Business Environmental Change on Foreign Direct Investment
Ownership Structures in Scandinavia
by
Ramon Velthuis
University of Groningen
Faculty of Economics and Business
Newcastle University
Business School
Master Thesis AIBM&M
October 19, 2020
Supervisors:
University of Groningen: Professor J. Shin University of Newcastle: Professor E.A. Alexander
Vondellaan 304 9721 LM Groningen
2
ABSTRACT
The main goal of this paper is to find out if fluctuating home and host country business environments influence a firm’s ownership structure when doing foreign direct investments, and what factors within these business environments are driving this change. There has been found that the relative overall ease of doing business in a country has a weak positive relationship with the level of ownership of the subsidiary. In order to find out what factors within the ease of doing business variable are driving this, a regression analysis has been done. Concluding that there are several factors positively influencing the level of ownership in a subsidiary when the host business climate changes relative to the home business environment. Those factors are the ease of paying taxes, dealing with construction permits, the ease of starting a business, enforcing contracts and registering property. Some factors were negatively related with the level of ownership in a subsidiary when the host business climate changes relative to the home business environment: trading across borders and resolving insolvency.
Acknowledgements
I am profoundly grateful to professor E.A. Alexander and professor J. Shin for the supervision, support, and constructive criticism I got during the process of writing my dissertation, I could not have done it without your help. Furthermore, I want to thank my family and friends for the mental support when writing a dissertation during a pandemic.
Word count: 10,926
Key words: Ease of Doing business, Business Environmental Change, Ownership, Entry Mode
3 TABLE OF CONTENTS 1. Introduction 4 2. Literature review 6 3. Methodology 14 3.1 Data collection 14 3.2 Data characteristics 15 3.3 Research method 16 3.4 Correlation 17 3.5 Factor analysis 17 3.3 Analysis 18
3.4 Validity and reliability 18
4. Findings 19 5. Discussion 22 5.1 Limitations 25 6. Conclusion 25 6.1 Future research 27 7. Reference list 28 8. Appendices 31
Appendix I: Factor loadings 31
Appendix II: Scree Plot 31
Appendix III: Frequency statistics 32
Appendix IV: Subsidiary countries 33
4
1. INTRODUCTION
In the current highly internationalised world, there is a shift towards open borders and trade agreements that make international trade and international expansion possible by foreign direct investments. The international monitory fund (1993) in the balance of payment manual defines foreign direct investment as “foreign direct investment refers to an investment made to acquire lasting interest in enterprises operating outside of the economy of the investor. Further, in case of foreign direct investments, the investor’s purpose is to gain an effective voice in the management of the enterprise.” This definition indicates that indicators for investment climate as given in Doing Business database can be important explaining foreign direct investment in- and outflows between countries. More favourable business climates should attract more foreign direct investments. (Singh, 2015)
5 environments (Morris and Aziz, 2011; Vogiatzoglou, 2016; Hassan and Basit, 2018). Mainly reviewing if a country becomes relatively more attractive in the eyes of a multinational when host country business environment changes. However, the risk factors by Corcoran & Gillanders and Aziz are including risks for distant economies, but not risk in the home market itself. (Corcoran and Gillanders, 2015; Aziz, 2018)
Risk assessment when doing foreign direct investment is usually done before entering a market, factors within the company or country culture have to be taken into account as well as factors in the foreign market. For example, do firms that want to avoid uncertainty and firms that have more power distance establish more fully- or majority owned subsidiaries. Cultural and economic factors combined create a nationality trait that influences foreign subsidiary ownership (Erramilli, 1996). Furthermore, multinational companies are more likely to exchange ownership for legitimacy in local industries than in host countries, and in local markets with high levels of political instability rather than in those with a low level of political instability (Chan and Makino, 2007).
Taking into account all the risks and uncertainties that firms have to address when expanding abroad, this research includes the home business environment in this paradigm. This leads to the following question: How do fluctuating home and host country business environments influence a firm’s ownership structure when doing foreign direct investments and what factors within these business environments are driving this change?
Because the decision-making environment for expanding is complex and potentially requires a significant commitment of resources, several people within a firm are typically involved in the decision-making process. These people compose a taskforce. The taskforce is likely to include firm executives, consultants having pertinent experience and representatives from the departments that might be involved in the foreign direct investment venture. The objective of the group decision making process is to integrate the many opinions of the group members regarding various aspects of evaluating entry mode and ownership structures alternatives into a single position. To do this, a set procedure is followed. This procedure are strategic managerial decisions made by this task force of the firm. After the advice of the taskforce, the final decision has to be made. (Levary and Wan, 1999)
6 spent on investigation and preparing reports by task forces. The average time to make the final decision after the investigation is 2.7 months (Wei and Christodoulou, 1997). This time frame makes that changes in business environment only become visible in the foreign direct investment entry mode and ownership level data two years after the regulatory change.
