Institutions and Business Strategies in Emerging Economies: A Study of Entry Mode Choice

Klaus E. Meyer University of Reading Business School km.cees@cbs.dk, Saul Estrin London Business School sestrin@london.edu Sumon Bhaumik Brunel University Sumon.Bhaumik@brunel.ac.uk

November 9th, 2005

Author contact: Professor Saul Estrin, Adecco Professor of Business and Society, London Business School, Regents Park, London NW1 4SA, United Kingdom, phone: (+44) 270 2625050, sestrin@london.edu Acknowledgements: We gratefully acknowledge comments received from Keith Brouthers, Igor Filatotchev and seminar participants at Warwick Business School, University of Nottingham, Manchester Business School, National Cheng-chi University Taipei, Kings College London and University of Queensland. This paper was written as part of a research project at the London Business Schools Centre for New and Emerging Markets. The team was Stephen Gelb (EDGE Institute, Johannesburg, South Africa), Heba Handoussa and Maryse Louis (ERF, Cairo, Egypt), Subir Gokarn and Laveesh Bhandari (NCAER, New Delhi, India), Nguyen Than Ha and Nguyen Vo Hung (NISTPASS, Hanoi, Vietnam). We thank Rhana Neidenbach, Gherardo Girardi and Delia Ionascu for their excellent research assistance; the Department for International Development (UK) for supporting this research under DFID/ESCOR project no R7844, and the Aditya Birla India Centre at the London Business School for its financial support.

Institutions and Business Strategies in Emerging Economies: A Study of Entry Mode Choice

Abstract Economic institutions set a framework within which businesses develop their strategies. Variations in institutions thus explain differences in the organizational forms. This applies in particular in emerging economies with institutional frameworks differ not only fundamentally from industrialized economies, but also vary greatly amongst each other. We investigate the impact of institutional variations on business strategies by analyzing the adaptation of outsides, namely foreign investors, to local contexts. We focus on their choice between joint venture, acquisition or greenfield as mode of entry. These modes differ along three dimensions, namely access to local resources, control and benefits of a new start. We theoretically analyse the impact of contextual variations on firms decisions, and on that basis estimate entry mode determinants on new enterprise level dataset for four emerging economies. As predicted, we find that institutional development reduces preferences for joint venture entry, and higher stages facilitates acquisition entry. Moreover, local resource needs increase the likelihood of JVs if these resources are tangible, and acquisitions if they are intangible.

Introduction The strategies that firms pursue are shaped by institutional frameworks (Oliver, 1997; Kogut, Anand & Walker, 2002; Ingram and Silverman, 2002; Peng 2003). This especially holds true in emerging economies where the sophisticated formal and informal institutions characterizing more developed economies are largely absent (Hoskisson, Eden, Lau & Wright, 2000; Wright, Filatotchev, Hoskisson & Peng, 2005). However, most management theories have been developed with respect to the institutional framework and resource endowment of the latter types of economy (Khanna & Palepu, 2000; March, 2005). An understanding of business strategies in these markets thus necessitates that the theories be adapted (Hoskisson et al., 2000), especially to explain how firms strategic decisions are moderated by contextual influences (Tsui 2004; Meyer & Peng, 2005). This has led recent studies to incorporate the specificities of emerging economy contexts into their theoretical reasoning (Delios & Henisz, 2000; Uhlenbruck & De Castro, 2000) with institutional perspectives having been identified as the most promising avenue (Wright et al., 2005; Peng et al., 2005; Meyer & Peng, 2005). Institutions are the humanly devised rules and regulation that govern economic activity (North, 1990). These rules of the game influence transaction costs in the national context (Williamson, 1985; Ingram and Silverman, 2002) and help to explain the ability of firms to succeed in competitive global markets (Hill, 1995). In addition to their economywide impact, (North, 1990), institutions can also govern activities of individuals within firms, (Meyer & Rowan, 1977; DiMaggio & Powell, 1983; Dacin, Goodstein & Scott, 2002). These internal institutions can constrain business strategy by raising the costs of implementing strategic change, for instance in acquired businesses and are a major cause of variations in business strategies across countries, in particular for foreign investors (Henisz, 2000; Meyer, 2001; Peng, 2003; Wan & Hoskisson, 200_).

We examine the adaptation of business strategies to local institutions by focusing on the strategies of multinational enterprises (MNEs) entering an institutional environment with which they are unfamiliar. Foreign investors choose between three organizational forms when establishing operations abroad: acquisition, Greenfield and joint-venture (Kogut & Singh, 1988). Most studies of entry modes assume that this choice concerns two distinct decisions, respectively on ownership and resource access. Theoretical work distinguishes between either forms of ownership, i.e. partial versus full control (Anderson & Gatignon 1986, Hennart 1988, Hill et al. 1990, Gomes-Casseres 1989; Brouthers & Brouthers, 2003; Henisz, 2000), or acquisition versus Greenfield entry mode (Caves & Mehra, 1986; Hennart & Park, 1993; Barkema & Vermeulen, 1998; Anand & Delios, 2002), taking the other dimension as given. However, case evidence suggests that this assumption is not appropriate for investors entering the complex and volatile institutional environment of an emerging economy (Danis & Parkhe 2002; Estrin & Meyer, 2004). Investors instead need to consider multiple aspects simultaneously, and to design their organizational forms to adapt to diverse external and internal pressures. Focusing on three modes together- joint venture, acquisition and greenfield -allows investors to minimize across a variety of opportunity costs of

establishing a local subsidiary simultaneously:

Control over the local project through greenfield entry or acquisition reduces the costs associated with sharing ownership with a local partner, and the associated potential for unauthorised diffusion of information and coordination problems between co-owners (Buckley & Casson, 1976; Anderson & Gatignon, 1986; Hennart, 1988).

Access to local resources can be obtained by cooperative modes such as acquisition

or joint venture. The local partner firm can provide for example brand names or distribution networks (Hennart & Park 1993, Anand & Delios 2002). Creation of a new entity through greenfield entry or joint venture averts the digestibility costs associated with taking responsibility for an existing company (Hennart & Reddy 1997).

Institutions directly affect the choice between these modes of entry, and their influence varies between lower and higher levels of institutional development. External institutions affect the costs of alternative organizational forms (Williamson, 1985) and thus the relative costs of operation in different modes of entry (Henisz 1999, Meyer 2001). Moreover institutions indirectly influence how investors can access the different types of local resources they require to implement their strategic objectives and the extent of organizational change subsequent to the acquisition of a local firm. i For example,at low levels of institutional development, foreign investors might seek local partners to help them negotiating the complexities of the local environment but this need for a partner could decline with the advancement of the institutional framework (Meyer, 2001; Peng, 2003). At higher levels of development of institutions, especially of the financial markets, the costs of acquiring local firms might decline. We test our propositions on a unique firm-level dataset for Egypt, India, South Africa and Vietnam, These countries were selected because they show substantial variation with respect to the focal independent variables- describing the institutional environment, as recommended by Cheng (1995). They also represent a cross-section of emerging economies and have all substantially liberalized their economies during the 1990s. We extend the domain of management research by this choice of countries because earlier studies of entry in emerging economies have concentrated on transition economies in Eastern Europe

(Brouthers & Brouthers, 2000, 2003; Meyer, 2001) and China (Tse, Pan & Au, 1997; Pan & Tse, 2000; Luo, 2001). The paper offers three theoretical contributions. First, we contextualize research on entry strategies by focusing on local variables, notably the institutional environment, the local resources sought by the investor, and local firms. This extends the literature on entry mode choice, which has largely focused on firm and industry specific variables (e.g. Hennart & Park, 1993; Hennart & Reddy, 1997; Harzing, 2002). Second, we advance the institutional perspective of business strategy (Oliver, 1997; Peng, 2003) by providing a more fine-grained analysis of the relationship between the institutional framework and business strategies. In particular, we are show that different relationships hold at different stages of institutional development, and that institutions not only affect the choice of joint venture but also the choice between greenfield and acquisition entry. Secondly, Thirdly, we develop entry mode as a three dimensional construct that allows investors to minimize different types of costs associated with foreign entry, and thus bridge two literatures that have been largely separate, namely on joint ventures, and on acquisition versus greenfield. In the next section, we discuss the institutional perspective of international business strategies in emerging economies. In section 3, we develop propositions on how these contextual influences impact on MNEs choice between greenfield, acquisition and JV entry. Section 4 introduces the methodology and the dataset. The empirical results are reported in the fifth section, and are then discussed in the sixth, before developing conclusions.

