Emerging Market Multinationals: Overcoming the Trust Deficit in Developed Markets

Emerging Market Multinationals:

Overcoming the Trust Deficit in Developed Markets

University of Groningen Faculty of Economics and Business

MSc thesis IB&M (EBM719A20) Supervised by professor S.R. Gubbi

2 ABSTRACT

The current study examines how emerging market multinationals are able to overcome the trust deficit in developed markets due to increased need for legitimacy when compared to developed market multinationals. Two strategies have been explored, that of an ownership decision in the subsidiary in the developed market and a corporate social responsibility engagement strategy, to overcome the trust deficit. This study examines whether a compensation effect for emerging market multinationals relative to developed market multinationals is observed regarding the two mentioned strategies, since emerging market multinationals face a greater trust deficit. Different statistical regression procedures have been applied to examine the compensation effect regarding those strategies. To become socially embedded in the foreign advanced market, emerging market multinationals seem to face a more difficult task to find a local partner willing to share equity. As a consequence, emerging market multinationals seem to be forced to aim for a higher percentage equity owned in the subsidiary relative to developed market multinationals.

3 INTRODUCTION

Previous research on emerging market multinationals (EMNCs) suggest these firms do compete successfully with established multinational corporations from developed regions (DMNCs) (Du, Boateng & Newton, 2016; Matthews, 2006; Wright, Filatotchev, Hoskisson & Peng, 2005). EMNCs are able to compete employing market-based as well as non-market-based advantages (Cuervo-Cazurra & Genc, 2011; Sun, Peng, Ren, & Yan, 2012). The former emphasizes the development of resources over time as a competitive strategy

(Cuervo-Cazurra & Genc, 2011), such as low-cost production capabilities due to low labor cost and cheap raw materials (Sun, Peng, Ren, & Yan, 2012). By utilizing home country cost advantage in combination with serving cost-conscious customers, EMNCs can build a competitive advantage by making better use of available technology or via new business models (Mathews, 2006). The non-market advantages relate to resources developed by a firm to operate in a country’s institutional environment (Cuervo-Cazurra & Genc, 2011). Since, emerging markets are characterized by high institutional uncertainty due to a less developed economy and institutions (Hoskisson, Eden, Lau & Wright, 2000), to be successful in such a volatile environment and to cope with the uncertainty of changing regulations and

interventions of governments (Hoskisson, et al., 2000), EMNCs develop non-market based advantages by building network-ties such as those within business groups (Kayaci, 2017). Above advantages of EMNCs serve well insofar as they can compete with other firms in their home markets or in other developed markets.

However, recent research has shown that EMNCs also seem to encounter competitive disadvantages, especially when conducting business activities in advanced markets (Akdeniz Ar & Kara, 2014; Peng, 2009). In particular, local stakeholders in developed countries seem to show less positive attitudes towards EMNCs that conduct business activities in developed economies due to lower perceptions of trust. Therefore, in order to overcome the greater liability of foreignness in developed countries, EMNCs attempt to seek greater legitimacy so as to survive as a foreign firm (Dean & Cohen, 2005).

According to Scott’s framework (1995), the institutional environment of a country constitutes three pillars: regulative, cognitive and normative. Based on these three pillars, EMNCs face larger threats to their status regarding being perceived as a legitimate player compared to developed MNCs (Liou, 2013). First, since the formal institutions are less developed in emerging markets (Peng, Wang & Jiang, 2008), EMNCs find it more

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deviate from the more rigorous rules in advanced economies (Liou, 2013). Secondly, EMNCs use different cultural–oriented practices in more developed host countries, which local

stakeholders may observe as non-legitimate (Liou, 2013). Finally, what may be a common business practice in emerging economies isn’t necessarily observed as acceptable in

developed markets, for instance state-ownership and paying bribes (Shaheer, Yi, Li & Shen, 2019). According to Akdeniz Ar and Kara (2014) one of the biggest disadvantages is the negative country-of-origin perceptions of the emerging countries and the resulting lack of trust in EMNCs: as a result of lacking information about EMNCs, developed market stakeholders may evaluate EMNCs based on country-level characteristics of the home

emerging market (Bitektine, 2011). Because of emerging market firms’ latecomer status in the global business environment these stakeholders have less information about the EMNC and are likely to evaluate those based on stereotypes associated with the country of origin (Bitektine, 2011) which may result in lower trust perceptions (Akdeniz Ar & Kara, 2014; Peng, 2009). Therefore, given the EMNC’s potential difficulties in gaining legitimacy in developed markets, this study focuses on how EMNCs are able to deal with the competitive disadvantages associated with liability of foreignness in advanced countries (Akdeniz Ar & Kara, 2014; Peng, 2009). More specifically I ask are EMNCs able to overcome their

disadvantages associated with liability of foreignness in advanced countries? This question is relevant since people in favor of institutional theory theorize that overcoming this liability of foreignness is crucial for survival (Cohen & Dean, 2005; Dowling & Pfeffer, 1975; Suddaby, Bitektine & Haack, 2017).

In order to answer above research question, I examine two strategic decisions that EMNCs may undertake to deal with their trust issue in developed markets. The first strategy relates to an ownership decision in the subsidiary and the second strategy focuses on

corporate social responsibility engagement. I propose that, compared to other MNCs, EMNCs encounter additional liability of foreignness since EMNCs have less to offer to local

stakeholders in developed countries in terms of superior capabilities such as technology and managerial skills (Matthews, 2006). Furthermore, EMNCs are perceived as being less trustworthy in the eyes of developed market stakeholders due to weak country-of-origin perceptions and opaque corporate governance standards at home (Peng, 2009). As a

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on average stronger CSR engagement, compared to DMNCs.

The country of context constitutes the United States and the data analyzed derives from the time period 2010-2015. In this study support is found for a compensation effect with regard to equity percentage owned in the subsidiary for EMNCs relative to DMNCs. This study adds to strategic management literature and in specific how EMNCs deal with liability of foreignness in advanced countries. Given the rising development of EMNCs in global competition (Zhang, Cui & Chan, 2014), the findings of this research have implications for managers of EMNCs to formulate effective strategies to establish legitimacy in advanced markets.

