THE DETERMINANTS OF FOREIGN ENTRY MODE

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1 THE DETERMINANTS OF FOREIGN ENTRY MODE BY Detlev Nitsch Richard lvey School of Business Graduate Program in Business Administration Submitted in partial fulfilment of the requirements for the degree of Doctor of PhiIosophy Faculty of Graduate Studies The University of Western Ontario London, Ontario January 1999 O Detlev Nitsch 1999

2 National Library 1+1,,ad, Acquisitions and Bibliograptiic Services Bibliothèque nationale du Canada Acquisitions et services bibliographiques 395 Wellington Street 395. nie Wellington Ottawa ON K1A ON4 UttawaON KIAON4 Canada Canada Your file Votre reurence Our iüe Notre rafdrence The author has granted a nonexclusive licence dowing the National Library of Canada to reproduce, loan, distribute or sell copies of this thesis in microfom, paper or electronic formats. The author retains ownership of the copyright in ths thesis. Neither the thesis nor substantial extracts fkom it may be printed or otherwise reproduced without the author's permission. L'auteur a accordé une licence non exclusive permettant à la Bibliothèque nationale du Canada de reproduire, prêter, distribuer ou vendre des copies de cette thèse sous la fonne de microfiche/fïlm, de reproduction sur papier ou sur format électronique. L'auteur conserve la propriété du droit d'auteur qui protège cette thèse. Ni la thèse ni des extraits substantiels de celle-ci ne doivent être imprimés ou autrement reproduits sans son autorisation.

3 ABSTRACT This thesis investigates the role of criteria used by managers when making investment-based foreign entry mode decisions. and develops a resource/knowledge-based model of entry mode choice. The determinants of both the Ownership Decision. which distinguishes between a wholly-owned new entry and a joint venture, and the Build/Buy Decision, which relates to the acquisition vs. greenfield choice. were studied. One of the most important contributions of this study is that it is based on responses from managers about the direction and degree of influence that various criteria have on their choice of mode. As well as providing empirical support for many of the conjectures about management behavior made by previous researchers, new insights were gained about the inter-related roles of resources and managers' preferences in determining the choice of entry mode. which is analyzed using a Resource-based framework. Parent firm resources were grouped into Management-based, Technical. and Financial categories. and knowledge-based decision criteria were developed from the literature. Resource-rich firms were expected to favor sole ownership and greenfield modes. The roles of location. previous experience. government influence, and cultural distance were also investigated. A survey. distributed to manufacturing subsidiaries of Japanese parent firms, yielded 91 responses usable for the full model, which was analyzed using the Partial Least Squares (PLS) structural modeling technique. This technique iii

4 permitted, for the first time. the analysis Gr the determinants of both decisions simultaneously. while also modeling the influence of cultural distance. The model explained 18% and 30% of the variance in the Build18uy and Ownership decisions, respectively. A less-restricted mode1 with more paths achieved even higher R2 values:.24 on the BuildlBuy decision, and.32 on the Ownership decision. These figures compare favorably to those achieved in previous research. Of the three categories of criteria used by managers in evaluating mode choice alternatives (Management. Technical, and Financial j, Management criteria were aligned most closely with the actual decision that was made. Preferences based on Technical and Financial criteria were not associated with the Ownership decision in a significant way, and Financial Criteria preferences were actually the opposite of the BuildlBuy decision that was made. Results of the model-building portion of the study demonstrate that a resource-based approach explains mode choice as well as previous approaches, but in a conceptually more parsimonious way. Keywords: International business, foreign direct investment, entry mode. structural modeling.

5 ACKNOWLEDGEMENTS I have looked fomvard to writing this part of the thesis for a long time, because it means that the seemingly endless process is finally over. 1 have thought often about what I might Say in this section, and always told myself not to waste time thinking about it yet, not to put the cart before the horse. Now, at long last, the time has come when this final piece can be written. Our adventures in Ph.D.-land actually began before I ever contemplated a doctorate as the ultimate goal. When I entered the MBA program at lvey (then still the Western Business School), it was for a quick sixteen-month stint to upgrade my job prospects. I still remember the conversation behnreen me and my wife, Karen, when we sat at Our kitchen table in Calgary and discussed our options. Going back to school full-time was not something I thought was even within the realm of the possible, until she said, "Well, why can't we do it? Let's look at the numbers." There was a way, as it turned out, and for that I owe Karen a debt that can never be repaid. That one conversation, as it turns out, has changed my whole life. The Admissions office at lvey is due a vote of thanks for taking a chance on me as a "Special Admission" student back in 1989, when I did not have the formal qualifications required for admission to the MBA Program. I also want to than k the exceptional faculty team that I had the pleasure of getting to know through those two years - I certainly emerged as a different person from the one who entered. In my tenure as a Ph.D. candidate, 1 have exhausted the patience of three Ph-D. Program Directors. Sincere thanks to Christoph Haehling von Lanzenauer for permitting me to enter the program when he already had a full class, to Rod White for his cooperation and flexibility when I had to temporarily withdraw for financial reasons, and to Sid Huff for tirnely intervention that allowed me to gasp across the finish line. Thanks also to my proposal cornmittee. Don Lecraw, Jay

6 Anand, and Rod White (again), and to John Hulland for his unfailing generosity with time and expert advice. My classmates in the program were a constant source of strength, especially in the early years. There was always someone to bounce ideas off, to vent frustrations on, to provide that critical reference. to help with computer glitches. or to be a source of inspiration at times of weakness. In particular, I want to single out Julian Birkinshaw, without whose collaboration I might not have made it through cornps, and Andrew Delios, who provided a constant fiow of ideas and commentary, as well as a dataset. Staff at lvey were also unçtintingly helpful, including those who worked on the production process of mailing the survey, and Linda Dittmer-Pino in the Ph.D. Program office, who was always bailing me out of trouble. The environment at the lvey School is a supportive and cooperative one - without this, I doubt I would have suwived. The role of the thesis advisor is a difficult one at the best of times, and I must confess that working with me was probably not the best of times for my advisor. It is no exaggeration to Say that, without Paul Beamish in my corner, this document would not exist, and the whole initiative could easily have gone down in Rames years ago. Paul's contributions were enormous on so many dimensions that this should be considered his second doctorate. Heartfelt thanks, Paul, for never losing faith, even when 1 did. There is no such thing in life as a purely individual accomplishment - everything we do affects others, and must be supported by those closest to us. In this regard, my family deserves rnuch of whatever credit goes with completing this project. Our children, Erika and Zachary, have had to put up with an absentee Dad, sometimes physicaily, more often psychically. My parents have also been supportive, financially and emotionally, and probably can't believe that I'm not a student any more. Finally, Karen has stuck with the program through some very

7 diffcult times, even when she did not truly believe that the road ahead was the best one. Staying with it in these circumstances requires the most incredible leap of faith, because it is made despite al1 instincts screaming STOP!! Karen, thank you for seeing it through, and I can only promise you that, while the payoff may look dubious from your point of view right now. it really is there, and you will see it too, in time. No amount of contribution on the part of others implies accountability for any errors. omissions. and flaws in this dissertation. That responsibility remains mine alone. vii

8 TABLE OF CONTENTS Certificate of Examination... ii... Abstract....III Acknowledgements... v Table of Contents... viii... List of Tables... xi.. List of Figures....XII CHAPTER 1 : INTRODUCTION O Ovenriew l mportance for practising managers Contribution to Theory Objectives of this research Methodology Organization of the Thesis CHAPTER 2: LITERATURE REVIEW = Introduction O Entry Mode Determinants Product Divêrsification International Experience Size Asset specificity Culture Market attractiveness Summary CHAPTER 3: THEORETICAL APPROACH = Introduction Ovewiew of previously-used theories Summary of Conceptual Approach Discussion of previously-used theory Resource-Based View of the firm Phase i: Traditional mode determinants, replication and validation Hypotheses Phase II: Development of the theoretical model Summary of theoretical approach CHAPTER 4: DEVELOPMENT OF SURVEY. MEASURES viii

9 .... Process of survey developrnent Introduction 4.2 O 4.3 Developrnent of Measures Product Diversification Experience Size Asset specificity Culture Country and industry variables Sample Choice of home country base Toyo Keizai Dataset Conclusion CHAPTER 5: RESULTS: SAMPLE CHARACTERISTICS AND HYPOTH ESlS TESTING C haracteristics of the sarnple...= Data source Sampling Suwey distribution Response rate... IO Response profile Results - Hypothesis testing Discussion of results Implications for theory-building stage CHAPTER 6: CONSTRUCTION OF THE MODEL O Resource constructs Discussion of rationale for item groupings O Decision Criteria constructs BuildlBuy Decision O Decision Criteria constructs - Ownership Decision Causal model construction Measurement Model assessrnent Structural Model Assessrnent CHAPTER 7: RESULTS: BUlLDlBUY DECISION O Overview O Buildlbuy Decision = Discussion of BuildlBuy Model Resource -+ Criteria links Criteria + Decision Links Resources + BuildlBuy Decision (direct links not in the main model) CHAPTER 8: RESULTS: OWNERSHIP DECISION O Discussion of Ownership findings Management resources links

10 Technical resources links Financial resources links Management Criteria links Technical Criteria links Financial Criteria links Cultural Distance Relative Contribution of Resources - Both Decisions Results CHAPTER 9: EFFECT OF CONTROL VARIABLES Introduction Government Influence Geographic Previous Experience Asset S pecificity Summary CHAPTER 10: CONCLUSIONS, DISCUSSION LIMITATIONS Categories of firm resources Dimensions of decision criteria Influences on Mode Decisions Hierarchy of influences - Resources to Decision Criteria O Contributions to theory = Contributions to practice O Limitations of this study External validity limitations Data insufficiency limitations O Directions for future research References 213 Appendix A - Survey Appendix B - Ethics Approval Vita

11 LIST OF TABLES Table 2-1 Most frequent hypothesized influences on Ownership and BuildlBuy decisions Table 2-2 Effect of R&D and Marketing intensity on Ownership and Build/Buy choices Table 2-3 Summary of previous research hypotheses and findings Table 2-4 Frequently-used measures in FDI Entry Mode research Table 3-1 Traditional proxies to measures in this study Table 5-1 Summary of Survey Distribution and Responses Table 5-2 Geographic distribution of responses Table 5-3 Industry distribution of responses Table 5-4 Mode distribution of responses Table 5-5 Means of responses on descriptive characteristics Table 5-6 Means of Ownership influence factor items Table 5-7 Means of BuildIBuy influence factor items Table 6-1 Resource item groupings Table 6-2 Resource variables: Two-factor extraction Table 6-3 Resource variables: Three-factor extraction Table6-4Cronbach'sAlphasforresourcefactors Table 6-5 Resource constructs' internal consistency measures within the PLS model Table 6-6 BuildIBuy Criteria constructs: interna1 consistency measures Table 6-7 Item loadings and convergent and discriminant validity of Criteria constnicts Table 6-8 Measurement model assessment data Table 6-9 Correlations of constructs Table 7-1 PLS Model Paths - BuildlBuy Decision Table 8-1 Ownership Decision Model Paths Table 8-2 Direct and Indirect effects of Resources Table 9-1 Cultural Distance from Japan by Country Table 9-2 Responseç to Experience items Table 9-3 Path differences based on Government influence Table 9-4 Path differences based on Location Table 9-5 Path differences based on Experience Table 9-6 Path differences based on Asset specificity Table 10-1 BuildIBuy section of the models - Significant path coefficients Table 10-2 Ownership section of the models

12 LIST OF FIGURES Figure 1-1 I nternationalization Decision Tree... 2 Figure 1-2 lnternationalization Research Conceptual Model Figure 3-1 The ResourceslCore Cornpetence Cycle Figure 3-2 RBV-based conceptual model of mode choice Figure 6-1 Conceptually-essential paths in PLS model Figure 7-1 Conceptual mode Figure 7-2 Ovewiew of PLS mode Figure 7-3 PLS Model of BuildlBuy Decision influences Figure 8-1 PLS Model of Ownership Decision influences Figure 10-1 Influence of Resources and Criteria on Mode Decisions xii

13 CHAPTER 1 : Introduction Overview One of the most important and complex decisions made by firms is the decision to establish a foreign subsidiary. In making this decision. managers must compare the costs and risks of such an initiative with the potential benefits that it may bring to the Company. Their objective is to make a decision that minimizes costs while providing the highest return. Such a seemingly simple statement of the managerial task conceals many complexities: the concepts of cost, risk, and returns are multidimensional, containing aspects of time horizon differences. how performance is measured (financial, relative to competitors, etc.). what unit of analysis is employed (parent or subsidiary, for example), the nature of risk. and how it should be measured, to what extent externalities such as industry and macroeconomic effects need to be considered, what alternatives should be considered, and so on. In al1 this, the manager, or management team, must make sorne very pragmatic decisions that have significant consequences and go to the heart of a firm's strategy and structure. This study focuses on one of those strategic decisions: the choice of foreign entry mode. We propose a theoreticai framework for analysing investrnent-based foreign entries based on an extension of the Resource-Based View of the firm (RBV; see Barney 1986, Peteraf 19931, as proposed by Madhok (1997a), called the Organizational Capabilities perspective (OC).

14 The complete foreign market entry decision can be conceptualized in decision tree form as follows: Figure 1.I - lnternationalization Decision Tree 1 International activity Focus of this study: Entry Mode Location, nvest Green field BuildlBuy Non-investment modes, for example: Export Licensing This study's research focus is on foreign subsidiaries. as a subset of al1 possible international business activities a multinational corporation (MNC) might undertake. This focus irnplies that we examine only those international activities in which an MNC has an ownership stake. Contractual arrangements such as licensing and exporting are thus not within the purview of this research. although these are often alternatives to investment-based modes. Further, we do not look at portfolio investments, as our rnodel is intended to apply to those investments

15 in which equity ownership goes along with the prerogative to exercise some level of managerial control. Along with this prerogative, of course, comes the assurnption that managerial input from the parent(s) will add value and make the investrnent perform better than it would have without such input. With our stated focus on investment or equity-based foreign market entries, we define entry modes along two dimensions: ownership (wholly-owned or joint venture) and build or buy (greenfield or acquisition). The complete foreign direct investment (FDI) decision under consideration here can be viewed as the product of three subdecisions: location, ownership (shared or sole ownership) and build or buy (greenfield or acquisition). The first of these, Location, is controlled for in this study. The latter two. Ownership and BuildfBuy, fully determine what may be called the FDI entry mode. This study follows most previous entry mode research in treating Ownership and BuildlBuy as separate decisions, but extends earlier research in considering them together in the same structural rnodel. Existing research has either looked at the decisions one at a time in different studies, or has modeled the decision as a choice among three alternatives (wholly-owned subsidiary, joint venture, or acquisition). The former approach makes it awkward to draw conclusions about the complete mode decision. A comparative analysis across studies is not possible, because different variables with different operationalizations are used to explain mode, the samples are different, and the joint nature of the two choices is not possible to sort out from one study to the next. The latter approach, on the other hand, tends to classis entry modes in such a way that it is difficult to distinguish which decision the explanatory factors

16 are related to. By treating wholly-owned subsidiaries, joint ventures. and acquisitions as discrete alternatives, the overlaps and distinctions between the two decisions that are actually involved become lost Importance for practising managers The entry mode choice, from a practitioner's point of view, can only be made after a thorough assessrnent of costs and benefits, long-term implications for the firm. resources available for execution, possible foregone returns on alternatives not pursued, and evaluation of the uncertainties around al1 the decision parameters. Clearly, relying exclusively on a rational-analytic, quantitative approach is likely to lead to a false sense of security. Nonetheless, rigorous analysis is necessary both ex ante and ex post: first, to quantify whatever is possible in order to set out some boundaries within which the decision can be made; then, to leam from the resuits of past decisions in order to inform managers' intuitions about present and future ones. We hope that a parsimonious conceptual model can help practitioners identify what they might most productively subject to quantitative analysis. This study provides a new conceptual framework to help managers understand the critical variables that influence the mode choice. We outline a rigorous, empirically grounded way for managers to think about their foreign entry decisions based on a conceptually easy-to-understand model. The framework has practical relevance because:

17 it treats the Ownership and BuildlBuy decisions as conceptually discrete; al1 major influences on the decisions are captured in the same model; and, data were collected from managers themselves. The model employed is more parsirnonious than previous models used to explain mode choice, and is thus more accessible as an analytical tool for practitioners. A minimum of latent constructs, and links between thern, are used to explain variance in the mode choices. Our findings are important to managers responsible for long-term strategic resource building. We are able to conclude that adequate managerial resources are crucial for maintaining the flexibility to exploit a full range of entry mode alternatives: it is thus important, if that flexibility is considered desirable, to keep those resources at a high level of cornpetence and mobility Contribution to Theory At the level of theory, determinants of the selection of entry modes have been explored from a number of different perspectives, including the Scandinavianbased "Stages" model of internationalization (Johanson and Vahlne 1977), transaction cost and internalization theory (eg.: Beamish and Banks 1987; Buckley and Casson 1 W6), Industrial Organization economics (10) (eg.: Caves and Mehra 1986; Hennart and Park 1993). and other, eclectic approaches (eg.: Woodcock 1994). Sorne approaches, such as 10, treat foreign entry as an

18 extension, or a special case, of the multi-plant firm, which it is. The amplified differences on many dimensions that often come to prominence in the international arena, such as culture and political risk. are downplayed in favor of explanatory variables that focus on industry structure and other economic characteristics of the home and host countries (see, for example. Caves and Mehra 1986). Other approaches focus on a foreign entry's foreignness. and highlight such variables as cultural differences and efficiency of knowledge transfer to explain choices of mode (e.g.: Kogut and Singh 1988). Still others have attempted to include strategy variables in an attempt to capture more information in a single model, and thus explain mode choices more completely (eg.: Hill, Hwang. and Kim IWO). In al1 this body of work, a comprehensive yet parsimonious theory of mode choice has remained elusive. We hope, with this study, to move closer to such a theory Objectives of this research This study has two parts. In the first part, previous mode choice research is essentially replicated using a different conceptual framework from those employed in the past, and a different methodology. The second part builds on the validity established in the first part, and proposes a theoretical framework that can be used to explain entry mode more simply than models used in the past. The history of this research stream is characterized by independent variable proliferation, in that each new study seems to propose a different, fresh set of important determinants of entry mode. When these new measures, as often

19 happens. are found to be significantly related to mode choice, the next researcher can il1 afford to ignore thern. The new researcher's ideas, often involving the addition of different variables to test a specific proposition, must therefore be grafted ont0 the existing set of "proven" determinants of entry mode. and thus grow the models. at the cost of interpretability. We feel that taking a new, resource- or knowledge-based approach to entry mode choice frees us to some extent from the constraints of past research, while still allowing us to take advantage of al1 the important insights that have been gained in previous work. The first part of ihis study was motivated by a desire to investigate the links between contingency variables and management decision preferences. and between managers' preferences and the decisions that are ultirnately made. We had made the observation that managers had seldom, if ever, in previous research, been consulted on their preferences about mode choice, and thought that this would be an appropriate starting point in developing a model of mode choice. Managers. after ail, do not always do what they would like to do: capabilities may not exist, other factors may intervene, or their preference on one criterion may be outweighed by the opposite preference on another. Thus the research approaches used in the past have usually, in effect, skipped the managerial choice step. Researchers have implicitly assumed that whatever decision was made represented the choice of the decision-making body. We felt it was time to investigate managers' preferences directly, for these reasons:

20 Existing research contains many "stories" about how management would prefer one mode over another in a given circumstance - these are largely conjectural. and in need of verification. Further. existing research has. in some cases. advanced competing rationales to explain or describe managers' mode choices - when these rationales are equally plausible and theoretically well-grounded, an opportunity exists to resolve the matter through empirical investigation. With the proliferation of statistically-supported determinants of entry mode choices, it is becoming difficult to ignore the fact that many firms must have sets of characteristics that sirnultaneously predict decisions at opposite ends of the choice spectrum. Simple frequency counts or comparisons of the size of regression coefficients do not provide enough insights to sort out how such conflicting criteria are dealt with. The predominant approach to investigate the deterrninants of FDI mode choice has been to use theoretically-derived proxy variables as predictors of the choice managers will make on one of the two decisions: the choice between joint venture and sole ownership (Ownership Decision) and the choice between an acquisition and a new startup (BuildlBuy Decision). The selection of predictor variables has typically been based, with varying degrees of consistency. on a transactions cost argument. although sorne studies have attempted to model the Ownership decision as a function of what has been called strategic variables. while still others have relied on a resources-based conceptual framework. While there are differences in the way that sorne of the variables have been operationalized. a dominant set of six firm and environmental characteristics

21 emerged from Our literature review as the factors most frequently linked to Ownership and Build/Buy decisions. All extant studies have identified firm-level and environmental attributes to explain the choice of mode; in doing so, researchers have been at pains to supply plausible rationales that support the inclusion of the particular set of variables included in their studies. The reasons advanced for supposing that a given characteristic should make a difference when managers are selecting among their mode choice alternatives must inevitably resort to conjectures about managers' behavior. All existing studies in this area have, implicitly or explicitly, followed this pattern, which is graphically depicted in Fig. 1.2 below. As noted, we investigate managers' mode preferences on various criteria directly, as a moderating variable in the mode choice model. The use of direct data to measure the factors which influence Ownership and BuildlBuy decisions extends previous research and verifies whether or not the conjectured behaviors are taking place. Researchers interested in the determinants of entry mode decisions have traditionally used proxy variables to represent various firm characteristics such as their asset endowment (tacit knowledge-based assets, financial assets, or hurnan resou rces), reluctance to expose proprietary knowledge. and experience. In many cases, these proxies have been represented by secondary data, which have the advantage of being free of researcher bias and affording economical access ta large samples. This study however, departs from such a traditional approach by employing measures based on managers' responses to direct questions about the influences of

22 various factors on these two decisions. By focusing on managers' decision inclinations or preferences on each set of factors, we avoid the use of both proxy variables and secondary data, while maintaining the benefits of having access to a reasonably large sample for analysis. The approach strengthens links between theory and practice, and identifies areas where theory can be made more finegrained to help practitioners make more insightful decisions. Figure lnternationalization Research Conceptual Model - Relariotisirips restrti ur rradirrorial niode cirorce researcll Prolty VanabIe. b Company Attnbute resolved 10 through in En try Managers' Drcision SIode + preferences + Crirena * choice - not represented on this figure; they would have an independent impact on the choice of mode. Prevroirs~. imesced lirik L ~ I die chaw cite focrls of rhls snicf~. The measures used in previous studies to represent mode choice determinants are often secondary data at the firm, or in many cases, industry level.

