 𝐼𝑁𝑇𝑖𝑡 = real long-term interest rates in country i in year t 𝑒𝑖𝑡 = error term
3.3.3 Stationarity Test
The first step of applying panel data analysis is to do Stationarity Test (Unit Root Test). This step is essential to make sure that the empirical result is correct and meaningful. Some non-stationary time series always show the similar variation trend, even though the time series themselves are not certainly directly related. When using a regression with these time series data, although the result shows a relatively high R-squared value, the result is actually meaningless. Situation like this is defined as Spurious Regression. In order to avoid Spurious Regression and make sure the validity of the test results, Stationarity Test is important to review whether the data is stationary or not.
Pool unit root test: Summary Variable
Null: Unit root (assumes common unit root process) Statistic Prob.** of Levin, Lin & Chu t* MA -3.61826 0.0001 TEC -1.99785 0.0229 HUM -14.3883 0.0000 GDP -3.68612 0.0001 IFR -14.9075 0.0000 REER -4.31474 0.0000 ITR -10.1927 0.0000
** Probabilities for Fisher tests are computed using an asymptotic Chi-square distribution. All other tests assume asymptotic normality.
(Table 4: Summary of Stationarity Test)
3.3.4 Model Selection Based on Hausman Test
Following the Stationarity Test, I will have to select a proper model to process the panel data. There are two kinds of models in panel data analysis: random effects model and fixed effects model, but which model is more suitable depends on the result of Hausman Test. In Hausman Test, the null assumption is that the random effect model is correct. If the value of probability in the test result is bigger than 0.05, then the Hausman Test is considered to accept the null hypothesis. Therefore, doing Hausman Test is another important step to take before a proper model is decided to analyze the data.
Correlated Random Effects – Hausman Test Test cross-section random effects
Test Summary Chi-Sq. Statistic Chi-Sq. d.f. Prob. Cross-section random 107.916234 7 0.0000
The result of Hausman Test is shown above. The value of probability in the test is 0.0000. Clearly, the null assumption that the random effect model is correct is rejected. Therefore, the proper model to analyze the data should be fixed effects model.
3.3.5 Fixed Effects Model
According to Hausman Test, the data has to be tested by fixed effects model. If there are omitted variables, which maybe correlated with the variables in the model, a fixed effects model can provide a means for controlling for omitted variable bias (Allison 2009).
The test result is shown in the following tables below:
Variables Coefficient Std. Error t-Statistic Prob. C -1.711210 0.506930 -3.375633 0.0008 TEC 0.162215 0.069717 2.326761 0.0204 HUM -0.213799 0.126557 -1.689342 0.0918 GDP 0.692569 0.156154 4.435157 0.0000 IFR 0.440851 0.156498 2.816983 0.0051 REER 0.012691 0.200099 0.063423 0.9495 ITR 0.501292 0.546989 0.916458 0.3599 M&A(-1) 0.456483 0.039427 11.57758 0.0000
(Table 6: Result of Fixed Effects Model)
Weighted Statistics
R-squared 0.931638 Mean dependent var 1.971407 Adjusted R-squared 0.930654 S.D. dependent var 0.686560 S.E. of regression 0.180797 Sum squared resid 15.88611 F-statistic 946.1759 Durbin-Watson stat 2.453637 Prob(F-statistic) 0.000000
Therefore the estimated equation between CBM&A and home country environment variables will be presented below:
𝑙𝑛 𝑀&𝐴𝑖𝑡 = −1.7112 + 𝛼𝑖 + 0.1622 𝑙𝑛 𝑇𝐸𝐶𝑖𝑡− 0.2138𝑙𝑛𝐻𝑈𝑀𝑖𝑡 (-3.3756) (2.3268) (-1.6893) +0.6926 𝑙𝑛 𝐺𝐷𝑃𝑖𝑡+ 0.4409 𝑙𝑛 𝐼𝐹𝑅𝑖𝑡+ 0.0127 𝑙𝑛 𝑅𝐸𝐸𝑅𝑖𝑡+ 0.5013 𝑙𝑛 𝐼𝑁𝑇𝑖𝑡 (4.4352) (2.8170) (0.0634) (0.9165) + 0.4565𝑙𝑛 𝑀&𝐴𝑖𝑡−1 + 𝑒𝑖𝑡 (11.5776)
Country-specific Effects: 𝛼𝑖 is shown in the table below:
Australia 0.107032 France 0.197779 Italy -0.069240 Portugal -0.003348 Austria -0.123189 Germany 0.119750 Japan -0.055781 Slovak
Republic -0.322538 Belgium -0.059880 Greece -0.078678 Luxembourg -0.210279 Spain 0.079268
Czech Republic
-0.225399 Hungary -0.297603 Netherlands 0.071357 Sweden 0.114701
Canada 0.266488 Iceland -0.236472 New Zealand
-0.145273 Switzerland -0.015764
Denmark -0.033200 Ireland 0.011274 Norway -0.036970 UK 0.346405
Finland 0.015879 Israel -0.034870 Poland -0.057861 US 0.272563
(Table 8: Country-specific Effects)
where:
𝑀&𝐴𝑖𝑡 = the number of CBM&A in country i in year t 𝑀&𝐴𝑖𝑡−1 = the number of CBM&A in country i in year t-1 𝑇𝐸𝐶𝑖𝑡 = the number of patents in country i in year t
