FDI
AND THET
RANSITIONT
OWARDSG
OODG
OVERNANCE:
ASEAN
ANDT
HEC
ONFLICTINGV
ALUES OFG
OVERNANCEP
RINCIPLESSupervisor:
Dr. R.W. de Vries
Co-Assessor:
Dr. O. Lindahl
Name: Atika R. Winardono
Student number: S2919850
Abstract
Globalization has been one of the major drivers to the worldwide growth in economic development with various kinds of international trade and investment activities as tools to allow for capital mobility. Foreign direct investment (FDI) has become one of many entry modes chosen by multinationals to expand their businesses abroad to countries or regions perceived to be attractive investment destinations, such as ASEAN. Major economic growth and production in member countries of ASEAN have captured the attention of foreign investors. However, multinational companies are exposed to different kinds of challenges, uncertainties and risks that are specific to different regions or countries when they engage in FDI. This paper aims to look at the different indicators underlying the governance system that are specific to ASEAN countries and how it correlates to FDI inflow to the member countries. Using panel data from 1998 to 2018, I conducted tests for the governance indicators of all ASEAN member countries to the FDI inflow. However, the outputs do not provide any support for the hypotheses and that further study, specifically interdisciplinary study, might offer better insights into the complexity of the problem.
Chapter 1: Introduction
Previous studies show that FDI and corporate governance are interrelated, as well as providing evidence that large part of FDI is intra-regional with institutional quality as one of the important determinants (Cheung & Chan, 2004; Claessens & Yurtoglu, 2013; Farooque, Yarram, & Khandaker, 2009; Magasházi, 2015; Masron, 2017; Masron & Nor, 2013; Morrissey & Udomkerdmongkol, 2012; OECD, 2004a; Ullah & Inaba, 2014; Vogiatzoglou, 2016). There are three streams of research that study the preferential trade policies and geographical proximity as the drivers of FDI flows. The first stream of research has provided arguments that FDI flows are driven by preferential trade policies (Cheung & Chan, 2004; Magasházi, 2015; Ullah & Inaba, 2014). The second one argues that FDI flows are determined by geographical proximity (Krugman, 1991; Summers, 1991). The last one suggests that both preferential trade policies and geographical proximity can affect FDI flows (Frankel & Wei, 1997). These arguments were tested based on the gravity model and the concept of distance.
inflow is driven by institutional quality—holds true in the case of the Association of Southeast Asian Nations (ASEAN). The Asian Development Bank described ASEAN as ‘extremely diverse, yet bound by a common desire for peace and prosperity for its people, ASEAN gradually broke through barriers that previously blocked cooperation in fighting common problems. Today, ASEAN is a unique model for socio-economic integration – widely recognized globally’ (Asian Development Bank Institute, 2014, p. 4).
On one hand, ASEAN has established a unique system with a set of norms that member states still strongly hold onto and is affecting their interactions, which was built upon the adoption of the non-interference principle or: (1) the preference of informal cooperation and a shared unfavourable views for the institutionalization of cooperation, and (2) the consensus built upon consultation that is based on equality and tolerance (Acharya, 1997, 2004, 2008, 2009a, 2009b; Antolik, 1990; Haacke, 2003; IMF, 1995). On the other hand, the OECD has criticized the system and has provided guidelines to move towards good governance based on the humanitarian
intervention principle that: (1) aims to serve the population interest, and (2) address
how to best respond to future humanitarian crises (Dunn, Nyers, & Stubbs, 2010; Lu & Batten, 2001; OECD, 2004a, 2004b, 2011, 2014, 2019).
Considering the correlation between FDI and corporate governance, this interaction dynamic might have direct implications for firms or investors. According to Pugel (2016), multinational enterprises have inherent disadvantages against foreign competitors when they enter a foreign market, and therefore their investment strategy decisions are determined by firm-specific advantages, location and internalization factors, as well as competition in the market. Additionally, as suggested by Dunning’s OLI model, investment decisions of multinational firms are motivated by the ownership advantage of specific assets, location advantage to exploit the firm-specific assets in multiple countries, and internalization advantages (Madhok, 1997; Rugman, 2006; Verbeke, 2013).
Though there is a clear interdependency between FDI and corporate governance as discussed earlier, it is unclear in the case of ASEAN whether the FDI inflows are driven by the adherence to governance principles based upon the
non-interference principle or by the subtle transition into governance principles based
principle are consistent with the stewardship theory, while the underlying values of the humanitarian intervention principle are consistent with the agency theory. Stewardship theory promotes collaborative cooperation based on collectivist behaviour, while agency theory promotes the use of monitoring systems to control individualistic and opportunistic behaviour (Sundaramurthy & Lewis, 2003). The two conflicting principles result in a theoretical paradox embedded in the transition process of the ASEAN corporate governance system.
Building upon this dynamic, the research question of this paper is:
To what extent do the humanitarian interference principle, used as a base of the OECD Principles of Good Governance, correlate with FDI inflows to ASEAN member states after the member countries adopted the OECD Principles?
This paper is structured as follows. In the following section, a historical background is provided. The third chapter shows a review of relevant literature. The literature review is divided into two subsections: (1) FDI theories; and (2) corporate governance theories. Gaps in practical application are discussed in chapter four. Hypotheses construction and conceptual model are presented in chapter five. Chapter six focuses on the methodology. Statistical analysis and discussion are presented in chapter seven. Lastly, the conclusion and limitations are presented in chapter seven.
