Master thesis
Psychic distance and the choice between brownfield and greenfield
FDI
August 2007
Author: Maarten Bus s1576445
Supervisor: Dr. B. Kibriscikli-Ozcandarli Co-assessor: Drs. I. Haxhi
MSc International Business and Management University of Groningen
Abstract
Table of content
1. Introduction ... 4
2. Literature review... 6
2.1 FDI behaviour ... 6
2.2 Transaction cost theory ... 7
2.3 Type of FDI... 8
2.4 Psychic distance ... 9
2.5 FDI and psychic distance ... 11
2.6 Hypotheses ... 11
2.6.1 Psychic distance and outward FDI ... 11
2.6.2 Geographical distance ... 12 2.6.3 Cultural distance... 12 2.6.4 Linguistic distance... 13 2.6.5 Institutional distance ... 14 2.7 Control variables ... 15 2.7.1 Multinational experience... 15 2.7.2 Asset size ... 16 3. Method... 17 3.1 Sample... 17 3.2 Variables... 18 3.2.1 Dependent variable ... 18 3.2.2 Independent variables ... 18 3.2.3 Control variables... 20 3.3 Data-analysis ... 21 4. Results ... 22 5. Discussion... 25 6. Conclusion... 27 References ... 28 Appendices ... 33
Appendix 1 Distribution of deals ... 33
Appendix 2 Descriptive Statistics ... 34
Appendix 3 Correlation, FDI – Psychic Distance ... 35
Appendix 4 Multiple regression analysis, Psychic Distance – FDI ... 38
Appendix 5 Correlation analysis, Psychic Distance variables ... 39
Appendix 6 Logistical regression analysis, FDI type – Independent variables ... 40
Appendix 7 Sector distribution ... 41
1. Introduction
After the Second World War, there has been an extraordinary growth in foreign activities of multinational firms. Transportation and communication have become increasingly faster and cheaper, which made it easier for firms to look beyond the boundaries of their home country. Firms became aware of the possibilities foreign markets have to offer, and started their internationalisation process. The process of internationalisation does not occur by chance, but is often the outcome of a sequence of management decisions (Johanson & Vahlne, 1977). Why do we want to invest in foreign markets? How do we want to invest? And also: ‘Where do we want to invest?’
The process of internationalisation is influenced by many variables and as a whole too complex to study. Most previous studies about the internationalisation process of firms often distinguish three levels of variables; i.e. firm-, industry-, and country-level variables (Hymer, 1976; Kogut & Singh, 1988). This study primarily focuses on the country level variables, although I acknowledge that for a complete analysis, firm- and industry-level variables need to be added as well.
This study makes a distinction between two types of foreign direct investment (FDI); i.e. brownfield FDI and greenfield FDI. When starting new international activities, managers have to consider whether they want to acquire existing firms, which is considered to be a brownfield investment, or start new subsidiaries from scratch, i.e. greenfield investment. The purpose of this study is to examine whether the psychic distance between the home firm and the host country is of influence while deciding on the type of FDI.
Barkema & Vermeulen, 1998). Brewer (2007) observes that lots of previous studies about psychic distance are primarily focused on cultural differences that exist between the home and the host country. The concept psychic distance however is more than just cultural distance, and thus more sufficient to explain cross-country differences. This indicates the research gap that exists. This study uses four psychic distance dimensions which I consider to be most interesting, and most useful. The dimensions are: geographical-, cultural-, institutional-, and linguistic distance. The sample for this study contains 233 cross-border deals with a British equity share between 40 and 60 % of the foreign subsidiary.
The research question is: “Does psychic distance influences the choice between brownfield and greenfield foreign direct investment?”
2. Literature review
2.1 FDI behaviour
The first question which has to be answered is: ‘Why do firms invest abroad?’ This seems a rather simple question, but essential to answer, when doing research about FDI behaviour of companies.