23 Researchers have employed R&D to sales and marketing expenditure to sales ratios, for example, to measure the existence of specialized knowledge possessed by parent firms. Specialized knowledge, in turn, has been linked to mode choice through the logic that managers, seeking to protect this proprietary knowledge from unauthorized (and unremunerated) appropriation by opportunistic partners, will tend to favor sole ownership entries (Anderson and Gatignon 1986). Similarly, a firm that lacks intangible assets such as local market knowledge must somehow gain access to these assets in order to be competitive. Because markets for this knowledge are imperfect or nonexistent, it is not efficient to contract at arms-length for access to it. Nor would an arms-length relationship be effective in transferring the knowledge, because of its complexity, tacitness. and uncodifiability (Teece 1981). As a result, a joint venture or acquisition, which brings the knowledge within the boundaries of the firm, is the preferred mechanism. This reasoning relies on the assumption that (1) managers recognize a deficiency in their knowledge assets, and (2) will seek to correct it through the use of either a joint venture or acquisition. The assumption makes intuitive sense, but is in need of empirical investigation. The total asset bundle (tangible and intangible) possessed by the firm is thus a determinant of decisions on both the Ownership and BuildlBuy choice dimensions. While al1 firms will lack assets of some kind, a given specific deficiency will be more important to some than to others, and will Vary in importance depending on the existence or absence of other assets, as well as

24 characteristics of the industry and the local cornpetitive environment. This view is the foundation of theoretical approaches to al1 entry mode research. and is merely made explicit here to a greater extent than some other studies have done. One exception was the Anderson and Gatignon (1986) conceptual paper. They argued, in essence, that sole ownership is the default mode. and that shared ownership would only be entertained if a resource deficiency (could be tangible or intangible) existed. In surnmary. the nature of the asset bundle possessed by a firm influences its decisionç with regard to foreign entry mode. If the important tangible and intangible assets required to achieve a competitive advantage are available to the new subsidiary from the parent firrn, a joint venture will be less likely. Sirnilarly, an acquisition will be less likely if the firm's managers perceive that a successful entry can be mounted with assets already present in the firm. This basic assumption underlies past approaches to research in this area (see, for example. Brouthers. Brouthers. and Wilkinson 1995). and is used in this study as the foundation for a series of specific hypotheses which are tested under conditions that control for other contingencies. such as host government restrictions, availability of local partners and acquisition targets, and some industry characteristics. Since most of these contingencies are country-specific, location is controlled for in this study at the level of global regions.

25 7.3 - Methodology The sample frame of Japanese manufacturing subsidiaries was drawn from the 1994 edition of the Japanese Overseas lnvestments (Toyo Keizai 1994), and supplementary data were supplied by the 1997 edition of the same publication. This database lists the worldwide su bsidiaries of Japanese parent cornpanies traded on the three major Japanese stock exchanges, and includes information about mode and year of establishment, capital invested. sales. nurnber of employees, ownership structure, and performance. These archival data were used to create a survey distribution list. The survey items are based on theoretically-derived conjectures about how firrns approach the mode choice decision. These conjectures have been a critical part of the reasoning that underlies explanations of mode choice in previous research, but they have never been explicitly tested. The survey was designed in such a way that managers could indicate, for each influencing factor, which direction they felt the influence was in their particular case. The survey questions ask respondents to rate how important various criteria were to their firms' Ownership and BuildIBuy decisions. Items include three categories of resources, as well as industry and country influences. In addition, a short scale is included to elicit respondents' impressions of the resource endowment of their parent firm at the tirne of the move. The resource scale is used to develop a resource profile for each firm. Various control variables are tested for their effect on mode decisions, and on managers' mode decision criteria. It is possible to compare the characteristics of

26 Japanese FDI mode choices in North America with non-north American investments. It was also possible to subdivide the responses into two groups based on whether the host country government was a factor in the decision. Third, firms are classified as high or low asset specificity on the basis of their possession of proprietary technology, and the two groups are compared. Fourth, the role of previous international experience is investigated by using survey item responses to classify firms into two categories. Finally. Cultural Distance. which has often been linked to mode choice in previous research is included in this study as a mediator variable with a direct effect on both the BuildIBuy and Ownership decisions. The survey also included a section about subsidiary performance. A seven-item scale represented the criteria used by the parent Company to evaluate performance, and the same seven items were repeated to elicit actual performance on those dimensions. The originai research plan called for a multidimensional performance rneasure to be developed, which would be linked to mode choice, managers' decision criteria, and resource endowment in a causal model. However. responses proved to be less numerous than predicted. and the smaller-than-anticipated sample we had to work with precluded analysis of this component of the data. Adding performance measures to the model simply created too many degrees of freedom to allow the drawing of any meaningful conclusions, statistical or substantive. Thus, while the survey instrument appended to this thesis shows two short sections devoted to performance measurement, this information is not reported. The most important contribution of

27 this thesis was intended to be in the investigation of the under-researched area of management decision preferences. and we have decided to focus on this rather than try to stretch the available data into unsupportable territory. Data analysis was conducted with a view to drawing out general relationships between the decisions and their antecedents. We report findings that generally support the relationships between mode choice and rationales used by past researchers for their variable selections, but this information is not the central purpose of this work. Our motivation was to make sense of many complex interrelationships rather than trying to find convincing statistical significance on any single issue. Thus the findings reported in the hypothesis-testing section are used primarily as a validation tool to support the construction of a causal model. The contribution of this study is that it provides a relatively comprehensive picture of a very complex phenomenon, using a more parsimonious conceptual approach than has been employed in the past. The findings suggest areas where a researcher might deploy scarce resources in conducting future studies Organization of the Thesis Chapter 2 reviews the existing literature in the foreign entry mode field. The review is confined, for the most part, to publications that deal with a similar domain. that is, investment-based foreign entries. While conceptual approaches Vary in nature and in explicitness from study to study, a short list of recurring variables and measures can be extracted from past work. These variables are characterized by a tendency to focus on firm characteristics, based upon which researchers have devised rationales for why one mode or another might be

28 preferred in a given set of circumstances. Even in the relatively rare cases when direct measures have been used, they merely substitute direct measures of proxies for the underlying attributes that previous researchers relied upon in justifying the measures they employed. A review of traditional theoretical approaches to the mode choice phenornenon is contained in Chapter 3. Past research on the Ownership Decision has been dominated by variants of the transaction cost approach, which enabled researchers to Iink attributes of firms with mode choices based on whether a market (contractual) or hierarchy (internalized) governance mode would be more efficient. The BuildIBuy Decision has been investigated using similar conceptual approaches, and with the application of l nd ustrial Organization concepts. In this way, a combination of Company and industry attributes can be linked, theoretically, to a preference for acquisition or greenfield entries. Chapter 3 proposes a different view of mode choice that relies on a combination of organizational capabilities and managers' opinions on various decision criteria to explain mode choice. We outline how the frarnework adopted in the current study is not a rejection of past approaches; nor does it represent a competing approach. We see our framework as complementary to existing research. in effect a look at the same reality through a different lens, which might provide some new insights. Hypotheses based on traditional research are developed, as a means of providing some testable research questions that can help to validate the data and survey methodology before attempting to make new contributions to theorj.

29 Chapter 4 explains the derivation of measures used in this study. in particular the logic followed in translating the results obtained from traditional conceptual approaches to Our resources-based framework. A description of the suwey is included, together with an expianation of the rationale for its various characteristics. Chapter 5 describes the process and results of the data collection phase of the study. and presents the characteristics of the final sample used for analysis. This chapter also reports the results of hypothesis testing that was performed as a precursor to moving on to the theory-building stage. As noted above, the findings were generally in alignment with the conclusions of previous research, using a completely different conceptual and methodological approach. These findings are interpreted as a validation of Our data, justifying its use in a cornprehensive causal model. A causal model using Partial Least Squares is used as the principal analytical tool in this thesis. Chapter 6 describes the construction of this model, and presents the results of analyses that attest to its validity and reliability. The combination of relatively weak theory in this area, exploratory measures, and inadequate sample size led to the decision not to attempt a covariance structure analysis using, for example, LISREL. A simple, eleven-construct model is then built. containing seven paths for each of the decisions. Chapter 7 reports the results of the PLS model related to the Build/Buy decision. Principal findings are that Management Criteria, such as overall management

30 resource sufficiency and knowledge of the host country market. are assigned greater importance by managers than Technical Criteria, as measured by the strength of the correspondence between respondents' preferences on these criteria and the actual decision made. Financial criteria lead to a preference opposite to the actual decision, suggesting that these factors, while recognized by managers, are not relied upon when making the choice between acquisition and greenfield entry. Of the resource constructs in the model. Management and Technical resources had the strongest influence on managers' preferences. and Financial resources were relatively unimportant. Greater Cultural Distance was significantly associated with a tendency to choose greenfield entries. Chapter 8 presents the results of the Ownership decision, and discusses the relative strength of the three resource categories as influences on each decision. As with the BuildlBuy decision, Management criteria were found to play the most important role in the choice of the mode. Technical and Financial Criteria had no significant association with the Ownership decision. New models containing both direct and indirect paths are analyzed, and the total effect of the resources were computed. Management resources were the most strongly linked to both the Ownership and BuildlBuy decisions. Chapter 9 analyses the effect of government influence, location, previous experience, and asset specificiiy variables, by running the same PLS model on different subsarnples of the dataset. Government influence is found to behave as an externality that decreases the strength of the correspondence between managers' preferences and the Ownership and BuildlBuy decisions, although the

31 links between resources and those same preferences remained strong. A test of the effect of location confirmed that cultural distance plays an important role in both decisions, leading to joint venture and greenfield preferences. Previous experience tended to be associated with a preference for acquisitions, while high asset specificity led to a preference for joint ventures. Chapter 10 presents summary conclusions drawn from the results reported in earlier chapters. Based on a research approach that is more comprehensive than those employed in the past. and is also managerially grounded. this study permits the drawing of stronger inferences about the drivers of firms' mode choices. Overall. the findings indicate that Management-related variables figure rnost prominently in the ranking of criteria used by respondents in making both the Ownership and BuildlBuy decision. Some ambiguous previous findings can also be resolved with greater confidence, most notably the direction of the Cultural Distance effect. The study also has limitations. and the rnost important of these are outlined. Implications for theory are then discussed. making the point that the conceptual framework developed in the thesis shows promise as an alternative to the approaches taken by previous researchers. The results of this first, exploratory test of the model. in terms of variance explained, were at least as strong as those achieved in the past, and sorne new insights were made possible by the use of a comprehensive model. It is clear from these results that managers' decision criteria are influenced by firm resources. and that there is a hierarchy of criteria that are actually used when the decision is made. The chapter concludes with some ideas for the direction future research might take.

32 The next step is seen as a return to the field to interview managers again, using the new insights gained from this study. Mode choice is a cornplex phenornenon that will be better understood when more diverse approaches are used to study it.

33 CHAPTER 2: Literature Review Introduction This chapter reviews previous research on FDI entry mode choice determinants, discussing the most frequently-used (and -supported) variables that have been found to be related to the ownership and buildlbuy decisions. Table 2.2 (at the end of this chapter) provides an overview of these variables, grouped into six categories based on the rationale for their use in the studies that employed them. Of these six categories, the first four are firm-level characteristics, and the final two are industry andlor country-level controls. The table is followed by a discussion of each category of variables. A synthesis of the reasoning advanced by previous researchers to support the measures they used reveals that assumptions and conjectures about management decision-making behavior underlie al1 the major categories of variables used in existing research. Further, it is argued that al1 the measures can be linked to a firm's resources, in the sense that the Resource Based View of the firm uses the term. The perspectives of the existing literature converge on the idea that mode choices are determined by the tangible and intangible resources and capabilities that a firm is able to deploy in a foreign entry Entry Mode Determinants Most previous research dealing with international FDI entry mode choice has tended to focus either on the choice between greenfield and acquisition entries (BuildlBuy choice), or the choice between sole and shared ownership

34 (Ownership choice). While Kogut and Singh (1988) dealt with joint ventures. acquisitions. and greenfield entries as de facto exhaustive set of aiternatives. their study did not distinguish between the two decisions that are actually involved. Instead. they treated the mode decision as a single decision with three possible outcomes. In this chapter, the factors that have previously been found to influence mode choice will be discussed with respect to their influence on both the Ownership and the BuiIdlBuy choice. Table 2.1 surnmarizeç the mostfrequently hypothesized influences on each of the decisions in previous research. Table Most frequent hypothesized influences on Ownership and BuildlBuy decisions Hiqher degree of-. Product Diversification International experience - Influence on: Ownership Decision BuildlBuy Decision 1 No inf uence -+ acauisition -+ sole (with exceptions) I -+ acquisition (with exce~tionsl 1 Size (various measures) 1 + sole ownershio 1 -+ areenfield 1 ~ssei Specificity Cultural Distance Market attractiveness Country risk L -+ sole ownership + both ownershi~ shared ownership -+ shared ownership Y -+ greenfield -+ acauisition - + acquisition 1 No body of research i 1 l Product Diversification The degree of diversification that a foreign entry represents to the parent company has been hypothesized to influence the build/buy decision. Two lines of reasoning have been ernployed by researchers to explain why this should be so: First, at the parent company level, a more highly diversified parent's cornpetitive strength arises from its superior management (Caves and Mehra 1986; Dubin 1975; Kogut and Singh 1988). Using this rationale, a high level of diversification

35 is taken as prima facie evidence that the parent firrn's management group has greater skill, relative to a less-diversified firm. in adding value at the corporate. as opposed to business unit (SBU), level. They would thus be less likely to be concerned about the ability to leverage existing business-level skills and knowledge. Assets necessary to create a cornpetitive advantage at the SBU level (whether technical or market knowledge) would be considered, by such a firm, as tradable commodities that they would be willing to buy. This would increase the propensity of a highly-diversified parent companies to expand by acquisition. Conversely, a firm that is highly specialized (ie.: not diversified), is presumed to possess... various skills and intangible assets usable in its new subsidiary. as well as tangible capacities that can be coordinated with the new subsidiary's, reducing the incentive to seek these in the asset bundle of a going firm. (Caves and Mehra 1986: 461 ) Qualified support for this hypothesis was found by Dubin (1975), but in more recent studies the link between parent Company diversification and acquisition (Caves and Mehra 1986; Hennart and Park 1993; Kogut and Singh 1988) did not prove to be statistically significant. One explanation for this may be found in the underlying assumption of superior management skill in highly diversified conglomerates. Diversification research (beginning with Wrigley [1970] and Rumelt [1974]) has demonstrated that level of diversification, by itself, is not a good predictor of corporate performance. Practitioner literature (eg.: Peters and Waterman 1982; Prahalad and Hamel 1990) has tended to advocate corporate strategies based on "core competencies" and "sticking to your knitting". The

36 value of corporate management skill in highly diversified firms may be thus overrated. The second line of reasoning which links a firm's level of diversification with its tendency to acquire relies on operationalizing the variable at the SBU level. Hennart and Park (1993) used a dichotomous (highllow) measure of diversification, based on SIC codes, to reflect whether the new subsidiary represented a diversification for the parent. Contrary to the corporate-level measure used in previous studies, this measure focused on the foreign market entry itself. If the new subsidiary was to produce a product that was not already in the corporate portfolio, Hennart and Park (1993) reasoned that it would be more likely to be established via acquisition than if the parent already produced the product elsewhere. Product-specific knowledge necessary to establish a competitive diversibing entry, they felt, could and would be acquired. This hypothesis was strongly supported in their study. As a final note, it is worth mentioning that Hennart and Park (1993) also specified a hypothesis that predicted the opposite behavior: an entry representing a diversification for the parent Company was hypothesized to lead to a lower likelihood of acquisition, because of the higher possibility of post-acquisition integration problems between a parent and a target firm from two different industries. This hypothesis was not supported, perhaps because it relied on the assurnption that managers are both aware of and act to avoid this potential problem.