Chapter 2: Historical Background
2.1 The History of ASEAN
communication, and living standards, promoting South-East Asian studies, as well as to maintain close and beneficial cooperation between, but not limited to, the member states of ASEAN (ASEAN, 1967). Member states have also agreed to a few mechanisms placed to ensure that the work is being carried continuously towards the goals of the association, including arranging annual meetings for foreign ministers from each member state.
Based on the commonly shared problems, mutual interests, as well as ties of history and culture, member states of ASEAN have built normative behaviour to which they share collective interpretations and understandings. This normative behaviour then resulted in the development of a unique approach regarding the political and security operation. There are six norms at the core of this normative terrain, which are the principles of sovereign equality, the non-recourse to the use of force and the peaceful settlement of conflict, non-intervention and non-interference, quiet diplomacy, mutual respect and tolerance, and the principle of not involving ASEAN in mediating bilateral disputes among the membership (Haacke, 2003). In his book, Haacke (2003) discussed that the norms of the ‘ASEAN way’ were applied long before the formation of ASEAN itself. The emergence of the so-called “ASEAN way” was due to some major events in the region, which originated back to the Bandung Conference in 1955, the experience of konfrontasi – a course of confrontations that include hostile acts between the neighbouring countries Indonesia, Malaysia and Singapore – major power rivalry and the post-formation phase of ASEAN (Haacke, 2003; Severino, 2002, 2006; Tan & Acharya, 2008). Although the norm seems new, the principle that base the 'ASEAN way' is rooted in the Southeast Asia tradition following Hindu-Buddhist cosmological principle, which then led to a formation of a distinctive characteristics of ASEAN as a cooperative, consultative organization instead of a supra-national organization (Haacke, 2003; Heine-Geldern, 1942; Tambiah, 1987; Wah, 1995).
working to achieve regional economic integration, and seeking regional solutions to solve regional problems. Though member states possess rich cultures, religions, languages, histories and natural endowments, along with a history of conflicts, the member states of ASEAN seem to have developed common characteristics and interests to work together to become a free-trade area or integrated economy (ASEAN, 1967; Severino, 2002). Severino (2002) also stated that the countries in Southeast Asia have reached a point of remarkable economic dynamism, shown by adopting the market-driven approach to encourage development, consciously and actively keeping their doors open to the rest of the world, opening up their trade regimes, welcoming foreign direct investment, and encouraging private enterprise and entrepreneurship.
When ASEAN was founded in 1967, it was originally established for political and security purposes (ASEAN, 1967; Asian Development Bank Institute, 2014; Frankel & Wei, 1997), until the first ASEAN Leaders’ Summit in 1976. The summit introduced important economic agenda to encourage trade and investment liberalization, which then led to the declaration of ASEAN as a preferential trade area, or trading bloc, in 1977 (Asian Development Bank Institute, 2014; Frankel & Wei, 1997).
According to the Asian Development Bank Institute (2014), the economies of ASEAN founding members (Indonesia, Malaysia, the Philippines, Singapore, and Thailand) in the early 1990s were considered to be an integral part of the “East Asian Miracle.” Following the expansion of the association membership, with the admission of CLMV countries (Cambodia, Lao PDR, Myanmar, and Viet Nam), numerous initiatives for cooperation have been introduced by the association (Asian Development Bank Institute, 2014).
The preferential trade area, or trading bloc, then led to the decision to form a few other major economic cooperation, such as the ASEAN Free Trade Area (AFTA) in January 1992, the ASEAN Framework Agreement on Services (AFAS) in 1995, and the ASEAN Investment Agreement (AIA) in 1998 by the ASEAN Economic Minister (Asian Development Bank Institute, 2014; Frankel & Wei, 1997).
to encourage higher investment flow to ASEAN member states’ manufacturing sectors by ASEAN investors. He then stated that due to the Asian financial crisis in 1997-1998, ASEAN decided to promote intra-regional investments to which the leaders of member states agreed on at the sixth ASEAN summit in Hanoi in 1998. Throughout the years, ASEAN has achieved many milestones in integrating the economy of its member states (Figure 1.1) (Asian Development Bank Institute, 2014). According to Frankel and Wei (1997), a review of previous studies concluded that trade flows within ASEAN were relatively low compared with other regions of the world despite the efforts made. However, they challenged the view and argued that low levels of trade in the ASEAN region depend upon what metrics were used to measure the investment flows. Furthermore, ASEAN are considered to be historically one of the destinations of world FDI as they have established economic and trade agreements throughout the years — such as the AFTA and AIA that were proven to be strong drivers pushing the emergence of regional investors — which shows that two ASEAN countries trade six times more than two otherwise similar countries (Frankel & Wei, 1997; Masron, 2013; Winters & Wang, 1991).
The establishment of the ASEAN Community in 2003, the adoption of the ASEAN Charter and the creation of the Committee of Permanent Representatives in 2007 resulting in a higher economic growth to ASEAN member countries. According to Asian Development Bank Institute (2014), ASEAN represents one of the major economic blocs with the population of 620 million people and gross domestic product (GDP) of more than $2.3billion or 3.3% of the world total. ASEAN economies are also considered to be one of the world’s most open economies for trade with merchandise exports of more than $1.2 trillion or nearly 7% of the world total (Asian Development Bank Institute, 2014). The Asian Development Bank Institute (2014) also pointed out that ASEAN economic growth in a regional context is comparable to other Asian economies (see Appendix 2).
to become the primary players in ASEAN market. Their study conclusions emphasize the importance of national policies reformulation to encourage and include local players in the long-term economic development strategy of the region.