2. LITERATURE REVIEW
7 that were imported towards their countries. This forced U.S. companies to open production facilities on the local market, to maintain market share in Europe. Leading towards a situation where firms race to get products with new technology on the markets. (Vernon, 1966)
The Uppsala model is created to show the internationalization process focussed on development of individual firms. Particularly on its gradual acquisition, integration and use of knowledge about foreign markets and operations, and on its successfully increasing commitment to foreign markets. It is shown that all the decisions that, taken together, constitute the internationalization process-decisions to start exporting to a country, to establish export channels, to start a selling subsidiary, and so forth-have some common characteristics which are also very important to the subsequent internationalization. This model shows that firms first expand towards locations that have lower market risk for that specific firm. These risks can be lowered due to existing market commitments or lack of existing market uncertainties. The authors distinguish four steps: (1) the company has no regular export activities, (2) exports through an independent agent, (3) implementing a sales subsidiary, and (4) production in the foreign country. (Johanson and Vahlne, 1977)
On contrary, born global firms are defined as business organizations that, from inception, seek to significant competitive advantages derived from the use of resources and the sale of outputs in multiple countries (Oviatt and McDougall 1994, p. 49). Born global firm concerns a company that integrates from the beginning of their business, constraints, and opportunities of the global economy and the acceleration of trade. In other words, born global theories concern over the large multinational groups and have become the model of development of these agile and ambitious entrepreneurs. (Rennie, 1993; Tarek et al., 2019)
The internalisation theory explains the growth of transnational companies and their motivations for achieving foreign direct investments. The theory was developed by Buckley and Casson, in 1976 and then by Hennart, in 1982 and Casson, in 1983. Initially, the theory was launched by Coase in 1937 in a national context and Hymer in 1976 in an international context. In his Doctoral Dissertation, Hymer identified two major determinants of foreign direct investments. Those were the removal of competition and the advantages which some firms possess in a particular activity. (Hymer, 1976)
8 In 1982, the idea is developed that internalization by developing models between two types on integration: horizontal and vertical. In a follow-up research, Hymer created the concept of firm-specific advantages and demonstrates that foreign direct investments only take place if benefits of exploiting firm-specific advantages outweigh the relative costs of operations abroad. Multinational enterprises appear due to market imperfections, which led to a divergence from perfect competition in the final product market. In its research the problem of information costs for foreign firms respected to local firms, different treatment of governments and currency risks are taken into account. This resulted in an equal conclusion, that transnational companies face some adjustment costs when the investments are made abroad. Whereas foreign direct investments are no capital-market financial, but rather a firm-level strategy decision. (Hymer, 1976)
Countries with better institutional quality should be able to attract more investment due to reductions in both the cost of doing business and in uncertainty. It shows that institutional quality, represented by bureaucratic quality, rule of law, corruption, risk of expropriation and government repudiation of contracts, is an important determinant of foreign direct investment inflows (Tun et al., 2012). Institutional quality variables of economic freedom, ease of doing business and international country risk (ICRG) have a positive and significant impact on foreign direct investments inflow in Arab Economies (Aziz, 2018). Moreover, in a worldwide context are better business regulatory environments, as defined by the World Bank’s ease of doing business measure, attracting more foreign direct investment. One aspect of the business regulation stands out: the ease of trading across borders (Corcoran and Gillanders, 2015; Jovanovic and Jovanovic, 2018). Being in a cluster of countries with good trade regulation improves a country’s ability to attract foreign direct investment, while being in neighbourhood with bad general regulation (other than trade) reduces a country’s ability to attract foreign direct investment. U.S. companies are attracted by clusters of countries with good trade regulation, but shy away from countries that find themselves in bad general regulatory neighbourhoods (Corcoran and Gillanders, 2015).
9 that are foreign owned pay less taxes in the host country. Making the tax money flow towards countries with lower tax rates. This influence shows that subsidiaries get used by foreign firms to shift profits over country borders to reduce taxes. (Egger et al., 2010, p. 18)
Furthermore, reducing of taxes seems to be a driver for multinational firms to shift countries. Whereas ten percent higher tax rates are associated with five percent lower foreign direct investments. These tax effects are particularly strong within Europe, where ten percent higher tax rates are associated with 7.7 percent lower foreign direct investment and 1.7 percent lower returns on assets. Indirectly owned foreign affiliates also exhibit strong tax effects, ten percent higher tax rates being associated with 12.0 percent lower foreign direct investments and 1.4 percent lower returns on assets. U.S. firms finance a growing fraction of foreign operations indirectly through chains of ownership, which now account for more than 30 percent of aggregate foreign assets and sales. These ownership chains are particularly concentrated among European affiliates. Since multinational firms from countries other than the U.S. face tax environments similar to those faced by indirectly owned affiliates of U.S. companies, these results suggest a greater sensitivity of foreign direct investment to taxes for non-American firms. (Desai et al., 2003 p. 96)
10 To open a new firm in a country, there are several obstacles to face. All the procedures and time-consuming waiting periods are hideous for entrepreneurs. The financial cost of starting a business is a bigger hindrance to firm creation than the administrative or time costs.