𝐻𝑈𝑀𝑖𝑡 = the number of researchers per 1000 employees in country i in year t 𝐺𝐷𝑃𝑖𝑡 = real GDP per capita in country i in year t
𝐼𝐹𝑅𝑖𝑡 = inflation rate in country i in year t
3.4 Results
According to the test result, both R-squared and adjusted R-squared are around 0.93, and the value of F-statistics is 0.0000. As we all know, R-squared indicates the Goodness of Fit of the model, and it varies between 0 and 1. The closer R-squared is to 1, the better the Good of Fit of the model is. In my case, the accountability of the designed model is around 93%, which means a strong explanatory power of the model to explain the reality. The value of F-statistics indicates whether the model is efficient. When the value of F-statistics is below 0.05, the model is considered to be sufficient. Therefore the model can sufficiently explain the relation between CBM&A and home country environment factors. The DW (Durbin-Watson) value is used to indicate the serial correlation. When it’s bigger than 2, the data is safe in the sense of serial correlation. According to the result shown above, the DW value is 2.45, which means the series data is free of the serial correlation issue.
In sense of statistics, the result of the model shows convincible evidence of the relations between CBM&A and home country environment factors.
3.4.1 Factors of Ownership Advantages
1. Technology
The empirical result in this dissertation shows that the effect of technology on CBM&A is significant and positive. As is shown in the table above, the value of t-Statistic is 2.3268. Statistically, the value of t-Statistic is used to evaluate the significance of the variable. When the absolute value of t-Statistic is bigger than2, the variable is considered to be significantly related to the depend variable.
geographically integrate complementary technology to secure the s upply of their intermediate product for lower costs or higher efficiency. Integrating complementary technology and back-up products has become an important way to maintain firms’ competitiveness.
2. Human Capital
The relation between human capital and outward CBM&A is negative but insignificant. Therefore, the hypothesis that human capital is positively related to CBM&A is unconfirmed.
The possible reason for this result is that all the data collected is from a group of countries which are relatively developed, where human capital is already abdundant. Therefore, an increase in human capital may not have much marginal effect to cause significant increase in CBM&A, resulting insignificant effect.
Another reason may be the choice of the data for this indicator. In order to indicate the human capital, I use the number of researchers per 1000 employees of each country. According to the definition provided by OECD Data, these researchers are professionals engaged in the conception or creation of new knowledge, products, processes, methods and systems, as well as in the management of the projects concerned. Human capital may not be best described by this indicator, because although researchers are imperative to the overall competitiveness of a firm, not all the researchers are capable of governing or leading a firm to make proper decisions of CBM&A. Therefore, this data may not be good enough to test the decisive power of human capital. However, as I mentioned in the section o f introducing the variables, a better alternative proxy – the enrollment of tertiary education is not available in some of the countries.
3.4.2 Factors of Location Advantages
1. GDP Per Capita
selected home country environment factors. The value of t-Statistic is about 4.44, indicating that the effect of GDP per capita is very significant. Therefore, GDP per capita significantly and positively affects outward CBM&A, and Hypothesis 3 is confirmed.
This result is consistent with the findings of Vasconcellos’ & Kish’s (1996), Nocke’s & Yeaple’s (2008), and Boateng’s (2013). Nocke & Yeaple believe that high production costs in a country with high GDP per capita stimulate domestic firms to engage in CBM&A for the purpose of lowering costs. Boateng holds the view that firms from high GDP per capita have more cash at their disposal, encouraging them to engage in CBM&A activities.
2. Inflation Rates
Inflation rates are positively and significantly related to CBM&A as theoretically expected. The result means that when the inflation rates in home country become higher, firms will more likely to engage in CBM&A to protect their assets from depreciating. Hypothesis 2 is confirmed.