Source: Asian Development Bank Institute (2014, p. 5)
2.2 The OECD Principles of Good Governance: What Is the Difference? Good governance systems are different for every country. A study by Marquis and Raynard (2015), which focuses on institutional strategies in emerging countries, identified what are the critical factors and produced an integrated perspective of institutional strategies. They were able to classify economic conditions and institutional differences based on different types of markets (see Appendix 1). Another set of studies (Guthrie & Turnbull, 1995; Khanna, Kogan, & Palepu, 2006; Maassen, 2002; Sheridan & Kendall, 1992) have also concluded that different national systems have different ideas to what constitutes good governance, and therefore each of them has different corporate governance systems, which then are used as multiple strategies by various cultures to secure the agents processing the corporate information to the user.
legalistic decision-making procedures. The OECD Principles of Good Governance acknowledge that ownership structure in majority of Asian countries is dominated by family-ownership, and therefore there is a need for effective rules and regulations to protect shareholders to avoid expropriation; pointing out the importance to change relationship-based governance to rules-based governance through legal framework and control, enforcement of laws, the role of authorities and judicial systems, and cross-border enforcement by bilateral or multilateral arrangements (OECD, 2004a, 2004b, 2011, 2014). These differences in bargaining styles between the two systems are aligned with the governance approaches by the agency theory and the stewardship theory that will be explained in the next section. On one hand, the ASEAN Way interaction is aligned with the stewardship theory, with the non-confrontational approach and advise-based systems that are based on the non-interference principle. On the other hand, the OECD Principles system is aligned with the agency theory, with stricter negotiation approach and legalized control systems that are based on the humanitarian interference principle, which will be discussed further in chapter 4.
Chapter 3: Literature Review
3.1 The Theories of Foreign Direct Investment Flows
By definition, foreign direct investment – or FDI – is ‘the flow of funding provided by an investor or a lender (usually a firm) to establish or acquire a foreign company or to expand or finance an existing foreign company that the investor owns and controls’ (Pugel, 2016, p. 336); or according to Dunning and Rugman (1985), international production. In his book, Pugel (2016) also explains how FDI benefits a host country, namely increasing job opportunities, business expansion or supplier opportunities, increasing tax collected by the government, knowledge and technological spillovers, as well as sources of additional skilled workers or other intangible assets provided by foreign multinational firms. However, by deciding to invest in FDI, an MNE is also exposed to competition from host countries companies or any other foreign companies operating in a chosen host country.
the field is also known as the Heckscher-Ohlin-Samuelson model, which explain that trade is also affected by the opportunity costs arising from the differences of factor endowments of capital and labour between different countries. Among the other factors considered to be important are the fluctuations of direct and indirect labour quantity, price level (cost of labour divided by productivity), technology differences, and factor endowments (Bernhofen & Brown, 2018; Beugelsdijk et al., 2013; Stigler, 1958).
Patterns of FDI flows can also be explained with the concept of distance. There are five distances that will affect the decision to invest in a foreign country: geographical distance, cultural distance, institutional distance, economic distance and language distance (World Bank, 2008). Consistent with the concept of distance, countries tend to trade with their neighbours with close geographical proximity in order to reduce costs associated to shipping expenses, time lags, and cultural barriers (Frankel & Wei, 1997; Krugman, 1991; Summers, 1991).
In the study of FDI behaviour based on economic determinants, it is important to acknowledge that different locations put different levels of importance toward FDI and that these determinants result in various aspects of investments, namely: (1) motive of FDI; (2) mode of entry; (3) investment sectors or industries; and (4) investor size (Dunning, 2003; Masron & Yusop, 2012). Masron and Yusop (2012) further discussed that when entering host countries, companies have different motives which commonly determined as: (1) resource-seeking FDI; (2) market-seeking FDI; (3) efficiency-seeking FDI; and (4) strategic asset-seeking FDI. According to Masron and Yusop (2012), companies with resource-seeking motives will engage in FDI to look for a location with resource abundance. Second, when companies have market-seeking motives, they will look for the market size of a country or a region. Next, efficiency-seeking motives drive companies to focus on low production costs, which push them to invest in locations with low labour cost. Lastly, companies with strategic asset-seeking motives engage in FDI to earn the competitive advantage of host country’s uniqueness in a form of strategic assets, such as technology (Makino, Lau, & Yeh, 2002; Masron & Yusop, 2012).
governance are interdependent, with the implication that FDI is determined by governance and vice-versa. They also find that the interdependence still holds when they controlled for macroeconomic factors, time, region, and income factors. The further implication of their study is that sustainable actions are needed to improve the countries’ governance systems.