This suggests that entrepreneurs are more financially driven by low costs than by an easier process when starting a business. Or that they are discouraged more by costs than by well-designed procedures (Canare, 2018).
In general, the presence of good institutions tends to improve productivity, which stimulates foreign investment. Efficient institutions reduce transaction costs, a crucial factor in the calculation of (foreign) investment revenues and is taken into account by foreign enterprises considering making investments abroad. In this context, efficiency refers to the ability to minimise transaction costs, which are mainly the costs of production, information about conducting business, logistical operations, and monitoring risk. These costs may arise due to inadequately protected property rights, undeveloped financial markets, weak incentive structures, widespread corruption or the absence of a properly regulated institutional system. (Dunning, 2004)
Transaction cost theory as a predictive model argues that both competitiveness and the form of the international operations of a multinational enterprise depend on the configuration of three critical elements; those three elements of the transaction cost theory of the multinational enterprises are: ownership specific advantages, location specific advantages and internationalization advantages. Ownership specific advantages or firm specific advantages refer to proprietary know-how (unique assets) and transactional advantages. Transactional advantages reflect the multinational enterprises’ capabilities of economising on transaction costs as a result of the multinational coordination and control of assets. In this context, recent research effort focusses on the multinational enterprise capability to develop optimal internal coordination and control mechanisms, while considering costs and benefits.
11 for internalization. These imperfections can be related towards government-imposed imperfections as well as natural market imperfections. The greater the benefit of participating in foreign markets, the more likely a firm will engage in foreign production rather than taking licencing agreements with other firms (Dunning, 1980; Rugman and Verbeke, 1992)
This transaction cost theory copes with two managerial issues, where on firm level two types of foreign direct investments must be distinguished; location and non-location bound firm specific advantages. Location bound firm specific advantages benefit a firm only in a specific location or set of locations and lead to national responsiveness benefits. These location-bound firm specific advantages cannot easily be transferred and require significant adaptation to be used in other locations, leading to eventual (partial) loss of these advantages. In contrary, non-location bound advantages can be exploited globally, profiting from national differences, different scopes, and benefits of scale. When these non-location bound firm specific advantages are transferred abroad in foreign direct investment, the advantage can be used effectively in foreign operations at low marginal costs without substantial adaptation. All multinational enterprises firm specific advantages of transaction cost nature fit typically into this category (Rugman and Verbeke, 1992).
On the other hand, multinational enterprises whose advantages are highly embedded in the home environment tend to adopt a multi-domestic strategy and decentralised organisational structures. Organisational embeddedness lowers the breadth of internationalisation of multinational enterprises and increases the tendency of these firms to employ a global strategy. Moreover, multinational enterprises whose competitive advantages are tacit and complex, have lower depth of internationalisation and tend to be more likely to expand into culturally similar countries as seen in the Uppsala model (Lo, Mahoney and Tan, 2011, p. 291; Johanson and Vahlne, 1977).
13 Multinational enterprises evaluate the markets and regulations to find the best fitting entry mode. In a situation with sufficiently low fixed cost where greenfield investments are a viable option and other foreign direct investment modes involve sufficiently low fixed costs a joint venture will be agreed to by the local firm, although the multinational enterprise prefers a joint venture to a merger. In contrary, multinational enterprises prefer mergers to greenfield investments if the fixed cost of greenfield investments are sufficiently large. However, if a greenfield investment is less profitable than exporting, local firms may refuse to participate in a joint venture, leaving the multinational to choose between mergers and acquisitions, and exporting (Raff, Ryan and Stähler, 2009, p. 4). Furthermore, multinational enterprises are found to prefer a joint venture with a host-country firm over a wholly owned subsidiary when: (1) the capabilities of the local firm complement those of the MNE: (2) the contributions of both firms are costlier to transfer contractually than through ownership channels, and (3) costs due to shirking by partners and conflicts between them do not outweigh the benefits of joint ownership.(Gomes-Casseres, 1988)
For subsidiary survival there are some important main effects of ownership, institutional distance, and host country experience. Furthermore, the effect of ownership is contingent on institutional distance and host country experience. In institutionally distant countries, subsidiaries have better survival chances if foreign parents have more ownership. Host country experience has a negative impact on subsidiary survival, but the effect is weaker if foreign parents have larger ownership positions in the subsidiary. (Gaur and Lu, 2007)
Ownership in subsidiaries tends to have cultural implications, multinationals from countries with a high power distance tend to want more ownership in subsidiaries as multinationals from low power distant countries. Furthermore, do firms that want to avoid uncertainty establish more fully- or majority owned subsidiaries. Cultural and economic factors combined create a nationality trait that influences foreign subsidiary ownership. Moreover, home market size tends to have a positive influence for a firm’s propensity for majority ownership. (Erramilli, 1996)
14 ownership for legitimacy in local industries than in host countries, and in local markets with high levels of political instability rather than in those with a low level of political instability. (Chan and Makino, 2007) Taking into account all the levels of uncertainty influencing ownership levels and that changes in the business environment leads towards more risk and thereby uncertainty. The following hypotheses is formulated:
Hypothesis 1a: The relative change of the Ease of Doing Business between home and host country market influences ownership structures of subsidiaries.
