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The impact of institutional hazards on foreign multinational activity: A contingency perspective

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Abstract

Prior studies have shown that institutional hazards in the form of formal governance deficiencies and informal cultural distance are both negatively related to the amount of foreign multinational activity in countries. We argue that the strength of these negative relationships varies systematically with the type of foreign activity (horizontal or vertical) and the type of institutional hazard (governance or cultural). Because institutional hazards striking vertical affiliates generally also have negative consequences for other parts of a multinational enterprise (MNE) while those striking horizontal affiliates do not, we hypothesize that institutional hazards are more negatively related to vertical foreign activity than to horizontal foreign activity. Since cultural hazards can generally be reduced or resolved once they materialize while governance hazards cannot, we also hypothesize that the impact of governance hazards on each type of foreign activity is more negative than the impact of cultural hazards on that type of activity. A panel data analysis of sales by US foreign affiliates to affiliated and local unaffiliated customers over the period 1996–2004 lends support to these hypotheses. Our findings thus show that the impact of institutional hazards on foreign MNE activity is more complex than previously assumed.

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Notes

  1. Although vertically integrated MNEs can sometimes restore their production chains by relocating vertical affiliates that have been struck by an institutional hazard, relocation processes are time consuming and costly, and lead MNEs to incur substantial sunk costs (Benito, 1997; Motta & Thisse, 1994). Hence even MNEs with vertical affiliates whose activities can be relocated should be very reluctant to locate such affiliates in institutionally hazardous countries.

  2. Note that we do not intend to argue that foreign MNEs cannot reduce governance hazards ex ante. Indeed, MNEs may be able to change a host country's governance system to their advantage (Root, 1988). We argue only that MNEs generally cannot resolve governance hazards once these hazards become reality, i.e., once they materialize in governmental decisions or in political or societal upheaval with negative consequences for MNE affiliates.

  3. When we used the original Kogut and Singh index, we obtained results similar to those reported in Table 2.

  4. This was confirmed by the fact that the replacement of population size by GDP generally lowered the explanatory power of our models and yielded a non-significant effect of GDP in several models.

  5. We thank an anonymous reviewer for bringing this point to our attention.

  6. To directly control for inter-country differences in the sectoral composition of US MNE activity, we collected data on the shares in total US affiliate value-added of a selection of industries for which sufficient and usable data were available from the BEA. When we added these sectoral value-added shares to our regression models, we obtained results quantitatively and qualitatively similar to those reported in Table 2.

  7. Following Cannella, Park, and Lee (2008), we generated the VIFs through OLS regressions, since VIFs are unavailable for FGLS regressions.

  8. The sizes of the standardized betas of governance imperfections (β= −0.16) and cultural distance (β= −0.40) in Model 3 indicate that the extent to which institutional hazards have a more negative effect on vertical activity than on horizontal activity is 2.5 times larger for cultural hazards than for governance hazards. We thank an anonymous reviewer for bringing this point to our attention.

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Acknowledgements

We thank Area Editor Arjen van Witteloostuijn and three anonymous JIBS reviewers for their valuable comments and suggestions. We also thank Africa Arino, Farok Contractor, and other participants in the 2007 AIB Junior Faculty Consortium for their feedback on a draft proposal for this paper. The helpful comments of Torben Pedersen, Marc van Essen, and Frank Wijen on earlier versions of this paper are also gratefully acknowledged. The second author thanks the Netherlands Organization for Scientific Research (NWO) for its financial support.

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Authors and Affiliations

  1. Amsterdam Business School, University of Amsterdam, the Netherlands

    Arjen H L Slangen

  2. University of Groningen, the Netherlands

    Sjoerd Beugelsdijk

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  1. Arjen H L Slangen
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  2. Sjoerd Beugelsdijk
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Correspondence to Arjen H L Slangen.

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Accepted by Arjen van Witteloostuijn, Area Editor, 6 November 2009. This paper has been with the authors for four revisions.

APPENDIX

APPENDIX

See Table A1.

Table A1 Host countries included in the sample
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Slangen, A., Beugelsdijk, S. The impact of institutional hazards on foreign multinational activity: A contingency perspective. J Int Bus Stud 41, 980–995 (2010). https://doi.org/10.1057/jibs.2010.1

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