The thesis of Stephen Hymer (1976) was one of the first established papers about FDI behaviour of the multinational firm, i.e. a firm which owns assets and controls activities in different countries (Teece, 1981). Hymer (1976) discusses several essential issues in his study, which are all related to the investing behaviour of firms in foreign markets. He starts his thesis by mentioning the essential distinction between ‘direct investment’ and ‘portfolio investment’. Direct investment involves the transfer of a package of assets or intermediate products, which includes money capital, management and organizational expertise, technology, entrepreneurship and access to markets across national boundaries. Portfolio investment involves only the transfer of money capital (Dunning, 1993:5). Most countries treat a foreign investment as direct whenever the investor is able to exert a significant control or influence over decisions that are taken by the foreign firm (Dunning, 1993:5). About the level of equity share which is deemed necessary for effective control, and thus leads toward a ‘direct investment’ is some discussion (Dunning, 1993:5; Hymer, 1976:1). According to the United States Department of Commerce we can speak of an effective voice when the investor owns 25% of the equity. The OECD already speaks about a direct investment when the investor controls 10% of the equity.
better fulfil their objectives when controlling the investment than when not. By investing in foreign countries, firms could be able to acquire resources at lower costs, or pre-empt their competitors form gaining access to these resources. In addition, they can explore new markets and enhance their competitive position (Dunning: 1993: 192).
Uncertainty emerges when investing firms look beyond the boundaries of their home country, and this could seriously influence the FDI behaviour of firms. Particularly in the first phases of internationalisation, uncertainty plays a considerable role (Johanson & Valhne, 1977; Benito & Gripsrud, 1992). Investing firms have to deal with lots of uncertainties when investing abroad, and have to overcome these disadvantages in order to be able to compete with the local firms. These disadvantages can include for example language barriers, different law systems, or simply the lack of knowledge of a foreign firm in comparison with local firms about the local market (Hymer, 1976; Johanson & Valhne, 1977; Dunning, 1992:69).
2.2 Transaction cost theory
The primary theory which is often used to explain international expansions of firms is the transaction cost theory (Williamson, 1975). The transaction cost theory describes the market and the firm as alternative instruments for completing a related set of transactions. Whether the transactions are carried out across markets or within a firm depends on the relative efficiency of each mode (Williamson, 1975:8). This theory can be best illustrated by means of an example.
would be too high when relying on market relations, it might consider internalizing these operations. This can be accomplished by acquiring firm B (brownfield investment), or by starting an ore factory from scratch in country B (greenfield).
If the markets were perfect, and firms did not have to fear opportunistic behaviour of other firms, transaction costs would not exist, and all activities would be carried out as exchange between units (Teece, 1981; Gulati, 1995). Above mentioned example illustrates why firms would consider integration of foreign activities. However, it is not clear yet how transaction costs could also influence the type of integration, i.e. the type of FDI.
2.3 Type of FDI
When having decided to invest in foreign activities, the type of FDI must be considered. One must decide about the level of ownership, and make the choice between brownfield and greenfield FDI. In general terms, investing in an existing entity is considered to be a brownfield investment, and building an entity from scratch is considered to be a greenfield investment.
Previous studies about FDI considerations can be categorized into two streams of research. The first stream focuses on the level of ownership, i.e. the inclination of a firm to go alone or with more partners (Gatignon & Anderson, 1988; Gomes-Casseres, 1990; Delios and Beamish, 1999). The second stream focuses on the choice between brownfield and greenfield FDI (Caves & Mehra, 1986; Kogut & Singh, 1988; Hennart & Park, 1993; Andersson & Svensson, 1994; Barkema & Vermeulen, 1998; Padmanabhan & Cho, 1999; Belderbos, 2003).