37 In summary, the diversification measure has been partially supported in previous research, with some differences in the way the measure was operationalized, and depending on which industry and other controls were employed. Of primary relevance for this study however, is the fact that the reasoning used in previous research for including the variable. and for explaining the results. relied on assumptions about (1) the existence of knowledge in the investing Company and, (2) managers acting on the basis of their company's stock of knowledge. Previous experience in an industry (a non-diversifying entry) represented product or market knowledge, while a lack of previous experience (a diversifying entry) represented a knowledge gap which a firm would fiil by acquiring an existing business International Experience Experience has been proposed as a determinant of both Ownership and BuildJBuy choices. This general category of variables encompasses two major sub-classifications: (1) general international experience, rneasured by the length andlor scope of a parent firm's international activity, and (2) country-specific experience, measured in a similar way, but at the host country level. As an influence on Ownership, experience has received only equivocal support in the literature. Beginning with Vernon (1971) and Johanson and Vahlne (1977), a long stream of research has adopted the "incremental internationalization" hypothesis, which suggests that firrns start their international activities in markets with which they are most familiar. Familiarity with a distant market is gained in step-wise fashion, beginning with tentative, low-risk activities such as exporting

38 and licensing. As their uncertainty about the location's opportunities and challenges is reduced through repeated exposure and contact, managers may be prepared to risk larger amounts of resources. They would thus be willing to move to investment-based modes, beginning with sales offices, proceeding to joint ventures, and ultirnately to wholly-owned production with completely integrated. seif-sufficient facilities. The notion of a step-by-step process of international involvement by parent firms has been partially supported in the literature. The research by Johanson and Vahlne (1977) showed that Scandinavian companies had a tendency to use lower-cornmitment (non-investment) modes of entry before establishing ownerçhip-based subsidiaries. A study of 121 mode change decisions made by small to medium-sized Ontario firms (Calof and Beamish, 1995) reported that 52 percent of the mode changes were of the incremental, single-step variety, in the direction of increasing cornmitment. Companies thus appear to be comfortable with ever-increasing levels of involvement and cornmitment to increasingly distant markets. Davidson (1980; 1983) found that firms invested in wholly-owned subsidiaries in countries with similar cultures, where they have previous (even non-investment-based) experience, and where they or their competitors have invested before. Going to familiar markets, he reasoned, facilitated the transfer of technical and managerial resources, and helped reduce uncertainty about demand and costs. Direct experience and not market research seemed to be the preferred way to acquire information (Davidson 1983). Gatignon and Anderson (1988) also found that

39 greater multinationality, measured by the number of foreign affiliates operated by the parent firm, tended to increase a firm's propensity to choose sole ownership over joint ventures. Agarwal and Ramaswami (1992), in a service-sector study (auto leasing) used a factor score measure that combined firm size (sales volume) and multinationality (ratio of foreign to total sales, and two perceptual suwey items). While the combination may be criticized because this technique makes it impossible to disentangle whether it was size or multinationality (or both) that drove the result, Agarwal and Ramaswami's empirical investigation demonstrated defensible psychometric characteristics in terms of the factor [oading table and the scale's Cronbach's alpha score (.81). From a face validity point of view, it is reasonable to believe that size and multinationality are closely, if not causally, linked. In Agarwal and Ramaswami's (1992) study. the variable was positively related to a tendency to prefer sole over shared ownership, although the effect was more pronounced in hig h-potential markets. A contrary finding was made by Erramilli (1996) in a study of advertising firms' subsidiaries. Using a parent multinationality measure that simply counted the number of countries in which the firm had operations, he found an inverse relationship between multinationality and propensity to use majority ownership. He reasoned, by way of an explanation, that This may be an attempt on the part of the firm to conserve its resources by seeking minority stakes or even non-equity positions when operating in a large number of countries. (Erramilli 1996: 239)

40 In short, a firm is less likely to be able to afford sole ownership if it wants to be active in many countries. A trade-off is implied between optima in international scope as opposed to level of control of the subsidiaries, but the issue of experience is not addressed directly. For the BuildlBuy decision, Kogut and Singh (1988) hypothesized that higher degrees of multinationality or previous host country experience would lead to a preference for acquisitions over greenfield subsidiaries. The hypothesized relationship was based on Caves and Mehra's (1986) result which showed a significant relationship between high degrees of multinationality and the propensity to acquire an existing business (contrary to their expectations). Kogut and Singh (1988) reasoned that a firm with greater international experience is able to bear the risk of an acquisition and to integrate subsidiaries of diverse managerial nationality.... mhe greater the multinationality. the greater a firm's ability to acquire; the lesser the multinationality, the more likely a firm will share the risks and management responsibility through a joint venture. Multinationality should, thus, favor the ability to acquire. (p. 420) Statistical tests of this relationship were inconclusive in the Kogut and Singh (1 988) study, with regression coefficients that were in the hypothesized direction but not significant. Wilson (1980) observed a slight but statistically insignificant link between greater experience and a reduced tendency to enter through acquisition, but the tirne period covered by the data (1900 to 1971) leaves open the possibility for alternative explanations. Wilson (1980) suggested that the acquisition option in

41 the early years of world-wide multinational business activity rnay have been limited by the lack of companies available for purchase. Thus firms which expanded abroad early (which would give them a high experience value) would have found few opportunities for acquisition, accounting for their small numbers in the early part of the sample. Second. Wilson speculated that. since " is often considered to be the beginning of the great rush to invest overseas". a sense of urgency and a rush to "get on the bandwagon" may have combined with the greater number of companies available for purchase to account for the greater number of acquisitions in the more recent part of his sample. Hennart and Park (1993) were also unable to dernonstrate a relationship between foreign experience and acquisitions. Their study of 558 American subsidiaries of Japanese parents employed an experience measure based on the length of time since the first entry by that parent Company. Two contradictory hypotheses were proposed, each based on equally plausible reasoning. First. they reasoned that local market knowledge is tacit, and hence its purchase in disembodied form is subject to high transaction costs. One may therefore expect Japanese entrants with little experience of the U.S. environment to prefer acquisitions. (Hennart and Park 1993: 1056) Their second, opposite, hypothesis was based on mergers and acquisitions theory, which suggests that experienced Japanese investors will see themselves more able to handle post-acquisition management problems, and hence are more likely to choose acquisitions. (p. 1059)

42 Unfortunately, the experience variable was not significant, a result which the authors attributed to the possible offsetting effect of both hypothesized mechanisrns. The inconclusiveness of the empirical results. in the face of the experience factor's face validity and intuitive appeal, may be resolvable by resorting to a finer-grained analysis. Encouraging fragments frorn other research indicate possible forrns this analysis might take. Caves and Mehra (1986) found a significant negative relationship between the experience of the industry as a whole and the tendency to acquire: in instances where the foreign entry in question was the first in the industry into that host country, the probability of acquisition was higher, although only in industries characterized by high R&D intensity. Similarly, they found a positive link between the number of foreign subsidiaries of a parent firm and its propensity to acquire. This finding was significant only in low-r&d industries. An industry effect may be at work here: since acquisition tendencies appear to be at least partially explained by a combination of a firm's industry mernbership and the experience of that industry, information and knowledge rnay be transmitted between firms in an industry. Moreover, foreign experience is not a unidimensional construct. Previous researchers have suggested that both the length and scope of foreign experience are important determinants of entry mode, but for different reasons (ErramiIli 1991 ; Hennart & Park 1993). Scope of experience appears to have an influence on location (market) selection, while length of experience influences the ownership decision:

43 Diversity of experience, not intensity, is more effective in preparing firms for entry into culturally distant markets. (Erramilli i991, p. 494, emphasis ir: the original) Further, Erramilli found some support for Wiiliamson's (1 975) assertion that full control is a more efficient way to reduce uncertainty, leading to a tendency among inexperienced firms to choose full ownership in greater proportions. However, rather than suggest that the relationship between ownership level and experience is a simple linear one, Erramilli maintained that it follows a U-shaped curve. As firms gain some experience, he found that they undergo a change which includes reduced ethnocentrism, leading to a propensity to seek out partners as they increasingly venture into less familiar countries. Erramilli speculated that in the final phase, having gained all the knowledge there is to gain, and having grown to the point where the firm possess the means to adopt whatever mode it wishes, it rnay return to a preference for more efficient sole ownership. The complexity of the relationship is summed up in Erramilli's closing sentence on this matter: All this speculation suggests that one has to view the relationship between experience and entry mode as a dynamic, evolutionary process that is intirnately meshed with market selection practices. (1991 : 495) Hisey and Caves (1985) suggested an explanation for some of the ambiguous results of studies that preceded theirs. In looking at the propensity for firms to engage in related as opposed to unrelated diversification, they observed that... experienced MNCs behave in a systematic way whereas novices seem to make random choices. (1 985: 61 )

44 Companies appeared to engage in random experimentation at first. while formal systems evolved with experience. This notion was supported in Millington and Bayliss's (1990) life-cycle mode1 of the mode decision procesç. In this model, cornpanies at medium levels of internationalization employ the most formal. systematic techniques to make their decisions, while those at very early and late stages tend not to use formal planning. The model suggests that observations of a firm's early international entry behaviour may contain little more than random statistical noise. The foregoing review suggests that, while international experience undoubtedly affects both Ownership and BuildlBuy choices, the direction and underlying causes of these effects are far from clear. The consensus of previous research, from a conceptual point of view, is that greater international experience increases managerial knowledge. and therefore reduces uncertainty, with respect to doing business in unfamiliar environments. However, it is not yet settled if an increase in knowledge leads to either an increase or decrease in the desire to retain full control over an international subsidiary (the effect on Ownership). Neither does previous research conclusively answer the question of how (or if) managers perceive and act on their level of experience. Do they compensate for a lack of experience by acquiring an existing firm or allying with a local partner that, presumably, has the requisite local knowledge? Or does a lack of knowledge create so much uncertainty that managers resort to entry modes which minimize management cornplexity (ie.: sole ownership, greenfield), in an attempt to retain

45 control over as much of an already-unfamiliar environment as possible? These questions bear further investigation Size Firm size. measured at the parent company level. has been employed as a proxy for the existence of financial and management resources. At one level, this is closely related to the notion of "slack" (Cyert and March 1963; Bourgeois 1981), through the idea that. the larger the parent firm. the more likely it is to have an abundance of managers with which it can pursue (international) growth (Penrose 1959). Whether in-house management resources are sufficient for a foreign investrnent of a given size then becomes a relative issue: the larger the parent firm (and thus the larger its assumed stock of managers and other resources available to establish a new foreign subsidiary), the less likely it is to need to acquire an existing company. with its built-in cadre of management. Firrn size was operationalized by Kogut and Singh (1988) as the value of nonhost country (non-us.) assets possessed by the parent firm. This rneasure was found to be significantly related to the choice of wholly-owned greenfield entries over joint ventures and acquisitions, when used in a mode1 also containing a measure of uncertainty avoidance (Hofstede 1984). The relationship suggests that parent firm size has an influence on both the Ownership and BuildIBuy su bdecisions. Hennart and Park (1993) employed two measures of firm size based on number of employees. The first measure was the ratio of domestic employee growth to

46 the growth of domestic sales. A high value represented high (or excess) human resource endowment, and was hypothesized to be positively related to a firm's propensity to favor greenfield entry over acquisition. Contrary to this expectation however, the relationship of hurnan resource endowment with the BuildlBuy choice was significant in the opposite direction. Higher values on the employeelsales growth ratio led to an increased likelihood of acquisition. This anomalous result was explained by Hennart and Park (1993) as the consequence of Japanese firms' reluctance to fire redundant workers (due to lifetime employment traditions among large firms), leading to a need to obtain quickly the complementary resources necessary to develop new activities. (Hennart and Park 1993: 1065)' The second size measure used by Hennart and Park (1993) was the ratio, in employees, of subsidiary to parent. A high value on this variable implied a constraint on the capacity of existing management to take on the additional workload of starting a greenfield investment. Thus firms investing in subsidiaries that were large relative to the parent firm were hypothesized to have a higher propensity to acquire, because in-house management resources were insufficient to oversee and staff a greenfield start-up. This hypothesis was supported. Caves and Mehra (1986) had the same finding using a similar relative employee çize rneasure. Their rationale summarizes the size-acquisition relationship: 1 This is not a completely satisfactory explanation, however. Since the measure is based on a ratio of employee growth to sales growth. a high value is, most likely, the result of an increase in employees rather than a decrease in sales. But lifetime empioyment policies affect the ability of a fim to reduce its staffing complement; they do not expiain a tendency to increase it, which is what the measure reflects. The question becomes, why was employment increased at a rate in excess of sales growth in the first place? Further, is it realistic to suppose that firrns acquire other firms simply to find things to do for their excess staff?

47 ... [Alcquisition helps the firm to avoid some constraints that othetwise may limit its ability to make large additions to its asset holdings. The going firm comes with its own management cadre, which reduces the force of Penrose constraints (Penrose 1959) on the growth rate of the parent MNE. It may possess unutilized borrowing capacity or marketable assets that can serve to reduce the parent's financial constraints. Acquiring an established firm generally entails a less uncertain stream of returns than does a greenfield venture, and a risk-averse parent rnay apply a higher discount rate when a proportionally larger sum is at stake. (Caves and Mehra 1986: 460-1) In surnmary, firm size as used in these studies is meant to reflect the existence or absence of resources and assets that the expanding firm has at its disposa1 to support international expansion initiatives. In general, acquisitions tend to be employed over greenfield entries when firms are lacking in such assets. Joint ventures tend to be used instead of wholly-owned subsidiaries in similar circumstances. The final effect of firm size on mode choice departs from the resource- or competency-based reasoning used by the studies discussed thus far. While the foregoing studies used size to represent the existence of resources that could be used to enter a foreign market, Caves and Mehra (1986) felt that the size of the new entry's impact on the existing industry would also influence the build-buy decision. Specifically, they hypothesized that (in h ig hly concentrated industries), a new entrant would be reluctant to add a significant increment to overall industry capacity, because of the possible downward pressure this would place on prices (and thus profits). They measured the proportion of employees in the subsidiary relative to the total production workers in its (four-digit) industry. There was a

48 significant positive relationship between this variable and a fin's propensity to acquire (Buy) instead of entering via greenfield (Build) Asset specificity The degree to which a firm's asset bundle is product-market specific has been hypothesized to influence both the Ownership and the BuildlBuy decision. The rationale is that. having invested heavily in developing expertise and knowledge about manufacturing andlor marketing a product. a firm will be inclined to set up operations abroad only if it can retain full control, leading to a preference for sole ownership over joint ventures. With sole ownership, there would be no risk of its proprietary knowledge "leaking" to a joint venture partner who might become a cornpetitor. In addition, such product-specific knowledge would be difficult to transfer to an existing business which has developed different cornpetencies, suggesting that acquisitions would be avoided in favor of greenfield startups. High and low asset specificity are ofien inferred from the level of specialized knowledge possessed by the firm, which in turn is inferred from the arnount of money it spends on R&D and marketing. High R&D spending is thought to be linked to a high level of proprietary content of both products and processes (Gatignon & Anderson 1988; Hennart and Park 1993; Kogut & Singh 1988). High marketing expenditures are similar dues to the existence of a proprietary brand name, and the expertise to leverage it. R&D intensity has been empirically supported in previous research as a determinant of the BuildlBuy choice (Hennart and Park 1993). High values of

49 R&D tended to be significantly associated with greenfield instead of acquisition entries. However, the studies by Kogut and Singh (1988) and Caves and Mehra (1 986) yielded insignificant results. For the Ownership decision, the effect is even less clear. Kogut and Singh (1988) reporteci results which suggested that joint ventures were sig nificantly more likely than acquisitions if the R&D/Sales ratio was high, but their result for marketing expenditures was not significant. Gatignon and Anderson (1988). on the other hand. found that high values on both R&D and marketing ratios led to a preference for sole ownership. The table below reproduces part of Table 2.4 (presented in full later in this chapter). as a means to clearly surnmarize the findings of the reviewed studies. Table Effect of R&D and Marketing intensity on Ownership and BuildIBuy choice Ownership BuiIdlBuy Study Effect Study Eff ect R&D Kogut and Singh (1988) JV Hennart and Park (1993) GF intensity Gatignon & Anderson (1988 Sole Caves and Mehra (1986) ns Kogut and Singh (1988 ns M ktg Kogut and Singh (1988) ns Hennart and Park (1993) ns intensity Gatignon & Anderson (1988) Sole Caves and Mehra (1986) Kogut and Singh (1988) ns not supported JV - joint venture (shared ownership) GF - greenfield ErramiIli and Rao (1993), in a study of service firms, departed from the comrnonly-used R&D- and marketing intensity operationalization of asset specificity by employing a three-item scale to measure asset specificity. Their ns ns

50 results showed that the effect of asset specificity on the Ownership choice varied depending on interactions with other variables. In general. service firms tend to favor shared-control modes more when asset specificity is low than when it is high. This tendency intensifies (1) when services are inseparable (relative to when they are separable, (2) with increasing country risk, and (3) as firms becorne smaller. (Erramilli and Rao 1993: 33; emphasis in the original) These results lent support to Gatignon and Anderson's (1988) findings but contradicted the general trend of Kogut and Singh (1988). However, they provided a possible explanation both for this contradiction and for the non-results of the other studies. By highlighting the interactions of other variables with asset specificity, Erramilli and Rao (1 993) provided some evidence that the influence of this construct should not be dismissed, despite its apparent lack of significance in some studies. More fine-grained research might enable future researchers to sort out possible confounding influences Culture Despite the equivocality of the closely-related experience argument, culture is undeniably an important factor in the mode decision process. The incremental internationalization strearn of research has used the concept of "psychic distance" (Johanson & Vahlne 1977) to reflect the notion that managers are more cornfortable with rnoves into a country or market with which they are familiar. Gatignon and Anderson (1988) employed the nine country groupings developed in Ronen and Shenkar's (1985) synthesis of previous comparative cross-culture research. While the clusters have high face validity, they provide only a

51 categorical variable, There is no measure of distance between the clusters, making it impossible to use this method as anything but a dummy variable. The cultural distance concept has since been more formally quantified, using Hofstede's (1984) research that identified four dimensions along which national cultures might be defined. These four dimensions were integrated into a single index of cultural distance in an often-cited study performed by Kogut and Singh (1988). Their findings suggested that a high amount of cultural distance between the local market and the entering firm's home country led to a higher likelihood of greenfield (and wholly-owned) entry, relative to acquisitions. Joint ventures were also more likely than acquisitions the higher the cultural distance. The relative probabilities of joint ventures and greenfield (wholly-owned) entries are impossible to sort out in this çtudy, because the research design treated mode choice as a single decision with three possible outcornes (Greenfieldlwhollyowned, Joint Venturelgreenfield, Acquisition/wholly-owned), rather than the product of two decisions. Thus, while it is possible to state, based on these results, that the BuildlBuy choice is strongly infiuenced by greater cultural distance, (in favor of greenfield over acquisition entries) the effect of cultural distance on the Ownenhip decision is not clear. However, the coefficient for the cultural distance variable was significant at the.o01 level for the joint venture mode. and only at the -1 level for greenfield. This provides some evidence that increased cultural distance would tend to lead to a preference for joint ventures over greenfield, but firmly drawing such a conclusion from this evidence is premature.

52 Other researchers have since used the same cultural distance formulation to operationalize the construct in research that investigated mode choices. In a study of US.-based service firms with international operations, Errarnilli and Rao (1993) hypothesized that greater cultural distance would increase the probability of shared ownership entries. and that the effect would be heightened as asset specificity (measured by three survey items) increased. This hypothesis (which, it should be noted. is consistent with the foregoing interpretation of the findings reported by Kogut and Singh [1988], but runs counter to the argument advanced by Anderson and Gatignon [1986: 181 in support of their proposition on this matter) was not statistically supported. In a study of 337 subsidiaries of large international advertising agencies. Erramilli (1996) reported differences in the propensity to choose majority over rninority ownership depending on the firm's home country. Two of Hofstede's (1984) measures of the home country's national culture (Power Distance [PDI] and Uncertainty Avoidance [UA]) were significantly - and positively - related to ownership levels. as measured by a dichotomous variable. The variable had these categories: Majority (1). which included those cases with more than 50% equity, including full ownership, and Minority (O). which comprised everything with 50% or less equity. Parent firms from countries which were high on uncertainty avoidance, and those high on power-distance, were more likely to establish majority-owned subsidiaries. This was consistent with expectations. The same study showed an insignificant relationship between ownership levels and the Kogut and Singh (1988) composite measure of Cultural Distance,

53 however. Rather than draw the conclusion that Cultural distance does not matter, the author speculated that the lack of a relationship was because al1 the subsidiaries in the sample were based in European host countries. One might also add that 68% of the subsidiaries had US.-based parents; this rneans, in effect, that over two-thirds of the sample would have almost zero variance on this measure. This characteristic of the data rnay have contn'buted to the failure to find a significant relationship between ownership and the Cultural Distance composite measure, and makes it the more remarkable that PD1 and UA - which are two of the four components of the composite measure - ended up with significant parameter estimates in the log regression models. Notwithstanding some examples of statistical evidence in research using the cultural distance measure, it suffers from a validity problem. Cultural distance is important because of its influence on managers' attitudes to foreign locations, but this does not necessarily justify the use of a measure at the level of countries2. Treating the country and firm levels of analysis as interchangeable assumes that national cultures are. if not perfectly, at least highly correlated with managerial or firm cultures. As this has not been demonstrated, it is little more than a conjecture. Furthermore, if national culture is different from firm culture, it is in multinational firms where this difference is likely 'to be most apparent. Senior managers in large MNCs have had more exposure than most to cultures around the world, and are, in many cases, natives of countries other than either the One example of this problern is found in Kogut and Singh (1988). At p H2 is specified as a positive assopciation between uncertainty avoidance in the investing fim, and mode choice. But on pp it becomes clear that uncertainty avoidance is a measure of national culture, despite the specification of H2.