Hypothesis 1b: The relative change of the Ease of Doing Business between home and host country market does not influence ownership structures of subsidiaries.
In several studies has been found that not business environment as a whole, but parts of business environment are influencing foreign direct investments more than others. Often researched is the influence of entry regulations (Klapper et al., 2006; Bruhn, 2011), trade regulations (Corcoran and Gillanders, 2015; Jovanovic and Jovanovic, 2018) influencing openness (Beugelsdijk, Smeets and Zwinkels, 2008, p. 465), change in transaction costs (Dunning, 1980; Rugman and Verbeke, 1992) and spill-over effects (Desai, Foley and Hines, 2005), all influencing foreign direct investments. To test what factors in business environment are leading for this change, the following hypotheses is conducted:
Hypothesis 2a: The relative change of factors within Ease of Doing Business between home and host business environment influence ownership structures of subsidiaries.
Hypothesis 2b: The relative change of factors within Ease of Doing Business between home and host business environment influence ownership structures of subsidiaries.
3. METHODOLOGY
To find out if there is a relationship between fluctuating parts of Scandinavian business climates or the business climate as a whole and the amount of ownership a firm needs when entering a foreign market, a quantitative research will be conducted. The factors within business climates are made quantitative by the World Bank by creating ‘ease of doing business’ variables to be able to compare countries on the ability for firms to do business within them.
3.1 Data collection
15 doing business. Moreover, the gross domestic product data of the countries was conducted using desk research at the world bank.
The independent variable home and host business environmental change consists of ease of doing business data grouped per Scandinavian country, wherein a country gets a score between 0 and 100 based on topics concerning business climate, with 100 being a perfect score. Two steps are used to calculate the ease of doing business score. Firstly, individual component indicators are normalised to a common unit to rescale. Those 41 component indicators y (except contribution rate and total tax) are rescaled using linear transformation (worst – y)/ (worst – best). Here the highest score represents the best regulatory performance on the indicator across the economies (World Bank, 2020) With this method it becomes possible to rank countries. This ease of doing business construct is and average based on ten underlying variables. These variables are explained in table 3.1 Ease of Doing Business topics.
Table: 3.1 Ease of Doing Business topics
3.2 Data characteristics
Starting a business Procedures, time, cost, and paid-in minimum capital to start a limited liability company for men and women
Getting electricity Procedures, time, and cost to get connected to the electrical grid; the reliability of the electricity supply; and the transparency of tariffs
Registering property Procedures, time, and cost to transfer a property and the quality of the land administration system for men and women
Getting credit Movable collateral laws and credit information systems Protecting (minority)
investors
(Minority) shareholders’ rights in related-party transactions and in corporate governance
Paying taxes Payments, time, and total tax and contribution rate for a firm to comply with all tax regulations as well as post filing processes
Trading across borders Time and cost to export the product of comparative advantage and to import auto parts
Resolving insolvency Time, cost, outcome, and recovery rate for a commercial insolvency and the strength of the legal framework for insolvency
Dealing with construction permits
Procedures, time, and cost to complete all formalities to build a warehouse and the quality control and safety
mechanisms in the construction permitting system
16 The dependent variable ownership is data grouped in five groups per ownership category. The groups are: A, for independent companies – those with known recorded shareholders, each of them having less than 25 percent of direct or total ownership of the company. B, companies with known recorder shareholders with ownerships below 50 percent, but with one or more shareholders with ownership percentages above 25 percent. C, companies with known recorded shareholders that have a total or calculated ownership above 50 percent. D, companies with a recorded shareholder that has a direct ownership above 50% and U, Companies with an unknown degree of ownership concentration. (Horobet, et al., 2019)
Gross Domestic Product data are derived in the same years as the ease of doing business data (2012 and 2014), in order to control for changes coming from more business activity per country. However are these expected to have a correlation, because when a country has an improving dealing with construction permits, protecting minority investors, paying taxes, trading across borders and resolving insolvency, Gross Domestic Product rises as well (Estevão, et al., 2020).