Both streams of research often use the transaction cost theory as departing point for their analysis. When discussing the level of ownership, the general idea would be that, the higher the expected transaction cost are, the more hierarchal the contract will be. So, if transaction costs are expected to be high, the investing firm would consider total vertical integration, or at least a high equity position, so it is able to exert substantial control over the subsidiary (Gulati, 1995).
a comparison between two hierarchal options. Seen from the eyes of a transaction cost theorist, the investing firm would choose the most efficient options, i.e. the options with the smallest transaction costs. For example, firm X might prefer setting up a subsidiary from scratch since acquiring and integrating an existing firm Y is expected to be too costly to control. Firm X especially thinks that the post-acquisition phase will be troublesome, since organizational cultures must be combined, old routines must be unlearned, while new routines must be developed. Another example is firm R, which prefers acquiring firm S instead of setting up a new entity. After a critical assessment, firm R concludes that firm S is interesting, since lots of synergies exist. Firm S owns lots of technological advanced machinery, which are too costly to develop from scratch. Moreover, firm S is culturally similar and also speaks English. The post-acquisition process could take a while, but overall it is expected that acquiring is cheaper than starting a totally new subsidiary.
The above mentioned simplistic examples illustrate shortly how firms could assess the various investment options. It should be clear that lots of other variables play a role while deciding upon the type of FDI. Most studies about the FDI behaviour of multinational firms focus primarily on firm- and industry-level variables. For example, Caves and Mehra (1986) used the firm-level variables, size, multinationality and product diversity. Padmanabhan and Cho (1999) used the variable ‘previous experience with ownership structures and establishment modes’.
Other studies added country-level dimensions to the analysis, and focused on cultural differences (Kogut & Singh, 1988; Cho & Padmanabhan, 1995; Bettis & Prahalad, 1995; Barkema, Bell & Pennings, 1996), or institutional dimensions (Xu & Shenkar, 2002). However none took more psychic distance variables into account and / or focused primarily on the concept psychic distance.
2.4 Psychic distance
(1975) acknowledged the uncertainty firms have when investing abroad. They studied the internationalisation process of four Swedish firms. Their basic assumption, based on several studies of international business at the University of Upsalla, is that the process of internationalisation is often an incremental process, which starts after the firm has developed domestically. They also assumed in accordance with Hymer (1976) that the most important obstacle to internationalisation is lack of knowledge and resources. Firms first want to gain knowledge about a particular market, before they expand their activities to that market. Normally, a firm wants to avoid uncertainty, and therefore firms are more inclined to start exporting to neighbouring countries, which are already comparatively well-known (Johanson & Wiederheim-Paul, 1975).
Johanson and Wiederheim-Paul (1975) launched the concept of psychic distance, which could explain the internationalisation process of a firm. Psychic distance is a concept which combines factors which prevent or disturb the flow of information between the firm and the market (Johanson & Wiederheim-Paul, 1975). The concept psychic distance is built on the idea that for any manager, knowledge is easier to gain from certain countries than from others (Brewer, 2007). A lower psychic distance leads to a higher chance that a particular country will be selected (Brewer, 2007).
Psychic distance is correlated with geographical distance (Johanson & Wiederheim-Paul, 1975), however due to colonisation and globalisation, lots of exceptions can be found. For example, the United Kingdom and Australia are geographically far apart, however when talking about psychic distance, these countries are relatively near. They share the same language, have similar institutional environments, and are also culturally relatively similar. Another interesting example is the relation between the USA and Cuba. These countries are geographically near, but politically and culturally far apart.
2.5 FDI and psychic distance
The study of Kogut & Singh (1988) is a leading study that tries to explain the choice of FDI type by means of country differences. Their study was primarily based on cultural differences
that exist between countries. Brewer (2007) observed that lots of researchers (see Shenkar,
2001 for an overview) are inclined to equate the differences between countries with cultural differences. Although cultural distance might be the most important psychic distance variable, I argue that only this dimension does not capture the complexity of cross-country differences. Therefore this study focuses primarily on four country-level dimensions of psychic distance; geographical distance, linguistic distance, cultural distance and institutional distance.