3.2 The Theories of Corporate Governance
Corporate governance has various definitions depending on whom it concerns, though they commonly fall into two categories, namely behavioural and normative (Claessens & Yurtoglu, 2013; Tricker, 1993). According to Claessens and Yurtoglu (2013), the behavioural definition of corporate governance focuses on the actual sets of behaviours shown by companies, such as performance, financial structure, efficiency, growth, as well as relationships with shareholders and stakeholders. They also define normative corporate governance as the rules affecting companies operations, such as the legal system, the judicial system, and the rule of the financial or labour markets. Furthermore, Claessens and Yurtoglu (2013) discussed that behavioural definition of corporate governance is suitable to study a single country or companies within one country, as it focuses on direct behaviour of the subject of the study. Meanwhile, the normative definition of corporate governance is more suitable in a comparative study, as it focuses on the differences of the rule of the game that affect the behavioural pattern in the subjects of the study.
However, Claessens and Yurtoglu (2013) further discussed that it is important to define how broad is the framework when one decides to do a comparative review of corporate governance and stress that both rules and institutions matter in reality, choosing one of them can be misleading. They divided the definition into two, which are the rules in capital markets and the protection of outside investors. The first one focuses mainly on indicators such as listing requirements, insider dealing arrangements, disclosure requirements, and protection of minority shareholder rights; the second one also focuses on indicators such as minority right protection, as well as the strength of creditor rights, requirements on the composition of the executive directors, the rights of executive directors, and the ability to pursue class-action suits (Claessens & Yurtoglu, 2013).
Other than the behavioural versus normative framework of corporate governance, the governance system can also be explained with the use of agency theory and stewardship theory.
According to Sundaramurthy and Lewis (2003), agency theory focuses on the costs and limitations of strict control mechanisms, while the stewardship theory focuses on contextual factors that may hinder or allow a collaborative approach. They suggest that the agency theory has a theoretical base on economics and finance, while the stewardship theory has a theoretical base on sociology and psychology.
Sundaramurthy and Lewis (2003) further differentiate between control and collaboration. They argue that control highlights goal conflicts between principals and agents, which based on the challenge of individualistic and opportunistic behaviour, as well as the extrinsic motivation of human tendencies. Meanwhile, collaboration highlights collective goal alignment conflicts, which based on the challenge of groupthink or collective bias to decision making, as well as human tendencies that are ‘collectively oriented and intrinsically motivated’ (Sundaramurthy & Lewis, 2003, p. 398).
Although the level of analysis in their study is on the firm level, the underlying assumptions of the two theories fit with the case of ASEAN. Based on these assumptions, the collaboration approach results in service and an advice-based system, which is aligned with the values of the ASEAN Way. Meanwhile, the control approach results in strict control or monitoring mechanisms, which is aligned with the values of the OECD Principles.
Chapter 4: Gaps in Practical Application
4.1 ASEAN and Strong Adherence to the Non-Interference Principal In the case of ASEAN, they choose to follow the ‘socio-cultural norms’, which is the preference for an informal and shared perspective that the institutionalization of cooperation is not desirable, as well as consensus built upon consultation based on equality and tolerance (Acharya, 2004, 2008; Haacke, 2003). According to Haacke (2003), the ASEAN way shows that there is a tendency to avoid ‘institutional over-centralization’ and to leave each state to make their own sovereign decision-making. Antolik (1990) identified the ASEAN way as a ‘diplomacy of accommodation’ with an emphasis on three principles, which are: (1) the principle of restraint, based on non-interference as the norm; (2) the principle of respect to ensure that ASEAN member states consult important issues to other members; and (3) the principle of responsibility that stress the importance of consciously considering neighbouring member states’ interests and sensitivities.
Secretariat office in Indonesia regarding the strict adherence to the non-interference principle (Acharya, 2009b).
Despite the underlying differing values of the two principles, previous studies (Asian Development Bank Institute, 2014; Lu & Batten, 2001; OECD, 2004a; Tyler, Wang, & Brown, 2017) produced two conclusions regarding the Asian governance system following the Asian financial crisis in 1998: (1) that the Asian governance model was perceived as inadequate by the OECD; and (2) this perceived inadequacy led to the introduction of Western-style systems by the OECD with two goals, which are improving corporate governance policies in the region and allowing policymakers and practitioners to track the evolution of the governance system in the region. Lu and Batten (2001) presented five propositions and argued why the Western-style systems may not be suitable for Asian countries, which will be discussed further in the following sections. Two out of five propositions, however, need more extensive research into the cultural background of the ASEAN countries, which are not the focus of this study and therefore will not be discussed. On the other hand, the three other propositions by Lu and Batten (2001) are subject to normative governance codes as they concern regulation system in ASEAN member states, which are: (1) ownership structure affects compliance to the minority shareholder protection regulation (OECD Principles I and II); (2) the role of relationship-based business to the participation of stakeholders (OECD Principle III); and (3) the effect of the presence of insiders to the compliance to the disclosure and transparency regulation (OECD Principle IV). Hypotheses construction will be discussed in subsection 4.3. 4.2 ASEAN and the adoption of OECD Principles of Good Governance According to Dunn et al. (2010), the OECD governance system is based on humanitarian principle, which argues that: (1) sovereign authority is only legitimate as long as the interests of the population are being served, and (2) aims to address how the community might best respond to future humanitarian crises.
Allen (2005) remarked that most of the literature on corporate governance that regards firms operating in the interests of shareholders, is based on the assumption of perfect and complete markets. He argued that this assumption is flawed as many countries, in particular emerging nations, are far from being perfect, complete markets.