The data about the different sectors is derived from the Swedish firms investing in other Scandinavian countries. There are 17 different sectors present in this data: 1. Banks 2. Chemicals, rubber, plastics, non-metallic products; 3. Construction; 4. Education, Health; 5. Food, beverages, tobacco; 6. Gas, Water, Electricity; 7. Hotels & restaurants; 8. Machinery, equipment, furniture, recycling; 9. Metals & metal products; 10. Other services; 11. Post & telecommunications; 12. Primary sector; 13; Publishing, printing; 14. Transport; 15. Wholesale & retail trade; 16. Wood, cork, paper; 17. Textiles, wearing apparel, leather. These sectors are the main sectors that companies are active in.
3.3 Research method
17 economies and over a timespan of two years. These differences are going to be tested towards the dependent variable “level of ownership” between 2014 and 2016, because of the delay in decision making firms have when considering foreign direct investments. (Wei and Christodoulou, 1997)
Table 3.2 Correlation matrix
3.4 Correlation
Reviewing the correlation coefficients of Table 3.2 Correlation matrix, multicollinearity issues arise as there are multiple correlated independent variables. Some of these variables seem to be influenced by the same constructs or are measuring the same constructs. To overcome these multicollinearity issues, a factor analysis will be conducted to merge several variables that are measuring the same constructs. Furthermore, is no change found in getting credit between Sweden and other Scandinavian countries in the given timeframe. Moreover, in protecting minority investors and getting electricity is the difference over those years both less than 0.02, which is not variance to be able to include them in factor analysis and regression.
3.5 Factor analysis
The factor analysis conducted results in three values with an eigenvalue higher than 1. However, the variable ΔTaxes tends to be a stand-alone variable because of a high factor loading on component 1 (.766) and a high factor loading on component 2 (.662). So ΔTaxes is excluded from the factor analysis. As made visual in Graph 3.1: Factor Analysis; the included variables have high factor loadings on factor 1: trading across borders (-1.015), enforcing contracts (.981), starting a business (.981) and dealing with construction permits (.928). Furthermore,
Kendall's Correlation d e lt a tra d in g d e lt a st a rt in g d e lt a in so lve n cy d e lt a p ro p e rt y d e lt a in ve st o rs d e lt a ta xe s d e lt a e le ct ri ci ty d e lt a cre d it d e lt a e n fo rci n g d e lt a co n st ru ct io n d e lt a e o tb 1 4 1 2 deltatrading 1,000 -,991** ,257** -,257** ,094** -,982** -,094** -,989** -,564** -,564** deltastarting 1,000 -,257** ,257** 0,005 ,992** -0,005 ,998** ,573** ,573** deltainsolvency 1,000 -1,000** -0,048 -,266** 0,048 -,262** ,170** ,170** deltaproperty 1,000 0,048 ,266** -0,048 ,262** -,170** -,170** deltainvestors 1,000 ,094** -1,000** 0,049 0,005 0,005 deltataxes 1,000 -,094** ,998** ,565** ,565** deltaelectricity 1,000 -0,049 -0,005 -0,005 deltacredit deltaenforcing 1,000 ,570** ,570** deltaconstruction 1,000 1,000**
18 Factor 2 consists of resolving insolvency (1.025) and registering property (-.918). These two factors explain 98.80 percent of variance of the ease of doing business variables.
Graph 3.1: Factor analysis
3.6 Analysis
The method of analysis will be a linear regression to find how the variables and factors relate to different ownership structures when Swedish firms invest in other Scandinavian countries. Models will be created to stepwise insert all variables into the regression analysis and to control for other variables influencing results. The first model includes the delta of overall ease of doing business factor of the years 2014 and 2012 regressed towards the delta of ownership structures of the years 2016 and 2014. The second model includes the two factors created in the factor analysis and paying taxes on the delta of ownership structures. Model 3 includes the two factors created in the factor analysis and paying taxes and the control variables GDP and Sector on the delta of ownership structures.
3.7 Validity and reliability
19 within those countries; however, these factors have not changed from 2012 till 2016. Furthermore, there are control variables added to make sure that differences in sector or GDP do not influence the results.