LITERATURE REVIEW

Institutional distance

Organizational theorists focused on institutional differences between countries which lead to the introduction of a new construct ‘institutional distance’ (Kostova, 1999). Institutional distance is a construct that has been developed to capture the differences between institutional environments of multiple countries (Kostova, 1999; Gaur & Lu, 2007). The construct

originates from Scott’s definition of institutions constituting three pillars: regulative, normative and cognitive (1995). Hence, institutional distance is defined as ‘the degree of similarity or dissimilarity between the regulatory, normative and cognitive institutions of two countries’ (Kostova, 1996).

6 Organizational legitimacy and liability of foreignness

Institutional distance enacts a major source of liability of foreignness (Kostova & Zaheer, 1999). Liability of foreignness refers to “all additional costs a firms operating in a markets overseas incurs that a local firms would not incur (Zaheer, 1995 p. 342-343)”. Researchers in favor of institutional theory theorize that organizational legitimacy is crucial for survival (Cohen & Dean, 2005; Dowling & Pfeffer, 1975; Suddaby, Bitektine & Haack, 2017).

Organizational legitimacy refers to the congruence between the organizational values implied by the firm’s activities and the social values of the environment in which these organizations conduct business activities (Dowling & Pfeffer, 1975).

Based on Scott’s framework, the institutional environment consists of three pillars: regulative, cognitive and normative (1995). The institutional dimensions illustrate various kinds of conformity to establish legitimacy. The regulative pillar refers to conformity to rules and regulations enforced by the state (Scott, 1995). The normative pillar refers to a moral base assessment of organizational legitimacy brought by professions (DiMaggio & Powell, 1983). The cognitive pillar of institutional pressure views organizational legitimacy as the

organizations’ activities congruent with the shared cognitive structure in a society (DiMaggio & Powell, 1983). Thus, the different pillars represent qualitatively different pressures

regarding organizational conformity.

Kostova and Roth (2002) found that that the institutional profile of a specific host country, based on the three pillars of an institutional environment, impacts the foreign subsidiary regarding the entry mode decision. Kostova and Roth (2002) showed that foreign firms respond in a strategic way to the different institutional pressures from the host country to gain legitimacy.

Liability of foreignness associated competitive advantages and associated solutions

The liability of foreignness results in three main competitive disadvantages for MNCs

entering distant markets. According to Eden and Miller (2004), the competitive disadvantages are unfamiliarity hazard, relational hazard and discrimination hazard.

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unfamiliarity hazard is by entering the host market via a local partner who possesses this knowledge and therefore may alleviate unfamiliarity hazard (Makino & Delios, 1996). Secondly, relational hazard refers to the disadvantage of a foreign firm in effectively communicating with host market constituents due to different norms, values and beliefs based on the cognitive and normative pillar of institutional distance (Kostova, 1997). Transaction-cost literature suggests that a foreign firm may face relational hazard coming from internal or external constituent’s potential opportunistic behaviors. This opportunistic behavior occurs under the conditions of bounded rationality and information asymmetry (Buckley & Casson, 1998; Henisz & Williamson, 1999). As a consequence, MNCs may be at a disadvantage in effectively communicating with foreign market constituents. Hence, the relational hazard stems from the lack of innate host-cultural knowledge which is needed to monitor host-market constituents’ potential opportunistic behaviors as well as to reunite different values and

beliefs (Liou, 2013). A locally embedded partner in the host institutional environment may mitigate for this disadvantage by effectively monitoring and facilitation of business activities to make coordination more efficient within and outside the company (Makino & Delios, 1996).

Lastly, discriminatory hazard refers to a different treatment of foreign firms relative to local firms in the host country (Eden & Miller, 2004). Due to the lack of familiarity with the MNC by local market stakeholders, higher standards may be imposed on the foreign firm (Kostova & Zaheer, 1997). Partnering with a local organization may result in spillover effects regarding the local firm’s legitimacy and may alleviate the local market stakeholders’ concern regarding the foreign acquirers legitimacy (Yiu & Makino, 2002).

Hence, by sharing ownership with a partner in the host institutional environment multinational corporations in general may alleviate the three competitive disadvantages of unfamiliarity hazard, relational hazard and discriminatory hazard relating to liability for foreignness which result from institutional distance (Eden & Miller, 2004; Makino & Delios, 1996; Liou, 2013; Yiu & Makino, 2002).

To overcome the liability of foreignness, multinational corporations would tend to become ‘social embedded’ as a firm to deal with the liability of foreignness related hazards discussed above. Social embeddedness refers to ‘the extent to which economic transactions occur through social connections and networks of the relationships that utilize social criteria to conduct business deals’ (Marsden, 1981).

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Further, when local market stakeholders judge the legitimacy of a certain foreign subsidiary, they are likely to refer to the legitimacy of other firms belonging to the same cognitive category (Yiu & Makino, 2002). Kostova and Zaheer (1999) refer to this as ‘external legitimacy spillover’. Chen and Chen (1998) proved that the network connections drives foreign direct investment decisions, since firms may gain access to strategic assets by means of these relationships. The network connections or socially embeddedness due to this linkages may facilitate foreign direct investment for reasons that, due to this network connection firms can overcome entry barriers and they are able to reduce transaction costs.

In short, previous research has shown that foreign acquirers can gain legitimacy by becoming social embedded in the host foreign environment (Marsden, 1981; Chen & Chen, 1998). Additionally, according to institutional theory company’s conformity to different types of institutional pressures (Scott, 1995) leads to establishing legitimacy (DiMaggio & Powel, 1983). The theory discussed above has been extracted from studies mainly focusing on MNEs originating from developed regions, internationalizing into developing countries. However, a new type of firm has entered the global business environment (Wells, 1983).