Furthermore, previous studies also compared a larger set of countries and focus on the relationship between legal origins, investor protection and finance (Cheung & Chan, 2004; La Porta, Lopez-de-Silanes, Shleifer, & Vishny, 2000; La Porta, Lopez-de-Silanes, Shleifer, & Vishny, 1998; La Porta, Lopez de Silanes, Shleifer, & Vishny, 2000; Lu & Batten, 2001). These studies have concluded that investor protection varies depending on a country’s legal regime and that individual countries focus should be aimed to improve national standards of regulations first before they agree on a common set of matrices.
Aside from the implementation of Western governance codes, in the case of ASEAN—despite their participation in international movements and agreements— Haacke (2003) pointed out that the principles of non-interference, consensus and sovereign equality are still tightly held among the member states in the region.
Dunn et al. (2010) assert that the competing norms, namely the
non-interference and humanitarian intervention, between the Asian countries and the
Western worlds will pose a challenge to both sides to coexist and to compromise each others’ set of norms on the international stage. These conflicting underlying norms embedded in each of the two principles may create practical problems.
Chapter 5: Hypothesis Construction
opportunism. Deriving from these studies, it is of interest to take a closer look at which governance codes affect the flow of FDI, especially between ASEAN member states.
For the present study, three out of the five propositions derived from the study by Lu and Batten (2001) are used. Each of the three propositions will be discussed in this subsection separately.
The first proposition suggests that the ownership structure affects minority shareholder protection. As opposed to the OECD Principles I and II, which focus on ‘the rights and equitable treatment of shareholders’, Asian firms commonly have corporate structures that are highly concentrated and family-dominated (Claessens, Djankov, Fan, & Lang, 1999; Claessens, Djankov, & Lang, 2000; Lu & Batten, 2001).
Lu and Batten (2001) identified two features of corporate ownership structure, which are concentration and composition. They defined concentration of corporate ownership structure as the degree of dispersion between management and ownership. When the majority of the ownership is held by a large number of individual, minority shareholders, it means that the ownership structure is highly dispersed or has a lower concentration. When the majority of the ownership is held by a small number of large shareholders, it means that the ownership structure has low dispersion or has a high concentration. This will be operationalized by measuring the extent of ownership and control index over time towards the level of FDI inflow to ASEAN member countries. The extent of ownership and control index, according to World Bank (2018), is aimed to measure the governance or rules that companies have to follow regarding structural changes and ownership or control changes within the companies.
Lu and Batten (2001) further suggest that there is a risk of agency problem in companies with low ownership dispersion and high ownership concentration. The reason behind this is that a small group of people, or possibly a group of a family, has a relatively larger power compared to the large group of shareholders with smaller values of shares in the company. This could lead to the issues of goal conflicts between the principal and the agent, and therefore the risk of agency problems arise.
as there is seldom a clear separation between the management and ownership. In typical Asian corporations and their business affiliation groups, consisting public and private companies, one or several members of the founding family own both the shares of the companies as well as the shares of the members of its business affiliations groups (Claessens & Fan, 2002). Lu and Batten (2001) further suggest that as corporations are established by founding families, ownership composition might be the result of ownership concentration.
However, a series of previous studies (Bodnaruk, Massa, & Yadav, 2017; Claessens & Fan, 2002; La Porta, Lopez-de-Silanes, & Shleifer, 1999; Shleifer & Vishny, 1997) suggest that family-dominated ownership may not always harmful and could offer protection from expropriation, while at the same time possesses risks of expropriation against minority shareholders themselves. The studies also argue that in countries with the high value of political connections, family firms could be attractive investment opportunities. For those investors with high sensitivity to the risk of expropriation by both the government and the majority shareholders, they are particularly responsive to this trade-off. The studies further concluded that the reason for this is due to concerns of weak legal and institutional environments, as concentrated ownerships provide relatively larger benefits in countries with underdeveloped property rights and judicial systems.
Lu and Batten (2001) suggest that outside investors are more prone to expropriation risks given that family-dominated ownership structure is common in Asian corporations. They further argued that the existence of family-dominated corporations might hinder the improvements of minority shareholder rights, namely the ability to participate, protection to the participation rights, and exercising the participation rights. According to Lu and Batten (2001), the OECD Principles suggest increasing this ability, such as improving the extent ownership and control, control of corruption, the extent of director liability, and the extent of shareholder right.
indicators towards the level of FDI, namely: (1) the score for control of corruption; and (2) the shareholder right index. According to Claessens & Fan (2002), monitoring power of minority shareholders may be exercised only when they hold long-term significant equity stakes of the company. They further suggest that when the minority shareholders attempt to monitor the majority shareholders, it is unclear that their efforts are effective in challenging the powerful controlling owners. This will be operationalized by measuring the director liability score over time towards the level of FDI inflow to ASEAN member countries.
Hypothesis 1a: an increase in the extent of ownership and control lead to a decrease in FDI inflow to ASEAN member countries.
Hypothesis 1b: an increase in control of corruption lead to a decrease in FDI inflow to ASEAN member countries.
Hypothesis 1c: an increase in director liability lead to a decrease in FDI inflow to ASEAN member countries.
Hypothesis 1d: an increase in shareholder right lead to a decrease in FDI inflow to ASEAN member countries.
