Emerging Market Firms in the Global Economy 9781784410650, 9781784410667

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EMERGING MARKET FIRMS IN THE GLOBAL ECONOMY

INTERNATIONAL FINANCE REVIEW Series Editor: J. Jay Choi International Finance Review publishes theme-oriented volumes on various issues in international finance, such as international business finance, international investment and capital markets, global risk management, international corporate governance and institution, currency markets, emerging market finance, international economic integration, and related issues in international financial economics. Volume 5:

Latin American Financial Markets: Developments in Financial Innovations, Edited by Harvey Arbela´ez and Reid W. Click, 2004, Elsevier Science (ISBN 0-7623-1163-0)

Volume 6:

Emerging European Financial Markets: Independence and Integration Post-Enlargement, Edited by J. A. Batten and C. Kearney, 2006, Elsevier Science (ISBN 0-7623-1264-5)

Volume 7:

Value Creation in Multinational Enterprise, Edited by J. Jay Choi and Reid W. Click, 2007, Elsevier Science (ISBN 0-7623-1392-7)

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Asia-Pacific Financial Markets: Integration, Innovation and Challenges, Edited by Suk-Joong Kim and Michael McKenzie, 2008, Elsevier Science (ISBN 978-0-7623-1471-3)

Volume 9:

Institutional Approach to Global Corporate Governance: Business Systems and Beyond, Edited by J. Jay Choi and Sandra Dow, 2008, Emerald Publishing (ISBN 978-1-84855-320-0)

Volume 10:

Currency, Credit and Crisis: In Search of Financial Stability, Edited by J. Jay Choi and Michael G. Papaioannou, 2009, Emerald Publishing (ISBN 978-1-84950-601-4)

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International Banking in the New Era: Post-Crisis Challenges and Opportunities, Edited by Suk-Joong Kim and Michael D. McKenzie, 2010, Emerald Publishing, 2010 (ISBN: 978-1-84950-912-1)

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Institutional Investors in Global Capital Markets, Edited by Narjess Boubakri and Jean-Claude Cosset, 2011, Emerald Publishing, 2011 (ISBN: 978-1-78052-242-5)

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Transparency and Governance in a Global World, Edited by J. Jay Choi and Heibatollah Sami, 2012, Emerald Publishing, 2012 (ISBN: 978-1-78052-764-2)

Volume 14:

Global Banking, Financial Markets and Crises, Edited by Bang Nam Jeon and Marı´ a Pı´ a Olivero, Emerald Publishing, 2013 (ISBN: 978-1-78350-170-0)

INTERNATIONAL FINANCE REVIEW VOLUME 15

EMERGING MARKET FIRMS IN THE GLOBAL ECONOMY EDITED BY

CHINMAY PATTNAIK The University of Sydney Business School, The University of Sydney, Sydney, Australia

VIKAS KUMAR The University of Sydney Business School, The University of Sydney, Sydney, Australia

United Kingdom
North America
Japan India
Malaysia
China

Emerald Group Publishing Limited Howard House, Wagon Lane, Bingley BD16 1WA, UK First edition 2014 Copyright r 2014 Emerald Group Publishing Limited Reprints and permission service Contact: [email protected] No part of this book may be reproduced, stored in a retrieval system, transmitted in any form or by any means electronic, mechanical, photocopying, recording or otherwise without either the prior written permission of the publisher or a licence permitting restricted copying issued in the UK by The Copyright Licensing Agency and in the USA by The Copyright Clearance Center. Any opinions expressed in the chapters are those of the authors. Whilst Emerald makes every effort to ensure the quality and accuracy of its content, Emerald makes no representation implied or otherwise, as to the chapters’ suitability and application and disclaims any warranties, express or implied, to their use. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library ISBN: 978-1-78441-066-7 ISSN: 1569-3767 (Series)

ISOQAR certified Management System, awarded to Emerald for adherence to Environmental standard ISO 14001:2004. Certificate Number 1985 ISO 14001

CONTENTS LIST OF CONTRIBUTORS

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PART I: AN OVERVIEW EMERGING MARKET FIRMS IN THE GLOBAL ECONOMY: AN OVERVIEW Chinmay Pattnaik and Vikas Kumar

xv

PART II: INTERNATIONALIZATION ACQUIRING FIRM-SPECIFIC ADVANTAGES: ORGANIZATIONAL INNOVATION AND INTERNATIONALIZATION AT INDIAN MULTINATIONAL CORPORATIONS Prasad Oswal, Winfried Ruigrok and Narendra M. Agrawal

3

DEGREE OF INTERNATIONALIZATION AND ECONOMIC PERFORMANCE OF SMES IN BANGALORE: INFLUENTIAL FACTORS AND OUTCOMES M. H. Bala Subrahmanya

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THE ROLE OF PERSONAL NETWORKS IN RUSSIAN MNCS’ INTERNATIONALIZATION Snejina Michailova and Kseniya Nechayeva

73

LOW-LEVEL MANAGEMENT CONTROL AND CROSS-BORDER KNOWLEDGE TRANSFER OF EMERGING ECONOMY FIRMS Chang Liu, Zijie Li, Yi Li and Lin Cui

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CONTENTS

THE INTERNATIONALIZATION OF RUSSIAN MOBILE TELECOMMUNICATIONS OPERATORS Olga E. Annushkina

121

PART III: CORPORATE STRATEGY SHAREHOLDER VALUE CREATING STRATEGIES FOR EMERGING MARKETS Hemant Merchant

147

DO SERVICE FIRMS PREFER DOMESTIC EXPANSION DESPITE PRIOR INTERNATIONAL EXPERIENCE: THE CASE OF INDIAN SOFTWARE MNES Naveen Kumar Jain, Nitin Pangarkar and Yuan Lin

181

BRAZILIAN COMPANIES IN THEIR HABITAT: THE IMPACTS OF PRO-MARKET REFORMS IN THEIR EVOLUTION AND INTERNATIONALIZATION Afonso Fleury and Maria Tereza Leme Fleury

207

PART IV: CORPORATE GOVERNANCE CORPORATE FINANCIAL REPORTING IN THE BRIC ECONOMIES: A COMPARATIVE INTERNATIONAL ANALYSIS OF SEGMENT DISCLOSURE PRACTICES Helen Kang and Sidney J. Gray

233

ARE CHINESE CEOS STEWARDS OR AGENTS? REVISITING THE AGENCY
STEWARDSHIP DEBATE Helen Wei Hu and Ilan Alon

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Contents

HOW DO FAMILY, INSIDER, AND INSTITUTIONAL SHAREHOLDER PERCEIVE INSTITUTIONAL RISKS IN FOREIGN MARKET ENTRY? EVIDENCE FROM NEWLY INDUSTRIALIZED ECONOMY FIRMS Wiboon Kittilaksanawong EFFECTS OF MARKET TIMING ON THE CAPITAL STRUCTURE OF BRAZILIAN FIRMS Tatiana Albanez and Gerlando Augusto Sampaio Franco de Lima

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307

LIST OF CONTRIBUTORS Narendra M. Agrawal

Centre for Software and IT Management, Indian Institute of Management Bangalore, Bangalore, India

Tatiana Albanez

College of Economics, Business and Accounting, University of Sa˜o Paulo, Sa˜o Paulo, Brazil

Ilan Alon

Rollins College, Winter Park, FL, USA

Olga E. Annushkina

SDA Bocconi School of Management, Milan, Italy

M. H. Bala Subrahmanya

Department of Management Studies, Indian Institute of Science, Bangalore, India

Lin Cui

Research School of Management, Australian National University, Canberra, Australia

Afonso Fleury

University of Sa˜o Paulo, Sa˜o Paulo, Brazil

Maria Tereza Leme Fleury

Fundac¸a˜o Getulio Vargas, Sa˜o Paulo, Brazil

Sidney J. Gray

The University of Sydney Business School, The University of Sydney, Sydney, Australia

Helen Wei Hu

Department of Management and Marketing, University of Melbourne, Melbourne, Australia

Naveen Kumar Jain

College of Business, University of Akron, Akron, OH, USA

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LIST OF CONTRIBUTORS

Helen Kang

Australian School of Business, University of New South Wales, Sydney, Australia

Wiboon Kittilaksanawong

Faculty of Management, Nagoya University of Commerce & Business, Nisshin, Japan

Vikas Kumar

The University of Sydney Business School, The University of Sydney, Sydney, Australia

Yi Li

Research School of Management, Australian National University, Canberra, Australia

Zijie Li

Department of Management, University of International Business and Economics, Beijing, China

Gerlando Augusto Sampaio Franco de Lima

College of Economics, Business and Accounting, University of Sa˜o Paulo, Sa˜o Paulo, Brazil

Yuan Lin

Faculty of Business Administration, University of Macau, Macau

Chang Liu

Indiana University, IN, USA

Hemant Merchant

Kate Tiedemann College of Business, University of South Florida
St. Petersburg, St. Petersburg, FL, USA

Snejina Michailova

Department of Management and International Business, University of Auckland Business School, Auckland, New Zealand

Kseniya Nechayeva

Department of Management and International Business, University of Auckland Business School, Auckland, New Zealand

Prasad Oswal

Research Institute for International Management, University of St. Gallen, St. Gallen, Switzerland

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List of Contributors

Nitin Pangarkar

NUS Business School, National University of Singapore, Singapore

Chinmay Pattnaik

The University of Sydney Business School, The University of Sydney, Sydney, Australia

Winfried Ruigrok

Research Institute for International Management, University of St. Gallen, St. Gallen, Switzerland

PART I AN OVERVIEW

EMERGING MARKET FIRMS IN THE GLOBAL ECONOMY: AN OVERVIEW The adoption of pro-market economic reforms by emerging market economies in the last two decades has substantially increased their role in the global economy. These economies account for around half (50.4%) of the world GDP on the basis of purchasing power in 2013 (IMF, World Economic Outlook, 2013) compared to 31% in 1980. Together with the economic development, the economic reforms have transformed the institutional context for firms operating in these economies. The new institutional landscape has not only provided enormous opportunities for domestic and foreign firms to expand their businesses to access large consumer base but also introduced substantial challenges requiring these firms to adopt new laws and regulations and face competition from a more diverse set of domestic and foreign competitors. Firms from these economies have successfully responded to such opportunities and challenges by pursuing growth opportunities at domestic as well as global level. In the domestic market these firms are successfully competing with established foreign firms which have entered these markets. The Boston Consulting Group (BCG) has identified 50 such firms from emerging market economies which have outpaced their foreign competitors through customized business models for the local market with a 28% annual revenue growth over the last five years (Bhattacharya & Michael, 2008; Chin & Michael, 2014). Together with the domestic success, these firms are also becoming major source of foreign direct investment (FDI) in recent years. According to UNCTAD, the share of the outward FDI from developing and transitional economies reached 31.8% of the total outward FDI in 2010 (UNCTAD, 2012). These firms are expanding to international market rapidly through cross-border M&A. The cross-border M&A by emerging market firms reached approximately 20% of the total number of deals and 30% of the total deal value in 2010. The top 100 largest transnational corporations (TNCs) from developing and transition economies accounted for approximately 30% of the sales and assets and 55% of

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INTRODUCTION

the total employment as compared to TNCs from developed economies (UNCTAD, 2012). Their success is also evident from their share amounting to 85 firms in the top Fortune 500 list in 2010 compared to 23 firms in 1990. These figures suggest that firms from emerging markets play an increasingly important role in the global economy. Therefore, there is a need for systematic and in-depth understanding of the actual transformation of these firms and of the specific strategies adopted for such transformation after two decades of institutional change in their home contexts. This volume focuses on three major themes to illustrate the role of emerging market firms in the global economy. The first theme addresses the internationalization aspects of emerging market firms, the second theme addresses the corporate strategy aspects and the final theme examines the corporate governance aspects. We believe the competitiveness of these firms is determined by these three themes. In order to set the context for our readers, the introduction section provides a brief conceptual background of each of the themes, especially the unique features of emerging market firms in terms of their internationalization, corporate strategy and corporate governance. Thereafter, we have provided a summary of each article which is included under these themes. The volume consists of 12 chapters which have examined several facets of the strategy, organization and management of firms from emerging market economies. These studies have examined firms from several institutional contexts such as Brazil, Russia, India, China (BRIC) and Taiwan, which are representative of emerging market economies. The chapters have employed various research methods, including quantitative and qualitative approaches to address the research question. Such a mix of topics, contexts and methodologies provides a fine-grained understanding of emerging market firms.

INTERNATIONALIZATION OF EMERGING MARKET FIRMS Due to the adoption of pro-market reforms and subsequent reduction in the tariff and investment barriers, Multinational Corporations (MNCs) have entered the emerging markets, increasing the competitive intensity for domestic firms (Chari & David, 2012; Cuervo-Cazurra & Dau, 2009). While the net effect on firm performance of such an increase in the competitive environment in emerging market economies remains unclear

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(Dau, 2013), that these emerging market firms use internationalization as a response mechanism to institutional changes at home is well established (Chittoor, Sarkar, Ray, & Aulakh, 2009). Considering that these firms do not possess global brands and leading-edge technologies, one of the ways these firms have responded to such a challenge is through expansion into international markets to acquire strategic assets to compensate for their late comer disadvantages (Luo & Tung, 2007; Ramamurti & Singh, 2009). Existing studies on internationalization of emerging market firms have identified certain distinguishing features of these firms compared to developed country MNCs. First, most of these firms lack strategic assets which are usually viewed as the drivers of MNCs’ overseas FDI (Mathews, 2006). Second, these firms expand into international markets at an accelerated pace to both developed and developing countries. Finally, these firms have the preference for external growth through alliances and M&A compared to organic growth through wholly owned subsidiaries (Elango & Pattnaik, 2011; Guillen & Garcia-Canal, 2009). Under such background, this section has five chapters each examining a unique aspect of internationalization of emerging market firms. The first paper by Oswal, Ruigrok, and Agrawal titled “Acquiring firm specific advantages: organizational innovation and internationalization at Indian multinational corporations” provides findings on the transformation of organization innovation which includes organization structure, process, human resource, leadership and culture and their impact on internationalization of Indian firms between 2003 till 2008. Based on a survey of respondents from 76 companies with substantial international operation, findings of the study suggest that respondents ranked the role of leadership in providing vision and stretch goal together with “world class” product and service quality are the greatest organization innovation in last five years. Vision of the leadership, “world class” product and service quality and technological and operational competence vis-a-vis international competition are the three major innovations which facilitated internationalization of firms. These findings demonstrate that Indian organizations together with their leaders have transformed themselves to compete in the international market in the last decade. The second paper by Bala Subrahmanya titled “The degree of internationalization and economic performance of SMEs in Bangalore: Influential factors and outcomes” has empirically examined the factors influencing the degree of internationalization and the performance outcomes of SMEs in Bangalore. Based on a questionnaire survey of 84 SMEs in engineering industry, this study has found that firm level resources and competence and

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INTRODUCTION

firm level strategy significantly contributed to the degree of internationalization. However, the degree of internationalization had a negative impact on sales turnover and no impact on firm growth. The third paper by Michailova and Nechayeva titled “The role of personal networks in Russian MNCs’ internationalization” is a conceptual paper examining the influence of personal networks on internationalization of Russian MNCs. Based on network perspective, this study theoretically explains the role of personal networking in providing access to information and knowledge; commit resources, development of sales and marketing capabilities and further network expansion facilitating internationalization of Russian MNCs. The fourth paper by Liu, Li, Li, and Cui titled “Low-Level Management Control and Cross-Border Knowledge transfer of Emerging Economy Firms” examines the factors and processes which influence the relationship between management controls and knowledge transfer from acquired to an acquiring firm. Based on multiple case studies, this study shows that low level management control facilitates knowledge transfer compared to high level management control as low level management control mitigates hostile attitude and encourages cooperation and willingness of the employees of the acquired firm. The fifth paper by Annushkina titled “The internationalization of Russian mobile telecommunications operators” examines the internationalization process of two Russian mobile phone operators, that is, VimpelCom and Mobile Telesystems (MTS). Based on a qualitative case study approach from 1997 to 2007, the study has found that Russian telecom operators preferred starting their internationalization from markets which are geographically closer with lower levels of economic development and at a lower stage of mobile telecom industry development. The characteristics of a top management team composition also impacted the nature of internationalization pursued by these firms.

CORPORATE STRATEGY OF EMERGING MARKET FIRMS One of the key distinguishing features of emerging market economies as compared to developed economies is their prevailing institutional context. Institutional context refers to formal rules and regulations and informal norms and cultures which provides a framework for firms to operate in an

Introduction

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economy (North, 1990). The institutional context in emerging markets is characterized by lack of soft infrastructure such as information intermediaries which connect the buyer and the seller to reduce the information asymmetry between them. As a result, the product, labor and financial markets do not tend to function efficiently as compared to that in developed market economies. In addition to this, the regulatory and contract enforcement regimes in such markets are inefficient. These phenomena are collectively known as “institutional voids” (Khanna & Palepu, 1997). Due to the prevailing “institutional voids,” Khanna and Palepu (1997) argue that diversification as a corporate strategy creates value for firms in emerging markets firms in contrast to developed market where such strategy destroys firm value. As a result, firms affiliated with business groups which are a constellation of legally independent companies operating in diverse set of unrelated industries often controlled by a family can be more competitive by relying on their internal market by trading capital, labor, and product among their group affiliates as compared to independent firms which do not have access to such internal markets. While such assertion received empirical support in the initial stages of market reforms (Khanna & Palepu, 2000), subsequent studies found negative impact of corporate diversification strategy on firm value (Zattoni, Pedersen, & Kumar, 2009). Such finding is attributable to the transformation of institutional context and subsequent development of efficient market mechanism eroding the advantages of corporate diversification. In a recent perspective, Hoskisson, Wright, Filatotchev, and Peng (2013) discuss the different paths of institutional and factor market evolution that emerging market economies have embarked upon in the last decade suggesting the diversity of corporate strategies being adopted by emerging market firms. Part III examines the corporate strategy aspects of emerging market firms. This section consists of three chapters. The first chapter by Merchant titled “Shareholder value creating strategies for emerging markets” examines the role of firm-specific, country-specific and hybrid strategies on the stock market performance of firms investing in emerging markets. The findings suggest that while firm-specific, locationspecific or hybrid strategies independently did not create shareholder value, the right combination of them led to shareholder value creation in emerging markets. The second paper by Jain, Pangarkar, and Lin titled “Do service firms prefer domestic expansion despite prior international experience: The case of Indian software MNEs” examines the tradeoff between domestic and international expansion by Indian software firms. Based on the data on 37

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software firms between 2000 and 2009, this study finds that internally experienced software firms prefer to expand domestically. However, this relationship is weakened for reputed firms with industrial recognition and their rival’s opening of international expansion. The third paper by Fleury and Fleury titled “Brazilian companies in their habitat: The impacts of pro-market reforms in their evolution and internationalization” provides a historical analysis of evolution of Brazilian companies and their internationalization. The paper argues that the determinants behind adoption of pro-market reforms in Brazil, its compatibility with the prevailing institutional context and the relative bargaining power of local firms in relation to foreign companies explain the internationalization of Brazilian companies.

CORPORATE GOVERNANCE OF EMERGING MARKET FIRMS Finally, the way firms are governed in emerging market economies have certain unique features. First, the firms are often affiliated with a business group which is controlled by a family through concentrated ownership. The family controls these firms through stock pyramids or cross shareholding resulting in discrepancy between ownership and control rights over these firms. The voting (control) rights possessed by the family are frequently higher than the family’s cash flow (ownership) rights on the firm (Classens & Fan, 2002). Such ownership and controlled arrangement is quite different from developed (Anglo-Saxon) country firms where ownership is often dispersed with minority shareholders and residual control rights remain with the manager. Unlike developed (Anglo-Saxon) countries where the agency problem arises between the shareholder and the manager, the agency problem in emerging market firms arises between the controlling shareholder and the minority shareholder. Due to the discrepancy between the ownership and control rights of the controlling owner, there are instances where such ownership and control structure leads to expropriation of minority shareholders by controlling family due to the institutional context where property rights are not well defined and/or not well protected by the judicial systems (La Porta, Lopez-De-Silanes, & Shleifer, 1999). Moreover, the conventional governance mechanisms such as boards of directors (BOD) and takeovers are weak in emerging markets as corporate insiders dominate the BOD. Finally the insider domination of corporations leads to lack of corporate disclosure and transparency which

Introduction

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makes it difficult for outside constituents to monitor these firms (Pattnaik, Chang, & Shin, 2013). Part IV examines the corporate governance aspects of emerging market firms. This section consists of four chapters. The first chapter by Kang and Gray titled “Corporate Financial Reporting in the BRIC Economies: A Comparative International Analysis of Segment Disclosure Practices” examines the segment disclosure practices of 188 of the largest companies from BRIC countries. The findings show that the standard of reporting by the majority of BRIC companies is high and generally consistent with IFRS and the operating segment disclosures are positively associated with the extent of internationalization and majority of state ownership. The second chapter by Hu and Alon titled “Are Chinese CEOs Stewards or Agents? Revisiting the Agency
Stewardship Debate” examines the relationship between CEO duality and CEO tenure from agency and stewardship theory perspectives. Based on 5,165 observations of 1,036 listed companies in China over the period 2005
2010, the results suggest that stewardship theory is more applicable to China as compared to the agency theory. The third paper by Kittilaksanawong titled “How do Family, Insider and Institutional Shareholder Perceive Institutional Risks in Foreign Market Entry? Evidence from Newly Industrialized Economy Firms” examines how different ownership constituencies perceive institutional risk and decide the location and entry mode choice. Based on a panel data set of 732 companies from Taiwan making 3,691 FDI projects made in 41 countries during 2000
2007. The findings suggests that family and nonfamily insider shareholders tend to influence their invested firms to enter in institutionally smaller host countries through a shared ownership while domestic institutional shareholders tend to influence their invested firms to adopt a shared ownership and enter in host countries with larger and smaller institutional distances. The final chapter by Albanez and Lima “Effects of market timing on the capital structure of Brazilian firms” examines the influence and persistence of market timing in the financing decisions of listed Brazilian companies. Based on Brazilian firms that launched IPOs in the period from 2001 to 2011, the study found that market timing was not sufficiently persistent in the period studied to the point of determining these firms’ capital structure due to more advantageous alternative funding sources. Chinmay Pattnaik Vikas Kumar Editors

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REFERENCES Bhattacharya, A. K., & Michael, D. C. (2008). How local companies keep multinationals at bay. Harvard Business Review, March, 85
95. Chari, M. R., & David, P. (2012). Sustaining superior performance in an emerging economy: An empirical test in the Indian context. Strategic Management Journal, 33, 217
229. Chin, V., & Michael, C. (2014). How companies in emerging markets are winning at home. Boston Consulting Group. July. Retrieved from bcgperspectives.com Chittoor, R., Sarkar, M. B., Ray, S., & Aulakh, P. S. (2009). Third-world copycats to emerging multinationals: Institutional changes and organizational transformation in the Indian pharmaceutical industry. Organization Science, 20, 187
205. Claessens, S., & Fan, J. P. H. (2002). Corporate governance in Asia: A survey. International Review of Finance, 3(2), 71
103. Cuervo-Cazurra, A., & Dau, L. A. (2009). Pro-market reforms and firm profitability in developing countries. Academy of Management Journal, 52, 1348
1368. Dau, L. A. (2013). Learning across geographic space: Pro-market reforms, multinationalization strategy, and profitability. Journal of International Business Studies, 44, 235
262. Elango, B., & Pattnaik, C. (2011). Learning before making the big leap. Management International Review, 51(4), 461
481. Guillen, M., & Garcia-Canal, E. (2009). The American model of the multinational firm and the “new” multinationals from emerging economies. Academy of Management Perspectives, 23(02), 23
35. Hoskisson, R. E., Wright, M., Filatotchev, I., & Peng, M. W. (2013). Emerging multinationals from mid-range economies: The influence of institutions and factor markets. Journal of Management Studies, 50(7), 1295
1321. IMF. (2013). World economic outlook. Khanna, T., & Palepu, K. (1997). Why focused strategies may be wrong for emerging markets. Harvard Business Review, 75(4), 41
51. Khanna, T., & Palepu, K. (2000). Is group affiliation profitable in emerging markets? An analysis of diversified Indian business groups. Journal of Finance, 55(2), 867
891. La Porta, R., Lopez-De-Silanes, F., & Shleifer, A. (1999). Corporate ownership around the world. Journal of Finance, 54, 471
518. Luo, Y., & Tung, R. L. (2007). International expansion of emerging market enterprises: A springboard perspective. Journal of International Business Studies, 38(4), 481
498. Mathews, J. A. (2006). Dragon multinationals: New players in 21st century globalization. Asia Pacific Journal of Management, 23, 5
27. North, D. C. (1990). Institutions, institutional change and economic performance. Cambridge: Cambridge University Press. Pattnaik, C., Chang, J. J., & Shin, H. H. (2013). Business groups and corporate transparency in emerging markets. Empirical Evidence from India Asia Pacific Journal of Management, 30(4), 987
1004. Ramamurti, R., & Singh, J. V. (2009). Emerging multinationals in emerging markets. Cambridge: Cambridge University Press. UNCTAD. (2012). World investment report. Zattoni, A., Pedersen, T., & Kumar, V. (2009). The performance of group-affiliated firms during institutional transition: A longitudinal study of Indian firms. Corporate Governance: An International Review, 17(4), 510
523.

PART II INTERNATIONALIZATION

ACQUIRING FIRM-SPECIFIC ADVANTAGES: ORGANIZATIONAL INNOVATION AND INTERNATIONALIZATION AT INDIAN MULTINATIONAL CORPORATIONS Prasad Oswal, Winfried Ruigrok and Narendra M. Agrawal ABSTRACT Purpose
This study seeks to contribute to the relatively sparse literature on how emerging market firms (EMFs) acquire firm-specific advantages (FSA), how they adjust their organizational structures, processes, HR policies, leadership and cultures in the internationalization process, and how they interact with their domestic institutional context. Design/methodology/approach
We report the results of a survey sent off to the most internationalized Indian firms, measured by foreign income. Our survey includes 26 variables measuring individual aspects of organizational innovation. Emerging Market Firms in the Global Economy International Finance Review, Volume 15, 3
33 Copyright r 2014 by Emerald Group Publishing Limited All rights of reproduction in any form reserved ISSN: 1569-3767/doi:10.1108/S1569-376720140000015002

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Findings
Our respondents report significant changes along all 26 organizational variables over the period investigated (2003
2008). Based on self-reported assessments by top managers, our findings suggest: first, that Indian firms are rapidly transforming their organizations, second, that Indian executives are increasingly confident that they will be able to compete successfully on an international scale, and third, that Indian firms may increasingly benefit from organizational innovation complementing their low cost advantages. Research limitations/implications
First, our sample size is relatively small at 76. Second, the ratings on the organizational variables we studied are based on self-reporting. Finally, our survey especially captures developments at the largest and most international Indian companies. Practical implications
With its organization-wide scope of analysis, our study may guide EMF managers looking at organizational innovation in the internationalization context. Originality/value
This paper elucidates the interplay of Indian firms’ internationalization and organizational innovation. Keywords: Emerging Market Firms; Organizational Innovation; Indian Multinational Corporations; Internationalization; Organizational Capabilities

INTRODUCTION The recent economic history of India reads like a case study in globalization. After decades of inward-looking economic policies, India only opened its economy to the world in 1991. Licensing and restrictions for economic activity was abolished in most cases, and the path was made easier for Indian firms to go abroad and for foreign firms to enter India. Since liberalization, the value of Indian exports and imports has grown dramatically, with trade growing between 17 and 20 percent over 2005
2010 (World Trade Organization, 2012). From April 2000 to April 2011, India attracted $198 billion foreign direct investments (FDI) (Department of Industrial Policy & Promotion, 2012). FDI inflows into India increased from USD 73.5 million in 1991 to USD 32.1 billion in 2011 (World Bank).

Acquiring Firm-Specific Advantages at Indian MNCs

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At the same time, outward FDI have increased even faster over the past years (Subramanian, Sachdeva, & Morris, 2010), allowing conglomerates such as Tata and Reliance, and information technology service providers such as Infosys, to rise to global prominence. In fact it appears that large Indian firms increasingly prefer overseas expansion to the domestic market, despite the presence of a very large home market in India. The reason for this is that although the economic liberalization initiated in 1991 succeeded partly in making it easier to do business in India, significant hurdles still remain in the form of red tape, lack of clarity in the regulatory environment, and so on, that make overseas operations more attractive for Indian firms (Times of India, 2011). Despite their growing presence on the world stage, there however remains a relative dearth of academic research on Indian multinational corporations (MNCs), and more generally on EMFs (Hoskisson, Eden, Lau, & Wright, 2000; Jormanainen & Koveshnikov, 2012; Peng, 2003). Little is known about EMFs’ evolutionary trajectories, organizational designs, or the interaction between EMFs and their domestic institutional contexts. To what extent do EMFs suffer or benefit from their institutional heritage? Do EMFs perceive a strong liability of foreignness and newness abroad, due to their emerging market origins (cf. Zaheer, 1995)? Do EMFs pass through comparable development stages as developed market firms (DMFs)? If they do, this suggests that global competitive pressures are stronger than domestic institutional forces, and that EMFs may over time more resemble DMFs (see Contractor, 2013, for an excellent summary and also Narula, 2012). This paper focuses on organizational innovation at Indian MNCs over 2003
2008. This paper reports and analyses the results of a new survey instrument sent off to the most internationalized Indian firms. This survey was based on a design that has been previously used to examine patterns and the evolution of organizational structures, processes, and systems across European, North American, and Japanese DMFs (Pettigrew & Fenton, 2000; Ruigrok, Pettigrew, Peck, & Whittington, 1999; Whittington, Pettigrew, Peck, Fenton, & Conyon, 1999). This paper is organized as follows. The next section discusses theoretical perspectives on EMFs and organizational innovation. The method section explains the survey instrument, variables, and analytical methods used. Subsequently the results section presents and discusses our main findings. The conclusion section identifies the main contribution, relevance, and limitations of this paper.

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ANALYZING EMFs The last decade has seen the rise and growing importance of EMFs on the global stage. For instance, Contractor (2013) reports from UNCTAD’s World Investment Report 2012 that the 100 largest transnational companies (TNCs) from developing and transition economies already account for 32 percent of sales and assets and 56 percent of employees of all of the 100 largest TNCs worldwide. Several companies from emerging economies such as Embraer from Brazil, Lenovo from China and Infosys from India have created globally recognized brand names for themselves. This rise to prominence of EMFs has increasingly caught the attention of management scholars. The literature on EMFs has shown a growing appreciation of the differences between DMFs and EMFs, and of the theoretical and methodological implications of these differences. In a first stream of the EMF literature, classical theories of the internationalizing firm have been applied in order to understand the rise of the DMF and EMF alike. Many DMFs have been pioneers of economic globalization or comparatively early followers, and by internationalizing took on formerly entrenched domestic players. Thus Dunning’s OLI framework (1988) allowed scholars to track how firms leveraged existing Ownership-specific advantages, such as property rights and/or intangible asset advantages and advantages of common governance, Location-specific advantages, and Internalization-Incentive advantages (I). However, when EMFs set out to internationalize, they were confronted with established DMFs and hypercompetitive markets. The OLI framework appeared more helpful in explaining how DMFs accessed emerging markets than in explaining how EMFs accessed developed market economies (Chen, 2008; Hong & Chen, 2001; see however Sun, Peng, Ren, & Yan, 2012). In particular, the OLI framework was less applicable to understand the rise of the EMF as it focuses on firms’ existing advantages, yet fails to account for dynamic skill augmentation as recently seen in EMFs from countries such as India and China (Luo, 2002; Mathews, 2002; Mathews, 2006). In a second stream, therefore, researchers have started to address the rise of EMFs’ nascent advantages. Since EMFs do not typically possess unique firm-specific advantages (FSA) (Rugman, 1981), a key feature of EMF internationalization has been to acquire such FSA in the process (e.g., Lee & Rugman, 2012). Two recent frameworks have emerged that explain such FSA acquisition by EMFs. According to the first framework, EMFs apply an “international springboard strategy,” and “systematically and recursively use international expansion as a springboard to acquire

Acquiring Firm-Specific Advantages at Indian MNCs

7

critical resources needed to compete more effectively against their global rivals at home and abroad and to reduce their vulnerability to institutional and market constraints at home” (Luo & Tung, 2007). A second popular approach is the LLL (Linkage, Leverage, Learning) framework (Mathews, 2002; Mathews, 2006). This framework similarly suggests that EMFs are latecomers to the industry where they seek to compete, which leads them into accelerated internationalization with the aim of gaining access to resources and capabilities not found in their home market. The two frameworks offer alternative ways of understanding how EMFs pursue “global growth through accelerated internationalization combined with strategic and organizational innovation” (Bonaglia, Goldstein, & Mathews, 2007). A third stream of the EMF literature has therefore looked at specific emerging markets’ domestic institutional environments and the organizational, strategic, and performance effects (e.g., Cheng & Yu, 2008; Contractor, 2013; Davies & Walters, 2004). For example, Contractor (2013) has proposed a number of institutional factors that may explain the success of EMFs internationally including patience and long-term orientation, greater tolerance or acceptance of ambiguity, a relationship-based home culture, propensity to learn from alliance/supply chain/outsourcing partners, greater humility, or servant-leadership style of top management, a frugal mindset, a “global” mindset. Further, Contractor suggests that it is possible that the underdeveloped home country environment actually confers an advantage to EMFs in foreign environments, by making them more resilient, adaptable, and more unwilling “to take no for an answer” in the foreign environments. The following discussion focuses on India which is the context of this study and which has received markedly less attention in the EMF literature than China (Jormanainen & Koveshnikov, 2012). A first motive in the EMF literature with a focus in India has been the issue of knowledge and learning in the context of firm internationalization. This is not surprising since Indian EMFs have been particularly successful in industries such as BPO (Business Process Outsourcing) and pharmaceuticals (UNCTAD, 2011). Ramamurti and Singh (2009) suggest that key FSAs developed by Indian firms since the 1990s include low-cost production and innovation capabilities, excellence in processes and project management, and an ability to quickly restructure and ramp-up scale. These FSAs are leveraged on India’s country-specific advantages (CSAs) including its large domestic economy, its technical and managerial human capital, relatively well-developed capital markets and rule of law, and historically rooted entrepreneurial traditions. Chittoor, Sarkar, Ray,

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and Aulakh (2009) found that Indian pharmaceutical companies facing discontinuous changes in their institutional environment internationalized their technology and financial resource bases, thus effectively transforming their organizations. Gubbi, Aulakh, Ray, Sarkar, and Chittoor (2010) used a sample of 425 cross-border acquisitions to show how international acquisitions allowed Indian firms to internalize tangible and intangible resources, and thus create shareholder value. Analyzing 808 south-north acquisitions by EMFs including Indian firms, Rabbiosi, Elia, and Bertoni (2012) found that EMFs’ international experience and home-country characteristics shape their learning and play an important role in determining their acquisition behavior in developed countries. Other authors, such as Kedia, Gaffney, and Clampit (2012) have also posited that knowledge is the EMFs’ most important resource, as they attempt to overcome disadvantages as latecomers by seeking knowledge internationally. A second motive in the literature on Indian EMFs has been the influence of business group membership. Elango and Pattnaik (2007) found that EMFs that belong to a business group may use their understanding of their parental networks to build capabilities (FSAs) for operating in international markets. Vissa, Greve, and Chen (2010) found differences in behavior between business groups affiliated and unaffiliated firms which suggest the former are more externally oriented and more likely to respond to low market performance. Likewise, Kumar, Gaur, and Pattnaik (2012) highlighted the importance of gaining specific internationalization related knowledge and capabilities for the success of Indian business groups in international markets (see also Gaur & Kumar, 2009). A third motive in the Indian EMF literature is the inclusion in global production or value chain networks. Kumaraswamy, Mudambi, Saranga, and Tripathy (2012) studied the automobile industry in India and found that domestic supplier firms need to adapt strategies from catching up initially through technology licensing, collaborations and joint ventures with DMFs to subsequently developing strong customer relationships with downstream firms. Furthermore, the authors suggest that successful catchup through these two strategies lays the basis for a strategy of knowledge creation as domestic industry integrates with the global value chain. However, as the above overview shows, there has been little attention in mapping patterns and trends in Indian EMFs’ organizational structures and transformation. Not surprisingly, therefore, the views of (Indian or other) EMFs’ strength in designing organizational structures and processes and managing human resources vary widely. On the one hand, some authors have pointed at the lack of global experience, managerial

Acquiring Firm-Specific Advantages at Indian MNCs

9

competence, and professional expertise in EMFs. According to Luo and Tung (2007), “many EM MNEs do not have sufficient experience in structuring, organizing, and managing large-scale and sophisticated world-wide operations.” On the other hand, it has been suggested that “there are some indications that EMFs from China and India are utilizing very innovative approaches in their human resources management” (Jormanainen & Koveshnikov, 2012). The present paper seeks to address this research gap.

ORGANIZATIONAL TRANSFORMATION AND CAPABILITIES It has long been understood that firms may build organizational capabilities or organizational configurations that can facilitate international success (Bartlett & Ghoshal, 1992a; Bryan & Joyce, 2007; Getz, 2009; Miles, Miles, Snow, Blomqvist, & Rocha, 2009; Perez-Batres & Eden, 2008; Teece, Pisano, & Shuen, 1997). Organizational capabilities are an important determining factor in firm performance (Cool & Schendel, 1988; Rumelt, 1991). Wernerfelt and Hansen (1989) for instance found that administrative factors explain about twice as much of variance in profit rates as economic factors. Rumelt, Schendel, and Teece (1991, p. 22) stressed that organizational capabilities rather than product market positions or tactics are the enduring sources of competitive advantage. In an extensive review of the literature on organizational “coordination” mechanisms used by MNCs for their international operations, Martinez and Jarillo (1989, 1991) suggested that companies adopt a mix of formal and informal coordination mechanisms to deal with the challenges of internationalization. Formal coordination mechanisms include centralization, formalization, planning and output and behavioral control systems. Informal coordination mechanisms include lateral relations, informal communications and organizational culture. Subsequent research on multinational coordination and the requirement to simultaneously meet the demands of integration and responsiveness led to proposed organizational models including the “transnational” (Bartlett & Ghoshal, 1989), “multifocus” (Prahalad & Doz, 1987), and “heterarchy” (Hedlund, 1986) (see Ghoshal & Westney, 1993 for a summary). In the same context, Malnight (2001) summarized the literature on “ideal type” multinational organizations. According to him, such organizations are characterized by: (1) complex, internally differentiated structures; (2) global dispersion of

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operations, interdependence and tight coupling of subunits; and (3) an emphasis on cross-unit learning and structural flexibility (following Bartlett & Ghoshal, 1989, 1990; Ghoshal & Bartlett, 1993; Hedlund, 1986, 1993, 1994; Nohria & Ghoshal, 1997; Prahalad & Doz, 1987, 1993). Several scholars have however questioned the actual extent of the move towards “ideal” and “high performance” organizational types (Pettigrew & Fenton, 2000) such as those elaborated in the previous sub-sections, and wondered whether these moves, if any, are idiosyncratic in different institutional contexts (Ruigrok et al., 1999). All above insights have been based on DMFs. Very little is known and few studies have been published about the interaction between Indian firms’ internationalization on the one hand and strategic and organizational innovation on the other. Some sources have suggested that Indian firms have transformed their organizations beyond the 1990s realities of excessive centralization and high levels of inefficiency (e.g., Forbes, 2002; McKinsey & Company, 2001). Some authors have suggested that Indian companies have started to acquire new capabilities such as operational efficiency and improved marketing skills (Ahmad & Chopra, 2004; Ghoshal, Piramal, & Bartlett, 2000). However, no systematic study has been conducted of patterns and trends in Indian EMFs’ organizational transformation. To complicate matters further, no dominant method has crystalized in studying organizational innovation
whether in developed or in emerging markets. Organizational innovation has been studied at different (e.g., functional, divisional, firm, group, or individual) levels, in different contexts, and with a focus on its determinants, the organizational process, or the organizational outcome (Crossan & Apaydin, 2010). Crossan and Apaydin compare the field of organizational innovation with the “proverbial elephant” characterized by different philosophical traditions, theoretical lenses, and empirical traditions (Crossan & Apaydin, 2010). In view of these many open issues, we propose that researchers, when studying the interplay of EMF internationalization and strategic and organizational innovation, should meet three tests. First, they should apply an instrument that has been used successfully in earlier prominent research on organizational innovation, even if in doing so they may risk applying a DMF lens. By applying an established instrument they may identify pertinent organizational features and prevent that EMF organizational practices that are merely different from DMF practices are mistakenly interpreted as innovative and deliberate. After all, “(a)ll organizational change is not innovation” (Singh, 2011). Second, researchers should apply a method that allows them to compare EMF and DMF patterns of organizational innovation. Only this way, meaningful differences between EMFs and DMFs may

Acquiring Firm-Specific Advantages at Indian MNCs

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be established. Third, researchers should aim to measure and understand the full scope, instead of merely individual aspects of organizational innovation. In this paper, we build on the work by Pettigrew and Fenton (2000), Pettigrew et al. (2003), Ruigrok et al. (1999), and Whittington et al. (1999) who understood organizational innovation in terms of structure, process, and system variables. In the second half of the 1990s, the above authors were part of the INNFORM (Innovative Forms of Organizing) research group that developed a survey instrument in order to elicit detailed information on patterns and trends in Western-European, North American, and Japanese firms’ structural, process-related and system-related organizations. The authors found, first, that over 1992
1996, new organizational arrangements had supplemented rather than supplanted the multidivisional organizational form across Western Europe (Ruigrok et al., 1999). Second, building on the notion of complementarities (Milgrom & Roberts, 1995) they identified ‘complementary linkages’ (of restructuring) amongst high and low performers, suggesting that successful organizational innovations clustered around nine variables, grouped in three categories (internal structures, internal processes, and external boundaries (Whittington et al., 1999). Using this established instrument in the Indian context, the three above tests may be met. First, work using the instrument has been widely used and published; second, the results allow us to compare patterns and trends with those found in the earlier survey; and third, we will be able to identify to what extent Indian firms rather emphasize organizational innovation in terms of changing organizational structures, processes, or systems. In doing so, we will be able to address the question to what extent EMFs effectively internationalize in order to overcome domestic institutional restraints (Mathews, 2006). Earlier research in this tradition found that US firms rather tend to innovate their organizations by focusing on structural features, utilizing higher institutional degrees of freedom, while German and Japanese firms rather focused on process-oriented variables, for example, because they were more restrained to change structural variables (Lewin, Massini, Ruigrok, & Numagami, 2003).

SURVEY In order to examine patterns and trends in organizational innovation in Indian firms, we chose to use a survey instrument. Surveys are useful to describe and analyze a large population, even more so if very little is known

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about this population. A survey also allowed us to capture management perceptions on the extent of transformation in their organizations. We build on the survey methodology developed by Pettigrew and Fenton (2000) in their multi-country, multi-researcher INNFORM research project. Researchers based in France (ESSEC), Japan (Hitotsubashi), Netherlands (Erasmus), Spain (IESE), Sweden (Jo¨nko¨pping), Switzerland (St.Gallen), UK (Warwick), and USA (Duke) were involved in this project. The INNFORM survey instrument (available in Pettigrew et al., 2003) has been described by Pettigrew and Fenton (2000, p. 37) as follows: “The survey instrument measured three sets of aggregated variables: changing structures, changing processes and changing boundaries. Changing structures measured delayering, the existence of project-based structures and operational and strategic decentralization. Changing processes measured horizontal interactions, IT infrastructure and strategies, and new human resource practices. Changing boundaries measured outsourcing, alliances and diversification trends.” We modified the INNFORM survey instrument in some important ways. First, some items had not stood the test of time. Thus, we excluded items that dealt with, for example, the rise of electronic data interchange and email, as well as items such as delayering which were heavily influenced by the 1990s discussion of deconstructing conglomerates. We also removed questions on a holding versus a multidivisional structure since we were unsure respondents would understand such differences in the same way as in developed market economies. Second, we added new questions on firms’ internationalization strategies. Thus, we included items on market-entry strategies, the extent of learning and innovation at subsidiaries, international rotation of managers, and brand recognition in international markets. Third, partly based on interviews with Indian executives, we adapted the survey to an EMF context. We conducted interviews with two-three top managers associated with the internationalization efforts at Infosys Ltd. (a leading Indian IT EMC), ICICI Bank (India’s leading private sector bank with growing international operations), and Suzlon (world’s fourth largest wind power company). Based on their inputs we cut down the size of the survey, since it was felt that Indian respondents would not be open to completing a survey that took a very long time, or that included detailed financial questions. Thus, we excluded detailed questions on, for example, operating and financial performance. We administered the survey as follows. First, in order to be able to study the interplay of firm internationalization and organizational innovation, we selected the largest 1,000 Indian firms by foreign income (including exports

Acquiring Firm-Specific Advantages at Indian MNCs

13

and/or as sales of foreign affiliates, and other miscellaneous items such as royalties, dividend and interest incomes received in foreign currencies) for the financial year 2006
2007 (the latest results available at the time of administration of the survey). The company list was derived from the CMIE Prowess database
a corporate database containing detailed information on over 10,000 Indian firms, which has been earlier used by, for example, Khanna and Palepu (2000). Second, we sent out the sample only to listed public and private sector Indian firms, as listed companies are more used to disclosing information, which is a challenge researchers particularly face in the Indian context. Third, like with the INNFORM survey, we asked respondents to compare their current (i.e., 2008) position with that of five years previously, using a five-point Likert scale. The time frame of five years was chosen to ensure a sufficiently long period to capture organizational innovation, while at the same time ensuring a reliable respondent recall (cf. Pettigrew & Massini, 2003). Fourth, we asked respondents to rate an abridged list of the conceptualized variables on their importance in facilitating internationalization success. Again this was done using a five-point Likert scale and served to have a first-hand validation of the relevance of the conceptualized variables in reference to Indian firms. Fifth, in view of the fact that Indian firms have little experience in responding to surveys from non-government sources, we did not ask companies to provide financial or other potentially confidential information, or to provide information that would be time-consuming to collect. Sixth, in order to increase the response rate we required only one response from each company. In an EMF context, respondents are less used to completing research surveys. Requesting more than one response per company may foster unnecessary suspicion with respondents (“why don’t they believe me,” “what are they after”) or could induce coordination among respondents before sending off the survey. The questionnaire was finalized in March 2008 and mailed by regular post to the chairmen/managing directors of the list of 1
500 top companies ranked by the level of foreign income. A follow-up mailing was done to non-respondents about 3 months later. Subsequently, a second mailing was sent out to companies ranked 501
1000. We did not send a follow-up mailing to this group of 501
1,000 for two reasons. First, we obtained a significantly lower number of responses from these smaller companies in response to the first mailing (only 21 out of the total 76 usable responses came from this group of 501
1,000 companies). Second, the follow-up mailing to the first 1
500 top companies had not yielded a large number of additional responses. The addressees were requested either to complete the

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questionnaire personally, or request an appropriate member of their staff with a strategic overview of their international operations to do so. This request was made to ensure as far as possible that the respondents would have an overview of what their company looked like at the current time and also five years earlier. Companies below the top-1,000 were ignored because they had foreign earnings close to or less than USD 2 million, which would make their international operations relatively insignificant in absolute terms. In all, we obtained 79 responses, out of which 3 responses were unusable (for details see Table 1). While an overall response rate of 7.6 percent is admittedly low, this may still be considered satisfactory, given (a) the lack of experience at Indian firms in responding to surveys implemented by a university, as this was not an official (e.g., government-run) survey, (b) the relatively large size and detailed nature of the questionnaire, and (c) the fact that the questionnaire was supposed to be filled in by the topmost members of the companies’ management teams. The usual tests for randomness of response were carried out for the sample, which suggested a slight bias in favor of the larger and more internationalized respondents. However, in view of (a) the sample selection of Indian firms ranked by international sales, (b) the objective to study the interplay of internationalization and organizational innovation, and (c) the fact that this is the first time a largescale study has been undertaken of organizational innovation in India, we believe this bias does not undermine the purpose of this exploratory study.

KEY ORGANIZATIONAL FEATURES STUDIED An exploratory review of the literature on organizational excellence led to the identification of five organizational design categories or areas that find consistent mention as important in the firm internationalization context. Table 1.

Descriptive Statistics of Sample of Companies (for the Year 2008 in Rs. 10 million).

