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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 UniversitySumon.Bhaumik@brunel.ac.uk

November 9th, 2005

Author contact: Professor Saul Estrin, Adecco Professor of Business and Society, LondonBusiness School, Regents Park, London NW1 4SA, United Kingdom, phone: (+44) 2702625050, sestrin@london.edu

Acknowledgements: We gratefully acknowledge comments received from Keith Brouthers,

Igor Filatotchev and seminar participants at Warwick Business School, University ofNottingham, Manchester Business School, National Cheng-chi University Taipei, KingsCollege 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 teamwas Stephen Gelb (EDGE Institute, Johannesburg, South Africa), Heba Handoussa andMaryse Louis (ERF, Cairo, Egypt), Subir Gokarn and Laveesh Bhandari (NCAER, NewDelhi, India), Nguyen Than Ha and Nguyen Vo Hung (NISTPASS, Hanoi, Vietnam). Wethank Rhana Neidenbach, Gherardo Girardi and Delia Ionascu for their excellent researchassistance; the Department for International Development (UK) for supporting this researchunder DFID/ESCOR project no R7844, and the Aditya Birla India Centre at the LondonBusiness School for its financial support.

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mailto:km.cees@cbs.dkmailto:sestrin@london.edumailto:Sumon.Bhaumik@brunel.ac.ukmailto:Sumon.Bhaumik@brunel.ac.ukmailto:sestrin@london.edumailto:km.cees@cbs.dk

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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.

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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 economy-

wide 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_).

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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), oracquisition 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

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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

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(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

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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 industry-

specific 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).

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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

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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,

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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

Control

Access to

localresources

Joint venture

Acquisition

Greenfield

Benefits of

Newstart

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

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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.

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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

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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).

Fi ure 2: Predicted e ect o institutional develo ment on entr modes

13

Acquisition

Greenfield

JV

Weak inst. Strong inst.

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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

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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 time-

consuming 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

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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

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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.

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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 resource-

based 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

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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.

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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.

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Figure 3: Summary of hypotheses

H 2c H 2a

H 2b

H 1a

Acquisition

H 1bH 3

Joint venture Greenfield

Table 1: Summary of the predicted effects

Hypothesis Construct Effect on Mode Proxy for Empirical

analysis

1a Market-supporting institutions Joint Venture TI-index, EFS-index

1b Market-supporting institutions Acquisition TI-index, EFS-index

2a Need for resources Greenfield Two indices based on Q

2b Need for intangible resources Acquisition Index based on Q

2c Need for tangible resources Joint Venture Index based on Q

3 Munificence of local firms

(quantity, quality)

Acquisition Two indices based on Q

Note: Q = questionnaire survey by the authors.

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

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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

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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

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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

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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

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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 isourced 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 wibe the weight associated with eachxi, sothat w1=3,

w2=2 and w3=1, w0=0. For both types of resources, the index was calculated using the formula

iwixi/iwi. 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

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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 industry-

level 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

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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

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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 ofeconomic 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

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transparency dominates with respect to acquisitions, while the negative effect ofeconomic

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 oftangible 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

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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

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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 percapita 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

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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

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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.

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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

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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

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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.

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