As Schneider & Frey (1985) interpretd, high inflation rates indicate poor health of an economy. The location advantages provided by the home country environment are impaired because of high inflation rates. Firms’ tend to minimize the negative effects brought by inflation rates by shifting the production location to other coutries via CBM&A (Sayek 2009).
3.4.3 Factors of Internalization Advantages
1. Exchange Rates
First, because CBM&A transactions involves a long period to be prepared and decided, such as searching targets, designing contract terms, and negiotiating, and the exchange rates are often flexible and volatile, firms may not be able to make fast decisions or adjustments in response to the instant variations of exchange rates. Therefore, although exchange rates affect the transaction costs in CBM&A deals, firms’ decisions about CBM&A can’t respond to the exchange rates as quickly as exchange rates change.
Second, in financial market, there are multiple financial instruments designed for firms to offset the risk and negative effect by exchange rates. There are many important financial instruments: spot foreign exchange, currency futures, foreign exchange options, outright forwards, currency swap, and so on. All these intruments help firms to minimize the influences by unexpected exchange rates.
2. Interest Rates
Unexpectedly, the test result shows that the influences of interest rates on CBM&A is insignificant. Hence, Hypothesis 6 is not confirmed.
4. Discussion
The dissertation discusses six home country environment factors that are expected to contribute to a firm’s ownership advantages, location advantages, and internalization advantages. By collecting data from 32 OECD countries over 24 years as sample points for panel data analysis, I test the relation between home country environment factor and firms’ propensity of engaging in CBM&A, and the real explanatory power of each factors are revealed. Within the OLI advantages framework, three factors are confirmed to have the theoretically expected effect, while the rest are left unconfirmed or inconclusive. The table below shows the general empirical result:
Test Result
Ownership Advantages
Technology confirmed Human Capital unconfirmed
Location Advantages
GDP Per Capita confirmed Inflation Rates confirmed
Internalization Advantages
Exchange Rates insignificant Interest Rates unconfirmed
(Table 9: General Result)
It’s critical for a firm or MNE to have a good understanding of both internal and external conditions to improve its competitiveness. The study focuses on the external environment – home country environment, and provides four important implications, which a firm or MNE need to be aware of:
advantages. The technology in home country enables firms to generate technological inputs, and engourages firms to seek for complementary technology by CBM&A. Therefore, firms can be significantly influenced by the abundance of technology in home country in CBM&A deals. It also implicates that technology itself is important for firms to get invloved in CBM&A. In order to increase the competitiveness in CBM&A, firms have to put more effort on absorbing technology.
However, as I clarified in Section 2.3, there’s a limitation to simply apply the country effects to each individual firm. Abundant technology in home country doesn’t necessarily mean that each individual firm is abundant in technology. The correct way to understand this is to consider the relation in a statistical sense. The abundance of technology has positively stimulated domestic firms’ collective behavior of engaging in CBM&A. To be more specific, technology in this dissertation is indicated by the number of patents in a country, approximating the ability of firms in the country to generate technological input (Kyrkilis & Pantelidis 2003). Therefore, in a country where firms are more capable of generating technological input, firms in the country are more likely to engage in CBM&A. For an individual firm, it’s important to understand the implication that generally firms with greater technological capability are more inclined to engage in CBM&A, because those firms are more competitive due to their greater ownership advantages.
Compared to the effect of technology, human capital in OECD countries seems to help much less in CBM&A. An important reason is the role of time. In this study, human capital is indicated by the number of Researchers per 1000 Employees, who are experts in areas of new knowledge, products, processes, methods and systems, and management. It takes more time to train these employees or to convert their R&D results into use than to acquire current technology that is available in home country to drive the ownership advantages. Take time into consideration, the current status of human capital may turn out to be important to affect the propensity of CBM&A in the next few years.
rather than human capital to efficiently increase its advantages.
Second, the factors of location advantages is significant to the CBM&A activities. Apparently, GDP per capita has the most significant effect of all the home country environment factors. In order to increase the advantages, a wise MNE should select a portfolio of countries with great performance in GDP to operate as a reside nt in these countries. GDP may lead the firms in the country to further international expansion (Boateng et al. 2013). Combining the location advantages from the countries in which the MNEs dwell seems to help the MNEs’ to raise competitiveness for market expansion. It lives up to the requirements of lo ng term development strategies. However, a country with high GDP per capita also has high levels of COP (Costs of Production). Therefore, it’s contraditory for MNEs to recklessly target at coutries with great performance in GDP. The suggestion is that the portfolio MNEs choose should include countries with great GDP performance as well as countries with lower level of GDP performance, in order to balance the benefit of location advantages for further international expansion and the disadvantages brought by the corresponding COP in countries with great GDP performance.