Emerging markets and liabilities of foreignness

Emerging economies are an important constituent of the global economy (Economist, 2011). Relative to stagnating or sluggish growth in developed countries, less economically developed countries show impressive growth (UNCTAD, 2008). In addition to rapid economic growth emerging markets are characterized by weak formal market-supporting institutions, such as the legal framework and enforcement, property rights, regulatory regimes and information systems (Meyer, Estrin, Bhaumik & Peng, 2009). Relative to strong market-supporting institutions in developed markets the weaker market-supporting institutions in emerging markets may “fail to ensure effective markets or even undermine markets, as in the case of corrupt business practices” (Meyer, et al., 2009). The term emerging economy is used as an umbrella term for representing countries that are characterized by rapid growth but do not achieve the majority of developed markets, in specific regarding the development of formal institutions (Liou, 2013).

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only engaged in export or import business activities. In addition, utilizing this definition leads to focusing on EMNCs which have substantial investment in foreign activities and as a consequence are perceived as having influence in the eyes of developed market stakeholders (Luo & Tung, 2007). These internationalizing firms from emerging markets increasingly become big players in the global business environment. Already in 2010 the World

Investment Report claimed that foreign direct investment from emerging economies would continue to rise (UNCTAD, 2010). Research focusing on the development of these firms demonstrate the promise of these ‘third world multinationals (Wells, 1983)’ to become an important area for theorizing (Cuervo-Cazurra & Genc, 2008).

The last decade EMNCs have been characterized by rapid internationalization in global competition (Zhang, Cui & Chan, 2014), among others in developed markets (Zhang, Cui & Chan, 2014). Because of EMNC’s latecomer status in the global business environment, local stakeholders in advanced countries may have less information about EMNCs and are likely to evaluate those based on stereotypes associated with the country of origin (Bitektine, 2011). These stereotypes based on country-of-origin perceptions result in lower levels of trust in EMNCs relative to DMNCs (Akdeniz Ar & Kara, 2014; Peng, 2009). Hence, EMNCs face greater challenges regarding their legitimacy in developed markets. The additional lack of legitimacy faced by EMNCs in developed countries can be explained by the larger

institutional distance between emerging market and host developed market relative to firms originating from other developed markets (Kostova & Zaheer, 1999).

At first, EMNCs encounter challenges regarding establishing legitimacy because their routine corporate practices are inconsistent with the more sophisticated regulations and institutions in advanced markets (Peng et al., 2008): investor protection procedures, accounting standards (Pagano, Roell & Zechner, 2002) and legal rules regarding stock registration and listing (Marosi & Massoud, 2008) may differ between developed and

emerging countries due to less developed regulations in emerging markets (Peng et al., 2008). Hence, EMNCs may find it a challenging task to gain legitimacy in a developed market if their domestic corporate practices are inconsistent with the more rigorous rules in advanced economies.

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in cultural differences between domestic emerging market and host developed markets. Doing so may result in abundance from local stakeholders in the developed economy (Liou, 2013). Therefore EMNCs face legitimacy concerns and may encounter pressures regarding

conforming to the host country’s cultural values (DiMaggio & Powell, 1983).

Lastly, normative pressures may vary between emerging and advanced economies regarding what is observed as acceptable corporate practices (Liou, 2013). Practices that are seen as acceptable in emerging markets may not be so common in advanced economies. An example is that of state-ownership. State-ownership is a prevalent form of organizations among EMNCs (Shaheer et al., 2019). Countries where the practice of state-ownership are common, that is emerging markets, are evaluated as less trustworthy in the perspective of developed market stakeholders (Shaheer et al., 2019). In addition, there have been practices implemented to improve transparency among DMNCs (Johnson, Daily & Ellstrand, 1996). These practices are however not commonly adopted among companies originating from less developed economies (Liou, 2013). Further paying bribes is seen as a form of corruption in advanced economies, but may be a common business practice in certain emerging countries (Shaheer et al., 2019).

Above discussion suggests that EMNCs face various types of threats to their organizational legitimacy when entering advanced countries. Since the rapid expansion of EMNCs in advanced markets (Zhang, Cui & Chan, 2014) in combination with the insight that overcoming liability of foreignness is key to be able to compete with other multinationals (Cohen & Dean, 2005; Dowling & Pfeffer, 1975; Suddaby, Bitektine & Haack, 2017), it is important for managers of EMNCs to formulate effective strategies to establish legitimacy in developed markets.

Gap in literature: how do EMNCs deal with the legitimacy threats?

Previous international business related studies show how multinational corporations from developed markets deal with their legitimacy issue in less developed countries (Eden & Miller, 2004; Makino & Delios, 1996; Yiu & Makino, 2002; Liu, Marshall & McColgan, 2017). Despite the recent upraise of EMNCs expanding to developed markets less attention has been devoted to strategic management research investigating how EMNCs deal with their legitimacy challenges (Liou, 2013).

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Similarly, brand attractiveness of global products deteriorates when produced in low-image countries relative to production in a developed country in the eyes of developed market constituents (Hui & Zhou, 2003). Hence, these studies have shown that EMNCs face

additional liability of foreignness relative to DMNCs when conducting business activities in advanced regions (Peng, 2009). The results of these studies are warranted in the current fast changing and integrating globalizing markets in which the share of emerging market firms in trade as well as foreign direct investments activities has increased (Shaheer et al., 2019; UNCTAD, 2010).

In addition to research focusing on the social-cognitive element of EMNCs operating in advanced countries, research has focused on EMNC’s competitive advantages in developed countries. For instance their cost advantage, flexibility or strong financial leverage due to state-ownership (Du, Boateng & Newton, 2016; Mathews, 2006; Wright et al., 2005). In this study it is argued that these competitive advantages may be a necessary condition and a precursor for internationalization. However, these competitive advantages may not be sufficient to compensate for the additional liability of foreignness that EMNCs encounter in developed environments. The next question would be: ‘Which strategies do these EMNCs apply to compensate for their liability of foreignness and resulting trust deficit?’. In the following section the uncommon strategies that EMNCs seem to employ to overcome their liability of foreignness to establish trust are explored.