THEORETICAL PERSPECTIVES

Institutions and Business Strategy in Emerging Markets International business and strategy research has focused primarily on explaining the behavior of

firms in mature market economies. However, such models do not always provide satisfactory explanations of behavior of MNEs in emerging economies because the contexts are different, (Hoskisson et al., 2000; Tsui, 2004; Wright et al., 2005). The principal differences lie in the institutional set-up: emerging economies typically have a less sophisticated formal institutional framework. This includes a less extensive legal framework as well as less effective law enforcement, information systems, market intermediaries and bureaucracy.ii In consequence, businesses rely to a larger extent on informal rather than formal mechanisms of control and contract enforcement (Peng, 2003; Makhija, 2003; Khanna, Palepu & Sinha, 2005). Recent research in emerging economies has demonstrated that markets are always embedded in institutions. There is no atomistic market of textbook theory, because such markets cannot be observed in practice (Kogut and Spicer, 2002: 9). In other words, the efficiency of markets can be inhibited by the absence of market-supporting institutions, also known as institutional voids (Khanna & Palepu, 2000), or by inappropriate institutions, such as erratic government policy interventions. When market-supporting institutions are weak, the ownership of resources, and the means by which an entrant can gain control over those resources, will be subject to considerable risk. Markets may be inhibited by high cost of contracting, weak information systems (and thus extant information asymmetries), lack of specialized intermediaries (e.g. in financial markets), or bureaucracy and corruption (Mauro, 1995; World Bank, 2004; Khanna, Palepu & Sinha, 2005). Moreover, formal constraints may restrict the permissible set of business strategies. For example, in many emerging economies there are still industryspecific ceilings on the extent of foreign equity ownership. The less sophisticated the institutions supporting the market mechanism, the more political, economic and social uncertainties are likely to affect firms strategies (Khanna & Palepu, 1998; Peng, 2003; Meyer & Nguyen, 2005).

The direct consequences of the particular institutional environment in emerging markets have been analyzed more than the indirect ones. The idiosyncrasies of the local context imply that different types of resources may be required for firms to gain competitive advantages (Newman, 2000; Meyer & Peng 2005). While industry-specific capabilities are often the prime drivers of competitiveness in mature economies, firms operating in emerging markets may find context-specific resources equally important (Kock & Guilln, 2000; Peng, 2003). Foreign entrants have to develop or access such resources, and combine them with their own (Anand & Delios, 2002). Investors would prefer to control these resources since they are crucial for attaining competitive advantages, especially when it comes to developing new capabilities by combining capabilities contributed by different partners, though control may be inhibited by institutional constraints. Moreover, internal organizational structures that are not compatible with those of foreign investors may deter acquisitions by foreign investors. They may need to invest considerable resources in the restructuring of the local firm, including extensive re-building of organizational structures and cultures, to an extent that may even exceed the initial investment for the acquisition (Uhlenbruck & DeCastro, 2000; Meyer & Estrin, 2001). For example, in transition economies, restructuring must be sufficiently deep to alter firms previously organized to perform under one set of institutions (state-ownership, central planning) to henceforth perform under different institutional prerogatives (private ownership, market). Thus, internal structures need to be de-institutionalized (Newman, 2000; Dacin et al., 2002). Hence in a context where inherited internal institutions differ substantially from those that a foreign investor would want to create, investors may instead opt for the benefits of a new start. Thus, in emerging economy contexts, the following variables can be expected to be crucial for explaining business strategies, and entry strategies in particular: the institutional development, the access to context-specific local resources, and the benefits of a

new start. In the remainder of this paper, we develop, operationalize and test hypotheses about the effects of these variables on entry strategies into emerging markets

Entry Mode as Three Way Choice

The modes of establishing an FDI can be classified into three types that differ in the origin of the resources employed in the local operation: Greenfield projects, acquisitions, and joint ventures with a local partner (Kogut & Singh, 1988; Ellango & Sambharya, 2004). A greenfield project creates a de novo subsidiary; the investor combines own resources from international and host country markets. An investor might prefer greenfield entry, for

example, if the new operation was build on a unique embedded resource that could be replicated in the local affiliate, while complementary resources such as skilled workers and real estate were easily available locally (Hennart & Park, 1993; Danis & Parkhe, 2002). Acquisitions refer to the purchase of stock in an already existing company in an amount sufficient to confer control (Kogut & Singh 1988:412). In acquisitions, many resources of the local affiliate are embedded in the acquired local company, and they may capture internal routines and local organizing principles (Kogut, 1991). Finally, a JV is created by an MNE joining its resources with those embedded within one or more local firms, and both partners contributing resources to the de novo local company and jointly sharing control over its operation. From a strategic management perspective, entry mode choice concerns the origins of the resources to be employed in the new venture, as well as the control of the new operation (Meyer & Estrin, 2001; Anand & Delios 2002; Danis & Parkhe, 2002). Greenfield entrants use their own resources and combine them with local assets, while an acquisition uses primarily assets of a local firm and combines them with the investors resources. A JV provides an alternative route for access to selected resources contributed by a local partner,

without the responsibilities that arise from taking over an existing organization. Yet the foreign investor attains only shared control over the resources, which may inhibit strategic flexibility and rent extraction. Figure 1 illustrates the considerations affecting this three way choice of entry mode. Entry by joint venture and acquisitions would provide access to local resources; control over local operations would be higher in greenfield and acquisitions; the benefits of a new start, including avoiding post-acquisition restructuring costs, would accrue in a greenfield operation or a joint venture. The relative importance of these motives is crucially influenced by the institutional context. Figure 1: Entry mode as a three way choice Acquisition

Access to local resources

Control

Joint venture Benefits of Newstart

Greenfield

The literature recognizes the three modes as distinct, but few studies analyze all three simultaneously (Kogut & Singh, 1988; Chang & Rosenzweig, 2001; Ellango & Sambharya, 2004), and even these studies do not theorize over the multiple dimensions that distinguish them. Kogut and Singh (1988) focus on psychic distance, Chang and Rosenzweig (2001) focus on differences between first and second entries, while Ellango and Sambharya (2004) focus on host industry characteristics. The theoretical development in these studies focuses solely on the differences between greenfield on one side and JV and acquisition on the other 10

side, although the empirical results indicate some differences between JVs and acquisitions. Most empirical studies analyze either bimodal choices of alternative ownership arrangements (e.g. Anderson & Gatignon, 1986; Beamish & Banks, 1987; Hennart, 1988, 1991; Hill, Hwang & Kim, 1990; Gomes-Casseres, 1989, 1991; Tse et al., 1998), or bimodal choices between acquisitions and greenfield (e.g. Hennart & Park, 1993; Barkema & Vermeulen, 1998; Anand & Delios, 2002). Some studies incorporated ownership dummies in acquisition-versus-greenfield analyses, or vice versa: Two of them study joint venture (JV) versus wholly owned subsidiary (WOS) decisions and find that the acquisition dummy is not significant in their full sample, but is significant in certain sub-samples (Hennart & Larimo, 1998; Padmanabhan & Cho, 1996). Similarly, the impact of ownership control variables has been significant in some studies of acquisition versus greenfield but not in others (Hennart & Park, 1993; Hennart, Larimo & Chen, 1996). Barkema and Vermeulen (1998) include three dummies for minority, equal and majority ownership (full ownership being the base case), and find the latter two to have a significant impact. Other studies focus on selected modes to test particular theories developed by the authors. Thus, Hennart and Reddy (1997) focus on JV and full acquisitions to test the proposition that indigestibility of local firms induces firms to invest in JV. Anand and Delios (2002) and Brouthers and Brouthers (2000) test acquisition versus greenfield by focusing on fully foreign owned firms only. Such bimodal choice models imply that entry and ownership can be viewed as two sequential decisions (Kogut & Singh 1988), but this is not how decisions are made in practice and the empirical literature points to important interdependences between the ownership and resource dimensions. We therefore move beyond bimodal choice to conceptualize entry mode as a simultaneous three way choice.

11

HYPOTHESIS DEVELOPMENT

Institutional Framework Direct Effects All markets are potentially subject to market failure, to different degrees, and this influences foreign investors preference for internalizing them (Hennart, 1982; Buckley & Casson, 1976). Markets propensity to fail depends on the formal and informal institutions governing the market (North, 1990), which in turn affects corporate strategies of domestic firms and foreign entrants (Hill, 1995; Olivier, 1997; Peng, 2003). In particular, institutional voids emerge where formal institutions supporting the functioning of the market mechanism are weakly developed (Khanna & Palepu, 1999; Khanna et al., 2005). Weak institutions supporting the market mechanism thus inhibit the efficiency of market transactions in ways that lead firms to internalize markets (Khanna & Palepu, 2000) or use network-based strategies (Peng & Heath, 1996). Such strategies allow firms to overcome costs such as those associated with extensive bureaucracy, network based business practices, and corruption. Foreign investors tend to be disproportionately affected by inefficient markets because they are less familiar with the intricacies of non-market transactions in a given context. Restrictions on foreign ownership may limit the stake foreigners are allowed to hold, while informal norms may favor (partially) locally owned firms over foreign investors. Prolific use of informal means of coordination requires foreign investors to build local networks, or tap into existing ones, which they may do by JV or acquisition. In emerging markets, formal and informal institutions are fundamentally different to those that businesses face in the US, Japan or Western Europe. For example, formal institutions such as commercial law and specific foreign investment laws may provide less than equal opportunities for firms of foreign nationality. Informal institutions, such as relationship-based exchanges and lack of specialized intermediaries, require adaptation to 12

local business practices. One of the most significant aspects of informal institutions in emerging markets is corrupt business practices. Corruption was cited by almost 20% of respondents as being a severe obstacle to the investment climate, and as a major obstacle by a further 15%, in a survey of more than 26,000 firms in 53 countries (World Bank 2005). Corruption requires measures to minimize exposure, which creates extra costs for protective actions, for delays in project implementation or for paying bribes (Lambsdorff, 2002). Arbitrary corruption may encourage foreign investors to develop social networks to gain legitimacy (Rodriguez, Uhlenbruck & Eden, 2005) and to build relational trust in order to engage in transactions with other firms (Rose-Ackerman, 1999). It has been found that the higher the level of corruption, the more likely foreign investors would enter by JV, (Smarzynska & Wei, 2002). Thus, institutional voids reduce the efficiency of markets so that firms have to create new organizational forms to overcome them. The development of the institutional framework has a complex and differential impact on the entry mode choice. First, when the institutional environment is relatively underdeveloped, foreign investors may seek local JV partners to help them in managing the idiosyncrasies of the institutional context. Second, certain types of transactions, for instance on financial markets, would not take place unless the institutional framework guarantees transparency, predictability and efficient contract enforcement. Thus, the impact of institutional development may vary as the institutional environment improves from a low to a medium level, facilitating greenfield entry at the expense of JV, while higher levels of institutional improvements (such as the establishment of relatively deep and liquid capital markets ) will be associated with an increased preferences for acquisitions (Figure 2). Figure 2: Predicted effect of institutional development on entry modes Acquisition Greenfield JV Weak inst. 13 Strong inst.