When considering the choices of target countries for the combination of a portfolio of countries, inflation rates also need to be considered. High inflation rates increase the investment risk. Considering ROI (Return on Investment) and COC (Costs of Capital), engaging in CBM&A is also an option for firms to increase the ratio of investment return to capital costs, which caused by inflation rate. As a investment-smoothing measure, firms need to minimize the negative effects of inflation rates by shifting the production location between home and foreign countries (Sayek 2009). For MNEs, outward CBM&A is important to secure the value of the assets.
In this aspect of location advantages, country effects are related to individual firms through two types of costs, which will probably occur in many circumstances as long as production and capital are involved.
costs. According to TCE, exchange rates and interest rates are all related to costs in CBM&A transactions. Exchange rates are related to the costs due to the changes in relative prices for trading firm assets, and interest rates are related to financial costs due to raising funding for CBM&A. According to the result of the samples, in the trade-off between internalization advantages (saving transaction costs) and other aspects of advantages, internalization advantages seem less important. The possible explanation for this empirical result is that saving transaction costs is not the purpose of involving in CBM&A, and the transaction costs can be saved by multiple financial instruments and covered by saving production costs because of the economies of sca le after CBM&A, or the benefits brought by CBM&A because of the higher efficiency of integrated resources.
From the perspective of the role of time, as I explained in the result section, before a CBM&A transaction happens, the whole process involves a long period. Nevertheless, the exchange rates are often flexible and volatile. It’s challenging for firms to make timely responses to the variations of exchange rates. Therefore, exchange rates lose efficient effect when it comes to a long period of preparing for CBM&A transactions. In this sense, it is difficult to build up internalization advantages by catching an ideal level of exchange rates.
advantages in the fourth stage of investment development are created by managing and coordinating assets geographically, and this kind of ownership advantages become more critical than the ownership advantages that are derived from country-specific characteristics only.
Firms need to analyze the OLI advantages brought by home country environment as a whole before making any dicision. Which factor should be considered as a priority may become a tradeoff, because firms need to focus on strengthening the factors that can be used to improve one particular aspect of OLI advantages that they need to improve or build up. And firms need to make strategies accordingly to improve their overall competitiveness. According to IDP theory, ownership advantages is more decisive to a firm’s competitive advantages. Ownership advantages should be more focused in CBM&A for two reasons: first, the advantages generated from controlling and distributing the factors that can be owned by a firm are always easier to be created than the advantages drived purely from location; second, the influence of country- level marcoeconomic factors diminishes when the factors of ownership advantages and ownership advantages themselves become more complex.
Always be aware of that country effects are not able to perfectly predict the behavior of individual firms. The study of home country environment factors theoretically reveals the effects of home country on firms’ propensity of engage in CBM&A. And this propensity is the result of collective behavior of many firms concerned in CBM&A. The purpose of this study is to remind firms of the importance of home country environment factors to raise their own OLI advantages in CBM&A, and provide some important implications about home country environment.
5. Conclusion
CBM&A, but human capital seems to be insignificant; both factors (GDP per capita and inflation rates) selected to indicate the effect of location advantages are confirmed to be significantly related to firms’ propensity to engage in outward CBM&A; unexpectedly, both both factors (exchange rates and interest rates) selected to indicate the effect of internalization advantages failed to significantly verify the assumed relation between them and the propensity (measured by the number of outward CBM&A).
The study helps firms to better understand the environment in which they operate to make strategies for CBM&A, and therefore they will put more attention on the factors that contribute to one or more aspects of OLI advantages that they need to improve, make strategies accordingly, and adjust the assets portfolios of firms. This dissertation explains how home country environment factors affect CBM&A from the perspective of a firm’s OLI advantages, which is affected by the environment in which a firm operates, and is related to a firm’s competitiveness advantages in CBM&A. It provides firms with important implicatio ns of how to react according to the home country environment to raise competitiveness in the competition of CBM&A transactions and make firms’ strategic decisions. Firms need to consider OLI advantages as a whole in response to home country environment, because advantages are closely related to each other as well.
6. Limitations
Two limitations need to be noticed, and some possible issues in this area are suggested for further study:
proxy for human capital due to unavailable data of enrollment of tertiary education. Second, in this dissertation, only the number of CBM&A transactions is considered. The value of CBM&A is another important indicator to implicate the significance of the effect of each home country environment factor.
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