THEORETICAL MODEL AND HYPOTHESES

Higher level of ownership position in terms of percentage equity owned in the subsidiary

In this paper it is argued that becoming socially embedded like MNEs from developed regions do when entering less developed regions, by partnering up with a local constituent, may not be a feasible option for EMNCs to the same extent as for DMNCs based on the different legitimacy challenges and additional liability of foreignness discussed before (Akdeniz Ar & Kara, 2014; Peng, 2009). Based on the below suggested theorizing a different strategy is proposed.

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advantages relative to EMNCs. Sequentially, firms originating from emerging markets have limited resources and less international experience relative to DMNCs (Matthews, 2006). Not to mention that EMNCs may not be able to utilize their non-market advantages, that of being flexible in dealing with uncertain institutional environments and business groups, since these are only useful in a nation with a similar institutional environment to the home market (Cuervo-Cazurra & Genc, 2008). Thus, based on the above mentioned reasoning EMNCs seem to lack certain resources relative to DMNCs. Consequentially, it is argued that developed market firms are less willing to partner up with an EMNC relative to an DMNC due to this lack of resources.

Compensation Effect

Due to the negative country-of-origin stereotype in the eyes of developed market stakeholders (Bitektine, 2011), EMNCs have a weaker stand in negotiations which results in the need to pay above market value when acquiring to offset the greater liability of foreignness, relative to developed markets competitors (Hope, Thomas, & Vyas, 2010). This example shows a compensation effect to offset the additional liability of foreignness for EMNCs. In this study it is argued that this compensation effect also transfers with regard to the equity percentage owned in the subsidiary as a way of becoming socially embedded. This theorizing is based on the combination of the lack of resources and the additional lack of legitimacy in comparison with DMNCs; due to the lack of both, developed market stakeholders are argued to be less willing to partner up with EMNCs. Hence, the more feasible option for an EMNC seems to be to offset the additional liability of foreignness by aiming for a higher percentage equity owned in the subsidiary on average, relative to DMNCs.

To achieve EMNC’s strategic goals in advanced countries, these firms need to exercise substantial control over their foreign subsidiary (Liou, 2013). Transfer of tacit knowledge requires strong coordination efforts of the EMNC (Teece, 1977). Kogut and Zander (1993) have argued that a sole hierarchical structure provides superior efficiency in transferring tacit knowledge over other organizational structures. Sequentially, EMNCs may decide to go for a higher level of control in the subsidiary to achieve successful transfer of the acquired strategic assets, represented by a higher equity percentage in the subsidiary (Milgrom & Roberts. 1992). In sum, limited headquarter control is not a feasible option since EMNCs entry

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It could be argued that a dominant ownership position is not the only way to achieve control. Also non-ownership mechanisms can be used to achieve control (Beamish & Banks, 1987), like management teams, formal contracts or other mechanisms securing informal control (Yan & Gray, 1994). EMNCs lack international experience and have limited resources as argued before and therefore may be less knowledgeable in exploiting non-ownership control mechanisms (Demirbag et al., 2009). Hence, to achieve exploitation of the acquired strategic assets, EMNCs are prone to opt for higher ownership in terms of equity percentage owned in the subsidiary.

In sum, based on the results of past studies it seems to be the case that EMNCs face a larger issue compared DMNCs in establishing legitimacy (Hope, Thomas, & Vyas, 2010; Mulok, Raja & Ainuddin, 2010): EMNCs seem to encounter additional liability which they need to offset. Based on the country-of-origin liability, which is grounded in institutional distance between emerging and developed market, it is expected that EMNCs face a trust deficit and as a consequence encounter a more difficult task to find a local partner willing to share equity with in the subsidiary. Put differently, EMNCs mitigate for their additional liability of foreignness by aiming for an on average higher ownership position in terms of percentage equity owned in the subsidiary. The theory behind this reasoning is grounded in the argument that EMNCs need to compensate for their additional liability of foreignness (Peng, 2009) in establishing legitimacy by facing larger institutional distance relative to DMNCs (Kostova & Zaheer, 1996).

H1: Emerging MNCs acquire on an average greater ownership position with increasing institutional distance, compared to developed MNCs when conducting foreign direct investment in developed markets.

Overcoming the liability of foreignness in foreign direct investment: the role of corporate social responsibility

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being increasingly expected to consider the societal and governmental impacts of their business activities (Soros, 2002). This emphasis on incorporating corporate social

responsibility activities is crucial as a part of a foreign entrant’s strategy in the host market: “Firms without a capacity to appreciate and create social value or to become locally

embedded in the social infrastructure may struggle to overcome their liability of foreignness (London & Hart, 2004)”.

Relative to domestic companies, foreign subsidiaries may operate at a competitive disadvantage when operating in a host nation due to unfamiliarity hazard (Zaheer, 1995). CSR related strategies can be characterized as efforts to organize business activities to ensure and achieve transparency and assurance of stakeholders’ goals and interests (Jones, 1995). Multinational corporations with a strong CSR reputation are expected to invest time investigating the local environment and these efforts reduce the unfamiliarity disadvantage that firms encounter in a host foreign markets (Rhee & Haunschild, 2006). Moreover, strong CSR performance results in improved governance, firms are sequentially able to reduce risks associated with this asymmetric information (Klapper & Love, 2004). Based on above reasoning it is argued that a strong CSR reputation for EMNCs may add in gaining local knowledge which sequentially may reduce unfamiliarity hazard.

MNCs may receive discriminatory treatment from the local consumers and government (Eden & Miller, 2004), which is based on their limited embeddedness and involvement in the local community (Luo, 2001). It is argued that CSR reporting and

disclosure activities improve a company’s internal transparency and external legitimacy. CSR engagement is a long-term corporate communication practice that may improve the firm’s public image (Seok Sohn, Han & Lee, 2012). MNEs with strong CSR performance have been proven to encounter less discrimination from the host country local residents, since the local residents presume that the firms continue their strong CSR performance (Kostova, Roth & Dacin, 2008; Luo, 2001). Hence, firms with strong CSR performance are more likely to be incentivized by the host country government and accepted by host country stakeholders (Dadush, 2013), a favorable reputation has a positive influence on the willingness of local suppliers and buyers to transact with the foreign company (Doney & Cannon, 1997).