4. FINDINGS
In this analysis the independent variables will be tested towards the dependent variable ownership structure difference in the years 2014 till 2016. The first independent variable is ΔEOTB1412 explaining delta between the difference of all Ease of Doing Business factors between the main country Sweden and the Subsidiary countries in other parts of Scandinavia. The second independent variable is the delta of the “paying taxes” construct of the world bank between Sweden and subsidiary countries and between 2012 and 2014. The third independent variable is Factor 1: derived from factor analysis and includes the delta of the differences between Sweden and subsidiary countries on the ease of doing business parts: trading across borders, enforcing contracts, starting a business and dealing with construction permits over 2012 till 2014. The fourth independent variable is Factor 2 also derived from factor analysis, explaining the delta constructs resolving insolvency and registering property between Sweden and subsidiary countries over the years 2012 till 2014.
To control for changes in ownership structures not influenced by ease of doing business factors, the delta of the GDP between Sweden and the subsidiary countries is taken into account for the years 2012 till 2014. Moreover, the sectoral differences are also weighted, to find out if the variance of ownership structures might be influenced by factors not included in ease of doing business variables.
The variables ΔEOTB1412, Δ Taxes, Factor 1, Factor 2 and ΔGDP are continuous variables. Whereas the sector data is categorised in seventeen categories and subsidiary country data is categorical and includes four countries.
Graph 4.1: Descriptive statistics
20 Since none of the VIF values where below 0.1 and none of the tolerance values were above 10, the assumption of no multicollinearity has been met. Durbin-Watson statistics fell within an expected range, thus indication that the assumption of no autocorrelation of residuals has been met as well. Finally, the scatterplot of standardised residual on standardised predicted value did not funnel out or curve, and thus the assumptions of linearity and homoscedasticity have been met as well.
Variable\model Model 1 Model 2 Model 3
ΔEOTB1412 .574*** (11.133) ΔTaxes 6.874*** (89.609) 6.280*** (89.451) Factor 1 .574*** (-14.681) .573*** (-14.638) Factor 2 -1.040*** (36.597) -1.241*** (36.561) ΔGDP .286*** (78689211.5) Sector -4.552e-15*** (0) Constant .101*** (2.069) 3.98*** (-14.681) -.437*** (-14.112) Rsquared .106 .739 .768 N 1057 1055 1055 ***= p<0.001
Graph 4.2: Regression output
21 cent of the variance, it can give direction on this research. To overcome multicollinearity issues between the overall Ease of Doing business and ΔTaxes and factor 1 and factor, the overall ease of doing business variable is not included in model 2 and 3.
Model 2 is measuring the independent variables delta taxes, factor 1 and factor 2, This model is explaining 73.9 percent of the variance of ownership levels. There is significant statistical correlation found in delta taxes of β=6.874, this means that when taxes relatively increase, Swedish firms want to achieve more ownership when doing foreign direct investments. Factor 1 consisting of trading across borders, enforcing contracts, starting a business and dealing with construction permits has statistical correlation (β=.574) with ownership structures. This means that when it gets relatively easier to enforce contracts, start a business and deal with construction permits, firms tend to have more ownership when doing foreign direct investments. On the other hand, trading across borders loads negatively on this factor, therefore when trading across borders gets relatively easier, firms tend to have less ownership when doing foreign direct investments. Factor 2 including resolving insolvency and registering property correlates significantly with ownership structures (β=-1.040). This correlation explains that when resolving insolvency rises, less ownership is found in foreign subsidiaries. Furthermore, that when improving registering property variables are found, more ownership in foreign subsidiaries is found.