54 home country of the grounds, it might be parent or the host country of the subsidiary. On these very unrealistic to assume that they are representative specimens of their parent firms' national cultural characteristics. In this regard, it is perhaps interesting to note Erramilli's (1996) finding that the effect of nationality on Ownership seemed to decrease as firm size increased. For very large firms in his sample (defined as those whose sales were two standard deviations above the mean), there was no discernible difference between home countries in the probability of majority subsidiary ownership. Large firms, of course, would be likely to have a more culturally diverse senior management team than small ones, as a consequence of being older, more internationalized, and better able to recruit from a world-wide talent pool. Erramilli's observation is thus seen as corroboration for some of the foregoing conjecture. In summary, as noted, previous research offers no clear direction about what the effect of cultural differences should be on the Ownership or the Build Buy decisions (Shane 1994: ). Despite well-formulated hypotheses based on solid theoretical foundations, many studies failed to find cultural distance variables to have a significant influence on mode choice (eg.: Gatignon and Anderson 1988, Erramilli and Rao 1993). Significant results, when they were obtained, were explained by the use of plausible narratives which speculated about how and why managers might prefer, for example, joint ventures over sole ownership in culturally distant countries. However, equally plausible rationales can be put forward to explain the opposite preference. There is a lack of convergence, both at the conceptual and empirical levels, which can be resolved

55 by asking managers whether cultural distance was an important factor in their decision Market attractiveness A local industry's size and growth rate contribute to the propensity of a firm to prefer FDI over non-investment entry modes. In differentiating behveen investment-based entry modes, it has been hypothesized that firms will feel some urgency about entering a market that is experiencing a high growth rate (Caves and Mehra 1986; Hennart and Park 1993). The acquisition mode is a faster way to achieve market penetration, since the new entrant is buying an established business, with existing customers, managers, and supply networks. By contrast, the greenfield mode can take a considerable amount of time before an entry has carved out a position, relative to indigenous rivals, in the local market. Both Caves and Mehra (1986) and Hennart and Park (1993) showed a significant link between growth rate and the tendency to enter by acquisition. Both market attractiveness and country risk are location-bound influences on the entry mode decision. As such, their influence has been found primarily in the decision whether to invest at all. A relatively unattractive market (from the point of view of size, growth rate) would suggest an investment-minimizing decision on the part of the firm. Similarly, entry into a country that is politically risky would be done with a view to limiting exposure to downside risk. Both unattractive markets and high risk would argue strongly in favor of seriously examining noninvestment entry modes, such as exporting and licensing, before the issue of Ownership and BuildlBuy decision-making is even raised. If investment is

56 considered unavoidable, the general tendency would be to keep it as small as possible, suggesting shared ownership. Since the current study controls for location, country risk and market attractiveness are treated as exogenous influences Surnmary Previous studies' treatment of the determinants of mode choice has revolved around the identification of secondary firm characteristics that can be conveniently measured and that reflect some underlying characteristic or attribute which is thought to influence the decision. As the table shows. the attributes represented by the measures employed in existing research invariably rely, for their validity and relevance, on the presence or absence of some rent- generating resource, such as management knowledge. technical wherewithal, or financial strength. These constructs fit comfortably into the resource-based view of the firm (Barney, Peteraf, others). since they are treated as resources which act as determinants of strategic decisions (govemance structure, in the context of this study). The conceptual mode1 followed by previous researchers, at a highly abstract level, can be characterised as one in which mode decisions made by managers can be explained by the extent to which a firm's existing resources are the ones necessary for the new foreign subsidiary to be successful. A lack of a resource judged to be critical for success, such as technological knowledge, market knowledge, or financing, leads to a choice which compensates for the resource

57 deficiency. lnvestigating the phenornenon in the traditional way. through the use of secondary proxy measures. is a valid and useful approach that has led to many interesting insights. An alternative approach would be to attempt to measure the drivers of mode choice more directly. and at the level ûf individual firms instead of the industry level as much existing research has done. If resources are determinants of mode choice. it is arguably less important to know the configuration and quantity of resources possessed by a firm in an objective sense, than it is to know how managers perceived the resource base available to them. Table 2.3 presents a condensed summary of hypothesized influences (reproducing Table 2.1) and most frequent findings in previous research. The theme of resource access as a rationale for joint ventures and acquisitions is evident both in the hypothesized relationships and the results. However, there are mixed results on rnany of the influences. most notably with respect to the effect of cultural distance. Despite some ambiguity, however, some testable hypotheses can be developed from the general trend of previous findings. These hypotheses will be presented following a discussion of theory in the next chapter.

58 Table Summary of previous research hypotheses and findings I Inf uet ce on: Most frequent findings Higher 1 Ownership BuildlBuy Ownership BuildlBuy 1 degree of: Decision Decision Decision Decision i Diversification No influence -+ acquisition - / Mixed! / + soie Experience + + sole 1 acquisition + i acquisition! 1 ownership ownership / 1 I! S ize Asset + sole 1 Specificity 1 ownership Cultural + both Distance Market 1 + shared 1 attractiveness / ownership Country risk + shared ownership -+ greenfield + greenfield + acquisition + acquisition No body of research M ixed 1 + greenfield 1 I! Mixed 1 -+ greenfield 1 Mixed 1 -+ greenfield / 1 1 No influence + shared ownershi~ 1 + acquisition I - Recasting existing research in light of the resource-access theme suggests that the mode decision question is perhaps approachable from a different perspective. The next chapter examines this possibility and proposes a conceptual mode1 that is later subjected to quantitative analysis. Table 2.4 provides more detail on the specific studies reviewed, measures employed, and conclusions reached.

59 A Table Frequently-used measures in FDI Entry Mode Research Category Measures employed Study Results Product Diversification International Experience S ize Unknown (Dummy?) Specialization (inverse) Sarne product (inverse) Low previous diversification Number of SIC codes Experience in host country Overall int'l experience Multinationality Parent assets (host country) Parent assets (non-host country) Parent Sales Parent employees Subsidiary employees Subsidiary relative to parent Subsidiary relative to industry Kogut & Singh(1988) Caves & Mehra (1986) Hennart & Park (1 993) Hennart & Park (1 993) Dubin (1975) Wilson (1 980) Caves & Mehra (1 986) Kogut & Singh (1988) Hennart & Park (1 993) Wilson (1 980) Hennart & Park (1993) Gatignon & Anderson(1988) Caves & Mehra (1986) Kogut & Singh (1 988) Agatwal & Ramaswami (1 992) Kogut & Singh (1 988) Kogut & Singh (1 988) Asset R&D/SaIes ratio Gatignon & Anderson(l988) s pecifici ty Kogut & Singh (1988) Hennart & Park (1993) Caves & Mehra (1986) Marketing ExpenseISales Ratio Gatignon & Anderson(1988) Kogut & Singh (1988) Caves & Mehra (1986) Hennart & Park (1993) Survey items Erramilli & Rao (1993) Cultural K & S (1988) summary Kogut & Singh (1988) Distance measure Erramilli & Rao (1993) Country classifications (dumrny variables) Market (Various size and growth attractiveness measures) Country risk and restrictiveness - - not tested ns - not supported JV -joint venture (shared ownership) Effect on Ownership n s - - & n s Sole - n s Sole a JV ns Aganval& Ramaswami (1992) 3 Sole Hennart & Park (1993) Gatignon & Anderson(1988) JV Hennart & Park (1993) - Caves & Mehra (1986) - Caves & Mehra (1986) - Sole 3 JV - 0 Sole n s - depends on in teractions JV ns Effect on BuildiBuy ns ns GF* n s Acq Acq ns ns n s ns n s - 0 Acq ns - +? c=> GF - ns - ns Acq Acq Gatignon & Anderson(1988) 3 Sole - (sorne) Hennart & Park (1993) - (generally) Caves & Mehra (1986) - => Acq Gatignon & Anderson(l988) a JV - Makino & Beamish(1998) JV - Beamish & Delios (1998) JV - GF - greenfield Acq - acquisition

60 CHAPTER 3: Theoretical Approach Introduction The preceding chapter reviewed a rich body of empirical research that linked a number of firm, industry, and country attributes with mode choices on both the ownership and the greenfieldlacquisition dimensions. These studies ernploy conjectures about firm (and individual) behavior to support the use of these proxies. Close reading of the reviewed papers. however, reveals that convergence around theory has been elusive. Most of the previous research has relied upon variants and extensions of the transactions cost approach (Coase Williamson 1975). such as internalization theory, to explain why managers might prefer one choice instead of another in a given set of circumstances. That the research is performed in the international context has given rise to a tendency to employ concepts and frameworks that have their origins in the Economics discipline; many of these concepts were originally intended to explain why firms are multinational at al1 (such as the Eclectic Paradigm. Dunning 1980). or why foreign direct investment occurs when contractuai relationships and foreign trade are theoretically al1 that is needed Overview of previously-used theories In research on entry mode choice, two research streams stand out: the stages model of internationalization (Johanson and Vahlne 1977), and the transaction cost approach. The stages model of internationalization relies ori the concept of

61 psychic distance to explain why firrns choose higher levels of international activit? as their experience grows. The more managers are exposed to parts of the world that are culturally different (psychically distant) from their home country, the more cornfortable they become with operating abroad. Over time, they undergo a reduction in perceived uncertainty about the risks and benefits of international business. leading to a greater willingness to commit resources to foreign markets. Firms will thus choose increasingly higher levels of ownership in their international activities, beginning with no investment at all. and proceeding in stages to wholly-owned subsidiaries. According to this theory, a principal determinant of entry mode is therefore international experience. For the current study. this is considered too narrow a theory, since it excludes many other possibie influences. In addition, the full breadth of this analytical framework would not be used in this study, because we focus only on investment-based modes. Transaction cost theory, originating in the work of Coase (1937) and later elaborated by Williamson (1975) focuses on efficiency as the objective function of mode choice. Using the transaction as the unit of analysis, the theory attempts to explain firms' governance structures in terms of the relative costs of transacting across markets as opposed to within hierarchies. 3 This Stream of research uses a conceptual framework based on the level of cornmitment and risk entailed in alternative modes of international activity. Thus exporting and licensing. neither of which put financial resources at nsk, are considered to be at the low end of the scale, while whoily-owned production facilities are at the extrerne high end. Joint ventures, because the financial and business risks are shared with one or more partners, are considered to be median-level modes on this continuum.

62 The markets/hierarchies framework addresses the question of why and under what circumstances firms employ hierarchical control over certain functions rather than allowing market processes, operating through the price mechanism. to achieve the same objectives. Using exchanges in intermediate product markets as the analytical unit, the theory suggests that transaction cost minimization underlies managerial decision-making. A closely related theoretical stream is internalization theory. Buckley (1 988) stated its two main axioms as follows: 1. Firms choose the least cost location for each activity they perform; and, 2. Firms grow by internalizing markets up to the point where the benefits of further internalization are outweighed by the costs. (Buckley 1988; pp ) Internalization's focus is on explaining why firms engage in foreign investment (Rugrnan 1980,1985). not necessariiy on how they choose to structure those investments. As a result, the theory remains incomplete in terms of its ability to explain, or even fully describe, mode choice. Buckley (1993) asserted that internalization needs to be combined with locational and market power considerations "to give a satisfying picture of the rate and direction of growth of multinationals" (p. 198). The Eclectic Paradigrn of International Production explains international investment by bringing together three main strands of theory: classical location theory, drawing on early notions of comparative advantage; industrial

63 organization theory. with its focus on proprietary (ownership) advantages; and internalization theory, with its transaction cost basis and effkiency motivation. The transaction cost approach's eficiency focus makes it the most attractive theory when it comes to aligning theory with practice. Managers are primarily interested in making choices which improve the likelihood that their organizations will earn profits. Other frameworks do not explicitly incorporate a performance variable, although they imply that. on average. firms will tend to behave in conformance with their predictions because they are rational profit maximizers. Dunning's (1980) Eclectic Paradigm of International Production attempts to incorporate al1 the relevant sub-theories that have been used in previous research bearing on these issues. The use of the Eclectic Paradigm permits separation of Location effects from the effects of other theoretically-predicted mode determinants. While many previous studies of mode choice have been based on transaction cost economics, even these studies incorporate features that are outside the scope of the theoq in order to develop control variables for location-specific factors (e.g.: Gatignon and Anderson 1988). Being predominantly an attempt to explain foreign investment, the eclectic paradigm also focuses on investment-based modes, possibly making it more appropriate than, the stages mode1 of internationalization in this context. Concepts from Industrial Organization Economics (10) have been primarily used to investigate the BuildlBuy decision. The focus of this branch of theory is on market power as the main determinant of entry mode. As a result, it leans heavily on industry characteristics to explain decisions made by managers. Local

64 business environments are seen as competitive arenas which are bounded by entry barriers. These barriers arise out of the size of investment needed, the nature of related and supporting industries, the intensity of competition, strengih and growth rate of demand, government policies, and other location-based attributes. The theories ernployed in previous research thus suffer from three main limitations when applied to the question of mode choice: first, they were initially developed to deal with a different unit of analysis (the nation. or the industry, or the transaction, as opposed to the firm); second. they are not fine-grained enough to differentiate between different levels of investment once the investrnent decision has been made; finally, by focusing attention on costs, they fail to consider the value-enhancing potential of alternatives to whollyownedlg reenfield entries. After reviewing extant theory in this area, this chapter outlines a different theoretical approach based on the Resource-Based View of the firm. This framework is considered to be suitable for modeling mode choice because: 1. its unit of analysis is the firm, 2. its origins are in strategy formulation, 3. it is more parsimonious while at the same time being comprehensive - no eclecticism is needed. Finally, a theoretical mode1 is proposed, which will be subjected to quantitative analysis in later chapters of this thesis.

65 Summary of Conceptual Approach The fact that so many of the variables tested in previous research have proved to have significant statistical relationships with mode choice is testimony to the robustness of the conceptual thinking which motivated their use. It also lends support to the conjectural reasoning about firm behavior that is the basis for the theov. On the other hand, there is great inconsistency from one study to the next in terms of the way concepts have been operationalized, and in the nature of the results that were reported. Relationships between independent variables and mode choice seern to come and go, and even change direction, from study to study, as is evident from Table 2.4. In addition, the total variance explained in the models is rarely more than 25%. Finally, the actual decision-making criteria used by managers have never been explicitly tested. Overall, this area is dotted with many successes and important insights, but is also pewaded by a somewhat scattershot approach to mode1 building - integrative, comprehensive theoretical models are rare, and it has been hard to resist the ternptation to add more independent variables, which only serves to make matters more complicated. The approach to entry mode choice determinants taken by existing studies can be conceptually outlined as one in which mode choice is a function of 1) firm characteristics and 2) external factors, usually treated as control variables. Key firm characteristics, as explained previously, can be grouped into three categories: 1. Non-technical knowledge and management resources 2. Technical knowledge resources

66 3. Financial resources Proxies such as extent of diversification. international experience. asset specificity. and firm size have been used in the past to represent these resources. Contingency variables at the country or industry level round out most explanatory models. In this area, cultural distance, political risk, and market attractiveness are the most-often used controls. These factors are relevant to the mode choice because they are dues to 1) the existence of firm-specific advantages, and 2) the existence of contextual factors that enable or inhibit the firm in its attempts to capture rents from the deployment of its advantages. Selection of the right mode can leverage strengths and avoid costly mistakes. while the wrong mode needlessly inflates costs or exposes the firm to strategic ris ks Discussion of previously-used theory In developing the list of factors that are thought to contribute to mode choice, researchers have often resorted to what, at first glance, seems to be a rather atheoretical approach. Variables have been chosen on the basis of reasoning about how they might influence managerial decision-making; the rationales. however, have been rooted in two farniliar streams: transactions cost economics (or the closely-related internalization approach), and industrial organization (10) economics. The former stream focuses on ownership-based advantages of the firm, and the reasoning about mode choice is based on predictions about the most efficient way to earn economic rents from gaining access to and /or deploying these advantages in foreign markets. The 10 side contributes control

67 or contingency variables that influence the location decision first, and only then have an impact on the choice of mode. This fits the conceptual framework of the Eclectic Paradigm of International Production (Dunning 1980, 1988). with its Ownership, Location, and lnternalization advantages positioned as determinants of FDI. The Eclectic Paradigm has previously been used as an overarching theory in entry mode research (e.g., Woodcock 1994). Its strengths are in its comprehensiveness: no possible influence on the mode decision need be ignored. However, the Paradigm has some limitations as a theoretical anchor for this kind of research. First, it has been argued (for example by kaki 1391) that there are overlaps and ambiguities between the 0, L, and 1 constructs that lead to problems, and make it something less than a rigorous, testable theory. Further, it is not falsifiable, in the Popperian sense (Popper 1968) of making clear predictions which lead to hypotheses that can be empiricaily tested. In Dunning's own writings about the Eclectic Paradigm (since the initial 1980 version), he is careful not to actually cal1 it a theory. It is labelled a "paradigm", or a "framework", and is simply a way of conceptualizing foreign investment that attempts to capture al1 the possible influences under a single umbrella. Finally. even Dunning adrnits that the paradigm is not at its best in its applicability at the firm level. Its purpose is to explain FDI and international production, at a highly aggregated level, and not to comment on the rights and wrongs of mode choices made by individual firms:... while the Eclectic Paradigm acknowledges the significance of firm specific characteristics in determining international production, its main focus is on country and industry characteristics. (Dunning 1993: 83)

68 Thus while the Eclectic Paradigm can be useful in suggesting a starting point in the development of a mode decision model, more fine-grained theory is necessary to help understand firrn-level decisions. The Eclectic Paradigm's real utility resides at the industry and national levels, as a way to explain why. where, and to what extent FDI occurs. Perhaps more pertinent is the fact that the combination of Ownership, Location, and lnternalization cornponents only explain mode choice in passing, and that only at the level of investment vs. not investment. For this study, the investment decision is assumed to have been made - what remains is to decide the Ownership and BuildlBuy question. Contractual and other non-equity modes of foreign entry are not considered as alternatives; therefore to the extent that the Eclectic Paradigm, Internalization, and Transaction cost approaches are models of the entire range of entry options, they are much more comprehensive than is needed in this thesis. We are interested in finding a way to explain differences between possible levels of investment for a single foreign entry, and in explaining why firms might choose to acquire an existing firm rather than starting a new enterprise from scratch, given that the decision to invest has been made. Existing mode choice research has been characterized by the appearance of ad hoc model-building; variables that might bear some relationship to foreign entry mode were selected because they seemed to make sense, and then a theoretical rationale was sought to justify their use. Concepts have been borrowed from a number of areas, but a truly integrated and parsimonious theoretical approach still eludes researchers. In part, this is because of the high level of cornplexity

69 surroonding the circurnstances in which these decisions are made: it is simply a fact that there are many factors that have an impact on mode choice. There has been a tendency, over time, for researchers to extend work that preceded them by adding more variables to existing models, and demonstrating that the new variables made a difference (eg: Hill. Hwang, and Kim adding strategy variables to the Eclectic Paradigm). The interrelatedness of influences further complicates matters, leading to "Contingency Theory" explanations for firm behavior which explain little additional variance, but confirm that the situation is indeed cornplex. The foregoing is not meant as a criticism of previous research in this area. It is acknowledged that earlier work made tremendous conceptual and empirical contributions to our understanding of the influences on entry mode choices. and that the practice of adding a few more variables to see if they make a difference is a defensible approach in the early stages of trying to build a theory. The goal of this thesis is to find a way to reduce the inherent complexity - to adopt, in other words, a theoretical frame which enhances understanding of the essential relationships between contributing factors and the mode choices, and what factors can be ignored, grouped together, or subsumed under others Resource-Based View of the firm An approach to conceptualizing the Ownership and BuildlBuy decision can be found in the mainstream strategy literature, in the Resource Based View (RBV) of the firm (see, for example: Barney 1986: Peteraf 1993). Within the RBV, firms are

70 conceptualized as unique bundles of resources (especially intangible, or knowledge-based assets). Effective strategic decision-making is concerned with the identification and exploitation of these resources in such away that a rentyielding competitive advantage can be gained. Intangible resources are non-tradeable assets which develop and accumulate within the firm. Such assets defy imitation because they have a strong tacit dimension and are socially cornplex. Peteraf (1 993) p Four mechanisrns lead to cornpetitive advantage based on intangible resources: 1. Resource heterogeneity creates monopoly rents, and is the result of superior productive factors that are and remain in lirnited supply. "Thus efficient firrns can sustain this type of competitive advantage only if their resources cannot be expanded freely or imitated by other firms." (Peteraf 1993; p. 181 ). Core cornpetencies are examples of these resources, and may suggest a trajectory of growth that is embedded in the firm's knowledge base. 2. Ex ante limits to competition keeps costs from offsetting the rents. Profits corne from ex ante uncertainty about the value of assets - if the costs and retums were perfectly known in advance. their price would be competed up so as to deny any opportunity for supernormal profit. 3. lmperfect mobility ensures that valuable resources remain within the firm (when employees leave, for example). This is because of the tacit nature of knowledge, and the fact that complementary assets, knowledge, routines, and systems are needed to fully exploit it.