The results of earlier empirical studies indicate that there is a preference for greenfield investment over brownfield investments when country differences are substantial (Kogut & Singh, 1988; Cho & Padmanabhan, 1995). This because during the post-acquisition phase differences increase the implementation problems (Bettis & Prahalad, 1995; Barkema & Vermeulen, 1998). The implementation problems which coexist when acquiring an existing firm are widely acknowledged, particularly when two firms are rooted in different national cultures (Hofstede, 1980).
However, several other arguments do prevail which lead to a preference of brownfield over greenfield investment, however the arguments are not based on psychic distance variables. An example is the study of Caves and Mehra (1986), who found that size, product diversity, and multinational diversity significantly influenced the decision to acquire.
2.6 Hypotheses
2.6.1 Psychic distance and outward FDI
and have the closest economic, political, language, and cultural ties (Dunning, 1993: 41; Brewer, 2007). This idea will lead to the following hypothesis.
Hypothesis 1
A lower psychic distance (geographical-, cultural-, institutional-, and linguistic distance) between the home- and host country leads to more FDI from the home towards the host country.
2.6.2 Geographical distance
Although the markets in the world are becoming more open, transportation and communication gets faster (Porter, 1998), it is still argued that geographical proximity does matter. Firms want to be close to each other, since this could trigger innovation (Babtista & Swann, 1998), or improve inter-firm relations (Porter, 1998). Proximity improves the communication between partners, which improves the coordination of activities, and generates trust (Porter, 1998:81).
It sounds logical that geographically distant firms are more difficult to integrate, and therefore an inclination towards greenfield investments could exist. However, this might be too simplistic to suggest, since other psychic distance variables could have influence as well. Australia, for example, is geographically far away from the United Kingdom, however institutionally, linguistically and culturally near. In this case, one would argue that investing in Australia has relatively few boundaries, and therefore one would not be influenced by the geographical distance. However, ceteris paribus, based on the implementation problems I expect that geographical distance is related with the choice of greenfield over brownfield FDI. Hypothesis 2
Other things being equal, a firm is more likely to enter a market via greenfield over brownfield investment, when geographical distance is high.
2.6.3 Cultural distance
Moreover they expected that, if cultural factors influence the perceived or real costs and uncertainty of the FDI modes, there should emerge country patterns in the inclination of firms to engage in one type of FDI as opposed to others (Williamson, 1975; Kogut & Singh, 1988). It is expected that it is more difficult to integrate a culturally distant existing firm (Bettis & Prahalad, 1995). Barkema, Bell and Pennings (1996) also found that the failure rate of brownfield acquisitions increased sharply compared with greenfield investments, when cultural distance is high. Cho and Padmanabhan (1995) and also Kogut and Singh (1988) found that Japanese firms are more inclined to set up new ventures from scratch in culturally distant countries. Based on these studies, one would assume that firms are more inclined to choose for a greenfield joint venture when cultural distance is high.
Hypothesis 3:
Other things being equal, a firm is more likely to enter a market via greenfield over brownfield investment, when cultural distance is high.
2.6.4 Linguistic distance
The important difference between individual learning and organizational learning is that organizational learning depends on communication (Cohen & Levinthal, 1989). Only by means of communication, one can share information and make cross-fertilization between ideas and knowledge possible (Huber, 1991). Communication becomes easier when people share the same language. However, due to the increasing cross-border movements of people, one must deal with other languages. During the internationalisation process of a firm, linguistic distance could form an obstacle in the communication with the partner firm, or with the foreign market (Johanson & Wiedersheim-Paul, 1975; Brewer, 2007).