Moreover, as the regulatory environment in emerging economies improves, more sectors are opened up to FDI and foreign investors face fewer formalities, permits and licenses. Thus, the need for local partners declines. Similarly, improved regulatory frameworks lower transaction costs and reduce the need for relationship-based transactions (Oxley, 1998; Meyer, 2001; Peng, 2003; Peng et al. 2005). Hence, we expect progress in institutional development across a range of market supporting institutions to be positively associated with greenfield and acquisition entry.

H1a: Foreign investors are less likely to enter in emerging economies by joint venture, the better developed the market-supporting institutions in the host economy. Acquisitions require a t mechanism for the transfer of corporate control. The method and efficiency by which this can be done varies considerably. In Anglo-Saxon countries, with their stock market based systems of corporate governance, firms can be taken-over via a friendly or hostile bid after acquiring a substantial proportion of the equity (Shleifer & Vishny, 1997). This facilitates foreign entrants by acquisition of local firms. In emerging markets, efficient stock markets are the exception rather than the rule. Rather, firms are typically controlled by a dominant stakeholder (individual or family), a business group, or the state (e.g. Dharwadikar & ____; 2000, Young et al., 2002). Financial data and other information may be less transparent than in countries with extensive disclosure requirements and sophisticated accounting and auditing standards and there will be a shortage of specialized financial intermediaries as one aspect of underdeveloped capital markets (Peng 2003, Khanna et al. 2005). This raises the complexity, and thus the

14

transaction costs, of undertaking due diligence and contract negotiations. In many emerging markets, stateownership has until recently played an important role; according to Megginson (2005), the states ownership share of GDP in developing countries in the 1980s was around 16%, compared with only 8% in developed economies.. The supply of firms for foreigners to acquire thus comes to a large extent in form of privatization of state-owned firms. Transactions on this market involve complex and timeconsuming negotiations with the privatization agencies, the local firms management as well as other stakeholders such as employees (Antal-Mokos 1998). Government agencies often taken an active role and pursue political objectives along with revenue maximization, for instance to retain partial control over the firm, or to secure employment or investment guarantees (Ramamurti 1992, World Bank 1996). The conditions surrounding privatization also have a major impact on foreign companies ability to acquire local firms (Uhlenbruck & De Castro 1997, Meyer 2002). The costs of searching for suitable targets, analyzing their economic viability, negotiating with management and owners, and fulfilling side-conditions imposed by governments are all transaction costs that may inhibit acquisitions. If however there is little substantive privatization or methods of privatization favor domestic owners, then acquisition opportunities may be scarce or costs be prohibitively high. Hence, underdeveloped institutions, such as weak financial institutions and high shares of state ownership may critically constrain foreign acquisitions:

H1b: Foreign investors are more likely to enter in emerging economies by acquisition, the better developed the market-supporting institutions are in the host economy.

Indirect Effects of Institutions Resource Needs. As a consequence of the idiosyncratic institutional framework in emerging economies, investing firms usually require context-specific tangible and intangible resources to

15

achieve competitive advantages. Since these resources are typically embedded in local firms, the desire to tap into local resources may induce MNEs to seek local partners. Context-specific resources come in a variety of forms. First, networks with other businesses, with agents in the distributional channels, and with government authorities are important assets in emerging economies (Peng & Heath, 1996). If legal institutions such as contract law and enforcement of property rights are weakly developed, businesses may also need to rely more on network-based strategies, thereby developing the ability to enforce contracts, which are often informal, using norms as opposed to litigation. Second, context-specific organizational capabilities such as strategic and organizational flexibility enhance competitiveness in highly volatile institutional and economic environments (Lane, Salk & Lyles, 2001; Uhlenbruck et al., 2003). Other important capabilities relate to managing large low-skill labor forces, managing interfaces with government authorities (Henisz, 2003) and developing contact capabilities that enable firms to build and maintain networks (Kock & Guilln, 2000). Third, as in mature market economies, tangible and intangible assets may be important to attain competitive advantage in emerging economies. This includes both intangibles such as brand names and tangibles such as real estate. Foreign investors that consider local resources, either tangible or intangible, to be important for their competitiveness would prefer to establish their operation with a local partner as joint venture or acquisition:

H2a: Foreign investors are less likely to enter emerging economies by greenfield the more they rely on local resources to enhance their competitiveness. A new operation build with resource contributions from two of more partners could be established as a joint venture or by the two partners becoming one firm, notably by one partner acquiring the other. Transaction cost theory suggests that a joint venture would be

16

preferred if contributions from both partners are subject to market failure, and an acquisition is not feasible (Buckley and Casson, 1998, 200x). Investors would prefer an acquisition over a JV because it provides full control over the local operation, without the possibility that disputes between owners inhibiting its operation or the exploitation on the pertinent local resources. For instance, a local partner may use a brand name or a distribution network for products other than those produced by the joint venture. The literature applying transaction costs has focused on market failure affecting the assets (especially knowledge-based assets) that the investor would transfer to the new affiliate (Anderson & Gatignon, 1986; Hennart, 1988). However, similar market failures may inhibit the purchase of local resources. The local contributions to a new operation are often intangible and thus difficult to specify ex-ante, such as knowledge of the local market and business networks. This makes it hard to define the sharing of such resources in a contract, and to enforce agreements ex-post. Thus, contracts over the transfer or sharing of intangible resources are potentially subject to high transaction costs. With ownership over the local operation, a foreign investor would attain full control of the sought assets. If on the other hand, investors seek tangible assets, for which local markets may be reasonably well developed, then they would be less concerned about market inefficiencies because the contracts between the parents may stipulate more precisely the transfer and usage of assets in the joint venture.

H2b: Foreign investors in emerging economies are more likely to enter by JV, the more they require local tangible resources to enhance their competitiveness. H2c: Foreign investors in emerging economies are more likely to enter by acquisition the more they require local intangible resources to enhance their competitiveness.

17

Empirical studies have shown that resources contributed by the foreign partner are a major cause of internalization. This literature draws on both transaction cost (Gatignon & Anderson, 1988; Hennart, 1998; Brouthers & Brouthers, 2003) and evolutionary or resourcebased theories (Kogut & Zander, 1993). Thus, foreign investors transferring assets that are potentially subject to market failure would be more likely to establish wholly owned operations as greenfield or acquisition. Since this proposition is well established in the literature, we do not theorize further on the matter but control for it in the empirical analysis.

Benefits of new start.

A major challenge for investors seeking joint ventures and

acquisitions in emerging economies is the identification of an appropriate local target company (Hitt et al., 2000; Hitt, Ahlstrom, Dacin, Levitas, Svobodina, 2004), especially acquisition targets with resources of suitable quality and organized in ways that fit into internationally competitive multinational firms. In Central and Eastern Europe, where the scale of privatization programs kept prices low, MNEs sometimes acquired firms and effectively restructured them from scratch (Estrin, Hughes & Todd, 1997), but even this option was not always available. In particular, internal structures and institutions of host country firms may reflect past institutional pressures that have persisted beyond the time of economic reform (Newman, 2000, Kogut, McDermott & Spicer 2000). The resulting lack of suitable targets, a supply side constraint, may be binding in emerging economies to such an extent that acquisitions are inhibited, even in industries where firms traditionally grow through mergers and acquisition. Where suitable acquisition targets are scarce, post-acquisition restructuring and integration become a particular concern. If the organizational structures and institutions of the acquired firm are too different from those of the acquirer, then they may not be digestible, and thus incur significant integration costs (Hennart & Reddy, 1997). This

18

applies especially to contexts of economic reform, or where the external institutions under which the firm used to operate, for example state governance, are substantially different from the operations of an affiliate of an MNE (Uhlenbruck & DeCastro 2000). External institutional change may require fundamental change of internal structures and processes, yet such change is subject to considerable inertia, as existing organizational practices are not easily deinstitutionalized (Newman, 2000; Dacin et al. 2001). Hence, the ability of local firms to adopt the MNEs technology, production processes and business practices, also known as absorptive capacity, may be crucial to attract foreign acquirers. This absorptive capacity is a function of not only the human capital associated with the local firm but also of its organizational structure and business culture (Fiol & Lyles, 1985; Zahra & George, 2003). Strong absorptive capacity would facilitate knowledge transfer and thus lower restructuring costs while if it were weak, investors may face high post acquisition investments needs. In this situation, foreign investors who were initially inclined to an acquisition may instead prefer to avoid the restructuring costs by buying sought resources without taking over an entire company. They may thus prefer a greenfield entry, or a joint-venture in which only selected resources rather than the entire operation have to be integrated from the local partner (Hennart and Reddy 1997). The supply-side constraint on the number and quality (from the perspective of the acquiring firm) of acquisition targets is eased as the number of firms competing in the host economy industry increases. As well as increasing the choice of potential targets, competition puts pressures on organizations to upgrade their capabilities and to create more flexible and market oriented structures, which may increase their attractiveness to potential acquirers.. Thus, foreign investors would be more likely to pursue an acquisition entry in contexts with more and/or stronger local firms, which we capture in the term munificence.