71 4. lmperfect imitability and substitutability (Lippman and Rumelt 1982) create ex post limits to competition, that prevent rents from being competed away. These limits exist because of the irnmobility of tacit assetç. and because of their path-dependent nature. As an alternative to the outside-in approach to strategy formulation advocated by 10 approaches (eg.: Porter ), the RBV is in a sense. a return to the early traditions of Business Policy concepts. By acknowledging that firms are heterogeneous with respect to their resource and capabilities base, the RBV approach to strategy formulation is based on identiving these resources (through concepts such as core cornpetence, strategic intent, etc. - see for example Hamel and Prahalad 1990) and, through the application of the appropriate strategyktructure combination, achieving a competitive advantage. Competitive advantage leads to improved performance, which in turn provides more resources to keep the cycle going. (See Figure 3-1).

72 Figure 3-1 The ResourceslCore Competence Cycle Performance The connection of this RBV-based framework to the current research question is as follows. Firm characteristics measured in previous mode choice literature have been shown, in Chapter 2, to be the visible outcroppings of an organization's resources and capabilities, often of the tacit and intangible variety. The governance mode of a foreign subsidiary is a strategic choice made by managers based on their assessrnent of the adequacy of these resources for the contemplated foreign entry; managers make these choices with the expectation that they have chosen the most appropriate alternative for achieving a competitive advantage and thus superior performance. Managers make decisions based, at least in part, on the nature, quality, and quantity of resources available to them, since resources affect the feasibility of implementing a given strategy. This is a reiatively simple relationship in the case of tangible resources, but may be less obvious, and more difficult to demonstrate in the case of

73 intangible resources. Despite the difficulties in measuring intangible resources. it is nevertheless argued that managers are implicitly aware of the capabilities of their organizations, and make their decisions in accordance with their perceptions of those capabilities. It requires only the assumption that managers rnake choices in the best interests of their firms - an assumption generally relied upon in management research - to validate the notion that the foreign entry mode they choose is the most appropriate to deliver whatever strategy they are pursuing. To put it another way, managers' choices are assumed to be equivalent to the best choices possible, especially over a large sample. The RBV-based approach does not represent a departure from previous research. It is a complernentary rather than a cornpeting way to look at entry mode choice. We follow traditional mode choice research in drawing from various strands as required in order to understand a complex and dynamic phenornenon, but use the RBV to tie the various strands together under one conceptual roof. A comprehensive theory of entry mode choice has not yet been developed, making the current research very much an exploratory effort. The implication of this observation is, of course, that theory-based hypothesistesting is not our principal objective. Theory-building, as opposed to theorytesting, has been the tradition of mode choice research, and this study is no exception.

74 Data sources The departure this thesis makes from some of the previous research is that we collect data at the level of the constructs that are being investigated, instead of relying on proxies to represent constmcts. Most previous research in this area has, in fact, been conducted a further step away from the phenomenon, by using secondary data to measure proxy variables. Even when primary data were used. however, they merely substituted direct measures of the proxies. Examples of this have been noted in the literature review. We argue that managers' impressions of (especially intangible) resource availability within their firms are at least as valid a measure as the traditional approach using "objective" measures. First, while traditional "objective" measures are attractive for many reasons (for example, they are free from respondent bias and usually quantitative in nature). it has not been demonstrated that they represent the constructs they are meant to stand for. For exarnple, the appropriateness of using R&D intensity to represent the quantity of technical knowledge-based specialized assets in a firm (as in, for example, Gatignon and Anderson 1988) is open to question, especially when, as often happens, the measure is taken at the industry instead of the firm level. Even when a firm-level rneasure is used, questions remain: What role do accounting conventions play in determining the results? 1s there knowledge in the firm that is not captured by accounting measures? To what extent is there a lag between R&D expenditure and usable knowledge? When R&D spending drops, does knowledge cease to exist? When R&D spending stays the same but sales increase, causing the

75 often-used R&D/sales ratio to drop, has knowledge decreased? These are illustrations of some questions that arise out of the use of such a rneasure; notwithstanding that sorne studies have found statistically significant support for hypotheses using these measures. on the whole the empirical track record in this area of research is not glowing. Second. managers may have views about resource adequacy that is at odds with the views of other managers, or indeed international business researchers. Since it is their own opinions upon which managers base their decisions. not those of others. let alone IB theorists, it makes sense that they should be asked about their assessrnent of resources instead of assuming that an "objective" measure represents the same level of resource suffciency to all. If theory-building in this area is to explain managers' behavior, it behooves researchers. at some point. to find out what that behavior is instead of speculating about it. In contrast to traditional studies of entry mode determinants. this study asks managers direct questions about the influence of a number of factors on their Ownership and BuildJBuy decisions. This approach enables us to examine assumptions about management behavior. an untested link in the chain of reasoning about entry mode determinants. The analysis thus proceeds in two phases. Phase I of this research is intended to replicate previous research findings using the RBV approach described above. Managers' preferences on various mode choice criteria are investigated, supplying this missing link in the chain that leads to the decision. Phase II is

76 concerned with building a parsimonious theoretical model of the mode decision based on RBV concepts. Having validated the overall RBV conceptual approach in Phase Il we use the data to identiw broad patterns of relationships among a few constructs, as an initial step towards a new direction in theory development Phase 1: Traditional mode determinants, replication and validation Hypotheses This section develops the hypotheses that arise out of the foregoing literature review and theoretical discussion. Hypotheses are derived from mapping the familiar deterrninants of the Ownership and BuildIBuy Decisions onto managers' decision criteria. As described previously, the entry mode literature identifies six major variables that influence a firm's choice of mode. These are: Diversification Asset specificity Size Experience Market attractiveness Culture The importance and relevance of each of these proxy variables is based, in traditional entry mode research, on conjectures about firrn behavior and profit maximization. The firm-level proxies represent the existence of tangible and intangible resources, such as capital, management capacity, proprietary

77 knowledge, and technical or management know-how. In general. the expected mode choice for a firrn which has adequate resources of al1 kinds is whollyowned/greenfield, because it has no need to burden itself with the costs and risks of partners or acquisition. Within the theoretical frame supplied by the combination of the RBV and the transactions cost/internalization approach. a firm would Vary from this pattern only as the result of: 1 ) other factors outside the firm, or 2) management error. Thus. in the absence of other contingencies. resourcerich companies should tend to make foreign entries using wholly-owned and greenfield modes. A firm which reports that it is in possession of al1 required resources would be expected to have chosen joint venture or acquisition only if other factors were rated as highly important. These "other factors" are represented in traditional entry mode research by industry and country-level variables, and have been found to have a contingent relationship to mode choice, at the level of the proxies used in previous studies. In this study, we test the relevance and importance of these factors (such as: host country governrnent restrictions, cultural differences. and the desire to protect proprietary knowledge) by means of direct questions in a suwey. This provides information about the relationship and importance of industry and country characteristics, from the point of view of the managers who are making the decisions. No hypotheses are developed about market attractiveness and country risk in this study. The reasoning is that they are location-bound influences on the entry mode decision. As such. their influence has been found primarily in the decision

78 whether to invest at all. A relatively unattractive market (from the point of view of size. growth rate) would suggest an investment-minimizing decision on the part of the firrn. Similarly, entry into a country that is politically risky would be done with a view to limiting exposure to downside risk. Both unattractive markets and high risk would argue strongly in favor of seriously examining non-investment entry modes, such as exporting and licensing. before the issue of Ownership and BuildlBuy decision-making is even raised. If investment is considered unavoidable, the general tendency would be to keep it as small as possible. suggesting shared ownership. Market attractiveness and country risk are thus not central to the mode choice questions being investigated in this study. and are treated as exogenous influences. The first stage in the proposed analysis is to determine whether the subject parent firrn has the characteristics that are linked with sole ownership and/or greenfield entry. As discussed elsewhere, there have been many studies which link a variety of attributes with preferences for more or less "control" over an international subsidiary, and for or against acquiring an existing firm. These firm attributes are summarized in Table 3.1, which also relates them to the underlying reasoning that led researchers to include thern in their models. The final column in the table "translates" the proxy into the variable that is employed in this study. The proxies that have been found significantly linked to ownership choices in previous research can be collapsed into two categories: 1) measures of resource adequacy in terms of: knowledge (technical, market), capital, or human (that is, management), and 2) contingency variables (host country government, industry,

79 culture). From the table, five hypotheses are developed which deal with the major determinants of mode choice. These are discussed below. Marketknowledge Previous host country experience has been linked to a higher likelihood of sole ownership entries. Past research explained this phenornenon by positing that firms without experience in the host country had no knowledge of the market. and would have to ally thernselves with a partner (Gatignon and Anderson 1988) or acquire ati existing Company (Caves and Mehra 1986) to gain access to market knowledge. Managers should rate access to market knowledge as an important influence in making decisions that lead to shared ownership or acquisitions. Hl A lack of knowledge of the local (host country) market is positively associated with shared ownership and acquisition modes. Technicai knowiedge - manufacturing/product development A firm which lacks technical knowledge on manufacturing or product development dimensions must compensate for this by forming a joint venture with another firm that has such knowledge. or by acquiring a suitable going concern. Managers who report that gaining access to technical knowledge was an important consideration would have made the choice to joint venture or acquire. H2 A lack of technical knowledge is positively associated with shared ownership or acquisition modes.

80 Management resources Previous research has conceptually (but not statistically) iinked firm size with the existence of management depth, (Hennart and Park 1993). Along similar lines, the greater the size of the planned subsidiary relative to its parent. the more difficult it will be for the parent to adequately staff and oversee the new subsidiary with its existing stock of managers. Relatively large subsidiaries tend to be joint ventures (Gatignon and Anderson 1988) and acquisitions (Caves and Mehra 1986). Thus, H3 A need to supplernent existing, in-house management resources is related to a tendency to choose shared ownership and acquisitions Financial resources lnsufficient capital or an aversion to risk may also lead to a tendency to shared ownership. In the past, financial resources have been inferred from firm size, measured by sales (Agamal and Ramaswami 1992) and assets (Kogut and Singh 1988). These studies linked larger firrns with preferences for sole owners hip and greenfield su bsid iaries. respectively. H4 A need to access additional financial resources is related to a tendency to choose shared ownership and acquisitions. Possession of proprietary fechnology The risk of unauthorized and unremunerated appropriation of proprietary knowledge is a deterrent to joint venture formation. Proprietary knowledge, or asset specificity, is inferred in previous research from a high level of R&D intensity. it has been statistically linked to a preference for sole ownership (Gatignon and Anderson 1988), although Kogut and Singh (1988) reported a

81 tendency to prefer joint ventures over acquisitions (with non-sig nificant results on the greenfield - acquisition cornparison). In addition. proprietary knowledge is difficult to transfer to another organization. and is thus better utilized in greenfield startups than in acquisitions. Hennart and Park (1993) demonstrated this relationship using the R&D intensity variable, while others have noted that high levels of diversification (irnplying little product-specific knowledge. with regard to the importance of any one market entry relative to the corporate whole) tend to be associated with acquisitions (Dubin 1975; Wilson 1980). Thus. H5 Managers who rate the protection of proprietary technology as important will tend to prefer sole ownership and greenfield modes.

82 Table 3.1- Traditional proxies to measures in this study Variable Diversification Proxy in traditional research SIC difference between parent and sub R&D intensity What the proxy stands for Lack of rent-yieiding knowledge assets Possession of rent-yielding knowledge assets that can be redeployed at minimal cost Reluctance to expose knowledge assets to unauthorized appropriation lnability to fully exploit value of knowledge assets through market structure Measure used in this study (Importance of this factor) Need for inbound technology transfer (market, process and product) Does the firm have assets it can use to generate profits in a foreign market? Risk of losing proprietary knowledge Cost. complexity of management (if low in importance) Size - su b/parent Size - sub/industrv Experience Host country economic attractiveness Host country risk, restrictivenes S Host country industry attractiveness Culture Assets Employees Sales Assets Employees Employees ForeignAotal sales or as sets Number of foreign subs Length of time in foreign activity Economic growth rates GNP Per capita GNP Categories defined in other research -- growth rate culture Existence of management and financial resources Ability to assume financial ris k Adequacy of management and financial resources Reiuctance to add to industry capacity Skill in managing foreign operations (overall international management knowledge assets) Attractiveness of location Urgency of entry Influence of gov't policy on mode and location decisions Availability of sole ownership as an alternative ~Gactiveness of location differences Adequacy of mgmt Adequacy of interna1 financing Avoidance of financial risk Did you have adequate mgmt. depth to staff and oversee a new su bsidiarv? Was increasing industry capacity a concern? Previous favorable experience? Needed to gain local knowledge Control variable Importance of entry speed Government influence Availability of partners. acq. targets lndustry growth Availability of partners, acq. targets Control variable

83 3.3 - Phase II: Developmen t of the theoretical model The overarching conceptual mode!, based on the RBV approach described above. is summarized in Figure 3.2. This figure adds external factors as a direct influence on the choice of mode. and condenses Figure 1.2 in the following way: Proxy variables and Company attributes are represented by "Resources" Managers preferences and Decision criteria are represented by "Decision Criteria" Figure 3-2 RBV-based conceptual model of mode choice The model postulates that a firm's entry mode choice is a function of its resource complement, moderated by the effect of decision criteria employed or preferences held by managers. In addition, we include external factors for their contribution to the decision, to the extent that it is necessary to control for them in order to make sense of the resource-driven influences.

84 Conceptually. this approach closely parallels the view of mode choice put forward by Madhok (1997a. 1997b). which advocates a perspective based on what he calls organizational capabilities. This approach views the firm as a collection of resources and capabilities, in which the development of new knowledge and capabilities is a central objective (Kogut and Zander 1992). The firm is essentially a knowledge-acquisition and -transformation device: new knowledge leads to new capabilities, which in turn provide the wherewithal to create cornpetitive advantage. Viewed in this way. entry modes (indeed al1 expansion or growth decisions) are selected at least partly on the basis of their ability to provide new resources and capabilities to the organization as a whole. Adopting a resource-based framework to examine the determinants of entry mode choice has some advantages over traditional approaches. First, like Madhok (1997b), we find the transactions cost (TC) approach too one-sided with respect to its predictions about mode choice. Focusing primarily on the efficiency of transactions, the TC argument is based on the assumption that resource and management costs for each mode are incurred in pursuit of opportunities to earn a standard amount of rwenue. That is, revenues are implicitly assumed to be unchanged across modes, while costs are hypothesized to Vary. The focus on transactions does not permit a view of the firm as a knowledge-transformation device.

85 Second. the resource-based view is more inclusive in terms of assessing subsidiary performance. The TC approach admits of nothing other than financial measures to evaluate subsidiaries, but this flies in the face of numerous examples of firms that have endured financial underperformance from some foreign operations. Beginning with the reasonable assumption that the managers of these firms were not acting irrationally, they must have had different objectives, or different criteria on which to assess performance. Foreign operations have the potential to contribute to a multinational firm's strategic goals in areas other than simply marginal profit. Third. the RBV of mode choice is parsimonious while being comprehensive. Al1 the influences adopted by the traditional mode choice frameworks are included, and with fewer feats of logical gymnastics than have sometimes been in evidence with other approaches. The RBV is a well-established, mainstream way of looking at strategy formulation which comfortably incorporates al1 the concepts used in previous mode choice research Summary of theoretical approach This study has two parts. The first part of the study is essentially a replication of previous research: variables employed in past studies are reconceptualized, remeasured and tested against hypotheses that flow from the generally-accepted Ownership and Bu ildlbuy decision logic. This phase, aside from provid ing some additional support for existing findings. broadly confirms that assumptions that previous research has made about management behavior are realistic. Finally.

86 because the results are largely in accord with expectations, this phase builds the case for the validity of our data, necessary for the second phase. Phase two is seen as grounded theory-building (Glaser and Strauss 1967). Constructs have been identified (see Figure 3.2), but their dimensionality and their relationships to one another are not known until the empirical analysis is done. The methodology and results sections of this thesis will deal at greater length with these issues.

87 CHAPTER 4: Development of Survey, Measures Introduction The objective of this research is to investigate the entry mode decision from a new, resource-based perspective. lt was considered vital at this stage to obtain information directly from managers who were involved in the decisions that their companies made, in accordance with our goals of filling the conceptual gaps were outlined in preceding chapters. These goals and objectives imply that primary data must form the foundation of this study, if it is to remain tnie to its stated intent. Given that primary data must be obtained, two principal data collection options present themselves: interviews and larger-çcale surveys. Typically, the trade-offs between the two are seen as depth vs. scope of information (Judd. Smith and Kidder 1991). Interviews allow the researcher to collect richer, in-depth data about each case, at the expense of generalizability, while large-n surveys smooth out some of the individual idiosyncracies and details of each case, losing some information in the process. We were interested, for this project, in identiwing the dimensionality of the constructs employed in the conceptual model, and in detecting broad patterns that might provide dues to the location of the most productive areas for future research. These considerations led to the decision to make a survey the primary data source, because:

88 a relatively large sample was considered highly desirable in the quantitative stages of data analysis; detailed and complex contextual information was considered a lower priority at this stage; and, time and budget constraints meant that interviews would probably have had to be restricted to the immediate geographic surroundings - a convenience sample. in effect. This constraint would have negatively affected generalizability of any results and conclusions. while also not allowing investigation of the effects of at least one of the key mode choice determinants (cultural distance). The balance of this chapter is organized as follows. First, the process followed in developing the survey is described. Then, the individual measures contained in the survey are discussed, with reference to their conceptual links to both previous research and the current conceptual model. Copies of the complete instrument and covering letter are included in Appendix B Process of survey development The first attempts to create a list of questions for managers regarding mode choices contained a number of ambiguous, redundant, and improperly worded items. Early versions were subjected to an iterative process of review and revision. Upon completion of this process, the instrument was field-tested with a small subsample drawn from the overall sample frame for this study, and further minor revisions were made. Interviews were conducted with the managers of six subsidiaries listed in the source (Toyo Keizai 1994) publication. Interview sites were selected on the basis

89 of reasonable road accessibility from London, Ontario. The sample frame for selection consisted of 12 firms within a two-hour driving distance. and the final sample was simply those with whom appointments could be arranged at a rnutually convenient tirne. At each interview, the respondent was guided through the proposed questionnaire, with the objective of identifying items that were irrelevant, redundant, poorly worded, or othewise inappropriate. In addition, a general indication of relevance and interest in the subject of the research was sought. The intewiews revealed the fol towing: The subject matter (location and entry mode selection, and their effect on performance) was easily understood and interesting to managers. Although the researcher drew explanatory frameworks to aid their understanding of the mode choice subdecisions, it is believed that respondents faced with filling the questionnaire out alone will be able to grasp the basic intent. All respondents indicated that this was an important area of investigation. especially if links to performance could be identified. A surprisingly large proportion of the companies interviewed seemed to be "exceptional" cases, [eading to the conjecture that the exception may be the rule in this area of research. The original draft of the survey was modified on the basis of input from these managers. In a few cases, items were deemed redundant, and deleted altogether. In other cases. the wording of a question was changed to make its

90 meaning clearer. The majority of the changes from the original proposal were in the forrn of deletions due to redundancy or irrelevancy to the immediate purpose. The survey was subjected to revisions based on insights obtained after each interview. When the changes became redundant, and no more value was being added by the interviews, a final draft was sent on for review by the Ethics Comrnittee. The approval letter is appended as Appendix C. Because a substantial nurnber of the desired respondents were expected to be native Japanese. it was considered important to permit them to respond in the language they might be most cornfortable in. A Japanese translation firm was therefore engaged to provide a Japanese translation of the survey. The translation they produced was verified for accuracy by back-translation Development of Measures The foregoing review of the literature revealed six measures that are linked to the FDI entry mode choice. These are: Diversification Experience Size Asset Specificity Culture Market Attractiveness

91 The discussion that follows will outline how each of these fits into this study's conceptual frarnework and has been operationalized. Table 3.1 summarized the transition from traditional measures of these mode choice determinants to the measures employed in this thesis, by linking both to a cornmon underlying conceptual foundation Product Diversification As an influence on the Build Buy choice, a firrn's level of product diversification has been thought to reflect the degree to which a firm possesses two key resources: 1) broad senior management skill and knowledge. and 2) industryspecific knowledge. In the present study, these resources are measured by direct questions in the Resources section of the survey. Three items in particular are designed to elicit responses about the firm attributes which diversification is meant to reflect. These are 1) technical knowledge in manufacturing. 2) technical knowledge in product development, and 3) management resources. The rationale for supposing that the extent of a firm's diversification (or its inverse, specialization) is related to the BuildlBuy choice rests on an assumed link between the number of lines of business a firm is in and the knowledge resources it possesses. An entry into a new line of business (a diversifying entry) represents an excursion into an area where the firrn is lacking knowledge, and would thus be more inclined to buy this knowledge by acquiring an existing business. Evidence for the existence of a knowledge gap represented by such an entry is captured directly in this study through responses to one or more of the three survey items listed above.