declines the psychic distance between countries (Johanson & Wiederheim-Paul, 1975; Brewer, 2007), however no studies were found on the relation between linguistic distance and the choice on FDI type. One could argue that inter-firm relations and integration will be less problematic when both partners share the same language. When acquiring an existing English speaking firm, language is not a barrier. However, whenever the foreign firm is rooted in a non-English speaking society, language could be a barrier and could influence the FDI decision. Fore example, in the case when a British firm wants to invest in a non-English speaking country, one might prefer doing this by means of greenfield investment. The native employees of the new entity will get used to the fact that one of the partners is British. When the firm hires British employees it might be that corporate communication will become English. In the case of brownfield investment, employees of the acquired company have to overcome the language barrier, which is difficult because unlearning linguistic routines takes time, and might result in a problematic post-acquisition phase (Barkema & Vermeulen, 1998). Hypothesis 4
Other things being equal, a firm is more likely to enter a market via greenfield over brownfield investment, when linguistic distance is high.
2.6.5 Institutional distance
Literature on multinational firm behaviour has shown a growing appreciation of the importance of the institutional context and of the patterns in the way how firms respond to that context (Xu & Shenkar, 2002). It is assumed that institutional distance can play an important role during the selection process of the target country and while deciding on the type of FDI (Xu & Shenkar, 2002). Institutional distance is the extent of similarity or dissimilarity between the regulatory, cognitive, and normative institutions of two countries (Kostova, 1996). Regulatory institutions refer to the formal rules and regulations of a country. Cognitive institutions refer to the beliefs and value system in a country / society (DiMiaggio & Powell, 1983). And normative institutions refer to legitimate means to pursue goals (Scott, 1995).
the target country and to transfer routines to the foreign subsidiaries. In order to avoid organisational conflicts and difficulty while integrating the new subsidiary, firms would prefer greenfield over brownfield FDI when institutional distance is large. This also because it is assumed that greenfield subsidiaries are, compared with acquired local subsidiaries more receptive to the routines of the investing firm ( Xu & Shenkar, 2002).
Hypothesis 5
Other things being equal, a firm is more likely to enter a market via greenfield over brownfield investment, when institutional distance is high.
2.7 Control variables
The emphasis in this study is on country differences. However, to study the relation between psychic distance and FDI types, one must control for other influences as well. The variables multinational experience and asset size have been added. Moreover, there has been made a distinction between ‘service’ and ‘manufacturer’ deals.
2.7.1 Multinational experience
starting with a clean sheet do not have the problem of having to run down an unlearning curve in order to be able to run up a learning curve (Bettis & Prahalad, 1995).
2.7.2 Asset size
3. Method
3.1 Sample
The sample exists of 233 cross-border deals with the United Kingdom as home country. There has been chosen to focus on British investing firms, since the United Kingdom is the largest European investor (UNCTAD, 2006), and its psychic distance dimensions (ex-colonist, European and English speaking) are expected to result in interesting comparisons.
The deals are derived from the database ZEPHYR. The database ZEPHYR provides data containing mergers and acquisitions (M&A), initial public offering (IPO) and venture capital deals between the years 1997 and 2007 with links to detailed financial firm information. For this study the deal classifications of ZEPHYR have been adjusted in order to create a better and clearer comparison. The terminology of greenfield and brownfield investment does not appear at all in the deal classifications of ZEPHYR.
The deals are divided into two groups; 112 being greenfield investments and 121 being brownfield investments, see appendix 1. Deals which result in wholly owned subsidiaries could not be included, since ZEPHYR does not provide data on wholly owned greenfield investment. ZEPHYR does provide a category with joint ventures. According to ZEPHYR, these joint ventures can all be typified as start up investments, thus greenfield investments. Moreover ZEPHYR does provide in most cases information about the equity percentages held by the partners. Based on these figures, two samples are drawn.
It appeared that most ‘greenfield’ joint ventures deals with a known equity percentage were held between 40 and 60 percent by the British partner. To create two comparable groups, the cross-border deals are selected based on the equity percentage (40 – 60%) of the British investing firm. Deals where the investor increased its share are directly excluded.
completed greenfield cross-border deals with a British partner between 1997 and 2007 was 504. However the majority of deals are excluded since information about equity stakes were not published, or because the deals were not owned between 40 and 60 percent by the British partner. As can be seen from appendix 1 the majority of greenfield deals within the sample are owned on a 50/50 basis.