Variable Total sales Foreign sales FSTS %

Obs

Mean

SD

Min

Max

76 76 76

4476.19 1403.82 37.71

16379.87 6859.55 26.51

25.91 10.39 2.74

119465.30 58532.42 96.32

Note: FSTS = Foreign Sales to Total Sales.

Acquiring Firm-Specific Advantages at Indian MNCs

15

These are organizational structure, processes, HR policies, leadership, and culture (Bartlett & Ghoshal, 1989; Doz & Prahalad, 1984; Gibson, Ivancevich, & Donnelly, 1979; Pettigrew & Fenton, 2000). These five broad categories are briefly described next. Each category was further conceptualized into its measurable variables, which we present in the Results section of this paper in Table 2. 1. Structure Thompson (1967) defines organizational structure as “an organization’s internal pattern of relationships, authority, and communication.” In the literature on organizational structure, characteristics such as centralization, formalization, flexibility, and the emergence of cross-unit and cross-functional teams have been identified as important foci of research in the firm internationalization context (Fredrickson, 1986; Malnight, 2001; Martinez & Jarillo, 1989; Pettigrew & Fenton, 2000). This typology forms the basis of our conceptualization of structure variables for the purposes of this study. 2. Processes Organizational processes have been defined by Lawler (1996, p. 49) as “the systems that the organization puts in place to help control, manage, inform, and direct its members’ behavior, both individually and collectively, so that they focus on the correct strategic actions.” In the context of internationalizing companies, Bartlett and Ghoshal (1992a, chapter 8) and Ghoshal et al. (2000) argued that in order to effectively tackle the demands of internationalization, companies need to develop the use of three types of processes (in addition to mastering their operational and strategic processes): entrepreneurial processes, integrative processes, and renewal processes. This general process-typology is adapted in this study to examine organizational processes in the context of firm internationalization in this study. 3. HR Policies Human resource (HR) policies refer to the recruitment, development, and deployment of human capital (Hatch & Dyer, 2004). In the internationalization context, this includes choosing people with the right skills for international management, training them through education and international assignments, deploying them effectively throughout the organization, appraising them correctly, and finally establishing a satisfactory career path for them (following Bartlett & Ghoshal, 1992b; Black, Gregersen, & Mendenhall, 1992; Gomez-Mejia, 1988). The above forms the basis for our HR variables conceptualization.

Organizational Innovation

Structure Decision-making decentralization to international operations and subsidiaries Formalization of best practices and operating procedures Professionalization of workforce Use of cross-functional/divisional/ geographical teams and collaboration

Usefulness in Internationalization

Prior Studies

Change %

2.75

3.76

50.83a

3.02

3.92

43.37a

3.04

3.84

38.26a

2.59

3.53

54.27a

2.85

3.76

46.68

Bartlett and Ghoshal (2000), Pande, Neuman, and Cavanagh (2000) Douglas and Judge (2001), Powell (1995), Zaheer (1995)

3.01

3.88

39.18a

3.40

4.30

36.66a

Bartlett and Ghoshal (1992a), Kanter (1985)

2.90

3.90

48.76a

Birkinshaw (1997), Ireland, Hitt, Camp, and Sexton (2001), Kanter (1985) Helps ensure consistent and higher Fredrickson (1986) quality output Useful in countering bureaucratic Fredrickson (1986), Hall (1972) effects of high formalization Effective coordination tool as Galbraith (2002), Ghoshal and organizations become more Bartlett (1990) complex

Innovation and learning at international operations and subsidiaries

Increases international competitiveness and helps in overcoming “liability of origin” Enables transfer, adaptation and improvement of knowledge

PRASAD OSWAL ET AL.

Year 2008 1
5

Facilitates speed and the ability to respond to localized needs

Helpful in reducing costs and increasing quality

Average Ratings for Variables (1
5) Scale 5 years back 1
5

Average Process Technological and operational competence vis-a`-vis international competition “World-class” quality of products and services

16

Table 2. Patterns and Trends in Organizational Innovations at Indian Firms.

Recognition of brand in international markets Level of employee entrepreneurship Use of IT systems for worldwide information-sharing Managerial rotation through international operations Ability to quickly renew and readapt existing routines and practices

Useful when entering markets where one’s products are relatively unknown Creating awareness and loyalty for products and overcoming “liability of origin” Helpful in seizing international opportunities Facilitates free information flow and creation of flatter and more responsive organizations Tool for socializing, spreading tacit knowledge, and fostering the communication system Useful in dealing with environmental changes and complexities

Kotler and Keller (2003), Slater and Narver (1999)

2.83

3.70

38.81a

Schultz and Schultz (2001), BusinessWeek (2005a, 2005b)

2.65

3.5

44.8a

Covin and Slevin (1989), Oviatt and McDougall (1999) Galbraith, Lawler, and Associates (1993), Lawler (1993)

2.75

3.50

38.69a

2.60

3.65

60.50a

Edstro¨m and Galbraith (1977), Martinez and Jarillo (1989)

2.30

2.86

28.73a

Nonaka (1990), O’Reilly, Harreld, and Tushman (2008), Teece et al. (1997)

2.90

3.85

47.70a

2.81

3.68

42.64

Carpenter, Sanders, and Gregersen (2001), Roth (1995), Sambharya (1996) Katz and Seifer (1996)

2.75

3.35

34.01a

3.30

3.98

36.18a

Black et al. (1992), Briscoe and Schuler (2004)

3.48

4.04

26.85a

Average HR Extent to which international Prior international experience experience is considered a facilitates performance in selection criterion international assignments Extent to which personality factors Factors such as open mind, selfare considered as selection confidence and cross-cultural abilities facilitate success in criterion international assignments Extent to which necessary job Job proficiency helps mitigate the qualifications are considered a challenges of the international selection criterion environment

Acquiring Firm-Specific Advantages at Indian MNCs

Foreign market-entry and marketdevelopment skills

17

Organizational Innovation

Extent to which desire for foreign assignment is considered a selection criterion Extent employees are given training in international management skills Tailor-made employee appraisal and reward systems for international assignments Strong international career planning process

Usefulness in Internationalization

Prior Studies

5 years back 1
5

Year 2008 1
5

Change %

Black et al. (1992), Briscoe and Schuler (2004)

3.07

3.55

27.84a

Briscoe and Schuler (2004), Gomez-Mejia (1988)

2.44

3.15

40.11a

Briscoe and Schuler (2004), Gomez-Mejia (1988)

2.31

2.93

38.24a

Black et al. (1992), Bolino (2007)

2.42

3.02

35.23a

2.82

3.43

34.06

3.62

4.29

30.29a

Average Leadership Role of leadership in providing vision and stretch goals

Compelling and salient visions enhance commitment to strategic direction; stretch goals foster success

Average Ratings for Variables (1
5) Scale

Hamel and Prahalad (1989, 1993), Oswald, Mossholder, and Harris (1994)

PRASAD OSWAL ET AL.

Motivation of self and family helps overcome challenges of operating in international locations Can be an alternative to hiring people from outside the organization Appraisal systems should be sensitive to local issues; reward systems should have incentive/ equalization components Employees should not feel penalized for taking on international assignments and should be properly reintegrated upon return

18

Table 2. (Continued )

Aids multinational decisionmaking

3.21

3.90

35.76a

3.41

4.09

33.02

Barling and Beattie (1983), Gist and Mitchell (1992), Taylor, Locke, Lee, and Gist (1984) Johnson, Lenartowicz, and Apud (2006), Levy, Beechler, Taylor, and Boyacigiller (2007) Martinez and Jarillo (1991), Pfeffer (1982)

3.12

4.05

44.88a

2.74

3.56

40.87a

2.83

3.58

40.47a

Great Place to Work Institute, Kerr and Slocum (1987)

2.70

3.38

36.42a

2.84

3.64

40.66

Daily et al. (2000), Gregersen et al. (1998), Maruca (1994)

Average Culture Employees’ confidence in being able to successfully compete with the best in the world Employees’ level of cross-cultural competence Unifying and binding effect of culture Company as a sought-after workplace for international employees

Employees’ confidence/self-efficacy associated with work-related performance Offers the ability to transcend barriers in communicating and dealing with people Helps communicate the way of doing things, decision-making styles, and values and objectives Great workplaces receive more qualified job applications and increase retention rates

Average a

Acquiring Firm-Specific Advantages at Indian MNCs

Extent to which leadership brings international experience to the company

Difference in variable ranks between the two time periods significant at the 0.01% level in t-test analysis.

19

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PRASAD OSWAL ET AL.

4. Leadership Etzioni (1965, pp. 690
691) describes leadership as involving “the ability, based on the personal qualities of the leader, to elicit the followers’ voluntary compliance in a broad range of matters.” The leadership function of an organization is suggested to play an important role in organizational performance (Hambrick & Mason, 1984). Key leadership areas relevant to the firm internationalization context include leadership vision and (stretch) goal setting (Collins & Porras, 1994; Hamel & Prahalad, 1989, 1993) as well as international experience of the top management team (Daily, Certo, & Dalton, 2000; Gregersen, Morrison, & Black, 1998; Maruca, 1994). 5. Culture Organizational culture has been defined by Schein (1985) as “a pattern of basic assumptions
invented, discovered, or developed by a given group as it learns to cope with its problems of external adaptation and internal integration
that has worked well enough to be considered valid and, therefore, to be taught to new members as the correct way to perceive, think and feel in relation to these problems.” Organizational culture has been suggested to be a rent-yielding strategic resource with the potential to generate sustainable competitive advantage (Lado & Wilson, 1994). Important culture attributes in the firm internationalization context include the self-confidence of employees in their international competitive ability, the cross-cultural competence of employees, the attractiveness of the workplace and its culture, and the ability of organizational culture to bind the organization. These attributes are conceptualized in Table 1.

RESULTS Table 1 summarizes our sample. The sample covers a very broad scope of firms and includes some of India’s largest and best-known firms. The sample displays a wide variety of foreign sales percentages. In 2008, the most internationalized firm reported 96 percent of its sales abroad, while the least internationalized firm in our sample only generated less than 3 percent of its sales abroad. Table 2 summarizes our organizational innovation variables. For space economy reasons, this table also includes the relevant results of our survey. The last three columns report the values of these variables five years earlier,

21

Acquiring Firm-Specific Advantages at Indian MNCs

in the year 2008, plus the change (increase/decrease) in these variables over the five years. The results of our survey indicate that the surveyed firms report to have implemented significant organizational innovations in the five years preceding 2008. Two sided t-test analysis suggests that the difference in variable ranks between the two time periods was significant at the 0.01% level in the case of all the variables. Below, we examine our highlights. Fig. 1 summarizes the five areas where Indian firms reported the highest levels of implemented organizational innovations. Respondents rated their companies highly in terms of the “world class” quality of their products and services for the year 2008, and also gave high ratings to the quality of leadership in providing vision and stretch goals (4.29/5). Finally, our results indicate that employees at Indian companies have developed a high level of self-confidence in their competitive ability (4.05/5). Fig. 2 presents the organizational variables showning the highest percentage change over the five-year period preceding 2008. The significantly large increase in the use of information technology to integrate international activities is not surprising, given India’s well-known strength in this field. Fig. 2 also suggests that Indian firms have become significantly flatter and decentralized, and are also focusing on innovation and learning, and organizational adaptability. Meanwhile, at the level of the main organizational categories, the highest overall organizational transformation was seen in organizational structure followed by processes and culture. This was calculated by averaging

Extent to which personality factors are considered as selection criterion

3.98

Extent to which necessary job qualifications are considered a selection criterion

4.04

Employees’ confidence in being able to successfully compete with the best in the world

4.05

Role of leadership in providing vision and stretchgoals

4.29

“World-class” quality of products and services 3.8

Fig. 1.

4.3 3.9

4

4.1

4.2

4.3

4.4

Organizational Innovations where Indian Firms Report Highest Scores in 2008.

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PRASAD OSWAL ET AL.

Ability to quickly renew and readapt existing routines and practices

47.7%

Innovation and learning at international operations and subsidiaries

48.76%

Decision-making decentralization to international subsidiaries and operations

50.83%

Use of cross-functional / divisional / geographical teams and collaboration

54.27%

Use of information technology systems to integrate international activities and share information worldwide

60.5% 0

Fig. 2.

10

20

30

40

50

60

70

Organizational Innovations where Indian Firms Report the Highest Percentage Change.

the ratings for each of the conceptualized variables that constituted the respective category (see Table 2). Finally, we asked respondents to rate the organizational variables conceptualized in this study on their importance in facilitating internationalization success, based on respondents’ experiences within their organization. Results show that every variable was rated a mean score above the value of 3/5 suggesting that all the variables conceptualized in this study were considered important by respondents in facilitating internationalization success. Fig. 3 presents the five organizational variables that received the highest ratings. Each of these variables received a rating between important and very important (higher than 4/5). Three organizational process variables including achieving world-class quality, technological and operational competence and organizational ability to renew and readapt were ranked amongst the top 5. The other two top-ranked variables belong to the leadership category, again underlining the importance of the top management team in achieving international success. The survey had one open question, which asked respondents if there were any other organizational factors they thought were important in the firm internationalization context. Twenty-three respondents filled in this part. The range of answers was very wide and difficult to cluster. Some of the organizational factors mentioned as important include: “increase in social responsibility levels and bringing down the carbon footprint”, “general grace in conducting business”, “building customer relationships”, “understanding the local legal framework”, “high quality infrastructure for

23

Acquiring Firm-Specific Advantages at Indian MNCs

Organizational ability to renew itself in response to changing international circumstances

4.16

International experience of top management team and board of directors

4.16

Vision and stretch-goals provided by top leadership to drive international operations

4.37

Technological and operational competence vis-àvis international competition

4.37

World class product and service quality

4.53 3.9

Fig. 3.

4

4.1

4.2

4.3

4.4

4.5

4.6

Organizational Innovations Rated Highest by Respondents on Their Importance in Facilitating Internationalization Success.

employees,” “salary levels for employees should be much higher than they currently are in India,” “quick market analysis and response,” and “sense of pride in being from ‘the emerging global India’.”

DISCUSSION The purpose of this study has been to map patterns and trends in Indian firms’ organizational innovation. Our main result is that Indian firms that have substantial international activities over 2003
2008 reported to have implemented major organizational innovations. Our survey included 26 variables measuring individual aspects of organizational innovation. Respondents reported significant changes along all 26 variables, which suggests that over 2003
2008, Indian firms have implemented organizational innovations across the board, that is in terms of structures, processes, HR policies, leadership, and culture. This paper contributes to a research stream that seeks to understand the rise of EMFs’ nascent FSA (Rugman, 1981) and that examines how EMFs acquire FSA in the internationalization process (e.g., Lee & Rugman, 2012). EMFs have typically faced the challenge to develop adequate structures, processes, and systems over a short period of time allowing them to operate sizeable operations on a worldwide scale (Luo & Tung, 2007). Meanwhile, there is a growing literature on how EMFs are strengthening

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PRASAD OSWAL ET AL.

FSA by transforming and innovating their organizations (e.g., Ahmad & Chopra, 2004; Chittoor et al., 2009). A common denominator of these studies appears to be that internationally operating EMFs (i.e., EMNCs) are leading this process (cf. Bonaglia et al., 2007; Liou, Rose, & Ellstrand, 2012). Since we sent our survey specifically to Indian firms with substantial foreign income, this may explain why we obtained significant changes across all variables in our study. Numerous questions remain regarding the ways in which EMFs build FSA. It seems plausible enough that EMFs, and in particular EMNCs, will initially transform their organizations across the board in view of their nascent development stage. However, in view of the growing division of labor and global specialization in the world economy (UNCTAD, 2011), EMFs and EMNCs may eventually progress toward developing FSA that are distinct from those of DMFs and that are difficult to imitate. Future research should seek to identify FSA differences between DMFs and EMFs, as well as amongst EMFs, for instance based on EMNC internationalization trajectories. This could be done by conducting cross-country studies or, more realistically, by adopting established instruments such as the INNFORM instrument employed in this study. Turning to the Indian context, we find that Indian firms appear especially confident in terms of leadership development. This is remarkable as leadership capabilities have not been prominently discussed in the EMF literature, and have not been associated primarily with Indian firms. However, in her popular business book Business Maharajas, Piramal (1996) already pointed to the important role played by leadership at top Indian companies in the success of their companies in the pre- and postliberalization eras. Capelli, Singh, Singh, and Useem (2010) identified as one of the success factors of Indian companies that Indian employers and top managers display a high level of reciprocity vis-a`-vis their workforce, supporting their employees both at work and outside the workplace, thus implicitly motivating them to work in line with the firm’s interests in return. These authors also found that while U.S. executives have tended to become “increasingly attentive to external demands
regulatory concerns, the board, and shareholders,” Indian executives on the contrary have tended to become more involved with setting strategy and have an “intense focus on culture and human capital” (Capelli et al., 2010). The fact that Indian executives reported significant changes along all 26 organizational variables supports this notion. We found no explicit evidence that Indian firms felt a competitive disadvantage as a result of their domestic institutional environment (cf. Mathews, 2006; Yamakawa, Peng, & Deeds, 2008). First, Indian firms

Acquiring Firm-Specific Advantages at Indian MNCs

25

reported the highest change levels in innovating organizational structures. This suggests that Indian firms have considerable degrees of freedom to adapt their organizations. Earlier research on the effects of domestic institutional contexts suggested that inflexible domestic institutional (e.g., legal or political) barriers to organizational restructuring had led German and Japanese firms to focus on redesigning processes (Lewin et al., 2003). Second, our respondents rated the “world class quality of products and services” highly. This is remarkable as Indian companies have not been traditionally associated with high-quality products and services (McKinsey & Company, 2001). Respondents may have been overly confident, yet this finding does suggest that Indian firms no longer consider their “made in India” label a major liability, and effectively are of the opinion that they are making progress in overcoming the “liability of Indianness”. This paper raises several methodological issues. Since we sent the survey to Indian firms with international operations, it seems plausible enough that respondents reported significant changes along all 26 variables. However, the question should still be raised how likely it is that Indian firms actually implemented organizational innovations across all these dimensions. The survey instrument has been designed to measure change which may have led our respondents to understate the situation five years prior to the survey, or overstate the situation in 2008, thus creating the impression of “positive” or “desirable” change. DMF respondents to the INNFORM survey on which our instrument was based on the reported changes in both directions (Pettigrew & Fenton, 2000). More research will be needed to establish if and when EMF top executives tend to report to scholarly surveys by responding “as it is” rather than what they want researchers (or themselves) to believe. Due to the limited sample size we are unable to make any inferences on the causality of the relationship between organizational innovation and internationalization, that is, we are unable to establish if organizational innovations have driven internationalization or vice versa, or certain internationalization trajectories and market-entry modes tend to be associated with specific organizational transformations. A more elaborate data set may help to establish such correlations and causalities.

IMPLICATIONS AND LIMITATIONS This study has implications for DMF and EMF managers alike. Our survey suggests that Indian firms with international activities, that earlier were

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PRASAD OSWAL ET AL.

often associated with poor organizational features, are rapidly transforming their organizations. Indian executives are increasingly confident that they will be able to compete successfully on an international scale. If their assessments were to be correct, it will put greater pressure on DMFs and EMFs from other countries to face up to successful Indian competitors as the latter complement some of their low-cost advantages with organizational innovation. Given that our study is unique in attempting a full-scope analysis of variables that may be considered important in the internationalization context, instead of looking at just individual aspects, it could also serve as a potentially comprehensive guide to EMF managers looking at organizational innovation in the internationalization context. Non-riskaverse young managers, both from emerging and developed markets, joining the ranks of an EMF, and especially of an EMNC, are likely to experience an interesting and dynamic work environment and an opportunity to witness a key global business transformation. There are a number of limitations for this study. First, the size of the sample was relatively small, 76. Future work should attempt to obtain larger samples which will give higher confidence in the results, and which will allow for more detailed econometric analyses. At the same time, obtaining survey response rates of 15 percent or higher when asking such delicate and detailed organizational questions will be a challenge in many emerging markets. Second, the ratings on the organizational variables in this study are based on self-reporting, which can bring its own bias. In our case, the question remains if some respondents may have displayed a certain degree of hubris in answering the survey. Third, we had a sample bias in the sense that the companies that responded to the survey were significantly more international than the sample of surveyed companies, and significantly larger than the entire universe of Indian firms. Thus, the findings of our exploratory study have a higher relevance for more internationalized Indian firms and are not generalizable to all Indian firms or other EMFs.

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533. Thompson, J. D. (1967). Organizations in action. New York, NY: McGraw-Hill. Times of India. (2011). India’s billionaires frustrated, want to shift base overseas. Times of India. Accessed on October 13, 2013. UNCTAD. (2011). World investment report. FDI from developing and transition economies: Implications for development. Geneva: United Nations. Vissa, B., Greve, H. R., & Chen, W. (2010). Business group affiliation and firm search behavior in India: Responsiveness and focus of attention. Organization Science, 21(3), 696
712. Wernerfelt, B., & Hansen, G. (1989). Determinants of firm performance: The relative importance of economic and organizational factors. Strategic Management Journal, 10(5), 399
411. Whittington, R., Pettigrew, A., Peck, S., Fenton, E., & Conyon, M. (1999). Change and complementarities in the new competitive landscape: A European panel study, 1992
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600. World Bank. Country Report on India. Retrieved from http://data.worldbank.org/country/ india. Accessed on October 14, 2013. World Trade Organization. (2012). Trade profile India. Retrieved from http://stat.wto.org/ CountryProfile/WSDBCountryPFView.aspx?Language=E&Country=IN. Accessed on February 12, 2012. Yamakawa, Y., Peng, M. W., & Deeds, D. L. (2008). What drives new ventures to internationalize from emerging to developed economies? Entrepreneurship Theory and Practice, 32(1), 59
82. Zaheer, S. (1995). Overcoming the liability of foreignness. Academy of Management Journal, 38(2), 341
363.

DEGREE OF INTERNATIONALIZATION AND ECONOMIC PERFORMANCE OF SMES IN BANGALORE: INFLUENTIAL FACTORS AND OUTCOMES M. H. Bala Subrahmanya ABSTRACT Purpose
This paper probes the factors which influence (i) the degree of internationalization and (ii) the subsequent economic performance, achieved by SMEs in India. These two objectives have been examined in the context of firm level push/pull factors, barriers/challenges, firm resources, and strategy. Design/methodology/approach
This study is based on empirical data gathered through a semi-structured questionnaire from 84 exporting SMEs in the (most internationalized) engineering industry of Bangalore in India during January 2012 to February 2013. The two key research questions have been analyzed using stepwise multiple regression models.

Emerging Market Firms in the Global Economy International Finance Review, Volume 15, 35
71 Copyright r 2014 by Emerald Group Publishing Limited All rights of reproduction in any form reserved ISSN: 1569-3767/doi:10.1108/S1569-376720140000015003

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The degree of internationalization is defined as the percentage of foreign sales in total sales turn over, as of 2010/2011, and economic performance is represented by (i) the value of sales turnover as of 2010/2011, and (ii) growth of sales turnover from inception till 2010/2011, alternatively. Firm level variables (age of firms, firm size, nature of firm organization), entrepreneurial characteristics (age of the founder and education), time taken to enter the export market for the first time, mode of entry, degree of initial internationalization, years of experience in the international market, whether operated in the international market continuously or not, number of markets currently exported, and number of learnings made are used as the possible explanatory factors for the first objective. In addition, current degree of internationalization is used as the possible explanatory factor for the current level of economic performance whereas initial degree of internationalization for the growth of sales turnover. Findings
It is firm age, size and experience, and education of the CEO which influenced the degree of internationalization of SMEs. In addition, continuous operation in the international market after an early entry, leading to more learnings positively influenced the degree of internationalization. Further, those who adopted the MNC route as the mode of entry achieved a higher degree. However, what is more significant is the degree of initial internationalization achieved by the SMEs which had strongly influenced its current degree of internationalization. All these bring out that (i) firm level resources & competence and (ii) firm level strategy, together significantly contributed to the degree of internationalization achieved by the SMEs in an emerging economy like India. However, the degree of internationalization had a negative influence on the current sales turnover achieved. Whereas those SMEs, older in age, organized as private limited companies and led by more qualified CEOs, which catered to more number of countries could achieve a higher sales turnover. But degree of internationalization did not have any influence on firm growth. Only younger and smaller firms grew faster than older and larger firms, irrespective of the degree of internationalization. Research implications
The above results bring out that to achieve a larger firm size, entering the international market need not be the only route, in the current era of globalization. It is possible to achieve a higher economic performance even with a domestic market focus, especially when the domestic market is registering a higher growth compared to the international market.

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Originality
The degree of internationalization and its impact on the economic performance of SMEs have been hardly probed adequately based on empirical data in the context of emerging economies. This study fills this void. It reveals that in the era of globalization where domestic firms might have to face competition though not as much as those which operate in the international market, a larger firm size can be achieved with larger focus on the domestic market and with limited focus on the international market. Keywords: SMEs; internationalization; economic performance; influential factors; Bangalore; India

INTRODUCTION Geographical expansion, particularly growth by international diversification, is one of the most important growth paths for firms, irrespective of firm size (Lu & Beamish, 2001). In recent decades, within the broad internationalization trend a significant development has been an increasingly active role played by Small and Medium Enterprises (hereafter SMEs) in international markets (Oviatt & McDougall, 1994, 1999). More and more SMEs across the global economy are increasingly resorting to internationalizing their activities (Andersson & Floren, 2011; Schweizer, 2012). This is primarily attributed to (i) declines in government imposed barriers and (ii) continued advances in technology (Lu & Beamish, 2001). With increasing global competition, falling barriers to international trade, and improved international ICT networks, internationally active SMEs are emerging in notably large numbers across the world and it is likely to gain further momentum in the future (Knight, 2001; Lu & Beamish, 2001; Ruzzier, Hisrich, & Antoncic, 2006; Wright & Etemad, 2001). An export strategy has been the primary foreign-market entry mode adopted by SMEs in their internationalization efforts (Wolff & Pett, 2000). This is because exporting fits the capabilities of SMEs by offering them a greater degree of flexibility and minimum resource commitments combined with minimum risk exposure (Young, Hamill, Wheeler, & Davies, 1989). Exporting offers an effective means for SMEs to achieve an international position without over extending their capabilities or resources (Ohmae, 1990; Young et al., 1989). The increasing trends of SME internationalization the world over, particularly through exports have resulted in more and more empirical studies,

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leading to many theoretical developments in the last couple of decades. Of them, the prominent ones are theories relating to three major internationalization patterns covering (i) gradual approach, (ii) born globals, and (iii) born-again globals (Kalinic & Forza, 2012; Olenjnik & Swoboda, 2012). However, these theories are more concerned with the pace at which SMEs enter the international market through exports and progress, rather than with the degree of internationalization. Further they have not adequately focused on analyzing the impact of internationalization on the economic performance of such SMEs. This study is proposed to throw light on these two core research issues in the context of an emerging economy like India, which has a long standing history of protecting and promoting SMEs in the domestic market (Bala Subrahmanya, 1998). India has joined the “international trends of globalization” by gradually but consistently resorting to economic liberalization covering foreign direct investment, dismantling of trade barriers, and promoting ICT networks across the country, since 1991 (Bala Subrahmanya, 2005). Therefore, it would be appropriate to examine what factors determine the degree of internationalization and whether the degree of internationalization has any influence on the economic performance of SMEs in India. Accordingly, an attempt has been made to answer these two research questions based on primary data covering 84 exporting SMEs of the engineering industry in the context of Bangalore city.

SMES AND INTERNATIONALIZATION: DEFINITION OF CONCEPTS SMEs play an important role in the world economy and contribute substantially to income, output, and employment. In every region, SMEs are in evidence (Edinburgh Group, 2014). But SMEs are defined and identified differently in different economies, using different yardsticks such as employment, investment, or sales turnover or a combination of these variables (Edinburgh Group, 2014). Irrespective of the criterion adopted for their definition, more than 95% of the enterprises across the world are SMEs, accounting for approximately 60% of the private sector employment (Ayyagiri, Demirguo-Kunt, & Maksimovic, 2011). In India, SMEs have been defined currently by the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006 (Ministry of MSMEs, 2014). According to this Act, all manufacturing enterprises

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having investment in plant and machinery (P&M) up to Rs. 2.5 million are considered micro enterprises, those with investment in P&M above Rs. 2.5 million and up to Rs. 50 million are considered small scale enterprises and those with investment in P&M above Rs. 50 million and up to Rs. 100 million are considered medium scale enterprises. We have adopted this definition of SMEs in this study. The SME sector (comprising micro, small, and medium enterprises together) currently contributes nearly 8% of the GDP, 45% of the manufacturing output, and 40% of the total exports in India (Ministry of MSMEs, 2014). Considering the importance of SMEs in India, their internationalization process and achievements covering their economic performance merit an empirical research analysis. Internationalization broadly refers to the expansion of an enterprise’s products or activities into overseas markets. Accordingly, Welch and Luostarinen (1988) defined internationalization as “… the process of increasing involvement in international operations ….” Internationalization is a synonym for the geographical expansion of economic activities over a national country’s border (Ruzzier et al., 2006). Internationalization is also defined as the process of adapting a firm’s operations (strategy, structure, resource, etc.) to international operations (Kuivalainen, Saarenketo, & Puumalainen, 2012). Two of the most important avenues of internationalization are exporting and FDI (Lu & Beamish, 2001). But the most frequently cited modes of internationalization by SMEs relate to direct exporting whereas joint ventures and partnerships are rarely cited, particularly in traditional manufacturing activities (Westhead, Wright, & Ucbasaran, 2002; Wright, Westhead, & Ucbasaran, 2007). SMEs in fact begin their international involvement by trade related activities, and export activity is most often recognized as being the first step in the internationalization process (Jones, 2001; Wright & Etemad, 2001). Accordingly, we define internationalization of SMEs as their “international expansion through exports.” Therefore, this study is confined to SMEs which have entered the international market through exports.

DEGREE OF INTERNATIONALIZATION AND ECONOMIC PERFORMANCE OF SMES: A REVIEW OF LITERATURE AND A CONCEPTUAL MODEL The declining barriers for internationalization in the era of globalization characterized by advancement in technology development within

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communications and transportation, together with fewer constraints in international trade have been encouraging firms, irrespective of size, to enter the international market more intensively than ever before. These developments have particularly made it easier for SMEs to do business internationally (Andersson & Floren, 2011). This can prompt many SMEs across the world to enter the international market through exports, because such internationalization can bestow several benefits on them: (i) access to know-how or technology, (ii) access to capital, (iii) access to network/ social ties and supply chain links, (iv) access to knowledge, (v) growth opportunities, as they can exploit a similar market niche in different countries, (vi) exploit the economies of scale, and (vii) enhance competitiveness (Edinburgh Group, 2014; European Commission, 2003; Pangarkar, 2008). In addition to the above, un-anticipated and un-solicited enquiries from foreign customers or a major domestic market-based MNC customer might place orders for its foreign affiliates and thereby lead SMEs to foreign markets (Child & Rodrigues, 2007; European Commission, 2003). But there could be internal factors as well such as over production, declining domestic sales, excess capacity and saturated domestic markets which might prompt an SME to look towards foreign markets (Forsman, Hinttu, & Kock, 2010). Though entering the international market might enable SMEs to reap diverse benefits and thereby enhance their competitiveness, they, at the same time, face a range of challenges or hurdles (on the path to internationalization) that are associated with the liabilities of foreignness (Hymer, 1976; Zaheer, 1995), and newness (Stinchcombe, 1965). The complexity of foreign markets arises from the great diversity among cultures, customers, competitors, and regulations (Hsu, Chen, & Cheng, 2013). SMEs in general have fewer tangible/intangible resources relative to large MNCs (Knight & Kim, 2009), to tackle these complexities. Therefore international expansion presents greater risks for small, resource-poor firms than for large, established multinationals (Musteen, Francis, & Dutta, 2010). Most SMEs are plagued by a general problem of inadequate expertise and skills at several levels
managerial, supervisory, and production employees (Malecki & Veldhoen, 1993). SMEs are unlikely to have business development specialists like large firms, and they will have fewer financial and managerial resources to meet the costs and demands of new market entry (Child & Rodrigues, 2007). According to Armario, Ruiz, and Armario (2008), the two major barriers to SME internationalization are a lack of information and a scarcity of resources, which generate uncertainty. This will be reflected in (i) shortage

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of working capital to finance exports, (ii) unable to locate, identify, and analyze foreign business opportunities, (iii) unable to contact potential overseas customers, and (iv) lack of managerial time, skills and knowledge required to explore foreign markets (Edinburgh Group, 2014; OECD, 2009). Evidence suggests that some SMEs find it difficult to enter foreign markets even when local support agencies and associations try to develop their competencies (Le Gales, Trigilia, Voelzkow, & Crouch, 2004). However several SMEs, including traditional manufacturing SMEs (with neither particularly advanced processes nor products) have rapidly internationalized their operations in new and unknown markets (Kalinic & Forza, 2012). It is the specific strategic focus (as against knowledge intensity, international network and international experience) of a firm which determines the success of its internationalization process. The strategic focus is reflected in persistent endeavors to form local relationships, proactive entrepreneurial orientation in a host environment, the scope of international commitment, and the development of commitment in the host country (Kalinic & Forza, 2012). The strategic focus of a firm will revolve around its decision maker and his/her characteristics such as qualification, knowledge, attitudes, and motivation (Chetty, 1999). That is why, Calof and Beamish (1995) held the view that it is the attitudes of decision makers in SMEs that propelled them into internationalization rather than environmental factors. Thus, managerial competence plays an important role in internationalization (Sapienza, Autio, George, & Zahra, 2006). If the management of SMEs has the right attitude and motivation, it will take appropriate steps to overcome its resource barriers in different ways. One way of overcoming the risks associated with lack of information and scarcity of resources is to begin its internationalization by choosing markets that exhibit less uncertainty and export only when the foreign market is favorable. Therefore, some SMEs with little international experience would rather enter markets that resemble their domestic markets (Armario et al., 2008). Some other SMEs overcome their resource limitations by forming business networks to acquire these resources and to benefit from being larger in size as a result of their networks. For example, firms that have limited foreign market knowledge and experience seek this knowledge from their suppliers and customers (Welch & Luostarinen, 1988). Here international trade shows play an important role as they facilitate SMEs to establish and enhance a network infrastructure to grow and expand internationally (Evers & Knight, 2008). Some others resort to internationalization through low resource access modes by building links with larger firms,

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and internationalize on the back of these linkages (Le Gales et al., 2004). Thus, barriers to internationalization are circumvented by SMEs by using their MNC customers as international conduits for international expansion (Acs, Morck, Shaver, & Yeung, 1997). In recent years, however, advancement in communication technologies is making internationalization a more viable and cost-effective option than just a few years ago (Knight, 2001). As a result, more and more SMEs are able to adopt, diffuse, and deploy internet-based technologies and processes that increasingly serve as the backbone of internationalization, especially among the innovative entrepreneurial firms (Etemad, Wilkinson, & Dana, 2010). Thus, it is the international market opportunities perceived/experienced by SMEs, their firm level resource position, the extent of challenges/ barriers faced by them, and the strategies adopted by SMEs to overcome these barriers to enter the international market are the decisive factors for SME internationalization. To be specific, they would together determine the speed at which it has entered a foreign market, the nature of foreign market/s entered, and the proportion of foreign sales in total sales (FSTS) achieved through internationalization. FSTS is often used as a measure of the degree of internationalization (DOI) (Contractor, Kumar, & Kundu, 2007; Pangarkar, 2008). International sales as a percentage of total sales is a viable proxy for the degree of internationalization (Jawalgi & Todd, 2011; Kumar & Singh, 2008). Jawalgi and Todd (2011) concluded that human capital and management commitment are positively related to the degree of internationalization of SMEs in India. However, empirical research is very limited to throw light on the factors which would determine the degree of internationalization achieved by SMEs, either at the first instance of internationalization or over a period of time, after its initial entry. The other important issue concerning SME internationalization is its impact on SME economic performance. Two of the most common goals attributed to international expansion are achieving firm growth and improving a firm’s profitability (McDougall & Oviatt, 1996). International expansion provides SMEs with the opportunity for growth (Hsu et al., 2013). SMEs which develop and accumulate firm-specific advantages in the domestic market transfer these advantages to foreign markets so as to achieve higher profitability during their growth stage (Zahra, Ireland, & Hitt, 2000). Additional volumes gained from the foreign markets might be particularly valuable for attaining economies of scale, especially when volume gains are constrained in the domestic market (Pangarkar, 2008). By broadening the customer bases through entering into new (foreign)

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markets, SMEs would be able to achieve a larger volume of production and growth (Lu & Beamish, 2001). As a result, firms operating in the international market tend to grow faster than firms which are operating primarily in the domestic market (Lu & Beamish, 2006). Further, SMEs with greater internationalization tend to report a higher turnover growth relative to SMEs with lesser internationalization (Edinburgh Group, 2014). All these imply that the degree of internationalization will have a positive influence on the economic performance of SMEs. However empirical studies have not arrived at unequivocal findings to support the positive relationship between degree of internationalization and economic performance. Contractor, Kundu, and Hsu (2003), and Lu and Beamish (2004) contend that the effect of international expansion on performance is not monotonic. Initial international expansion (Stage 1) has a negative effect on financial performance, further internationalization (Stage 2) produces a positive effect on performance, and excessive internationalization (Stage 3) again results in a negative slope. This results in an S-shaped curve for all three stages, on the performance versus internationalization graph (Contractor et al., 2007). But empirical studies ranging from the 1970s till the recent decade have produced diverse relationships such as linear (a positive or a negative) or curvilinear (U-shaped or Inverted U-shaped) effect, or no effect of increasing international expansion on firm performance (Chiao & Yang, 2011; Contractor et al., 2007; Pangarkar, 2008). The divergent findings could be attributed to the lack of uniformity in the key dependent variable (firm performance) and doubtful validity of the independent (DOI, FSTS) variable (Pangarkar, 2008), or to the differences in the set of independent variables used for the analysis. It could also be due to variations in firm specific advantages acquired through internationalization (Zahra et al., 2000) or the capabilities or intangible assets that firms developed during the initial stages of internationalization (Chiao & Yang, 2011; Musteen et al., 2010; Sapienza et al., 2006). The divergent relationship could be even due to variations in CEO attributes (Hsu et al., 2013). The above discussion brings out that for analyzing the relationship between the degree of internationalization and the economic performance of SMEs, it is essential to consider all the relevant variables, apart from the degree of internationalization, to reflect on the relative strengths of individual firms. These would include firm level characteristics comprising firm age, firm organization, the foreign markets they served, the duration of their international experience, the important learnings they made, and the

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CEO attributes (age, international experience and education), all of which would have together contributed to the building of firm capability/ intangible assets over time, which would represent firm specific advantages. Accordingly we have developed a conceptual framework based on the identification of the key variables and their possible inter-relationships, to propose the prospective influential factors for the degree of internationalization as well as the economic performance of SMEs. The proposed conceptual framework is given in Fig. 1. A description of the conceptual model is in order. An SME may be motivated to enter the international market due to the internal realization that it can gain an access, in the process, to technology, capital, supply chains, knowledge, or growth opportunities to achieve the economies of scale, or due to its excess production, which in turn, may be, due to its declining domestic sales, or saturated domestic market or even due to its excess idle capacity. We would like to call these factors collectively “push factors.” Alternatively, or in addition to the push factors, some SMEs may respond positively to unsolicited/unexpected enquiries from foreign markets, or some of its MNC customers located in the domestic market might lead these SMEs to their home markets, or on their own some SMEs might learn about the growing global opportunities due to the falling trade barriers as a result of the increasing trends of globalization. We would like to label these external factors together as “pull factors.” However, entering the international market may not be as easy as selling the SME products within the domestic market. The culture, language and the rules and regulations are most likely to be different in a foreign country and SMEs may not have adequate familiarity with any of these. Even a lack of tangible/intangible resources would hamper the international market entry ambition of an SME. Added to these, many SMEs may not have adequate information about the market demand. All these would together constitute entry
challenges or barriers. Given the challenges/barriers, motivated SMEs due to either push factors or pull factors or a combination of both, would adopt an appropriate strategy to overcome or reduce the challenges/barriers. This could be by hiring a CEO who has got foreign market/s exposure, higher education and knowledge, and experience. Some others might choose to export only when it is convenient and export to a foreign market which is largely similar to the domestic market of the SME. Still some others might take more time to study a foreign market for subsequent entry. The mode of entry chosen by a SME will also form part of its strategy to overcome the barriers faced by it. Some might rely on joining/forming a network for direct exports

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Internationalization and Economic Performance of SMEs

Pull Factors (External)

Challenges or Barriers

1. Enquiries from abroad 2. MNC customers’ demand 3. Knowledge about growing global opportunities

1. Unfamiliar culture, language, and regulations 2. Fewer tangible/intangible resources 3. Lack of information

Degree of Internationalization (DOI) as measured by Foreign sales as a percentage of Sales Turnover (FSTS)

Push Factors (Internal)

1. Access to technology 2. Access to capital 3. Access to supply chains 4. Access to knowledge 5. Growth opportunities 6. Economies of scale 7. Over production 8. Declining domestic sales 9. Excess capacity 10. Saturated domestic market

Strategies or moves to overcome Challenges/ Barriers 1. Focused (continuous) exporting versus opportunistic (intermittent) exporting 2. Choosing market similar to the domestic market (nature of market entered) 3. Taking time to study a foreign market for entry (speed at which it has entered a foreign market) 4. Mode of entry

Firm Level Resources-1

1. Firm age 2. Firm ownership 3. Firm size 4. CEO age 5. CEO education 6. CEO experience

Economic Performance

1 Sales Turnover (ST)

2 Growth in Sales Turnover (GST)

Firm Level Resources-2 1. Number of foreign markets entered 2. Duration of international experience 3. Learnings made in the international market

4a. Forming/joining a network for direct exports 4b. Building links with larger firms (MNCs) 4c. Adopting Internet based technologies and E-Commerce 4d. Visiting international exhibitions to learn about foreign markets

Fig. 1. Factors Influencing Degree of Internationalization and Economic Performance of Internationalized SMEs: A Conceptual Model.

whereas some might exploit the links with their MNC customers, some others might prefer to make use of the Internet and adopt E-Commerce whereas some others might even make use of international exhibitions to reach foreign markets.

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But the impact of all these factors on the degree of internationalization would largely depend on the firm level resources. The firm level resources are of two kinds: (i) resources prior to internationalization (as represented by firm age, nature of ownership, firm size, CEO age, education and experience), and (ii) resources acquired after internationalization (number of foreign markets entered, duration of international experience, and the number of learnings made through international operations, such as importance of adhering to time schedule, superior packaging, quality of products, etc.). While the former would influence the degree of internationalization at the first instance, the latter (along with the former) would influence the degree of internationalization in the subsequent years. The degree of internationalization together with the firm level resources would influence the economic performance of SMEs. It is based on the research gaps identified and the conceptual model proposed that we have formulated our research objectives.

OBJECTIVES, SCOPE AND RESEARCH METHODS The research objectives of the study are as follows:
What factors influence the current degree of internationalization of SMEs?
How does the degree of internationalization, along with firm level factors, influence the economic performance of SMEs? These two objectives are studied with respect to the internationalized SMEs in the engineering industry of Bangalore in India. Bangalore has a long-standing history of the growth of engineering industry in general and machinery & electrical equipment manufacturing industry in particular. With the setting up of six major Public Sector Undertakings (namely, Hindustan Aeronautics Limited (HAL), Hindustan Machine Tools (HMT), Bharath Electronics Limited (BEL), Bharath Heavy Electricals Limited (BHEL), Bharath Earth Movers Limited (BEML), and Indian Telephone Industries (ITI)) in the 1940s to 1960s, the city got a fillip to its industrialization process soon after independence in 1947. This was followed by the setting up of industrial estates in different parts of the city in the 1970s and 1980s to encourage the growth of modern small scale industries. This has facilitated the wide spread growth of SMEs in

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the form of ancillary units in the engineering industry, over a period of time. Today Bangalore has a vibrant and growing SME sector in the machinery and electronics industry (Directorate of Industries & Commerce, 2009). To have an appropriate sampling of internationalized SMEs, we developed a database of internationalized SMEs by collecting the secondary data from three sources: (i) Visvesvaraya Industrial Trade Centre (VITC), Bangalore, (ii) Federation of Karnataka Chambers of Commerce and Industry (FKCCI), Bangalore. VITC is a state government organization which maintains a database of exporters for the entire state of Karnataka. FKCCI is a trade body which maintains a database of SME exporters. FKCCI also provided us with the database of Federation of Indian Export Organization (FIEO), New Delhi on SME exporters of Karnataka. We consolidated these three databases comprising 1724 SMEs and prepared a district-wise list of SME exporters. Since Bangalore urban district accounted for 1420 SMEs (>82%) of the total SME exporters in Karnataka, as of 2009/2010, we decided to confine our study to Bangalore city. After “data cleaning” to avoid duplications, we prepared an industrywise list of SME exporters and found that engineering industry accounted for a maximum share (387 out of 1325, i.e., about 30%) of the total SME exporters in Bangalore. Therefore we decided to confine our study to the engineering industry SMEs. To determine a representative sample size of machinery and electrical equipment manufacturing industry for primary data collection, we decided to have a confidence interval of 10 at 95% confidence level. For a population of 387 machinery and electrical equipment exporting SMEs, with a confidence interval of 10 at 95% confidence level, the required sample size is 77 exporting SMEs. Therefore, we decided to gather primary data from a minimum of 80 exporting SMEs in the machinery and electrical equipment industry of Bangalore urban district. We developed a semi-structured questionnaire based on literature survey, our own knowledge and discussion with SME exporters during October
December 2011. The full-fledged field survey for primary data collection was started in January 2012. Overall, we have approached more than 350 exporting SMEs, distributed schedules for data collection to about 150 exporting SMEs, and successfully gathered primary data from 84 exporting SMEs, over a period of about 14 months during January 2012
February 2013. Thus the two research objectives have been studied based on the primary data of 84 exporting engineering industry SMEs in Bangalore.

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The research analysis done to study the two research objectives is confined to step-wise multiple regression analysis. The two dependent variables used for the analysis are as follows: (i) To measure the Degree of Internationalization (DOI), we have used Foreign Sales as a percentage of Total Sales (FSTS) for 2010/2011. This is given as XC. (ii) To measure the Economic Performance (EP) of internationalized SMEs, we have used Sales Turnover (ST) for the initial year of operations as well as for 2010/2011 (both at 2004/2005 prices), and the Compound Average Growth Rate (CAGR) between the two. To convert the ST of the initial year as well as that of 2010/2011 to 2004/2005 prices, we have used GDP inflator/deflator as appropriate, by deriving it based on the GDP values given at current prices and constant (2004/2005) prices in the Economic Survey (Ministry of Finance, 2014). As the dependent variable to represent economic performance, we have used (a) ST for 2010/2011 (CST) and (b) Growth of ST (SG) from the initial year of operations till 2010/2011, alternatively. The sales turnover figures (2004/2005 prices) are expressed in log values to minimize the variance and bring normality. Thus both initial sales turnover (LIST) and current sales turnover (LCST) are log values. The various independent variables used for the analyses are as follows: (i) Firm age (FA) as of 2010/2011: Expressed in years. (ii) Firm organization: We are keen to ascertain whether private limited companies are better off to internationalize and grow. That is why, we have used a dummy variable (1) for private limited companies to distinguish it from proprietorship and partnership firms (0). The firm organization has changed for many of the SMEs from the inception to the present time, and therefore, we have used one dummy variable (FO) for the origin and another one (FC) for the current nature of firm organization. (iii) Firm size in the origin: Initial Sales Turnover in 2004/2005 prices (LIST). (iv) CEO age: expressed in years. We have used age of the CEO in two ways: (a) at the time of entering the international market (CA), and (b) as of 2010/2011 (AF). (v) CEO education (EQ): We have ranked the educational qualifications of CEOs from 1 to 6 (1. Up to X standard, 2. 12th standard, 3.