92 The same items are repeated in the survey section that asks managers to indicate whether a decisior; criterion influenced them in the direction of acquisition or greenfield. This provides the respondents' interpretation of the importance of the resource item to the decision, contributing the conceptual link from firm characteristics to the decision that has been missing in mode choice research to date Experience Previous research has identified a link between international experience and both of the decisions that are the subject of this study. Previous experience is used by firms as a context to predict future events, leading to the development of routinized processes to deal with strategic questions (Tallman and Shenkar 1994). Thus the nature and quality of previous experience would be expected to influence the way similar decisions are made the next tirne. The hypotheses and propositions that have been advanced to explain or justify the relationship of international experience with entry modes start with the supposition that knowledge assets are built up by doing more business abroad. The assumption is then made that the knowledge a firm's managers gain from experience in one or more international markets can be applied either in a new market or in a new business in the same market. So far, the logic is unassailable. However, the ne>d steps are contentious; the foregoing review of the literature noted that there is a lack of consensus (even at the hypothesis-building stage) about what the effect of such a knowledge increase will be when applied to either of the decisions studied here. Empirical findings, in the relatively rare cases that they are

93 significant, hint that higher control (sole ownership) and acquisitions might be preferred the higher the firm's international experience and multinationality. However. the overall picture is one that is still much in need of focus. This study employs experience in two ways. First, the underlying reason why experience should be important is the subject of a direct question in the Resources and the Criteria sections of the survey. Respondents are asked to rate their parent firrn's knowledge of the host country market (Resource) and for an indication of the direction of influence of a need to increase their host country knowledge. Experience is also used as a control variable. Survey items ask whether, and in what direction, previous experience with a mode, had an influence on their decision. Ali the non-neutral responses were assumed to represent fins where previous experience was a factor. The rest, having explicitly responded "no influence", or Not Applicable, or having given no response on these items, were assumed to belong to firms where experience was not a factor in the mode decision. This split the sample into two nearly equal halves, which can be compared to examine the effects of previous experience the relationships between the other variab!es in the rnodel. The operationalization of this control variable is explained in greater detail in Chapter Size The measures of size used in existing research have been meant to reflect the relative positions of sampled firms on financial and management resources. For

94 example, a large firm is thought to be more able to tolerate the financial risk of acquiring a given-sized foreign Company than a smaller firrn, simply because it has more rnoney and is thus risking a smaller proportion of its net worth with the move. Similarly, the Iikelihood is greater that a large firm will be able to adequately staff a wholly-owned entry using in-house management resources. Previous work has used size to represent the degree to which there are resources such as money, management capability (or headcount). available to the firm. Size has thus been a proxy for access to resources; as such, size in and of itself is not the variable of interest, based on the way researchers have reasoned why it should be part of their rnodels. This study measutes the availability of resources directly, instead of inferring it frorn the size of the parent as most previous work did. Two questions in the resources section elicit responses about 1) the level of the parent firm's access to financing, and 2) its ability to tolerate financial risk. These questions have their counterparts in the decision criteria sections, where respondents are as ked to indicate whether these factors influenced them towards one alternative or the other on both the Ownership and BuildIBuy decisions Asset specificity As with many of the other traditionally-used variables in mode research, the effect of asset specificity is not well settled. This may be because most previous research has employed a proxy such as R&D expenditures to reflect asset specificity, often at the industry level despite the fact that the unit of analysis was

95 the firm. In the current study, a direct measure of asset specificity was used. at the firm level. The survey had three questions to determine the degree of asset specificity and its effect, if any. on the decisions. The questions asked about: the parent firm's level of technical knowledge in manufacturing the parent firm's level of technical knowledge in product development the parent firrn's level of proprietary technology The first two items capture two of the main categories of R&D done by companies. while the second would reflect knowledge that might be in either category. In addition, responses to the proprietary technology resource question were used to develop, in effect, a control variable. The sample was dichotomized on the basis of responses to the proprietary technology question. Firms in industries which reported low proprietary technology were grouped together, and models containing this group were compared to models which were run on the "high proprietary technology" group Culture The concept of cultural distance and its application to the mode choice question is. like most mode choice determinants, unclear. Seen purely as an exogenous effect on the BuildlBuy and Ownership decisions, cultural distance has been operationalized at the country level by most researchers. This is defensible but conceptually less than ideal because it mixes units of analysis.

96 In this study, the effect of culture is measured in two ways. The first follows the traditional approach by modelling cultural distance as a construct that has an effect on the mode decisions independent of any other variables. The measure employed is the summary index of national cultural distance developed by Kogut and Singh (1988). This measure. which is based on Hofstede's (1984) four dimensions of national culture, has hivo advantages over other approaches that might have been used: 1. It is an interval scale, which permits it to be used in more ways in both quantitative analysis and interpretation than a categorical or ordinai-scaled variable 2. It is based on data that have been validated and are farniliar to most researchers in this field. The principal weakness of this measure, as argued in the literature review chapter, is that it is taken at the level of nations, not firms, and thus may not accurately reflect the cultural distance between a new market and the managers in a firm. For the current study, this is not seen as a major problem because senior managers of Japanese firms, as a group, are expected to be fairly homogeneous and representative of their country on cultural dimensions relative to the senior managers cf North American or European firms. Two reasons for this are: 1. Japanese firrns are expected to have more Japanese natives in senior positions than firms with other home bases, partly because the large-scale internationalization activities of Japan-based firrns are more recent than those of the others. Thus a mixture of trusted senior

97 managers of different nationalities has not yet had a chance to emerge in these relatively young (in terrns of multinationality) firms. Japanese fins are more likely to have adopted what is known as a global, as opposed to a multidomestic or multilocal, strategy (see. for exarnple Yip Morrison 1990). A global strategy tends to rely much more heavily on centralized decision-making and coordination at corporate headquarters. For the current discussion, this has two effects. First, since the more influential managers are more likely to be concentrated at the firms' Japanese head offices, there is a greater likelihood, from the outset, that they will be Japanese nationals. Second, a global stra tegy provides relative1 y few opportunities for developing general management capabilities outside the corporate headquarters. A talented nonjapanese manager in a foreign subsidiary will therefore be less likely to come to the attention of senior managers, and will be less likely to be given headquarters opportunities. The effect of this is to perpetuate the concentration of Japanese nationals in key decision-making roles. For these reasons, a measure of national culture is thought to be more satisfactory as a proxy for firm-level culture in Japanese companies than in others. Alternatives to the Kogut and Singh (1988) measure are categorical measures such as the one developed by Ronen and Schenkar (1985), or a firm-level scale which might have been developed exclusively for this study. The categorical measure was rejected for this project because it did not seem to provide the same amount of information as the interval-scaled K & S rneasure. Developing a new scale was also rejected because this is not the central purpose of this thesis,

98 and because the nation-level measure was judged adequate for the sample employed. The foregoing discussion has outlined the rationale for modeling a single-index measure of national culture as an independent effect on 6uildIBuy and Ownership decisions, and described the measure used in this study. The primary motivation was to create a moderator variable which would improve the model's explained variance. This was considered necessary because previous studies (notably Kogut and Singh, 1988, Erramilli and Rao 1993) have put forward fairly compelling conceptual arguments in support of such an effect. These arguments are difficult to dismiss, notwithstanding their limited and inconclusive empirical support. The next section will discuss how the effect of cultural issues on this study's central conceptual framework was handled. The mode choice Iiterature has treated cultural differences across nations as a barrier that can be surmounted by knowledge embodied in managers. The influences of culture on mode choice should therefore be measurable at the level of resources and decision criteria, which in turn would affect the decision. Items which would capture managers' knowledge of cultural differences (Resources) are "Host country knowledge" and "Management Resources". For decision criteria, the same two items are repeated, asking for responses about the direction of influence of a need to get more of either resource. Finally, the effect of a need to overcome cultural differences was also measured. Respondents were asked to report the mode they would prefer under these circumstances.

99 Country and industry variables Two additional contingencies that have been found to affect the choice of foreign entry mode are government influence (on Build/Buy and Ownership) and market attractiveness (on BuildlBuy). The question of govemment influence was part of the criteria section of the survey, where an item was included that asked respondents tu report on the extent to which the local government's intervention influenced them to choose one or the other of the avaiiable alternatives under each of the two decisions. When the replies had been collected, al1 the nonneutral responses (regardless of the direction of the effect) were classified as "government influenced", while those which had responded "no influence" or "Not Applicable" were deemed to have been free of influence. For analysis purposes, the data were separated into two groups on this basis. and cornparisons were drawn between them. Market attractiveness is a function of a country's overall economic characteristics combined with the size and growth rate of the industry that the planned subsidiary is meant to participate in. Previous research has suggested that the more attractive the market, the more likely an acquisition will be used to enter it. because the speed of entry would be a critical factor. To gain insights into the impact of this contingency, the criteria section of the survey asked respondents to report whether (and in what direction) speed of entry was a factor in their choice. The responses on this item were then coded so that the sample could be split into "Speed was important" and "Speed was not important" groups. This is a direct way of asking about the underlying reasons why market attractiveness

100 might have had an influence on mode choice. Previous research has argued that market attractiveness (rneasured in a variety of ways - see literature review) would influence the BuildlBuy decision primarily because of this perception of urgency on the part of managers Sample Choice of home country base All subject parent firms are based in the same country (Japan). and variance is supplied through the use of data about their international activities in a variety of host countries. This approach serves two purposes: 1. Since the appropriate respondent for the proposed survey is the top parent Company manager of each subsidiary, most will be Japanese nationals. However, even those that are not will be imrnersed in the corporate culture of their Japanese parent firms, which is more homogeneous across companies than that of MNEs based in other home countries. The combination of Japanese cultural and ethnic homogeneity at the national level, and the large percentage of Japanese respondents is expected to provide a sample which is more consistent, in terrns of cultural biases and predispositions, than a similar sample drawn from American or European firrns. This will reduce the likelihood of spurious variances due to differing interpretations of the suwey questions. 2. By holding the home country constant, the arnount of residual noise in the data is reduced, enhancing the possibility of discerning small effects in the phenornenon of interest. This is a study of the determinants of entry mode choice, thus the focus should be on variations in the variables related to the choice. The characteristics of

101 the decision actors should be as consistent as possible to allow variations in the decision process to be highlighted. This justifies the use of a sample of companies based in a single home country. Using a sample composed of Japanese-based firms in particular was considered preferable for reasons articulated in the discussion of the culture measures employed in this study. Briefly. these reasons have to do with the fact that, of the three major possibilities for a choice of home base. Japan was judged to be the one that would be the most homogeneous and where senior managers would have the hig hest proba bility of refiecting the home country's national culture Toyo Keizai Dataset The sample for this study is drawn from a compilation of data from the Japan Company Handbook (Toyo Keizai 1994). The Toyo Keizai (TK) data consist of information available on the three major Japanese stock exchanges and a short survey administered to the top Japanese manager in each subsidiary It has been estirnated that approxirnately 40% of al[ Japanese foreign investrnents are listed in this database (Makino 1995). This data source is increasingly being used by international business researchers (see. for example: Hennart and Park 1993; Ito and Rose 1994), and has been widely accepted as being reliable and representative. Data from the book were ccded into an SPSS-format dataset by the Richard lvey School of Business. The version used as the starting point for this study was created in 1995, based on the 1994 edition of the Toyo Keizai book. Additional cases were supplied by the 1997 edition.

102 Selecting the sample from the sample frame Date of subsidiary formation criterion. The survey relies on respondents to supply information about past events. This raises two possibie concerns: 1. The larger the time lag between the event and the time of survey administration, the higher the probability that respondents may not have been directly involved in the foreign entry decision. 2. The longer the time since the event. the less likeiy it is that even respondents who were involved will recollect everything accurately. These concerns rnay lead to: lnaccurate responses. Systematic differences between data from involved and non-involved respondents. To minimize the risks of these problems. it was decided that no respondent will be asked to recall events before or more than ten years in the past. This is thought to be a short enough interval to minimize the possibility of reliability problems or systematic biases in the responses. The data were screened to eliminate subsidiaries formed prior to that Kogut and Zander (1993), in a study performed in the early 1990s. asked engineers about innovations initiated by their firms as far in the past as Their results suggest that it is not unrealistic to expect managers to accurately recollect important events that occurred a considerable length of time in the past.

103 For this study, an alternative would have been to survey head office decision- makers instead of subsidiary managers. It was decided to use subsidiary-level informants for these reasons: The study's unit of analysis is the foreign entry, not headquarters international strategy. Surveying head office managers would have risked a reduction in variance, as the same heuristics would have been applied to al1 the decisions that particular manager was involved in. Subsidiary managers might even be better informed about what drove the decision than headquarters managers, since their careers depend to a greater extent on the success of the venture. Another risk is the possibility that the survey respondent was not in the position of decision-maker at the time the entry was made. Expatriate rotation schedules in the surveyed subsidiaries may have placed a new person in the position of subsidiary general manager. It is argued, however, that even if this occurred, there is an excellent chance that the person who completed the survey was employed at that location at the time of entry, and may have been promoted into a general management capacity. This individual would thus still be a competent informant. Finally, we asked that the respondents avail themselves of secondary information if necessary if they lacked the first-hand knowledge to give accurate responses. The memory issue was also one reason why every effort was made to keep the survey as short and simple as possible. The level of detail of the responses that

104 were requested was kept low, to avoid the tendency to guess or not respond to the item at all. The questions ask for information that a manager involved in the decision should be able to remember. They deal with issues of company policy which are not likely to change in a short period of time, and are sufficiently broad that it is reasonable to suppose a person would be able to recall them. Respondents are also prompted, in the covering letter, to refer to company files if necessary to refresh their recollection. Industry/sectoral criterion. Only manufacturing subsidiaries were surveyed for this study, since there is reason to believe that service and extractive businesses are different from manufacturing firms on a number of important dimensions (Erramilli & Rao 1993). First, service subsidiaries are typically less capitalintensive than manufacturing subsidiaries. This may bias results in favor of sole ownership for service firms, since financial resource constraints and risk are likely to be perceived as lower by service firms. Second, since there is really no way to export many services, an important non-investment mode for internationalization is not available to most service firms. Even though this study deals only with investment-based entry modes, it was felt that the lack of an exporting or licensing option for service firms might lead to some confusion about what factors motivated which choices. Service firms rnight have chosen an acquisition, for example, when a manufacturing firm with similar characteristics might have picked exporting, and option that did not exist for the service firm. The risk of obtaining results that would be incomparable across sectors was judged to be great enough to exclude al1 but manufacturing firms.

105 This study is airned at investigating mode choices made by firms which are interested in retaining some managerial control over their investments. As such, it does not deal with portfolio investments. It was therefore deemed necessary to exclude holding companies and other such non-operating firms from the sample. Also, no pure trading companies are in the sample, for similar reasons. Although these firms are often quite large in terms of total capitalization, most of their assets tend to be marketing, purchasing. or finance-related. They thus exist to engage in support as opposed to primary activities (Enderwick 1988). A final reason to restrict the sample to manufacturing firms is that (albeit with some very notable exceptions) most mode choice research to date has been manufacturing-based. With theoretical frameworks and measures employed in this study al1 drawn from manufacturing-dominated earlier work, there is a danger that these concepts and measures might not be portable across sectors Conclusion The following chapter describes the survey distribution methods, response patterns. and the results of tests of the hypotheses developed in the previous chapter. The final section of Chapter 5 discusses the need to build a comprehensive model of the mode decision to corne to a more complete understanding of this complex process.

106 CHAPTER 5: Results: Sam le Characteristics and Hypothesis B esting The first stage of data analysis was concerned with replicating previous research. with these objectives: 1. Provide additional support for previous findings; 2. Test validity of previous assumptions about managers' behaviors; 3. Provide evidence that these data are valid and reliable enough to carry on to the theory-building stage. The first part of this chapter will provide descriptive summary statistics about the data; a brief explanation of the statistical approach that was adopted is then followed by results of these tests. and a discussion of their implications for the hypotheses developed in Chapter 3. The final section sets up the model-building and -testing that will be the subject of the next two chapters Characteristics of the sample 5.1.A - Data source The sample for this study was drawn from a compilation of data about Japanesebased multinational firms called Japanese Overseas lnvestments (Toyo Keizai 1994). This publication is created annually by Toyo Keizai (TK) from information available on the three major Japanese stock exchanges and a short survey administered to the top Japanese manager in each subsidiary. It has been estimated that approximately 40% of al1 Japanese foreign investments are listed in this database (Makino 1995). This data source is increasingly being used by international business researchers, and has been widely accepted as being

107 reliable and representative (for example: Hennart and Park 1993, and Ito and Rose among others). Results reported here are based on data compiled by Toyo Keizai in The Toyo Keizai database lists the original mode of entry and year of subsidiary formation, as well as the host country. The respondents to Toyo Keizai's original survey, upon which the published volume is based. were Japanese nationals, at similar levels in their organizations, reducing the likelihood of culture-based and other sources of bias Sampling In accordance with the objectives of this study, and following the tradition of many previous studies of entry mode choice, the raw data from Toyo Keizai were filtered based on the following criteria. Subsidiaries were included if they operated in manufacturing industries, and if a single Japanese shareholder owned more than 5% of their equity. lnvestments coded as "capital participation" were not included in the study because these represent portfolio investments on the part of the Japanese owners. We were interested only in those investrnents in which owners have some management input and control. The equity in portfolio investments is held by non-operating holding companies as a financial instrument, often without any meaningful input or control from the parent except on bottom-line financial performance measures. Relationships between head office and subsidiary, and between subsidiaries of the sarne firm, rarely extend to the transfer of knowledge, know-how, experience, technology, or personnel, and

108 subsidiaries are simply held accountable for building shareholder wealth through deploying the resources that are available to them internally. While the parent company in these situations does contribute new capital and imposes some financial discipline on the subsidiary, these types of investments do not fit the model of a operating multinational corporation as it is conceived in this study, and are excluded frorn the sample. The final criterion was that the subsidiary had to have been created after This cutoff was used to minimize the effect of fading mernories on the part of respondents. The decision they were being asked to refiect on took place at some time in the past, and the further back they had to remernber. the less likely it would be that their memories would be accurate. The survey covering letter encourages respondents to refer to company files to refresh their memories if necessary, but it is not considered likely that any actually did so. The suggestion was added to the covering letter simply as a way of conveying the importance of accuracy and cornpleteness in the responses. There is reason to believe that retrospective data such as those which form the basis of this study become increasingly suspect the longer the intewal between the event and its recollection. Golden (1992) suggested that Retrospective accounts of past facts or behaviors are more likely to be accurate than accounts of past beliefs or intentions, which are more subjective and perhaps more vulnerable to the effects of cognitive biases and faulty memory. (1 992: 855)

109 The Golden (1992) study. which found that a large number of CEOs answered differently when asked the sarne question after a two-year interval, required respondents to identify a firm's strategy. a highly subjective, complex, and ambiguous concept. In the present study, many of the questions are also subjective. but we would argue that the subject matter in general does not have as much potential for interpretation, arnbiguity, error, and social acceptability bias. While the 1986 cutoff used in this study is somewhat arbitrary, it was put in place to avoid the likelihood of serious memory lapses, and to reduce the probability that the informant being asked to respond to the survey had not been involved (or even empioyed with the company) at the tirne of the decision. There are examples of studies that ask respondents to recall much more distant events (for exarnple, Kogut and Zander 1993, as noted in Chapter 4); a ten-year time span was deemed to be a reasonable compromise between obtaining a large quantity of responses over a variety of economic and political environments while still ensu ring accuracy. To summarize, the four filters used to define eligible cases were: 1. Sectoral (manufacturing only, defined as SIC Codes frorn 20 to 39 inclusive). 2. lnvestment percentage (at least one Japanese shareholder with more than 5% equity). 3. investment type (not "capital participation", as identified by the TK data).