19

H3:

Foreign investors in emerging economies are more likely to enter by acquisition, the more munificent the supply of local target firms.

Figure 3 and Table 1 summarise the predicted effects.

20

Figure 3: Summary of hypotheses Acquisition

H 2b H3 H 2c Joint venture H 1a

H 1b

H 2a Greenfield

Table 1: Summary of the predicted effects Hypothesis Construct 1a 1b 2a 2b 2c 3 Market-supporting institutions Market-supporting institutions Need for resources Need for intangible resources Need for tangible resources Munificence of local firms (quantity, quality) Note: Q = questionnaire survey by the authors. Effect on Mode Joint Venture Acquisition Greenfield Acquisition Joint Venture Acquisition Proxy for Empirical analysis TI-index, EFS-index TI-index, EFS-index Two indices based on Q Index based on Q Index based on Q Two indices based on Q

EMPIRICAL SETTING AND METHODOLOGY

The testing of hypotheses pertaining to contextual influences requires a cross-country sample that shows variation on the focal independent variable, yet limited variation on other dimensions. We have thus selected four emerging markets with considerable variation in their institutional environment: Egypt, India, South Africa and Vietnam. However, they all show similarities with respect to other features that may influence FDI; for example each is an important economy in the regional context, and each have pursued significant economic

21

reforms during the 1990s, including liberalization of the regulations governing FDI. All have received sufficient foreign inflows to provide an adequate population of foreign owned firms for a sample survey. Indeed, as a result of reforms, each experienced a surge of inward FDI during the 1990s, though FDI flows were not sustained at that high level. FDI peaked at $2.96bn in Egypt (1999), $3.4bn in India (2001), $6.66bn in South Africa (2001) and $2.6bn in Vietnam (1997) (United Nations, 2003). The four economies also provide significant variation in the local institutional environments. For example, South Africa has, on average, a higher state of development and better infrastructure than Egypt, India and Vietnam. India, on the other hand, has an underdeveloped institutional infrastructure, but a highly developed information technology sector. Moreover, the institutional environment has been adjusting differently in the four countries; improving markedly in Vietnam and to a lesser extent India, staying still or even going backwards in some respects in Egypt and South Africa. The cross-country and cross time diversity implies that data pooled from these four economies provide significant variations in terms of institutions and in consequence in the business and entry mode strategies these MNEs pursue.

Methods of Empirical Analysis We collected our data in the four countries so as to obtain appropriate measures of the local operation and the local context. We combine questionnaire data with archival data on a national level. Our survey instrument provides data about the local subsidiaries, the parent MNEs, and managers perceptions of the local environment. In addition, we conducted twelve case studies, three in each country, that have helped us designing this study. Questionnaire. The questionnaire was targeted at CEOs of local affiliates, whether local or expatriate, and was developed in stages by the authors in cooperation with the field

22

research team leaders including a pilot on about 35 firms during the summer of 2001. The questionnaire was revised based on the feedback provided in the pilot stage and the insights into the strategic decision-making process of the MNEs by way of the case studies. iii Base population. The base population for the survey was defined as all FDI projects newly registered in each of the four countries between 1990 and 2000 that had a minimum employment of 10 persons, and minimum of 10% equity stake by the foreign investor. The time limit was chosen to ensure that information relevant to the decisions taken at the time of entry was still part of the organizational memory at the time of the survey. The stipulations concerning size and equity stake of the foreign investor ensured that firms in the base population were substantive and operational businesses. The base population was constructed from locally available databases. In India and Vietnam, comprehensive databases were obtained from the authorities that regulate FDI but in Egypt and South Africa, the base population had to be constructed from scratch using commercial databases supplemented with research by the country research teams. Data collection. The questionnaire was administered in the four countries between November 2001 and April 2002. MNE affiliates were selected using stratified random sampling. The stratification was used to ensure that the inter-sectoral distribution of firms in the sample closely resembled that of the population at the 2-digit level. Once a firm was selected, teams that were specially trained for the administration of the questionnaire interviewed a top-level manager, usually the CEO. A total of 613 responses were received with response rates varying between 10% in Egypt and 31% in South Africa. If less than 150 firms responded in any country, the sample size was made up by replacement using randomly selected firms in each 2-digit industry. However, there were some missing values in the dataset, especially in response to questions about the local environment, so the full regression model uses 422 observations, though some of the restricted versions somewhat

23

more. Before undertaking any final empirical work, we investigated whether the pattern of missing values might lead to bias in the estimation. We therefore analysed the characteristics of enterprises by missing values in terms of country, sector, size and entry mode, testing whether the observations that had to be dropped because of missing values are systematically different from those retained in the sample. We rejected the hypothesis that there was sample selection bias in the data used for the regression analysis.iv

Regression Specification Dependent Variable and regression model. Our analysis focuses on the choice between greenfield, acquisition and JV entry, so the dependent is a categorical variable, taking the value of 1 for greenfield entries, 2 for acquisitions and 3 for JVs. The classification is based on the self-classification by respondents in the questionnaires. We use a Multinomial Logit (M-Logit) regression model to identify the determinants of this categorical variable. The M-Logit estimates the effect of the independent variables on the probability (differential odds) that one of the alternatives is chosen. Independent variables combine respondents assessment on Likert-type scales and objective measures like data on the parent firm as well as archival data (notably, on institutions) to avert common method bias. The explanatory variables are constructed as follows.v Institutions. We proxy institutional development by two measures based on

archival data, which is available on a yearly basis for the four host countries. We noted above that the extent of corruption is widely regarded as a leading indicator of the strength of market supporting institutions in emerging markets. The variable Transparency uses the corruption perception index (cpi) published annually by Transparency International which is based on an aggregation of multiple published indices that measure managerial perception of corruption. This rates countries in terms of the degree to which corruption is perceived to

24

exist among public officials and politicians. It is a composite index, drawing on expert surveys carried out by a variety of institutions, and reflects the views of business people and analysts, including experts who are locals in the countries evaluated. Thus the index captures corruption and with it closely related institutions, especially informal ones such as efficiency of the public sector and infrastructure services (Rose-Ackerman, 1999). The Economic Freedom index developed by the Heritage Foundation provides information about a broader notion of institutional development, focusing on the freedom of individuals and firms in country to pursue their business activities. It contains data about 50 independent variables divided into 10 broad categories. Variables noted in our discussion as being of particular relevance for investors into emerging markets are measured directly, including capital market development, property rights enforcement, regulation, trade policy and government intervention in the economy. We experimented with using individual key indicators separately, but they are all highly correlated and we thus report regressions that employ the aggregate index. We inverted the scores reported by the Heritage Foundation, such that for both proxies of institutions, higher values indicate a more advanced institutional framework. Economic freedom primarily captures aspects of the formal institutions, while transparency captures primarily informal institutions. Naturally, formal and informal institutions are closely related and we address this issue in our empirical work. Both proxies have an essential advantage over other measures used in the literature as they are available as time series, which allows us to assign each observation the value pertaining to the year of entry. However, these data are incomplete for the early 1990s, and we address this in two ways. First, we estimate the regressions using only data for the period after 1995, when the institutional proxies are available. Second, we use a technique of backward extrapolation to construct data for missing values in the institutional variables. We do this by estimating a variety of models (linear and quadratic) to predict the value of each institutional

25

variable, and then using the best fitting form to forecast the values of the variable backwards to the start of the sample period. The regressions estimated using each method are very similar and in fact our findings with respect to the three hypotheses are not affected by which method is adopted. In the paper, we report the regressions using the entire data period. Need for local resources. We constructed two indices to measure the need of investors for tangible and intangible assets. The survey instrument required the MNE affiliates to respond to two related questions. The first required them to identify the three tangible or intangible resources that were important to the success of their business ventures.vi A MNE could choose 0, 1, 2 or 3 tangible resources, and correspondingly 3, 2, 1 and 0 intangible resources. The second question required the MNEs to provide information about the extent to which in percentage terms these resources were contributed by the parent MNE, the local affiliate (if any), overseas markets, and the local market. We defined the share of key resources sourced from the host country as the sum of the shares sourced from the local partner and the host country market. Given this information, we defined the indices for tangible index and intangible index as follows: Let the percentage of a resource i sourced from the host country be xi. Each resource is assigned a weight corresponding with its ranking by the respondent, which may be 1, 2, 3 or 0 (= not ranked). Let wi be the weight associated with each xi, so that w1=3, w2=2 and w3=1, w0=0. For both types of resources, the index was calculated using the formula i wi xi / i wi. The index thus reflects the relative contribution of local resources to the overall package of resources that the firms considers essential for its competitiveness, giving more weight to the resources ranked as more important. Munificence of Local Firms. We rely on two survey-based measures to proxy the quality and quantity of local firms. First, respondents were asked to report their perceptions about the quality of the resource of local firms at the time of entry, using a 5-point Likert scale. They reported their perceptions about the quality and range of products and services of the

26

competing local firms, their management capabilities, and their marketing capabilities at the time of entry. We created a three-item measure for quality of the local firms, the index being an arithmetic average (Crombachs alpha: 0.79). Second, respondents were asked to report the number of competitors in the host country markets at the time of their entry into those markets. Local firm quantity is based on a five-point scale, where responds reported how many competitors there were in the market before the affiliate started operations, ranging from 1 (=none) to 5 (=more than 10). Unfortunately, because of the paucity of data in many emerging markets, we are not able to supplement this information with reliable or consistent industrylevel statistics on, for example, concentration indices, or expenditures for R&D and advertising.