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(vi)

(vii)

(viii)

(ix) (x)

49

Diploma holders in engineering, 4. Non-technical graduates, 5. Graduates in engineering, and 6. Post-graduates in engineering). Objectives of internationalization: We have used two dummy variables to distinguish Business Expansion (BE) and Customer Requirements (CR) from Global Opportunities (GO). Strategies adopted for internationalization: The strategy of exporting SMEs are considered as follows: a. An SME having a strong international focus might operate continuously in the international market after its initial entry. Therefore, we have used a dummy variable to distinguish a continuous exporter (1) from an intermittent exporter (0). b. To have an easy entry, an SME might prefer to enter a country which is similar to its domestic economy in terms of culture, income level, etc. To broadly represent this, we have used the per capita income of the first country (FE) entered through exports, as of 2010/2011 in US dollars. c. An SME to succeed in the international market might take more time to study and develop an appropriate strategy. Thus, the time taken to enter the international market might have an influence on the degree of internationalization. Therefore, we have used the time taken to enter the international market (TT) expressed in number of years as another variable. d. An SME might adopt different entry modes as a strategy to circumvent its barriers for entering the international market. The possible entry modes are (i) direct exporting (DE) based on networks developed, (ii) with the help of MNCs (MC), (iii) adopting E-Commerce (EC), or (iv) selling through International Exhibitions (IE). Number of foreign countries currently exported (NE): expressed in number of countries to which the SMEs are exporting currently. Number of years of experience in the international market (YI): expressed in number of years. Number of learnings made in the international market (NL): An SME might learn the value of product quality, sticking to delivery schedules, cost competitiveness, packaging, product/process innovations, E-Commerce, International Exhibitions, government support, networking, or MNC customers. We have given equal importance to each of these learnings, and expressed this variable in number of learnings (NL) made by each SME.

50

M. H. BALA SUBRAHMANYA

(xi) Initial degree of internationalization: The initial foreign sales as a percentage of total sales (FSTS) might have an influence on the current degree of internationalization as well as on the growth of sales turnover. This is given as XI. To ascertain what factors influence the current degree of internationalization (XC), we have used the following two models, alternatively: XC = bo þ b1FA þ b2FC þ b3AF þ b4EQ þ b5TT þ b6BE þ b7CR þ b8MC þ b9IE þ b10EC þ b11ES þ b12FE þ b13YI þ b14NE þ b15NL þ b16LIST

ð1Þ

XC=boþb1FAþb2FCþb3AFþb4EQþb5TTþb6BE þb7CRþb8MCþb9IEþb10ECþb11ESþb12FEþb13YI þb14NEþb15NLþb16LISTþb17XI

ð2Þ

The first model includes all the relevant variables excluding the initial degree of internationalization (XI) whereas the second model includes it. To ascertain whether the current degree of internationalization, along with other relevant variables, influence the economic performance of SMEs, we have used the following two models, alternatively: LCST = bo þ b1FA þ b2FC þ b3AF þ b4EQ þ b5YI þ b6NE þ b7NL þ b8XC þ b9LIST SG = bo þ b1FO þ b2CA þ b3EQ þ b4TT þ b5YI þ b6NE þ b7NL þ b8XI þ b9LIST

ð3Þ

ð4Þ

The third model will analyze to bring out the factors which influence the current level of economic performance (LCST) whereas the fourth model will analyze to ascertain the factors which influenced the growth of sales turnover (SG) since firm inception till 2010/11. We have carried out backward elimination stepwise regression for all the above four econometric models using Stata 11 software. The use of backward elimination stepwise regression is advantageous because it starts with a multiple regression equation including all the independent variables, but then deletes independent variables that do not contribute significantly to

Internationalization and Economic Performance of SMEs

51

explain the variation in the dependent variable and retains only those variables which make a statistically significant contribution to explain the dependent variable. Sequential search methods which include backward elimination multiple regression, among others, offer a perfect solution to researchers because it results in a model with maximum predictive power with only those variables that contribute in a statistically significant amount to explain the dependent variable (Hair, Black, Babin, Anderson, & Tatham, 2007).

CHARACTERISTICS OF INTERNATIONALIZED SMES IN BANGALORE At the outset, it is appropriate to describe the salient features of internationalized SMEs in Bangalore. The age of internationalized SMEs (FA) varied from a minimum of 3 years to a maximum of 61 years, the average being about 22 years. The nature of firm organization reveals that private limited companies accounted for 27% of the total SMEs at the time of origin (FO) but it increased to 42% as of 2010/2011 (FC). The age of CEOs (CA) varied form 26 years to 72 years at the time of entering the international market but it (AF) varied from 31 years to 78 years as of 2010/2011. The educational qualifications of CEOs varied from a mere X standard to M.E./M.Tech. On an average, these CEOs have a higher educational qualification, with majority accounting for engineering graduates and postgraduates. However, we did not find any CEO with business management/ international business qualifications. The push/pull factors prompting SMEs to enter the international market can be viewed in terms of the objectives with which they entered the international market. There are three clearly identified objectives for SME internationalization. While 60% SMEs internationalized to achieve business expansion (BE), 15% SMEs were prompted by customer requirements (CR) whereas 25% SMEs internationalized to exploit global opportunities. The strategies adopted by the SMEs for internationalization reveals that 86% of these SMEs have been continuously exporting (ES) after their initial entry, indicating their clear focus on the international market. The first country entered through exports varied from low income countries to middle income and high income countries. Accordingly, some of these SMEs would have entered countries (FE) which are similar to Indian economy in income levels whereas some others would have entered advanced

52

M. H. BALA SUBRAHMANYA

rich countries. As a result, the time taken (TT) by these SMEs to enter the international market varied from a minimum of one year to a maximum of 35 years. Further, the mode of entry chosen by these SMEs comprised four alternative routes: direct exporting (DE) based on their own networking (17%), participation in international exhibitions (IE) for sales (20%), adopting E-Commerce (EC) (26%) but the largest share of these SMEs (37%) made use of their MNC customers (MC) for their maiden foreign market entry (Table 1). The international experience gained after their maiden entry comprised (i) entry to more countries (NE), continued international operations over time (YI), and more learnings from the international market (NL). All these would have enabled the SMEs to create and strengthen their own knowledge capital over a period of time. The degree of internationalization achieved by these SMEs varied from a minimum of 1% to a maximum of 100% at the beginning (XI), with an average of about 21% whereas their current degree of internationalization (XC) varied from a minimum of 2% to a maximum of 100%, with an average of about 30%. Thus, it brings out that the degree of internationalization of these SMEs, on an average, has improved over a period of time. The sales turnovers of internationalized SMEs varied both at the beginning (LIST) and currently (LCST) but it has improved, on an average between the two periods of time. However, not all the internationalized SMEs could achieve positive sales growth over a period of time. While many have experienced a positive growth, some have experienced a negative growth. On an average, sales turnover of these SMEs grew (SG) by about 15%, from the period of their inception till 2010/2011. The correlation coefficients between these variables are given in Table 2. All the coefficients >±0.21 are statistically significant at 0.05 level (twotailed). FA has a statistically significant negative relationship with FO and SG but a positive relationship with CA, AF, TT, MC, NL, YI, and LIST. FO has a positive relationship with FC but a negative relationship with TT. FC has a negative relationship with TT but a positive relationship with YI and XI. CA has a positive relationship with AF and TT but a negative relationship with FE and XI. AF has a positive relationship with TT, YI, and LCST and a negative relationship with FE and SG. EQ has a positive relationship with LCST. TT has a positive relationship with MC but a negative relationship with XI, XC, and SG. BE has a negative relationship with LIST, whereas CR has a negative relationship with NL. IE has a positive relationship with NE, and EC has a positive relationship

53

Internationalization and Economic Performance of SMEs

Table 1.

Descriptive Statistics of Variables.

Variable Firm level characteristics Firm age (FA) Firm organization
origin (FO) Firm organization
current (FC) CEO age (first internationalization) (CA) CEO age
current (AF) CEO education (EQ)

Mean

Standard Minimum Maximum Deviation

21.65 0.27 0.42 46.14 53.73 4.47

11.23 0.45 0.50 10.39 12.06 1.17

3 0 0 26 31 1

61 1 1 72 78 6

Objectives of internationalization (push/pull factors) Business expansion (BE) 0.60 Customer requirements (CR) 0.15 Global opportunities (GO) 0.25

0.49 0.36 0.44

0 0 0

1 1 1

Strategies for internationalization Continuous/intermittent exporter (ES) 0.86 First country exported (FE) 36086.98 Time taken for first exports (TT) 11.25 Mode of entry
MNC help (MC) 0.37 Mode of entry
International exhibitions (IE) 0.20 Mode of entry
E-commerce (EC) 0.26 Mode of entry
direct exporting (DE) 0.17

0.35 19512.41 8.62 0.49 0.40 0.44 0.37

0 600 1 0 0 0 0

1 64840 35 1 1 1 1

Dimensions of international experience Number of current countries exported (NE) Years of international experience (YI) Number of international learnings (NL)

2.31 9.44 3.45

1.96 7.18 1.87

1 1 1

10 39 9

Degree of internationalization Initial degree of internationalization (XI) Current degree of internationalization (XC)

21.19 29.96

20.87 24.54

1 2

100 100

Economic performance variables Initial sales turnover (LIST) Current sales turnover (LCST) Sales turnover growth (SG)

15.11 17.05 15.43

1.55 1.27 17.39

10.81 13.83 −9.43

21.77 19.74 85.65

with ES. FE has a negative relationship with LCST. NE has a positive relationship with YI and XI. NL has a positive relationship with XC. YI has a positive relationship with XC and LIST but a negative relationship with SG. LIST has a negative relationship with SG whereas LCST has a positive relationship with SG. All other coefficients are not statistically significant.

Table 2. Correlation Coefficients between the Variables. FA FO FC CA AF EQ TT BE CR GO MC IE EC DE FE ES YI NE NL XI XC LIST LCST SG

FA

FO

FC

CA

AF

EQ

TT

BE

CR

GO

MC

IE

EC

DE

1.0000 −0.2728 −0.1491 0.3594 0.6385 −0.1418 0.6489 −0.0016 0.1135 −0.0930 0.2314 −0.0216 −0.2047 −0.0348 −0.2086 −0.1772 0.4564 0.0612 0.2184 −0.1903 −0.0038 0.3272 0.1691 −0.4849

1.0000 0.6724 −0.1816 −0.1308 0.0471 −0.2922 −0.0376 0.1063 −0.0462 −0.0270 0.0894 0.0593 −0.1313 −0.1003 0.1744 0.0594 −0.1247 0.0659 0.1321 0.1082 0.0653 −0.0619 0.0241

1.0000 −0.0748 0.0697 0.0486 −0.3122 −0.0902 0.0389 0.0697 −0.0459 0.1152 0.0458 −0.1188 −0.0924 0.2070 0.2186 0.0268 0.1449 0.2902 0.1359 0.0023 0.1510 0.0341

1.0000 0.7728 0.0857 0.4168 0.0091 −0.0346 0.0186 0.1470 0.0246 −0.1340 −0.0587 −0.2722 −0.1491 −0.0942 −0.1338 0.0784 −0.2879 −0.1861 −0.0160 0.2048 −0.1916

1.0000 0.0668 0.3237 −0.0067 −0.0314 0.0338 0.1410 0.0016 −0.1423 −0.0164 −0.3151 −0.1768 0.4142 −0.0829 0.0963 −0.1911 −0.1241 0.1721 0.2161 −0.3443

1.0000 0.1055 0.0249 0.1081 −0.1185 −0.0800 0.1764 −0.1512 0.0918 −0.1712 0.0210 −0.0512 −0.0125 −0.2047 0.1699 0.1374 −0.0256 0.2104 0.1404

1.0000 −0.0354 0.2027 −0.1292 0.2426 −0.0943 −0.1470 −0.0392 −0.1972 −0.1112 −0.1868 −0.1456 0.0220 −0.2392 −0.2130 0.1489 0.1884 −0.2950

1.0000 −0.5189 −0.7001 0.0275 −0.0072 −0.0604 0.0434 0.0910 −0.0594 −0.0137 0.1059 0.1092 0.0029 0.1092 −0.2525 −0.0645 0.0986

1.0000 −0.2470 0.0820 0.0302 −0.1052 −0.0147 0.0114 −0.0134 0.0151 −0.0847 −0.2456 −0.0864 −0.0830 0.1281 0.0410 −0.0849

1.0000 −0.0997 −0.0171 0.1563 −0.0369 −0.1127 0.0786 0.0029 −0.0493 0.0813 0.0689 −0.0544 0.1792 0.0388 −0.0408

1.0000 −0.3852 −0.4556 −0.3420 0.1597 −0.1813 −0.0265 −0.1213 0.0527 −0.0391 0.0810 0.0398 −0.1363 −0.0555

1.0000 −0.3001 −0.2253 −0.0824 0.1210 0.1267 0.3149 0.1483 −0.0618 0.0408 −0.1599 0.1910 0.1006

1.0000 −0.2664 −0.0111 0.2432 −0.0520 −0.0945 −0.1157 0.0076 −0.0502 0.1230 0.0679 0.0095

1.0000 −0.1049 −0.1826 −0.0410 −0.0709 −0.0916 0.1083 −0.0897 −0.0242 −0.1095 −0.0478

Note: All coefficients > ±0.21 (marked in bold) are statistically significant at 0.05 level (two-tailed).

FE

ES

YI

NE

NL

XI

XC

LIST

LCST

1.0000 0.1817 1.0000 −0.0997 0.0681 1.0000 −0.0131 0.1170 0.2142 1.0000 0.0260 −0.0836 0.0334 0.2040 1.0000 0.0840 0.0743 0.0690 0.1979 0.1615 1.0000 0.1691 0.1821 0.2249 0.2765 0.2611 0.6402 1.0000 −0.1403 −0.0115 0.2467 0.0162 −0.0046 −0.0545 0.1389 1.0000 −0.2424 −0.0185 0.0065 0.1511 0.1379 −0.0394 −0.1037 0.0238 1.0000 0.1249 0.1529 −0.3045 −0.0339 −0.0459 0.1736 −0.0184 −0.5524 0.2930

Internationalization and Economic Performance of SMEs

55

THE FACTORS INFLUENCING DEGREE OF INTERNATIONALIZATION AND ECONOMIC PERFORMANCE: RESULTS OF ANALYSIS The results of the backward elimination stepwise regression analysis for the first econometric model, to ascertain the factors which influenced the current degree of internationalization (XC) are presented in Table 3. The stepwise regression analysis removed nine of the sixteen independent variables while retaining the remaining seven variables as the explanatory variables. The model is statistically significant as indicated by the F value and the seven explanatory variables accounted for more than a quarter of the total variation in the current degree of internationalization (as revealed by the adjusted R2). There is no problem of multicollinearity as revealed by the vif values, excluding FA and TT. However we have retained both the variables as they had influences in the opposite direction. It is appropriate to describe the role of each of the seven explanatory variables in influencing the current degree of internationalization. First of all, firm age (FA) had a positive influence on the degree of internationalization implying that the older firms could achieve a higher degree compared to the younger ones. This could be due to the “more knowledge capital” that they have gained over a period of time, relative to the younger firms. Further, those firms which had a more number of learnings (NL) from the international market are able to achieve a higher degree of internationalization compared to those which had a less number of learnings. In addition, firms with younger CEOs (AF) and CEOs who had a higher educational qualification (EQ) are able to achieve a higher degree relatively. The firms which took less time to enter the international market (TT) achieved a higher degree compared to those which took more time. The firms which are continuous exporters (ES) gained more compared to intermittent exporters. Another significant factor which made a difference to the degree of internationalization is the MNC mode of entry. The SMEs which made use of their domestic market based MNC customers (MC) to enter into the international market could achieve a higher degree of internationalization relative to those which resorted to international exhibitions (IE), E-Commerce (EC) and direct entry (DE). These results reveal that it is the “firm level competence” and “firm strategy” which significantly determined the degree of internationalization achieved by the SMEs over a period of time. The “firm level competence” is reflected in its age, CEO age, CEO qualification, and the learnings it

Factors influencing the current degree of internationalization: Results of Stepwise Regression Analysis
I.

.stepwise, pr(.10): regress XC FA FC AF EQ TT BE CR MC IE EC ES FE YI NE NL LIST begin with full model p = 0.9929 > = 0.1000 p = 0.9617 > = 0.1000 p = 0.8399 > = 0.1000 p = 0.6051 > = 0.1000 p = 0.5657 > = 0.1000 p = 0.4087 > = 0.1000 p = 0.3604 > = 0.1000 p = 0.2804 > = 0.1000 p = 0.2340 > = 0.1000 Source

df

Model Residual

15981.8557 34005.0372

7 76

Total

49986.8929

83

XC FA NL AF

Coef. 1.150862 3.533933 -.6787846

Std. Err. .3725364 1.304965 .2636627

Removing CR Removing FC Removing EC Removing YI Removing IE Removing BE Removing FE Removing NE Removing LIST

MS 2283.12224 447.4347 602.251721

t

P>|t|

3.09 2.71 -2.57

0.003 0.008 0.012

Number of obs. = 84 F(7,76) = 5.10 Prob. > F = 0.0001 R-squared = 0.3197 Adj R-squared = 0.2571 Root MSE = 21.153 (95% Conf. Interval) .4088911 .9348697 -1.203914

1.892832 6.132997 -.1536548

M. H. BALA SUBRAHMANYA

SS

56

Table 3.

XC EQ TT ES MC _cons .vif Variable

Coef. 7.438661 -1.4554 14.48092 9.196743 -3.419183

(Continued )

Std. Err.

t

P>|t|

2.183553 .3835488 6.809357 5.030919 16.51858

3.41 -3.79 2.13 1.83 -0.21

0.001 0.000 0.037 0.071 0.837

(95% Conf. Interval) 3.089737 -2.219304 .9189087 -.8231995 -36.31879

11.78758 -.6914967 28.04293 19.21669 29.48042

VIF

1/VIF

FA TT AF EQ NL MC ES

3.25 2.03 1.87 1.20 1.11 1.11 1.07

0.307955 0.493450 0.533565 0.830819 0.903489 0.903809 0.938173

Mean VIF

1.66

Internationalization and Economic Performance of SMEs

Table 3.

57

58

M. H. BALA SUBRAHMANYA

made in the international market. An older firm, with younger but more qualified CEO, which had more learnings from its international experience would have built up more “knowledge capital” over time, which would have enabled it to achieve a higher degree of internationalization compared to a younger firm, whose CEO is older and less qualified and therefore, would have had less learnings from its international experience and “less knowledge capital.” The “firm strategy” is reflected in whether a firm is a continuous exporter or an intermittent exporter, the time taken by it to enter the international market and the mode of entry chosen by it. A firm which has entered the market earlier and continued to operate in the international market consistently has achieved a higher degree of internationalization compared to those which are intermittent exporters and which have taken more time for entry. Further, MNC customers have benefited their suppliers to achieve a higher degree relative to others who have preferred either international exhibitions or E-Commerce or network based direct entry. While early entry and continuous operations would have helped the SMEs to have a “better grasp and grip” over the international market, the winning over of their MNC customers to gain entry would have given them further leads into the export market. “Supplying to an MNC itself gives an identity and a brand name to an SME in the market” as revealed by one of the SME CEOs in one of the interviews. Together, SMEs would have succeeded in increasing their degree of internationalization over a period of time. Another factor which can make a difference to the current degree of internationalization is the initial degree of internationalization (XI) achieved by these SMEs. Therefore, we carried out backward elimination stepwise regression for the second econometric model and the results are presented in Table 4. The stepwise regression analysis removed eight of the seventeen independent variables while retaining the remaining nine variables as the explanatory variables. The econometric model is statistically significant as indicated by the F value and the nine explanatory variables accounted for more than 52% of the total variation in the current degree of internationalization (as revealed by the adjusted R2). Thus the explanatory power of the model has significantly improved with the addition of initial degree internationalization (XI) as one of the independent variables. There is no multicollinearity problem as revealed by the vif values, with the exceptions of FA and TT. However we have retained both the variables as they had influences in the opposite direction.

Factors influencing the Current Degree of Internationalization: Results of Stepwise Regression Analysis
II.

.stepwise, pr(.10): regress XC FA FC AF EQ TT BE CR MC IE EC ES FE YI NE NL LIST XI begin with full model p = 0.9593 >= 0.1000 p = 0.8853 >= 0.1000 p = 0.6224 >= 0.1000 p = 0.4449 >= 0.1000 p = 0.3998 >= 0.1000 p = 0.2649 >= 0.1000 p = 0.1760 >= 0.1000 p = 0.1405 >= 0.1000 Source

SS

df

MS

Model Residual

28741.6842 21245.2087

9 74

3193.52046 287.097415

Total

49986.8929

83

602.251721

XC

.5247356 -9.040846 .7006387 3.493598

Std. Err. .2487117 4.209924 .0981461 1.751915

t

P>|t|

2.11 -2.15 7.14 1.99

0.038 0.035 0.000 0.050

Number of obs. = 84 F(9,74) = 11.12 Prob. > F = 0.0000 R-squared = 0.5750 Adj R-squared = 0.5233 Root MSE = 16.944 (95% Conf. Interval) .0291668 -17.4293 .5050783 .0028302

1.020305 -.6523898 .8961991 6.984365

59

FA FC XI EQ

Coef.

Removing YI Removing NE Removing FE Removing CR Removing EC Removing IE Removing BE Removing AF

Internationalization and Economic Performance of SMEs

Table 4.

XC TT ES LIST MC NL _cons .vif Variable

(Continued )

Coef.

Std. Err.

t

P>|t|

-.9706955 15.59426 2.300907 8.142967 2.506925 -56.99314

.3175978 5.571234 1.284465 4.041864 1.087126 21.27345

-3.06 2.80 1.79 2.01 2.31 -2.68

0.003 0.007 0.077 0.048 0.024 0.009

60

Table 4.

(95% Conf. Interval) -1.603523 4.493339 -.2584456 .089377 .340779 -99.38141

-.3378681 26.69519 4.860259 16.19656 4.673071 -14.60487

1/VIF

FA TT FC XI EQ NL LIST MC ES

2.26 2.17 1.26 1.21 1.21 1.20 1.15 1.11 1.11

0.443335 0.461774 0.793407 0.824403 0.828148 0.835335 0.873270 0.898478 0.899274

Mean VIF

1.41

M. H. BALA SUBRAHMANYA

VIF

Internationalization and Economic Performance of SMEs

61

All the explanatory variables of the previous model excluding the age of CEOs, have been retained. In addition, the nature of current firm organization (FC), firm size (as represented by the initial sales turnover) (LIST), and initial degree of internationalization (XI) are the explanatory variables of the dependent variable (XC). These results re-affirm the inferences derived from the previous analysis. In addition, it reveals the importance of initial degree of internationalization achieved by these SMEs in achieving the current degree of internationalization. Thus, firm level competence, firm strategy and initial degree of internationalization significantly determined the current degree of internationalization. The firms which are older (FA), larger in size (LIST), led by more qualified CEOs (EQ), which are either proprietorships or partnerships (FC), and which had more learnings (NL) in the international market, have been able to achieve a higher degree of internationalization relative to those which are younger, smaller in size, led by less qualified CEOs, which are private limited companies, and which had less learnings in the international market. Further, firm strategy in terms of early entry (TT) as against late entry and continuous as against intermittent exporting (ES), apart from utilizing the support of MNC customers, helped. In addition to all these, what mattered was the initial degree of internationalization achieved by these SMEs. Those firms which could achieve a higher degree of internationalization at the first instance, could able to “build upon it” further in the subsequent years. Such SMEs, therefore, could achieve a higher degree of internationalization subsequently. With an understanding of the factors which influenced the current degree of internationalization, it is important to examine whether the degree of internationalization has benefited an SME to improve its economic performance. Therefore, we carried out a backward elimination stepwise regression for the third econometric model, to understand whether the current degree of internationalization has, in any way, influenced the current economic performance of these SMEs. The results of the stepwise regression model are given in Table 5. The model removed four of the nine independent variables and thus retained the remaining five variables. The model is statistically significant, though it has a low explanatory power. The five explanatory variables accounted for only 12% of the variation in LCST, as indicated by the adjusted R2. The model has no problem of multicollinearity, as revealed by the vif values. The older firms (FA), which are private limited companies (FC), led by more qualified CEOs (EQ), and which are exporting to more number of countries (NE) currently, have achieved a higher level of economic

62

M. H. BALA SUBRAHMANYA

Table 5. Role of the Degree of Internationalization in the Economic Performance of SMEs: Results of Stepwise Regression Analysis
I. . stepwise, pr(.10): regress LCST FA FC AF EQ YI NE NL XC LIST begin with full model p = 0.9016 >= 0.1000 Removing LIST p = 0.5143 >= 0.1000 Removing AF p = 0.2794 >= 0.1000 Removing YI p = 0.1518 >= 0.1000 Removing NL Source

SS

df

MS

Model Residual

23.3983093 109.821166

5 78

4.67966185 1.40796366

Number of obs. = 84 F(5,78) = 3.32

Total

133.219475

83

1.60505392

Prob. > F = 0.0090 R-squared = 0.1756 Adj R-squared = 0.1228 Root MSE = 1.1866

LCST

Coef.

.0251626 FA .5007518 FC -.0113686 XC .2880495 EQ .1267325 NE _cons 15.05015 .vif Variable

Std. Err.

t

P>|t|

(95% Conf. Interval)

.0118651 2.12 0.037 .001541 .0487842 .2681055 1.87 0.066 -.0330052 1.034509 .0056302 -2.02 0.047 -.0225774 -.0001598 .1139973 2.53 0.014 .0610983 .5150007 .069242 1.83 0.071 -.0111177 .2645826 .6399238 23.52 0.000 13.77616 16.32414

VIF

1/VIF

XC NE FA EQ FC

1.13 1.09 1.05 1.04 1.04

0.888574 0.917841 0.955307 0.959195 0.959390

Mean VIF

1.07

performance compared to those which are younger, proprietorships or partnerships, led by less qualified CEOs, and are exporting to fewer countries. What is significant to note is that, firms which had a higher degree of internationalization, in fact, had a lower level of economic performance.

Internationalization and Economic Performance of SMEs

63

This implies that there is a negative relationship between the degree of internationalization and the economic performance achieved by these SMEs. The question is why? To achieve a higher economic performance what is important is not just the “degree of internationalization” but the “quality of internationalization.” The minute perusal of our primary data enabled us to understand that those SMEs, which are younger and are partnerships or proprietorships, led by less qualified CEOs, which had a smaller sales turnover, in fact focused on one or two Asian countries, but derived a larger share of their total revenue through exports. In contrast, those SMEs, which are private limited companies, older in age, led by more qualified CEOs, focused on multiple countries which are more advanced, but derived only a smaller share of their total revenue. These firms, over a period of time, had a “firmer footing” in the domestic market much more than in the international market. This explains the negative relationship between the degree of internationalization and the economic performance. The other important factor relating to economic performance is whether the degree of internationalization made any difference to the growth of sales turnover (SG)? To ascertain the answer, we carried out backward elimination stepwise regression analysis for the fourth econometric model. Table 6 presents the results of the analysis. The regression model eliminated five of the nine independent variables, with retaining the remaining four variables as the explanatory variables of sales growth. The model has statistical significance and it explained about 40% of the variation in the sales growth of internationalized SMEs. The model is free from the problem of multicollinearity, as indicated by the vif values. The results reveal that firms which had a smaller size (LIST) to begin with, but which entered the international market early (TT), and had less experience in the international market (YI), but led by more qualified CEOs (EQ) achieved a higher sales growth relative to larger sized SMEs, which took more time to enter the international market and operated for a longer time in the international market but led by less qualified CEOs. In fact, the combination of TT and YI together reflect the age of firms. This implies that smaller and younger firms led by more qualified CEOs have registered a higher sales growth compared to larger and older firms led by less qualified CEOs. The results clearly indicate that the initial degree of internationalization (XI) did not influence the sales growth of firms (SG) in any way. That is, the smaller and younger internationalized SMEs with more qualified CEOs registered a higher growth compared to the larger and older internationalized SMEs with less qualified CEOs.

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Table 6.

Role of the Degree of Internationalization in the Economic Performance of SMEs: Results of Stepwise Regression Analysis
II.

.stepwise, pr(.10): regress SG FO CA EQ TT YI NE NL XI LIST begin with full model p = 0.9272 >= 0.1000 p = 0.6283 >= 0.1000 p = 0.6810 >= 0.1000 p = 0.5743 >= 0.1000 p = 0.1422 >= 0.1000 Source

df

MS

Model Residual

10681.0112 14409.6573

4 79

2670.25279 182.400726

Total

25090.6685

83

302.297211

SG LIST YI EQ TT _cons

Coef.

Std. Err.

t

P>|t|

-5.005761 -.5835557 2.192224 -.5832568 93.33798

1.00924 .2192028 1.279314 .1798519 15.85642

-4.96 -2.66 1.71 -3.24 5.89

0.000 0.009 0.091 0.002 0.000

Number of obs. = 84 F(4,79) = 14.64 Prob. > F=0.0000 R-squared = 0.4257 Adj R-squared = 0.3966 Root MSE = 13.506 (95% Conf. Interval) -7.014603 -1.019868 -.3541876 -.9412431 61.77657

-2.996919 -.1472435 4.738635 -.2252706 124.8994

M. H. BALA SUBRAHMANYA

SS

Removing NL Removing NE Removing FO Removing XI Removing CA

.vif Variable

(Continued ) VIF

1/VIF

YI LIST TT EQ

1.13 1.11 1.09 1.01

0.887617 0.898672 0.914853 0.986681

Mean VIF

1.09

Internationalization and Economic Performance of SMEs

Table 6.

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The above analyses bring out that internationalization did not prove to be an effective mechanism to achieve a higher economic performance, in the form of either current sales turnover or sales growth over a period of time, for the SMEs in Bangalore. But one factor which significantly stands out is the educational qualification of the CEOs. More qualified CEOs could contribute to a higher degree of internationalization as well as to a better economic performance.

INFERENCES AND CONCLUSIONS This study contributes to the existing body of knowledge on internationalization, by examining two important research questions in the context of an emerging economy: • What factors determine the degree of internationalization of SMEs? • How does the degree of internationalization, along with other relevant factors, influence the economic performance of SMEs? These questions are analyzed with reference to engineering industry SMEs of Bangalore in India. Bangalore is an internationally recognized high-tech city, with a heavy concentration of engineering, electronics and IT industries, among others. It has a fairly large concentration of manufacturing SMEs in the engineering industry. The research objectives are examined based on primary data obtained from 84 internationalized engineering industry SMEs of Bangalore. Their internationalization was confined to export activities. These SMEs were primarily prompted to enter the international market to achieve business expansion, or to meet customer demands or to exploit global opportunities, alternatively. The strategy adopted by them to overcome the barriers/challenges to enter the international market, comprised focused (continuous) exporting as against opportunistic (intermittent) exporting, varied time taken for the maiden entry, different markets chosen for the maiden entry, mode of entry chosen for the maiden entry. Majority of these SMEs preferred early entry, continuous exports, richer countries, and relied on their MNC customers or ECommerce for their maiden entry. Further, majority of these SMEs confined their exports to one or a few countries, and had fewer international experience as well as learnings, subsequently. Given these characteristics of internationalization, their initial degree of internationalization revealed that these SMEs included both “born globals”

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and “gradualists”. Their degree of internationalization as well as economic performance, on an average, improved over a period of time. It is with this understanding that we analyzed the two research questions. Our results, for the first research question, revealed that “firm level competence” (as reflected in firm age, firm size, CEO education, number of learnings made in the international market) and “firm strategy” [as reflected in focused attention in the form of continued operations in the export market, (less) time taken for the maiden foreign market entry and MNC mode of entry] together contributed to the current degree of internationalization achieved by the SMEs. International market is a difficult terrain, whose entry would call for “adequate resources” and “appropriate strategy” on the part of SMEs. An SME which is larger in size, older in age, led by a CEO who is more qualified and therefore had “more learnings” in the international market would have acquired a “larger pool of knowledge capital and competence” over time. In addition, if an SME has entered the international market early, particularly with the help of MNC customers, and has a focused attention on the international market in the form of continuous exporting, it is in a better strategic position to “understand and respond” to the changes in the international market. Together, such SMEs, would have achieved a higher degree of internationalization. The ultimate objective of internationalization of SMEs would be to improve their economic performance. Therefore, we examined the second research question to understand the role of internationalization in the economic performance of SMEs. Our results, again, suggested that firm level competence mattered much more than the degree of internationalization for the economic performance of SMEs. The firms, which are older in age, private limited companies, led by more qualified CEOs, which have entered multiple countries but actually have a lower degree of internationalization, could achieve a higher level of economic performance. Thus, our results indicated that there is a negative relationship between the degree of internationalization and the economic performance of Bangalore SMEs. A closer examination of data enabled us to understand that the SMEs, which are either partnerships or proprietorships, younger in age, led by less qualified CEOs, actually focused on one or a few countries in Asia and thereby achieved a higher degree of internationalization though their total sales turnover remained rather at a modest level. In contrast, SMEs, which are private limited companies, older in age, led by more qualified CEOs, could penetrate many rich countries, but exported only small fractions of their total sales turnover. Since they have “established themselves well” in

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the domestic market, they had no great pressure to internationalize either rapidly or intensively. Finally, we probed whether the degree of internationalization mattered for firm growth, over a period of time. We found that it did not. Only younger and smaller firms led by more qualified CEOs could grow faster compared to older and larger firms, led by less qualified CEOs. Why smaller and younger firms grow faster? Coad (2007) provides the answer. The basic theoretical prediction pertaining to firm growth is that firms require resources which are specific to niches, and these niches have a particular “carrying capacity.” If a firm has discovered a new niche with a rich resource pool, then this firm will be able to grow without hindrance. The number of firms in the niche will also grow, due to entry of new organizations. If the population grows to a level where the niche’s resource is saturated, then competition between firms will limit the growth rates of firms (Coad, 2007). Given this, it hardly matters whether the market is domestic or international. Therefore, degree of internationalization did not make any difference to the growth of internationalized SMEs in Bangalore. However, the present study has certain limitations for generalization. It is sector specific as well as region specific. We do not expect the “internationalization environment” to be the same for other sectors and in other regions, within Indian economy. A larger sample based, multi-sector focused, country-wide study might only reveal a macro scenario on the relationship between the degree of internationalization and the economic performance of SMEs.

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THE ROLE OF PERSONAL NETWORKS IN RUSSIAN MNCS’ INTERNATIONALIZATION Snejina Michailova and Kseniya Nechayeva ABSTRACT Purpose
This paper examines how personal networks influence the internationalization process of Russian multinational corporations. Design/methodology/approach
We identify and review 78 articles published in five International Business journals that address the role of networking and relationships in firm internationalization. We then use the network perspective to examine how Russian multinationals internationalize. Findings
Combining the key conclusions of the reviewed studies with insights from the network perspective, and adding insights that we have gained both through first-hand experience and by following the Russian business media, we develop a model that links personal networking and Russian multinationals’ internationalization. We outline four functions that personal networking plays
access to information and knowledge, resource commitment, development of marketing and sales capabilities, and further network expansion.

Emerging Market Firms in the Global Economy International Finance Review, Volume 15, 73
95 Copyright r 2014 by Emerald Group Publishing Limited All rights of reproduction in any form reserved ISSN: 1569-3767/doi:10.1108/S1569-376720140000015004

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Originality/value
This paper challenges established views of how firm internationalization occurs. It combines two previously unrelated streams of literature, the network model of internationalization and the role of personal networking within the Russian business environment, and argues that personal networking plays a much larger role in how Russian MNCs internationalize than has the International Business literature has acknowledged. Keywords: Multinational corporations; personal network; internationalization; Russia

INTRODUCTION International Business (IB) research has established that networking usually affects how firms internationalize. For instance, it can influence decisions about market entry (Axelsson & Johanson, 1992; Chen & Chen, 1998; Coviello & Munro, 1997; Elg, Ghauri, & Tarnovskaya, 2008; Ellis, 2000) and the speed of internationalization (Lee, Abosag, & Kwak, 2012). Yet, although we understand how networking influences internationalization in small- and medium-size enterprises (Chetty & Blankenburg Holm, 2000; Coviello & Munro, 1997; Kontinen & Ojala, 2011; Ojala, 2009; Sharma & Blomstermo, 2003; Shirokova & Storchevoy, 2012), we know little about how personal networking affects internationalization by multinational corporations (MNCs). Because individuals are fundamental to any organizational processes (Foss, Husted, & Michailova, 2010, p. 457), this lack of understanding is surprising. In the spirit of this Special Issue, we consider the above question in the context of Russia, where personal networking has been essential for conducting business. Under a planned economy, unofficial channels of informal business exchange gave rise to blat, an ingrained phenomenon of giving and receiving favors (Ledeneva, 1998). The shift to a market-driven economy that accompanied the dissolution of the USSR in the early 1990s intensified this phenomenon (Mattsson & Salmi, 2013; Michailova & Worm, 2003) as uncertainty increased and formal institutions were weakened. Informal institutions, particularly personal networks, provided a new type of coordination for Russian businesses (Lebedeva, 2001; Puffer & McCarthy, 2011; Salmi, 1996) and substituted for fragile formal institutions (Luo, 2003; Peng & Luo, 2000). Over time, they became part of the business culture and

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developed into a driving force for strategic activities, including internationalization of Russian MNCs. These processes challenge established assumptions about what internationalization entails. Most prior research on internationalization views it as structured and calculated, requiring analytical skills and linear/sequential decision-making (Aharoni, 1966; Dunning, 1980; Hymer, 1976; Johanson & Wiedersheim-Paul, 1975; Vernon, 1966). In our study, we regard personal networking as an invisible driver that often influences and sometimes directly determines MNCs’ strategic moves and behavior. Theoretically, we attempt to identify a connection between two seemingly separate phenomena: the internationalization of firms through personal networking and the importance of personal networking in the Russian business environment. Several authors argue that it is appropriate to use the network model of internationalization to describe Russian MNCs’ internationalization (Filippov, 2010; Kalotay, 2008; Shirokova & Storchevoy, 2012). In order to provide more nuanced insights into this link, we briefly review the literature on how MNCs from emerging economies internationalize. On that basis, we develop a model that captures some functions played by personal networking in Russian MNCs’ internationalization. In the sections below, we explain how we performed our literature review. We present the key literature on the links between personal networking and internationalization by MNCs. We then consider networking in emerging economies and analyze personal networking in Russia as a phenomenon with deep roots. Based on that discussion, we present a model that captures four roles of personal networks in Russian MNCs’ internationalization: access to information and knowledge, resource commitment, development of marketing and sales capabilities, and further network expansion. We conclude by summarizing our key points, suggesting avenues for future research, and outlining some practical implications of our arguments.

LITERATURE REVIEW Our literature search involved three stages: an initial database search, a snowball technique, and a final database search. First, we attempted to identify a cluster of articles in IB journals
Journal of International Business Studies, International Business Review, Management

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International Review, Journal of World Business, and Critical Perspectives on International Business. We used three keywords to search for articles: “networking” OR “relationship” and “internationalization.” We used ‘OR’ in our search because (a) in IB literature, “networking” and “relationships” are often used interchangeably, and (b) inter-organizational networks are built through personal relationships (Michailova & Worm, 2003). Through this search, we identified 38 articles, which we screened in order to eliminate articles that did not focus mainly on internationalization through networking. This effort left us with five relevant articles: Coviello and Munro (1997), Harris and Wheeler (2005), Ojala (2009), Johansson and Kao (2010), and Lee et al. (2012). In order to identify additional relevant literature, we used the references cited in these articles to find other work that considered networks and internationalization. We used the new journal articles, books, and book chapters to extract the ideas and concepts that became the theoretical foundation of our model. Appendix lists the journals we looked at and the number of relevant articles that appeared in them. To date, International Finance Review has not published any articles that link personal networking and firm internationalization. An increasing number of scholars have begun to examine the emergence of MNCs from developing economies. Of the 78 articles we reviewed, 53 percent focused on transition and emerging economies; 27 percent on developed economies; and the remaining 20 percent either did not specify the context of the study or did not distinguish between different types of economies. Significantly more attention has been paid to Asian and South American firms than has been given to Russian MNCs (Filippov, 2008; Jormanainen & Koveshnikov, 2012; Michailova, McCarthy, & Puffer, 2014) even though Russia has given rise to numerous prominent MNCs (Kuznetsov, 2011). In order to understand how Russian MNCs have internationalized, we use theories about internationalization and networks. Of the 78 articles we reviewed, 19 used business network theory, 9 used social exchange theory, 4 used social network theory, and 4 used a combination of all three theories. The remaining articles referred to other theories, including the eclectic paradigm (Dunning, 1980), FDI theory (Buckley, 1989; Hymer, 1976), born globals (Sharma & Blomstermo, 2003), and international new ventures (McDougall, Shane, & Oviatt, 1994). Overall, this review suggested that social exchange theory, social network theory, and business network theory shed light on our research question. These theories have been used together to study the role of personal networks in

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internationalization (Johansson & Kao, 2010), but address different levels of analysis. Social exchange theory examines how individual actors behave. It examines how firms transfer information and resources within a network and how network structure affects interactions among these firms (Burt, 1982, 1992; Thibaut & Kelly, 1959). Social network theory builds on social exchange theory by focusing on how individual interactions are embedded. It emphasizes relationship strength and network embeddedness, which affects the transfer of information among actors (Granovetter, 1973, 1985). Because it emphasizes how the individual actor can influence the network, it is used to explain how firms interact through informal connections such as personal networking and associations (Coviello, 2006; Sharma & Blomstermo, 2003). Business network theory assumes that long-term relationships among business actors facilitate attainment of experiential knowledge (Johanson & Mattsson, 2006). This theory is used mainly in the Uppsala model of internationalization (Johanson & Vahlne, 1977; Johanson & Wiedersheim-Paul, 1975) and the industrial marketing and purchasing literature on business relationships. It is the main framework of scholars who study how personal networking affects internationalization, particularly when a firm builds relationships within a business network in order to acquire experiential knowledge that will enable it to enter an international market (Johansson & Kao, 2010). Two models that are based on this theory, the Uppsala internationalization process model (Johanson & Vahlne, 1977, 1990) and the network model of internationalization (Johanson & Mattsson, 1988), diverge on a core assumption about the nature of internationalization. The former posits that internationalization is incremental and that companies forge relationships in countries with low psychic distance from the home country (Vahlne & Johanson, 2013). Some studies that use this model also examine how networking with local governments and business actors can assist firms that are expanding in foreign markets (Lo´pez-Duarte & Vidal-Sua´rez, 2010; Zaheer, 1995). In contrast, the network model emphasizes the role of the “insider,” who has access to knowledge through relationships (Vahlne & Johanson, 2013). Our conceptual model focuses on how internationalization processes are stimulated by personal relationships. It goes beyond research that uses the network model and examines degrees of internationalization (Hadley & Wilson, 2003) in that it examines the “fundamental constituents” (Foss et al., 2010, p. 457)
the individual actors who create and nurture critical personal networks in order to take advantage of internationalization opportunities.

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NETWORKING IN THE CONTEXT OF EMERGING ECONOMIES Although IB scholars have focused increasingly on firms from emerging markets (Deng, 2003, 2012; Gaur & Kumar, 2010; Goldstein, 2007), most research on how networking affects internationalization has ignored emerging economies until relatively recently (Elg et al., 2008; Giroud & Scott-Kennel, 2009; Kontinen & Ojala, 2011). When countries like Russia and China were closed markets with planned economies that were governed by central political bodies, empirical research in these settings was impossible (Jansson, Johanson, & Ramstro¨m, 2007). Even as these markets have opened and researchers have begun to focus on them, relatively little of this literature has attended to networking (Khanna & Palepu, 1997; Luo & Tung, 2007; Santos & Rufı´ n, 2010). Emerging markets are different from developed economies (Lee et al., 2012). For instance, although they have changed rapidly (Bruton & Ahlstrom, 2003; Hoskisson, Eden, Lau, & Wright, 2000), many lack adequate regulatory frameworks and enforcement regimes. This institutional void (Khanna & Palepu, 1997) is often a serious burden to transparency and breeds corruption and inefficiency (Danis, De Clercq, & Petricevic, 2011; De Clercq, Danis, & Dakhli, 2010). This burden is also felt in the form of ineffective, unpredictable, or unreliable regulations and the lack of appropriate market information (Aidis, Estrin, & Mickiewicz, 2008). While certain institutional burdens still exist in developed economies, they are more problematic in emerging economies (Hoskisson et al., 2000). In economies with lower levels of institutional development, there is a stronger positive correlation between networking and business activity (De Clercq et al., 2010). Peng and Luo (2000), Luo (2003), and Michailova and Worm (2003) argue that informal networking partially compensates for weak institutional ties because the social capital that it creates facilitates business activity (Batjargal, 2003; Peng, 2003; Peng & Heath, 1996; Peng & Luo, 2000). Firms in emerging economies rely on less formal mechanisms such as networking, personal relationships, and social ties to ensure that parties fulfill contracts (Bruton, Ahlstrom, & Puky, 2009; Danis, Chiaburu, & Lyles, 2009; Danis et al., 2011; De Clercq et al., 2010; Khanna & Palepu, 1997; Peng, 2003; Peng & Heath, 1996; Puffer, McCarthy, & Peterson, 2001). Networks also help firms to access critical market information and serve as channels for information flows that allow firms to discover and exploit hidden opportunities that are not readily available (Manev, Gyoshev, & Manolova, 2005). Hence, they are crucial to managing

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a complex, unpredictable environment (Chung-Leung et al., 2008; Peng & Luo, 2000; Xin & Pearce, 1996). For instance, Bruton et al. (2009) demonstrated that venture capitalists in newly developed and emerging economies seek to fund individuals with whom they have established a personal relationship. Similarly, Danis et al. (2009) found that managers in transition economies spend on average 24 hours per week developing and maintaining their networks and regard market-based strategies as less important. In the next section, we explain how institutional transition in post-Soviet Russia has led to heavy reliance on informal institutions. This focus is distinct from that of most IB literature, which has focused primarily on formal institutions (see Chavance, 2008; Marinova, Child, & Marinov, 2012).

PERSONAL NETWORKING IN RUSSIA Given the importance of personal networks in emerging markets (e.g., Lebedeva, 2001; Michailova & Worm, 2003), we use the Russian economy as the context for our analysis. The Soviet economy was based on centralized state control over business exchanges. The state supplanted the role of the market (Peng & Heath, 1996); firms received and had to follow the instructions regarding products, suppliers, prices, salaries, etc. (Johansson, 2008). In this environment, formal and informal channels of business exchange developed. The first occurred though the governing system, and the second evolved through unofficial channels and informal networking among business actors. Due to shortages in the economy, Russian firms could not rely on the official distribution system and had to find resources through unofficial channels. Informal activities such as horizontal trading and vertical bargaining became integral to the economy (Mattsson & Salmi, 2013). Personal networks facilitated such activities. This development resulted in a substantial divide between official and unofficial relationships and formal and informal institutions (Halle´n & Johanson, 2004). When the Soviet Union disintegrated in 1991, this economy was dismantled. Firms had to develop and maintain business networks and transactions on their own. They relied on personal networks to survive, or assumed new business norms based on impersonal exchange and competition (Peng, 2003). The ensuing instability led to an exceptionally unpredictable business environment, wherein interpersonal trust (rather than trust in institutions) became vital to economic exchange (Frye, Yakovlev, & Yasin, 2009; Lebedeva, 2001, 2006; Peng & Heath, 1996). Because many Russian

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institutions have become even weaker since then, these changes continue to affect networks in Russia and the internationalization of Russian firms. Further, Russians have tended to distrust those who are not in their personal circle (Ayios, 2004; Michailova, 2000; Michailova & Husted, 2003). It is therefore not surprising that business transactions in Russia are typically based on long-term relationships rather than formal procedures and/or codes of conduct. In Russia, blat refers to “the use of personal networks for obtaining goods and services in short supply and for circumventing formal procedures” (Ledeneva, 2009, p. 257); it is a culturally embedded phenomenon of giving and receiving favors that has long been perceived as reasonable and necessary for conducting business. In the Soviet economy, it was used for informal bartering, wherein the exchange of favors provided a way to source goods and services during shortages (Michailova & Worm, 2003). Because it occurs among members in a particular network, it should not be confused with bribery (vzyatki) (Puffer, McCarthy, & Boisot, 2010). Blat does not entail a monetary exchange; bribery is explicitly transactional. Further, whereas bribery is against the law, blat is not mentioned in the Russian criminal code (Lovell, Ledeneva, & Rogatchevski, 2000). Nevertheless, blat is logically correlated to the current increase in corruption (Puffer et al., 2010).