110 4. date of subsidiary formation (later than 1986). This procedure produced a raw sample frame of 1488 eligible companies from the entire dataset of 5, Survey distribution The Toyo Keizai publication from which the sample is drawn reports Company names, addresses, and telephone numbers, but no fax numbers. In approximately 20% of the cases, the name of TK's survey respondent. who was supposed to be the top ofkial in the subsidiary, is also provided. The first group of surveys was distributed by fax. The rationale for this was that faxing surveys would allow maximum Rexibility in terms of timing, content of the survey and cover letter, and would, it was hoped, lead to a better response rate because a faxed survey might seem less "threatening" or "weighty" to respondents. It was also thought that turn-around time might be reduced. because faxes are imbued with a sense of immediacy. if not urgency, that does not attach to mailed documents. To ascertain fax numbers, each Company on the list had to be contacted by telephone; at the same time as the fax number was obtained, an attempt was made to obtain the name of a suitable respondent, so that the fax could be directed to that individual. In the case of firrns for which the TK book provided a reference name, this part of the conversation with the Company started with an attempt to confirm whether the person whose name listed in the TK publication was the appropriate recipient. A "suitable" candidate was defined as the person

111 with the most senior position who had been part of the decision-making process when the su bsidiary was established. The telephone process was followed for the US. and Canadian companies on the list, and resulted in a total of 494 companies for which fax deliveries could be atternpted (35 in Canada, 459 in the US.). Of these, a total of 203 were successfully completed (31 Canada, 172 U.S.). The balance of the surveys were distributed by mail because of the difficulties in obtaining fax numbers for firms in many different languages. Companies were selected frorn the TK publication based on the sarne criteria as those used for the U.S. and Canadian sarnple. Because of the possibility that the target respondent might be more cornfortable responding in Japanese instead of English, a translated version of the survey and covering letter was provided in every mailed package. The translation was verified to be accurate by Japanese-speaking colleagues. The mailing was cornpleted in July Sorne of the Company addresses in the TK book were listed in Chinese, not English. Out of a total of 859 eligible cornpanies, 215 were therefore rnailed with Chinese-laquage labels, while the balance had English labels. Not surprisingly, the Chinese-labelled set went to destinations predominantly in China, Taiwan, and Hong Kong. Both sets of rnailings had identical contents, that is, the survey and covenng letter were provided in both English and Japanese. A final wave of faxed surveys were distributed to North American companies selected from the 1997 edition of Japan Overseas Investments. As discussed in

112 the next section. response rates, especially to the Chinese-labelled mail surveys. were disappointing, leading to a smaller than anticipated sample size and related data analysis problems. A second attempt was therefore made to raise the number of valid cases closer to 100 (considered a rough minimum to perform the necessary analyses). New faxes were successfully sent to 132 firms which had not previously been contacted Response rate There were a total of 96 usable responses. Of these, 37 were replies to the US. and Canadian faxes (30 and 7 respectively). for a combined response to successful fax rate of 18.6%. The rate of responses to the total number of available companies was 7.2%. Details about the survey are reported in Table 5.1. Because the mailing list was created from addresses that were three years old at the tirne of mailing. there was a good chance that a number of them were outdated, if the number of invalid telephone numbers and unsuccessful faxes is any indication. An estimate of the proportion of the number of surveys that reached their destination was computed from the proportion of US. qualified companies to which faxes were successfully sent ( =.375). This value is used in the response-rate calculation as a crude way to adjust for the fact that many surveys that were sent were not able to reach their destinations.

113 Table Summary of Survey Distribution and Responses 1 l I (5) (1 ) (2) (3) (4) Estimated (6) Successfui Da te Starting Attempted Delivenes Group seni number Deliveries Responçeç Canada (fax) U.S.(faxl) Feb 1 1 i complete Faxes) / 35 7 Mar 1997 English-label July mailing (Computed value) I Dec N.A. (fax 2) Sub-total Chinese- (Computed Juiy label value) 4 mailing 84 TO ta/ Not usable Available foranalysis 1 96 l Overall Net 1 rate rate 1 l The second column in Table 5.1 reports the date when the surveys were delivered. The third column reports the number of firms that met the selection criteria. The fourth cotumn is the number of firms for which fax numbers were obtained after they were contacted by telephone, or the number of addresses that were available in the TK source data. Some firms could not be contacted at all, either because they had ceased operations, rnoved with no fowarding address. or because an invalid phone number appeared in the book. In addition. some firms were unable or unwilling to provide a fax number within the tirne frame permitted by the survey distribution schedule. The fifth column contains the number of faxes that were successfully sent, or the estimated number of mailed

114 surveys that reached their destination, based on the adjustment factor computed from fax-delivery rates. The sixth column shows the number of responses that were received. The seventh column is the response rate based on responses received divided by the number of firms in the overall initial sample frame. This does not, however. present a fair picture of the response rate. A different picture emerges if the response rate is based on the number of surveys that were actually delivered to the intended destination. The eighth column thus shows the response rate based on responses received divided by the number of surveys successfully delivered. The Chinese-language mailing was a failure from the point of view of response rate. Only four responses were received from a total of 215 surveys mailed out. As the table shows, without the Chinese-language labels, the net response rate approaches 16%. while with the Chinese surveys included, it drops to 14.5% Response profile Geographic distribution The replies reflected a bias towards North American responses, with 56% of the total responses originating in that region. Largely because of this, a high percentage of the responses are also from industrialized countries. Sixty-eight (71 %) of the 96 responses were from developed economies, and 28 (39%) came from emerging countries. Both these statistics differ from those in the original sample frame. which had 29% North Arnerican representation, with 32% from developed economies. Table 5.2 reports the country-by-country breakdown of responses. with corresponding percentages for the original sample frame.

115 Region Table 5.2 Geographic distribution of responses Country I Percent in 1 Nurnber of Percent of 1 original responses Total sample I l 1 tlnited Kinadom I 1 - i 1 Germany 2 I Belaium ! Netherlands i 1 Total Europe North America Totals United States Canada Mexico I 1 I Total North America ( / 28.6 Phillippines 1 Taiwan 3 China 2 Hong Kong 4 Asia Thailand 5 tndonesia 1 2 Malaysia 8 India 2 Australia 3 1 Total Asia l 46 i O I I 1.O I O , 1 1 The heavy emphasis in our responses on especially in North America, suggests that subsidiaries in developed countries, the sample is not as representative, on the geographic dimension, of the spectrum of international Japanese manufacturing investments as we would have liked. Fortunately, however, location selection was not a central feature of this study, and our results can still be used to draw broad conclusions about the determinants of mode choice, even if generalizability is sornewhat limited by the discrepancies pointed out above.

116 Distribution by industry Table 5.3 presents the characteristics of the responses with respect to industry affiliation, and contrasts the sample were contributed. The table shows a with the group from which the responses reasonably close correspondence between the overall industry distribution of the TK sample frame and the responses that were received. Table 5.3 lndustry distribution of responses SIC Code lndustry 20 / Food Products 22 1 Textiles Totals Apparel LumberNVood Products Paper Products Chernicals RubbedPlastic Products Primary Metal Industries Fabricated Metal Industrial Machinery Electronic Equipment Transportation Equipment Instruments Miscellaneous Manufacturing Percentage in original sample frame Percentage of responses Distribution by mode As the Table 5.4 shows, the sample contained a nearly equal distribution of joint ventures and wholly-owned subsidiaries (49 and 47 respectively). This differs somewhat from the proportions found in the sample frame, where 35.7% were wholly-owned and 64.3% were joint ventures. The difference can be explained by

117 the heavy concentration of responses from developed countries, and North America in particular. In the United States for example, the country with the largeçt nurnber of responses. the sample frarne contained 55.6O/0 wholly-owned subsidiaries, a proportion that is very close to that found in the responses received. Thus the distribution of responses by Ownership is accounted for by geographic bias. The percentage of responses that were acquisitions is 19.8%. compared to 9.9% in the entire dataset from which responses were solicited. Again, taking the United States subsample as an illustration, its percentage of acquisitions was 24.7; the relatively heavy concentration of responses from North America thus once again accounts for the observed difference in BuildlBuy proportions between responses received and the overall dataset. Table 5.4 Mode distribution of responses I Ownership Decision Sole Ownership Shared Ownership B~ildlBu~ Decision Totals 5 rp *- ' -3 0 O Greenfield Acquisition Ownership Decision Totals Other Characteristics It was possible to compare responses with non-responses on some other characteristics, because the data on these measures was available in the TK

118 source book from which the çample was drawn. Four comparisons were made: subsidiary age, number of employees, amount of equity in the subsidiary, and sales in US dollars. Table 5.5 shows how the responses cornpared with the population from which they came on these dimensions. Table 5.5 Means of responses on descriptive characteristics 1 Whole 1 dataset / Responses Measure 1 (n=96) Subsidiary age in years Sales in millionus$ (n= 1294) A Mann-Whitney non-parametric test was performed on the mean values for the two groups; this procedure revealed that age and employment means were not significantly different between the responses and the sample frame, but that the sales and equity figures differ at a level of p =.000. It would appear, therefore, that Our responses came from a significantly smaller group of subsidiaries than is typical for the Japanese investments contained in the TK source book Results - Hypothesis testing Host country market knowledge Hl A lack of knowledge of the local (host country) market is positively associated with shared ownership and acquisition modes. The suney item that corresponded to this hypothesis was the "Need to gain knowledge of the host country market". The mean of this item was 2.60, which was significantly different from 3.00 at p = Since low values on this scale

119 corresponded to a preference for shared ownership, this is interpreted as an indication that managers prefer joint ventures when gaining knowledge of the local market is important. For the BuildlBuy Decision, the item's mean of 2.74 suggested a preference for acquisitions. This value was different from the "no influence" value of 3.00 at p = -066, providing some support for the hypothesis that acquisitions are preferred when there is a lack of host country knowledge in the parent Company. Hl is therefore supported for both the Ownership and the BuildfBuy decisions. Joint ventures and acquisitions were viewed by managers as a way of making up for a lack of host country knowledge, as previous research has indicated Technical knowledge H2 A lack of technical knowledge is positively associated with shared ownership or acquisition modes. There were two items that measured the "Need to gain technical knowledge" - one for manufacturing, and one for product development, since these are the two most frequently-encountered R&D activities. On the Ownership scale, the means of the items significantly favored sole ownership, in contrast to the hypothesized direction of influence. Similarly, for the BuildBuy scale, the item means strongly indicated that managers preferred greenfield entries when considering the "need to gain technical knowledge". Both items were significant on each decision, at p <.O1 for the Ownership scale, and p <.O5 for the BuildlBuy scale. Upon reexamination of the rationale for the hypothesis, the wording of the survey item, and the characteristics of the population from which the responses were

120 drawn, the following explanation is put foward for these apparently anomalous findings. First, the hypothesis was developed from the theoretical proposition that a deficiency in technological know-how, on the part of a firm entering a foreign market, would be a motivation to seek out a partner or acquisition that could supply the necessary knowledge. However, the firms represented in our sample, with parents in a technologically-sophisticated home country, are possibly not at al1 deficient technologically, especially with respect to the level of technological know-how that might be available from partners or acquisition targets in the countries represented in our sample. Many of these potential partners and targets would have little to offer a Japanese firm in the way of technical expertise. Thus the apparent preference for whoily-owned and greenfield modes might be spurious, or at best, a refiection of a residual "default" preference that is always present in the background of these decisions. A simple test of this was performed by examining a subsample of subsidiaries in the United States, because this is one country where a Japanese parent might expect to find joint venture partners or make acquisitions that could make a technological contribution. The same test of significance nin on only the US. data revealed that the means were still well over the neutral value of 3.0, but that only one of four tests achieve a level of significance better than p =.O5 The item that remained significant was "Need to gain technical knowledge in manufacturing" for the BuildlBuy Decision. Because the means were still approximately the same values, however. this test has to be seen as inconclusive, because the lower significance levels can easily be explained by the much smaller sample size used to compute a T-statistic.

121 A more promising explanation might be that respondents interpreted the survey item at the subsidiary level. In combination with the obsewations made above, about the relative technological capabilities of the Japanese parent firms and likely partners and acquisition targets, a subsidiary manager in need of technological support would be expected to favor as strong as possible a link to the likeliest source of such knowledge. In this instance, the likeliest source of knowledge is the parent firm, since it is probably at least as technologically sophisticated as any firms in the host country. By the same token, the strongest link is the institutional one to the parent firm. uncomplicated by partners or a need to learn an acquired firm's routines, systems, and people. Thus the subsidiary manager. in these circumstances, would want to maintain sole ownership, and start a new venture from scratch, as the best way to gain the technical knowledge necessary to make the subsidiary successful Management resources H3 A need to supplement existing, in-house management resources is related to a tendency to choose shared ownership and acquisitions The "Need to supplement existing management resources" item waç not significantly difierent from 3.00 on either the Ownership or the BuildIBuy scales, not supporting the hypothesis Financial resources H4 A need to access additional financial is related to a tendency to choose shared ownership and acquisitions.

122 This item, "Need to access additional outside financing". was not a significant overall influence on the Ownership Decision. However, respondents showed a slight preference for greenfield entries on the BuildlBuy scale, with a mean of 3.19 (p = -079). Neither of the other finance-related indicators ("Avoidance of financial risk" and "Large size of investment") seemed to have any influence on either of the decisions. This hypothesis was therefore not supported Proprietary knowtedge H5 When the protection of proprietary technology is important, firms will tend to choose sole ownership and greenfield modes. This hypothesis was strongly supported with respect to both decisions. with T- tests of the difference between their means and the neutral value (3.00) yielding p-values of.000. This demonstrates that the need to protect proprietary knowledge from unauthorized or unintended dissemination leads, as expected. to a preference for sole ownership. On the Buildlbuy dimension. this finding is in accord with the findings of previous research that suggested a high level of asset specificity would be a motivation for managers to greenfield modes. This tendency would be increased the greater the assets in question are intangible and knowledge-based. Intangible assets are tacit and diffwlt to codify, characteristics which make transferring them to a newly-acquired firm an uncertain process.

123 Table 5.6- Means of Ownership influence factor items Need to gain knowledge of the local market Need to gain technical knowledge in manufacturing Need to gain technical knowledge in product developmen t Need to supplement existing management resources Need to access additionai outside financing Avoidance of financial risk - -- Significance of difference from "3.0" (no influence) Hypothesis Hl supported H2 contradicted HZ contradicted H3 not supported H4 not supported Previous experience: joint venture Previous experience: whollyowned subsidiary Large size of investment Host government restrictions Protection of proprietary technoloqy Minimize management complexity and overhead Speed of market access Overcome cultural differences Approached by partner (if applicable) 5 = favors wholly-owned 1 = favors joint venture Supports previous findings n.s.- unexpected supports previous findings H5 supported Supports previous findings As expected supports previous findings As expected

124 Table 5.7- Means of BuildlBuy influence factor items l tem Significance of difference from "3.0" (no influence) Hypotheçis implications Need to gain knowledge of the local market Need to gain technical knowledge in rnanufacturing Need to gain technical knowledge in product development Need to supplernent existing management resources Need to access additional outside financina I Hl supported HZ contradicted HZ con tradicted H3 not supported H4 supported / Avoidance of financial risk / Previous experience: acquisition Previou s experience: g reenfield su bsidiarv / Large size of investrnent 1 1 Host government restrictions Protection of proprietary. technoloav i Minimize management cornplexity and overhead Supports previous I findings 1 n.s.- unexpected Supports previous 1 findings l H5 supported 1 Supports previous findings 1 Speed of market access n.s.- unexpected i I Overcome cultural differences Approached by target (if applicable) 5 = favors green1 - eld 1 = favors acquisition i

125 5.3 - Discussion of results These results, with some exceptions, tend to be in line with expectations based on previous research and theory development. Both joint ventures and acquisitions were seen by respondents as ways to overcome a lack of host country market knowiedge (Hl), and the protection of proprietary technology was thought to be best done with wholly-owned and greenfield modes (H5). These findings support the logic of previous research that positioned entry mode as being determined partly by experience and asset specificity. The need to supplement existing management resources did not seern to lead to a preference in either direction on either decision, which undermines one of the pillars of previously-argued links between size and entry mode. These arguments are based on the fact that wholly-owned and greenfield entries place the burden of supplying the new entry with operating staff on one parent Company. Joint ventures, on the other hand, have at least two parents that might provide a source of managers to run the new subsidiary, and acquisitions, of course, corne complete with a whole set of employees who are already operating the firm. Despite the appeal of these arguments, respondents to this survey did not seem to think it made a difference. One related transaction cost argument, however, was supported. Management and control costs for joint ventures and acquisitions have been argued to be higher than for wholly-owned and greenfield entries. Whether this is true in a absolute sense is an empirical question that has not been directly tested, but its relevance here in terms of an input to the decision-

126 making process is demonstrated by the fact that managers seem to believe it is true. The "Minimize management complexity and overhead" item showed a strong preference for wholly-owned and greenfield entries. These results thus strongly support the argument that control costs are higher for joint ventures and acquisitions, as perceived by managers, and as argued in Woodcock et al (1994) and Nitsch et al (1996). The primary financing survey item, "Need to access additional outside financing", probes a rationale for joint venturing based on the relationship between subsidiary size and parent financial resources. It has been argued that very large entries would be more likely to be undertaken via joint venture for the simple reason that no single parent firm can muster the required amount of capital. On these results, this hypothesis must be rejected. The mean of the item suggests a slight influence in the wrong direction (3.17). but this value is not statistically significant (p =.17). For the BuildIBuy decision, on the other hand, the "Need to access additional outside financing" led to a slight preference for greenfield entries (mean = 3.19, p =.079). Arranging financing for acquisitions is seen by respondents as being slightly more difficult than for greenfield entries, supporting the argument that acquisitions are possibly fraught with problems in terms of the potential for overpayment andlor overly optimistic performance projections. The "Host government restrictions" items were in the expected direction. For the Ownership decision, government restrictions influenced managers in the direction of joint ventures, and for the BuildlBuy decision, in the direction of greenfieid entries. This corresponds to the way govemments are generally

127 expected to behave with regard to foreign entries into their jurisdictions. Multinational firms, when governments get involveci, are usually encouraged to partner with a local firm. and discouraged from taking over existing domestic firms. Our results are in line with these predicted influences. "Speed of market access" was an item thought to influence primarily the BuildlBuy decision, and was included on the Ownership portion of the survey simply to keep the two lists consistent. Previous research does not suggest that speed of entry should be a factor in the Sole vs. Shared ownership question, although ownership mode could make a difference to the speed with which a new entry could be established. especially if a local partner were able to help expedite the process for an inexperienced foreign firm. The literature does, however, propose that speed might be a consideration for the BuildIBuy decision, since market entry via acquisition is virtually instantaneous, and greenfield entries could take some time (for construction, recruiting a workfo rce, etc.). Our results, however. suggest that speed makes a difference for the Ownership Decision to a measurable degree, while for the BuildlBuy Decision the relationship is not supported. The mean of the "Overcome cultural differences" item was significantly shaded in the direction of shared ownership on the Ownership Decision scale, in line with previous research. A joint venture is seen by respondents as helping to overcome barriers to market entry that have their origin in a difference between the parent's home country and the host country of the subsidiary. Despite the fact

128 that acquisitions would seem to be influenced by the same logic. however, the item did not significantly favor greenfield or acquisition entry. Both the "Approached by partner" and "Approached by acquisition target" items were in the expected direction. Joint ventures were favored if the partner had made an overture to the parent company, and acquisitions were favored if the target company had approached the acquirer. This suggests an element of opportunkm on the part of entering cornpanies, if their entry mode was influenced by initiatives launched by another firm. Bounded rationality rnay have lirnited the choice of mode to sole ownership andlor greenfield - that is, options fully within the control of the entering firm, and not requiring any search or scanning activity. Previous experience in the case of joint ventures and acquisitions seemed to have no influence on the direction of choice, but experience with a wholly-owned or greenfield subsidiary was related to a preference to do the same thing again. Several interpretations of this result are possible. Previous experience with joint ventures and acquisitions rnay have been mixed, leading to some ambivalence about trying it again, whereas sole ownership and greenfield operations may have been better performers and thus more likely to be repeated. On the other hand, it may be that joint ventures and acquisitions are simply not the first choice under any circumstances; fewer companies may prefer them, al1 things being equal, without knowing more of the details about the specific venture being planned. Sole ownership and greenfield choices are not as ambiguous with respect to costs, risks, objectives, operational details, and rnyriad other

129 characteristics. They may be, in fact, the "default" or base case to which firms compare the other options if and when circumstances permit (or dictate) their consideration. If this is tnie, a firm having had a previous experience with a joint venture or acquisition would not be favorably or unfavorably disposed to a similar mode of entry - until more of the specifics of the proposed deal are revealed. A wholly-owned, greenfield entry can be subjected to a context-free evaluation because it is a mode that is always available. The other options are dependent for their attractiveness on factors external to, and outside the control of, the focal firm, and thus cannot be "favored" without at least some of those factors being known. Good or bad previous experience with a joint venture for exarnple might lead to an "it depends" response to the "would you do it again?" question implications for theory-building stage The analysis of results thus far has provided general support for many of the conjectures about management behavior and preferences that were embedded in previous mode choice research. As expected, a lack of knowledge of the local market and concern about cultural differences lead to a preference for joint ventures and acquisitions. The high management complexity of joint ventures and acquisitions, however. leads to a preference for wholly-owned and greenfield entries, as does a concern for protection of proprietary technology. Surprisingly, financial issues carried no weight in either direction on either decision. In ail, however, these results are interpreted to be broadly consistent with previous research, and thus serve as a validation of the data.