Control Variables MNE parent. We need to control for firm specific effects to test our propositions, and thus adopt variables from earlier research, simplified by the limitations of our questionnaire survey instrument. MNEs that possess resources that are easily transferable across borders but difficult to transfer across organizational boundaries are expected to prefer greenfield entry. Empirical research provides strong support for this relationship, finding for example, that R&D intensive firms prefer greenfield entry (Kogut & Singh, 1988; Hennart & Park, 1993; Padmanabhan & Cho, 1996; Brouthers & Brouthers, 2000). R&D intensity is measured by R&D expenditures as a percentage of sales, as reported in the questionnaire on a scale from 1 (0-0.5%) to 7 (over 15%). Similarly, firms focusing on one product line, who are likely to possess unique knowledge for the production processes and business practices of those product lines, are found to prefer greenfield entry while diversified firms prefer entry by acquisition or JV (Caves & Mehra, 1986; Hennart & Larimo, 1998; Brouthers & Brouthers, 2000). Conglomerate is a dummy variable that takes the value of 1 if the respondent found that out

27

of three options Conglomerate diversified into unrelated business sectors best described the parent firm, with focused and related diversification as alternatives choices. Finally, MNEs establishing large investments are less likely to possess all the required resources, and may thus opt for a cooperative mode to access complementary resources and to share the risks of the new business venture with a partner. Hence, relatively smaller FDI is frequently associated with greenfield projects (Caves & Mehra, 1986; Kogut & Singh, 1988; Hennart & Park, 1993; Brouthers & Brouthers, 2000). Relative size is based on a 6-point scale reported in the questionnaire, where 1 stands for 0 to 0.1% and 6 stands for over 20% of the MNEs global turnover. Experience. The foreign investors' experience has frequently been found to influence international strategies (Barkema & Vermeulen, 1998). We include two dummy variables that both are based on yes/no questions in the questionnaire, and capture respectively prior commercial experience in respectively the same country (experience country) or other emerging economies (experience EM). Home Country, Industry. Many studies have observed that the national origin of investors impacts the choice of entry mode (e.g. Hennart & Larimo, 1998; Brouthers & Brouthers, 2001). We therefore include GDP per capita of the investors home country, measured in 1000 US dollars.vii Further, we control for cultural differences between investing MNEs, using a cluster approach suggested by Ronan and Shenkar (1985). Thus, eight dummies are introduced based on nine clusters of countries of origin. Finally, we control for unobserved characteristics of the local industries, using five industry dummies. *** Table 1 (correlation matrix) approximately here ***

Of the MNEs in the sample, 41.7% entered by Greenfield, 11.7% by acquisition and 46.6% by joint venture. Table 1 reports the correlation matrix for the dependent and

28

explanatory variables used in the regression analysis. The correlations show, not unexpectedly, a moderate correlation between the two institutional variables. We thus include them separately as well as jointly in the regression. There are no substantive correlations between any of the other independent variables.

*** Table 2 approximately here ***

RESULTS
The results of the multinomial regression model are reported in Table 2. We report the marginal effects of the probability that any of the three alternatives being chosen over the other two. Three equations are presented including respectively one or both of the institutional variables, transparency and economic freedom to address potential issues of collinearity between these variables. The three models yield a similar story with respect to the hypotheses and the model which contains both proxies for institutional development has a slightly better fit, with both variables being significant. We therefore concentrate on this model in our discussion of the results. Hypotheses 1a and 1b on the effects of institutional development are supported by the pattern of coefficients of economic freedom and transparency. Both relate negatively to joint-ventures as predicted in H1a (economic freedom significantly so in models 1 and 3) and positively to acquisitions (transparency significantly so in models 2 and 3), as predicted in H1b. Thus, we find that institutional development discourages joint ventures and facilitates acquisitions. Greenfield investments take an intermediate position; the coefficient on transparency is negative and the coefficient on economic freedom is positive, but only the latter is significant. On balance, improved institutions also enhance the probability of entry by greenfield. When both variables are included (model 3) the positive effect of

29

transparency dominates with respect to acquisitions, while the negative effect of economic freedom dominates for joint ventures. Economic Freedom tends to capture primarily freedom from institutional constraints, formal institutions, such as those disallowing full foreign ownership. Transparency captures more subtle informal institutions and influences that affect for instance capital markets and the management of existing organizations. Overall, we interpret this pattern as support for our argument that institutional development at early stages would reduce pressures to form joint ventures, while at advanced levels it would facilitate in particular acquisition entry (Figure 2). Hypothesis 2a on the effect of resource needs is supported by the negative coefficients of tangible assets and intangible assets in the parts of the equations relating to greenfield investment. This result is highly significant on both proxies in all three models in Table 2. Thus, the need for local resources would discourage foreign investors from choosing greenfield as the mode of entry. The result is consistent with earlier studies on greenfield versus acquisition choice, which proxied the need for local resources indirectly (Hennart & Park, 1993; Anand & Delios, 2002). Since we here provide evidence through a direct measure, our result strengthens the support in the literature for the proposition. Hypotheses 2b and 2c argue that local resources would be accessed by different means, depending on their characteristics. This argument is supported in Table 2 by the positive coefficients of respectively tangible assets on joint ventures and intangible assets on acquisitions. In fact both proxies are positively related to both joint ventures and acquisitions but only the former coefficient is significant in all three models. In case of acquisitions, intangible assets are a significant motivator, but tangible assets are not. However, for joint ventures both tangible and intangible resources elicit an effect, and the two effects are very similar in scale; in model 3 the marginal effects are 0.0025 for tangible resources and 0.0024 for intangibles with standard errors of 0.0009 and 0.0008 respectively. The two effects are

30

therefore not significantly different from each other. Thus, access to intangible assets also leads to joint venture entry, an effect that theory did not lead us to predict. A possible explanation may be that for certain assets embedded in individuals, an acquisition of a firm may not secure control because these individuals may not want to work for the new owners, and thus quite their job (Dyer, Kale & Singh, 2004). Thus, contrary to transaction cost economics as applied by Buckley and Casson (200x) acquisitions may not be an effective means to internalize certain types of intangible assets. We conclude that as predicted, the mode of accessing local resources varies with the properties of the sought resources: intangible resources are typically organizationally embedded, and transfer is subject to high degree of market failure, such that investors may take over an entire firm to access and control them. However, in the case of tangible assets, a joint venture appears to be sufficient to protect the interests of the parties involved. Hypothesis 3 does not receive empirical support because the variables relating to the munificence of local firms remain insignificant, though with the predicted signs, for all entry modes in all three models. The coefficients on both the quality and the quantity of local firms are, as predicted, negative for Greenfield and positive for acquisitions. Yet they remain insignificant in these and numerous other regressions noted above not reported in which we experiment with the data period and with different patterns of control variables. This lack of support for hypothesis 3 challenges the argument by Hennart and Reddy (1997) that weak digestibility would deter acquisitions. However, we believe that our finding may be also be a consequence of weaknesses in the proxies for munificence used in our empirical work. The pertinent questions in the questionnaire about the quality and quantity of local firms in the industry were perhaps insufficiently specific in defining the industry in question. Local firm CEOs are possibly also not the best repositories of information about the supply of local firms from the perspective of ease of purchase and assimilation by a foreign investors, and

31

our research into this question is hampered by the absence of archival data on this important issue in emerging markets. Future research, using more specific measures of the supply side, may provide more conclusive evidence on hypothesis 3 for emerging markets. The pattern of control variables corresponds to our expectations, though levels of significance are rarely above 5%. As expected, we find that conglomerates are more likely to engage in joint ventures but not in greenfield projects. There are also significant cultural effects: Germanic, Japanese and Arab investors are significantly more likely to opt for joint ventures and against greenfield than Anglo-Saxon investors. The industry dummies are individually not significant, but a Wald test confirms that as a group they have a statistically significant influence.

DISCUSSION
Entry Mode as a Three Dimensional Construct We have argued that entry modes in emerging economies ought to be conceptualized as three-way choice, and we find support for this contention in that several of the coefficients in Models 1 to 3 point in opposite directions between JV and acquisitions; between greenfield and JV and between greenfield and acquisition. This effect is also significant for the controls, namely per capita GDP source and some of the cultural dummies. We have shown that two considerations simultaneously influence the three dimensions of entry mode choice, namely resource access and control. The results suggest that the dichotomous treatment of the control and resource dimensions may overly simplify the decision process. Moreover, the three-way conceptualization highlights that there may be other determinants at play, especially in distinguishing acquisition entry from modes that create a new entity. We suggested that these additional determinants would be related to the costs of restructuring acquired firms and thus the relative benefits of a new start. Our empirical results do not

32

support the fairly general hypothesis H3, such that future research may test the propositions on more specific aspects of local firms munificence, or further investigate theoretically what additional factors may deter acquisitions at the expense of all other modes. While the precise determinants remain to be proven, the theoretical perspective put forward in this paper builds a bridge between two largely separate literatures: ownership versus wholly owned, and acquisitions versus greenfield.