FUNCTIONS OF NETWORKING IN THE PROCESS OF INTERNATIONALIZATION OF RUSSIAN MNCS Four studies that we reviewed pay close attention to networking and relationships, but do not focus primarily on personal relationships. Harris and Wheeler (2005) propose that relationships: (1) serve sales or marketing efforts in new geographic markets, (2) provide a basis for developing new networks of inter-firm linkages in new territories, and (3) help firms gain knowledge about new markets. Lee et al. (2012) argue that networking facilitates resource commitment and experiential learning. Shirokova and Storchevoy (2012) propose that networking drives internationalization through knowledge accumulation and resource identification. Hohenthal, Johanson, and Johanson (2014) analyze how networks and relationships in foreign markets help firms obtain different types of knowledge. Based on these studies, along with the insights we gained through first-hand experience and observation, we highlight four functions of personal networking in Russian MNCs’ internationalization. These are: (1) access to information

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and knowledge, (2) resource commitment, (3) development of marketing and sales capabilities, and (4) network expansion. We link these four functions in Fig. 1. In the following sections, we elaborate on these functions and provide examples from four Russian MNCs to illustrate some of our key points: Troika Dialog, LUKOIL, Severstal Group, and Russian Standard Corporation. These firms operate in four different industries, so the model we propose is not bound to a specific sector.

Function 1: Access to Information and Knowledge One function of personal networking in internationalization is related to acquiring information and knowledge about new markets (Ha˚kansson & Snehota, 1995; Walter, Ritter, & Gemu¨nden, 2001). Access to relevant information and knowledge is particularly valuable for Russian MNCs. While firms in the West can easily access such information and knowledge, there is an embedded resistance to knowledge sharing in Russia (May, Puffer, & McCarthy, 2005; May & Stewart, 2014; McCarthy, Puffer, May, Ledgerwood, & Stewart, 2008; Michailova, 2000; Michailova & Husted, 2003; Michailova & Hutchings, 2006). In the former Soviet Union,

Fig. 1.

The Four Functions of Personal Networking and their Influence on Russian MNCs’ Internationalization.

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governing bodies monitored information and controlled its distribution. Those who had access to certain information did so at substantial personal risk. The Soviet regime had trained its citizens to remain silent for fear of undermining or interfering with the centralized and strictly governed distribution of knowledge. Further, “the values and behaviors that historically disrupted the flow of knowledge within the Soviet firms persist in Russia in both the public and private sectors” (May & Stewart, 2014, p. 156). This attitude is manifested as an ingrained hostility to the acquisition and sharing of market-based knowledge. Michailova and Husted (2003, p. 62) explain this “knowledge hoarding” in Russian organizations in terms of three features: “(1) the need to cope with high levels of uncertainty regarding how the receiver of information will use the shared knowledge; (2) the cultural proclivity to accept and comply with a strong hierarchy and formal power; and (3) the fear associated with anticipated and actual negative consequences of sharing knowledge with subordinates.” In light of these findings, we argue that it is more difficult for Russian MNCs to locate information about new markets than it is for Western firms. Russian firms thus need to rely on personal networks to gain access to relevant information and knowledge when they internationalize. Because the acquisition of private information about a new market is associated with a deeper understanding of that market, personal networks are a more reliable source of knowledge about new markets (Johanson & Vahlne, 2009). Styles and Ambler (2000) argue that personal networks can provide valuable knowledge about the culture in the host country, especially if the internationalizing firm is entering a culturally or psychically distant market. Furthermore, personal networks can provide current hardto-obtain information about new commercial opportunities (Ellis, 2010). Such learning enables the internationalizing firm to be aware of foreignness and more able to adjust to the new host country business environment (Lee et al., 2012). This knowledge can take numerous forms. For instance, it may help the entrant identify the best site to locate in the host country. The case of Troika Dialog suggests how personal networking promotes access to and the accumulation of knowledge during internationalization. Troika Dialog is a Russian multinational investment banking and asset management firm. Established in 1991, it has the longest operating history in this sector in Russia (Shekshnia, 2001). It has offices in London, Kiev, Almaty, and Nicosia, and services international companies and financial institutions. In 1998, Troika Dialog expanded its operations into the United States by setting up a subsidiary, Troika Dialog USA, to serve

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institutional clients. It also established an affiliate, Troika Dialog Asset Management, as the first open-ended mutual fund in the United States dedicated to Russian equities (Shekshnia, 2001). Prior to entering the US market, Ruben Vardanian, president and CEO of Troika Dialog, accumulated market knowledge through personal networks he had established over his career. He began accumulating market data from Peter Derby in 1991, a banker who had invested in Troika Dialog. Vardanian later met yet another American banker, Bernie Sucher, who had accumulated industry and market knowledge while working at Goldman Sachs. Vardanian regarded Sucher as his “mentor,” who had helped him gain essential knowledge about investment banking on an international scale (Shekshnia, 2001, p. 19). In addition to surrounding himself with experienced US bankers, Vardanian attended financial and executive programs at Merrill Lynch and Harvard Business School in the United States. This combination of events provided Vardanian with an extensive network, which allowed him to acquire in-depth knowledge of the market and the industry that enabled Troika Dialog to enter the United States in 1998. In 2000, the American Chamber of Commerce in Russia awarded Vardanian as “Businessperson of the Year.” In 2011, Sberbank acquired Troika Dialog for US$1 billion in order to capitalize on Troika Dialog’s global reach and Vardanian’s personal network (Golubkova & Dolan, 2011).

Function 2: Resource Commitment Once actors establish a relationship through networking, they tend to trust each other more. Relational trust often induces managers in firms to commit resources to a new country of operation because they rely on their personal network (Lee et al., 2012). This is particularly applicable to Russian firms, where “some kind of friendship is a precondition for developing business relations” (Michailova & Worm, 2003, p. 512). Resource commitment is more likely to occur if one knows and trusts the other party and the information it has provided. Accordingly, it helps strengthen the relationships within a personal network, as it demonstrates a firm’s confidence in the network (Axelsson & Johanson, 1992). Although Russian society has long been wary of foreigners (Michailova & Husted, 2003), a Russian firm’s commitment of resources should demonstrate to the other parties in a relationship that it trusts their judgment or recommendation, and therefore, values the given network.

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Interpersonal reciprocity is especially important to business relationships in Russia (May & Stewart, 2014). For instance, a Russian MNC might align itself with partners by treating resource commitment as an incentive to increase relational trust and consequently, to additional business exchanges. The oil and gas company LUKOIL (Neftyanaya Kompaniya LUKOIL OAO or NKLUKOIL OJSC) is a case in point. According to the Russian Forbes, LUKOIL is Russia’s biggest MNC by revenue and the second-largest producer of oil in Russia (Komarov, 2013). It operates through numerous subsidiaries and affiliates in the Russian Federation, the Commonwealth of Independent States, Eastern and Western Europe, Asia, and the United States (Forbes, 2013). In 1997, it signed an agreement with Atlantic Richfield Company (ARCO) to form LUKARCO (The New York Times, 1997). LUKOIL’s director, Vagit Alekperov, had a longstanding relationship with Viktor Chernomyrdin (Hrennikov, 2007), who was the Minister of Gas Industries in the USSR from 1985 to 1989 and later served as Prime Minister of Russia from 1992 to 1998. Chernomyrdin facilitated the deal with ARCO, which was the first cross-border joint venture that involved a Russian company. Since then, Chernomyrdin has frequently lobbied on behalf of LUKOIL in regard to international expansion. He used the government’s stake in LUKOIL to justify the company’s international expansion and the heavy resource commitment that it entailed. Such a commitment could not have occurred without solid personal relationships and intensive personal networks.

Function 3: Development of Sales and Marketing Capabilities Effective sales and marketing are critical to successful internationalization, and interpersonal relationships are as vital to these efforts as are contractual agreements (Dubuni & Aldrich, 1991; Johnsen & Johnsen, 1999). These roles can be staffed either internally (through a marketing manager) or externally (through a joint venture partner or a sales agent) (Andersen, 1993; Welch & Luostarinen, 1993). The development of these capabilities is especially crucial for Russian MNCs, which have fallen short in these areas when they have internationalized. In the planned Soviet economy, firms did not need to develop sales or marketing capabilities. They did not have to find suppliers, distributors, or buyers, which were assigned by the state (Johansson, 2008). Nor did they need to engage in international sales and marketing because they operated in a closed market, with little exposure to international trade. It was only

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during the privatization era of the 1990s that Russian firms begun to grasp the significance of effective sales and marketing. Today, many Russian MNCs still have limited experience in the global marketplace (Fey & Shekshnia, 2011; Holden & Vaiman, 2014; Puffer & McCarthy, 2011). Beyond this long isolation, the lack of business skills like sales and marketing capabilities in Russian firms is attributable to the absence of “capitalist” business education in the Soviet Union (Fey & Bjo¨rkman, 2001; Holden & Vaiman, 2014). Growth in such education has begun only recently (Michailova & Jormanainen, 2011). Many Russian firms are still catching up with the knowledge held by their Western counterparts (Holden & Vaiman, 2014). Nonetheless, such weakness can be overcome through the development and use of personal networks (Buckley, 1989). Ha˚kansson and Snehota (1995) state that new competencies and capabilities are created through the cooperation that is intrinsic to networks. Walter et al. (2001) argue that personal networking allows firms to exploit new market opportunities when they combine their resources. In this light, Russian MNCs can seek sales and marketing capabilities within their personal networks, while reducing the gap between them and their Western counterparts. As a result, Russian MNCs can gain exposure to foreign markets and compete internationally. Consider the Severstal Group, which is a leading steel producer with operations in Russia, Ukraine, Poland, Latvia, Liberia, Italy, Brazil, and the United States (Company Profile, n.d.). As of 2004, its total exports represented over 40 percent of its annual steel production. Its initial exporting efforts were driven heavily by personal networking. After the Soviet Union collapsed in 1991, Severstal lost most of its buyers, which had been locked into contracts. As its domestic sales plummeted, Severstal was forced to look for buyers outside of Russia. Due to its lack of experience with exporting, Severstal’s senior managers used their personal networks to recruit traders who could boost exports. Some of these traders were Russian immigrants who had established networks in overseas markets such as China and Malaysia, where Severstal could sell steel for high margins (Hlebnikov, 2004).

Function 4: Further Network Expansion Personal networking also provides Russian MNCs with access to wider networks in new markets. In fact, internationalization can be viewed as a way for firms to expand their networks into other countries (Lee et al., 2012).

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Internationalization can thus be the first step in the development of further personal networks (Coviello & Munro, 1997; McDougall et al., 1994) Because the distrust of outsiders makes it difficult to develop new business relationships in Russia (Mattsson & Salmi, 2013), Russian firms tend to stay within the boundaries of their existing personal networks when entering a new market. These networks can thus influence how an MNC internationalizes and define its positioning within the new market (Chen & Chen, 1998). Once a Russian MNC enters a host market, it continues to build on its current personal networks, layering new networks on top of its existing connections (Hadjikhani, Lee, & Ghauri, 2008). In short, the initial personal network established within the domestic market provides the basis for any future networks to be developed internationally (Harris & Wheeler, 2005). The expansion of existing networks is consistent with Russian culture. It is referred to as “friends of friends,” implying that one’s social reach equals the scope of her/his friends’ personal networks. Michailova and Husted (2003, p. 71) interviewed a Western manager who confirmed that in order to achieve anything in Russia, “one needs friends or friends of friends.” Mattsson and Salmi (2013) concluded that even distant and indirect relationships can affect the international business network of an organization. Although internationalization often entails risk and uncertainty, network expansion can provide a sound “safety net” in a new international market. The case of Russian Standard Corporation, a holding company owned by Roustam Tariko (Pronina & Ermakova, 2009), illustrates this point well. The company operates in over 75 countries and employs over 25,000 employees (Fact Sheet, n.d.) and it has one of the leading consumer brands in Russia. In 2013, it acquired Central European Distribution Corporation (CEDC), making it the second-largest vodka producer by volume in the world (Marketwatch, 2013). This acquisition reportedly resulted from an informal conversation between Tariko and William Carey, the founding CEO of CEDC. In 2001, Tariko was introduced to Carey by mutual friends (Skrinnik & Igumenov, 2013). Earlier in his career, he acquired the sole rights to distribute Ferrero chocolates and Martini Bianco products in Russia after being introduced to traders. Such examples demonstrate how personal networks can grow organically, and can then catalyze the further internationalization of an MNC.

CONCLUSION This paper has examined the role of personal networking in the process of internationalization by Russian MNCs. We reviewed research on how

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personal networking facilitates internationalization. We then used the network model of internationalization of Johanson and Mattsson (1988) to discuss some specific details about Russian MNCs’ internationalization. This contextualization of the network model has underpinned our literature review and helps position our contribution to the increasing scholarship about how MNCs in emerging markets internationalize. We illustrated connections between two previously unrelated streams of literature, namely the network model of internationalization and the significance of personal networking within the Russian business environment. We argued that personal networking is an invisible driver of the strategies of MNCs, specifically in regard to how they internationalize. Based on our inquiry, we proposed a model that highlights four roles played by personal networking in Russian MNCs’ internationalization: access to information and knowledge, resource commitment, development of marketing and sales capabilities, and further network expansion. We demonstrated that personal networking plays a much larger role in internationalization of Russian MNCs than the academic literature has suggested. Our focus is distinct from studies that have looked at why Russian MNCs internationalize (Bulatov, 1998, 2001) and what entry modes they prefer (Kalotay, 2005, 2008; Panibratov, 2010). The topic of internationalization through personal networking challenges established views about how internationalization occurs. Few scholars consider personal relationships and networking when they examine firm internationalization, especially in regard to how MNCs internationalize. That is why context(ualization) is important (Michailova, 2011). Further, such research is challenging because information about network ties between directors of large corporations generally remains hidden from the public domain. We have discussed personal networks in general, without specifying the multiple layers they involve. Russian MNCs have elaborate networks with various actors
government and governmental agencies, other MNCs, and smaller players. They also have different approaches to dealing with the government; such differences often depend on whether they interact with the central government or government in the provinces. For example, they may be more apt to have personal networks with officials from regional governments than they do with the central government because institutional rules and arrangements are weaker in these regions (Frye et al., 2009; Yakovlev, 2006, 2011). Studying those interactions through the lens of personal networking can reveal important insights about Russian MNCs’ internationalization decisions and behavior.

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Another research avenue involves studying the lifecycle of personal networking. The goals Russian MNCs pursue when personal relationships are established may differ from the goals they try to achieve when they can fully use and expand established networks. The mechanisms they use in different stages of this lifecycle might also be different, and understanding these mechanisms would advance knowledge of how these firms internationalize. Further, there may be differences in how well-networked and less connected MNCs invest. The aggressiveness of investment strategies and risk tolerance are dimensions on which there might be substantial differences. The influence of personal networking on internationalization may also vary by sector. MNCs may establish and utilize personal networks differently in strategic sectors (e.g., oil and gas) from how they do in other industries. Relatively little is known about Russian MNCs in non-strategic sectors. Finally, state-owned and private MNCs could approach networking similarly in some ways, but differently in other ways. Our analysis can also help non-Russian partners of Russian MNCs understand what drives these firms’ internationalization decisions and actions. Just as the perceptions about how MNCs internationalize are changing, so should the attention of firms shift towards the relationships amongst individuals, personal networks, and the potential value of such networks. By interpreting research in the context of Russia, we shed light on the complexities of a particular environment and deepened the understanding of how MNCs from emerging economies internationalize.

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363.

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APPENDIX: JOURNALS AND NUMBER OF ARTICLES ON THE LINK OF PERSONAL NETWORKS/RELATIONSHIPS AND FIRM INTERNATIONALIZATION Journal

Number of Articles

Journal of International Business Studies International Business Review Academy of Management Journal Industrial Marketing Management American Journal of Sociology Critical Perspectives on International Business European Management Journal Harvard Business Review International Marketing Review Journal of Business Venturing Journal of East-West Business Journal of International Entrepreneurship Journal of International Marketing Academy of Management Executive Academy of Management Perspectives American Sociological Review Australian Journal of Management Economics of Planning European Journal of Marketing Foreign Affairs International Executive International Journal of Emerging Markets International Journal of Entrepreneurial Behavior and Research Journal of Business & Industrial Marketing Journal of International Management Journal of Management Studies Journal of Marketing Management Journal of World Business Journal of World Investment Journal of World Investment & Trade Management International Review Progress in International Business Research Research in International Business and Finance Social Research Strategic Management Journal

14 12 8 4 2 2 2 2 2 2 2 2 2 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1

Sum

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LOW-LEVEL MANAGEMENT CONTROL AND CROSS-BORDER KNOWLEDGE TRANSFER OF EMERGING ECONOMY FIRMS Chang Liu, Zijie Li, Yi Li and Lin Cui ABSTRACT Purpose
This paper seeks to provide an understanding of the relationship between the management control policy of emerging economy (EE) firms and the knowledge transfer with the acquired firm, as well as the mechanism by which specific management control policy facilitates knowledge transfer with the acquired firms. Design
Employing an organizational learning theory, this paper examines the knowledge transfer from acquired firms to acquiring EE firms through multiple-case study of three EE firms. Findings
Based on organizational learning theory and the results of case studies, this paper finds that the cooperation and willingness of employees in the acquired firm and language barriers are the main factors influencing the relationship between management control policy and the parent company’s knowledge transfer process.

Emerging Market Firms in the Global Economy International Finance Review, Volume 15, 97
120 Copyright r 2014 by Emerald Group Publishing Limited All rights of reproduction in any form reserved ISSN: 1569-3767/doi:10.1108/S1569-376720140000015005

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Research implication
This study sheds light on cross-border knowledge transfer to EE firms from an organizational learning perspective and broadens the understanding of post-acquisition knowledge transfer in an emerging market context. Practical implications
This study suggests that the low-level management control facilitates knowledge transfer from acquired firms. This is especially true when the parent company from the EE has limited learning experience and faces substantial language barriers between itself and its acquired firm. Originality
This paper extends existing research by exploring how low-level control of acquired firms in developed markets facilitates knowledge transfer of EE firms after cross-border acquisition. Future research can extend this line of research by examining the knowledge transfer mechanism of EE firms through qualitative and quantitative methods. Keywords: Knowledge management; cross cultural management; international strategy; learning organizations

INTRODUCTION The knowledge transfer process after mergers and acquisitions (M&A) is an important research area in the field of international business (Birkinshaw, Bresman, & Nobel, 2010). Knowledge can be classified into two different categories, explicit knowledge and implicit knowledge, which are defined according to the extent of effective expression and transfer. The effective transfer of explicit knowledge enables the acquiring firms to assimilate advanced technology and patents of acquired firms. The effective transfer of implicit knowledge increases the core advantage of acquiring firms (Yin & Bao, 2006). Both explicit knowledge and implicit knowledge are crucial to the success of M&A (Fransson, Hakanson, & Liesch, 2011). Prior research suggests that management control policy is a major component of the organizational structure of firms (Brown & Duguid, 1991; Dodgson, 1993; Lyles, 1988), as it largely determines the relationship between the parent firm and its subsidiaries. The choice of management control policy is very important to the effectiveness of knowledge transfer (Bresman, Birkinshaw, & Nobel, 1999; Brown & Duguid, 1991; Dodgson, 1993; Fransson et al., 2011; Lyles, 1988; Puranam & Srikanth, 2007) given

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the importance of closeness and trust in the relationship between the parties involved in the knowledge transfer (Pe´rez-Nordtvedt, Kedia, Datta, & Rasheed, 2008). Designing and implementing appropriate management control policy for newly acquired firms is critically important for firms who are attempting to obtain advanced knowledge from their acquired companies (Bresman et al., 1999; Crossan, Lane, & White, 1999; Fransson et al., 2011; Hitt, Levitas, Arregle, & Broza, 2000; Lee & Caves, 1998; Tan, 2009). It is accepted in current research that the degree of acquiring firm control influences the knowledge transfer from acquired firms; however the nature of this influence is still unclear. While some existing research has shown that high-level management control by acquiring firms facilitated knowledge transfer from the acquired firms (Bresman et al., 1999; Fransson et al., 2011; Lee & Caves, 1998; Puranam & Srikanth, 2007; Tan, 2009), other research has indicated that higher headquarter involvement undermines knowledge transfer efficiency (Ciabuschi, Forsgren, & Martı´ n Martı´ n, 2012). In recent years, more and more emerging economy (EE) firms have engaged in cross-border acquisition with the aim of obtaining advanced knowledge from firms in developed markets. The increase in cross-border acquisitions has resulted in a greater research interest in knowledge transfer (Cui, Meyer, & Hu, 2014; Wright, Filatotchev, Hoskisson, & Peng, 2005). Comparing, EE firms have been found to concentrate more on learning by acquisition when compared with their counterparts from developed markets. These firms enhance their core competencies with knowledge they have obtained from their acquired companies. The cross-border M&A of developed-market firms by EE firms differs greatly to those between developed markets firms, in that EE firms have the intent of learning through cross-border M&A. Employees from an acquired firm from a developed market will have an increased likelihood of having negative emotions and expressions of hostility toward the EE firm which acquired them. By offering significant autonomy to acquired companies (through low-level management control), EE firms are more likely to achieve effective transfer of advanced knowledge after the acquisition of a firm from a developed market. While it has nevertheless become a real-world phenomenon within the last decade, research on this topic is minimal, especially regarding the mechanisms EE firms use during post-acquisition integration and how the extent of control influences knowledge transfer. Therefore, in this paper, we extend existing research by exploring how low-level control of acquired firms in developed markets facilitates

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knowledge transfer of EE firms after cross-border acquisition. We employ an analysis of the comparative cases to increase the external validity in this paper.

LITERATURE REVIEW The effective transfer of knowledge has always been considered crucial to the success of the M&A of firms. Transfer of explicit knowledge is much easier and less costly than the transfer of implicit knowledge, which is inimitable and tacit, and composes the core competency of a firm (Yin & Bao, 2006). While pre-acquisition investigation and preparation and postacquisition integration are both important to the success of M&A, postacquisition integration should be given more consideration by firms as they can achieve synergy and effective knowledge transfer by applying certain management control policy during this process. The mechanisms employed by organization leaders to ensure the alignment of employee behavior and the strategies of the organization are called management controls (Langfield-Smith, 1997; Ouchi, 1979). Current research has defined two different kinds of control, which are formal control and social control (informal control) (Dekker, 2004; Langfield-Smith, 1997). Formal control refers to specified and objective control mechanisms, while social control covers the informal, but crucial, sets of common beliefs and values held by the employees of a firm (Ouchi, 1980). Management control can also be classified into high-level and low-level according to the extent of the control. The level of control, as will be illustrated in this paper, directly influences the implementation of organizational strategy and the achievement of organizational goals. It also influences the knowledge transfer in the post M&A stage of integration (Child, 1973). From the perspective of the acquiring firm, knowledge transfer from an acquired firm can be treated as an organizational learning process. According to organizational learning theory (Brown & Duguid, 1991; Crossan et al., 1999; Dodgson, 1993; Fiol & Lyles, 1985; Hitt et al., 2000; Huber, 1991), learning environment, trust between groups within the organization, and coordination among organizational members have significant effects on the effectiveness and efficiency of organizational learning processes. Research has defined two conditions for knowledge spillover to occur from foreign firms to domestic firms
the opportunity for domestic firms to learn from foreign firms and the capacity of domestic firms to learn from foreign firms (Zhang, Li, Li, & Zhou, 2010). Learning environment,

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trust, and coordination can be shaped and influenced by organizational structure and strategies (Chandler, 1990). Crossan et al. (1999) found that shared understandings, mutual adjustments, and effective interaction systems, which are influenced by organizational structure and strategy, can facilitate organizational learning during the integration process. As a major component of the organizational structure and strategy of a firm, certain management control policy will have an effect on the attitudes and activities of organizational members toward the learning environment in terms of establishing trust and coordination between groups (Brown & Duguid, 1991; Lyles, 1988). These attitudes and activities will either facilitate or impede the learning process of the organization (Dodgson, 1993). Cultural differences on national and firm levels between the acquiring and acquired firms also play an important role in knowledge transfer. Research has identified that cultural differences have an influence organizational learning and knowledge transfer (Ambos & Ambos, 2009; Javidan, Stahl, Brodbeck, & Wilderom, 2005; Simonin, 1999). Vaara, Sarala, Stahl, and Bjo¨rkman (2012) have indicated that national cultural differences undermine the absorptive capacity of the acquiring firm to a greater extent than firm level cultural differences. According to the knowledge-based view, standardized organizational structures help parent firms create efficient formal communication channels with acquired firms, and promote intra-firm knowledge-sharing (Bresman et al., 1999; Fransson et al., 2011; Lee & Caves, 1998; Puranam & Srikanth, 2007; Tan, 2009). Communications, visits, and meetings between acquiring and acquired firms were more effective and efficient under highlevel management control, which thus facilitated knowledge transfer processes between the firms (Bresman et al., 1999). Ashkenas, DeMonaco, and Francis (1998) argues that top managers from acquired and acquiring firms should cooperate in dealing with the projects from the acquired firm as soon as possible after acquisition, in order to increase mutual understanding and promote knowledge-sharing between the two firms. Birkinshaw et al. (2010) found that fast post-acquisition integration, which means the acquiring firm acts quickly to impose its systems and rules on the acquired company, facilitated the acquiring firm to utilize the patents and market presence of acquired company. In general, researchers conclude that highlevel management control of acquired firms positively influences the facilitation of knowledge transfer after M&A. The existing research has predominantly focused on the acquisition and knowledge transfer conducted by corporations in developed markets which have ownership advantages and increased learning experience compared

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with EE companies. The main theoretical arguments in this literature are based on the assumption that employees in acquired firms are willing to cooperate with organizational members in the acquiring firm during the knowledge-sharing process. However, employees in the acquired firm may have hostile attitudes and passive emotions toward new parent company after M&A, which then has a negative impact on post-acquisition knowledge transfer. This negative impact could be enhanced when a well-known firm in a developed country is acquired by an EE firm. Compared with corporations from developed markets, most EE firms lack learning experiences and key resources (such as brand equity and advanced technology) when establishing their ownership advantages (Cuervo-Cazurra & Genc, 2008; Cui & Jiang, 2010, 2012). Thus EE firms rely heavily on the knowledge obtained from the acquired developedmarket firms to establish their competitive advantages (Sinkovics, Roath, & Cavusgil, 2011). In order to learn from an acquired company, firms must have sufficient absorptive capacity (Cohen & Levinthal, 1990; Dyer & Singh, 1998). When EE firms have had learning experiences and a developed set of learning skills similar to the acquired firm there is an increased capacity to absorb related knowledge (Ciabuschi, Dellestrand, & Kappen, 2011). However, acquired knowledge is often specific to the context from which it is derived (Delios & Beamish, 1998). Most EE firms do not have learning experiences similar to the acquired companies from a developed country. As a result, EE firms may find it difficult to learn managerial and technological capabilities from their acquired developed-market firms because of inadequate absorptive capacity. EE firms may require special actions on the part of their acquired firms to acquire such capabilities and related knowledge. In particular, employees in acquired developedmarket firms must be willing to share their expertise (Hitt et al., 2000).

RESEARCH DESIGN Method We adopted a multiple-case study approach to explore the research questions. The case study approach is particularly appropriate for the investigation of a contemporary problem when the questions posed are “how” or “why” questions and when it is very difficult to control for all variables (Yin, 2003). A multiple-case study design is preferable to a single-case

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design due to the increased analytic power and the reduction of chance associations (Eisenhardt, 1991). This paper aims to investigate the mechanisms by which low-level management control could facilitate knowledge transfer from acquired developed markets target firms to EE acquiring firms. Differences in institutional environments and cultural between developed markets and emerging economics poses obstacles to use M&A research conducted in developed markets for reference. Case analysis is the most appropriate method to investigate post-acquisition knowledge transfer issues while reducing these obstacles.

Case Selection Pauwels and Matthyssens (2004) recommend using polar cases to create a greater variance in the research. Ghauri (2004) suggests that polarity should be tempered as cases must also share some common features in order to make them comparable. Based on an abundant analysis of secondary data, we chose three polar cases of knowledge transfer by Chinese acquiring firms for this study. The three cases selected ensure external validity and generalizability under different circumstances based on the following five criteria. First, the firms all come from different industries. Second, both state-owned and privately owned firms are represented in the cases. Third, the cases cover different geographic and social context features. Fourth, the acquired firms come from different countries and have differing corporate cultures. Finally, the cases cover both successful and failed integration. With regard to internal validity, the polar cases chosen in this paper all took place in the first decade of this century, a period during which China experienced rapid economic growth. The three Chinese firms also acquired target firms from developed markets. These similarities make the polar cases comparable. The details of the acquiring and acquired companies are as follows: Chinese Company A was a small privately owned local company focused on the cash-in-transit vehicle manufacturing industry prior to acquiring UK Company B. UK Company B was a world leading cash-in-transit vehicle manufacturer located in the United Kingdom before it was acquired by Chinese Company A in 2003. After successfully integrating UK Company B, Chinese Company A became the world’s largest cash-in-transit vehicle manufacturer and occupied more than one-third market share in both Europe and China.

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Chinese Company C was a sizeable state-owned enterprise in the sewing equipment industry. The firm suffered from continuous financial losses until they strategically acquired Germany Company D, which was a famous sewing equipment manufacturer located in Germany, in 2005. After acquisition, Chinese Company C started to make a profit and sold 75% of its products to developed markets. Chinese Company C successfully obtained advanced knowledge from Germany Company D and benefited from the synergy between itself and the acquired firm. State-Owned Company E was a leading company in the Chinese television (TV)-manufacturing industry and occupied about 30% of the local market share before they undertook a cross-border acquisition. In 2003, Chinese Company E successfully acquired the French firm, French Company F, through leverage acquisition. However, in the following two years, during integration, the new Chinese Company E lost US$1 billion and had to sell the acquired company in 2005. Since then Chinese Company E has not been able to return to being within the top five Chinese TV manufacturers. The main features of the three polar firms are shown in Table 1.

Table 1.

A Summary of Major Characteristics of Three Selected Cases.

Characteristics Ownership structure Industry

Status in industry before acquisition Status in industry after acquisition

Nationality of acquired firm Status of acquired firm in industry

Knowledge transfer results

Case 1 Chinese Company A

Case 2 Chinese Company C

Case 3 Chinese Company E Co. Ltd.

Privately owned Cash-in-transit vehicle manufacturing Small local company in China World’s largest cash-in-transit vehicle manufacturer United Kingdom

State-owned Sewing equipment

State-owned Sewing equipment

Large company in China in financial difficulty Earning profit and selling 75% of its products to developed markets Germany

Leading company in China (30% of local market share) Laggard firm in local television manufacturing industry France

World leading cash-in-transit vehicle manufacturer

Sewing equipment manufacturer famous throughout the world

Successful

Successful

Former leader in world television manufacturing industry in the 20th century Failed

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Data Collection We employed different methods of data collection to ensure research validity through cross-data comparative analysis. The majority of our data were collected from first-hand interviews, and we also use secondary sources including company annual reports, newspaper reports, industry studies, and academic papers. First, we collected and categorized secondary data from annual report, newspaper, and magazine articles to summarize key elements. Then we collected qualitative data through semistructured in-depth telephone interviews which were conducted in May 2011. Interview-based research is often most favorable when the focus of research is on the depth rather than the breadth of data (Daniels & Mark, 2004). Senior managers who were involved in the after merger integration process for each case were selected as the key informant for this research and were invited to participate in the study. A predesigned protocol was used to guide the interview process for consistency across interviews. The majority of the interviews were audio-recorded. Extensive interview notes were taken in cases where interviewees did not want the interviews recorded. In total, we conducted 11 interviews with staff and managers of various levels in the three firms. The details of the data collection methods are listed in Table 2.

Table 2. Three Cases

Chinese Company A

Chinese Company C

Chinese Company E Co. Ltd.

Overview of Data Sources.

Secondary Sources

Number of Informants Interviewed

Informants Interviewed by Type

Company history, company internal documents, industry reports, newspaper and magazine articles Annual report (6), company announcements, industry reports, newspaper and magazines articles Annual report (5), company announcements, newspaper releases, academic research papers

4

1 executive director (4 hours) 3 employees (5 hours)

3

1 general manager (3 hours) 2 employees (4 hours) 1 senior manager (1 hour) 3 employees (6 hours)

4

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ANALYSIS AND FINDINGS Case Description Case 1: Chinese Company A-UK Company B: Low-level Control and Successful Knowledge Transfer Chinese Company A is a Chinese privately owned cash-in-transit vehicle manufacturer which acquired the UK Company B in 2003. Before conducting acquisition, Chinese Company A was a small manufacturer without advanced technology, although it had accumulated substantial profits from the local market. Because top managers in Chinese Company A were aware of the importance of advanced technology to the firm’s long-term development, they believed that knowledge transfer must be the major objective for the firm’s cross-border acquisition. During the first year of integration period, the parent company forced the newly acquired firm to follow its operational patterns (which indicates a high-level of control), in order to reduce the operational costs of the acquired firm and facilitate knowledgesharing between the two organizations. However, feedback from acquired firm in the UK indicated that the new subsidiary continued to lose money and that many key employees in R&D department intended to resign from their jobs. The senior managers of Chinese Company A conducted a thorough investigation into the UK subsidiary and found the employees believed that the only thing that was important to Chinese Company A was advanced technology. They feared being abandoned if key technology was transferred to the Chinese parent firm. Employees of the former UK Company B felt very disappointed to work for a Chinese firm when their company had previously been a leader in its field. Based on the findings regarding the hostile attitudes of UK employees, top managers in Chinese Company A decided to change management control policy from high-level control to low-level control. Specifically, the CEO said: We changed management style to UK subsidiary, and gave substantial autonomy to managers in that subsidiary … the annual objective of UK subsidiary was negotiated by top managers in both parties … We did not interfere operation management of UK subsidiary and only offered some supports if they needed … we tried our best to convince them that they, rather than existing patents, are key resources of the new Chinese Company A-UK Company B Company … we promised our UK employees that we would not lay off anyone of them even though the UK subsidiary was losing money ….

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In the following two years, the UK subsidiary began to make profits, and UK employees began to trust their new Chinese parent firm. As recalled by the CEO, UK employees were gradually willing to cooperate with staff from the Chinese parent firm, and they were also willing to help the Chinese parent company to improve the quality of their products. After two years of low-level control, most UK employees realized that they were key components of Chinese Company A and their performance significantly affected the development of the whole company. As suggested by top managers in the UK subsidiary, a new mechanism used to improve designing capability (absorptive capacity) of the Chinese R&D department was established. UK top managers reported that their engineers were willing to evaluate and revise the design of Chinese R&D department. The new process began with the UK R&D department making an initial plan about the new design. Chinese R&D employees were then responsible for completing the design experienced UK engineers would then evaluate and revise the design made by Chinese engineers. Finally, engineers from the two R&D departments would discuss and decide on the final version of new vehicle model. Case 2
Chinese Company C: Low-level Control and Successful Knowledge Transfer Chinese Company C is a Chinese state-owned company in the sewing equipment industry. In 2005 it acquired Germany Company D which was a famous sewing equipment manufacturer located in Germany. In regards to the motivation for this acquisition, the General Manager of Chinese Company C said: Although Chinese Company C was the leader in Chinese local market before acquisition, our products could only occupied low-end market. In an era of globalization, a firm cannot survive without advanced technology and substantial market share in global market. In order to obtain advanced technology from developed markets and enter high-end global market, we planned to acquire Germany Company D Corporation, a leading company in this industry.

Thus knowledge transfer from the acquired developed-market firm was the major objective for Chinese Company C. Unlike Chinese Company A, managers in Chinese Company C conducted a thorough investigation into Germany Company D before acquisition. Through this investigation, Chinese Company C’s managers found that fear of abandonment and hostile attitudes were severe among Germany Company D’s employees.

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They also found that language difference between Chinese and German employees contributed to a substantial communication barrier. Based on these findings, Chinese Company C’s managers believed that high-level control of Germany Company D would be ineffective for Chinese Company C’s post-acquisition knowledge transfer. Thus, Germany Company D was given sufficient autonomy soon after the acquisition. Regarding the low-level control policy, the General Manager recalled: We tried our best to retain managers and key employees in Germany Company D after the acquisition, and promised them substantial autonomy for firm’s operation … We only sent a vice president to Germany Company D in order to be aware of Germany Company D’s strategies and give our Germany Company D supports if needed …. In 2006, when former CEO of Germany Company D retired, we showed respect to our German employees through hiring a new German CEO by their recommendation …. Top managers of Germany Company D were invited to discuss new Chinese Company C’s future strategy with us before we implemented these new strategies.

In 2007, Germany Company D started to gain profit, with more than 75% of new Chinese Company C Group’s products being sold to developed markets. With the help of Germany Company D’s engineers in improving Chinese Company C’s product quality, the local market share of Chinese Company C increased by 20% between 2005 and 2007. This indicates a successful knowledge transfer to Chinese Company C. The General Manager explained: After showing our sincerity to Germany Company D’s employees, they began to believe that they were important components of new Chinese Company C Group …. Then we found that they (Germany Company D employees) were willing to cooperate with our staffs for improving product quality …. Then our two parties exchanged engineers each quarter. Chinese engineers sent to Germany Company D were taught by Germany Company D’s experienced engineers for product designing, while Germany Company D’s engineers sent to China learned how to improve product in order to accommodate big Chinese market …. Germany Company D’s engineers were also willing to help us optimize production process, which improve our product quality and reduced our production cost.

The General Manager also admitted that environments with low-level control by management gave Germany Company D more time to adapt to working with new Chinese parent, and this mitigated any negative effects of language barriers. Low-level control policy also gave two parties sufficient elasticity to make compromises with and accommodate each other, which again reduced the influence of communication difficulty due to language differences.

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Case 3
Chinese Company E: High-level Control and Unsuccessful Knowledge Transfer Chinese Company E is a Chinese state-owned corporation in the TVmanufacturing industry. In 2003, Chinese Company E acquired Francebased French Company F, which was the world leader in the TVmanufacturing industry. The senior manager of Chinese Company E admitted that getting advanced technology from French Company F was the major objective and motivation of the acquisition. French Company F’s more than 30,000 patents regarding TV were attractive to Chinese Company E, and French Company F’s large manufacturing capacity would lead Chinese Company E to being the world’s largest TV manufacturer after acquisition. Thus, Chinese Company E’s managers believed that this acquisition would facilitate the development of the firm. However, as recalled by the senior manager, Chinese Company E’s managers were overconfident about their integration capacity because of previous successes in China. During the negotiation procedure before acquisition, Chinese Company E insisted that the acquired firm must follow Chinese Company E’s operation patterns in order to reduce production costs. Although French Company F was finally sold to Chinese Company E because of its severe financial problems, its former parent refused to give Chinese Company E any patents regarding TV, which meant Chinese Company E had to negotiate with former parent to obtain each patent and they also had to make additional payments for each patent. Chinese Company E’s French employees refused to cooperate with their new Chinese parent during the integration procedure. Even though both parent and subsidiary were under the same organizational structure through highlevel control, the hostile attitude of the French employees made it difficult for managers from Chinese Company E to effectively manage the operation of the new French subsidiary. Additionally, language differences between Chinese and French employees resulted in difficulties with French employees fully understand the meaning of the orders of their Chinese managers. Many key employees in French Company F felt disillusioned regarding the Chinese Company E as the new parent company and chose to leave their jobs within the first few months after the acquisition. Because of the financial problems that came with the acquired firm and the unsuccessful knowledge transfer, Chinese Company E had to sell French Company F two years after acquisition. Chinese Company E lost US $1 billion and a substantial market share during the integration period, with no benefits gained from the acquisition of French Company F.

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Coding and Analysis Coding was undertaken by summarizing the data gathered in the interviews and identifying several key categories from each firm. As the analysis proceeded, categories were merged into more aggregate constructs. Interview data were analyzed following the procedures suggested by Yin (2003) and Eisenhardt (1989). First, building on the data collection from interviews, we developed a within-case analysis for each firm. This was followed by a cross-case analysis, which contrasted the firms across multiple categories (Gerring, 2004; Miles & Huberman, 1994). Data were analyzed by comparing the presence or absence of causal conditions with the presence or absence of outcomes. Finally, the results of the examination of similarities and differences between cases were compared with theoretical argument. Consistency across cases and between the empirical results and theoretical arguments were used to derive conclusions. Table 3 outlines the progression of data coding, categorization, and analytical dimensions. In the first stage of our analysis, we identified the general situations faced by firms in each case based on the firm-specific narratives we constructed. We identified the situations of the firms from the aspects of the relative status of the acquiring and acquired firms, the attitude toward M&A of the employees of the target firm, the willingness of employees to cooperate, cultural differences, conflicts in previous practice, and the learning ability of the acquiring firm. As the second column in Table 3 shows, these various situations involved considerable conflicts with the target firm, and thus there were significant challenges to knowledge transfer. In the second stage, we analyzed the response of parent companies to the situations that arose in the ancillary companies, situations that were resulted from the initial level of management control. These situations arose in the subsidiaries affected the quality of knowledge transfer. Chinese Company A and Chinese Company C chose low-level management control to give acquired firms autonomy, and they also promised not to lay off workers. This gradually reduced the hostility of target firm employees and contributed to building trust between the acquired and acquiring firms. In contrast, Chinese Company E stuck to their high-level management control strategy, which further provoked the discontent of their subsidiary employees. Subsidiary workers were unwilling to share knowledge or to cooperate, which made it impossible for Chinese Company E to engage in learning transfer. Cultural conflict created more problems and finally Chinese Company E had to sell the subsidiary company.

Situation

Progressions of Categorization and Analytical Dimensions. What Did the Firm Do

What Was the Result of the Strategy

Result of Knowledge Transfer

Local manufacturer acquires Loosened their management Gradually built trust with subsidiary employees; control on the subsidiary; leading company in the alleviated hostile attitude gave subsidiary managers industry who has high end of UK employees; UK autonomy; promised not technology; acquired firm subsidiary employees are to lay off UK employees; employees are ashamed of more willing to cooperate built new procedure in being acquired and of and help increase the subsidiary to reconcile working for a Chinese product quality of the previous conflicts. firm; employees very Chinese firm; UK reluctant to cooperate and subsidiary started to turn afraid of sharing a profit. knowledge; huge difference in culture and company common practice; low ability of learning due to hostile attitude of target firm.

Knowledge starts to transfer from UK subsidiary to Chinese parent due to willingness of employees to share information; Chinese Company A’s ability to learn was increased with direct help from UK subsidiary employees.

Chinese Company C

Subsidiary employees Acquiring firm takes lead in Chose low-level started to cooperate to management control Chinese market but has improve product quality; strategy; gave subsidiary no high end technology; headquarter and autonomy of nominating acquired firm employees subsidiary exchange CEO; involved new are very hostile to Chinese engineers periodically; subsidiary in headquarter parent firm and are afraid subsidiary started to turn strategic planning; of being laid off; huge a profit. worked actively to cultural difference and reconcile cultural conflict. severe cultural conflict; low ability to learn due to limited exposure to subsidiary knowledge.

Transfer of technical knowledge became possible due to positive exchange between engineers; production processes upgraded in Chinese parent company.

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Table 3.

Situation Chinese Company E

Acquiring firm is an industry leader in local market, while they still lack core and high end technology; acquired firm has high end technology; huge cultural differences.

What Did the Firm Do Forced the new subsidiary to follow operation patterns of the parent firm; little effort devoted to reconcile cultural conflicts.

What Was the Result of the Strategy Subsidiary employees felt disrespected and were unwilling to cooperate; subsidiary refused to give acquired firm patents; cultural conflicts increased.

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Table 3. (Continued ) Result of Knowledge Transfer Knowledge transfer becomes impossible; the M&A case failed.

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We subsequently compared the presence and absence of specific management control strategies of firms and the effect on knowledge transfer. Management control strategies are sorted into two categories in terms of the extent of control, which are low-level management control and highlevel management control. The results of knowledge transfer are categorized as either success or failure. In the final stage of analysis, we conducted cross-case comparisons to identify how particular management control strategies and success or failure of knowledge transfer are interrelated, that is, the mechanism through which management control strategy influences impacts knowledge transfer in terms of its success or failure. We identified two aspects that direct the choice of management control strategies of firms. These are the willingness of employees to cooperate with the new parent company and cultural difference, as shown in the fifth column of Table 3. Based on the categorization and codification, we developed propositions for understanding the influence of specific management control strategies on firm knowledge transfer, as well as the mechanisms that facilitate the knowledge transfer process. In the Chinese Company A-UK Company B M&A case, we observed that low-level management control over target firm facilitated the knowledge transfer to Chinese Company A. Chinese Company A acquired UK Company B to obtain cross-border knowledge transfer as they were aware that advanced technology is crucial to the future long-term development of firms. Chinese Company A adopted a high-level control in the first place, forcing the subsidiary to adopt its operational patterns. But this way of integration increased the concern of UK employees that they would be laid off and increased the sense of disappointment of being acquired by a company that are not as famous as their previous employer. The UK employees were reluctant to cooperate with their new Chinese parent firm, and many key employees in the R&D department intended to leave their jobs. The new subsidiary continued to lose money. Based on a thorough investigation into the hostile attitudes of UK employees, the Chinese parent adjusted its control policy over the new subsidiary from high-level control to low-level control, and gave substantial autonomy to the newly acquired firm. Chinese Company A also convinced its UK employees of their vital importance to the company and promised that the company would not lay off workers even if the subsidiary is at a loss. The negative impact of hostile attitudes and the fear of abandonment from UK employees were effectively mitigated, and UK employees became willing to cooperate with staff from the Chinese parent company. Moreover, UK engineers were willing to help the Chinese R&D department to improve absorptive capacity through

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a specialized mechanism, which also promoted the knowledge transfer process. Findings from this case suggest that low-level control encouraged Chinese Company C’s knowledge transfer process. Chinese Company C investigated its newly acquired German subsidiary and found out that the concerns of employees that they might be laid off and their hostile attitude toward the Chinese parent firm were very serious problems. Also, the cultural difference between China and Germany also posed communication obstacles between the Chinese firm and its new German subsidiary. As with Case 1, Chinese Company C’s low-level control policy enhanced the cooperation and willingness of its German employees, and also increased Chinese Company C’s absorptive capacity (with the help of Germany Company D’s engineers) and coordination with Germany Company D, which facilitated knowledge transfer. In addition, a low-level control policy mitigated the passive impacts of language barriers for both parties, which then reduced related potential conflicts during the knowledge transfer process. The Chinese Company E case indicated that high-level control of an acquired firm by an EE firm is ineffective for knowledge transfer. As the hostile attitude of employees could not be mitigated through high-level control, Chinese Company E’s French employees were reluctant to cooperate with their newly assigned Chinese managers. Moreover, language barriers made communication between Chinese managers and French employees especially difficult and created substantial discrepancy between the two parties. Therefore, Chinese Company E’s “selling” decision could be treated as a passive response to its false control policy and unsuccessful knowledge transfer. Our findings shed light on the factors and processes which influence the relationship between the management control policy of an EE firms and corresponding knowledge transfer results. All three cases indicated hostile attitudes and fear of abandonment in employees in acquired firms existed and had significant negative impacts on the parent company’s knowledge transfer when a developed-market enterprise was acquired by an EE firm. The two successful knowledge transfer cases suggest that low-level management control of acquired developed-market firms mitigate the negative influences of the hostile attitudes of employees to the new parent EE company. Low-level management control also enhances the willingness of subsidiary staff to cooperate with staff in the new parent company. The only unsuccessful case, whose failure can be mainly attributed to high-level management control policy, also supports my argument. The two successful cases also indicate that increased cooperation and willingness of the staff of

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the acquired firm can enhance the absorptive capacity of the parent company and promote coordination between employees in both acquired and acquiring firms. This would then facilitate the knowledge transfer process from the new subsidiary to the parent EE company. Accordingly, we put forth the following: Proposition 1. For emerging economy firms which lack ownership advantages and learning experiences, low-level management control of acquired developed-market firms will encourage the cooperation and willingness of employees in the subsidiary firm with the new parent company. This will then enhance the absorptive capacity of the parent company and the coordination between the acquiring and acquired firms. This, in turn, will facilitate the knowledge transfer for emerging economy firms after cross-border acquisition. Moreover, two cases, Chinese Company C and Chinese Company E, revealed that language barrier, as a specific form of cultural barrier, is also an important factor influencing the management control policy EE firms. Low-level management control can effectively mitigate the cultural barriers between a parent firm and its subsidiaries, and therefore alleviate the negative effects of cultural difference on knowledge transfer from developedmarket firms to EE firms. Accordingly, we put forth the following: Proposition 2. For emerging economy firms engaging in cross-border M&A, low-level management control can significantly mitigate common cultural barriers and therefore alleviate the negative effects of cultural difference on knowledge transfer from developed-market firms to emerging economy firms. Based on our results, the mechanism through which low management control contributes to knowledge transfer can be depicted in a conceptual model (see Fig. 1). The conceptual model suggests that absorptive capacity, coordination, and language barriers play important roles in the knowledge transfer process of the upward M&As conducted by EE firms. Low-level management control can enhance the capabilities of EE firms in terms of their knowledge transfer from acquired firms, due to increased cooperation willingness of acquired firms under low-level management. It can also mitigate the costs of language barriers as it reduces unnecessary conflicts and preserves the existing organizational structures and communication mechanisms of acquired firms.