130 The next step in the analytic process is to build a model of the way in which a firm's resource profile affects the way managers evaluate the various Ownership and BuildlBuy decision Criteria. The analysis so far has not taken into consideration the fact that a firm which already has knowledge of the local market for example, might not be as favorably disposed to joint venturing as one which is deficient in that area of knowledge. Each decision criterion is expected to be linked to a resource item, where the resource profile of the firm provides a platform on which managers base their mode preferences. Resource and decision criteria items are conceptualized as reflections of underlying and unmeasura ble characteristics. At the level of these constructs, the Resource - Criteria link is simply a bivariate one. More interesting would be if the dimensions of the Resources and Criteria constructs could be determined, and the much more complex interrelationships among al1 of them be described. This is precisely what the next step in the analysis will attempt to do. The seven Resource measures and ten of the Criteria measures for each decision are grouped into three conceptually sound and empirically supported constructs. A Partial Least Squares (PLS) structural model is used to test the relationships between theçe constructs, and ficdings are reported that help sort out what happens in situations where mode choices are not clear. For example, it is easy to Say that when a parent firm lacks knowledge of the host country market, it should use a shared ownership mode of entry to help overcome this resource deficiency. The question gets more cornplicated, however, if the same firm has abundant financial resources and a high level of proprietary technology,

131 both of which seem to argue in favor of sole ownership. We will explore these boundary cases, and provide some insights about how managers rnake their choices when the decision is not clear-cut.

132 CHAPTER 6: Construction of the Model For greater clarity and ease of interpretation, the factors that contribute to the entry mode decision were grouped into constructs that correspond, broadly, to the major categories of decision determinants uncovered in previous research. Following the logic articulated previously, the two mode choices are conceptualized as a function of 1) existing parent firm resources, and 2) criteria employed by managers to make the decision. Resources and Criteria influences were each grouped into three constructs that correspond to different aspects of the unique circumstances that existed in the subsidiaries at the time they were formed. This chapter begins with a description of how the constructs were developed, and a discussion of the tests that were performed to determine their validity and reliability. The construction of a Partial Least Squares (PLS) causal model for the decisions is then discussed. The PLS structural modeling technique was used in order to gain some understanding of the relationships between the variables, and to assess which relationships contributed most strongly to the decisions that were actually made. The PLS technique was chosen for these reasons: It provides an overview of al1 the construct relationships simultaneously It generates interpretable results more consistently than other causal modeling techniques such as LISREL.

133 It is more appropriate than comparable methods at this early stage of research, when theory is relatively undeveloped, and measures are not well normed or validated,. Tests of significance can be performed on relatively small datasets compared to other multivariate techniques such as General Loglinear Models. A single model was built containing both mode decisions. The following discussion will describe the process that led to the final configuration of measurernent variables and latent constructs for both the BuildIBuy and Ownership decisions. Discussion of the results will focus on each section of the model separately Resource constructs Parent firm resources were operationalized by seven measures which were grouped into three constructs on the basis of theoretical and empirical analysis. Table 6.1 outlines the groupings and is followed by a discussion of the rationale and methodology followed in developing it. The latent resource constructs were the same in the BuildlBuy model as in the Ownership model. Table Resource item groupings I Survey item I Construct I / Knowledge of the host country market Management - resources 1 Technical knowledge in product development Technical knowledge in manufacturing Possession of proprietary technology Access to financing Ability to assume financial risk Management Knowledge l I 1 Technical Knowledge Financial Resources

134 6.1.l- Discussion of rationale for item groupings The development of the survey items intended to measure parent firm resources was driven by two conflicting motivations. First, the measures had to be reasonably complete and comprehensive in capturing the resources that previous research has revealed to have a bearing on the mode choice. The second motivation was to keep the list of items as short as possible in order to make the suwey easier for respondents to answer. It was also felt that the survey could under no circumstances exceed three pages in length; anything longer than this would be more likely to be discarded by the intended respondents because its imposing heft would suggest that a large block of time would need to be set aside to answer al1 the questions. The three-page limit was based on providing space to print al1 the questions plus a cover page on a single 11" by 17" sheet of paper. which would be folded in half booklet-style with a finished size corresponding to standard North American letter-size paper. A cursory scan of the item list immediately suggests two groupings: the three "Technology" variables and the two finance-related items are conceptually related and would seem to be "tapping into" similar aspects of a firm's rescurce complement. With the two remaining items, host country market knowledge and management resources, the links are not as obvious. They were kept together for these reasons: Data reduction - statistical considerations With a total usable sarnple of slightly less than 100, every variable that is added to the analysis contributes to a reduction in the ability of statistical tools to find patterns or significant

135 relationships. The contingent nature of the mode decision-ma king process means that many factors are instrumental in determining the final result. With a limited sample. however, existing quantitative methods can not be relied upon to produce meaningful results when there are unlimited variables. Degrees of freedom were held to a minimum in an effort to glean broad insights and understanding. Data reduction - interpretability considerations. The more variables or constructs a model contains, the more difficult it becomes to interpret results. Though realisrn and representativeness are necessary for research to have any validity. to find patterns which explain or even predict phenornena requires some abstraction and obscuring of detail. The manager has related goals: what can I learn from experiences of other firms? What conceptual frameworks are useful in my situation? The goal of this study was to identify broad patterns and relationships between the major factors that influence mode choice. Thus a balance needed to be struck between the need to represent a complex world as faithfully as possible, and the need to leave some questions unexplored for now. Empirical justification. A confirmatory factor analysis of the entire seven-item scale lends some support to the classification of items described above. Principal components analysis with Varimax rotation (SPSS v8.0) was employed to determine whether the grouping made sense statistically. First, the data were analyzed to determine their factorability. Three tests were performed to assess if the set of Resource variables contained factors.

136 1. The correlation matrix was inspected for bivariate correlations that exceeded.3, the level at which one variable shares more than half its variance with another (-55' = 0.3); nine of the 21 relationships met this condition, which is a quick initial test to determine whether any of the variables are related at all. 2. The significance of the correlations was computed, to provide an indication of the reliability of the relationships between pairs of variables. If a matrix is factorable, a substantial number of significant correlations should bz foucd rabachnik and Fidell In this case, only three of the 21 pairs of variables had correlations with p- values greater than.1. For thirteen of the remaining pairs, the significance of the correlations was less than An examination of the matrices of partial correlations, where painivise effects are adjusted for the effects of al1 the other variables, is also recommended. If factors are present in the data, high bivariate correlations become low partial correlations. There are two ways to test this. The first is simply a visual inspection of the anti-image correlation matrix. On this matrix, the off-diagonal values should be mostly small ones. This condition was met for these data: the diagonal values exceeded the off-diagonals row-wise and columnwise. ln fact, over the entire rnatrix, the smallest diagonal value was larger than the largest off-diagonal. A more formal way to assess this characteristic of a dataset is the Kaiser-Meyer-Olkin (KMO) measure of sampling adequacy. This measure is a ratio of the sum of squared correlations between the variables, and the sum of the squared correlations plus the sum of the squared partial correlations. The result will approach 1.O if the partial correlations are small, and values over 0.6 are considered adequate for good factor analysis Fabachnik and Fidell In this case, the KM0 measure of sampling adequacy had a value of -706.

137 Initially, the SPSS program generated a two-factor solution accounting for 61 % of the variance, using an Eigenvalue cut-off of 1.O to retain factors. The rotated factor loading matrix (Table 6.2) shows that the three "Technological knowledge" items load strongly on Factor 1, but that the second factor is both difficult to interpret and suffers from troublesome cross-loadings on some of its items. Table Resource Variables: Two-factor extraction 1 Item 1 Factor 1 1 Factor2! 1 / Loadings 1 Loadings 1 1 Access to financing Financial risk capacity Host country knowledge 1.O Management resources / Proprietary technology O O00 i rtechng knowledge - manufacturing / BO Technical knowledge - product Il4 1 develo~rnent A three-factor solution was then generated, which accounted for 75% of the total variance. The third factor is not completely satisfactory as it has an Eigenvalue of.933 and the scree plot reveals that there are other factors present that are close to it in terms of variance explained. However, this analysis was performed with a view to exploring the characteristics of the data, and to verify the reasonableness of the theoretically-based items groupings as discussed above. The item loadings are reported in Table 6.3.

138 Table Resource Variables: Three-factor extraction 1 tem 1 Factor 1 Loadings Factor 2 Loadings Factor 3 Loadings Access to financing /.O Financial risk capacity Host country knowledge Management resources 1 Proprietary technology I Technical knowledge - manufacturing Technical knowledge - product development An examination of the preceding table reveals that the Financial Risk Capacity and Management Resources items are problematic in that they have large crossloadings on more than one factor while not loading above 0.7 on any single factor. While the largest loadings on each item confons to the desired pattern. there is substantial room for debate about whether this is enough to consider the factors to be strongly supported. On the other hand, there is no strong reason not to group the items as has been proposed either: indeed, if a choice had to be made. the preponderance of the evidence, weak though it may be, WOU Id lead to the proposed grouping. In addition, Iwo of the factors are made up of ' only two items, which is considered less than optimal for factor analysis.

139 Reliability analysis was performed on each of the groups of variables to further test whether they can reasonably be said to reflect a common underlying construct. Cronbach's alphas were computed. with the following results: Table Cronbach's Alphas for Resource Factors 1 Factor 1 Alpha I F 1 Significance 1, l / ltems in factor 1 (3) I 1 1 Items in factor 2 (2) O00 i / Items in factor 3 (2) i O00 i I Factors 1 and 2 are comfortably above the 0.7 alpha cutoff suggested by Nunnally (1 978) for exploratory research. The third factor, as expected, was well under this threshold and not significant. A final test of the reasonableness of the item grouping was conducted within the context of the PLS analysis that forms the next stage in the analytic process. It has been argued that reliability (or convergent validity) is most properly assessed within the nornological network that the measurements were made (Fornell and Larcker 1981). The measure of interna1 consistency deveioped by Fornell and Larcker (1981) uses the item loadings obtained in the causal mode1 to calculate an index based on the following formula: where À, is the loading of the each / item on the construct and E, is the + ((~&i)~ ~ Va(6)) meanurement error for each item.

140 This technique, it is argued, produces a more meaningful result than a traditional Cronbach's Alpha computation, because it does not rely on the assumption that each item in a scale has equal importance. Items are weighted according to their loadings on the construct of choice within the overall causal mode1 being estimated. The results of the Fornell and Larcker (FBL) computation for the BuildlBuy and Ownership models are presented in the tables that follow. Table Resource constructs' internal consistency measures within the PLS Model: Fornell and Larcker (1981) measure Construct Resource Items 1 Loadings I Residua' Management Resources (Factor 3) Technical Resou rces (Factor 1 ) Financial Resources 1 (Factor21 2) I I.81.OOO i Host, iuar country bvui knowledge Management resources Tech. knldge knlrlle- - manuf. Tech. 1 ~i 1. knldge AI ilude - prod. dev Proprietary technology Access to financing Financial isk tolerance I I -95 variance 1 ' Il 1 i Based on these results, and on the robustness of the internal consistency measures across the many models that were inspected, it was decided to continue with the grouping of resource items as originally conceived. Technical resources are reflected by the existence of technical knowledge in manufacturing and product development, as well as the possession of proprietary technology. Financial resources are reflected by the firm's ability to access financing (internal or external is irrelevant and the interpretation was left up to the respondent), and by its ability to tolerate financial risk. The latter item would receive a high rating if the parent firm was very large relative to the investment being contemplated, or if it was in a poor state of financial health at the time of the investment.

141 Management knowledge is reflected by the existence of adequate numbers (and skill complements) of managers, and by host country knowledge. This is a construct that is conceptualiy not orthogonal to the others. since management knowledge clearly overlaps and is a part of the technical resources construct and perhaps financial resources as well. Management knowledge is meant to capture firm resources that were not accounted for in the technical and financial categories, and thus is a sort of residual or catch-dl. This conceptual ambiguity, of course, goes a long way toward explaining the construct's statisticai ambiguity as well, especially in the factor analyses. The statistical behavior of the seven items used to capture parent firm resources attests to the multidimensionality of the resource concept. A single resource index computed from the responses of ali seven items would oversimplify the concept, while using al1 seven variables 1) would result in statistical problems from excessive degrees of freedom and 2) create difficulties in interpretation. Grouping the items according to the scheme developed above was judged to offer the best balance of parsimony while still allowing the most salient dimensions to play their independent roles in subsequent analyses Decision Criteria constructs - Bui/d/Buy Decision Each of the resource items has at least one decision criterion directly associated with it. A process of elimination was used to arrive at a set of constructs for BuildlBuy decision criteria. Using factor analysis, variables that did not cleanly load on a single factor, or were problematic for other reasons, were eliminated. As this is the first time this scale was used with a sample of any size, it is not

142 considered surprising that a few items would be les than satisfactory from a psychometric perspective. Time. available resources and a relatively srnall sample frame did not permit large-scale pretesting and scale refinement. A set of three constructs was identified that correspond to the three resource constructs developed in the previous section. The construct names, item grouping. item loads, and construct interna1 consistency measures (based on Fornell and Larcker 1981) are reported in the table below. Table BuildlBuy Criteria constructs: Interna1 Consistency measures Construct Management Criteria Technical Criteria Financial Criteria FU 1 measure Items Need to gain local market knowledge Need to suppiement existing management resources Need to overcome cultural differences Need to gain tech. knldge - 1 manuf. Need to gain tech. knldge - prod. dev Need to protect proprietary.. technology 1 Loadings Need access to additional outside financing 1 Size of investment 70 The items that were dropped from the analysis were "Minimize management complexity and overhead" and "Avoidance of financial risk". These items were not thought to be gerrnane to the buildlbuy decision anyway, and were included on the survey primarily to present respondents with consistent sets of items for the Ownership and Build/Buy sections of the questionnaire. It is therefore neither

143 surprising nor particularly worrisome that both these items proved to be unusable Decision Criteria cons tructs - O wnership Decision As with the BuildIBuy decision, responses to the criteria items from the survey were initially grouped according to what was thought were conceptually-sound rationales for why they should go together. The final grouping used in the model is the result of data-driven modifications to this ex ante scherne. The discussion below provides more details on reasons for the changes. Table 6.7 ltem Loadings and Convergent and Discriminant Validity of Criteria ~onstructs - Ownership Decision Construct ltem 1 Loading 1 consistency measure Owners hip Criteria - Management Ownership Criteria - Technical Ownership Criteria - Ris k Need to overcorne cultural differences Need to gain local market knowledae Need to supplernent existing 1 n QI U.V I management resources I Need to gain tech. knowledge - manufacturina 0.88 Need to gain tech. knowledge - prod. development Need to protect proprietary 70 u. 1 J technology Need access to additional A 7~ V.1 J outside financing. Ability to assume financial ris k Size of investment

144 Factor analysis and reliabiiity tests revealed that the "need to avoid management complexity and overhead" item did not fit well with the others; this item was consequently dropped. In hindsight, the item may have been poorly constructed from the outset, despite its significance in the preceding hypothesis-testing analysis that was based on single-item T-tests. In the present rnultivariate context, the item may have been interpreted as calling for a response to two factors - management complexity and overhead - that are viewed as separate issues by managers. As a consequence, the item did not load strongly on any one factor, showing cross-loadings that were problernatic enough to suggest its removal from the scale. When the item was removed, the factor structure of the scale was more convincing and easier to interpret. The management criteria items that made up the construct were: Need to overcome cultural differences Need to gain local market knowledge Need to supplement existing management resources Causal model construction In keeping with the stated intent of this research, the complete model contains what are considered to be the essential theoretical links (or paths) between latent constructs. This is illustrated in Figure 6-1 below.

145 Figure 6-1 Conceptually-essential paths in PLS model 2 Financial \\ Critena 1 Orvnership..- Crireria Measurement Mode1 assessrnent Before attempting to draw conclusions about the relationships revealed by estimating a PLS model, it is necessary to ensure that the measures of the

146 constructs used in the rnodel are valid and reliable. Assessrnent of the measurement model can be broken down into three steps: 1. An examination of the individual item reliabilities. 2. Convergent validity of measures with their related constructs. 3. Discriminant validity. The following sections will deal with each of these steps in turn Individual item reliability For PLS models, items with loadings on their constructs greater than 0.7 are generally considered acceptable (Hulland 1998, 1999). The rationale for this is the same as that used for assessing a factor loading matrix: A loading is a correlation, therefore a value over -7 implies that more than half the variance in an item is accounted for by (or shared with) the construct. Since anything remaining is error variance (within the nomological context of the item-construct relationship), the 0.7 threshold value ensures that the error variance is less than explained variance. Ail measurement item loadings cornfortably exceeded the 0.7 threshold value, and 18 out of the 24 are over 0.8. Based on this. it is concluded that the items are reliably measuring their constructs Convergent validity An assessment of convergent validity is necessary to evaluate the internal consistency of the constructs in the model. The internal consistency of each construct needs to be confirmed in order to ensure its unidimensionality. This is both a methodological and a conceptual issue. Conceptually, a causal model's

147 explanatory value rests on the assumption that its component parts - the constructs - consist of a single concept, at least at the level of analysis being employed in the model. The degree to which this is not true affects the interpretability of the results, and the conclusions that may reasonably be drawn from any observations about the model. A construct that has more than one dimension may have a large statistical link to another construct, but it cannot be known which of the dimensions is responsible for the relationship. Valid conclusions would be impossible to draw in such a situation. From a methods point of view, multidimensionality could affect whether any significant results are observed at all. Multiple dimensions within a construct could easily have cpposite effects; this would lead to a situation where one effect cancels another, with the result being random statistical noise. For the current model. the test developed by Fornell and Larcker ( discussed above) is used to assess construct unidimensionality. The interpretation of this measure is the same as that used for Cronbach's alpha reliability test (Hulland 1999), meaning that a coefficient over 0.7 is considered a reasonable standard in the early stages of research (Nunnally 1978). Some of this discussion has been provided in an earlier section, and will simply be summarized here. As can be seen in Table 6.8, al1 the interna1 consistency measures for this model exceed 0.8. It is thus reasonable to conclude that the items are measuring their respective constructs quite well, and that there is not a serious multidimensionality problem with any of the constructs. If

148 multidimensionality were an issue, the internal consistency measures would have been poor and the loadings would not have been as strong as they are. Table Measurement mode1 assessment data I Loading, consistency A VE Construct 1 F8L internal 1 J- Management Resources Technical ReSoUrCeS Financial Resources Ownership Criteria - Management Knowledge of host country market Management Resources Tech. knldge - manuf. Tech. knldge - prod. dev 'Proprietary technology Access to financing Financial risk tolerance Need to overcome cultural differences Need to supplement existing management resources Need to gain tech. knowledge - manufacturing Ownership Criteria 'Need to gain tech. knowledge - - Technical prod. development L Need to protect proprietary technology Need access to additional Ownership Criteria outside financing - Risk Ability to assume financial risk Size of investment BuildlBuy Criteria - Management BuildlBuy Criteria - Technical BuildlBuy Criteria - Financial Need to overcome cultural differences Need to gain local market knowledge Need to supplement existing management resources Need to gain tech. knowledge - manufacturing Need to gain tech. knowledge - prod. develoment - - l~eed ' I I to protect proprietary I technology Need access to additional outside financin Size of investment !

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