Institutions and Business Strategy We have shown theoretically and empirically how the institutional context moderates strategic decisions of firms, and foreign investors entry mode choice. In particular, we find that the more advanced the institutional environment, both formal and informal, the more likely investors would choose greenfield over joint ventures, and acquisitions over either mode. The strategic management literature has so far investigated the role of institutions at fairly aggregate levels (Meyer, 2001; Peng 2003; Wan & Hoskisson, 200_). Our analysis suggests a more differentiated treatment, differentiating in particular two effects. (1) Institutional development in the sense of liberalization and removal of excessive constraint on business opens up new forms of business, in our case greenfield investment and foreign acquisitions. (2) Institutional development in the sense of fine-tuning regulation such as to enhance predictability and transparency facilitates more complex business transactions such as acquisitions. In the process of economic reform, liberalization may often precede regulatory fine-tuning, such that new strategies developed by businesses would vary at different stages of reform. Future theorizing may further develop these two effects of institutional development, opening of new modes and facilitating complex modes. Since transparency is also used as a measure of corruption, our results also

33

contribute to the corruption literature (Rodriguez et al., 2005). In particular, we provide a more differentiated interpretation of the effect discovered by Smarzynska and Wei (2002) that low levels of corruption would facilitate wholly-owned subsidiaries. We show that this effect would apply only with respect to acquisitions, but not necessarily when distinguishing between joint ventures and greenfield. Foreign investors may have different coping strategies when dealing with corruption beyond the basic option to stay out altogether. One way would be to minimize sensitive interfaces and establish a greenfield operation with few local contacts. A second option may be to build local social networks such as to enhance legitimacy and bargaining power vis--vis those potentially asking for a payment (Rodriguez et al., 2005). This arrangement also allows for the joint ventures local partner to take care of sensitive issues about which the foreign investor prefers not to know (Lambsdorff 1999). The institutional framework is also an important moderator of transaction costs. While the literature has mainly focused on market failure that may inhibit the transfer of resources from parent to affiliate (Meyer, 2001), we analyze resources that foreign investors may want to acquire locally. In emerging economies, the access and control of local resources may be equally important for the choice of entry mode, which is underlined by the high levels of significance of the proposed effects. Future studies of joint ventures and strategic alliances may thus pay attention not only to resources transferred by investors, but also to the resources that they seek to obtain from others. The institutional framework also shapes local firms, and thus the potential joint venture partners and acquisition targets. As firms had adapted to their institutional context, they developed internal processes and practices that fit their old context. Their inherited structures would thus reflect pre-reform conditions in countries that recently underwent major reform (Newman, 2000), or otherwise be incompatible with the foreign investors organization. Thus, firms internal institutions can inhibit in particular acquisition entry.

34

Finally, we also make a small methodological contribution to the study of institutions and business strategy by introducing time varying proxies of institutions, namely transparency and economic freedom. Unlike in developed market economies, where the business environment is typically rather stable, this is important in emerging market contexts because institutions, especially formal ones, can often change rapidly with reform. With enhanced data availability, we expect this approach to be adopted in many future studies, because it allows for more differentiated treatment of institutions.

Limitations A pertinent question for empirical studies is always whether the empirical relationships identified in the study could be explained by different mechanisms than those proposed by the authors. In our case, we may be concerned about possible correlations of our institutional variables, transparency and economic freedom, with other country specific effects. To minimize this possibility, we control for GDP per capita, the most likely additional influence. Future research aiming to improve over this approach might wish to work with larger sets of countries, so as to increase the cross country and cross time variance in the set of institutional independent variables. A second common concern is the quality of the proxies. We collected local data to get as close as possible to the context (the focus of our research), and thus distinguish ourselves from earlier headquarter driven study designs. At the same time, we are able to represent a wide cross-section of host and home countries. Moreover, we combine different types of data, namely archival and survey data to avert common method biases. However, this approach implies that our controls for the parent firms may not be as good as in earlier research. Future research may aim to improve over this by collecting data at two sites in each firm. This however requires a major logistics effort as archival data on many foreign

35

investors in for instance Vietnam and Egypt are not readily available, as many of them are quite small and come from neighbouring countries such as Taiwan and Saudi Arabia.

CONCLUSION
This paper contributes to the development of strategic management theory as pertaining to emerging economies. Our empirical work supports our contention that entry modes in emerging markets should be conceptualised as a three way choice. We focus on the interaction of business strategy with the institutional environment and offer a more differentiated treatment, noting in particular that different aspects of the institutional framework may have different effects at different stages of their development. We also find that resource access and control have different effects according to the mode of entry. We expect our study to stimulate further theoretical and empirical research in the complex interface between business strategies and the institutional context. The broad research issues that such research may aim to push further include: What are the specific aspects of institutions that explain variations of business strategies (Meyer & Peng, 2005) both over time and between countries? In particular, how should one identify distinct effects of different institutions when within a country, many aspects of the institutional environment are usually highly correlated? What exactly are the resources that foreign investors acquire from local partners, and in what ways are transactions in these resources inhibited by the specific market failures of emerging markets to such an extent that they would become internalized? In particular, our findings suggest that joint ventures are not only sufficient to acquire tangible assets, but may be an entry mode capable of internalising intangible resources as well. One might speculate that this is because the intangible assets from local firms of relevance in entry to emerging markets relate more to networks and business relationships, from 36

which both parties to the venture might gain but over which there are less likely to be conflicts of control. How are entry strategies constrained by the supply side of local resources, embedded in local firms or otherwise, constrain entry strategies? In particular, what aspects of the munificence of local firms would significantly inhibit acquisition strategies? Our work suggests that availability, which may be associated with ownership structures as well as the actual number of firms, may be important. This is because, in emerging markets, many firms are owned by families or trading houses and cannot be acquired. Moreover, one has to conceive of quality from the perspective of the acquiring firm, and therefore in terms of digestibility of the local firm.

37

References Anand, J. & Delios, A. 2002. Absolute and Relative Resources as Determinants of International Acquisitions. Strategic Management Journal, 23: 119-134. Anderson, E. & Gatignon, H. 1986. Modes of Foreign Entry: A Transaction Cost Analysis and Propositions, Journal of International Business Studies, 17(Fall): 1-26. Antal-Mokos, Z. 1998. Privatisation, Politics, and Economic Performance in Hungary, Cambridge: Cambridge University Press. Barkema, H.G. & Vermeulen F. 1998. International Expansion Through Start-up or Through Acquisition: A Learning Perspective, Academy of Management Journal, 41: 7-26. Brouthers, K.D. &. Brouthers, L.E. 2000. Acquisition or Greenfield Start-Up? Institutional, Cultural and Transaction Cost Influences, Strategic Management Journal, 21: 89-97. Brouthers, K.D. & Brouthers, L.E. 2001. Explaining the National Culture Distance Paradox, Journal of International Business Studies, 32(1): 177-189. Brouthers, K.D. & Brouthers L.E. 2003. Why Service and Manufacturing Entry Mode Choices Differ: The Influence of Transaction Cost Factors, Risk and Trust, Journal of Management Studies, 40(5): 1179-1204. Buckley, P.J. & Casson M.C. 1998. Analysing Foreign Market Entry Strategies: Extending the Internalisation Approach, Journal of International Business Studies: 29. 539-562. Buckley, P.J. & Casson M.C. 200X, in: Pitelis & Sugden, eds.: . 2nd ed., Rutledge. Caves, R.E. & Mehra S.1986. Entry of Foreign Multinationals into U.S. Manufacturing Industries, in: Michael Porter (ed.): Competition in Global Industries, Boston: Harvard Business School Press. Chang S.-J. & Rosenzweig, P.M. 2001. The Choice of Entry Mode in Sequential Foreign Direct Investment. Strategic Management Journal 22: 747-776. Cheng, J.L.C. 1994. On the Concept of Universal Knowledge in Organizational Science: Implications for Cross-national Research, Management Science, 40: 162-168.

38

Dacin, M.T., Goodstein, J & Scott, W.R. 2002. Institutional Theory and Institutional Change: Introduction to the Special Research Forum, Academy of Management Journal, 45: 45-57. Danis, W. & Parkhe, A. 2002. Hungarian-Western Partnerships: A Grounded Theoretical Model of Integration Processes and Outcomes. Journal of International Business Studies, 33: 423-455. Delios, A. & Henisz, W.J. 2000. Japanese Firms Investment Strategies in Emerging Markets. Academy of Management Journal, 43: 305-323. Dharwadikar & - AMJ 2000 DiMaggio, P. & Powell, W.W. 1983. The iron cage revisited: Institutional isomorphism and collective rationality in organizational fields. American Sociological Review, 48: 147160. Dyer, J.H., Kale, P. & Singh, H. 2004. When to Ally and When to Acquire, Harvard Business Review (July-August) 109-115. Ellango, B. & Sambharya, R.B. 2004. The influence of industry structure on the entry mode choice of overseas entrants in manufacturing industries, Journal of International Management 10: 107-124. Estrin, S., Hughes K. & Todd, S. 1997. Foreign Direct Investment in Central and Eastern Europe, London: Cassel. Estrin, S. & Meyer, K.E., eds. 2004. Investment Strategies in Emerging Markets, Cheltenham: Elgar, Fiol, C.M. & Lyles, M.A. 1985. Organizational Learning. Academy of Management Review: 10, 4, 803-13. Gomes-Casseres, B. 1990. Firm ownership preferences and host government restrictions: An integrated approach. Journal of International Business Studies: 21: 1-22.