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Reinforce

Low-level Management Control of Acquired Developed Market firm

Employees’ Cooperation Willingness with New Parent Company

Mitigate

Fig. 1.

Enhance

Absorptive capacity of Parent Company

Enhance

Coordination Between Acquiring and Acquired Firms

Cultural Difference

Facilitate

Facilitate

Impede

Knowledge Transfer From Acquired Developed Market Firm to Emerging Economy Firm

Theoretical Model of Knowledge Transfer.

CONCLUSION This study extended existing M&A research regarding the relationship between the management control policy of acquiring firms and the effectiveness of knowledge transfer to the acquiring firm. Based on organization learning theory (Brown & Duguid, 1991; Crossan et al., 1999; Dodgson, 1993; Fiol & Lyles, 1985; Hitt et al., 2000; Huber, 1991), this study emphasized the importance of the attitudes of employees to the new parent company, and claims that: 1. For EE firms which lack ownership advantages and learning experiences, low-level management control of acquired developed-market firms will reinforce the cooperation willingness of their employees with the new parent company. This will then enhance the absorptive capacity of the parent company and coordination between acquiring and acquired firms, which will then facilitate the knowledge transfer of EE firms after the cross-border acquisition and 2. For emerging economy firms engaging in cross-border M&A, low-level management control can significantly mitigate common cultural barriers and therefore alleviate the negative effects of cultural difference on knowledge transfer from developed-market firms to EE firms. The findings of this study hold both theoretical and practical implications. Theoretically, this study sheds light on cross-border knowledge

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transfer phenomena from an organizational learning perspective. Unlike post-acquisition knowledge transfer conducted by enterprises from developed markets, the cross-border knowledge transfer process of EE firms will be significantly influenced by the hostile attitudes of employees toward the new parent company. Organizational learning theory provides a theoretical lens through which to investigate in depth why low-level management control of acquired developed-market firm facilitates knowledge transfer for EE firms. In relation to business practice, this study suggests that low-level management control of acquired developed-market firms was more appropriate for the cross-border knowledge transfer of EE firms than high-level management control. This was especially true when the parent company from the EE had limited learning experience and had substantial language barriers between it and its acquired firm. Although the outcome of this research showed promise for continued study and had implications for both scholars and practitioners, it is important to acknowledge some caveats. First, these findings were limited in context, since the study focuses solely on EE firms in a single country (China). Future research could explore whether similar results to this study occur within the contexts of other countries. Second, although we would have liked to explore the relative extent of influence poses by different factors on the knowledge transfer process, we acknowledge that a lack of related information and the limited number of cases made this exploration unsuitable. Future research could examine the relative extent of influence poses by different factors on the relationship between management control and knowledge transfer effectiveness. For these reasons, caution should be exercised when generalizing the findings of this study. Further corroboratory research is needed along the theoretical lines of this study. Future research would extend the contribution of this study by examining the knowledge transfer mechanism of EE firms through qualitative and quantitative methods, using improved measures and finegrained datasets.

ACKNOWLEDGMENT This research was supported by the Program for Excellent Talents, UIBE, and the UIBE Networking and Collaboration Center for China’s Multinational Business. The authors would like to express appreciation for the editor’s guidance and constructive comments.

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989.

THE INTERNATIONALIZATION OF RUSSIAN MOBILE TELECOMMUNICATIONS OPERATORS Olga E. Annushkina ABSTRACT Purpose
This study addresses foreign markets selection decisions by Russian mobile telecommunications operators and the impact of top management team composition on the degree of firms’ internationalization. Design/methodology/approach
The qualitative exploratory study analyzed 24 foreign market entry decisions and the composition of the top management team of the two leading Russian mobile telecommunications operators, VimpelCom and Mobile Telesystems (MTS/AFK Sistema). Findings
Russian mobile telecommunications operators adopted a gradual approach to foreign market selection, as the study revealed the positive impact of the target market’s geographic proximity to Russia on the investment decision. The international background of the top management team was positively related to the increasing distance of the selected foreign markets.

Emerging Market Firms in the Global Economy International Finance Review, Volume 15, 121
144 Copyright r 2014 by Emerald Group Publishing Limited All rights of reproduction in any form reserved ISSN: 1569-3767/doi:10.1108/S1569-376720140000015006

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Research limitations/implications
Further studies may include quantitative evaluation of investment decisions by mobile telecommunications operators from other emerging-market firms, as well as a longer observation period and investment decisions by firms operating in other industries. Practical implications
Russian and other emerging-market firms should evaluate the importance of the top management team composition and international experience prior to initiation of the internationalization process. Originality/value
Russian multinationals represent a relatively understudied phenomenon, despite the importance of outward foreign direct investments from Russia among other emerging-market firms. Keywords: Multinational enterprises; telecommunications; Russian MNEs; emerging-market MNEs; foreign market selection; internationalization of top management teams

INTRODUCTION Since the mid-1990s, multinational enterprises (MNEs) from emerging countries have started to create significant business disruptions for incumbent firms in developed countries, and not only because of their export activities. In 2008
2009 the “new” MNEs experienced a post-crisis shrinking of their home and export markets that intensified the competition on global markets, leading to increasing attention to understanding the globalization intentions of “new” MNEs from emerging countries, often perceived as “invaders” by the incumbent firms. The developed economies had already experienced several successful entries by the “new” MNEs, often indirectly supported by their home governments or new tycoons, leading to “purchases of the crown jewels” of the local economies and obtaining access to new technologies, brands, and distribution channels (e.g., IBM, Benelli, Godiva, Lucchini, Arcelor, Marionnaud, and other firms from the developed economies that were fully or partly acquired by MNEs from emerging countries). In the post-2007 crisis years some of the “new” MNEs experienced stagnation of their home and export markets that generally intensified competition on global markets.

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The structural economic, political, and social reforms of the past two decades have brought, among other changes, new possibilities for local and foreign entrepreneurship and unleashed economic potential in many industries in the emerging economies. The development path of Russian firms that were founded or received their second wind after the launch of reforms in their home countries almost inevitably (with few exceptions, such as Kaspersky Lab, a truly “born global” company) started from their domestic markets. Compared to other BRIC (Brazil, Russia, India, China) economies, Russia experienced the sharpest and quickest economic, institutional, political, social, and cultural changes. After the economic crisis and hyperinflation of the 1990s, the mass privatization of 1992
1994, subsequent monetary reforms leading to a barter-based economy, the economic and financial crisis of 1998, the growth years of the early 2000s, and the slowing growth of the late 2000s, the main goal of Russian firms evolved first from “survival” to “growth at home” and only from the early and mid-2000s did Russian firms start evaluating opportunities in the Commonwealth of Independent States (CIS) and other foreign markets. According to the World Investment Report (UNCTAD, 2013), in 2012 Russia was the eighth largest source of outward foreign direct investments (OFDIs) globally and the second largest investor in terms of OFDIs among BRIC economies after China, even if the top three recipients of Russian foreign direct investments (FDIs)
Cyprus, the Netherlands, and the British Virgin Islands
were also the main sources of FDIs to the Russian economy, suggesting that a part of Russian OFDIs should be better considered as domestic investments (UNCTAD, 2013). The main objective of this study was to analyze the internationalization path of major Russian mobile telecommunications operators. The telecom industry was selected as one of the most relevant industries unrelated to natural resources that was actively growing on international markets. According to the analysis of 443 cross-border deals conducted by Russian firms from 1997 to the first quarter of 2007, telecommunications was among the top five most internationally dynamic industries and the most active one operating in a business-to-consumer (B2C) industry (Table 1). Most Russian mobile telecommunications firms were founded after the launch of the political and economic reforms in the early 1990s. The subsequent concentration of the Russian mobile telecommunications market reduced the number of players to three major operators: VimpelCom, Mobile Telesystems (MTS), and Megafon. Among the top non-financial transnational corporations from developing countries in 2011, Russia was represented by VimpelCom Ltd (telecommunications), Lukoil OAO (petroleum and natural gas), Gazprom JSC

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Table 1. Russian M&A and Joint Venture (JV) Cross-Border Deals (Number), 1997 to June 2007. Acquiring Firm’s Business

Deals Per Industry

Financial services Natural resources extraction Industrial goods and equipment Telecom Metallurgy Food industry Private investors Utilities Other services Chemical industry Consumer goods Media Logistics Automotive Wholesale trade Tourism and hotel industry Construction Government Pharmaceuticals Retail trade Agriculture Entertainment n/a (industry not specified) Total number of deals

90 66 44 41 39 30 25 16 13 9 9 9 8 6 6 5 4 2 2 2 1 1 15 443

Source: Author’s analysis of Zephyr database.

(petroleum and natural gas), Evraz Group SA (metal and metal products), Severstal Group Holdings (metal and metal products), Mechel OAO (metal and metal products), Sistema JSFC (telecommunications), and Rusal (metal and metal products; UNCTAD, 2014). Majority of the Russian MNEs were involved in industries related to the country’s advantageous natural resources endowment: metal, metal products, petroleum, and gas. The object of this research was to investigate the internationalization path of the remaining two MNEs, VimpelCom Ltd and Mobile Telesystems (Sistema JSFC), both an exception to the general rule that sees the outward internationalization of the Russian economy as strongly linked to extraction or primary industries. This case-based research, undertaken through an extensive analysis of firms’ annual reports and the press in both Russian and English, aims at .

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adding new knowledge to the existing international business (IB) theories on multinationals from emerging countries, comparing and contextualizing the research findings to mainstream IB theories built on the basis of the experience of firms from developed economies and to new IB theories built on the empirical analysis of “new” MNEs from emerging countries. This exploratory study may also serve as a starting point for future analysis of the internationalization strategies and strategic management in general of MNEs from emerging countries, in particular from Russia. From the theory development point of view, the study contributes to a better understanding of the international growth patterns of Russian MNEs operating in other than natural resources or primary industries by analysis of their foreign market selection decisions and of the relation between the composition of their top management team and the degree of internationalization.

THE INTERNATIONALIZATION OF RUSSIAN MOBILE TELECOMMUNICATIONS PROVIDERS No single theory, according to Bohr’s (1950) principle of complementarity, comprehensively represents most phenomena. The internationalization of Russian MNEs has been considered from the viewpoints of the role of the state and of the firm’s ownership structures in general (Liuhto & Vahtra, 2007), of industry, with an emphasis on the impact of access to natural resources (Annushkina & Trinca Colonel, 2013; McCarthy, Puffer, & Vikhanski, 2009; Vahtra, 2007), and of export strategies (Filatotchev, Demina, Buck, & Wright, 2001; Filatotchev & Nolan, 2001; Liuhto & Vahtra, 2007), but few studies have been conducted at a single-industry level. The profitable internationalization of operators in the telecommunications industry is driven by the network effect (Rieck, Cheah, Lau, & Lee, 2004) and the first-mover advantage (Muck & Heimeshoff, 2012) on the one hand, and on the other is not limited by the risk of over-expansion, as some studies have shown that the performance of internationalizing telecom firms is not negatively influenced even by a high degree of internationalization (Rieck et al., 2004). By implementing an international growth strategy, telecommunications industry operators may derive a number of benefits that potentially exceed the liability of foreignness and the coordination and control costs related to that internationalization. Through growth on international markets, telecommunications operators may offer a better level of

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service to their internationally traveling retail customers and corporate customers with global activities. The possible benefits also include access to growing markets, the potential to profit from first-mover advantage on newly liberalized markets, and savings related to economies of scale (e.g., in procurement of equipment and of software) and economies of scope (diffusion of marketing, sales, network management best practices across borders). Telecommunications operations do not have the complexity of many other industries, as the core of the service is highly standardized, even if the complete commercial offer to a foreign customer, comprising decisions on pricing, promotion, distribution, and value-added services, may vary greatly from country to country. Once a telecommunications operator has managed to achieve a leading position on the domestic market and to accumulate financial resources and industry competences, the next logical step is to invest in the exploration of new growth options: internationalization and entry to adjacent services (e.g., cable TV services). Foreign markets as a possible growth direction may represent a valid growth alternative for telecommunications firms from developed and emerging markets. MNEs from emerging markets, compared to those from developed markets, are more competitive thanks to the possibility of accessing key resources (such as labor) at lower costs and of exploiting domestic market growth (Aulakh, Kotabe, & Teegen, 2000). However, most of these companies lack global experience and have weak technological and innovation capabilities, a relatively narrow line of products and inexperienced management, as well as demonstrating poor governance and accountability according to international standards (Aulakh et al., 2000; Luo & Tung, 2007). The deficit of financial and managerial resources and of experience in operating outside of domestic markets is one of the underlying factors explaining the potentially gradual approach to internationalization decisions, as described by scholars at Uppsala (Johanson & Vahlne, 1977, 1990; Johanson & Wiedersheim-Paul, 1975). The growing importance of “new” MNEs from emerging markets as outward investors has attracted attention to their decision-making processes in terms of foreign market selection. Some scholars suggest that “new” multinationals from the emerging markets tend to choose a “leapfrog” or “springboard” approach to internationalization (e.g., Luo & Tung, 2007) driven by the market opportunities, and also to select non-equity entry modes, allowing them to “link” to locational advantages with a lower risk exposure (Mathews, 2006). Other studies show that “new” multinationals, at least at the beginning of their internationalization process, tend to operate in the macroregions close to their domestic market (Diaz-Alejardro, 1977; O’Brien, 1980), their location choices determined by

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the foreign market’s cultural, economic, and geographic closeness and the availability of advantageous fiscal conditions. Previous research on the foreign market selection of Russian multinationals (Annushkina & Trinca Colonel, 2013) showed that Russian firms were influenced in their foreign market selection by the cultural, geographic, and political distance between Russia and the target foreign markets, with the exception of firms operating in natural resource industries, which were less influenced by the geographic or political proximity of the foreign market in their investment decisions. The internationalization of mobile telecommunications services is strongly affected by cultural, administrative, political, geographic, and economic (CAGE) distances (Ghemawat, 2007) between the country of origin and a new foreign market. The telecommunications industry is highly regulated, as originally it was considered to be one of the important elements of national security. The marketing, sales, and customer service activities of mobile telecommunications service operators require an extensive distribution network, or at least the possibility of access to a nationally located call center. A relatively high level of local adaptation is also demanded by differences in the level of economic and technological development, local fiscal and regulatory frameworks, local habits in business and private communication, and differences in levels of urbanization and income inequality. The penetration of mobile telecommunications grows with the national pro capita income level, making the economic distances between countries an146important factor to be taken into consideration in the formulation of adaptation decisions. Therefore, the importance of mobile telecommunications operators adapting to every new foreign market makes a gradual approach to foreign market selection more likely, as mobile operators seek to minimize the risks of failure through starting their internationalization by entering markets with lower levels of CAGE differences to the domestic market. Hypothesis 1. Foreign market selection by Russian mobile telecommunications operators is positively influenced by the distance of the target market from Russia, at least in the initial stages of internationalization. Even if several previous studies showed that “new” MNEs often use advanced managerial techniques and innovation (Mahajan & Kamini, 2006; Mathews, 2006), many scholars underline the fact that among the key characteristics of emerging markets is a shortage of skilled labor and of suitable occupants for managerial positions, as managers may lack relevant formal training, might have been promoted for their seniority, or their leadership positions might have been inherited from formerly state-owned

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organizations (Dharwadkar, George, & Brandes, 2000; Du & Choi, 2009; Filatotchev, Buck, & Zhukov, 2000; Gao, Murray, Kotabe, & Lu, 2009; Hitt, Dacin, Levitas, Arregle, & Borza, 2000; Hoskisson, Eden, Lau, & Wright, 2000; Meyer & Estrin, 2001). The difficulty in accessing highly qualified personnel locally may lead the “new” MNE to invite international advisers and managers to launch operations on international markets. Alternatively, the presence of expatriate managers in the top management team, as per the upper echelon theory, may trigger the internationalization decision (Finkelstein & Hambrick, 1996; Hambrick & Mason, 1984; Nielsen, 2010). We expect the decision to internationalize to be strongly related to top management’s international exposure. The key personal characteristics influencing the decision-making process include (Rawls, 1951) the person’s ability to evaluate and create links among the evidence; the desirable outcomes; the probability of those desirable outcomes being achieved; and his or her possible actions and belief in personal efficacy (Bandura, 1995), values, and learning capabilities. Intellectual reasoning ability, values, and learning experiences are strongly linked to a person’s background. Hence, national diversity in the top management team is more likely to contribute to a higher degree of internationalization at the firm. Hypothesis 2. Among Russian mobile telecommunications operators, the number of foreign market entries and the geographic distance of the chosen foreign markets from Russia are positively related to the national diversity of the top management team.

METHODOLOGY This study describes the internationalization process of the two largest Russian mobile telecommunications operators: VimpelCom and Mobile Telesystems (MTS), the only two Russian firms unrelated to natural resources or primary industries present among the top non-financial transnational corporations from developing countries in 2011, according to UNCTAD (2014). The internationalization process was described based on various types of publicly available information: annual reports, 20-F forms, press releases, and articles in the press. The foreign markets selected by two companies were mapped using the geographic distance in kilometers between Moscow (Russia) and the capital of the target foreign market. The study was conducted in relation to the main internationalization decisions

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from the firms’ foundation to 2013 and excluded internationalization decisions that regarded investments in tax havens. As it was not possible to collect valid data on the national background of the management team for all years of the study for both firms, in order to understand the impact of the international background of the firms’ governing institutions on the internationalization decisions, the national background of the Board of Directors, CEO, and Chairman of the Board of Directors was mapped starting from the year of the first internationalization decision by the analyzed firm.

RUSSIAN MOBILE TELECOMMUNICATIONS PROVIDERS INTERNATIONALIZATION: FINDINGS FROM TWO CASES The internationalization of telecom operators in the 1990s and 2000s was aimed at increasing the potential client base, mainly in the mobile telecom segment. Most of the telecom operators (Vodafone, Orange, America Movil) implemented external growth strategies via acquisitions of local mobile telecom operators. The acquired companies were usually integrated into the parent company, thus benefiting from its IT infrastructure and know-how, brand and new marketing strategy, and financial and managerial resources. The analysis of the Zephyr database revealed that from June 1997 to June 2007, the Russian telecom operators conducted 40 deals in 15 countries (including one tax haven), covering 125 million potential clients (excluding financial deals completed in the United States and Virgin Islands) and 293 million of total population. The annual reports and press statements of publicly traded Western telecom operators revealed the following indicators traditionally used to access the potential of a foreign telecom market: number of users and ARPU (average revenue per user), market growth, and, particularly for emerging markets, market saturation. As a preliminary step in the analysis, the number of deals conducted by Russian telecom operators on foreign markets in the above-mentioned period was compared with the following indicators of foreign market attractiveness: total number of mobile telecom users and its growth, GDP per capita, and total population (Table 2), including in our analysis also the largest mobile telecom markets that were excluded by Russian mobile operators.

M&A and JV Deals by Russian Telecom Operators in Foreign Telecom Markets, 1997 to June 2007. Mobile Telecom Users, 2003, mln

Population, 2005, mln

GDP Per Capita, USD, 2005

37 270 159 87 65 57 53

107 69 20 18 42 37 33

143 1,316 298 128 83 58 60

5.349 1.533 41.768 35.593 33.800 30.339 36.851

46 42 37 30 28 26 23 19 17 17 14 13 11 10 10 10 9 8 7

52 50 43 62 66 87 57 65 87 51 20 45 33 74 53 47 51 57 137

186 60 43 107 73 1,103 83 223 39 47 20 16 25 10 11 10 10 16 22

4.289 34.128 26.115 7.180 4.954 726 1.176 1.263 7.527 5.035 35.199 38.296 5.159 11.972 20.252 17.466 35.590 6.833 4.540

Number of Deals by Russian Telecom Operators

5

2 (1 deal in Virgin Islands)

2

1 2 1

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Russia China USA Japan Germany Italy UK (incl. Virgin Islands) Brazil France Spain Mexico Turkey India Philippines Indonesia Poland South Africa Australia Holland Malaysia Czech Republic Greece Portugal Belgium Chile Romania

Mobile Telecom Users: CAGR, 1996
2003 (%)

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Table 2.

7 6 6 4 4 3 2 2 1.3 1.1 1 0.7 0.7 0.3 0.1 0.1 0.05

109 159 116 120 101 117 71 62 102 108 71 127 92 65 442 134 80

31 74 46 11 8 132 3 3 15 10 2 4 4 27 5 3 7

1.617 1.370 1.757 3.244 3.420 863 7.247 3.796 3.783 3.031 6.608 1.450 694 466 464 1.614 360

7

3 1 1 1 1 6 2 3 2

Russian Mobile Telecommunications Operators

Morocco Egypt Ukraine Serbia Bulgaria Nigeria Lithuania Jamaica Kazakhstan Belarus Latvia Georgia Moldova Uzbekistan Kyrgyzstan Armenia Tajikistan

Source: UN World Development Indicators, database Zephyr, 1997
2007.

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Russian telecom operators from June 1997 to June 2007 completed 25 (out of 40) deals in countries with underdeveloped telecom markets and relatively high annual growth rates (exceeding 50% in 1996
2003): Turkey, Ukraine, Kazakhstan, Belarus, Georgia, Moldova, Uzbekistan, Kyrgyzstan, Armenia, and Tajikistan. The overall number of telecom users in those countries in 2003 only slightly exceeded the number of mobile telecom users in Russia (38.8 million in 2003); in terms of potential mobile telecom users, those 10 countries accounted for 191 million of population in 2005, compared to 143 million people living in Russia. Twenty-three out of forty deals were completed in countries with a lower level of economic development (GDP per capita) compared to Russia (Ukraine, Kazakhstan, Belarus, Georgia, Moldova, Uzbekistan, Kyrgyzstan, Armenia, and Tajikistan). The analysis of deals completed by Russian telecom operators from June 1997 to June 2007 indicated their gradual approach to internationalization. Several basic indicators of telecom market attractiveness in terms of its maturity, future growth, and buying potential showed that Russian telecom operators preferred starting their internationalization from nearby markets with lower levels of economic development and at a lower stage of mobile telecom industry development. The analysis of the first and second deals conducted by Russian telecom operators (Table 3) also contributed to confirmation of the Hypothesis 1 proposition on the gradual approach to their internationalization process: most of the first deals were completed in Ukraine, Kazakhstan, or Belarus, ex-USSR republics with the largest Russian population. After the preliminary analysis of internationalization decisions conducted at the industry level, the study followed by mapping the international growth of the two major Russian mobile telecommunications operators: Mobile Telesystems (MTS) and VimpelCom. Both firms were founded with Table 3. Host Countries for the First and Second Cross-Border M&A and JV Deals Completed by Major Russian Telecom Operators. Company Name

First Foreign Market

Second Foreign Market

Belarus (2002) Kazakhstan (2004) Kazakhstan (2000) Ukraine (2002) Ukraine (2005)

Ukraine (2003) Ukraine (2005) USA (2000 and 2001) Uzbekistan (2004) Moldova (2006)

MTS VimpelCom Golden Telecom Alfa Telecom (affiliated with VimpelCom) Evroset Source: Author’s analysis of Zephyr database.

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the participation of foreign investors, but from the beginning VimpelCom has shown a higher degree of internationalization in both the composition of its top management team and its selection of foreign markets. A synthesis of top management team composition is shown in Table 4. In VimpelCom, non-Russian members on the Board of Directors were in a majority since its foundation, except for 2012 (VimpelCom, 1996
2013). In the same period, VimpelCom always had a non-Russian CEO or Chairman of the Board of Directors, except for 2008. In contrast, MTS’s top management was predominantly Russian’s (MTS, 2001
2013). Its first nonRussian Chairman of the Board was appointed in 2006. In the period 2002
2013, MTS had a non-Russian Chairman for only five years in total, in 2006
2007 and 2009
2011. In the same period, MTS had a non-Russian CEO for three years, in 2011
2013. Among the members of the Board of Directors, non-Russians were always in a minority, with a maximum of four members out of nine in 2009. In “new” MNEs few “native” managers have been exposed to international markets (Filatotchev, Liu, Buck, & Wright, 2009). The exception in the case of VimpelCom and MTS was Alexander Izosimov, with an MBA from Insead (Fontainebleau, France) and work experience in London Table 4. Top Management Team Composition of Mobile Telesystems (MTS) and VimpelCom: Number of Non-Russian top Managers. Year

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Mobile Telesystems (MTS)

VimpelCom

CEO

Chairman of the Board

Board of Director Members

CEO

Chairman of the Board

Board of Director Members

0 0 0 0 0 0 0 0 0 1 1 1

0 0 0 0 1 1 0 1 1 1 0 0

3 (out of 7) 3 (out of 7) 3 (out of 7) 2 (out of 7) 2 (out of 7) 2 (out of 7) 3 (out of 9) 4 (out of 9) 4 (out of 10) 4 (out of 9) 3 (out of 9) 3 (out of 9)

1 0 0 0 0 0 0 0 0 1 1 1

1 1 1 1 1 1 0 1 1 1 0 0

6 (out of 10) 5 (out of 9) 5 (out of 9) 6 (out of 9) 5 (out of 9) 5 (out of 9) 5 (out of 9) 5 (out of 9) 5 (out of 9) 5 (out of 9) 4 (out of 9) 5 (out of 11)

Source: Author’s analysis of firms’ annual reports (MTS, 2001
2013; VimpelCom, 1996
2013) and media coverage.

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(UK) and Stockholm (Sweden), who served as VimpelCom’s CEO from 2003 to 2009 (Telenor, 2009). Both VimpelCom and MTS were founded in the early 1990s in Moscow and the internationalization of both firms started around the same period, 2002 for MTS and 2003 for VimpelCom (MTS, 2001
2013; VimpelCom, 1996
2013). Mobile Telesystems (MTS) was created as an entrepreneurial project of Moscow City Telecommunication Network (MGTS), Deutsсhe Telecom (DeTeMobil), Siemens, and several other minority shareholders in October 1993, with the share capital split between Russian shareholders and the two German firms 53%/47% (MTS Annual report, 2012). In 1996 a Russian conglomerate, JFC Sistema, bought out the shares of the Russian founding partners (53%), while DeTeMobil bought out the shares of Siemens (MTS Annual report, 2012). Ownership by JFC Sistema gave MTS access to financial resources, together with assistance in acquisitions and postacquisition integration, and in lobbying activities with the State and other stakeholders. MTS started operating in Moscow and the Moscow region in 1994 and after three years of significant growth, the company launched its regional expansion in Russia by obtaining licenses for Tver and Tver regions, Kostroma and Komi Republic in 1997, by acquiring the Russian Telecommunication Company (Russkaja Telefonnaja Kompanija) and accessing the regions of Smolenk, Pskov, Kaluga, Tula, Vladimir, and Ryasan (all in Central Russia) (MTS, 2014). The company continued its growth in Central Russia and the Urals, combining greenfield building of new networks, alliances, and acquisitions (MTS, 2014). In 2000 MTS made an initial public offering (IPO) and its American depositary receipts (ADRs) were listed on the New York Stock Exchange (NYSE) (MTS, 2001
2013). By the end of 2003, mainly thanks to acquisitions of regional operators, MTS services were available in 76 regions with 127.3 million of population (MTS, 2003
2004). By 2007 the company was operating in all Russian regions except for two regions in the far east (MTS, 2007a, 2007b). The internationalization of MTS started in 2002 with entry to Belarus in 2002 (MTS, 2014), followed by acquisition of 100% of the shares of UMC, the leader in mobile telecommunications in Ukraine, in 2003 (MTS, 2003). In 2004 MTS acquired 74% of the share capital of Uzdunrobita, an important mobile operator in Uzbekistan (MTS, 2004). In 2005 MTS started operations in Turkmenistan with the acquisition of Barash Communications Technologies (MTS, 2005a). In 2005 MTS acquired a 51% share in Tarino Ltd, the owner of Bitel, a mobile telecommunications

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provider in Kyrgyz Republic, with the possibility of acquiring the remaining shares by 2006 (MTS, 2005b). The acquisition was followed by a long legal dispute with VimpelCom, another Russian operator, who also claimed ownership of Bitel. The dispute was settled in 2013 with MTS receiving a settlement and renouncing the Kyrgyz market (Reuters, 2013). According to Zephyr database, in 2004 MTS started considering for the first time the growth potential of markets that were not part of the former Soviet Union by opening a subsidiary in Turkey via its parent company, AFK Sistema. In 2005 MTS participated in a tender to acquire Telsim, a Turkish mobile telecommunications operator. The tender was won by Vodafone Group (RiaNovosti, 2005). In 2005, MTS announced its interest in international expansion into the Middle East, India, and Central and South-East Asia. The following year it made several attempts to increase its international presence significantly by participating in tenders for Global System for Mobile Communications (GSM) licenses in Iraq (PMR, 2006), Egypt (Teagarden, 2006), and Saudi Arabia (Sostav, 2006), but without success, as the tenders were won by mobile operators from the Middle East. In the same year MTS considered participating in the privatization of one of the largest mobile operators in Serbia (Sotovik, 2006a) and a mobile operator in Bosnia (Sotovik, 2006b), but after the initial interest the parent company of MTS, JFC Sistema, renounced its participation in both deals. In 2006 MTS also intended to participate in the privatization of Algir-Telecom (Finam, 2006), but later withdrew from the deal. According to Zephyr database, in the same year it founded subsidiaries in the Netherlands and Bermudas. In 2006 MTS also started negotiations with the Italian company Pirelli Spa for the acquisition of Telecom Italia, the largest mobile telecommunications operator in Italy, which was at that time suffering from significant financial difficulties, but the deal was not concluded (De Rosa, 2007). Regardless of its numerous failed attempts in 2006 to increase its presence outside of former Soviet Union territory, MTS announced its intention to increase its presence on the international markets further, also outside of the CIS. Later, during one of the meetings of the Board, it was announced that the company intended to change its internationalization strategy. In the first place, MTS announced the intention to change its evaluation methodology by replacing financial analysis with strategic analysis of a potential acquisition target and eventually to consider paying a premium price if the target asset was to be considered strategic by the company. Second, it declared its intention to focus on potential growth, also via acquisitions, in CIS countries (Sostav, 2007).

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In 2007, MTS consolidated its presence in CIS countries by obtaining Universal Mobile Telecommunications System (UMTS) and Worldwide Interoperability for Microwave Access (WiMax) licenses in Uzbekistan (MTS, 2007a) and a 3G license in Armenia (MTS, 2007b). In 2007, MTS acquired 80% of the shares in the leading Armenian operator, K-Telecom (which had the VivaCell trademark) (MTS, 2007b). In the same year MTS attempted to acquire Magticom, one of the largest mobile telecommunications operators in Georgia, but the asset was acquired by a British investment fund, Sun Capital Partners Ltd, and several Georgian entrepreneurs (Kommersant, 2007). In 2007 AFK Sistema completed its first deal in the mobile telecommunications industry outside of the CIS by acquiring 41% of Shyam Telelink, a mobile operator working in 21 Indian states (BusinessWire, 2007), in 2014 known as Sistema Shyam TeleServices Ltd. In the following years (2008
2014) AFK Sistema and MTS were rumored to be interested in expanding to Kazakhstan (Titus, 2007). In 2014, MTS remained a regional mobile telecommunications operator as it continued the consolidation of its positions on the four international markets outside Russia that it had accessed in the early 2000s, Armenia, Belarus, Ukraine, and Turkmenistan, and is currently refocusing its strategy on diversification into related multimedia and data services, along with most of its Russian competitors. VimpelCom was founded in November 1990 by several Moscow-based engineers working for RTI, a research institute for radio communications inside of Vimpel, a research and production unit of the Soviet military defense system focused on antimissile equipment (Annushkina, Venzin, & Gryaznova, 2012). The start-up, KB Impuls, produced electronic appliances for cable and satellite television and radar detectors for cars. As the Soviet and later Russian State drastically reduced its military spending, Vimpel and RTI management actively searched for civil applications for the existing technologies and infrastructures, and one of the possible applications was mobile telecommunications. In 1991 Vimpel, together with a US entrepreneur, founded two joint ventures: in mobile telecommunications services and in mobile telecommunications equipment. The mobile telecommunications services became operative in June 1994, and in 1996 VimpelCom, with its brand Beeline, became the largest cellular operator in Russia and listed its ADRs on the NYSE to raise additional capital to finance growth. In the years following the 1998 crisis, VimpelCom expanded in Central Russia, Volga, North Caucasus, and Siberia. In late 1990 it innovated by focusing its marketing strategy on the broader population rather than the upper middle class by introducing easy-to-use,

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pre-activated handsets and a prepaid SIM card, managing to capture an important segment of first-time clients. In 1998, Telenor (telecommunications, Norway) acquired 31.6% of VimpelCom common shares (25% and 13 voting shares of the voting stock) and in 2000 Alfa Group (conglomerate, Russia) acquired 25% and two shares (Annushkina et al., 2012). The new ownership contributed financial resources and a new manager: the co-founder of VimpelCom, Dmitry Zimin, had to step down as Jo Lunder was appointed as a new General Director. Augie K. Fabela II, the second co-founder of VimpelCom and its Chairman of the Board since 1995, also stepped down from his position in May and became Chairman Emeritus of VimpelCom. The internationalization of VimpelCom started in 2003 with the acquisition of KaR-Tel, a mobile telecommunications operator in Kazakhstan (Annushkina et al., 2012). The next market was Ukraine. In 2005 VimpelCom acquired a small Ukrainian operator, Ukrainian RadioSystems, generating conflict as one of VimpelCom’s shareholders, Telenor, controlled KyivStar, a second major mobile operator in Ukraine. In 2005 VimpelCom also acquired a majority stake in Tajik mobile operator Tacom LLC. In 2006 VimpelCom acquired Bakrie Uzbekistan Telecom LLC, the fourth largest GSM operator in Uzbekistan, and Unitel LLC, the second largest cellular operator in that country. In 2006 VimpelCom also announced the acquisitions of Armenian telecom operator CJSC ArmenTel and Mobitel, a Georgian mobile operator that at the time of acquisition had not started providing any services. After expansion into the adjacent CIS markets, in 2008 VimpelCom entered Vietnam via a joint-venture agreement under the name of GTEL-Mobile JSC (VimpelCom, 2008). In 2012, after achieving circa 3% of the Vietnamese population, VimpelCom announced the sale of its 49% stake in the joint venture (Economica, 2012). In 2008 VimpelCom acquired a 90% stake in Sotelco, at the time of the acquisition claimed to be the only company in Cambodia holding a wireless license (TeleGeography, 2013). In 2013 VimpelCom sold its 90% stake in Sotelco to its local partner (Telegeography, 2013). In 2011 VimpelCom acquired 50.1% of Kyrgyz mobile network operator Sky Mobile (Telegeography, 2011a, 2011b) and completed the acquisition of Millicom Holding Laos BV, the owner of a 78% interest in Millicom Lao Co., Ltd., a cellular telecom operator with operations in Lao PDR (VimpelCom, 2011). In 2011 VimpelCom acquired the telecommunications assets in Africa, Asia, and Italy of Egyptian entrepreneur Naguib Sawiris, paying in cash and shares (TeleGeography, 2011b). In 2014, VimpelCom was present on

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Table 5. Year

The Internationalization Pattern of Mobile Telesystems and VimpelCom (Distance from Russia, km).a Mobile Telesystems (MTS)

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

2006

2007

2008 2009

The company is listed on NYSE Acquisition of 31.6% of VimpelCom by Telenor (Norway) The company is listed on NYSE Belarus (674) Ukraine (756) Uzbekistan (2,788) Turkmenistan (2,512) Failed attempts to enter Turkey (1,792), Kyrgyz Republic (2,988) Failed attempts to enter Iraq (2,552), Egypt (2,902), Saudi Arabia (3,534), Serbia (1,715), Bosnia (1,901), Algeria (3,342), Italy (2,381) Armenia (1,803) India (via AFK Sistema) (4,338) Failed attempt to enter Georgia (1,642) Failed attempt to enter China (6,232) Announced interest in Kazakhstan (2,269) and Azerbaijan (1,928)

2010 2011

2012 2013 2014

VimpelCom

Withdrawal from Uzbekistan (2,788) Announced interest in Kazakhstan (2,274) and Azerbaijan (1,928) and to return to Uzbekistan (2,788)

Kazakhstan (2,269) Ukraine (756) Tajikistan (2,988) Uzbekistan (2,788) Georgia (1,642) Armenia (1,803)

Vietnam (6,742) Cambodia (7,543)

Kyrgyztan (2,988) Laos (6,815) Orascom deal: Algeria (3,341) Central African Republic (5,967) Burundi (6,626) Zimbabwe (8,218) Bangladesh (5,547) Pakistan (3,656) Italy (2,381) Canada (7,166) Withdrawal from Vietnam (6,742) Withdrawal from Cambodia (7,543)

Source: Author’s analysis of firms’ annual reports and media coverage. Distance from Moscow to the country’s capital, km (http://www.distancefromto.net/. Accessed on June 12, 2014). a

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more than one global market with its operations organized into five business units: Russia, Italy, Africa (Algeria, Central African Republic, Burundi, Zimbabwe), Asia (Laos, Bangladesh, Pakistan), and Ukraine and CIS (Kazakhstan, Uzbekistan, Kyrgyzstan, Armenia, Tajikistan, and Georgia). A summary of the internationalization decisions by MTS and VimpelCom is shown in Table 5.

DISCUSSION AND CONCLUSIONS The analysis of the internationalization decisions by MTS and VimpelCom confirmed the proposition of Hypothesis 1 about the gradual nature of the firms’ approach to foreign market selection. While one of the key motivations for entering foreign markets for both firms was market-seeking (Dunning, 1988), the internationalization decisions were driven primarily by the proximity of the target markets rather than by analysis of the future market potential. Both firms started their international growth from neighboring markets with significant historical, cultural, and linguistic ties to Russia, Ukraine, and Kazakhstan. The subsequent decisions guided both firms to seek entry to other former Soviet Union markets, characterized by geographic, cultural, historical, linguistic, and institutional proximity to Russia. After the initial stage of internationalization, VimpelCom concluded an important deal that insured it access to markets outside of the CIS area. Hence, the internationalization pattern of foreign market selection showed a gradual approach to internationalization (Johanson & Vahlne, 1977, 1990; Johanson & Wiedersheim-Paul, 1975) by both VimpelCom and MTS. During the period of study of top management team composition, 2002
2013, the internationalization of VimpelCom was guided by a Board of Directors with a stronger presence of non-Russian members compared to MTS. Between 2002 and 2013, only in 2012 did the Board of Directors of VimpelCom have a majority of Russian members. In 2002
2013 at least one of the top managers of VimpelCom (CEO or Chairman of the Board of Directors) was not a native Russian. In the same period the Board of Directors of MTS always had a majority of Russian-born directors. In 2002
2005 and in 2008 both top managers of MTS (CEO and Chairman of the Board of Directors) were Russian. The comparison of the top management teams’ national diversity with the results achieved by both companies on global markets confirmed the

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proposition of Hypothesis 2. Of the two firms, VimpelCom, with its more international top management team, showed a higher degree of internationalization, both in terms of pattern of foreign market selection during the initial stages of internationalization (by entering Vietnam and Cambodia in 2008
2009) and at the end of the 12 years of the period of observation, regardless of the attempts of MTS to participate in various tenders in nearby and distant markets in 2005
2007. In 2014, MTS was present only in one foreign market outside of the former members of the USSR, India, via a joint venture stipulated by its holding company, AFK Sistema, while VimpelCom had become a truly globally present mobile operator with activities in former USSR republics, Asia, Africa, Western Europe, and North America. The findings of the study not only shed light at the internationalization patterns of emerging-market firms through the analysis of two cases of two Russian “national champions” of the mobile telecommunications industry, deepening the analysis of foreign market selection decisions by “new” MNEs, but also bring forward the importance of the international experience of the top management team in the implementation of internationalization strategies. Among the strategic factors often missing in emerging-market firms is managerial and entrepreneurial know-how (Yiu, Lau, & Bruton, 2007). This study confirms that the presence of nonnative (non-Russian) members of the Board of Directors positively contributes to the firm’s implementation capacity for entering foreign markets, both geographically close and distant, suggesting that the internationalization process of emerging-market firms can be facilitated by the inclusion of internationally independent members of the Board and top managers. The limitations of this study may offer possible future research directions. The analysis of the internationalization patterns of MTS and VimpelCom was qualitative and conducted for one industry
mobile telecommunications
and may not be readily extendable to the internationalization decisions of firms operating in other industries. The study was limited in time and included only the initial stages of the two firms’ internationalization. As the paper was finalized, the press published rumors about the further withdrawal of VimpelCom from such geographically distant markets as Laos and Canada. Finally, the analysis of the internationalization pattern and of the impact of the top management team on the firm’s capacity to implement its internationalization strategy can be extended to mobile telecommunications operators from other emerging economies.

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540.

PART III CORPORATE STRATEGY

SHAREHOLDER VALUE CREATING STRATEGIES FOR EMERGING MARKETS Hemant Merchant ABSTRACT Purpose
This study empirically identifies three strategies for creating shareholder value for firms who venture into Emerging markets (EMs) in search of corporate growth and profitability. Methodology
To uncover these value creating strategies, we apply Cluster analysis techniques, analysis of variance as well as survey several qualitative case-studies of firms who have entered EMs worldwide. Findings
Our findings demonstrate how firms can
and do
tap into the potential that EMs offer, despite the inherent riskiness of these markets and/or constraints on corporate resources. Statistically, no single shareholder value creating strategy is more (or less) remunerative than other strategies. Many equally profitable trajectories coexist vis-a`-vis corporate growth in EMs. Research limitations/implications
Our findings are based on stockmarkets’ expectations of firm performance; these expectations may not correspond to the actual future firm performance.

Emerging Market Firms in the Global Economy International Finance Review, Volume 15, 147
179 Copyright r 2014 by Emerald Group Publishing Limited All rights of reproduction in any form reserved ISSN: 1569-3767/doi:10.1108/S1569-376720140000015007

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Practical implications
The principles we have isolated have a broad appeal because they identify variety of paths that facilitate shareholder value creation via participation in EMs. We expose the inner workings of these trajectories and illustrate particular firm-specific and locationspecific combinations associated with profitable EM ventures. Originality/value
This study seriously challenges the conventional view that value creation is a function of singular positive influences. On the contrary, this study establishes that value creation is multidimensional and submits that a more refined way to augment performance is to develop an ability to combine relevant firm-specific and location-specific factors so that they can, if needed, offset the impositions of each other. Keywords: Joint venture; value creation; strategy; shareholder value; firm performance

The economic rise of Emerging markets (EMs) worldwide is widely documented in the popular business press. These markets are expected to prevail, at least for the foreseeable future (Merchant, 2007). Indeed, recent surveys estimate that EMs not only account for 58% of the global GDP growth over 2010
2015 (Deloitte Consulting LLP, 2011) but also engender a large increase in demand for goods and services, fueled by rising incomes which are expected to increase an additional U$8.5 trillion by 2020 (Accenture, 2012). Not surprisingly, entering EMs is a top priority for many Western companies who, ultimately, seem to want to augment their revenues and profits. Evidently, companies prefer to enter these markets either through organic growth or joint ventures (Deloitte Consulting LLP, 2011). Yet, according to one report, one-third of business executives not even believe that their company has a clear strategy for high-growth markets
despite the fact that 80% of those surveyed said their company’s primary focus for growth was on emerging economies (Financial Times, 2012). On the contrary, even the strategies of the “biggest and brightest” companies often do not work in EMs (Bhattacharya & Michael, 2008). Therein lies a big conundrum: How should companies tap into the potential that EMs offer when, according to stock-market analysts, entering these markets often is a risky proposition for a majority of corporate forays (see Fig. 1)? Indeed, can companies tap into this potential at all?

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80.00% 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00%

A A SIA SI ( A M (N ) M ) BR BR IC IC (M A (N ) A ME M M R ) ER IC IC AS A (M S (N ) E M EUUR ) O RO P E PE (M (N ) M ) N N ICS IC ( S M (N ) M ) RO RO W W (M (N ) M ) D D EV EV E EL LO O PED PE D (M (N ) M ) A L A L LL (M (N ) M )

0.00%

POSITIVE

NEGATIVE

Legend: M=Manufacturing companies, NM=Non-manufacturing companies ROW=Rest of World, DEVELOPED=Developed countries, ALL=All countries

Fig. 1. Stock-Market Expectations of Joint Venture Performance by Emerging Market Regions. M = Manufacturing companies, NM = Non-manufacturing companies, ROW = Rest of World, DEVELOPED = Developed countries, ALL = All countries.

Our quantitative study of the stock-market performance of almost 250 American companies who entered the largest EMs via joint ventures found that companies can
and do
enter EMs profitably (The appendix contains various methodological details about our study). These companies pursued three broad strategies for achieving the elusive
but not impossible
profitability goal: (1) firm-dominant strategies, (2) location-dominant strategies, and (3) hybrid strategies. Companies that pursued these strategies created, on average, approximately US$ 21million, US$ 23 million, and US$ 7 million, respectively. We corroborated our analysis qualitatively via secondary research of American as well as nonAmerican companies who had entered EMs via joint venture as well as

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other entry modes. In fact, several American companies, from General Electric and PepsiCo to Cessna Aircraft and Logitech, have successfully adopted the principles underlying the above-mentioned strategies. Many non-American companies, such as Finland’s Nokia, Italy’s PVM Group, Jamaica’s Digicel, Korea’s Hyundai Group and LG Corporation, Norway’s Telenor, South Africa’s Deposita, and UK’s Vodafone, have similarly adopted these principles. Even local emerging market companies, such as China’s Baidu, India’s CavinKare, and Mexico’s Grupos Elektra seem to be applying these levers to successfully compete within their home markets. Apparently, the principles discovered in our study have a global following. They should
because our study also indicates that, statistically, no single shareholder value creating strategy is more (or less) remunerative than other strategies. Many equally profitable trajectories coexist vis-a`-vis corporate growth in EMs. Our study exposes the inner structure of these trajectories (see Table 1) and illustrates particular firm- and location-specific combinations associated with profitable EM ventures. Almost 30% of value creating companies, our research shows, skillfully leveraged corporate strengths (e.g., size and industry experience) to compensate for weaknesses in EMs they have entered (e.g., weak IPR laws and lack of market openness). Another 40% of value creating companies took a very different approach: they leveraged country-specific strengths (e.g., large consumer base) to offset their corporate weaknesses (e.g., unfamiliarity with EMs and limited product offerings). The remaining 30% pursued an approach that lay in-between the above trajectories. Thus, focusing on weaknesses alone, be they firm- or location-specific, deprives companies of remunerative opportunities in EMs. Indeed, we found that both types of weaknesses can be complemented with strengths existing elsewhere. The secret to accomplishing this lies in establishing what the relevant offsets are and how they can be combined, and then striking the right balance between the two. Our study found companies that understood the above imperative increased their shareholder value, on average, between US$ 7 million and US$ 23 million depending upon the nature of trajectory pursued. Companies destroyed their shareholder value, on average, by about US$ 17 million when they ignored the element of fit. Almost 48% of companies in our sample were unable to initially design the right mix of firm- and location-specific conditions (see Table 2). Apparently, many of these companies had a lop-sided emphasis on either set of conditions that jeopardized their well-reasoned emerging market entry strategies, as illustrated in the case of computer maker Dell. In entering Brazil during early 2000s to

Shareholder Value Creating Strategies for Emerging Markets

Table 1.

151

The structure of value creating strategies in emerging markets. Firm-Dominant Strategy

Strategic architecture

Strong resource profile Modest locational appeal

Principal value creating leverage

Corporate resource portfolios

Approach to value creation

Offset location-specific weaknesses with firm-specific strengths Prospecting for economic gains

Principal value creating mechanism Role of corporate resources

Resources “push”

Role of locations

Explore locations

Risk preference/ profile Generally suitable for … Entry strategy

Risk-seeking/Bold Large companies Relatively less selective

Location-Dominant Strategy

Hybrid Strategy

Modest resource profile Modest resource Strong locational profile appeal Modest locational appeal Institutional strengths Combination of of a location resources and institutional strengths Offset firm-specific Some combination weaknesses with of the other two location-specific approaches strengths Synergistic resource Some combination deployment of the other two mechanisms Exploit resources Some combination of the other two roles Locations “pull” Some combination of the other two roles Risk-averse/Timid Risk-neutral/ Moderate Small companies Medium-sized companies Relatively more Neutral selective

establish a strategic Latin American production base, Dell focused heavily on its business model of low-cost manufacturing, and had signed a very favorable agreement with the state of Rio Grande do Sul. However, shortly before the project’s launch, Dell found itself in hot water when Partido dos Trabalhadores, a leftist party with socialist ideology, came to power and appeared likely to rescind Dell’s signed agreement. Dell had ignored its awareness of a likely shift in political climate in the then pro-business Brazilian state. Although the deal was eventually resuscitated, Dell faced a real possibility of a strategic and financial setback. Dell’s case demonstrates how fragile the foundations of successful emerging market entry are (Dell’s Dilemma in Brazil: Negotiating at the State level. Thunderbird case study #A03-03-0021).