The second proposition by Lu and Batten (2001) suggests that the role of relationship-based business will affect the participation of stakeholders in the governance system. As opposed to the OECD Principle III, which focus on ‘the role of stakeholders in corporate governance’, most Asian capital markets are underdeveloped and dominated by bank-corporation relationship. Lu and Batten (2001) compared the size of bank lending to equity market capitalization, which shows that there is a high dependency on bank finance over equity in Asian firms. Some scholars argue that in this kind of relationship, equity market capitalization dilutes the control of members as it expands the ownership base, and therefore suggest that the role of bank financing is to protect control and limit the power dilution to outside parties or investors (Asian Development Bank, 2001; Batten & Kim, 2000; Berglof & von Thadden, 1999; Lu & Batten, 2001).
large part in the governance system because of the control—through finance—that they have on corporations.
However, Lu and Batten (2001) further suggest that in most cases in Asia, the governance weakness of creditors limit their ability to influence the governance of their debtors. This will be operationalized by measuring the strength of legal right index over time towards the level of FDI inflow to ASEAN member countries. Lu and Batten (2001) further suggest that relationships affect the participation level of creditors because relationships are used as collateral, and therefore trust is seen as an important feature. The reciprocal nature of this trust resulted in a lack of monitoring by banks. Therefore, there is a resistance to shift to equity market capitalization due to the risk of decreasing ability to maintain control through an objective commercial lending environment. This will be operationalized by measuring the creditor participation index over time towards the level of FDI inflow to ASEAN member countries. These propositions by Lu and Batten (2001) suggests: (1) the importance of relationships; and (2) that the concept of stakeholder involvement itself is based on relationships.
Hypothesis 2a: an increase in the strength of legal right lead to a decrease in FDI inflow to ASEAN member countries.
Hypothesis 2b: an increase in creditor participation lead to a decrease in FDI inflow to ASEAN member countries.
will be operationalized by measuring two indicators towards the level of FDI, namely: (1) the corporate transparency index; and (2) the regulatory quality index. This further shows that ownership structure and regulatory quality are important to the implementation of the OECD Principles that were imposed on Asian firms post-crisis.
Hypothesis 3a: an increase in disclosure regime lead to a decrease in FDI inflow to ASEAN member countries.
Hypothesis 3b: an increase in corporate transparency lead to a decrease in FDI inflow to ASEAN member countries.
Hypothesis 3c: an increase in regulatory quality lead to a decrease in FDI inflow to ASEAN member countries.
Aligned with the theories discussed in the literature review, the indicators mentioned in the hypotheses above are expected to have a negative relationship with FDI inflow to ASEAN member countries.
Figure 1: Conceptual Model
FDI Infow to ASEAN countries Hypothesis 1:
a. Extent of ownership and control (-) b. Control of corruption (-) c. Director liability index (-) d. Extent of shareholder right (-)
Hypothesis 2:
a. Strength of legal right (-) b. Creditor participation (-)
Hypothesis 3: a. Disclosure regime (-) b. Corporate transparency (-)
Chapter 6: Research Method
6.1 Variables
Data used for this research is panel data, which indicators were gathered from the World Bank databases, namely World Development Indicators, World Governance Indicators, and Doing Business database. The dataset consists of ten countries of ASEAN and ranges from the year 1998 to 2017. The dependent variable used is foreign direct investment inflow to the ten member countries of ASEAN from 1998 to 2017.
Taking into account the FDI theories discussed in the literature review chapter, specifically following the labour theory by Ricardo (1966) and the argument that different locations determine different investment decisions (Dunning, 2003; Masron & Yusop, 2012), the control variables used in this study are: (1) Market Size (GDP); (2) Labor Cost (calculated by Manufacturing Value Added/Education Expenditure); and (3) Working Age Population (15-64 years old).
The independent variables used to measure hypothesis one are: (1) ownership and control index; (2) control of corruption; (3) director liability index; and (4) shareholder right index. The independent variables used to measure hypothesis two are: (1) strength of legal right index; and (2) creditor participation index. The independent variables used to measure hypothesis three are: (1) disclosure index; (2) corporate transparency index; and (3) regulatory quality index.
6.2 Methodology
Statistical analysis for this study was conducted in four steps. First, I conducted a descriptive statistical analysis. Second, I performed panel data statistical analysis using both the fixed-effects model and the random-effects model.
The rationale behind the fixed-effects model is that ‘time-invariant characteristics of the individuals are perfectly collinear of the person (or entity) dummies. Substantively, fixed-effects models are designed to study the causes of changes within a person (or entity). Time-Invariant characteristics cannot cause such change, because it is constant for each person’ (Kohler & Kreuter, 2005, p. 245). Meanwhile, the rationale behind the random-effects model is that ‘unlike the fixed-effects model, the variation across entities is assumed to be random and uncorrelated with the predictor or independent variables included in the model’ (Torres-Reyna, 2007, p. 25). Furthermore, according to Greene (2008, p. 183), ‘...the crucial distinction between fixed and random effects is whether the unobserved individual effect embodies elements that are correlated with the regressors in the model, not whether these effects are stochastic or not.’
The rationale behind the random-effects model fits theories used in this research better than the rationale behind the fixed-effects model. Various socio-cultural, environment, geographical, and other factors may cause FDI differences for each of the ten-member countries overtime. Recall that it was already discussed in the literature review section of this study that FDI is also determined by different kinds of forces. To present evidence on this choice, the third step is that I performed the Hausman test on the outputs of the fixed-effects and random-effects tests.