The deals are divided across 63 host countries. China, India and Russia have the largest stake in the sample. Respectively they are responsible for 9.4, 8.2 and 6.9 percent of the total sample.
3.2 Variables
3.2.1 Dependent variable:
The dependent variable is the type of foreign direct investment (FDI). In this study the type of FDI is divided into two categories. Brownfield investment is coded as 0 and greenfield investment is coded as 1.
3.2.2 Independent variables: Geographical distance
The geographical distance is the direct distance between London and the nearest large city in the target country in km, round up by 50, measured by means of Google Earth.
Cultural distance
The cultural distance index is based on the study of Hofstede (1980), who uses four cultural dimensions; power distance, uncertainty avoidance, masculinity/femininity and individualism. The additional fifth dimension, long-term orientation, is excluded, since lots of scores on this dimension are missing. The index used in this study is based on the cultural deviation of the target country, compared with the United Kingdom. The Kogut & Singh (1988) formula is used to measure the cultural distance:
4
CDj = {(Iij – Iiu)²/Vi}/4
Iij = index cultural dimension of the jth country u = index cultural dimension of the United Kingdom Vi = variance of the index of the ith dimension
CDj = cultural distance of the jth country vs. the United Kingdom Linguistic distance
The linguistic distance index is based on the study of Chiswick and Miller (2004), which developed a linguistic distance measure. There measure is based on the difficulty Americans have learning other languages. They developed a scale between 1.0 and 3.0, where 1.0 is the highest, and 3.0 the lowest linguistic distance. This study uses the scale differently and uses the next formula: Linguistic distance = 4 – score Chiswick & Miller (2004). The score 0 is assigned to the countries that have English as a native language (inclusive India and South Africa).
Institutional distance
The institutional distance index is based on the six institutional dimensions from the World Bank Governance Indicator of 2005:
1. Voice and accountability 2. Political stability / no violence 3. Government effectiveness 4. Regulatory quality
5. Rule of law
6. Control of corruption
The dimensions illustrate to what extent the regulatory- (3,4,5), normative-, and cognitive (1,2,6) institutions of the host countries are developed. Normative and cognitive institutional dimensioned are often grouped, because these aspects of institutions are quite similar to one another (Scott, 1995). In order to provide one figure that explains the institutional distance between the United Kingdom and the host countries, the six dimensions have been combined by means of the Kogut & Singh (1988) formula. The use of this formula is legitimate, since Gaur and Lu (2007) also used this formula to measure institutional distance.
6
IDj = {(Iij – Iiu)²/Vi}/6 i = 1
Iij = index institutional dimension of the jth country u = index institutional dimension of the United Kingdom Vi = variance of the index of the ith dimension
IDj = institutional distance of the jth country vs. the United Kingdom World Bank Indicator dimensions
The six World Bank institutional dimensions are also used individually. This has been done, in order to study whether the dimensions individually have explanatory power.
3.2.3 Control variables Multinational experience
Multinational experience of the home firm is measured by means of the number of countries in which a firm is active. This number is in most cases not exactly given. However, most company websites do provide an indication. Therefore the deals are divided into the following categories:
1 = first time exit
2 = international junior (1 – 5 countries)
3 = advanced European player (> 5 countries within Europe) 4 = advanced global player (> 5 countries also outside Europe) Asset Size
Sector dummy
The choice of entry mode can be influenced by sector characteristics. In order to control for these influences the deals are assigned to two ‘major’ sectors; manufacturing and services. This has been done to avoid a bias, since some host countries could for example attract relatively more manufacturing deals and brownfield investments. In addition, this has been done to see whether an inclination exists towards one of the FDI types within a sector.