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Table 2. Stock-market performance of clusters. Cluster

A

B

C

D

E

F

G

H

Cluster 30 33 29 33 21 30 16 21 size Average −0.88% 1.74% 1.09% −0.68% −0.43% 2.29% 0.02% 0.77% Deviation 0.06 0.04 0.03 0.02 0.02 0.05 0.02 0.07 p value n.s. 0.0179 0.0841 n.s. n.s. 0.0312 n.s. n.s. Average shareholder value created or destroyed (US$ millions) −11.32 21.09 22.90 −37.68 −33.14 7.12 0.47 9.06 Percentage of companies who have created shareholder value 46% 70% 60% 42% 26% 60% 50% 52% Significant pairwise contrasts (involving cluster with statistically significant returns) B
A p < 0.0250 C
A p < 0.0996 F
A p < 0.0084 B
D p < 0.0338 F
D p < 0.0115 B
E p < 0.0959 F
E p < 0.0413 Response variable: Abnormal returns (%).

STRATEGIES FOR EMERGING MARKETS Yet, 52% of the companies in our multi-industry sample evidently secured these foundations to create shareholder value for themselves. Our analysis reveals three strategies
each with a distinct value creating mechanism
which companies have pursued to skillfully combine the firm- and locationspecific drivers of profitable entry into EMs. How did companies design these combinations when their competitors could not? How did companies overcome the impediments posed by less-than-ideal company and/or market conditions? What can we learn from these companies about creating market value by participation in EMs? Firm-Dominant Strategies Our study found that one way companies created value by leaning relatively more on their corporate resources and less on the institutional quality of EMs in which they deployed the resources. These companies did not view an emerging market’s locational-specific traits to be unimportant. Rather, these companies leveraged their internal strengths to compensate for location-specific weaknesses. Companies let resources “push” them, enabling them to explore promising locations for new product-market growth. These principles underscore a firm-dominant strategy for creating value in emerging markets.

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Companies in our sample’s firm-dominant cluster were very large in terms of their assets, had the highest level of market experience, and held strong/moderate competitive positions vis-a`-vis rivals. These highly favorable attributes permitted companies to assume a high level of risk in their emerging market ventures. Indeed, these ventures were marked by highest level of task complexity and the lowest level of business scope overlap with the standalone companies. Remarkably, these companies totally ignored conventional wisdom about shunning “risky” markets. On the contrary, they purposefully ventured into economically and institutionally risky emerging markets, like India, with several unfavorable legacy conditions: (i) lowest level of market openness, (ii) lowest level of skilled labor availability, (iii) weakest IPR regime, and (iv) highest level of political risk. Of course, these markets had some redeeming qualities such as a modest GDP growth rate and a small cultural distance from the USA. However, on the whole, these positives still were overshadowed by endemic weaknesses. Conventional wisdom decrees that companies avoid any emerging market with the above portfolio of negative conditions. Yet, one group of companies not only ignored such one-eyed prescriptions but also increased their market value by doing just the opposite! Clearly, it is possible for companies to offset the presumed limiting effects of weak local emerging market institutions with corporate strengths. Focusing excessively on an emerging market’s negatives
something many companies are prone to fall easy prey to
will deprive companies of value creating opportunities. Strategic managers therefore must be acutely aware of their companies’ strengths and find ways to leverage resources in the toughest, but also the most profitable, emerging markets. In fact, several large companies have done exactly that. The US-based retail giant Walmart has set up a joint venture with Bharti Enterprises, an Indian conglomerate, to establish a wholesale supply business that would lay the foundation for expansion into retail. Although the political backlash has forced India’s reversal of planned reforms allowing foreign retailers’ majority holdings in local supermarket chains and ownership of single-brand stores (Jopson & Weaver, 2011), Walmart will benefit when these reforms take root. Meanwhile, the company is building its understanding not only of the large, but diverse, Indian retail segment but also of other related strategic processes, such as infrastructure weaknesses and HR practices, it will need to master to fully benefit from India’s promise. Walmart is utilizing its experience in countries like Brazil, China, and Russia to enter India (Jopson & Weaver, 2011).

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Japan’s Honda Motor Company faced a similar ownership constraint when it first sought entry into India’s growing automotive segment. Honda teamed up with the venerated Hero Group and spent several years learning about the local market and quietly developing its own distribution network (Hero Honda Motors (India) Limited. Thunderbird case study #A09-030012). Shortly after India fully opened up for foreign investment, Honda announced it would set up a 100% subsidiary to manufacture scooters and motorcycles for the local market. Today, Honda is firmly entrenched in India: its joint venture with Hero commands a 50% share of the 2-wheeler motorcycle segment whereas its wholly owned subsidiary has a 46% market share in the 2-wheeler scooter segment (http://www.surfindia.com/automobile/automobile-industry.html. Accessed on March 31, 2012). The Walmart and Honda cases illustrate how even the largest global companies encounter significant entry barriers in EMs, but also how they strategically position themselves for the value creation by aligning corporate resources with a very turbulent and challenging local context of EMs. Both companies lean heavily on their corporate resources: Honda relies on its competence in “small engines” and Walmart on its retailing experience, and both have deep pockets as well as strong competitive positions which allow them to commit to a long-term growth strategy in India, and possibly elsewhere. Both companies seem to have leveraged their resources without seeking many typical synergies. For example, Walmart cannot leverage its existing distribution and logistics infrastructure due to the physical separation between, say, its American and Indian operations as well as different government regulations. Honda appears content just to make inroads into the Indian automotive market. It would have gained some production synergies by increasing India-destined output at one of its existing plants. Instead, Honda has established its own production facility in Gurgaon, a city in northern India, likely as a beachhead move to serve nearby markets. Walmart is “a bold example of a retailer trying to change shopping habits … [It is] willing to put its neck out and do something that may fail” (Jopson & Weaver, 2011). Clearly, both Walmart and Honda are exploring the boundaries of their existing corporate strengths.

Location-Dominant Strategies Of course, many companies do not possess the depth and breadth of resources that large corporations have; many only possess modest resources. Yet, as our study found, even these companies can increase their

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market value provided they start from a different point than that of companies in the firm-dominant strategy cluster. Companies in our locationdominant strategy cluster created value by leveraging the high quality of emerging market institutions relatively more than corporate resources. These companies did not perceive their internal strengths to be trivial. On the contrary, companies deployed resources to maximally extract their potential under favorable location-specific conditions. Companies let emerging market locations “pull” them so they could more fully exploit incumbent resources. These principles underscore a location-dominant strategy for creating value in emerging markets. Companies in our sample’s location-dominant cluster formed ventures in EMs, like South Korea and China, with highest level of market openness, strongest IPR regimes, highest market growth rates, lowest level of political risk, and moderate level of skilled labor. These favorable conditions permitted companies
who were both smaller as well as less experienced than those in the firm-dominant cluster
to seek synergies with their existing operations elsewhere. In fact, companies in this cluster deployed resources to ventures whose scope was more closely related to that of their own standalone firms. Also, these deployments were less risky as the ventures usually focused on singular functional roles even though all companies were in a strong or moderately strong competitive position; none of these companies was competitively weak in comparison with their industry peers. Clearly, high-quality locations both compensate for modest resources and facilitate value creation for companies that conventional wisdom would urge against venturing into EMs due to, say, lack of experience. Yet, some companies not only defied such one-sided thinking but also increased their market value by grasping the salient location-specific offsets, and assessing where and how they could leverage these offsets. It is thus imperative that strategic managers in resource-constrained companies identify specific emerging market conditions which best enable optimal leveraging of current resources. Several small companies seem to be doing exactly that. Consider the case of Cessna Aircraft, the $2.5 billion small airplane manufacturer based in Wichita, Kansas. The company recently formed a joint venture with China’s state-owned Aviation Industry Corporation. Why China
and why now? Unlike for Walmart and Honda, weak demand, manufacturing inefficiencies, and meager profits (and losses) have compelled Cessna to seek growth in EMs. In 2010, Cessna posted a US$29 million loss (2% of revenues) compared to US$198 million profit in 2009. Its CEO, Jack Pelton noted Cessna’s recovery would be “long and slow”

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(Niles, 2010). Cessna hopes to overcome its growth barriers by entering China which now is a promising market for the company. With bottlenecks such as military-controlled airspace and deficient aviation infrastructure clearing rapidly as well as government interest in developing general aviation, significant easing of rules governing private aircraft operations, new airport openings, and a growing base of wealthy consumers, Cessna (and its rivals) finally are in a position to capitalize on China’s potential for corporate growth (Rabinovitch, 2012). The company’s product development venture is close to the company’s core business, and offers synergies. Yet, Cessna does not seem to want to shape competition
even in China’s nascent aviation industry
or take a big-bet risk. Cessna prefers to glide safely into China; it is not alone. Other companies like Korea’s LG Telecom (now LG U + ) and Hyundai Group, Swiss computer peripherals maker Logitech, and Jamaica-based mobile phone network provider Digicel have similarly adopted a location-dominant strategy. Digicel’s case exemplifies how companies can grow profitably by leveraging favorable conditions in even the poorest markets. (The Digicel example is an outlier vis-a`-vis our sample. The company has not entered any of the 10 emerging markets included in our quantitative study.) Aware that most multinationals had ignored these markets, Digicel entered Jamaica in 2001, and has quickly grown into a US $3.5 billion company that serves 31 markets across the Caribbean, Central America, and Pacific (http://www. digicelgroup.com/en/about. Accessed on April 2, 2012). It entered Haiti in 2006, drawn by the country’s inexpensive labor costs, recently liberalized telecommunications sector, and a benign local competitive environment. While Digicel still has to deal with Haiti’s weak purchasing power, it leverages Haiti’s proximity to relatively well-off diaspora who help relatives pay for their phones. Digicel’s understanding of bottom-of-the-pyramid segments and its experience in serving similar markets
all within a telecommunications umbrella
has allowed the company to profit from its Haitian venture. With 2.4 million customers, Haiti now is Digicel’s largest market, representing over 20% of the company’s customer base. In 2011, Digicel reported a whopping 40% year-on-year revenue growth in Haiti (http://defend.ht/money/articles/business/559-digicel-revenue-up-32-throughstrong-haitian-market-39. Accessed on April 2, 2012). The Cessna and Digicel examples illustrate how companies achieve profitability by skillfully leverage the endemic strengths of EMs. Cessna relies on a more permissive aviation regime that only recently materialized in China (Rabinovitch, 2012) whereas Digicel, over time, has found ways to leverage smaller kernels of potencies in the Haitian context (http://defend.

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ht/money/articles/business/559-digicel-revenue-up-32-through-strong-haitianmarket-39. Accessed on April 2, 2012). Both forays extend the companies’ core business and generate additional synergies that such companies truly seek, as Digicel CEO Colm Delves suggested. While the group was looking for new opportunities, it was equally focused on expanding the portfolio of products and services it (currently) offered (http://defend.ht/money/ articles/business/559-digicel-revenue-up-32-through-strong-haitian-market-39. accessed on April 2, 2012). Evidently, Digicel and Cessna intend to further exploit their existing resources under favorable market conditions. Both companies ultimately expect their location-dominant strategy will increase market value.

Hybrid Strategies Our study uncovered a third value creating strategy which leverages corporate resources as well as local emerging market strengths, albeit less heavily than either the firm- or location-dominant strategy. A hybrid strategy combines key features of both these strategies. Companies that follow the hybrid approach: (i) allow resources to push and locations to pull, (ii) explore locations while exploiting available resources, and (iii) seek risk as well as synergies. Of course, successful adoption of this midrange stance places a higher premium on achieving a good fit between corporate resources and the local emerging market context. These qualities underscore a hybrid approach. Companies in our study’s hybrid strategy cluster are smaller as well as less experienced than their counterparts in the firm-dominant cluster, but have more experience than their peers in the location-dominant cluster. These companies venture into markets with IPR regimes that are more favorable than in the firm-dominant cluster but less favorable than in the location-dominant cluster. Other location-specific conditions follow the same pattern: level of political risk, market openness, and cultural distance. It is therefore not surprising that companies who adopt a hybrid strategy purse ventures that are less complex and have a higher level of business scope overlap than those undertaken by companies in the firm-dominant cluster. The US $17 billion ultrasound unit of GE Healthcare, a division of General Electric, is an example of how companies create value with a hybrid strategy. During a strategic review of its divisions, GE realized its healthcare unit could grow 2
3 times faster by leveraging highly populated

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countries like China and India where rising incomes, favorable government priorities, and increasing health awareness coalesced. The big challenge was these markets wanted products which met specific local needs (Immelt, Govindrajan, & Trimble, 2009). In China, price was a paramount factor and portability as well as ease of use were imperative. The legacy of China’s health-care infrastructure required it so. A majority of China’s population relies on poorly funded, low-tech rural hospitals staffed by doctors with limited knowledge of sophisticated (ultrasound) technology (Immelt et al., 2009). Yet, GE could not ignore this potentially lucrative emerging market. So it set out to build a portable ultrasound machine from the ground up
but drawing heavily on the company’s existing R&D competency. GE Healthcare combined its organizational commitment to reverse innovation and existing R&D expertise with China’s engineering talent to develop additional capabilities it needed in areas such as miniaturization and low-power systems, and recruited a product commercialization team well versed in health care in rural China. The portable machine soon became the growth engine of GE’s ultrasound business in China. And it fueled revenue growth in the developed world by pioneering new applications. In late 2011, GE’s investment in health-care equipment and devices was expected to generate US $1.5 billion annually in new revenues (Layne, 2011). Another case in point is the Perfetti Van Melle (PVM) Group, a Italian manufacturer and marketer of sugar confectionery and chewing gum; it owns famous brands such as Chupa Chups lollipops and Mentos chewing gum. After being in Asia for a few years, PVM entered India in mid-1990s, attracted by India’s newly liberalized economic regime and a large young population that could afford inexpensive treats like hard candies. Despite India’s socialist legacy, a weak IPR regime, and bureaucracy, PVM realized it could combine its core industry and regional experiences with political receptivity to foreign investment. In fact, PVM’s moderate size would further insulate the company from anti-foreign sentiment that pervaded the country. So PVM drew upon its core R&D and manufacturing expertise to reformulate candies for the local palate as well as regional variances in India’s hot and humid climate
a move that has paid off in US $300 million in local sales (2011 estimates). PVM’s success has prompted the Group to diversify
for the first time in its history
into a new industry, savory snacks. Moreover, India has become PVM’s base for producing international advertising films and a regional base for South Asian expansion; its subsidiary provides technical and financial support to newly formed subsidiaries in nearby emerging markets like Bangladesh (Bryant & Gorst, 2011).

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The GE Healthcare and PVM Group examples demonstrate how companies develop a “locations pull and resources push” approach that takes measured risks (new product-market development) while also promoting synergies (through diversification into nearby areas) to exploit incumbent resources (e.g., R&D expertise and regional experience) as well as explore previously untapped physical and product-market geographies. The hybrid strategies adopted by these companies have paid off. GE’s Healthcare unit in China is growing at 30% annual rate and operates seven global manufacturing sites (Crooks, 2011; Forbes, 2011) whereas the PVM Group is, according to its Vice President and COO Stefano Pelle, the “undisputed market leader” with a 26% overall share and a 50% share in the chewing gum segment (2011). Its nearest rival holds a 10% share of the Indian market.

FATHOMING THE IMPLICATIONS Our study and secondary research underscore a key takeaway: companies should not treat gaps in their firm- and location-specific contexts as absolutes. These gaps dissipate when companies adeptly offset them with relevant complements. Value creation is achievable even in less than optimal corporate or institutional settings. We believe the key to profitable emerging market strategies lies in nurturing the ability to see the proverbial trees, and not just the forest. Focusing on the big picture sometimes can be misleading. Digicel might never have entered Haiti on the basis of the country’s small GDP or its population; in fact, its competitors did not. China’s GDP and population figures are much higher than Haiti’s, but Cessna might not have made any meaningful gains until other favorable conditions appeared on the horizon. Our illustrations of companies that have succeeded in EMs suggest they have developed a very keen understanding of how their resources can commingle with existing local conditions. Walmart understands its deep pockets permit waiting in a (political) coalition-driven India: despite occasional setbacks, Indian retail sector reforms are imminent given the projected upward economic shift in the well-being of the Indian bottom-of-thepyramid segments (Singhi, Mall, Subramanian, Sanghi, & Ramesh, 2012). Cessna Aircraft understands that its prowess in aviation technology can be vital to China’s goal of national infrastructure development. GE recognizes the imperative to reverse innovate or be “destroyed” by emerging market

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firms (Immelt et al., 2009). PVM Group has grasped that its confectionery is an inexpensive indulgence for India’s poor and rich alike. Companies must build such mosaics to successfully compete in EMs. Our study suggests that the key to strategic emerging market designs lies in a company’s ability to astutely pair tradeoffs. Without this, the same company can succeed in one emerging market but not another
even if it competes with the same resources in similar local contexts. Two identical combinations of corporate resources and local conditions can interact differently in different EMs. When they do, a company could find itself facing dissimilar outcomes, as the one-stop German wholesaler Metro Cash & Carry (MCC) found out when it ventured into China, India, and Russia. Both China and Russia had similar business contexts. Competition in both countries’ wholesale sector was fragmented and the market structures were under-developed. This had resulted in inefficiencies that both Chinese as well as Russian politicians were interested in eliminating. MCC offered to bring market discipline: it combined governmental agenda with the company’s vast industry and emerging market experience. In China, MCC offered politicians an easy way to showcase their commitment to economic development by welcoming large multinationals. In Russia, MCC leveraged the Moscow mayor’s goal of radically enhancing the city’s image and creating formal distribution channels from which the city could collect tax revenues which were otherwise lost. Spurred by its success, MCC entered India where local contextual conditions were very similar to those in China and Russia. Yet, MCC’s efforts stalled. While the company had already received the political support it needed from the central government, MCC failed to fully appreciate the potential resistance from local actors who had different political loyalties due to India’s acceptance of multiple political parties at the state and central levels. In China, these loyalties were given because the career progression of local politicians depended on their more senior government officials. In Russia, Mayor Yuri Luzhkov was widely believed to be on the same page as the central government. MCC needed a political ally in India
and not as much its own experience (Metro Cash & Carry. Harvard Business School case study #707
505). MCC’s rival, Walmart, found such an ally in its joint venture partner, Bharti
one of India’s leading business groups
when it entered India under nearly identical conditions that MCC faced (Jopson & Weaver, 2011). Like MCC, Walmart has the industry and global experience. Both companies are very large, operate very similar business models, and compete in adjoining industry sectors. Both companies have support from the Indian central government, and both face considerable local opposition.

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However, Walmart seems to have fared relatively better, although MCC appears to have turned the corner also. The MCC experience illustrates how the same set of resources can interact very differently with the same set of location-specific conditions and produce different outcomes across EMs, and the Walmart example highlights how a single pertinent variable can influence the odds of a positive outcome. The fragrance group Coty’s CEO, Bart Becht, would concur. Justifying his company’s recent US $10 billion bid for Avon Products, Becht mentioned that Avon’s network of door-to-door sellers was “a big prize in [Brazil] where cosmetics are still dominated by direct sales” (Jopson, 2012). Brazil is the world’s third largest cosmetics market after the US and Japan. To increase the odds of value creation, companies should venture into EMs only after taking a careful inventory of their own resources and local emerging market conditions.

CONSTRUCTING MOSAICS Our secondary (qualitative) analysis uncovered how companies had prepared themselves for a firm-dominant strategy. Companies that had done well had audited their internal strengths by asking four simple questions: (i) What is our core resources? (ii) How unique are our resources? (iii) Can we afford to deploy these resources? and (iv) Which local emerging market impediments would our resources complement?

Core Resources Different companies resorted to different types of resources as a basis of their firm-dominant strategy. Walmart’s deep pockets and patience permitted it to take a long-term view of India (Jopson & Weaver, 2011) whereas Honda entered the country on the basis of its own technological capability and strategic intent [Hero Honda Motors (India) Limited. Thunderbird case study #A09-03-0012]. PepsiCo’s vast industry experience enabled it to enter India, but its entry into (former) USSR was anchored in the political goodwill PepsiCo had created during the Cold War (How Pepsi won the cola wars in Russia, 2012). In contrast, Gol, the Brazilian airline, established itself with newer, more fuel-efficient planes (GOL Airlines becomes first South American operator to order LEAP-1Bpowered 737 MAX, 2014). These examples show successful emerging

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market entry is not restricted to a single type of resource
even when entering the same country or even for same company entering different EMs. On the contrary, a variety of tangible and intangible resources often are in the play. Companies therefore must first identify what their internal strengths are and then match them to the emerging market they want to win in. Only resources that can complement local emerging market requirements should play a leading strategic role.

Uniqueness of Resources However, merely possessing complementary resources is not a sufficient condition for creating value in EMs, as KFC found out when it entered China. Faced with a perennial shortage of well-trained recruits, an essential component of KFC’s very rapid growth in China, KFC set up a training program long before its competitors did. This program now provides a steady stream of personnel to meet the company’s staffing needs. Although competitors like McDonald’s have copied KFC’s staffing footprint, KFC’s training program “is an advantage that is difficult for any competitor to emulate” (Bell & Shelman, 2011). Successful companies have cleverly nurtured other unique resources. Proctor & Gamble’s (P&G) success in India arises from, among other, the company’s deep understanding of local consumers (Walmart take its retail tips from P&G India, 2012), whereas Nokia’s high-tech IT platform and speedy product development routines permitted it to fend off Chinese rivals who had gained a substantial share of the local mobile handset market (Nokia connects, 2012). These illustrations suggest companies should consciously nurture their resource psyches to establish a long-term basis for creating value, particularly since local emerging market firms (and even Western incumbents) often have a competitive edge over newcomers (Jopson & Weaver, 2011).

Affordable Resource Deployment Our research indicated successful Western companies have also considered whether they can (or want to) afford to deploy their resources to EMs. P&G can afford to deploy its market insights and knowledge of Indian consumers with only a small risk of appropriation; these intangibles are soft resources. So can Walmart. In contrast, Honda seemed comfortable sharing R&D capabilities with Hero, its joint venture partner, fully aware

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that Hero primarily sought Honda’s R&D capabilities. Honda strategically shared its R&D know-how, perhaps comforted in the belief that Hero had a finite capacity to internalize those contributions [Hero Honda Motors (India) Limited. Thunderbird case study #A09-03-0012]. GE Healthcare had decided it would go all the way to develop the portable ultrasound machine market in China, and incurred the organizational costs associated with the initiative. GE purposefully designed various new internal structures (such as staffing protocols, resource access by the product development team, reporting protocols, and even performance evaluation) throughout its value chain which would enable the initiative to thrive and succeed. And it did (Nokia connects, 2012). Affordability is not simply a monetary issue. Companies begin to incur financial and non-financial outlays as soon as they commit to entering EMs. While the financial costs are easy to calculate, the intangible costs of entering EMs may hold the real sway over a strategy aimed at creating value. A company, like Cessna Aircraft, might not commit core resources
even if these resources are unique
if it believes there will be a greater benefit to holding out until later (e.g., if favorable changes in regulatory regime is on the horizon) or until a more lucrative venture takes roots.

Location-Specific Offsets Successful companies have asked themselves one more fundamental question: Which local emerging market conditions do our core resources offset? P&G countered India’s lack of infrastructure and low consumer purchasing power with its strength in distribution and logistics network, and its expertise in consumer marketing, and its understanding of the Indian culture of frugality (P&G versus Unilever in India, 2012). P&G sold shampoos in single-use sachets that it distributed via existing network of retailers. Walmart is countering India’s retail sector regulatory roller-coaster with its deep pockets, and alliance with Bharti (Jopson & Weaver, 2011). Honda’s R&D capabilities permitted it to offset its own lack of knowledge about the Indian automotive market [Hero Honda Motors (India) Limited. Thunderbird case study #A09-03-0012]. A important goal of any resourceassessment exercise is to carefully evaluate the firm- and location-specific contours so that the most potent core resources can be deployed efficiently and effectively. If increasing the odds of a profitable emerging market entry requires countering a particular local condition, it only makes sense to enter that market with core resources that have the relevant intrinsic offset.

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LEVERAGING LOCAL CONDITIONS Our research found successful companies who adopted a locationdominant strategy followed the above dictum as well. However, unlike their firm-dominant counterparts, these companies asked themselves a different set of questions: (i) Which local conditions appeal to the company
and why? (ii) In which geographies do these conditions exist? (iii) Will the strength of these conditions change over time and, if so, in what direction? and (iv) Which resources do these conditions support?

Appealing Local Conditions Successful companies sorted through the morass of local factors and identified those that could balance their core resources. Moreover, these companies sought to understand why a local condition held promise. H. J. Heinz, the US-based condiments maker, did not let its modest size and limited emerging market experience get in the way of entering EMs. In fact, Heinz saw a large condiment market in BRIC countries and Indonesia, based not on population size or the cultural preference for condiments but on the idea that a Westernizing middle class desired “variety and conveniences” (Johnson, 2011). It saw deeper than just the usual favorable local factors. Heinz then leveraged its core knowledge of product formulation: It created a range of ketchups and sauces with a local appeal, and packaged these “new” products in different sizes. Heinz’s fundamental understanding of a local condition has paid off: The company expects EMs will contribute over 20% of its 2011 revenues
and more than 30% of its revenues by 2015 (Johnson, 2011).

Locus of Favorable Conditions A key aspect of leveraging favorable market conditions is correctly identifying the space in which these conditions exist. For Heinz, the value creating space was at a national level; there were few regional levers the company had to adapt to (Johnson, 2011). Both Cessna and Digicel function in a national space as well, Cessna in China (Rabinovitch, 2012) and Digicel in Haiti [http://defend.ht/money/articles/business/559-digicel-revenue-up-32through-strong-haitian-market-39. Accessed on April 2, 2012]. Unlike these

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companies, KFC’s value creating space was at a regional level. KFC succeeded in China only after it accommodated regional “taste” differences within the country. The company realized it had to adapt its products to regional palates
not a national palate. KFC’s market was not one China, but several Chinas (Bell & Shelman, 2011). Germany’s Metro Cash & Carry similarly learned that Indian central government’s strong support for the company did not automatically percolate down to the state and city levels
as it did for the company in China [Metro Cash & Carry. Harvard Business School case study #707
505]. These examples suggest companies should not simply assume that a favorable local condition has uniform appeal between national and regional geographies, even within the same emerging market or even for the same company. To create value in EMs, companies must ascertain the spatial locus of conditions they intend to leverage.

The Role of Time Companies also have to be cognizant that conditions change over time
and so does their appeal to companies. Just because a condition is supportive today does not mean it will be equally supportive in the future, or even supportive at all. Changes in a company’s home country
not an emerging market
can sometimes alter the value creation landscape, as the German engineering giant Siemens found out. Only 30 months after its bullish assessment of the global nuclear industry, Siemens quit its joint venture with Russia’s Rosatom. Several factors contributed to this dissolution, prominent among them Germany’s decision to phase out nuclear power by 2022 and Japan’s Fukushima nuclear disaster (Bryant & Gorst, 2011). Neither event originated in an emerging market but both pushed Siemens away from Russia (Bryant & Gorst, 2011). Yet, the reverse can also be true: Dormant local conditions can, over time, gain economic appeal as illustrated by Cessna’s entry into China Rabinovitch (2012). Clearly, there is a temporal dimension to companies’ ability to capitalize favorable conditions in EMs.

Local Conditions and Core Resources A logical starting point for creating value is to identify which core resources local conditions truly support. GE Healthcare found China’s large rural health-care market supported the company’s R&D resources

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and less its brand equity in China. India’s large (but poor) population supported PVM Group’s Asian experience and product formulation strengths. The challenge is to pair relevant offsets. Companies that develop a keen understanding of both firm- and location-specific sides of the value creation coin stand to gain the most from their emerging market ventures.

SOME FINAL THOUGHTS Contrary to the conventional view, our study suggests that firm- and location-specific conditions need not always be favorable for creating market value in EMs. Even less favorable conditions can support value creation
provided that companies can creatively combine these conditions with their more attractive complements. A combination of modest resources and/or modest emerging market conditions also support value creation. Indeed, combinations of these factors denote alternate
yet equally remunerative
paths to profiting from emerging markets. Consequently, corporate strategists in search lucrative EMs ought not to feel constrained by singular internal and/or external conditions. On the contrary, these managers have at least three options about the manner in which they can create market value. However, mere participation in EMs is not sufficient for creating such value. The uncovered differences in location-specific (and firm-specific) conditions suggest that the “emerging markets” label must be applied and interpreted cautiously. Although the collective potential of these markets is deemed to be greater than markets not considered to be so, all EMs are not the same nor even similar. Hence, strategic managers must choose judiciously among these markets in ways that simultaneously accentuate the strengths (and attenuate the weaknesses) of firm- and location-specific factors. Moreover, corporate strategists must devote particular attention to issues of fit that are crucial for creating competitive advantage.

ACKNOWLEDGMENT This paper is a qualitative extension of the author’s 2008 Multinational Business Review article. An earlier version of that study was a Best paper finalist at the 2004 Academy of International Business conference.

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REFERENCES Accenture. (2012). Fast forward to growth: Seizing opportunities in high-growth markets. Bell, D. E., & Shelman, M. L. (2011). KFC’s radical approach to China. Harvard Business Review. 89(11), 137
142. Bhattacharya, A., & Michael, D. C. (2008). How local companies keep multinationals at bay. Harvard Business Review, 86(3), 84
95. Bryant, C., & Gorst, I. (2011). Siemens saves face as Russian nuclear tie-up fades away. Financial Times, September 20, p. 18. Crooks, E. (2011). GE expects double-digit growth in China. Retrieved from http://www. ft.com/intl/cms/s/0/1f6d2540-24e9-11e0-895d-00144feab49a.html#axzz1r5xwn21q. Accessed on April 4, 2012. Deloitte Consulting LLP. (2011, November). Fortresses & footholds: Emerging market growth strategies, practices and outlook. Financial Times. (2012). Execs in search of an EM strategy. Financial Times, January 25. Forbes. (2011). GE looking to double China revenues by 2014. Retrieved from http://www. forbes.com/sites/kenrapoza/2011/09/24/ge-looking-to-double-china-revenue-to-10-blnby-2014/. Accessed on April 4, 2012. GOL Airlines becomes first South American operator to order LEAP-1B-powered 737 MAX. (2014). Retrieved from http://www.cfmaeroengines.com/press/gol-airlinesbecomes-first-south-american-operator-to-order-leap-1b-powered-737-max/680. Accessed on July 29. How Pepsi won the cola wars in Russia. (2012). Retrieved from http://www.frumforum.com/ how-pepsi-won-the-cola-wars-in-russia/#. Accessed on April 4. Immelt, J., Govindrajan, V., & Trimble, C. (2009). How GE is disrupting itself. Harvard Business Review, 87(3), 56
65. Johnson, B. (2011). The CEO of Heinz on powering growth in emerging markets. Harvard Business Review, 89(10), 47
50. Jopson, B. (2012). Avon-Coty: It’s the distribution, stupid. Financial Times, April 6. Jopson, B., & Weaver, C. (2011). Emerging markets: Lessons from Walmart. Financial Times, December 18. Layne, R. (2011). GE says health-equipment investments yield $1.5 billion in sales. Retrieved from http://www.bloomberg.com/news/2011-11-28/ge-says-health-equipment-investmentsyield-1-5-billion-in-sales.html. Accessed on April 2, 2012. Merchant, H. (2007). Competing in emerging markets: Cases & readings. London: Routledge. Niles, R. (2010). Cessna declines sap Textron revenues. Retrieved from http://www.avweb.com/ avwebbiz/news/CessnaDeclinesSapsTextron_202461-1.html?type=pf. Accessed on April 2, 2012. Nokia connects. (2012). Retrieved from http://www.businessweek.com/stories/2006-03-26/ nokia-connects. Accessed on April 4, 2012. Pelle, S. (2011). Market leadership in emerging markets: The Perfetti Van Melle India case. Presentation made during the Academy of Management conference, San Antonio, TX, August. P&G versus Unilever in India. (2012). Retrieved from http://www.forbes.com/2010/04/12/ forbes-india-pg-unilever-soap-opera.html. Accessed on April 4, 2012. Rabinovitch, S. (2012). Cessna plans Chinese joint venture. Financial Times, March 23.

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Singhi, A., Mall, A. Subramanian, A., Sanghi, K., & Ramesh, R. (2012, February). The tiger roars: An in-depth analysis of how a billion plus people consume. BCG-CII report. Walmart take its retail tips from P&G India. (2012). Retrieved from http://articles.economic times.indiatimes.com/2008-04-08/news/27696361_1_wal-mart-s-india-cash-and-carrybusiness-bharti-wal-mart. Accessed on April 4, 2012.

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APPENDIX A Sample Selection and Description We searched Dow Jones News Retrieval Service for public announcements of two-party equity joint ventures between publicly traded American companies and non-American partners during an eight-year period. These ventures either had to involve a partner domiciled in a big emerging market or had to be located there. The big emerging markets include: Argentina, Brazil, Chinese economic area (China, Hong Kong, and Taiwan), India, Indonesia, Mexico, Poland, South Africa, South Korea, and Turkey [Metro Cash & Carry. Harvard Business School case study #707
505]. South Africa was the only big emerging market not represented in our sample. We deleted announcements that did not meet the above criteria. The “publicly traded” requirement facilitated development of a measure of shareholder value creation for the ventures’ American parents. Due to a potential concern about the comparability and reliability of non-American stockmarket data, our study did not investigate shareholder value creation for non-American partners. Yet, even American stock-market measures are sensitive to other firm-specific announcements of economically relevant events (e.g., dividend payout) which can distort findings
if these events are not controlled for. To eliminate their confounding effect, we deleted all announcements that also referred to non-joint venture formation events during the two-day window of interest to our study (Jopson & Weaver, 2011). These requirements yielded a sample of 241 joint venture formation announcements involving publicly held, US-headquartered, manufacturing and non-manufacturing companies (72% and 28% of the sample, respectively). Approximately 90% of all non-American partners were for-profit companies and the remainder were state-owned or state-controlled enterprises. Almost 95% of non-US partners were also domiciled in a big emerging market. Our sample included the following industry sectors as defined by Standard Industrial Classification codes: Mining (6%), Construction (1%), Manufacturing (72%), Transportation and Utilities (9%), Wholesale and retail trade (6%), Finance (2%), Services (4%).

Cluster Analysis Cluster analysis refers to a wide array of multivariate techniques for reorganizing data into homogenous groups. The statistical technique explicitly

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models the inter-connectedness among a large set of variables, and identifies distinct combinations of variables (here, firm-specific and location-specific variables). Thus, this technique permits a more meaningful evaluation of the stickiness among variables. In fact, unlike regression analysis which researchers commonly perform, cluster analysis is the more appropriate methodology for our purpose because it emphasizes the collective impact
not individual impact
of variables. Indeed, a key advantage of cluster analysis is that it simultaneously accounts for multiple interactions among variables. Technical Details The cluster analysis technique is sensitive to differences in variables’ measurement scales. These differences produce statistical distortions which can jeopardize the meaningfulness of results. However, the distortions can be eliminated by standardizing the cluster variates (to a mean of 0 and standard deviation equal to 1) so that all variables contribute equally to the formation of clusters. Our study not only standardized all variables, but also included an equal number of firm-specific variables and locationspecific variables to further ensure that neither set of variables dominated the empirical identification of clusters. These efforts help to better preserve structural integrity of findings. Our study did not detect high multicollinearity among cluster variates. The lack of multi-collinearity is particularly desirable because it implies no unintentional weighting of cluster variates
even after these have been standardized. Only 5 out of 120 correlations among the 16 cluster variates were greater than or equal to 0.40; the highest correlation, between Joint venture experience and Firm size, was 0.56 (p < 0.0001). Appendix B contains descriptive statistics for the variables included in our study. We subjected the standardized data to Ward’s (hierarchical) algorithm to generate number of clusters and cluster centroids as subsequent input for K-means (non-hierarchical) algorithm. Hierarchical algorithms begin by treating each observation as a separate cluster, and then join the two most similar observations into one cluster. Next, the observation most similar to this cluster is joined to the cluster, and the process is repeated until a single cluster comprising the entire sample is obtained. In contrast, nonhierarchical algorithms begin by assigning each observation to the nearest cluster centroid to form a temporary cluster. The cluster centroids are recomputed after each assignment, and a new observation is assigned to the nearest (recomputed) cluster centroid. Multiple passes are made through the data to allow observations to change cluster membership based

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on the recomputed centroid. The passes continue until no further changes occur in cluster membership. This approach was necessary to ascertain the validity and meaningfulness of cluster solutions identified in the data. A visual inspection of dendrograms generated via Ward’s algorithm indicated between 8 and 10 clusters in the data, depending on the conducted sensitivity tests. Moreover, inspection of the agglomeration coefficient also supported the identified cluster solutions. Dendrograms are graphs depicting the sequence in which observations join to form clusters and the similarity of joined observations. Agglomeration coefficients are numerical values at which various observations merge to form a cluster. Evaluating Cluster Validity To ascertain the validity of cluster solutions generated via Ward’s algorithm, our study conducted cluster analysis for a second time
but using the K-means algorithm. This algorithm yielded results that were consistent with those obtained via the Ward’s method. The K-means algorithm identified 8 clusters which represented almost 90% of the original data
after dropping 28 observations (based on density estimates) to reduce statistical distortions in the data. Moreover, we conducted a series of one-way Analysis of variance (ANOVA) tests on cluster variates to test the validity of eight identified clusters. As expected, we found highly significant statistical differences for 14 out of 16 cluster variates (all p < 0.0001 except one where p < 0.0337). A more conservative Multiple ANOVA test reinforced the above findings; it rejected the null hypothesis of no overall cluster effect (Wilks’ lambda statistic = 17.43; p < 0.0001). These results provide empirical support for the existence of distinct joint venture strategies that companies formulated for entering EMs. To assess the predictive validity of cluster solutions, we conducted ANOVA analysis on abnormal returns (see next section), its external variable. The ANOVA results rejected the null hypothesis of no overall cluster effect (p < 0.0717), and reinforced the validity of the identified 8-cluster solution. Having confirmed the robustness of this solution under two alternate algorithms and given non-hierarchical algorithms’ relative merits, the reported results are based on the K-means algorithm. Non-hierarchical algorithms, such as K-means, have two main advantages over hierarchical algorithms. One, they allow observations to switch cluster membership. Two, they make multiple passes though the data and so generate results that optimize within-cluster homogeneity and between-cluster heterogeneity. Appendix C contains the standardized mean scores and ANOVA results for our sample.

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Event-Study Methodology We employed the event-study technique to generate a measure of shareholder value creation, abnormal return (ABRET). Abnormal return refers to the difference between actual market return associated with a particular company-specific event (here, announcement of joint venture formation) and the company’s historical return. Shareholder value is created when this difference is positive; shareholder value is destroyed when the difference is negative. Following convention, our study computed abnormal return on day t for each company i as: ARit = Rit − (ai + bi*Rmt), where Rit is the actual rate of return for company i on day t; ai, bi is the estimated intercept and slope parameters (respectively) for company i; and Rmt is the rate of return on the value-weighted market portfolio on day t. We estimated the above model over a 200-day period beginning 51 days before a venture’s announced formation. For each company i, we cumulated abnormal returns over a two-day “event window” consisting of the day a company’s joint venture participation was first announced and the following day. Event-studies routinely undertake such aggregation to account for stock-markets’ reaction to announcements that may have been made after trading hours. The two-day return for our sample was 0.54% (p < 0.0948); about 52% of all American parents obtained positive returns (p < 0.0001).

CLUSTER VARIATES: DEFINITION, OPERATIONALIZATION, AND RATIONALE FOR SELECTION Task Complexity (TCPLX) Definition: Number of distinct types of value-chain activities (upstream; midstream; downstream) a joint venture will pursue simultaneously. Operationalization: Set of three dichotomous variables, one for each type of value-chain activity. A value of 1 denotes a particular type of activity will be conducted within the joint venture, and 0 denotes otherwise. The sum of values for the set of variables represents the score for this variable. Rationale: Complex tasks increase asset-specificity as well as the need for inter-partner coordination, thus raising the risk of opportunistic exploitation.

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Partner-Venture Business Scope (SCOPE) Definition: Extent of overlap between the core business of American partner and that of the announced joint venture. The overlap has four dimensions: products offered, markets served, basic research conducted, and technologies used. Operationalization: Set of four ordinal variables, one for each dimension. A value of 1 denotes the lowest level of overlap for dimension i, and 5 denotes the highest level of overlap. The sum of values for the set of variables represents the score for this variable. Rationale: Greater product-market overlap facilitates scale and/or scope economies, and lowers the costs of organizing resources within the joint venture.

Rivalry between Partners (RIVAL) Definition: Extent of overlap between the core business of American parent and that of its (non-American) partner. The overlap has four dimensions: products offered, markets served, basic research conducted, and technologies used. Operationalization: Set of four ordinal variables, one for each dimension. A value of 1 denotes the lowest level of overlap for dimension i, and 5 denotes the highest level of overlap. The sum of values for the set of variables represents the score for this variable. Rationale: Greater overlap between partners’ product-market scope facilitates scale and/or scope economies. However, it also increases the risk of opportunistic exploitation.

Firm Size (FSIZE) Definition: Stock-market value of the American partner during the twoday announcement window. Operationalization: Natural logarithm of the stock-market value (in million US$) of the American parent. Rationale: Largeness of companies indicates availability of slack resources with implications for their possible suboptimal deployment. Size differentials hint at differentials in partners’ administrative

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systems and procedures, and so at differences in the cost of implementing a joint venture’s plans. Joint Venture Experience (JVEXP) Definition: Joint venture experience of the American partner. Operationalization: Frequency of the American parent’s joint venture participation over a three-year period preceding the year in which its given venture was announced. Rationale: Greater experience provides partners with the criteria for judging the efficacy of actions, such that experienced partners can better anticipate challenges related to their ventures’ ultimate success. Moreover, greater experience lowers the cost of monitoring partners’ conduct. Ownership Structure (OWNER) Definition: Distribution of the joint venture’s total equity between partners. Operationalization: Percentage of a joint venture’s total equity held by the American partner. Rationale: Ownership structure provides a rough indicator of partners’ equity-based relative bargaining power and control. It hints at the complexity of managing joint ventures as well as at the risk of opportunistic exploitation by partners.

Decision-Making Structure (DCMKG) Definition: Type of decision-making arrangement between joint venture partners. Operationalization: Dichotomous variable, where 1 denotes both partners will participate in the joint venture’s decision-making process (Shared control decision-making) and 0 denotes only one partner will be responsible for the venture’s decision-making (Dominant control decision-making). Rationale: Shared decision-making implies close interaction between partners which facilitates inter-partner trust and organizational learning.

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Relative Competitive Position (RLPOS) Definition: Intensity of competition faced by the American partner in its core business during the quarter preceding that in which a joint venture was announced. Operationalization: Ordinal variable coded on a 3-point scale, where 1 denotes a “strong” competitive position and 3 denotes a “weak” competitive position. Rationale: Relatively “weak” resources limit a firm’s potential for creating competitive advantage, and raise the cost of joint venture management.

Availability of Skilled Labor (SKILL) Definition: Adult literacy rate in the joint venture host country. Operationalization: Percentage of total adult population with high school education in the year preceding that in which a joint venture was announced. Rationale: Access to location-specific skilled labor yields a cost advantage to companies. Moreover, the availability of skilled labor facilitates creation of knowledge-based externalities.

Market Potential (MSIZE) Definition: Market size of the joint venture host country. Operationalization: Total value of gross domestic product (US$ millions) in the joint venture host country in the year preceding that in which a joint venture was announced. Rationale: Large markets facilitate economies of scale, and lower the breakeven level of international market entry.

Market Growth Rate (MKTGR) Definition: Rate of economic growth in the joint venture host country. Operationalization: Average real GDP growth rate (percentage) in the joint venture host country for five years preceding the year in which a joint venture was announced.

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Rationale: Growing markets stimulate local demand by increasing local income and purchasing power.

Type of Joint Venture Partner (PTYPE) Definition: Type of partner (i.e., for-profit company or state-owned/ state-controlled enterprise) with whom the American company enters into a joint venture. Operationalization: Dichotomous variable, where 1 denotes the nonAmerican partner is a for-profit company and 0 denotes the nonAmerican partner is a state-owned or state-controlled enterprise. Rationale: The dissimilar agendas of profit-seeking companies and stateowned enterprises require dissimilar approaches to joint venture management. This jeopardizes joint venture performance. However, local partners (companies as well as state-owned enterprises) can also be important resource providers.

Intellectual Property Rights Regime (PATNT) Definition: Strength of the IPR regime in the joint venture host country. Operationalization: Number of patents issued in the joint venture host country during the year in which a joint venture was announced. Rationale: Strong property rights regimes offer protection against unfair competitive appropriation, and thus lower the business costs for economic actors.

Political Risk (PRISK) Definition: Level of political risk in the joint venture host country. Operationalization: Political risk scores for 18 months following the year in which a joint venture was announced. Lower scores denote lower political risk and vice versa. Rationale: Low levels of political risk render companies less vulnerable to the downside effects of unanticipated government-induced discontinuities. This preserves the value-in-use of companies’ resource deployments.

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Trading Openness (TRADE) Definition: Level of economic openness in the joint venture host country. Operationalization: Country-specific scores on trading openness for the year in which a joint venture was announced. Higher scores denote a higher level of economic openness and vice versa. Rationale: More “open” trading regimes lower factor prices and thus reduce production costs. Moreover, such regimes lower companies’ costs of obtaining local information. However, open regimes also remove government-induced market failures, and so eliminate economic rents.

Cultural Distance Joint Venture Partners (CDIST) Definition: Cultural distance between United States and the nonAmerican partner’s home country. Operationalization: Kogut and Singh index of cultural distance (i.e., cumulated deviation between the variance-adjusted Hofstede scores of joint venture partner countries). Rationale: Greater cultural distance increases companies’ perceived business uncertainty as well as the information costs of operating in international locations. Conversely, smaller cultural distance facilitates transfer of companies’ home country management techniques, and reduces spatial transaction costs.

Table B1. Mean TCPLX SCOPE FSIZE JVEXP PTYPE OWNER DCMKG RIVAL RLPOS CDIST MSIZE MKTGR TRADE SKILL PATNT ABRET PRISK

b.

c.

d.

e.

Descriptive Statistics. f.

1.28 0.46 0.10 −0.03 0.03 −0.05 0.06 13.83 4.12 1.00 −0.21 −0.23 0.01 −0.17 7.46 2.31 1.00 0.56 0.04 0.05 1.75 2.88 1.00 −0.00 0.09 0.89 0.31 1.00 −0.10 50.01 6.97 1.00 1.00 0.00 10.01 4.42 1.90 0.65 10.45 3.44 12.53 11.95 5.94 2.93 57.61 71.45 75.75 14.69 9.19 9.09 0.54 0.04 17.72 5.34 0.26 0.11 0.09 0.01 −0.00

g.

h.

i.

0.09 0.38 0.01 0.05 0.13 −0.07

−0.01 −0.11 −0.07 −0.01 0.08 0.16

1.00 −0.06 1.00

j.

k.

l.

m.

n.

o.

p.