Hausman (1978) specification test is a post-estimation tool that compares a consistent estimator with an efficient estimator under the assumption tested by the two models. The null hypothesis is that the difference in coefficients is not systematic, and if (1) the model is correctly specified by the fixed-effects model and (2) the error term is not correlated with independent variable of an entity in a time range, then the coefficients estimated by the fixed-effects model with the coefficients estimated by the test should not statistically differ (StataCorp, 2019).
panel data estimation to test for the validity of excluded instruments, correlation with error term and the exclusion of the instruments from the estimated equation (Baum, Schaffer, & Stillman, 2003; StataCorp, 2019).
Lastly, as there is a concern for endogeneity, I performed another statistical testing method to estimate the models. The method used is 2SLS estimator. The choice was made based upon the concern that the error terms of the dependent variables are correlated with other indicators used in the model (StataCorp, 2019), as outcomes from pooled regression will lead to biased results if the endogeneity problem is a concern in the models estimated.
Chapter 7: Statistical Analysis and Discussion
Appendix 4 shows the correlation matrix for all the variables used in this study. The table shows that there is a concern for endogeneity issues among the variables. However, this issues are expected as it has already discussed in the literature review and hypothesis construction that: (1) FDI and governance are interdependent, which implies that both FDI and governance could determine each other; and (2) there are great numbers of factors affecting both FDI and governance, which some of them might be difficult to quantify such as, but not restricted to, underlying cultural differences or cultural resistance towards change. Considering this issue, the random-effects model is used to perform statistical regression. To confirm this choice of model, I performed the Hausman test on the output of both fixed-effects model (see Appendix 5 for regression output) and random-effects model (see Appendix 6 for regression output).
The tables in Appendix 7 show the output from the Hausman test on the three models used to operationalize the three hypotheses. The outputs for all three models show evidence to reject the null hypothesis that difference in coefficients not systematic. This implies that assumptions for the Hausman specification test, discussed in the methodology subsection, are violated. Recalling the rationale of the random-effects model discussed in the methodology subsection, the outputs of the Hausman test suggest that the random-effects model is more applicable compared to the fixed-effects model.
Looking back on the table presented in Appendix 6, we can see that none of the indicators in model 1 are significant and thus provide no support for hypothesis 1. The regression outputs for model 2 shows that market size has a positive significant correlation with FDI inflow. It also shows that the working-age population has a negative significant correlation with FDI inflow. However, none of the indicators are significant, thus provide no support for hypothesis 2. In model 3, we can see that corporate transparency has a positive significant correlation with FDI inflow. However, none of the other explanatory variables and control variables shows significant value. Therefore, there is no evidence to support hypothesis 3.
model 2, the output shows that market size has a positive significant correlation towards FDI inflow. However, there are changes in the indicators for the working-age population and labour costs. The indicator for the working-age population has become insignificant; meanwhile, the indicator of labour costs has a positive significant correlation towards FDI inflow. The results for model three shows that: (1) working-age population has a positive correlation towards FDI inflow, and that (2) corporate transparency has a positive correlation towards FDI inflow.
The second test is performed to look for overidentifying restrictions on the random-effects model. The output of the tests explicitly suggests that there is a correlation between the error terms of the dependent variable to some of the regressors and that the estimates are equivalent to pooled OLS. However, I re-estimated the models using 2SLS (see Appendix 9 for regression output), recalling: (1) from the methodology section that the concern from endogeneity issues will lead to biased results, and (2) considering the output of testing for the overidentifying restriction that I performed on the output estimated by the random-effects model.
country is competitive in comparison to another country, but (2) it is the increase or decrease of value in the indicators used to measures the quality that will affect the FDI inflows to a country when compared to another.
The output for model 2 shows that the strength of legal right has a significant positive correlation with FDI inflow. According to Chuanrommanee and Swierczek (2009), there is a possibility that well-drafted corporate governance does not actually reflect performance as it does not translate to the actual practice and commitment in ASEAN countries. Furthermore, unlike in Western countries, the common measurement of governance might not be applicable to the Asian context, as in these countries good governance means institutional improvements (Chuanrommanee & Swierczek, 2009). This shows that foreign investors are exposed to high uncertainty or risks regarding the information asymmetry, institutional differences, or other foreignness costs, and therefore the strength of legal right might offer protection to investors when they decide to invest in ASEAN countries. The variable creditor participation also shows significance with negative correlation to FDI inflow. This shows that the model was not accurately specified with the random-effects model and that the output for model 2 supports hypothesis 2b. It is widely recognized that family-dominated ownership or conglomerates have significant power in the market of these countries (Lu & Batten, 2001; OECD, 2004a, 2011, 2014; Tyler et al., 2017). This output also offers support for one of the propositions by Lu and Batten (2001) that there is a weakness in the governance of creditors that allows them to have a strong influence on their debtors through financial control. Moreover, the output shows that market size and labour cost have positive significant value towards FDI inflow. This illustrates that multinational companies might be committed to engage in FDI in ASEAN countries due to market-seeking motives and efficiency-seeking motives.
not translate into real practice; (5) the importance of the strength of legal right; and (6) common measurement might not reflect environment in Asian market context. This implies that an improvement in the complex and multilayered institutional environment will attract foreign investors. However, considering the insignificant values of the output with only the corporate transparency indicators being the only significant indicator, they show evidence that hypothesis 3 is not supported.