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regarding their transparency, enjoy lower levels of agency and information asymmetry costs and additionally enjoy higher levels of external legitimacy (Cheng, Ioannou & Serafeim, 2014). Consequently, strong CSR performance is related to improved stakeholder engagement (Eccles et al., 2014) which may lead to a reduction of the relational hazard liability of

foreignness.

Summarized, above mentioned reasoning offers a number of arguments why CSR engagement is an important strategy regarding reducing the three hazards related to liability of foreignness faced by EMNCs when entering a developed market. Strong CSR performance may result in lower liability of foreignness costs (Liu, Marshall & McColgan, 2017).

Stronger CSR performance for EMNCs relative to DMNCs

When MNCs enter distant markets there are some recommended strategies for these firms to survive and get locally embedded (London & Hart, 2004). As can be derived from the recommended strategies from London and Hart (2004) is that focusing on corporate social responsibility (CSR) activities and integrating it into your business model is a strategic way of overcoming liability of foreignness. Looking at the current global business environment a new type of firm is rapidly internationalizing, the emerging markets multinationals (Wells, 1983; Zhang, Cui & Chan, 2014). These firms face challenges regarding becoming locally

embedded and dealing with the liability of foreignness when entering advanced markets (Liou, 2013; Park, 2018). Park (2018) investigated the relationship between the extent of internationalization of EMNCs and the sustainability strengths and concerns. This research indicated that a positive relationship exists between the extent of internationalization and sustainability strengths and concerns for EMNCs: internationalization increases the

sustainability strengths and the sustainability concerns of EMNCs (Park, 2018). This study (Park, 2018) contributed to the theory of EMNCs and organizational legitimacy (Kostova & Zaheer, 1999). Hence, engaging in CSR seems to contribute to the understanding of the legitimization process of EMNCs.

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competitive disadvantages by strong CSR engagement (London & Heart, 2004). DMNCs do not face this additional liability of foreignness; it is a unique liability of EMNCs when conducting foreign direct investment in developed markets (Akdeniz Ar & Kara, 2014). Therefore EMNCs’ CSR performance needs to be higher in comparison to DMNCs to win the trust of developed market stakeholders.

Thus, in line with the expected stronger positive relationship between institutional distance and percentage equity owned in the subsidiary for EMNCs relative to DMNCs, a stronger positive relationship between home country status, i.e. originating from an emerging market, and institutional distance is expected relative to originating from an advanced

country. Again, this hypothesized relationship is grounded on the insight that EMNCs seem to bear additional liability of foreignness (Akdeniz Ar & Kara, 2014) relative to other firms by facing larger institutional distance (Kostova & Zaheer, 1996).

H2: EMNCs have on average higher corporate social responsibility strength with increasing institutional distance, compared to developed MNCs when conducting foreign direct

investment in developed markets. METHODOLOGY

Sample and data collection

The sample central in this study integrates all emerging market multinationals that conducted merger and acquisition events in the United States during the time period 2010-2015. Among others, Western-Europe, United States and Japan are examples of advanced economies

(MSCI, 2019). In this research the focus is only placed on one of these developed countries as the context of testing the two mentioned hypotheses to reduce the noise as much as possible (Blumberg, Cooper & Schindler. 2014). The United States is used as the country of

investigation central in this study to represent developed markets. It provides a suitable

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will be on emerging and developed market firms that conduct foreign direct investment activities in the United States to test the two hypotheses. Financial firms might be subjected to different rules and regulations compared to other firms (Doidge, Karolyi & Stulz, 2007). As a consequence, firms from financial sectors have been excluded in the data collection.

The focus in this study on the time period 2010-2015 since more recent data may be vulnerable to changes or updates. Merger and acquisition events are studied because this type of entry mode seems to be a prevalent type of entry for EMNCs (Ramamurti & Singh, 2009). The data is derived from Zephyr, a database that explicitly constitutes data relating to merger and acquisition events. The classification regarding which country is taken into account as an emerging market is based on the Morgan Stanley Capital International Emerging Market Index (MSCI, 2019). This index measures equity market performance in global emerging markets and qualifies countries as an emerging economy. The following twenty-six countries have been classified as an emerging economy: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Qatar, Russia, Saudi Arabia, South Africa, Taiwan, Thailand, Turkey and the United Arab Emirates (MSCI, 2019). Only countries that conducted ten or more merger and acquisition events have been included in this study. As a result the sample contains 85 emerging market firms, originating from Brazil (10), China (31), India (30) Mexico (14). The developed market group contains firms from two developed countries, Germany and Japan. Germany has been chosen in the first place because it is a well-known developed market. Japan has been added to this sample since selecting one country would fall short to the representation of developed market firms and therefore would reduce the

generalizability of the results (Blumberg, Cooper & Schindler. 2014). All firms originating from countries labeled as emerging countries have been labeled with a ‘1’ and are compared with developed market firms from Japan and Germany in hypothesis one and two. The developed market firms conducting merger and acquisition events are labeled as ‘0.’ After correcting for missing values the sample contains 145 developed MNEs, from which 95 originate from Japan and 50 from Germany.

From the 230 MNCs used to test hypothesis one, only 105 firms provided accessible information and data with regard to testing the second formulated hypothesis: Brazil (2), China (7), Germany (23), India (8), Japan (65). The matched percentage regarding the sample of hypothesis two relative to the first hypothesis is as a consequence 45.65%.