Model 3 shows how the control variables ΔGDP and the Sectors influence the correlations between model 2 and the dependent variable ownership in subsidiaries. First of all, does this model explain more of the variance (Rsquared= .768) than model 2. The presence of these control variables influences the correlation coefficients of the independent variables; however, it does not change signs in the model. With a significant correlation coefficient of -.286 does ΔGDP correlate with ownership structures. Moreover, does sector correlate with ownership structures. For the variable ΔTaxes does the presence of the control variables lower the correlation significantly from 6.874 to 6.280 with ownership structures in subsidiaries. For factor 1 is only a difference of -.001 measured. In model 3 did factor 2 decrease significantly in correlation with subsidiary ownership levels from -1.040 till -1.241. This model 3 tends to have a good fit with 76.8 percent explained and 1055 cases included. What will lead towards the next calculation to explain the level of ownership in a subsidiary:
Level ownership in a subsidiary =
22
5. DISCUSSION
In this study has been found that if the overall ease of doing business factors are positively correlating with the levels of ownerships of firms in subsidiaries. This can have implications from both home business environment and host business environment. This fits with the conclusions of Raff, Ryan and Stähler, that multinational enterprises evaluate the markets and regulations to find the best fitting entry mode. In a situation with sufficiently low fixed cost where greenfield investments are a viable option and other foreign direct investment modes involve sufficiently low fixed costs a joint venture will be agreed to by the local firm, although the multinational enterprise prefers a joint venture to a merger. In contrary, multinational enterprises prefer mergers to greenfield investments if the fixed cost of greenfield investments are sufficiently large (Raff, Ryan and Stähler, 2009, p. 4). However, what is found in this study is when a greenfield investment is less profitable than exporting, local firms may refuse to participate in a joint venture, leaving the multinational to choose between mergers and acquisitions, and exporting. Furthermore, when firms are only exporting from their own country, they are not opening subsidiaries and are not present in this data. Leading towards a visible increase in ownership levels in subsidiaries. Moreover, when in other countries doing business gets harder, the uncertainty rises in those markets (Erramilli, 1996), leading towards uncertainty avoidance by firms in the home country Sweden. However, Sweden is very low on uncertainty avoidance, what means that when it gets harder in the host country market, they are unlikely to change their strategies. The correlation between ease of doing business and ownership can be explained by contribution cost, when the ease of doing business deteriorates, the contributions of both firms will become costlier to transfer contractually (than through ownership channels), what will lead towards more joint ventures (lower ownership levels) (Gomes-Casseres, 1988). Moreover, costs due to shirking by partners and conflicts may rise if the ease of doing business gets worse till a point that they do not outweigh the benefits of joint ownership (Gomes-Casseres, 1988).
23 it will get relatively worse in the home country to pay taxes, what will lead towards less foreign direct investments for domestic firms. Where a 10 percent higher tax rate is associated with a decline in foreign direct investments of 7.7 percent (Desai et al., 2003 p. 96). So there seems to be a point where domestic firms can evade from home country tax difficulties, however if these firms cannot quickly move towards other countries their foreign direct investment capabilities will be limited. In contrary, when there is a relatively deteriorating subsidiary country ease of paying taxes, the firm in the home country tends to expand with lower ownership levels within their subsidiaries. So, for firms in countries where it gets easier to pay taxes are more likely to expand abroad and go for a joint venture instead of a merger and acquisition. This can be explained by the lack of financial incentive to fully- or majority-own a foreign plant.
Factor 1 consisting of relative changes of enforcing contracts, starting a business, dealing with construction permits and trading across borders has a positive influence ownership levels within subsidiaries. Therefore, a relatively bettering enforcing contracts value in the subsidiary country tends to positively increase the level of ownership within subsidiaries. This empirical finding is not in line with the findings of Lien and Filatotchev, they found that if it is difficult to enforce contracts, also joint venture contracts are difficult to enforce and to overcome these issues firms are more likely to go for more ownership entry modes (Lien and Filatotchev, 2015, p. 638). It can be possible that also merger and acquisition contracts get more difficult to enforce, resulting in more joint ventures because of familiarity with of the other firm with the host market. The regression analysis also found that a relatively bettering starting a business value in the subsidiary country contributes to a higher level of ownership structure in those countries. When it is easier to start a business, it becomes easier to do a greenfield investment and to start your own plant, as the entry costs to move to that market decline. This is also in line with findings of Canare, that when the entry costs decline, entrepreneurs are more likely to enter the market because financial obstacles to start a business are their main hindrance (Canare, 2018). On the other hand, a relatively deteriorating starting a business variable in the host country leads towards lower levels of ownership. When starting a business gets more difficult, means that the costs for a greenfield entry mode rise, what leads towards a choice between mergers and acquisition and a joint venture. And according to this empirical study, a joint venture ownership structure is more common in this situation.
24 Stähler, 2009). Therefore, joint ventures can be a solution, when the other local firm already has a building, or can get construction permits more easily.
Trading across borders loads negatively on factor 1. Therefore, when trading across borders gets relatively easier, the ownership level decreases. This is explained by Lien and Filatotchev because even when firms are willing to assume the risks associated with internationalization, the threat of uncertainties combined with local partner opportunism may ultimately steer their investments away from distant locations and toward better-known locations. Furthermore, the fact that investing firms can safeguard their foreign direct investments from an overseas partner’s opportunism by seeking a majority ownership stake in their foreign ventures. (Lien and Filatotchev, 2015, p. 638) This means that when a partner opportunism can be held down by low trade costs and enforcing contracts, the ownership level lowers, because joint ventures become more attractive.
Factor 2 consisting of resolving insolvency and registering property has a negative relation with ownership levels within subsidiaries in Scandinavia. If resolving insolvency relatively gets better in the host country, the level of subsidiary ownership decreases. So when firms are expanding towards a country that is better in resolving insolvency, the firms do not have to safeguard their foreign direct investments from an overseas partner’s opportunism by seeking a majority ownership stake in their foreign ventures (Lien and Filatotchev, 2015, p. 638). By not having to hold a high controlling stake in their foreign subsidiaries, firms do not have to fully own a subsidiary to enjoy better legal protection. Therefore, are foreign direct investment location decisions, especially in risky areas of emerging markets, also affecting the choice of subsidiary ownership structure.