According to Meyer, Estrin, Bhaumik, and Peng (2008), institutional differences is important for multinational companies as it provides important pieces of information that could help prevent market failures, such as ‘the rule of the game’, behavioural differences of business partners and different agents in the market, and it can also help companies to decrease information asymmetries when doing business in host-countries. They further argued that a strong institutional framework would: (1) decrease the costs of doing business for foreign multinational companies, and (2) influence their entry mode choices. Cui and Jiang (2012) further confirm this and argue that regulatory and normative institutions of home and host countries are important factors for multinational companies strategic decisions for FDI. Different regulatory and normative institutions for different countries are important in a way that companies are responding to the different factors differently, and therefore there are different motives and entry modes chosen by different companies operating in multiple countries or regions (Dunning, 2003; Dunning & Rugman, 1985; Masron & Yusop, 2012).
Chapter 8: Conclusion and Limitations
8.1 Conclusion
specific to ASEAN member countries might be related to deeply-rooted conformed values, interdisciplinary study might offer better insights to the complexity of the situation underlying cross-country differences and within-country differences, such as cultural and historical background.
8.2 Limitations
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Appendices
Appendix 1
Appendix 2
Appendix 3: Summary Statistics
(1) (2) (3) (4) (5)
Variables N Mean Standard
Deviation
Maximum Minimum
Country 200 5.500 2.879 10 1
Year 200 2,008 5.781 2,017 1,998
FDIin 197 7.483e+09 1.422e+10 9.481e+10 -4.550e+09 (Foreign Direct Investment Inflow)
OwnCtrl 40 2.975 2.527 6 0
(Ownership and Control Index)
CtrlofCorr 180 49.25 26.54 100 3.333
(Control of Corruption)
DirLiab 120 49.08 34.59 100 0
(Director Liability Index)
ShdrRight 40 33.33 35.41 83.33 0
(Shareholder Right Index)
StrLegRight 81 61.60 28.87 100 0
(Strength of Legal Right Index)
CrdPart 140 1.279 1.100 3 0
(Credit Participation Index)
DiscIdx 120 63.50 32.27 100 20
(Disclosure Index)
CorpTpcy 40 2.975 2.527 6 0
(Corporate Transparency Index)
RegQual 180 57.42 27.41 100 1.478
(Regulatory Quality Index)
Market 198 1.545e+11 1.976e+11 1.015e+12 1.280e+09 (Market Size: GDP))
ManVA 198 19.70 6.470 31.95 7.165
(Manufacturing Value Added)
(Government Expenditure on Education)
WorkPop 200 3.799e+07 4.456e+07 1.784e+08 209,595 (Working Age Population)
LabCost 116 6.710 2.925 25.04 2.359
Appendix 5: Fixed Effects
(1) (2) (3)
VARIABLES Model 1 Model 2 Model 3
Market -0.0460 0.118*** -0.0674
(0.110) (0.0275) (0.157)
LabCost 4.015e+08 5.667e+07 -7.186e+07
(1.951e+09) (1.010e+09) (4.903e+09)
WorkPop -2,110 -2,887** -2,198 (1,993) (1,317) (2,007) o.OwnCtrl - CtrlofCorr -1.215e+08 (4.562e+08) o.DirLiab - o.ShdrRight - StrLegRight 1.139e+08 (5.478e+08) CrdPart -2.015e+09 (1.491e+10) o.DiscIdx - o.CorpTpcy - RegQual 1.871e+08 (1.390e+09)
Constant 1.222e+11 6.100e+10* 1.159e+11
(1.102e+11) (3.409e+10) (1.236e+11)
Observations 12 60 12
R-squared 0.636 0.316 0.617
Number of Country 7 9 7
Country RE Yes Yes Yes
Year RE Yes Yes Yes
Appendix 6: Random-Effects
(1) (2) (3)
VARIABLES Model 1 Model 2 Model 3
Market 0.0450 0.0817*** 0.00125
(0.0551) (0.0191) (0.0122)
LabCost 2.063e+08 4.085e+08 1.777e+08
(3.870e+08) (8.327e+08) (3.973e+08)
WorkPop -24.68 -276.9** 69.63 (141.7) (135.9) (50.35) OwnCtrl -8.491e+09 (1.179e+10) CtrlofCorr -2.213e+07 (4.991e+07) DirLiab -5.282e+06 (3.334e+07) ShdrRight 5.817e+08 (6.840e+08) StrLegRight 9.813e+07 (1.372e+08) CrdPart -2.097e+09 (3.566e+09) DiscIdx -1.236e+07 (9.453e+07) CorpTpcy 1.876e+09* (1.107e+09) RegQual -1.449e+06 (5.729e+07)
Constant 6.940e+08 -1.535e+09 2.172e+08
(4.445e+09) (1.071e+10) (4.250e+09)
Observations 12 60 12
Number of Country 7 9 7
Country RE Yes Yes Yes
Year RE Yes Yes Yes
r2_w 0.118 0.257 0.00284
r2_b 1.000 0.596 0.999
r2_o 0.969 0.494 0.964