39

Henisz, W.J. 2000. The Institutional Environment for Multinational Investment. Journal of Law, Economics and Organization: 16: 334-364. Henisz, W.J. 2003. The Power of the Buckely and Casson Thesis: The Ability to Manage Institutional Idiosyncrasies. Journal of International Business Studies: 34: 173-184. Hennart, J-F. 1988. A Transaction Costs Theory of Equity Joint Ventures. Strategic Management Journal: 9: 361-74. Hennart, J-F. & Larimo, J. 1998. The Impact of Culture on the Strategy of Multinational Enterprises: Does National Origin Affect the Ownership Decisions? Journal of International Business Studies: 29(3): 515-538. Hennart, J.-F. & Park, Y. -R. 1993. Greenfield vs. Acquisition: The Strategy of Japanese Investors in the United States. Management Science: 39: 1054-1070. Hennart, J.-F. & Reddy, S. 1997. The Choice between Mergers/Acquisitions and Joint Ventures: The Case of Japanese Investors in the United States. Strategic Management Journal: 18: 1-12. Harzing, A.-W. 2002. Acquisitions versus Greenfield investments: international strategy and management of entry modes, Strategic Management Journal 23: 211-227. Hill, C.W.L. 1995. National Institutional Structures, Transaction Cost Economizing and Competitive Advantage: The Case of Japan. Organization Science 6: 119-131. Hill, C.W.L., Hwang, P., & Kim, W.C. 1990. An Eclectic Theory of the Choice of International Market Entry Mode, Strategic Management Journal 9, summer special issue, 93-104. Hitt, M.A., Dacin, M.T., Levitas, E., Arregle, J. -L. & Borza, A. 2000. Partner Selection in Emerging and Developed Market Contexts: Resource-based and Organizational Learning Perspectives. Academy of Management Journal: 43: 449-467. Hitt, M.A.; Ahlstrom, D., Dacin, M.T., Levitas, E., & Svobodina, L. (2004): The institutional effects on strategic alliance partner selection in transition economie. China versus Russia, Organization Science 15: 173-185. 40

Hoskisson, R.E., Eden, L., Lau, C. M. & Wright, M. 2000. Strategy in Emerging Economies, Academy of Management Journal: 43(3): 249-267. Ingram, P. and Silverman, B. 2002. Introduction. In Ingram, P. and Silverman, B. (eds.), The New Institutionalism in Strategic Management: 1-30. Amsterdam: Elsevier. Khanna, T. & Palepu, K. 2000. The Future of Business Groups in Emerging Markets: Longrun Evidence from Chile. Academy of Management Journal: 43(3): 268-285. Khanna, T., Palepu, K. & Sinha, J. 2005. Strategies that Fit Emerging Markets. Harvard Business Review: 83 (June): 6Kock, C.J. & Guilln, M.F. 2000. Strategy and Structure in Developing Countries: Business Groups as an Evolutionary Response to Opportunities for Unrelated Diversification. Industrial and Corporate Change: 10: 77-113. Kogut, B. 1991. Country Capabilities and the Permeability of Borders. Strategic Management Journal: 12 (summer special issue): 33-47. Kogut, B. & Singh, H. 1988. The Effect of National Culture on the Choice of Entry Mode. Journal of International Business Studies: 19(3) 411-32. Kogut, B. and Spicer, A. 2002. Capital market development and mass privatization are logical contradictions: Lessons from Russia and the Czech Republic. Industrial and Corporate Change: 11: 1-37. Kogut, B. & Zander, U. 1993. Knowledge of the Firm and the Evolutionary Theory of the Multinational Corporation. Journal of International Business Studies: 24: 625-646. Lambsdorff, J. Graf 2002. Making Corrupt Deals - Contracting in the Shadow of the Law, Journal of Economic Behaviour and Organization 68: 221-41. Lane, P., Salk, J., & Lyles, M. 2001. Absorptive Capacity, Learning and Performance in International Joint Ventures. Strategic Management Journal: 22: 1139-1161. Luo, Y. 2001. Determinants of Entry in an Emerging Economy: A Multilevel Approach, Journal of Management Studies: 38: 443-472. Luo, Y. 2002. Capability Exploitation and Building in a Foreign Market: Implications for 41

Multinational Enterprises, Organization Science: 13: 48-63. Makhija, M. 2003. Comparing the Resource-based and Market-based Views of the Firm: Empirical Evidence from Czech Privatization. Strategic Management Journal: 24(5): 433-451. Makino, S., Lau, C-M. & Yeh, R. -S. 2002. Asset-Exploitation Versus Asset-Seeking: Implications for Localization Choice of Foreign Direct Investment from Newly Industrialized Economies. Journal of International Business Studies: 33(3): 403-422. March, J.G. 2005. Parochialism in the evolution of a research community: The case of organization studies, Management Organization Review: 1, 5-22. Mauro, P. 1995. Corruption and Growth. Quarterly Journal of Economics: 110(3): 681713. Meyer, J. & Rowan ... 1977 Meyer, K.E. 2001. Institutions, Transaction Costs and Entry Mode Choice. Journal of International Business Studies: 31(2): 357-368. Meyer, K.E. 2002. Management Challenges in Privatization Acquisitions in Transition Economies. Journal of World Business: 37 (4): 266-276. Meyer, K.E. & Estrin, S. 2001. Brownfield Entry in Emerging Markets. Journal of International Business Studies: 31(3): 575-584. Meyer, K.E. & Nguyen, H.V. 2005. Foreign Investment Strategies and Sub-national Institutions in Emerging Markets: Evidence from Vietnam, Journal of Management Studies, 42: 63-94. Meyer, K.E. & M.W. Peng, 2005. Theorizing in Central and Eastern Europe: Transactions, resources, and institutions, Journal of International Business Studies, forthcoming. Newman, K. 2000. Organizational transformation during institutional upheaval. Academy of Management Review: 25: 602-619. North, D. 1990. Institutions, institutional change, and economic performance, New York: Norton. Oliver, C. 1997. Sustainable competitive advantage: combining institutional and resource 42

based views, Strategic Management Journal 18: 697-713. Oxley, J.E. 1998. Institutional Environment and the Mechanisms of Governance: The Impact of Intellectual Property Protection on the Structure of Inter-Firm Alliances. Journal of Economic Behavior and Organization: 38(3): 283-310. Padmanabhan, P. & Cho, K.R. 1996. Ownership Strategy for a Foreign Affiliate: An Empirical Investigation of Japanese Firms. Management International Review: 36: 45-65. Pan, Y. & Tse, D.K. 2000. The Hierarchical Model of Market Entry Modes. Journal of International Business Studies: 31(4): 535-554. Peng, M.W. 2003. Institutional Transitions and Strategic Choices. Academy of Management Review: 28(2): 275-296. Peng, M.W. & Heath, P. 1996. The Growth of the Firm in Planned Economies in Transition: Institutions, Organizations, and Strategic Choices. Academy of Management Review: 21 (2): 492-528. Peng M.W., Lee, S.H. & Wang, D.Y.L. 2005. What determines the scope pf the firm over time? A focus on institutional relatedness, Academy of Management Review: 30, 622633. Ramamurti, R. 1992. Why are Developing Countries Privatizing? Journal of International Business Studies: 23, 225-249. Ronan, S. & Shenkar, O. 1985. Clustering Countries on Attitudinal Dimensions: A Review and Synthesis, Academy of Management Review: 10, 435-454. Rose-Ackermann, S. 1999. Corruption and government: causes, consequences and reform, London: Cambridge University Press. Rodriguez, P; Uhlenbruck, K. and Eden, L. 2005. Government corruption and the entry strategies of multinationals, Academy of Management Review: 30: 383-396. Shleifer, A. & Vishny 1997 JOF Smarzynska, B.K. & Wei, S.-J. 2002. Corruption and Cross-Border Investment: FirmLevel Evidence. William Davidson Institute Working Papers Series 494, William Davidson Institute at the University of Michigan.