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5.1 Limitations
This study has a few limitations. First it looks only at secondary country level data, were it is dependent upon the availability and correctness of the data collection of Orbis. Moreover, dependency on the ease of doing business measure by the world bank, computing scores for all business environments worldwide. However, the ease of doing business score is a widely used comprehensive measure to declare cross-country regulatory differences. Furthermore, was due to a lack of variance between Sweden and the subsidiary countries it not possible to include three ease of doing business variables. Unfortunately, the variables that were included were correlated, so they could not be tested separately. Moreover, is a limitation that the study is only conducted for Scandinavian countries, this construct would have been more powerful if it was conducted in more places over the world, also including more distant subsidiary countries. Due to time and money limitations it has not been possible to include more of these countries into the model.
6. CONCLUSION
Empirical evidence has been found that the relative change of ease of doing business factors between the home and host country do influence the ownership structures of foreign subsidiaries. The overall doing business indicator is positively influencing the level of ownership in the subsidiary country. When the business environment gets better in the host business country in comparison with the home business country, firms tend to be more likely to go for a higher ownership entry mode. This means that mergers and acquisitions or greenfield investments are more likely to happen, in contrast to joint ventures. The relation between ease of doing business and ownership can be explained by contribution cost, when the ease of doing business deteriorates, the contributions of both firms will become costlier to transfer contractually (than through ownership channels), what will lead towards more joint ventures (lower ownership levels) (Gomes-Casseres, 1988). Moreover, costs due to shirking by partners and conflicts may rise if the ease of doing business gets worse till a point that they do not outweigh the benefits of joint ownership (Gomes-Casseres, 1988).
The driving value in the business environment for changes in ownership levels is first of all paying taxes. For firms in countries where it gets easier to pay taxes are more likely to expand abroad and go for a joint venture instead of a merger and acquisition. This can be explained by the lack of financial incentive to fully- or majority-own a foreign plant, because the tax situation in the host country relatively deteriorates.
26 permits, registering property and resolving insolvency. Concerning the value enforcing contracts there is an contradictory finding with the literature, where Lien and Filatotchev, found that if it is difficult to enforce contracts, also joint venture contracts are difficult to enforce and to overcome these issues firms are more likely to go for more ownership entry modes (Lien and Filatotchev, 2015, p. 638). It can be possible that also merger and acquisition contracts get more difficult to enforce, resulting in more joint ventures because of familiarity with of the other firm with the host market.
Furthermore, the next value of business environment that empirically is substantiated is starting a business, when it is more easy to start a business, it becomes easier to do a greenfield investment and to start your own plant, as the entry costs to move to that market decline. Another factor driving the influence of business environment is dealing with construction permits, this can be explained in a situation wherein dealing with construction permits gets more difficult. Then it will be harder for firms to build new production plants or other buildings for their greenfield investments. Therefore, joint ventures can be a solution, when the other local firm already has a building, or can get construction permits more easily.
Furthermore, the next value in business environment is trading across borders, this value is important for all international trade and therefore the main driver of trade within ease of doing business. Trading across borders is positively empirically related with increasing ownership levels. This means that when a partner opportunism can be held down by low trade costs and enforcing contracts, the ownership level lowers, because joint ventures become more attractive. Furthermore, resolving insolvency is empirically influencing the ownership levels of subsidiaries. If resolving insolvency relatively gets better in the host country, the level of subsidiary ownership decreases. Therefore, when firms are expanding towards a country that is better in resolving insolvency, the firms do not have to safeguard their foreign direct investments from an overseas partner’s opportunism by seeking a majority ownership stake in their foreign ventures.
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Future research
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4. APPENDICES
Appendix I: Factor loadings
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Appendix III: Frequency statistics
Sector Frequency Percent Banks 362 32.0 Chemicals, rubber, plastics, non-metallic products 13 1.1 Construction 79 7.0 Education, Health 47 4.1 Food, beverages, tobacco 3 .3
Gas, water, Electricity 9 .8 Hotels & restaurants 46 4.1 Machinery, equipment,
furniture, recycling
139 12.3
Metals & metal products 30 2.6 Other services 219 19.3 Post & Telecommunications 20 1.8 Primary sector 1 .1 Publishing, Printing 4 .4 Transport 14 1.2
Wholesale & Retail trade
52 4.6
Wood, cork, paper 30 2.6
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Appendix IV: Subsidiary countries