3.3 Data-analysis
This study uses several statistical measures in order to provide answers to the hypotheses and the research question. The relation between the psychic distance variables and FDI (hypothesis 1) has been analysed by means of multiple regression analysis, since both dependent and independent variables are metric. In this way one can drawn conclusion about the extent the psychic distance variables together contribute to the dependent variable, FDI. The stepwise estimation method has been used; a method that eliminates correlated independent variables. Stepwise regression includes the variables starting by the best predictor of the dependent variable. The formula for the multiple regression analysis is:
FDI = b0 + GD X1 + CD X2 + ID X3 + LD X4
The relations between the psychic distance variables and the type of FDI (hypotheses 2-5) have been analysed by means of logistic regression analysis. This methodology is preferred, since the dependent variable (type of FDI) is non-metric and only consists of two groups; e.g. brownfield vs. greenfield. Logistic regression represents the two groups as a binary variable with values of 0 (brownfield) and 1 (greenfield) (Hair et al., 2005).
4. Results
Appendix 2 provides the descriptive statistics for all variables. 233 deals are included, however due to missing data, some deal details are missing. A noticeable outcome, based on 156 deals, is the high mean score of 3.55 on multinational experience, within a range from 1 to 4. This means that most firms from the sample can be typified as advanced global players, with considerable multinational experience.
Appendix 3 provides three correlation matrices which are used for interpreting hypothesis 1. The correlation matrices are based on the outflow of British FDI towards 31 countries. Besides the four psychic distance variables, the individual cultural distance indicators as well the individual institutional scores are added to the analysis. Table 3a shows that only cultural distance (-. 384; sign. 0.033) is significantly correlated with the outflow of FDI. Although the other variables from this table appear to be not significant, they all point towards the same direction. Table 3b provides more insight into the individual cultural dimensions. From this analysis is appears that especially the dimension ‘individualism’ is strongly correlated (-. 476; sign. 0.007) with the outflow of FDI. A noticeable outcome from this table is the fact that the dimension ‘masculinity’ appears to have a non-significant but positive relation (.193; sign. 0.291), which is in contrast with the other dimensions. Table 3b provides the correlation coefficients on the relation between FDI and the institutional scores. In contrast with the cultural dimensions, the institutional dimensions in the dataset are scores and not differences. From this table it appears that all institutional dimensions are positively related with the outflow of FDI. Only the dimension ‘political stability’ appears to be non-significant (.140; sign. 0.453).
The hypotheses 2 to 5 have been analysed by means of logistic regression analysis. In contrast with the amount of FDI, the type of FDI can be typified as a non-metric variable and therefore needs a different statistical approach. Before executing the logistic regression it is interesting to see to what extent the psychic distance variables are correlated with each other. Appendix 5 provides this analysis, which is in contrast with the upcoming logistic regression analysis based on 63 entities, i.e. the 63 countries involved are used once. This has been done to overcome invalid and high correlations. It appears that cultural distance is significantly correlated with linguistic distance (0.396; sign. 0.003) and institutional distance (0.275; sign. 0.042). This means that the more culturally remote the host country is, the more difficult it is for the British to learn their language, and the more distant their institutional environment is. The relation between cultural distance and geographical distance is also positive (0.192), however not significant (0.161). Culturally comparable countries like Australia and the United States weaken this result.
All psychic distance variables as well the control variables ‘asset size’ and ‘multinational experience’ are included in the logistic regression model in appendix 6. From appendix 6 one can conclude that none of the independent variables significantly predicts the type of FDI. The four psychic distance variables have less explanatory power than expected, and cannot be included in the equation. From the four psychic distance variables, cultural distance appears to have the most explanatory power (score 1.053; sign. 0.305). However even this result is far from significance. Therefore hypotheses 2 to 5 are all rejected.