−0.03 0.25 0.09 −0.26 −0.14 0.05 −0.13 −0.06 0.05 −0.09 −0.18 −0.01 −0.06 0.14 −0.03 −0.06 −0.00 0.08 0.04 −0.01 −0.18 −0.18 −0.19 −0.05 −0.01 −0.03 −0.06 −0.09 −0.09 −0.13 −0.10 0.04 0.06 −0.05 −0.00 0.05 0.06 0.03 0.11 0.00 −0.03 −0.03 0.06 −0.17 −0.06 0.05 0.11 0.04 0.07 −0.10 −0.05 −0.06 1.00 0.05 0.41 0.19 0.38 1.00 0.12 −0.54 −0.24 1.00 0.14 −0.12 1.00 0.11 1.00

0.03 −0.06 −0.37

−0.00 −0.11 −0.03 0.02 0.35 −0.13 −0.46 0.04 0.28 0.06 −0.23 −0.07 0.40 0.02 1.00 0.02 1.00 0.18 −0.23 −0.63 −0.03 −0.05 0.04

ABRET denotes abnormal returns. The means and standard deviations for MSIZE and PATNT are reported as natural logarithms. All correlations greater (in absolute value) than or equal to 0.26 are significant at p < 0.0001. The corresponding cutoff value for p < 0.01 is 0.18, for p < 0.05 is 0.14, and p < 0.10 is 0.11.

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a. b. c. d. e. f. g. h. i. j. k. l. m. n. o. p. q.

SD

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APPENDIX B

Table C1. Cluster Size

A 30

Firm-specific variables TCPLX 1.57 SCOPE 0.00 RIVAL 0.07 FSIZE −0.13 JVEXP −0.17 OWNER 0.16 DCMKG 0.00 RLPOS 0.26 SKILL 0.05 MSIZE 0.02 MKTGR 0.47 PTYPE 0.35 PATNT 0.03 PRISK 0.22 TRADE −0.28 CDIST 0.40 ABRET −0.36

B

C

Standardized Mean Scores and ANOVA Results. D

E

F

G

H

33

29

33

21

30

16

21

−0.48 0.32 0.12 −0.16 −0.40 −0.14 0.00 −0.69 0.48 0.00 1.00 0.35 0.05 −0.01 0.01 0.78 0.30

0.13 0.14 −0.12 0.08 0.39 −0.19 0.00 0.11 −2.01 0.00 −0.23 0.35 −0.11 0.82 −0.56 −1.30 0.14

−0.61 −0.86 −0.33 0.50 0.45 0.14 0.00 0.89 0.28 0.00 0.19 0.35 0.02 −0.33 −0.02 0.41 −0.31

−0.09 0.25 0.34 0.65 0.84 −0.45 0.00 −0.72 0.77 −0.02 −1.28 0.19 −0.02 1.06 −0.27 −1.62 −0.24

−0.24 0.69 0.17 −0.74 −0.55 −0.16 0.00 0.20 0.69 0.00 −1.16 0.35 −0.02 0.26 −0.38 0.33 0.44

−0.74 −0.52 0.09 0.13 −0.10 0.55 0.00 −0.23 −0.03 −0.11 0.28 0.16 −0.09 −2.22 3.22 0.20 −0.13

0.22 0.00 −0.43 −0.17 −0.17 0.31 0.00 −0.29 −0.23 0.02 0.49 −2.87 0.02 0.21 −0.32 0.37 0.06

ANOVA

Pairwise contrasts (p-values)

(p-value)

B
C

B
F

C
F

0.0001 0.0001 n.s. 0.0001 0.0001 0.0337 n.m. 0.0001 0.0001 0.0001 0.0001 0.0001 0.0001 0.0001 0.0001 0.0001 0.0737

0.0009 n.s. n.s. n.s. 0.0162 n.s. n.s. 0.0004 0.0001 n.s. 0.0001 n.s. 0.0001 0.0014 0.0001 0.0001 n.s.

n.s. n.s. n.s. 0.0175 n.s. n.s. n.s. 0.0001 0.1035 n.s. 0.0001 n.s. 0.0005 n.s. 0.0002 0.0030 n.s.

0.0393 0.0272 n.s. 0.0013 0.0024 n.s. n.s. n.s. 0.0001 n.s. 0.0001 n.s. 0.0429 0.0314 0.0838 0.0001 n.s.

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DO SERVICE FIRMS PREFER DOMESTIC EXPANSION DESPITE PRIOR INTERNATIONAL EXPERIENCE: THE CASE OF INDIAN SOFTWARE MNES Naveen Kumar Jain, Nitin Pangarkar and Yuan Lin ABSTRACT Purpose
Research on international experience notes its positive influence on subsequent international expansion by firms. We test this relationship in the context of the Indian software industry whose offerings, unlike many other services, are storable implying that delivery can be separated from production. Design/methodology/approach
We analyzed the domestic expansion of a sample of publicly listed Indian software firms over the period 2000
2009 with help of Poisson regression. Findings
We find that even internationally experienced Indian software firms might prefer to expand domestically because of limited financial and managerial resources and concerns about diluting their cost

Emerging Market Firms in the Global Economy International Finance Review, Volume 15, 181
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advantage. The storable and separable nature of software services will support this strategy of serving clients remotely. The domestic expansion of assets will, however, be slower for firms with the highest level of industry accreditation. It will also be slower if there are institutional pressures in the form of rivals locating development centers near clients in developed countries. Originality/value
Our results demonstrate that international experience alone is not sufficient for firms to expand overseas. Keywords: Indian software MNEs; international experience; domestic expansion; CMMI; rivalry

INTRODUCTION The availability of low-cost engineers in emerging markets, such as India, has entailed rapid growth of the offshore-outsourced software service industry there (Javalgi, Dixit, & Scherer, 2009). Indeed, the contribution of software services to India’s gross domestic product has grown from 1.5% in 1998 to 7.5% in 2012 (The Telegraph, 2013). This growth has been facilitated by the storable and separable characteristics of these services, enabling Indian software firms to export their low-cost products to clients based in developed countries. In this regard, a report by the Reserve Bank of India (2013) stated that during 2011
2012, as much as 69% (INR 2028.4 billion out of 2937.7 billion) of the international sales of the Indian software industry occurred by the simplest mode
exports. However, these very factors (plentiful low-cost engineers in the home country and the storability and separability of services) also imply that emerging market service multinational enterprises (MNEs) may prioritize expanding their productive assets, such as software development centers, domestically rather than internationally even after accumulating international experience. This pattern of expansion is interesting because it would be in direct contrast to the conclusions of the substantial research work that notes a positive relationship between the accumulation of international experience and the likelihood (as well as extent) of international expansion (Delios & Henisz, 2000; Johanson & Vahlne, 1977). Therefore, in this paper, we examine how the Indian software MNEs’ international experience influences their domestic expansion, specifically the number of their domestic development centers (DDCs) which are the software industry’s equivalent of factories. We further adopt a distinctive perspective by

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examining how an internal resource of Indian software MNEs in the form of CMMI certification, and an external factor in the form of greater number of international development centers (called Global Development Centers or GDCs in this paper) by rivals moderate the above relationship. Drawing from the literature on offshore-outsourcing, we argue that while deciding on the configuration of their productive assets, emerging market software MNEs have to choose between achieving greater cost efficiency, on the one hand, and creating greater customer value, on the other hand. For example, by allowing exploitation of low factor costs in the home market, DDCs enable Indian software firms to achieve and maintain cost efficiency. However, because of greater geographic and cultural distance from customers that are typically located in developed countries, DDCs might hamper the creation of customer value. To create greater customer value through an enhanced customer interface, software MNEs need to establish GDCs near their customers. While recognizing this tradeoff between higher cost efficiency and greater customer value, we argue that even with increased international experience, Indian software MNEs will opt for the achievement of higher cost efficiency over the provision of greater customer value because of two factors: limited organizational learning from their international experience possibly because of deployment of low-commitment modes, and the lack of financial and managerial resources. At the same time, some key characteristics of software, including its storability (after completion of design), low transportation costs and low tariff barriers, further facilitate the separability of development versus delivery of services. We also draw from the resource based view and the institutional theory to further argue that the positive relationship between international experience and the number of DDCs will be negatively moderated by the CMMI certification and the internationalization of rivals of Indian software firms. In other words, software firms with CMMI certification and rivals that are internationalizing aggressively will be less likely to opt for DDCs. By adopting a perspective that is suited to the industry as well as the home country context, our paper bridges the literatures on offshoreoutsourcing, international experience, and emerging market service MNEs. We identify the conditions under which emerging market service MNEs will expand domestically, and also the contingencies, including internal resources as well as external competitive pressures, that slow down their domestic expansion. We further contribute to the literature with the help of our unique and unexplored context of emerging market service MNEs offering storable and separable services such as offshore-outsourced software development where many emerging market firms tend to choose

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low-commitment modes for serving international clients. We base our analyses on a manually collected dataset which tracks the establishment of DDCs by the top 32 Indian software firms over a 10-year period, and find empirical support for our key predictions. The remainder of this paper is organized as follows. We first review some of the main characteristics of the phenomenon of offshore outsourcing, including key client considerations and motivations that have enabled the growth of Indian software firms. We, then, highlight the key features of the three alternatives (exports, sales offices, or GDCs) by which Indian software firms can serve their international clients. This is followed by the development of the hypotheses. We outline the empirical aspects, including our sample, operational measures, and estimation methods, in the next section. Subsequently, we discuss the results of our analyses. A discussion of the limitations of the paper and the directions for further research conclude our paper.

LITERATURE REVIEW Offshore Outsourcing Hahn, Bunyaratavej, and Doh (2011) define offshoring as relocation of work from the home country to a non-proximate host country. In offshore outsourcing, in addition to the aforementioned condition, the work must also be outsourced by a client to a vendor (Rottman & Lacity, 2008). Achieving a substantial reduction in labor costs is one of the main motivations for client companies to offshore outsource their IT operations (Gonzalez, Llopis, & Gasco, 2013). For example, Farrell (2005) reports that US companies realize cost savings of up to 58 cents for every dollar of IT tasks offshored to India. However, dislocation of work to another country makes offshore outsourcing riskier than a ‘simple’ (as in within the same country or onshore) outsourcing project. For example, offshore outsourcing involves additional risks related to data security, client coordination due to time separation and, possibly, lack of trust due to geographic, cultural and institutional differences (Gonzalez et al., 2013; Kedia & Lahiri, 2007; Mirani, 2007). These risks reduce the success rates of offshore outsourcing projects, and many a time induce developed country-based clients to offshore by either using a mediator or choosing geographically and culturally proximate nearshore locations, despite obvious cost advantages

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of a distant offshore location such as India (Hahn et al., 2011; Mahnke, Wareham, & Bjorn-Andersen, 2008). Moreover, well-publicized offshoreoutsourcing failures of high-profile companies such as Dell might cause other clients to be cautious about offshore outsourcing (Doh, 2005). Trust-based relationships between a client and a vendor can be one of the most effective means for vendors to attenuate client risks inherent in an offshore-outsourced project (Soderberg, Krishna, & Bjorn, 2013). Trust can be established or enhanced through a vendor’s proximity to the client (e.g., through the establishment of a development center near the client location) and through the adoption of effective communication mechanisms (Kelly & Noonan, 2008).

Alternative Paths for Software Firms to Service International Clients and Their Strategic Implications Software firms have a variety of alternatives to serve their international clients. They can: (i) choose to develop software in their existing DDCs or establish new DDCs and export the software as per client requirement (low commitment); (ii) develop software in existing or new DDCs but establish a sales office near the client (medium commitment); or (iii) locate proximate to the client by opening a GDC which allows them to not only customize their offering but also build relational assets (high commitment). Empirically, it has been observed that many software companies, especially small and medium-sized ones, are reluctant to choose the third option (Roberts, 1999). These firms may be apprehensive of losing their low-cost advantages upon choosing this high commitment option. Though it is a high cost alternative, a high commitment mode, such as the establishment of a GDC, offers plenty of benefits to a software firm. First, a firm can develop an in-depth comprehension of the institutional, cultural, and business practices of a host country. For instance, a GDC may help a firm appreciate the causal mechanisms leading to business success in a culturally distant country (Zeng, Shenkar, Song, & Lee, 2013) which, in turn, is likely to enhance the flow of business to the software vendor. Second, the development of client-specific relational assets is also a function of the deep commitment to the host country as created by establishing a GDC. GDCs can increase project effectiveness in terms of better client experience by enhancing the knowledge transfer between client and vendor, yielding reduced defects and improved vendor performance (Dibbern, Winkler, & Heinzl, 2008; Dyer & Hatch, 2006; Erramilli, 1991;

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Metiu, 2006). Riding on these positive results, a vendor company may gain client trust and greater business volume from clients in future. In fact, Indian software companies have been reporting multi-million dollar deal flows from their clients upon gaining their trust by locating close to them (Manning, Lewin, & Schuerch, 2011; Pant & Ramachandran, 2012). Furthermore, GDCs in other countries might help a software vendor assemble a virtual global team that can offer 24/7 services to its overseas clients, for example by following the Sun model for module handoffs and improve delivery time in the process (Kumar, Mohapatra, & Chandrasekhar, 2009). Therefore, we posit that software companies always encounter this strategic tension between creating customer value through undertaking costly initiatives such as opening GDCs and achieving cost efficiency through software development in DDCs and its subsequent exports.

HYPOTHESES DEVELOPMENT International Experience and the Choice between DDCs and GDCs Despite efficiency-related benefits, client companies might shy away from offshore outsourcing to an emerging market such as India because of the risks reported elsewhere in this paper. In order to attenuate client-specific risks by forging closer relationships, Indian software companies would ideally like to open GDCs close to their clients (Pant & Ramachandran, 2012). For such high commitment international expansion, the international business (IB) literature asks firms to lean on organizational learning accruing from their prior international experience. However, organizational learning is robust when managers scratch below the surface-level similarities and learn deeply about an activity (Haleblian & Finkelstein, 1999; Zeng et al., 2013). Therefore, learning from a host country is more likely when an Indian software firm commits itself highly to a host country, for example by establishing a GDC rather than serving the client through a low- or medium-commitment mode. Operating a GDC close to clients in developed countries, however, poses its own sets of challenges. Lacking reputational assets in a host country, an Indian software firm may be unable to attract local talent, and, thus, be constrained to follow an ethnocentric staffing policy (Anderson & Gatignon, 1986; Erramilli, 1991; Newburry, Gardberg, & Belkin, 2006), in turn, impairing its learning capabilities. Transferring subsidiary knowledge

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from a culturally distant country to either headquarters or other subsidiaries may also become challenging if a firm has not acquired in-depth knowledge in the culturally distant country (Zeng et al., 2013). Additionally, establishing a GDC also requires a substantial resource commitment. But, similar to other emerging market firms, Indian software firms face financial, managerial, and other resource constraints and may be especially disadvantaged compared to firms in developed countries (Luo & Tung, 2007). Moreover, the liability of foreignness, liability of outsiderness and liability of emergingness might worsen software firms’ cost structure (Goerzen, Asmussen, & Nielsen, 2013; Johanson & Vahlne, 2009; Madhok & Keyhani, 2012; Newburry, 2010), hampering their ability to remain as cost efficient as before. At the same time, the tangible, separable and storable nature of software services enables Indian software firms to service their clients cost-efficiently by exporting their services from DDCs, further blunting their incentives to go for GDCs (Erramilli & Rao, 1993; Javalgi & White, 2002). On the other hand, the software companies’ cost-based competitive advantage arising from cheap labor in their home markets may also be eroded by locating closer to their clients in developed countries with higher labor costs. In this regard, Roberts (1999) notes that computer services firms utilize embodied, trans-human, and wired exports as their chief means to service their overseas clients. In summary, because of limited organizational learning resulting from the (low commitment) international experience, the substantial resource requirement for operating GDCs, and the storable and separable nature of software services, we argue that Indian firms with international experience might prefer to channel their resources toward the expansion of their DDCs rather than GDCs. Therefore, we hypothesize that there will be a positive relationship between Indian software firms’ level of international experience and their number of DDCs. Hypothesis 1. An Indian software firm’s international experience is positively related to the number of its domestic development centers.

Interactive Effect of International Experience and CMMI Accreditation Resource-based view suggests that firms with stronger resources are able to undertake high-commitment internationalization because they can overcome liabilities of foreignness (Barney, 1991; Zaheer, 1995). In the

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following discussion, we argue that some firm resources (more precisely combinations of some resources) tilt the balance between creating value through GDCs and achieving cost efficiency through DDCs toward the former. For instance, we argue that while international experience alone might not be sufficient for firms to choose customer value creation over cost efficiency, international experience combined with CMMI certification, a key resource for IT vendor firms, will reduce the likelihood that Indian firms will pursue cost efficiency through developing software in DDCs and exporting it subsequently. The CMMI institute at the Carnegie Mellon University assigns levels ranging from one to five, with five being the highest, based on firms’ internal processes including alignment between business objectives and process goals (Kishore, Swinarski, Jackson, & Rao, 2012). Therefore, CMMI accreditation has been adopted globally by IT companies as a credible signal to a client that they follow disciplined and standardized processes (Chen, Park, & Newburry, 2009; Dosi, Faillo, & Marengo, 2008; Kishore et al., 2012). Since a CMMI accredited firm has invested in technologies with standardized processes, control, and reporting rules, it would likely have created a knowledge transfer mechanism which is not impacted by cultural, linguistic, or geographic distances among globally distributed teams stationed in various development centers (Ambos & Ambos, 2009). Indeed, geographic, temporal, and social distances among geographically distributed teams plague intergroup cooperation due to lack of rich, faceto-face communication (Lee, Delone, & Espinosa, 2006; Sidhu & Volberda, 2011). Rigorous reporting and the presence of disciplined processes of CMMI accredited firms can also overcome the challenge of stickiness of knowledge, and facilitate its sharing during software module hands-off by one team to another located in different development centers of a software firm (Kumar et al., 2009; Stringfellow, Teagarden, & Nie, 2008). Furthermore, reputation gained through a CMMI-accreditation can also help a firm attenuate its liabilities of foreignness in an overseas location by enabling it to attract talented and motivated employees, for instance (Hatch & Dyer, 2004; Newburry, 2010). These locally hired personnel may be able to create social networks with clients, reduce communication problems arising out of cultural and geographic distances with clients, and thus, increase the effectiveness and efficiency of a project’s execution (Dibbern et al., 2008; Hinds, Liu, & Lyon, 2011; Raman, Chadee, Roxas, & Michailova, 2013). The improved knowledge transfer between clients and a CMMI-accredited vendor firm might lower post-contractual extra costs that arise because of changes in project specification and design normally

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encountered in an offshore-outsourced IT project, leading to improved cost efficiency and overall financial performance of the vendor (Dibbern et al., 2008; Gu & Jung, 2013; Karlsen & Gottschalk, 2003). Local employees can also serve as important conduits for accessing ‘local-business-network’ knowledge that has been identified as a must-fill knowledge gap in host countries by a firm for reducing uncertainty in its subsequent foreign market expansions (Hilmersson & Jansson, 2012; Johanson & Vahlne, 2009). Further, the accumulation of pertinent knowledge in host countries enables a vendor to transfer it to the headquarters and create a knowledge-based repertoire that can be tapped to lower the risks and uncertainties associated with future internationalization (Asmussen, Foss, & Pedersen, 2013; Hilmersson & Jansson, 2012). In summary, a CMMI-accredited firm has both the financial resources and a repertoire of knowledge-based routines to undertake a high-commitment and, consequently, risky international expansion such as GDCs. On the other hand, a non-CMMI firm, despite possessing international experience, might lose out on both efficiency and knowledge transfer because the absence of standardized processes and control mechanisms place it in a difficult position to coordinate globally distributed teams. In its attempt to coordinate globally distributed teams based in different overseas locations and working on different modules of a software project, a non-CMMI firm runs the risks of overshooting cost and time budgets and providing services at non-competitive rates to its clients. Faced with the prospect of losing its cost-based competitive advantage, a non-CMMIaccredited firm might prefer to serve clients by opening more DDCs rather than GDCs. Therefore, among Indian software firms with international experience, those that have CMMI-accreditation will be less likely to choose DDCs than internationally experienced firms without CMMI certification, as hypothesized below. Hypothesis 2. The positive relationship between international experience and number of DDCs is less pronounced for firms with CMMI level 5 certification. Interactive Effect of Rivals’ International Expansion and International Experience The plentiful availability of low-cost, talented software professionals in India constitutes a key source of advantage for many Indian software firms.

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Many ambitious Indian software firms, however, may be tempted to enhance their competitive advantage by opening GDCs in a client’s proximity. If many rivals open GDCs, it would pressurize other software firms that have not opened their own GDCs to imitate rivals’ opening of GDCs (Henisz & Delios, 2001). Institutional theory would suggest that a focal firm will risk suffering a competitive disadvantage if the GDCs of its rivals are successful and enable the rivals to enhance their competitive advantage (Pangarkar & Klein, 1998). Even if the new GDCs do not turn out to be a competitive advantage enhancing strategy, by following its rivals, a software firm would ensure that it does not suffer a relative disadvantage. Prior studies have concluded that the pressure created by rivals’ investments is one of the determinants of international location choice of service firms (Alcacer, Dezso, & Zhao, 2013; Li & Guisinger, 1992). In summary, if many rival firms open GDCs, an internationally experienced software firm may be better off diverting its scarce resources from opening a DDC towards opening a GDC. Hence, we propose the following hypothesis. Hypothesis 3. Rivals’ establishment of GDCs will negatively moderate the relationship between international experience and number of DDCs by an Indian software firm. We summarize the hypothesized relationships in Fig. 1.

RESEARCH METHOD Context and Sample Starting from a very small base in the 1980s, the Indian software industry has shown sustained high growth rates over the last three decades (Pradhan, 2005). It has emerged as one of the largest industries in India by revenues (7.5% of India’s GDP; US$100 billion by 2012) as well as exports (20% of exports; The Telegraph, 2013). The industry has also witnessed vigorous activity in terms of new entry. The industry growth story extends well beyond numbers since many players have successfully transitioned from doing low value added work and a competitive advantage based on low factor costs to more complex business models and higher value added work (Arora & Gambardella, 2005). The growth record of some of the leading firms is even more impressive than the general industry. Infosys’s revenues, for instance, grew from $5 million in 1994 to more than $4 billion

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Possession of CMMI level 5 certification

H2: H1: +

International experience of the focal firm

Number of Domestic Development Centers of the focal firm

H3: -

Rivals’ Global Development Centers

Fig. 1.

A Schematic Representation of Hypotheses.

in 2009. Considering Indian software industry’s explosive growth, prominent status within India as a key contributor to GDP and exports and its strong position within the global industry, we believe that it provides an interesting context to examine our research questions. The variety of player profiles also implies adoption of diverse strategies thus providing us an opportunity to examine the antecedents of the adoption of these strategies.

Sample and Data Gathering We compiled a dataset of 237 firm-year observations by tracking the internationalization of the 32 largest Indian software companies (by sales) which make up 29% of the combined population of 110 publicly listed hardware and software Indian companies (as of June 2009) for a 10 year

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period between 2000 and 2009. These firms account for a large proportion of the revenues, exports and FDI of the industry. With regard to FDI in the form of GDCs, it is noteworthy that a very large number of small- and medium-sized players in the industry are too resource constrained to undertake it (Gopal & Gao, 2009; Nadkarni & Herrmann, 2010; Pradhan, 2007). We undertook manual data compilation because there was no up-todate and reliable database on foreign subsidiaries of Indian firms from the Government of India or other sources (Pradhan, 2007). We gathered information from several publicly available sources such as the individual firms’ websites, initial public offer documents, annual reports, company internal archival documents including intranets and presentations to media and investors, and company-related news items. We verified the accuracy of the secondary data by sending the list of countries where each firm had expanded to a senior manager in each company. In case of any discrepancies, we went back to the company for further data collection and/or resolution. Thirteen out of the thirty-two sampled software firms were affiliated with a business group. There was significant variation across the sampled firms in terms of the number of centers (DDCs as well as GDCs) operated.

Measures Dependent Variable Our dependent variable was the number of DDCs operated by a firm during any year. Independent Variables CMMI Level 5 Certification. We operationalized this variable as a binary variable assuming a value of 1 if the focal firm had attained a CMMI level 5 certification during (or before) the particular year and 0 otherwise. Rivals’ GDCs. We operationalized this variable as the number of GDCs operated by rival firms in a particular year. International Experience. We operationalized International experience as the number of years since the firm’s first international entry (either a sales office or a full-fledged GDC).

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Control Variables We included a number of control variables that could independently impact the number of DDCs operated by a company in any given year. Performance. We included Return on Sales (ROS) lagged by one year to control for the possibility that better performing firms open more DDCs simply because they are more profitable and hence have the resources to open more DDCs. While this measure is influenced by capital structure with higher levels of debt leading to better values of ROS, we believe that it should not be a major concern because of three factors. First, our sample is a single industry sample with similar asset intensity across competitors. Second, the software industry is a people intensive and asset-light industry. Third, a quick examination of the capital structure of these firms indicated that they were mostly funded by equity. Given the small asset base of the software industry, differences in leverage employed by various firms should not affect the ROS values for firms. Firm size. Larger size implies greater business volume and hence greater need for development centers. Larger firms may be in a better position to get contracts from multinational customers which, in turn, might require the opening of a greater number of development centers. Larger firms might also possess the managerial depth to successfully operate a large number of DDCs. Hence we included firm size, which was measured as logarithm of the number of employees, as a control variable. Number of GDCs was included as a control variable to account for the variation in firm strategies, specifically in terms of the emphasis on pursuing cost efficiency versus customer value. Firms aiming to provide greater customer value might be expected to have fewer DDCs and more GDCs, ceteris paribus. Number of DDCs in prior year was also included as a control variable. Finally, we also included year dummies as control variables. To avoid endogeneity (problem of loop of causality), we lagged all the independent variables by one year.

Estimation Methods Since the dependent variable is derived from count data, its discrete nonnegative nature generates non-linearities that render the usual linear regression models inappropriate. The Poisson regression is a natural

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choice for this kind of data structure. Moreover, the data extend over multiple years for the same firms, forming a time-series cross-sectional panel. In panel data, the presence of firm-specific unobservables or unobserved ‘heterogeneity’ such as the capabilities of local managers might influence the investment behavior. We accounted for these properties of the panel data by using a random-effects Poisson model to test our hypotheses (Hausman, Hall, & Griliches, 1984). We used the randomeffect regression estimations over fixed-effect models for two key reasons. First, in contrast to fixed-effects estimations which would omit timeinvariant control variables such as whether a firm is affiliated to a business group, the random-effects estimation allows us to perform estimations with these variables. Second, because of different assumptions of fixedand random-effects models, the fixed-effects model cannot be extrapolated to a period outside the sample period, while the random-effects model can be generalized to a longer time frame (Lee & Park, 2006; Li & Greenwood, 2004).

RESULTS We provide the descriptive statistics and correlation matrix in Table 1. As expected the average values of the DDCs variable are twice those of GDCs suggesting that opening DDCs is a more common strategy employed by Indian software firms. Interestingly the ratio of SD to mean is higher for DDCs than GDCs suggesting that there is considerable interfirm variation (and possibly even inter-temporal variation for the same firm). Some of the independent variables are correlated with each other. We will use Variance Inflation Factors to judge whether our regression estimates are impacted by multicollinearity. We provide results of the estimations in Table 2. We started with a model that included control variables only and then successively added the main effect of international experience and its interactions with CMMI certification and GDCs by rivals. Despite, their parsimony, our models performed quite well, as reflected in the significant value of the Wald chi-square statistics. The addition of the international experience and interaction variables also led to improved chi-squared values. The mean value of the Variance Inflation Factors for our models was 1.85 and the range was 1.02
3.47. Since these values are well below the suggested thresholds of 5, we believe that our estimates are not impacted by multicollinearity.

Number of DDCs (1) International experience (2) CMMI level 5 certification (3) Rivals’ GDCs (4) Number of GDCs (5) Size (6) Business group affiliation (7) ROS (8) Mean S.D. Min Max

Descriptive Statistics and Correlation Matrix (N = 237). (1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

1 0.663*** 0.446*** 0.201*** 0.846*** 0.724*** 0.259*** −0.105+ 16.399 19.371 1 139

1 0.167** 0.129* 0.536*** 0.740*** 0.142* −0.119+ 8.935 6.894 0 30

1 0.395*** 0.349*** 0.417*** 0.205*** 0.003 0.467 0.500 0 1

1 0.104+ 0.212*** −0.016 0.017 14.714 8.930 1 30

1 0.658*** 0.213*** −0.090 1.986 4.126 1 28

1 0.230*** −0.118+ 7.963 1.539 4.248 11.876

1 −0.021 0.431 0.496 0 1

1 0.12 0.13 −0.68 0.66

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Table 1.

+ Correlation is significant at the 0.1 level (2-tailed).* Correlation is significant at the 0.05 level (2-tailed). ** Correlation is significant at the 0.01 level (2-tailed). ***Correlation is significant at the 0.001 level (2-tailed).

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Table 2. Results of Random-Effect Poisson Regression Estimations. Dependent Variable: Number of DDCs Model 1

Model 2

Model 3

Model 4

0.317*** (0.042) 0.096 (0.112) −0.019* (0.009) 0.004 (0.003) −0.001 (0.001)

0.035** (0.013) 0.042 (0.061) −0.007 (0.018) 0.222*** (0.055) 0.105 (0.114) −0.015 (0.012) 0.002 (0.003) −0.001 (0.001)

0.038** (0.013) 0.167+ (0.093) −0.011 (0.018) 0.207*** (0.055) 0.099 (0.110) −0.019 (0.012) 0.006 (0.004) −0.001 (0.001) −0.012+ (0.007)

0.043*** (0.013) 0.016 (0.061) 0.001 (0.018) 0.220*** (0.053) 0.104 (0.105) −0.021+ (0.012) 0.007+ (0.004) −0.001 (0.001)

International experience CMMI level 5 Rival’s GDCs Size Business group affiliation No. of GDCs No. of DDCs in prior year ROS in prior year International experience × CMMI level 5 International experience × Rival’s GDCs Intercept Year dummies Wald χ2 N

0.479 (0.380) Included 1054.76*** 237

1.109+ (0.655) Included 1070.08*** 237

1.208+ (0.652) Included 1076.18*** 237

−0.001** (0.000) 0.968 (0.643) Included 1084.91*** 237

Standard errors in parentheses. *** p < 0.001. ** p < 0.01. * p < 0.05. + p < 0.1.

Turning to the hypotheses testing, Hypothesis 1 was strongly supported. The greater the international experience of the firms, the greater the number of their DDCs. It is noteworthy that we focused on the 32 largest Indian software firms which are expected to be better endowed in terms of both financial and managerial resources. Despite this endowment, as noted earlier, these firms open more DDCs than GDCs. We might speculate that the propensity to open DDCs among internationally experienced firms may be even greater beyond our sample. The coefficient of the interaction between CMMI and international experience was significant at the 10% level, providing weak support for

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Hypothesis 2. Thus while CMMI certification slows down the pace of DDC expansion because of a firm’s ability to coordinate geographically distributed centers, it does not do so in a strong fashion. The coefficient of the interaction term between rivals’ opening of GDCs and a focal firm’s opening of DDCs is strongly negative, providing strong support for Hypothesis 3. Thus when rivals open GDCs and become proximate to customers, a focal firm slows down its pace of opening DDCs, possibly because it is following rivals by allocating its limited resources to opening more GDCs. We also explored the interactive effects by plotting the relationships graphically (see Figs. 2 and 3). With regard to the interactive effect of CMMI accreditation and international experience, the graph is consistent with the weak support for Hypothesis 2. At low levels of international experience firms with CCMI accreditation open more DDCs but at high levels of international experience, firms without CMMI certification open more DDCs. The two curves are also rather close to each other, suggesting small differences in the strategies pursued by firms with or without CMMI. The graph for the interaction between rivals’ GDC expansion and international experience of the focal firm is more conclusive and clearly shows that when rivals operate more GDCs, a focal firm will likely follow them by operating its own GDCs and hence operate fewer DDCs. On the other hand, when rivals operate fewer GDCs, a focal firm will be less pressurized to follow the path of becoming more proximate to customer and hence 60

Number of DDCs

50 40 30

CMMI (No = 0) CMMI (Yes = 1)

20 10 0

0

5

10 15 20 25 International Experience

30

35

Fig. 2. Graphical Illustration of Interactive Effect Between International Experience and CMMI Level 5 Certification on the Number of DDCs.

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Number of DDCs

50 40 30

Low rivals’ GDC expansion High rivals’ GDC expansion

20 10 0

Fig. 3.

0

10 20 30 International Experience

40

Graphical Illustration of Interactive Effect Between International Experience and Rivals’ GDCs on the Number of DDCs.

operate more DDCs. This suggests that there is a substitution effect between domestic expansion and internationalization. Among other results, we find that larger firms operate a greater number of DDCs. One reason could be that they simply have a greater volume of business which needs a greater number of DDCs. Another explanation could lie in their financial and managerial resources which allow them to manage and coordinate an extensive network of DDCs. In contrast, business group affiliation had no impact on the number of DDCs, suggesting that either the business groups are loosely affiliated groups where member firms may not be able to draw on the group-wide financial resources or that industry-specific resources (rather than generic resources) such as management depth of the company are a more important determinant of the number of DDCs operated by a firm. The coefficient for GDCs was negative in two out of the four regression estimations which suggests that there may be some (though not very strong) substitution effect between the number of DDCs and GDCs. We deployed alternative regression models to check the robustness of our results. A casual inspection of our datasets reveals that its sample variance (19.37 for the number of DDCs) is larger than its sample mean (16.40 for the number of DDCs). Therefore, we used zero inflated negative binomial (ZINB) models, which relaxed the assumption of equal mean and variance and corrected for over-dispersion in the data (Osgood, 2000; Paternoster & Brame, 1997). The results, in terms of significance of the coefficients, were similar.

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DISCUSSION, LIMITATIONS, AND FUTURE RESEARCH In this study, we adopted a contrasting perspective to the literature on internationalization. The IB literature argues that greater international experience will lead to greater international expansion, possibly with an adoption of high commitment client servicing modes. In contrast, we argued that international experience alone might simply imply a greater number of domestic development centers. Our prediction was grounded in the industry as well as country context. With regard to the industry context, low transportation costs, low tariff barriers for software, and the storable and separable nature of the software services allow for the development of software in a location remote from the client followed by its subsequent exports. With regard to the country context, with its plentiful supply of trained software engineers available at relatively low wage rates, India provides a strong incentive for local firms to develop software in a DDC, and, then, export it. The stickiness (in terms of preference for DDCs) due to the industry and country context is, however, weakened by firm-specific as well as environmental factors. CMMI accreditation which signifies the presence of strong internal processes, and proxies the ability to overcome challenges posed by distributed development centers as well as the ability to consolidate and leverage the organizational learning at different locations, reduces the preference for DDCs among internationally experienced firms. Similarly, peer pressure created by rivals’ locating in customers’ proximity by undertaking high commitment internationalization also weakens the incentive for internationally experienced firms to expand DDCs and export the software. Thus, firm resources and rivals’ actions seem to reduce the tendency of Indian software firms to serve clients in developed countries via exports, even if it means diluting their cost advantages. Our paper also contributes to the client-servicing literature that recommends vendor companies to forge a strong relationship with clients by locating in their proximity (Dyer & Hatch, 2006; Pant & Ramachandran, 2012). The location literature, similarly, identifies client following as one of the most important determinants of the location choice by service firms (Erramilli, 1993; Petrou, 2007). In as much as Indian software companies would like to locate next to their clients by opening high commitment GDCs and enhance their competitive advantage, we report that not all firms are enabled to do so. In fact, we show that international experience is not a sufficient condition for locating close to customers, and therefore,

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resource constrained firms may continue to export especially when their home country environment offers significant cost advantages. We might further suggest that the application of the springboard perspective (Luo & Tung, 2007) proposed for emerging market firms (EMFs) may be contingent. Our study, for example, demonstrates that EMFs in services industries still seem to avoid high commitment overseas expansion. Though our results stand in contrast to those in the IB literature, they support many of the previous studies in the services literature by reiterating the use of exports as a predominant mode to serve international clients by service firms (Javalgi & White, 2002; Roberts, 1999). Our investigation of the Indian software industry shows that some aspects of service industry and home country based advantages outweigh firms’ international experience when firms choose between DDCs or GDCs to service their clients. At a general level, our analysis demonstrates that the relationship between international experience and international expansion is contextual, especially for emerging market service MNEs. The relationship is influenced by industry (rivals’ strategies as well product or service characteristics such as storability and transportability) and country context (specifically comparative advantage in home country), as well as by firm resources. We find that only emerging market service MNEs with stronger resources and internationalizing rivals seem to utilize their international experience for further international expansion, as recommended by the linkage-leverage-learning perspective (Mathews, 2006). Indian software firms with stronger capabilities might be able to strengthen their relationship with clients, leverage those relationships to expand overseas, and possibly gain insightful learning for further expansion. Firms without the said capabilities may find it too daunting to expand overseas through medium or high commitment modes, and, hence, prefer exports as a primary vehicle to serve their clients. Though, in general, our study extends the literature on prior international experience and subsequent international expansion by scrutinizing this relationship in the context of emerging market service firms, we specifically add to a small but emerging body of research that contends that international experience may not always reduce uncertainty in an overseas expansion. For example, Hilmersson and Jansson (2012) posit that international experience’s uncertainty reducing ability is moderated by institutional distance and knowledge specificity. Our study also finds that Indian software companies are not expanding internationally with high commitment despite gaining international experience. A potential explanation for this phenomenon seems to come from Zeng et al.’s (2013) work which notes

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that cultural and institutional distances impede cross-border knowledge transfer ability of a firm. We believe that the impaired knowledge accumulated in developed markets by Indian software firms, and consequently its incomplete transfer to headquarters hinder their abilities to use the experience for future overseas expansion. To further add to this incipient body of research, we recommend that future research examine various firm-level resources or actions that influence its cross-border knowledge transfer efforts. We also suggest future research to test the influence of international experience on domestic versus international expansion of leader and laggard firms for manufacturing industries where the dynamics could be different from a service industry such as software. This would also extend the work of Smeets and Bosker (2011) on leader and laggard firms. We also recommend future studies to examine how EMFs in knowledge-intensive service industries facing frequent technologically disruptive changes can augment their assets. Ramamurti and Singh (2009) recommend firms operating in these industries to go overseas to augment their assets. In general, however, our analysis of Indian software firms that operate in such an environment seems to suggest that the overseas expansion is contingent on firm and industry level factors, and not a norm. In the field of global strategy, pioneering works by scholars such as Porter (1986), Bartlett and Ghoshal (1989), and Prahalad and Doz (1999) have suggested that firms use particular strategies for specific industry contexts (Morrison & Roth, 1993; Roth, 1992). Firms in industries with a high need (or pressure) for local responsiveness, for instance, should follow localized strategies. In industries characterized by a high need for global integration such as aircraft or semiconductor manufacturing, on the other hand, globally coordinated strategies may be optimal. Though prior literature has made allowance for differences in resource endowments of firms that might call for deviation in suggested strategies, it has not accounted for the home country effect. Our examination of the Indian software industry suggests that the centralization in software development may be driven by not only the paucity of financial and managerial resources but also the lower costs of employing a good quality software engineer in India than in developed countries. Further, the peculiar characteristics of the software industry that allow the final product to be transported without logistics costs and import tariffs also play a key role in this situation. Our analyses thus suggest that optimal firm strategies are a function of not only industry characteristics and firm resources but also home market characteristics. They also suggest that in addition to the traditional dimensions of global integration and local responsiveness, other dimensions such as

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technological and other industry characteristics (e.g., storable and separable nature of the product development in service industry) are also important in determining the appropriate strategies for any industry context. We do acknowledge several limitations of our analyses that also suggest fruitful directions for future research. A key limitation of our analysis refers to the nature of our dependent variable—a count of development centers. We acknowledge that not all development centers, whether DDCs or GDCs, are equal in size, and urge future studies to include the size of development centers to proxy the resource commitment. Additionally, we did not consider the performance impact of various expansion strategies. It is possible that a domestic expansion in the form of DDCs has different performance implications from internationalization in the form of establishment of GDCs. Though examining performance implications was beyond the scope of this study, future studies might link these various strategies to their performance implications. It is also possible that our results are more applicable for storable and separable service industry such as offshore-outsourced software industry in an emerging market. Therefore, we ask future researchers to consider looking into varied services industries in both emerging market and developed country settings to resolve whether our results hold across varied contexts. Despite these limitations, we hope that our work will spawn a new stream of research that examines the contingent nature of the choice between domestic versus international expansion, and thus enhance our understanding about firm responses and strategies in relation to their international experience.

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509.

BRAZILIAN COMPANIES IN THEIR HABITAT: THE IMPACTS OF PRO-MARKET REFORMS IN THEIR EVOLUTION AND INTERNATIONALIZATION Afonso Fleury and Maria Tereza Leme Fleury ABSTRACT Purpose
This paper questions currently accepted arguments about the impacts of pro-market reforms in the internalization of emerging country firms, through an in-depth analysis of the Brazilian case, thus revealing new dimensions to add to the extant literature. Design/methodology/approach
Historical analysis is the central mode of investigation leading to a commitment of offering historically grounded explanation for pro-market reform impacts in the Brazilian industry. Findings
Outcomes reveal that the impacts of pro-market reforms depend on (a) the purpose of their adoption, (b) the compatibility with

Emerging Market Firms in the Global Economy International Finance Review, Volume 15, 207
229 Copyright r 2014 by Emerald Group Publishing Limited All rights of reproduction in any form reserved ISSN: 1569-3767/doi:10.1108/S1569-376720140000015009

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the features of the local institutional context, and (c) the relative bargaining power of local firms vis-a`-vis foreign multinationals. Research limitations
The research is based on the Brazilian experience only which is indicative of what may have happened in other Latin American countries; however, the analytical approach may be extended to the study of other emerging countries. Practical and social implications
By having a systemic perspective encompassing the different actors and the interdependence among themselves, it allows for an enhanced view of the factors which led to the adoption of pro-market reforms and the forces which acted for its configuration, thus helping policy-makers to better approach industrial policy-making. Originality
A longitudinal perspective within a historical analysis is adopted, focusing on the interplay of macro-level and firm-level factors, resulting in a better understanding of the reasons which led to the adoption of pro-market reforms, the resistance to its implementation and its real outcomes. Keywords: Pro-market reforms; Washington consensus; Brazilian multinationals; emerging country multinationals

INTRODUCTION The expansion of emerging country multinationals (EMNEs) is a reality. Not only have emerging countries become major recipients of FDI but also important outward investors. Their OFDI rose from $7 billion in 2000 to $ 87 billion in 2005, and $ 145 billion in 2012, or 10% of world flows (up from 1% in 2000) (UNCTAD, 2013). The rise of EMNEs has both quantitative and qualitative features. An article in the Economist magazine (March 5, 2011, p. 16) looking at the trajectory of EMNEs, including Brazilian Embraer and Votorantim, concludes that “The best emerging market companies have learnt a great deal from the West in recent years. It is time for the Western multinationals to return the compliment.” There are several approaches to explaining the rise of those firms. Some authors look at the firms’ internal factors, firm-specific advantages which give them competitive clout (Williamson, Ramamurti, Fleury, &

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Fleury, 2013). Others look at contextual factors which might have leveraged their internationalization. Within the latter group, some authors defend the argument that pro-market reforms had a relevant impact on internationalization. In the specific case of Latin America, pro-market reforms are said to have contributed to the rise of the multilatinas (CuervoCazurra, 2008; Cuervo-Cazurra & Dau, 2009). Nevertheless, some polemic points remain such as whether the greatest beneficiaries were local private companies, state-owned companies (SOEs) or developed country multinationals (DMNEs). However, those investigations tend to overlook more detailed contexts where economic liberalization set in. Although they have yielded key results, there are hidden dimensions that, once approached, may give rise to new insights. For example, the literature seems to neglect companies which had been previously affected in a negative way by pro-market reforms; in other terms, the losers in that process. Including these generally overlooked factors in the analysis may, therefore, shift the balance of pro-market reforms on internationalization. Moreover, this aligns with Cuervo-Cazurra and Dau’s (2009) concerns for whom the polemics around pro-market reforms requires more nuanced analyses, especially at firm level. Adopting a historical standpoint, this paper attempts to elucidate the impacts of the economic liberalization across the industry in Brazil. It shows that, like other Latin American countries, pro-market reforms clashed with the strongly nationalistic ideology which had been driving the industrialization policies since the 1930s. External markets were a distant reality and, with some exceptions, exportation was practiced only when there were local surpluses that met existing demands in international markets. The need for liberalization emerged in the early 1980s but initial policies in that direction were only implemented 10 years later, when macroeconomic imbalances imposed their adoption. The scope and means of liberalization policies changed during the 1990s, as the first half of the decade was characterized by economic and political turbulence while the second half featured the opposite: there was economic and political stability. Under those circumstances, the impacts of liberalization on industrial structure were awkward for several reasons, as will be discussed later. However, in spite of those hostile conditions, some local firms emerged and became global players. Historical analysis is the central mode of investigation leading to a commitment of offering historically grounded explanation for pro-market reform impacts over the industry in Brazil. Information was collected through archival analysis, information available in the media, websites,

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among other means. The evidences raised in this study suggest counterarguments against recent findings in the literature. The first evidence brings a different perspective for Cuervo-Cazurra and Dau’s (2009) statement that pro-market reforms improve profitability more for domestic state-owned and domestic private firms than for subsidiaries of foreign firms. The second evidence relates to the argument that family groups have privileged conditions to operate in turbulent environments. This paper is structured as follows. Prior to discussing the pro-market reforms in Brazil, the evolution of the context where they were introduced is described; the aim is to allow a contrasting view of what the actual situation of the country and its industry was when liberalization was brought about. Then, the pro-market reforms are analyzed in their distinct components. That is followed by the assessment of the impacts of pro-market reforms on industry, differentiating among local private firms, state-owned enterprises and developed country multinationals. In the conclusion, the main outcomes of the analysis are contrasted with current arguments prevailing in the literature.

THE CONFIGURATION OF THE CONTEXT WHERE PRO-MARKET REFORMS CAME INTO BEING In “The Third Wave” (1980), Alvin Tofler made a remark that every country had a moment in its history when the driver of national development shifted from agriculture to industry (what he called the second wave). That happened in the United States, in 1865, when the forces of the industrialized North subjugated the agricultural South. In Brazil that happened in 1930, after a revolution that deposed the government which represented the “milk and coffee” regions (the states of the federation whose economies were based on the production of coffee and dairy products). The Birth of the First Companies that Would Become Multinationals Before 1929, the main concern of the government was directed for permanently upholding coffee prices in the international markets. Their policies proved to be efficient until that moment in time, when the global crash strongly affected coffee exports. After the 1930s revolution, a new developmental project was revealed, based on import-substitution industrialization, under a nationalistic ideology.

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During the times of the “milk and coffee barons,” three economic activities were highly valued: banking, trading, and textiles. In spite of that, around 1930, there were already four private companies that would become global players almost a century after their foundation: Brahma and Antarctica (beverage), Gerdau (steel), and Votorantim (cement). Foreign multinationals were already established in Brazil, operating in a very low scale: British-American Tobacco, General Motors, Ford, Philips, Siemens, Ericsson, Electrolux, Rhone-Poulenc, among others.

1930
1955: The First Surge of Nationalist Development and the Creation of SOEs According to Simonsen (1969), until the end of World War II, importsubstitution industrialization was not associated with a long-term development philosophy but consisted of a series of individual reactions to trade balance difficulties. The notion that industrialization should drive the country’s economy became firmly ingrained only after World War II. The national-developmental spirit reached a peak after World War II when three state-owned enterprises were created: Companhia Sideru´rgica Nacional, Companhia Vale do Rio Doce and Petrobras, in sectors regarded as strategic for the country: steel, mining, and oil and gas. The creation of Petrobras followed a huge nationalist campaign whose slogan was: ‘the oil is ours’; to Petrobras it was granted the monopoly of both oil exploration and distribution in the Brazilian territory. To complement the project, the BNDE
National Bank for Economic Development was founded in 1952, aiming at financing projects deemed as strategic, namely at the infrastructural level. To serve those incumbents, a local capital goods industry was established. Two familiar groups, Villares and Vidigal, became predominant in the made-to-order and heavy equipment business. As to the production of machine-tools, several companies started production; among them, Romi was the leader.

1955
1964: Industrialization Accelerates thanks to Foreign Multinationals The 1955
1960 federal administration, adopting newly developed planning techniques, drew plans to boost industrialization, focusing on the production of durable goods. Industrial growth should be supported by a tripod

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constituted by private foreign capital, state-owned enterprises and, as a minor partner, local private capital (Lacerda, Bocchi, Rego, Borges, & Marques, 2006). Considering that, at that time, DMNEs were strongly expanding abroad, the Brazilian decision was very attractive for them. It was also in the interests of Brazilian industrialists, who preferred to be involved as financial partners in the large investments required for the establishment of greenfield-type plants rather than being directly responsible for the creation or management of those enterprises. Inward FDI jumped from an average of US$ 64 million a year, between 1950 and 1955, to an average of US$ 150 million a year in the upcoming quadrennium. Brazil’s dependence on foreign capital, know-how and technology became a basic feature of industrialization.