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‘Ownership position’. The dependent variable in this study for hypothesis one is ownership position of the acquiring firm in terms of percentage equity owned in the subsidiary. The data for this variable is derived from Zephyr database. Researchers in the past have approached ownership position as a dichotomous variable where a classification has been created like full acquisition or partial acquisition (Yiu & Makino, 2002). Ownership position in this study is however treated as a continuous variable, it is measured by the percentage of the acquired stake in the target firm (Malhotra, Sivakumar & Zhu, 2011). This is done in the first place because the continuous approach results oftentimes in more power which positively affects detecting statistical relationships (Fitzsimons, 2008). Likewise, any arbitrary classification may mask important information due to the creation of artifacts (Blumberg, Cooper & Schindler. 2014).

‘Corporate social responsibility strength’. The dependent variable for hypothesis two is CSR strength of as well emerging market multinationals as developed market firms. CSR strength is measured as the environmental, social and governance (ESG) score (Park, 2018). The ESG scores are selected based on the year of the merger and acquisition event. This measure takes continuous numerical values in the range: 0-100. A higher ESG score indicates good sustainability engagement. The data is derived from the dataset ‘Asset4’ from Thomson Reuters Eikon: as the global largest ESG rating agency (Durand & Jacqueminet, 2015). Thomson Reuters offers comprehensive and systematic ESG data investment analysis tools for investors to study ESG information (Cheng et al., 2014).

Independent variable

‘Institutional distance’. The measure of the central construct of this paper is constructed by using the World Governance Indicators which aggregates the perspectives of a large number of enterprises, citizens and expert survey respondents in industrial as well as developing countries (Du, 2009). The data sources underlying the aggregate scores are derived from a variety of international organizations, non-governmental organizations, survey institutes and think tanks (World Bank, n.b.). For the regulative pillar governmental effectiveness,

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investor’s domestic base and the United States, scaled by the variance of the attribute score (Kim, Li, Luo & Wang, 2016). For each emerging market investor the institutional distance between its home country and the United States, denoted by ‘institutional distance’, see formula one:

Formula 1 Institutional distance

∑[(Ik – IJ)2 Vk] / n

Ik refers to the institutional indicator for country k. IJ stands for the institutional indicator (I)

for the United States. Vk is the variance of the k formal institution attribute score among the

27 foreign countries used in this sample. Lastly, n is the number of institutional attributes (n=6). In addition, all the independent world governance indicators are analyzed as proxies for regulative and normative distance (Liou, 2013).

Control variables

Firm size as well as research and development intensity have been proven to influence corporate strategy and therefore international expansion strategy (Barkema & Schijven, 2008), as a consequence they are, among other variables, used as control variables. The former refers to a firm’s operational experience. According to Barkema and Schijven (2008) firm size may strengthen managerial learning, in specific learning in the evaluation of

contingencies regarding entry mode decisions. Firm size is measured by the total assets of the MNC before the merger and acquisition event and is derived from Zephyr database. Research and development (R&D) intensity data is approached as a control, because it can influence entry decisions in two ways. R&D intensity has been utilized to measure asset specificity as well as firm competence and both have been proven to influence entry mode strategy

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Factbook and is calculated as the great circle distance (orthodromic distance) between the United States and the emerging markets (Liou, 2013). This calculation is based on the coordinates of the geographic center of the different countries (Berry et al., 2010). Lastly, country economic factors have been taken into account. Prior work has shown that foreign firms favor sharing ownership over outright acquisition in host countries with higher economic growth (Barkema & Schijven, 2002). As a consequence, this study controls for GDP per capita of the host country measured by the average annual GDP per capita of the host country over the five year period prior to the foreign direct investment event (Mohamed, Singh & Liew, 2013).

Several variables are included as control variables that may affect corporate social responsibility. The following control variables have been proven to influence CSR

performance: firm size, firm age and firm performance (Park, 2018). Firm size is measured by total assets and firm performance is measured by the return on assets (ROA). Additionally, R&D intensity is used as a control since McWilliams and Siegel (2000) indicated that R&D intensity can affect corporate social responsibility. This control constitutes a dummy variable, ‘1’ referring to high-tech industry which indicates this firm may heavily invest in R&D. Lastly, this study controlled for advertising intensity, since it should impact CSR (strike et al., 2006). All variables included are derived from Thomson Reuters and refer to the company’s concerns regarding corporate reputation, which consequently may lead to corporate

sustainability (Park, 2018).

Analysis

Tobit regression is applied to test hypotheses one, since the dependent variable ownership position is approached as a continuous and truncated variable (Blumberg, Cooper &

Schindler. 2014). Ordinary Least squares is employed to estimate the causality between the interaction variable and CSR strength, since the measurement of the dependent variable ESG score is based on a continuum (Blumberg, Cooper & Schindler. 2014). To test the interaction-effect, centered variables have been utilized regarding creating the moderator variable to avoid multicollinearity (Blumberg, Cooper & Schindler. 2014).

RESULTS

21

The median of institutional distance is smaller than its mean (median = 0.107). Therefore, institutional distance is assumed to be positively skewed. This also accounts for home country status (median = 0). The median of ownership position is greater than the mean (median = 100). Hence, ownership position is negatively skewed. The difference between the median and mean of CSR strength is almost zero and is therefore assumed to be

approximately normally distributed (median = 64.906).

A weak positive correlation between the independent variable institutional distance and the dependent variable ownership position is observed, significant at the 5% level (ρ = 0.244). Further, a weak positive correlation between home country status and ownership position is observed at the 5% significance level (ρ = 0.259). Institutional distance and home country status show a significant positive correlation with a moderate effect size (ρ = 0.666). Furthermore, the independent variable institutional distance shows a weak positive correlation with the second dependent variable, CSR strength (ρ = -0.243), significant at the 5% level. Home country status and CSR strength show a weak negative significant correlation (ρ = -0.236). With regard to multicollinearity, no correlations above 0.7 are observed between the independent variables. However, when conducting the VIF test, GDP per capita, scored above ten with regard to its VIF score and was eliminated in the statistical regression procedures (Woolridge, 2011).