43

Spicer, A., McDermott, G. & Kogut, B. 2000. Entrepreneurship and privatization in Central Europe: The tenuous balance between destruction and creation, Academy of Management Review: 25: 630-649. Tse, D, K., Pan, Y. & Au, K.Y. 1997. How MNEs Choose Entry Modes and Form Alliances: The China Experience. Journal of International Business Studies: 28: 779-805. Tsui, A. 2005. Contributing to global management knowledge: A case for high quality indigenous research, Asia Pacific Journal of Management 21: 491-513. Uhlenbruck, K. & DeCastro, J.O. 1998. Privatization from the Acquirers Perspective: A Mergers and Acquisitions Model, Journal of Management Studies: 35, 619-640. Uhlenbruck, K. & DeCastro, J.O. 2000. Foreign Acquisitions in Central and Eastern Europe: Outcomes of Privatisation in Transitional Economies. Academy of Management Journal: 43, 381-402. Uhlenbruck, K., Meyer, K.E. & Hitt, M. 2003. Organizational Transformation in Transition Economies: Resource-based and Organizational Learning Perspectives. Journal of Management Studies: 40, 257-282. United Nations. 2003. World Investment Report 2003. Geneva: United Nations. Wan, & Hoskisson, R.E. AMJ 2003/4 Wright, M., Filatotchev, I., Hoskisson, R. & Peng, M.W. 2005. Strategy Research in Emerging Economies: Challenging the Conventional Wisdom. Journal of

Management Studies: 26(1): 1- . World Bank 1996 World Bank 2004 Yiu, D. & Makino, S. 2002. The choice between joint venture and wholly owned subsidiary: An institutional perspective, Organization Science 13:667-683. Young et al. 2002 Zaheer, S. 1995. Overcoming the Liability of Foreignness. Academy of Management Journal: 38(2): 925-950. 44

Zahra, S. & George, G. 2003. Absorptive Capacity: A Review, Reconceptualization, and Extension. Academy of Management Review: 27: 185-203.

45

Table 1: Correlation Matrix

1 1 2 3 4 5 6 7 8 9 10 11 12 13 Tangible assets Intangible assets Local firm quantity Local firm qualtity GDP host gdp_pc home Experience country Experience region Relative size R&D Conglomerate Transparency Economic Freedom 1.00 0.19 0.06 0.07 -0.03 0.01 0.02 -0.02 0.06 -0.07 0.06 0.02 0.05 1.00 0.16 0.10 0.06 0.06 0.03 0.10 -0.08 -0.07 -0.01 0.16 0.20 1.00 0.21 0.01 -0.02 0.10 0.11 -0.01 0.04 -0.03 0.13 0.18 1.00 0.05 -0.06 -0.03 0.09 -0.04 0.09 0.04 0.14 0.12 1.00 0.25 0.01 0.15 -0.11 0.07 -0.15 -0.16 0.23 1.00 0.12 0.15 -0.24 0.12 -0.07 -0.02 0.10 1.00 0.10 -0.10 0.09 0.06 0.13 0.14 1.00 -0.25 0.12 -0.03 0.24 0.34 1.00 0.02 -0.15 -0.07 -0.10 1.00 -0.11 0.19 0.15 1.00 0.07 -0.06 1.00 0.62 1.00 2 3 4 5 6 7 8 9 10 11 12 13

46

Table 2: Multinomial Regression

Greenfield --Model 1 Acquisition --Joint venture --Greenfield 0.0793 (0.0565) --Model 2 Acquisition 0.0259 *** (0.0064) --Joint venture -0.1051 * (0.0566) --Model 3 Greenfield Acquisition Joint venture 0.1440 ** 0.0114 -0.1554 ** (0.0707) (0.0103) (0.0707) -0.0650 0.0111 ** 0.0539 (0.0436) (0.0435) (0.0051) -0.0027 *** 0.0002 ** 0.0025 *** (0.0008) (0.0001) (0.0008) -0.0026 *** 0.0000 0.0026 *** (0.0001) (0.0009) (0.0009) -0.0051 0.0014 0.0037 (0.0297) (0.0027) (0.0297) -0.0082 0.0015 0.0067 (0.0223) (0.0020) (0.0223) 0.0120 0.0048 -0.0167 (0.0597) (0.0048) (0.0598) -0.0566 0.0095 0.0471 (0.0641) (0.0058) (0.0640) 0.0239 0.0001 -0.0240 (0.0174) (0.0015) (0.0174) 0.0071 0.0002 -0.0069 (0.0144) (0.0145) (0.0014) 0.0039 -0.1751 ** 0.1712 ** (0.0071) (0.0781) (0.0782) -0.0002 0.0000 0.0002 (0.0004) (0.0001) (0.0004) -0.0005 * 0.0000 0.0005 * (0.0003) (0.0000) (0.0003) yes *** yes *** yes *** yes yes yes Log pseudolikelihood -316.204 Wald chi-sq 7484.770*** Pseudo R-sq 0.210

Economic Freedom Transparency Intangible Assets Tangible Assets Local firm quality Local firm quantity Experience country # Experience region # Relative Size R&D Conglomerate # GDP pc source ('000) GDP host 8 culture dummies 5 industry dummies Model statistics

-0.0114 -0.0041 0.0155 *** (0.0348) (0.0349) (0.0038) -0.0026 *** 0.0002 ** 0.0024 *** (0.0008) (0.0001) (0.0008) -0.0026 *** 0.0001 0.0025 *** (0.0001) (0.0009) (0.0009) -0.0030 0.0012 0.0017 (0.0300) (0.0025) (0.0299) -0.0061 0.0016 0.0045 (0.0220) (0.0019) (0.0220) 0.0152 0.0052 -0.0204 (0.0595) (0.0044) (0.0595) -0.0408 0.0096 * 0.0312 (0.0619) (0.0618) (0.0058) 0.0244 0.0001 -0.0246 (0.0172) (0.0015) (0.0172) 0.0071 -0.0003 -0.0068 (0.0145) (0.0013) (0.0144) -0.1857 ** 0.0045 0.1812 ** (0.0069) (0.0759) (0.0766) -0.0002 0.0000 0.0002 (0.0004) (0.0000) (0.0004) -0.0004 0.0000 0.0003 (0.0003) (0.0000) (0.0003) yes *** yes *** yes *** yes yes yes Log pseudolikelihood -319.595 Wald chi-sq 10762.8*** Pseudo R-sq 0.2011

-0.0027 *** 0.0001 ** 0.0026 *** (0.0008) (0.0001) (0.0008) -0.0026 *** 0.0000 0.0026 *** (0.0001) (0.0009) (0.0009) 0.0017 0.0057 -0.0074 (0.0026) (0.0296) (0.0296) -0.0087 0.0013 0.0074 (0.0224) (0.0017) (0.0224) 0.0114 0.0032 -0.0146 (0.0598) (0.0041) (0.0600) -0.0620 0.0089 0.0531 (0.0633) (0.0055) (0.0634) 0.0245 0.0001 -0.0246 (0.0174) (0.0013) (0.0175) 0.0045 0.0003 -0.0048 (0.0142) (0.0011) (0.0142) 0.0022 -0.1861 ** 0.1838 ** (0.0060) (0.0754) (0.0761) -0.0001 0.0000 0.0001 (0.0004) (0.0001) (0.0004) -0.0004 0.0000 0.0004 (0.0003) (0.0000) (0.0003) yes *** yes *** yes *** yes yes yes Log pseudolikelihood -320.4400 Wald chi-sq 7188.3500*** Pseudo R-sq 0.1990

47

Wald tests (df)

Nobs Resources (2) Local firms (2) Institutions (1) Home country (8) Industry (5)

412 22.4900*** 1.6900 17.71*** 2299.95*** 18.7**

Nobs Resources (2) Local firms (2) Institutions (1) Home country (8) Industry (5)

412.0000 24.0500*** 2.1000 27.8400*** 2025.3600*** 19.0900***

Nobs Resources (2) Local firms (2) Institutions (2) Home country (8) Industry (5)

412.000 22.500*** 1.640 45.110*** 1762.480*** 18.450**

Levels of significance: *** = 1%, ** = 5%, * = 10%, (*) = 11%; standard deviations in parentheses; # = dy/dx is for discrete change of dummy variable from 0 to 1

48

Endnotes i A related line of research analyzes the impact on institutional isomorphism and pressures for internal and external legitimacy on the investing MNE on the basis of institutional theory as developed in sociology and organization studies. (Brouthers & Brouthers, 2000; Yiu & Makino, 2002; Rodriguez, Uhlenbruck & Eden, 2005). While this approach is complementary (Peng, 2003), we prefer to develop a consistent logic based on Northian and Williamsonian thought. ii Quantitative measures are contained in the World Bank, Doing Business in 2005. iii In Vietnam, respondents received the questionnaire in an English and the Vietnamese version, plus in the case of Chinese parent firms a Chinese version. The translations to respectively Vietnamese and Chinese were done with the established translation and independent back-translation procedure. While the Chinese version turned out to be an important instrument to establish contact and trust with the firms, almost all preferred to complete the Vietnamese or English version. In the other three countries, English is established as the major language of business and we abstained from translation iv We employed the two step Heckman procedure. In the first stage a probit model was estimated with the dummy dependent variable taking the value 1 if an observation is included in the sample and zero otherwise. This regression had a poor fit and the coefficient of the Inverse Mills Ratio in the second stage regressions were not significant. v The questionnaire upon which the variables are defined is available from the authors on request. vi The choice of tangible resources included in the questionnaire were buildings and real estate, equity, loans, machinery and equipment, patents, sales outlets, and licences. The choice of intangible resources included brands, business network, distribution network, managerial capabilities, innovation capabilities, marketing capabilities, networks with authorities, technological know-how, and trade contacts. There was also an other" option, but this obtained only a negligible number of entries. vii We also included other source-country related variables, such as geographic distance, but we found them to be highly correlated with each other such that we only include the source country GDP in the reported regression. Inclusion of other source country variables did not change the results of any of the focal variables.

49