Also the control variables ‘asset size’ (score 2.829; sign. 0.093) and ‘multinational experience’ (score 2.724; sign. 0.099) are not included in the equation; however these variables have substantially higher scores compared with the psychic distance variables. When interpreting these scores, one might conclude that firms with relatively high multinational experience and asset size, are more inclined to choose for greenfield FDI. However, the scores can still not be typified as significant.
most common (Bf 33 – Gf 43). This outcome is not totally unforeseen. Kogut and Singh (1988) also made the distinction between ‘services’ and ‘manufacturing’ in their sample, and they found also that in the manufacturing sector greenfield is preferred over acquisition (brownfield). It could be that manufacturing deals, compared with services deals are more technologically sophisticated, which could lead to more integration problems during brownfield acquisitions. On the other hand it could be that on average service firms are more dependent on the local market and local customers, which makes market knowledge more vital. Brownfield acquisitions can bring in more market knowledge, since one acquires an existing entity with existing market knowledge. When building a subsidiary from scratch market knowledge has to be gained first. This is especially the case when starting a wholly owned subsidiary. However, the deals used in this study do all have local partners which could provide market knowledge, since they are owned between 40 and 60% by the British investing firm. This could be a possible explanation for the fact that the results for this study on industrial differences are somewhat weaker than other studies.
5. Discussion
When interpreting the results one might question the explanatory power of psychic distance in relation with the choice between brownfield and greenfield FDI. Does psychic distance really have no influence, or are their other explanations for this result? When scrutinizing the sample, one can find several arguments which could provide more insight into the results. One interesting argument which is already mentioned is the high score on multinational experience. This means that most investing firms from the sample can be typified as multinational experienced. Moreover it is argued that when firms become multinational experienced, the influence of psychic distance reduces (Benito & Gripsrud, 1992). In addition, it is argued that particularly small and medium sized firms respond to psychic distance (Cicic et al., 1999). The skewed distribution of multinational experience in the sample is accentuated in appendix 8. Based on this table one can see that the multinational less experienced firms have a stronger tendency to choose for brownfield FDI. This tendency could have been stronger when the sample was equally distributed. Another interesting related issue is the question to what extent the British firms in the sample are British. Some might argue that firms which are highly multinational experienced are not purely British firms anymore (Dunning, 1993:11). The firms might be listed on the British stock exchange and might have their corporate head quarter in England; however most of these global giants are much diversified when looking at their board of directors, employees and owners. In addition, these firms have lots of assets and activities dispersed across lots of nations, and are therefore less bounded to the British culture and institutions. Psychic distance therefore would have less impact, compared with firms which are less experienced, and more British. For future research it might be interesting to focus primarily on small and medium sized firms.
acculturation is used whenever a firm sets up a wholly owned subsidiary. The firm in case only has to accommodate the national culture. Whereas, when a firm acquires a firm or sets up a joint venture, the firm has to accommodate both national- and corporate culture, which is called ‘double layered acculturation’. The British firms which are used in this study all have to deal with double layered acculturation, since all deals consist of more partners. When wholly owned greenfield investment were present, a clearer distinction would probably appear. Since an extra argument would emerge in favour of greenfield investment when psychic distance (especially cultural distance) is substantial.
6. Conclusion
Although psychic distance is considered to be an interesting concept with potential explanatory power, it has to be concluded, based on this study that psychic distance is not significantly related with greenfield or brownfield FDI. The research question, “does psychic distance influences the choice between brownfield and greenfield foreign direct investment?”, has to be answered negatively. Although, one could have expected, based on previous FDI studies with cultural indicators, a preference for greenfield investment when psychic distance is substantial, it is not entirely odd that no significant relation is to be found. Managers of multination firms are confronted with lots of uncertainties, and not every manager responds similar to those uncertainties. Clear causal relations are therefore difficult to find.
In contrast with the relation between psychic distance and the type of FDI, the relation between psychic distance and FDI was partly significant. Based on FDI figures from 31 countries it appeared that cultural distance is a significant predictor of FDI. Geographical-, linguistic-, and institutional distance also pointed towards the same direction, however there scores were non-significant.
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