In hypothesis one it is predicted that emerging MNCs acquire on an average greater ownership position in the subsidiary in terms of equity percentage with increasing

institutional distance, compared to developed MNCs when conducting foreign direct investment in developed markets. As presented in table two, the acquirer’s home country status significantly moderates the relationship between institutional distance and the acquirer’s ownership position in the subsidiary in the United States. This result was

Table 1 Descriptive statistics and correlations (N = 230, *p-value<0.05)

Mean St.

dev. Min Max (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13)

(1) Ownership position (%) 91.136 21.72 10 100 1.00

(2) Type M&A 0.830 0.38 0 1 0.905* 1.00

(3) CSR strength 62.746 20.98 15.97 95.07 -0.015 0.051 1.00

(4) CSR concern 74.687 33.77 0.85 100 0.013 -0.014 -0.361* 1.00

(5) Firm Size (total assets) 2.24e07 4.18e07 750.23 3.23e08 0.094 0.107 0.122 -0.135 1.00

(6) Firm Age 63.752 40.15 5 185 0.079 0.115 0.350* -0.202* 0.137* 1.00

(7) Firm Performance 2.74e07 3.73e08 -218444 5.65e09 -0.235* -0.151* 0.083 -0.179 -0.015 0.137 1.00

(8) R&D Intensity 0.052 0.22 0 1 -0.041 0.102 -0.105 -0.099 0.082 -0.011 -0.01 1.00

(9) GDP per capita 48934 1704 46775 51619 0.098 0.087 0.082 -0.239* 0.128 0.053 -0.05 -0.088 1.00

(10) Advertising Intensity 3.93e08 6.54e08 11563 2.13e09 0.199 0.166 0.184 -0.240 0.187 0.200 0.192 0.006 0.269 1.00

(11) Geographical Distance 9515.278 2571 2571 12045 -0.096

-0.096

(12) Home Country Status (Ems) 0.370 0.484 0 1 0.259*

0.274*

TABLE 2 Regression equity ownership position in the subsidiary Model 1 Model 2 Model 3 Year - 2011 -8.857 * -7.853 * -5.221 Year - 2012 -2.486 -1.204 -17.032 Year - 2013 -4.998 -5.347 -1.517 Year - 2014 4.043 3.685 -4.994 Year - 2015 -1.958 -2.998 -5.956 Firm Size Firm Age Firm Performance 2.597 0.155 -1.300 *** *** 2.515 0.119 -1.24 *** *** 0.566 5.593 4.19 High-Tech/R&D Intensity GDP per capita Advertising Intensity -9.006 Omitted 0.874 -6.689 Omitted 3.128 -15.346 Omitted 3.950 ** * Geographic Distance -6.861 * -5.029 -37.285 **

Home Country (Ems) 13.866 -50.142

Institutional Distance -1.180 -18.399

Home Country Status (Ems) x

Institutional Distance 120.301 **

Observations 230 230 230

Adjusted R2 _{0.1474 * 0.1849 0.2908 *}

∆R2

0.0378 0.1159 *p-value<0.10 **p-value <0.05 ***p-value<0.01

TABLE 3 Regression CSR strength

*p-value<0.10 **p-value <0.05 ***p-value<0.01

Robustness checks

Researchers focusing on entry mode decision in the past have approached ownership position as a dichotomous variable where a classification has been created like full acquisition or partial acquisition; full acquisition is specified as when 95% has been owned in the subsidiary or more, partial acquisitions are characterized when the acquired stake represents less than 95% in the subsidiary (Yiu & Makino, 2002). To check for robustness within this study this dichotomous variable, labeled as ‘type of acquisition’, is used as an alternative to the continuous variable equity percentage owned in the subsidiary. Based on the dichotomous nature of this variable, logistic regression has been applied (Blumberg, Cooper & Schindler. 2014). When testing for robustness regarding the results of hypothesis one logistic regression is applied with the same variables but with the dichotomous variable ‘type of acquisition’, a positive coefficient is found. This result is however not significant at the 1%, 5% or the 10% level as can be derived from table four (β = 0.310, p = 0.194).

Further, to exclude that one of the two subsamples, Japan or Germany, influence the results, tobit regression is again applied with the dependent variable ownership position in the

Model 1 Model 2 Model 3 Year - 2011 -0.141 3.825 3.869 Year - 2012 -0.734 -3.878 3.934 Year - 2013 6.363 11.643 11.822 Year - 2014 -4.712 0.662 0.716 Year - 2015 1.833 7.080 7.195 Firm Size Firm Age Firm Performance 1.339 8.143 1.77 ** 1.634 7.649 8.36 ** 1.634 7.661 8.51 ** High-Tech/R&D Intensity GDP per capita Advertising Intensity -11.091 Omitted -1.248 -13.897 Omitted -2.579 * -13.885 Omitted -3.035 * Geographic Distance -1.391 -6.170 -5.952

Home Country (Ems) -29.883 -29.105

Institutional Distance 4.105 4.390

Home Country Status (Ems) x

Institutional Distance -1.604

Observations 105 105 105

Adjusted R2 _{0.0696 * 0.1317 ** 0.1222 **}

∆R2

25

subsidiary. However, this time the DMNCs are represented by German or Japanese firms, not both. Hence, two times tobit regression has been applied to check whether the results are biased towards a positive moderation effect by home country status and institutional distance due to the inclusion of these subsamples within this study. Both robustness checks show a positive coefficient for the interaction-variable (see table 6 and 7). However, both results are not significant at the 1% nor the 5% or 10% level (β = 119.670, p = 0.290; β = 115.359, p = 0.110).

Park (2018) used the ESG controversies score as an alternative dependent variable for sustainable strength and labeled it ‘sustainable concern’. ESG Controversies score range, just like the ESG scores, from 0 to 100. A high score indicates lower controversies of firms. Companies with higher controversies have lower scores. So in opposition to the ESG score, a higher ESG controversies score is good for a firm and a low score is bad. In line with previous research (Park, 2018), sustainable strength has been used as an alternative variable to check for robustness with regard to CSR strength in this study. The OLS regression with the dependent variable CSR concern shows a significant result at the 5% level with a negative coefficient (β = -197.551, p = 0.015). Based on the negative significant coefficient for ESG controversies scores, hypothesis two is not supported (see table 7).

CONCLUSION AND DISCUSSION

In the first phase of this study it was investigated whether institutional distance influences EMNCs’ equity percentage in the subsidiary differently than DMNCs’ equity position. The evidence from the results with regard to hypothesis one seem to suggest that emerging markets firms put a higher ownership position in terms of equity percentage in the subsidiary compared to firms originating from developed markets. Where developed market firms seem to rely more on local partners to deal with liability of foreignness, EMNCs seem to opt for higher equity percentage, on average, in the subsidiary to compensate for their legitimacy concern. This indicates that EMNCs not only face additional liability of foreignness compared to DMNCs representing a lack of trust from the perspective of developed market stakeholders (Peng, 2009), EMNCs also need to compensate for the additional lack of legitimacy

differently than firms originating from developed markets. However, interpreting this result should be done carefully: when testing for robustness a positive coefficient was found, but it was not significant.

26

found with regard to CSR performance; whether EMNCs would focus on strong CSR engagement as a strategy of dealing with the legitimacy concern in developed markets. However, the results do not seem to support this theorizing: EMNCs seem not to show higher scores with regard to CSR strength compared to DMNCs. Further, evidence seems to indicate that EMNCs face more controversies than DMNCs. This could indicate that DMNCs in general are less vulnerable to CSR critics in developed markets, which supports the

argumentation that EMNCs face a trust issue (Peng, 2009) and DMNCs do not face the same issue in developed markets. It could also imply that DMNCs are simply better able to

decouple their business practices (Park, 2018).

This study adds to strategic management in specific how EMNCs deal with liability of foreignness in advanced countries. Given the rising development of EMNCs in global

competition (Zhang, Cui & Chan, 2014), the findings of this research have implications for managers of EMNCs to formulate effective strategies regarding establishing legitimacy in advanced markets.

LIMITATIONS AND FUTURE RESEARCH

Previous conducted research focusing on the effect of institutional distance on entry mode decision suggests an effect size of 0.06 approximately (Tihanyi, Griffith & Russel, 2005). Based on power analysis, achieving a desired power of 0.6 when conducting a hierarchical regression with the used amount of predictors, a sample size of 200 is required as a minimum (Soper, 2012). Based on the sample size within this study (N=230), it should be possible to detect statistical meaningful relationships. However, the sample size with regard to

hypotheses two constitutes only 105 firms with an uneven distribution of EMNCs and

DMNCs; only 17 firms originate from emerging markets relative to 88 DMNCs. Based on the small data sample with regard to hypothesis two and the small subgroup representing

EMNCs, the results should be carefully interpreted.

27

dichotomous alternative variable ‘type of acquisition’. Further, the robustness check with the subsamples where DMNCs were represented by German or Japan firms did provide positive coefficients for the interaction variable. Those were however not significant. This could be explained by the small sample sizes (e.g. Germany, N=135; Japan, N=180) for the separately conducted regressions and the resulting lack of statistical power to detect meaningful

statistical relationships (Soper, 2012).

Since EMNCs are relatively new players within the global business environment they may not have been exposed to strong CSR engagement demands as much as DMNCs, which could explain the results of this study; a lack of exposure to certain demands may explain the lower scores (Park, 2018). In addition, the CSR strength measure derived from Thomson Reuters may not be the best representation of CSR engagement regarding overcoming the trust deficit. In this study Park (2018) has been followed since it is one of the most relevant studies focusing on the same topic. However, the ESG score considers CSR investment by a company in its home country, not the CSR investment by this company in the US in

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34 Appendix

Table 4 Regression type of acquisition

Model 1 Model 2 Model 3 Year - 2011 -0.175 ** -0.158 ** -0.154 ** Year - 2012 -0.052 -0.026 -0.038 Year - 2013 -0.175 ** -0.168 * -0.210 ** Year - 2014 0.045 0.044 -0.027 Year - 2015 -0.061 -0.071 -0.099 Firm Size Firm Age Firm Performance 0.057 0.001 -1.42 *** ** 0.055 0.001 -1.31 *** ** 0.055 0.004 -1.38 *** ** High-Tech/R&D Intensity GDP per capita Advertising Intensity -0.260 Omitted -0.012 ** -0.215 Omitted 0.003 * -0.218 Omitted 0.015 ** Geographic Distance -0.115 * -0.092 -0.139 *

Home Country (Ems) 0.127 -0.082

Institutional Distance 0.013 -0.071

Home Country Status (Ems) x

Institutional Distance 0.310

Observations 230 230 230

Adjusted R2 _{0.1808 *** 0.2235 *** 0.2260 ***}

∆R2

35 Table 5 Regression ownership position (DMNCs = German firms)

*p-value<0.10 **p-value <0.05 ***p-value<0.01 Model 1 Model 2 Model 3 Year - 2011 0.357 0.776 0.409 Year - 2012 6.946 7.391 ** 5.732 Year - 2013 1.199 0.800 -0.162 Year - 2014 7.165 7.342 ** 7.490 ** Year - 2015 5.290 5.051 4.962 Firm Size Firm Age Firm Performance 0.955 -0.678 -1.40 ** 0.100 -0.680 -1.36 ** ** 0.967 -0.613 -1.37 * *** High-Tech/R&D Intensity GDP per capita Advertising Intensity -3.357 Omitted -0.168 -2.749 Omitted -0.178 -2.585 Omitted -0.200 Geographic Distance 0.886 0.828 0.294

Home Country (Ems) 8.133 -2.326

Institutional Distance -1.338 -120.719

Home Country Status (Ems) x

Institutional Distance 119.670

Observations 135 105 135

Adjusted R2 _{0.3101 *** 0.3229 *** 0.3201 ***}

∆R2