1964
1980: The Military Coup and the Revival of Nationalist Development In the 1960s, Brazil went through a period of turbulence that ended with the 1964 military coup. Nationalism resurged under a new philosophy, based on sovereignty and security doctrines, five-year national development plans, and science and technology development programs. The chief priority became the creation of infrastructure and the expansion of basic input industries, local companies having a larger share of this. That influenced the growth of local industries: petrochemicals, capital goods, engineering services, and defense. In the capital goods industry, the existing Brazilian firms (Villares, Vidigal) became large, diversified conglomerates that manufactured a broad range of complex products based on mechanical and electromechanical technologies. The second group comprised engineering firms (such as Odebrecht, Camargo Correa, Andrade Gutierrez; Promon), which were assigned as leaders of large infrastructural projects. The upgrading of the petrochemical industry was based on a tripartite model: state capital, foreign capital, and private local capital. The arrangement was such that foreign partners were expected to contribute with technology, while the state was a major shareholder and local private partners would be in charge of the day-to-day operations. Several Brazilian groups joined the program, such as Odebrecht, Ultra, Mariani, and Suzano. Three state-owned enterprises were created in the defense industry: Embraer (aircraft), Avibras (space), and Imbel (ammunitions) which joined Engesa (ground equipment), a privately owned company. Embraer was a product of the nationalistic period that followed World War II: in 1950, the government created ITA, the MIT-inspired Technological

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Institute of Aeronautics leading to the establishment of Embraer two decades later, for the local production not only of regional civilian aircraft, capable of integrating the Brazilian territory, but also of military equipment. The final component of that nationalistic project was the nuclear industry, realized through the design and construction of three power plants for electricity supply. For the military government at that time, the aerospace and the nuclear industries were expected to act as “technologydrivers” for the rest of the local industry; however, that objective was not achieved. Despite the prioritization of local enterprises, foreign capital expanded strongly. Even with protectionist mechanisms and government support for the growth of home-grown enterprises, the relative importance of MNE subsidiaries increased substantially. Brazilian firms became predominant in the so-called traditional sectors (timber, paper, furniture, textiles, food, beverages, publishing, and printing), whereas MNE subsidiaries dominated the modern sectors that relied on more sophisticated technology (transportation, pharmaceutical products, among others). As for the state-owned enterprises, they operated in infrastructural sectors like mining, oil, and gas, chemicals and metallurgy. Bielschowsky (1978) voiced an interesting analysis of this situation: “the Brazilian economy continues to follow a path of accruing capital through progressive internationalization, which is further strengthened by the firm support of the dominant economic policy. Thus, one witnesses the peculiar coexistence of a national project aiming at achieving greater technological autonomy with an actual process that is going in the opposite direction.” The outcome of this contradiction was high imports of production goods, reflecting the local industry’s technological dependence and feebleness. Over time, inflationary pressures and the growth of trade deficits came into being. However, the chief problem generated by that expansion was the growth of foreign debt; some authors classified that period as of “external financing driven growth.” Fig. 1 depicts the growth of inward FDI in that period.

1980
1990: The Economic Crisis and the Weakening of Imports Substitution Industrialization From 1980, long-term projects were put aside and two variables: external debt and inflation, became the key-drivers of short-term macroeconomic

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207 178 139

115

135

1970

1969

1968

1967

1966

86

1965

87

1964

1962

1961

1960

1959

1958

1957

1956

51

1955

1952

1951

1950

Fig. 1.

79

60

1954

63

1953

39

128

154 159

138 147 132

1963

94

158

Inward Foreign Direct Investment in Brazil, 1950
1970 (US$ million). Source: Almeida (2007).

decisions. The difficulties to manage those variables in an international context characterized by global recession aggravated that situation. The GDP, which had an average growth of 7% between 1947 and 1980, dropped to 2% during that period. In 1982, Brazil formally accessed the IMF
International Monetary Fund for resources needed to cope with the consequences of the Mexican crisis over the world economy. Hence, the 1980s are considered the lost decade. The symptoms diagnosed that the imports substitution model had been exhausted, there was a deficient integration with the international markets and a limited capacity for the domestic firms to develop new processes and products. The mechanisms adopted to stimulate industrial development in Brazil since the early stages of the import substitution period were highly efficient in terms of production growth but had two negative effects. The first was the mismanagement of issues such as competitiveness (both internal and external) and efficiency, while the second was an anti-exporting culture that predominated at least until the mid 1980s (Bonelli, 1997). In that context, economic liberalization was brought to the agenda of politicians, entrepreneurs, and unionists.

Economic Liberalization Since the early 1980s, there were pressures for economic liberalization based on the assumption that it would lead to increased efficiency of production factors. Timid initiatives were observed in Brazil in 1982, after

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215

unsuccessful attempts in other Latin American countries like Chile, Argentina, and Venezuela. However, nationalism still prevailed in the political debate. In 1988 the Brazilian constitution was revised and one of its clauses reinforced protectionism and intended to segregate the local market for local enterprises. Nevertheless, in that polarized scenario, economic forces prevailed leading to formal actions, in 1990, towards pro-market reforms. However, Brazil lived a period of unrest in the early 1990s. On the political front, a series of scandals led to the impeachment of the then elected President. On the economic front, inflation spiraled out of control, reaching more than 2,000% a year after a disastrous attempt of the government to freeze it through the confiscation of savings. In 1994, the Plano Real succeeded in controlling inflation, and from 1994 to 2002, Brazil fully complied with the International Monetary Fund (IMF) and the Washington Consensus requirements, embracing a neoliberal agenda, as did other Latin American countries. Industrial policy was deliberately abandoned, what was faithfully reflected in the utterance of the Finance Minister at that time: “the best industrial policy is no industrial policy.” The difficulties associated to managing the external debt, aggravated by the consequences of the Russian crisis, led the government to access the IMF once more in 1998. It received a stand-by package worth US$ 41.5 billion, through which resources were made available according to needs (Lacerda et al., 2006).

THE PRO-MARKET ECONOMIC REFORMS IN BRAZIL (1990
2000) In 1990, the government changed the competitive system by introducing a number of major policy initiatives: the Industrial Competitiveness Program, the Technological Capability Program and trade reforms. The Industrialization and Foreign Trade Policy (IFTP) established a timetable for a progressive reduction of import duties, in order to expose Brazilian producers to stronger competition. “The aims were clear: to improve international competitiveness, deregulate trade and achieve marketing selectivity, a transparent industrial policy, and medium- and long-term improvements in competitiveness, by developing enhanced skills and product quality” (Fleury & Humphrey, 1993).

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Trade liberalization, privatization of infrastructure, and deregulation made room for the foreign private sector. Among others, the following measures facilitated the actions of foreign capital:
extinction of entry restriction in the Information Technology industry in 1991;
elimination of the limits to participation in privatization in 1993;
elimination of the distinction between local and foreign capital, thus giving to the installed multinationals access to government loans and subsidies in 1994;
income tax exemption for profit and dividend remittance in 1994;
liberalization of restrictions to patenting in high-tech areas in 1995; and
lifting of the prohibition of intra-firm remittance of royalties for trademarks and patents in 1997. These changes, associated with the reorganization movements of the developed countries and of their MNEs, caused the flow of FDI into Brazil to recover gradually, as shown in Fig. 2. Privatization Redefines Governance in Strategic Sectors Starting in the 1990s, the Brazilian state-run production system went through deep restructuring and denationalization owing to the implementation of the National Privatization Plan (PND
Plano Nacional de Desestatizac¸a˜o) and the opening of the domestic market to foreign firms. This process was implemented at the start of the decade focusing on certain

35

34.6

32.8 28.9

30

28.6

25

22.5 19.0

20

15.1

15 10.8

18.8

18.1

16.6 10.1

10 4.4 1.0

1.1

2.1

1.3

2.1

1990

1991

1992

1993

1994

5

Fig. 2.

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

0

Inward Foreign Direct Investment in Brazil, 1990
2007 (US$ billion). Source: WIR.

Brazilian Companies in their Habitat: The Impacts of Pro-Market Reforms

217

sectors of the transformation industry, such as steel manufacturing and petrochemicals. From 1996 to 1998, it turned to the services and infrastructure sectors, such as telecommunication and energy, during which time the revenues from the sale of Brazilian government enterprises were much higher (Laplane, Coutinho, & Hiratuka, 2003). The main feature of the 1990
1994 privatizations period was the modest participation of foreign investors, in line with their introspective period to restructure in their home countries and the restrictions set by local authorities. Certain sectors, however, such as electric energy, mining, and oil could not be sold to foreigners according to the 1988 constitution. Furthermore, other issues corroborated to favor local investors, such as difficulty in working out the value of the assets of the several government enterprises, in the aftermath of years of high inflation, and the uncertainties regarding the positions of political groups regarding the privatizations (Giambiagi & Villela, 2005). In this first phase, state enterprises were acquired mainly by large Brazilian private-sector groups, often with state aid in the form of loans (BNDES, 2002) (Table 1). As of 1995, the privatization and state reform processes were stepped up and utilities started to be transferred to the private sector. The following sectors were included: electrical, financial, and concessions in the fields of transportation, highways, sanitation, ports, and telecommunications. The initial objectives to resume investment in and modernization of the Brazilian industrial complex, were superseded by other aims. Actually, privatizations became part of the economic policy, aiming at reducing the pressure of the government deficit on public debt. Thus, the attraction of foreign capital was a means of financing part of the country’s unbalanced current account. As of 1999, currency devaluation and fiscal adjustment corrected this issue and privatizations ceased to be a priority. The accrued

Table 1.

Sales Result by Type of Investor, 1990
1994 (US$ million).

Type of Investor

Sales Revenues

%

Domestic companies Financial institutions Individuals Pension funds Foreign investors

3,116 2,200 1,701 1,193 398

36 25 20 14 5

Total

8,608

100

Source: BNDES (2002).

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AFONSO FLEURY AND MARIA TEREZA LEME FLEURY

revenues from the sale of government enterprises reached some US$100 billion, with annual peaks of about US$27.7 billion in 1997 and of US$37.5 billion in 1998 (Giambiagi & Villela, 2005) (Fig. 3). The share of foreign capital was significant in the 1995
2002 period, during which it totaled 53% of the amount raised through all Brazilian privatization. The Constitution was amended in order to make it possible for the mining and energy sectors to be exploited in part by international capital (Giambiagi & Vilela, 2005). Domestic enterprises accounted for 26% of the revenues, 7% being connected with organizations from the domestic financial sector, 8% with individuals and 6%, with the private pension plan funds, as shown below (BNDES, 2002) (Table 2). In general, the government’s position was to give up its production activities entirely, delivering them into the hands of private sector firms, whether domestic or foreign, though it set up regulation processes based on regulating agencies to ensure the compliance of the services rendered with 37.5

US$ billion

27.7

10.7 6.5 3.4

4.2

1992

1993

2 1991

Fig. 3.

2.3

1.6

1994

1995

1996

4.5

1997

1998

1999

2000

2.9

2

2001

2002

Revenues from the Annual Evolution of Privatizations. Source: BNDES (2002).

Table 2.

Sales Result by Type of Investor, 1995
2002 (US$ million).

Type of Investor

Sales Revenues

%

Foreign investors Domestic companies Domestic financial sector Individuals Pension funds

41,737 20,777 5,158 6,316 4,626

53 26 7 8 6

Total

78,614

100

Source: BNDES (2002).

Brazilian Companies in their Habitat: The Impacts of Pro-Market Reforms

219

pre-defined performance criteria. This had different consequences, depending on the sector. In the high-tech areas, such as telecommunications, where there were still some local projects, the result was further denationalization, SOEs (like the Telebras system) giving way to foreign enterprises. On the other hand, in other sectors, state companies were kept under local control. Table 3 shows the dates of the CSN, Vale, Embraer, and Telebras privatizations. As for Petrobras, even though the Brazilian government sold part of its shares, it is still the controlling stakeholder. The privatization period also marks the entry of pension funds, mostly those of the former state-owned enterprises (Petrobras, Banco do Brasil, etc.). Certain local financial groups, especially Garantia and Vicunha, became important players on the industrial scene. Foreign Multinationals Increase their Presence in the Local Markets From the late 1950s until 1990, a coexistence of sorts between foreign and local enterprises was achieved, both groups operating within a highly protected environment. This balance was upset when foreign trade barriers were lowered drastically and Brazil embraced globalization. During the initial stages of developed country multinationals (DMNEs) subsidiaries operations in Brazil (roughly 1955
1970), parent companies transferred technology (plants, products, and processes), along with management policies and procedures (including human resources management). This was followed by a period of a relative accommodation (1970
1990). The transfer of technology, expertise, and information to subsidiaries was gradually reduced, so that they began operating with increasing autonomy, along the lines of the multidomestic pattern (Porter, 1986) in a protected environment. The loose control was explained by the fact that their financial performance was satisfactory, sometimes even exceeding their headquarters’ expectations. Table 3.

The Privatization of Brazilian State-Owned Enterprises.

Enterprise

Year

Governance

CSN CVRD Embraer Telebras

1993 1997 1994 1998

Brazilian Industrial Group, Bradesco Bank, Pension Funds Brazilian Industrial Group, Opportunity Bank and Pension Funds Brazilian Government, Brazilian Financial Group, Pension Funds Telefoˆnica (Spain), Portugal Telecom and local financial groups

Source: Fleury and Fleury (2011).

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Then, once the economy was thrown open to production globalization, the subsidiaries were reincorporated into the global strategies of their parent corporations. Two forces shaped the restructuring process: the new organizational directives issued by the headquarters of the DMNEs and the subsidiaries’ operating conditions in the Brazilian market. Overall, two distinct phases of the restructuring process of subsidiaries of foreign multinationals can be identified. In the first (1990
1994), while the headquarters in the developed countries experimented with new ways of organizing business, the Brazilian market experienced enormous unforeseeableness and turbulence. Depending on the orientation of the headquarters and on the relative importance and autonomy of the Brazilian subsidiaries, the MNEs that were active in the country expanded in some cases but shrank in others. In other words, in the early 1990s, a clear transition in the modus operandi of the Brazilian subsidiaries of MNEs was observed. Whereas previously they tended to be of the multidomestic kind, they now turned into a range of different types of companies: local implementers, specialized contributors, or global mandate holders, according the Birkinshaw and Hood (1995) classification. By the next phase (from 1994 to 2000, approximately), the international management model of the developed country DMNEs had matured somewhat. Concomitantly, Brazil’s institutional, political, and macroeconomic circumstances had stabilized and a system to encourage the inflow of foreign capital had been set up. The action of foreign multinationals speeded up and the relative share of the Brazilian economy in the hands of DMNE subsidiaries increased significantly, especially in the services sector. For instance, in the automotive industry, virtually all the global manufacturers set up subsidiaries in Brazil. Those that had been long established in the country, such as GM, Ford, VW, and FIAT, were joined by Toyota, Honda, Mitsubishi, Renault-Nissan, Peugeot-Citroen, Audi, MercedesBenz (cars), BMW (engines), and Chrysler. Hyundai arrived in the country in the 2000s. More recently, Chery and JAC, Chinese automakers, set up operations in the country. Those assemblers brought with them their own first-tier suppliers or relied on the ones already established in the country. In the telecom sector, privatization brought international operators in its wake, especially from the Latin European countries. The grid of the large global firms became almost complete with the subsidiaries of Nortel, Huawei, Celestica, Flextronics, and Solectron, among others. It is interesting to note that the new subsidiaries, from their very inception, were based on new international management models, most of them following the Birkinshaw and Hood (1995) local implementer type. Table 4

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Table 4. Share of Companies having Foreign Ownership (*) in Net Operational Revenue. Capital-Intensive Industries

1980

1995

Difference

Automotive vehicles Transportation equipment Office equipment and information processing Electrical machinery and materials Electronics and communication equipment General machinery Chemical products Textile Average Labor-intensive industries Furniture Publishing and printing Apparel Average Natural-resources based industries Food and drinks Wood products Rubber and plastics Average

95% 14% 33% 30% 35% 41% 46% 22% 36%

100% 63% 72% 57% 54% 64% 68% 20% 54%

6% 349% 119% 90% 57% 55% 47% −11% 68%

3% 3% 5% 7%

24% 13% 11% 19%

713% 341% 117% 275%

18% 5% 40% 28%

28% 9% 35% 43%

78% 73% −13% 111%

Source: Extracted from Moreira (1999). * More than 10% of total capital.

shows the evolution of foreign capital in almost all segments of the Brazilian industrial structure. Inward FDI increased significantly after 1995. In addition, DMNE subsidiaries in the services industry started to operate in the local markets. The global banks Santander and BBVA (Spanish), HSBC (English) and ABNAmro (Dutch) began operating in Brazil. In the apparel retail sector, C&A (Dutch) and JCPenney (American) established shops and local supply chains. In the supermarket sector, Wal-Mart (American) and Casino (French) started competing with Carrefour and the Brazilian Pao-deAcucar. In the building materials retail sector, St. Gobain and Leroy Merlin vied for business with the large local groups’ retail chains. Along with the international brands that also stepped up their presence in Brazil, these firms became the drivers of local production chains. Therefore, the figures of Table 4 may be considered conservative in what concerns the expansion of foreign presence in the Brazilian industry. That movement is clearly depicted in Fig. 4, showing the numbers of mergers and acquisitions (M&As) in Brazil. From 1994 to 2001, 60% of

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AFONSO FLEURY AND MARIA TEREZA LEME FLEURY 699 663

473 372 328 212 175 81

353

351 309

168 161

130

101

340

94

130

1994

1995

1996

204 1997

221 1998

208 1999

146

230 2000

227

230

143

116

194 2001

Cross Border

Fig. 4.

379

183

299 123

82 167

363

351

84

114

2002

2003

150 100

199

213

2004

2005

290

2006

348

2007

284

2008

Domestic

Number of Mergers and Acquisitions in Brazil. Source: KPMG.

the M&As were of the cross-border kind. In a study we carried out in the late 1990s with a sample of the 1,600 enterprises (local and subsidiaries), we found an unexpected and significant number of new subsidiaries of small- and medium-sized DMNEs that had recently been set up in the country. However, that trend was reversed after 2001, when 52% of M&As involved enterprises already active in the country. Consequently, “In 1998, Brazil held the eighth largest stock of FDI in the world: US$ 156.8 billion. Out of the 500 largest companies in the world, 405 had operations in Brazil, accounting for roughly 20 percent of GDP” (Matesco & Hasenclever, 2000). This led some economists to identify a paradox: “Among the industrialized countries, Brazil probably has the lowest ratio of local to foreign capital ownership, a feature
and its implications
yet to be properly understood by analysts and policy-makers” (Ferraz, Kupfer, & Serrano, 1999). Another consequence was that Brazil’s export performance has been driven by DMNE subsidiaries. Of the total value exported by the 200 largest Brazilian exporters, 64% originated from MNE subsidiaries, 30% from state-owned enterprises and only 6% from locally owned private enterprises (America Economia, 16 August 2006, p. 84). Resilient Brazilian Firms Internationalize For the vast majority of Brazilian firms, the early 1990s were an ongoing threat. The competitiveness in the domestic market increased drastically due to the fact that importing was made easy, there was a stronger

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participation of DMNEs’ subsidiaries in the local markets, which had the prerogative of engaging in international procurement, what was made feasible by the newly established trade policies. Additionally, the challenges to manage in an economy where inflation peaked at 2,781% in 1993 and political institutions were in a turmoil, resulted in major industrial groups and leading companies failing, what some authors called “the denationalization process” (Lacerda, 2000). The internationalization of Brazilian firms was never considered a strategic issue by the government until around 2005. In the 1990s, at the same time that the liberalization policies opened arms to foreign capital, the government condemned the investments of Brazilian firms abroad under the argument that it meant creation of jobs elsewhere, to the detriment of local creation of jobs. Table 5 shows the destiny of the firms mentioned as leaders of the industrialization process in the previous periods. Table 5 also provides detailed information in regards the deep changes observed in the Brazilian industry during the 1990s. In some industrial segments, Brazilian firms were almost washed-out from the picture; that is the case in the automobile industry (some second-tier suppliers still remain) and capital goods (some suppliers of basic equipment and systems still operate). On the other hand, 15 companies that are currently Brazilian multinationals are highlighted. They include ex-SOEs like CVRD (currently Vale), Companhia Siderurgica Nacional, Embraer, privately founded local enterprises and one SOE (Petrobras). Besides Embraer, an aircraft manufacturer, they essentially belong to traditional sectors like mining, oil, and gas, steel, cement, petrochemical inputs, consumer goods, and different metal-mechanics segments. They settled initially in other South American countries and later moved to developed countries (Fleury & Fleury, 2011). The question that arises is: how the local institutional environment, including pro-market reforms, influenced toward the creation of firmspecific advantages that supported the internationalization movement?

The Marks of the Local Institutional Environment on Internationalization From the previous discussion and Table 5 it becomes clear that Brazilian multinationals are, first of all, enterprises with a high degree of resilience, having thrived through the Brazilian institutional environment during decades. Studies on BrMNEs’ have identified two distinctive Firm Specific Advantages: (a) excellence in manufacturing and process engineering

224

Table 5. Origin

State-owned enterprises (1940
1950) Private companies created in the first wave of industrialization (1940
1950)

Antarctica Brahma Gerdau Votorantim CVRD CSN Petrobras Villares

Cobrasma Confab Romi Private companies created in the MetalLeve second wave of industrialization Varga Nakata Stevaux COFAP Sabo Marcopolo Brastemp Embraco WEG Odebrecht

Industry

Position Prior to Liberalization

Destiny after Liberalization

Beverage Beverage Steel Cement Mining Steel Oil & Gas Capital goods

Duopoly; merged in 1988 creating AmBev Among 5 largest Largest Largest; exporter Largest Largest Largest group

Capital goods Capital goods Capital goods Autoparts Autoparts Autoparts Autoparts Autoparts

Second largest group (Vidigal) Largest machine-tool First-tier supplier First-tier supplier First-tier supplier First-tier supplier First-tier supplier

Autoparts Buses White goods Compressors Electric motors Engineering

First-tier supplier Assembler Largest First-tier supplier General supplier

Internationalized (1993); now ABInBev Internationalized (1989) Internationalized (2001) Internationalized (1984) Internationalized (1994) Internationalized (1997) Divested gradually; core business sold to Schindler (Ger) Closed down (1991) Sold to Techint (Arg) (1993) Internationalized (2008) Sold to Mahle/Ger (1996) Sold to Lucas/GBr (1996) Sold to Dana/USA (1998) Sold to Dana/USA (1996) Sold to Mahle/Ger and Marelli/It (1997) Internationalized (1994) Internationalized (1991) Sold to Whirpool (USA) Internationalized (1993) Internationalized (2000)

Among the 4 largest

Internationalized (1980)

AFONSO FLEURY AND MARIA TEREZA LEME FLEURY

The pioneering companies

Name

Evolution of Leading Brazilian firms.

Defense industries

Petrochemicals

Source: authors.

Camargo Correa Andrade Gutierrez Mendes Junior Embraer Avibras Imbel Engesa Ultra Odebrecht Mariani

Engineering

Among the 4 largest

Internationalized and retreated

Engineering

Among the 4 largest

Internationalized and retreated

Engineering

Among the 4 largest

Internationalized and retreated

Aircraft Missiles Ammunition Combat cars Petrochemicals Petrochemicals Petrochemicals

Monopoly Monopoly Monopoly Monopoly Oligopoly Oligopoly Oligopoly

Internationalized (1977) Maintains operations Maintains operations Closed down (1993) Internationalized (2007) Internationalized (2007) Merged with Odebrecht

Brazilian Companies in their Habitat: The Impacts of Pro-Market Reforms

Engineering companies which grew during the third wave of industrialization (1964
1980)

225

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(Fleury & Fleury, 2011) and (b) agile business models (Sull, 2005; Sull & Escobari, 2004). They were developed: (1) as a response to [Brazilian] environmental conditions (macro-conditions: political and economic; mesoconditions: conflicts and rivalry among local business groups) (Cyrino & Barcellos, 2013; Fleury & Fleury, 2013); (2) focused in traditional types of business where the competitive advantage derives from conceiving new approaches to producing, selling, financing, or servicing existing products with costs, risks, and profits generated in ways that may not have been seen in developed countries. Generally operating in low-tech sectors, Brazilian firms practice process innovation, meaning radical new ways of obtaining standard or slightly commoditized products which are not easily imitable, thus equipping them with a strong competitive advantage. BrMNEs invest heavily in processoriented R&D, keep strong ties with local and foreign universities and research centers and own a significant number of patents. Petrobras, Gerdau, Votorantim, AmBev are good examples of firms that became competitive (a) in the commodity industries, from having learnt how to exploit efficiently the local abundance of natural resources and extraordinary climatic conditions; (b) in the wage consumer industries, from having learnt with the large and idiosyncratic local markets. Brazilian firms also developed distinctive agile business models which shape their internationalization strategies. Sull and Escobari (2004) coined metaphors such as Active Waiting, Fast Strategy Implementation, Golden Opportunities and Sudden Death, to describe how the leading Brazilian firms develop and implement their business models. They observed managers preparing for golden opportunities by managing smartly during the comparative calm of business as usual. During these periods of active waiting (Sull, 2005), managers probed the future and remained alert to anomalies that signaled potential threats or opportunities; exercised restraint to preserve their war chests; and maintained discipline to keep the troops battle ready for fast and integrated action. When a golden opportunity or ‘sudden death’ threat emerged, managers had the courage to declare the main effort and concentrate resources to seize the moment.

FINAL COMMENTS Pro-market reforms in Brazil came about like reforms in Latin American countries but rather differently from what happened in other emerging

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countries, such as China, India, and Russia. However, by better understanding the facets of that process in Brazil, it becomes possible to compare the findings of the studies related to those countries in search for more profound understanding of the real impacts of pro-market reforms. The Brazilian case unveils aspects which are not commonly addressed in analyses of pro-market reforms and internationalization, namely: (a) purpose: the reasons why pro-market reforms were adopted, (b) institutions: the compatibility between them and the features of the institutional context, and (c) power: the relative bargaining power of local firms vis-a`-vis foreign multinationals, which may result in idiosyncratic internationalization pathways. The purpose of pro-market reforms in Brazil, as well as in most Latin American countries, was associated to circumventing difficulties in the macroeconomic plan rather than being part of a national development strategy to increase the country’s competitiveness in international markets. Consequently, the internationalization of Brazilian firms was not envisaged in that process. Extreme institutional and economic turbulence justified the abrupt introduction of pro-market reforms. Both elements combined created such a complex environment that led to a Darwinian selection process: only the fit survived. Unprepared and unable to cope with the stringent demands of institutional turmoil and international competition in the internal markets, brittle companies succumbed. This group includes firms from all sectors, sizes, and governance systems, including influential family groups, contradicting some recent research on the issue (Guillen & Garcia-Canal, 2009). Contrarily, buoyant firms learnt and re-learnt the evolving rules of the game, and thus were able to thrive despite the challenges posed during the transition from closed to open competition, became international. Finally, the dynamic relationship between local firms and foreign multinationals substantially affected the pro-market reforms. Not only did the latter dominate the high-tech sectors but also built a strong presence in almost all key sectors. Such dominance was augmented by the privatization process. The room for maneuver of Brazilian firms shrank during the pro-market reforms period, except in sectors where comparative advantage prevailed. From the three types of enterprises: SOEs, DMNEs, and local private, the latter seem to be the most negatively affected by the changes as a block. Privatized, the ex-SOEs gained strength, especially the ones that were reengineered by financial groups which became part of their governance system. As to DMNEs, they expanded considerably and their influence on local markets increased steeply.

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Therefore, a systemic and longitudinal perspective encompassing the different actors and their interdependences seems to be a critical requirement for analyses of pro-market reforms. It allows for an enhanced view of the factors which lead to the adoption of pro-market reforms and the forces which act for their configuration.

REFERENCES Almeida, A. (2007). Internacionalizac¸a˜o de empresas brasileiras: perspectivas e riscos. Rio de Janeiro: Elsevier. Bielschowsky, R. (1978). Notas sobre a questa˜o da autonomia tecnolo´gica na indu´stria brasileira. In Wilson Suzigan (Ed.), Industria: Polı´ticas, instituic¸o˜es e desenvolvimento (p. 99
136). Rio de Janeiro: IPEA/INPES, Monografia. No. 28. Birkinshaw, J., & Hood, N. (1995). Multinational subsidiary evolution: Capability and charter change in foreign-owned subsidiaries companies. Academy of Management Review, 23(4), 773
795. BNDES. (2002). Desestatizac¸a˜o e Reestruturac¸a˜o, 1990
2002. Relato´rio BNDES. Retrieved from www.bndes.gov.br/publicacoes. Accessed on July 2002. Bonelli, R. (1997). O Brasil na Virada do Mileˆnio: Trajeto´ria de Crescimento e Desafios do Desenvolvimento. Brası´ lia: IPEA
Instituto de Pesquisas Econoˆmicas Avanc¸adas. Cuervo-Cazurra, A. (2008). The multinationalization of developing country MNEs: The case of multilatinas. Journal of International Management, 14, 138
154. Cuervo-Cazurra, A., & Dau, L. A. (2009). Promarket reforms and firm profitability in developing countries. Academy of Management Journal, 52(6), 1348
1368. Cyrino, A. B., & Barcellos, E. P. (2013). Cross-border M&A and competitive advantage of Brazilian EMNEs. In P. Williamson, R. Ramamurti, A. Fleury, & M. T. L. Fleury (Eds.), The competitive advantage of emerging market multinationals. Cambridge: Cambridge University Press. Ferraz, J. C., Kupfer, D., & Serrano, F. (1999). Macro/micro interactions: Economic and institutional uncertainties and structural change in the Brazilian industry. Oxford Development Studies, 27(3), 279
304. Fleury, A., & Fleury, M. T. L. (2011). Brazilian multinationals: Competences for internationalization. Cambridge: Cambridge University Press. Fleury, A., & Fleury, M. T. L. (2013). The Brazilian multinationals’ approaches to innovation. Journal of International Management, 19, 260
275. Fleury, A., & Humphrey, J. (1993). Human resources and the diffusion and adaptation of new quality methods in Brazilian manufacturing. Brighton: Institute of Development Studies. Research Report n. 24. Giambiagi, F., & Villela, M. (2005). Economia Brasileira Contemporaˆnea. Sa˜o Paulo: Editora Campus. Guillen, M., & Garcia-Canal, E. (2009). The American model of the multinational firm and the “new” multinationals from emerging economies. Academy of Management Perspectives, 23(2), 23
35. Lacerda, A. C. (2000). Desnacionalizac¸a˜o. Sa˜o Paulo: Editora Contexto.

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Lacerda, A. C., Bocchi, J. I., Rego, J. M., Borges, M. A., & Marques, R. M. (2006). Economia Brasileira (3rd ed.). Sa˜o Paulo: Editora Saraiva. Laplane, M., Coutinho, L., & Hiratuka, C. (2003). Internacionalizac¸a˜o e o desenvolvimento da industria no Brasil. Campinas: Editora UNESP/IE
UNICAMP. Matesco, V., & Hasenclever, L. (2000). As empresas transnacionais e o seu papel na competitividade industrial e dos paı´ ses: O caso do Brasil. In P. M. Veiga (org), O Brasil e os desafios da globalizac¸a˜o (161
192). Sa˜o Paulo: SOBEET/Relume Dumara. Moreira, M. M. (1999). Estrangeiros numa economia aberta. In F. F. Giambiagi & M. M. Moreira (Eds), Economia Brasileira nos Anos 90. Rio de Janeiro: BNDES. Porter, M. (1986). Competition in global industries: A conceptual framework. In M. Porter (Ed.), Competition in global industries. Boston, MA: Harvard Business School Press. Simonsen, M. H. (1969). Brasil 2001. Rio de Janeiro: APEC Editora. Sull, D. N. (2005). Active waiting as strategy. Harvard Business Review, (September), 120
129. Sull, D. N., & Escobari, M. E. (2004). Sucesso made in Brazil: O segredo das empresas brasileiras que da˜o certo. Rio de Janeiro: Elsevier. Tofler, A. (1980). The third wave. New York, NY: Bantam Books. UNCTAD. (2013). World investment report 2013. Geneva: United Nations Conference on Trade and Development. Williamson, P., Ramamurti, R., Fleury, A., & Fleury, M. T. (2013). The competitive advantage of emerging market multinationals. Cambridge: Cambridge University Press.

PART IV CORPORATE GOVERNANCE

CORPORATE FINANCIAL REPORTING IN THE BRIC ECONOMIES: A COMPARATIVE INTERNATIONAL ANALYSIS OF SEGMENT DISCLOSURE PRACTICES Helen Kang and Sidney J. Gray ABSTRACT Purpose
Our aim is to investigate the quality of segment disclosures by companies in Brazil, Russia, India and China (known as the BRIC economies) that are expanding their operations internationally, and in so doing to assess the extent of convergence with globally recognized standards, that is, International Financial Reporting Standards (IFRS). Methodology
We examine the financial statements and narrative information provided by the largest BRIC companies. We carry out a content analysis and also apply multivariate regression techniques to evaluate if key firm-specific factors are associated with the number of operating and geographic segments disclosed.

Emerging Market Firms in the Global Economy International Finance Review, Volume 15, 233
254 Copyright r 2014 by Emerald Group Publishing Limited All rights of reproduction in any form reserved ISSN: 1569-3767/doi:10.1108/S1569-376720140000015010

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Findings
Our results show that the extent of disclosure by the majority of BRIC companies is of a high standard taking into account both quantitative and narrative data. The disclosure of operating segments is commonly based on business lines though most companies also report additional geographic information. As expected, operating segment disclosures are positively associated with the extent of internationalization (percentage of foreign sales) and majority state ownership. Limitations
We have examined only the largest companies in each BRIC country and so there are limitations regarding the generalizability of our results. Future research could usefully examine the practices of a wider range of companies within each of the BRIC countries. This could also be extended to a study of disclosure behaviour in other emerging economies. Originality/value
Our study provides new evidence concerning the quality of corporate financial reporting in the BRIC economies with special reference to a comparative international analysis of the segment disclosure practices of major BRIC companies expanding internationally. Keywords: Corporate financial reporting; segment reporting; emerging markets; BRIC economies; IFRS

INTRODUCTION Emerging economies first captured the interest of global investors with the promise of offering substantially higher returns than the more developed financial markets in the 1990s (Price, 1994). The attention to these economies, however, shifted in the 2000s to a select group of high flying, top-performing emerging market companies, perhaps as a result of the 1997 Asian crisis. Subsequently, the term BRIC, representing emerging economies comprising Brazil, Russia, India and China, was introduced in 2001 by Jim O’Neil, the then chairman of Goldman Sachs (O’Neill, 2001). These four economies were identified as the emerging economies most likely to enjoy sustained high growth and to become the ascendant economies during this century (Bao, 2009). The importance of corporate financial reporting in the emerging economies is widely acknowledged in today’s dynamic business environment. For example, economic activities have been internationalized due to the

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growth of international financial markets and, as a result, financial reporting has extended beyond national frontiers (Lainez & Callao, 2000). As a consequence, there currently is an ongoing process of harmonizing accounting standards, which began in 1973 with the inception of the International Accounting Standards Committee (IASC), now the International Accounting Standards Board (IASB). As of 2014, there are 27 International Accounting Standards (IAS) and 13 International Financial Reporting Standards (IFRS), and 128 jurisdictions require or permit IFRS for their domestic listed companies (IASPlus, 2013). Given the widespread use of IFRS around the world, the adoption of, or convergence with, IFRS is a high priority for the BRIC countries looking for continued foreign investment to sustain their high economic growth (Borker, 2012). In addition, BRIC companies whose financial statements are prepared under IFRS (or domestic GAAP which are IFRS compliant) are likely to enjoy the benefits stemming from high-quality accounting standards. Currently, Brazil has mandatorily required IFRS since 2010. In Russia, listed companies are now required to prepare consolidated financial statements under IFRS (since 2012). India still maintains its own GAAP. However, Indian Accounting Standards (Indian AS) consistent with IFRS have been issued, though no date has been set for implementation as yet. China has adopted the ‘convergence approach’, issuing its own domestic accounting standards (CAS) that are substantially converged though not fully consistent with IFRS. The purpose of financial reporting is to provide relevant information to current and future stakeholders and, consequently, any event that is likely to affect a company’s current financial position or its future performance should be reported in its annual accounts. Segment information is perhaps one of the most important elements of corporate information integral to the investment analysis process as it reveals the impact of strategic decisions relating to business and international diversification (Financial Accounting Policy Committee, 1992). For companies with diversified business operations and/or geographic locations, it is likely that profitability, resources and returns will vary significantly across each segment (Kang & Gray, 2013). This is especially the case for BRIC companies expanding into international markets and establishing foreign operations. In terms of IFRS, segment reporting is governed by IFRS 8 Operating Segments, effective 1 January 2009, which states requirements with respect to the identification, measurement and disclosure of segment information. These requirements generally apply to what is disclosed as part of notes to the financial statements in the annual report of companies preparing

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financial statements in accordance with IFRS. The standard, first introduced in 2006 by the IASB, has been surprisingly controversial, where various stakeholders raised concerns in regards to an expected increase in the number of segments and the required disclosure line items. In addition, given that not all BRIC countries have fully adopted IFRS, segment information being reported by BRIC companies was expected to vary greatly, thereby reducing comparability. It was also expected that BRIC companies would engage in voluntary disclosure practices. That is, the uncertainties associated with IFRS adoption/convergence may provide incentives to these companies to voluntarily disclose segment information outside of the financial statements, as part of their narrative reporting. The term voluntary disclosures usually describe disclosures primarily outside the financial statements that are not explicitly required by GAAP or any accounting standards (Boesso, 2002). Companies who voluntarily disclose extensive business and financial information differentiate themselves by providing an enhanced level of information that helps investors and creditors understand the company better (Levinsohn, 2001). In addition, Choi and Levich (1991) argue that voluntary disclosure is a means by which companies can cope with the international diversity of regulations, presenting an alternative path to the potentially improbable harmonization of accounting standards. That is, given international differences in the BRIC countries and the importance of segment information, BRIC companies may engage in voluntary disclosure practices; in particular, they may disclose narratives about their segment activities outside their financial statements. The narratives contained in corporate annual reports, once the supporting act to the financial statements, are now viewed as worthy of sharing the leading role in corporate financial reporting (Beattie, McInnes, & Fearnley, 2002). In this paper, we examine the current disclosure practices of BRIC companies in regard to segment information relating to the outcomes of their corporate strategic decisions. In particular, we analyse the segment disclosures of the largest companies in each of the BRIC countries, both in notes to the financial statements (as per the requirements of the relevant accounting standard) and in the narrative sections outside the financial statements. Our findings indicate that the majority of BRIC companies have identified more than one reportable segment (73.40% of the sample), mostly based on business/products (76.01%), and for these companies, the number of reportable segments is positively associated with government ownership. Of the total sample of 188 companies, 145 companies (77.13%) also reported geographic segments where the number of geographic segments is positively

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associated with the extent of internationalization as measured by the percentage of foreign sales. At the same time, 145 out of 188 companies (77.13%) have engaged in narrative reporting of segment information outside the financial statements, with most of the companies choosing the Management Discussion & Analysis (MD&A) section to discuss segment activities. The remainder of this paper is organized as follows. In the next section, we outline the reporting requirements of IFRS 8 and review financial reporting in the BRIC countries. We describe the sample selection process and data collection in the section ‘Research Method’. The section ‘Results’ presents our results, which is followed by concluding remarks in the section ‘Concluding Remarks’.

LITERATURE REVIEW IFRS 8 Operating Segments Segment information is considered as one of the most important corporate disclosures (Hope, Kang, Thomas, & Vasvari, 2009). According to IFRS 8 Operating Segments, the main reason for a company to engage in segment disclosures is to ‘… enable users of its financial statements to evaluate the nature and financial effects of the business activities in which it engages and the economic environments in which it operates’ (IFRS 8; para. 1). That is, for companies engaging in operating activities spanning more than one business/product and/or one geographic location, it is not unreasonable for the stakeholders to demand disaggregated information about each segment, for the purpose of making operating decisions and assessing performance, both at the segment level and overall. The current IFRS on segment reporting is IFRS 8. It was first introduced as an exposure draft in January 2006 and became effective from 1 January 2009. It adopts a management approach to identifying and measuring the financial performance of firms’ operating segments. Operating segment is ‘a component of an entity that engages in business activities from which it may earn revenues and incur expenses’ (IFRS 8, para. 5). For each reportable operating segment identified, IFRS 8 requires companies to disclose accounting information including profit or loss, and total assets and liabilities. While there is broad support for the management approach from both preparers and users who thought that it supplies more

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useful information, users remained suspicious of preparers’ motives and the potential for avoiding negative disclosures about some operating segments (Crawford, Extance, Helliar, & Power, 2012). The extant literature finds that there are benefits of segment disclosures. For example, Ettredge, Kwon, Smith, and Zarowin (2005) find that segment disclosures improve the market’s ability to predict firms’ future earnings. Hope et al. (2009) find evidence that geographic segment disclosures are related to the pricing of foreign earnings. In addition, the CFA Society of the UK (2012) survey reports that the management approach of IFRS 8 has enabled analysts to better understand companies. On the other hand, segment reporting is considered to be a controversial issue since the nature of information disclosed can be perceived as being commercially sensitive (Parker & Sauer, 2009). As a result, segment reporting has been a problematic issue for standard setters; for example, when the IASB first issued the exposure draft for IFRS 8, it attracted 182 submissions of comments from interested stakeholders, mostly negative about the proposed standard (International Accounting Standards Board [IASB], 2006). Surprisingly, or perhaps not unexpectedly, the main objectors to the new standard were non-government organizations (NGOs) and charities who raised objections about the fact that companies may not disclose as much disaggregated information about their operating activities and different geographic locations. An example given in the comment letters was in regards to mineral and extraction sectors in developing countries and the possibility that they may not disclose the magnitude of payments made to governments and officials, thus undermining the company’s accountability (Crawford, Ferguson, Helliar, & Power, 2014). In addition, it probably did not help that IFRS 8 is virtually identical to its US GAAP counterpart, SFAS 131.

Implementation of IFRS 8 The current extant literature on segment reporting is biased towards the implementation of IFRS 8 and the pre-IFRS 8 and post-IFRS 8 segment disclosures as a consequence, using different country settings. For example, Crawford et al. (2012) compare segment disclosures under IFRS 8 versus IAS 14 (the preceding IFRS standard on segment reporting) in the United Kingdom, while Kang and Gray (2013) examine the same issue in the Australian setting. The implementation of IFRS 8 and its subsequent impact on segment disclosures has also been considered for Italian

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companies (Pisano & Landriana, 2012) and Jordanian companies (Mardini, Crawford, & Power, 2012), as well as for selected EU-listed companies (Nichols, Street, & Cereola, 2012). These studies overwhelmingly find that companies have not significantly changed the number of reportable segments under IFRS 8 and, in some instances, companies disclose much the same information under IFRS 8 compared to the previous standard (Kang & Gray, 2013; Mardini, et al., 2012; Nichols et al., 2012). It has to be noted, however, that these studies tend to examine the first-time adoption period; that is, companies may change their disclosure behaviour over time. One expected benefit of the management approach is that segment information reported in notes to the financial statements would be consistent directly with the management commentary (The IASB Agenda Paper 6B, 2013). That is, given that IFRS 8 requires companies to report information about reportable segments based on the way management organizes the company for the purpose of making operating decisions, what the management chooses to discuss in the MD&A section of the annual report should be consistent with segment information in notes to the financial statements. The extant studies, however, find mixed results: for example, Crawford et al. (2012) find UK companies’ discussion in narrative reports may not be consistent with IFRS 8 segment disclosures. On the other hand, Nichols et al. (2012) report that 96 per cent of European companies’ segment information is consistent with other sections of the annual reports. There would seem to be a need to consider further whether the management approach can improve consistency within annual reports in regards to segment information. As a consequence, the link between the IFRS 8 ‘management approach’ segment disclosures and the management commentary and presentations has been identified as one of the areas which the IASB should consider further (The IASB Project Report and Feedback Statement, 2013).

Financial Reporting in the BRIC Countries Emerging economies can be defined as ‘low-income, rapid-growth countries using economic liberalization as their primary engine of growth’ (Hoskisson, Eden, Lau, & Wright, 2000). As mentioned previously, investment trends in emerging economies have gone through changes in the 2000s, where the attention has shifted to a select group of top-performing companies. The BRIC countries, comprising Brazil, Russia, India and

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China, are perhaps the beneficiaries of such changes and are now the recipients of the hottest investments (Karim, 2006). The BRIC countries are often paired into two groups: Brazil/Russia and India/China. The former group is identified as large land mass countries with relatively low populations that are rich in natural resources and the latter as having two of the world’s largest populations (Borker, 2012). Given the growing importance of their participation in the global economy, it is not surprising for the BRIC countries to commit, in varying degrees, to the adoption of IFRS. For example, Brazil has adopted IFRS for all listed companies since 2010, whereas in Russia, public interest entities have been required to adopt IFRS since 2012 while other listed companies prepare their financial statements under Russian Accounting Standards (RAS). At the same time, Russian companies with foreign stock exchange listings prepare financial statements in accordance with IFRS. While India has commenced issuing IFRS-converged Indian Accounting Standards (IndAS) (since 2011), a date has yet to be set for their implementation. In China, their national accounting standards (CAS) are substantially converged though not fully consistent with IFRS. While the adoption/convergence with IFRS is a high priority for the BRIC countries due to their need for continued access to foreign capital (Borker, 2012), there exists some reluctance from individual countries’ regulators
taxation issues being one of the reasons. In addition, differences in the legal systems, financing systems and culture of the BRIC countries may not be resolved by the adoption of IFRS. For example, India is a commonlaw country, whereas others have code-law based legal systems. In terms of investor protection rankings, India is ranked higher than Brazil, followed by China and then Russia (The World Bank, 2013). As for transparency, proxied by corruption perceptions index (CPI), Brazil is ranked higher than China, followed by India and then Russia (Transparency International, 2012). These international differences are likely to result in differing levels of compliance with accounting standards, as well as different interpretations of IFRS if adopted (Borker, 2013). As a result, different disclosure practices are expected for companies originating from the BRIC countries; segment disclosures being one of the potential examples of such differences. In terms of financial reporting standards, IFRS 8, applicable from 1 January 2009, is the international accounting standard governing the disclosure requirements of segment reporting. Since Brazil has adopted IFRS, Brazilian companies are expected to follow the disclosure requirements of IFRS 8 when reporting segment information. In the case of Russia, India

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and China, disclosure requirements for segment information in the equivalent local accounting standards are in fact not significantly different from what is required under IFRS and are thus more or less converged. As such, we do not expect major differences in how these companies determine reportable segments. One area of segment disclosures that may differ between the BRIC countries is in the narrative reporting section of annual reports. Based on the differences in legal systems, and levels of investor protection and transparency rankings, companies from India and Brazil are more likely to engage in voluntary disclosure practices.1 That is, they are more likely to discuss segment information as part of the narrative section of their annual reports.

RESEARCH METHOD In order to examine the disclosure practices of BRIC companies in regards to segment information, the top 100 companies in each BRIC country were identified through each country’s main stock exchange. The list was then cross-referenced against Compustat Global Vantage database for availability of accounting information and to check for the GICS industry code. Companies which did not appear on the Compustat Global Vantage database and those with the GICS sector code 40 (Financials) were eliminated, along with companies whose annual reports were unavailable in English.2 The final sample therefore comprised 188 companies from all industry sectors (see Table 1). Table 1. Sample Companies. Country Brazil Russia India China Industry classification (GICS) Utilities/industrials Energy Consumer staple/disc Others

Number of Companies (n = 188) 50 47 47 44 70 57 34 27

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There are two reasons for selecting the largest companies from each BRIC country. First, segment reporting is more likely to be applicable to larger companies. That is, larger companies are expected to have more than one business/product segment and operate in more than one geographic location. In addition, these companies are also likely to request and need foreign capital, which increases the demand for corporate information given a wider range of stakeholders. As such, these companies are more likely to engage in voluntary disclosure practices, including the narrative reporting of segment information. Second, we expect English language annual reports to be available for larger companies rather than for smaller companies. Each sample company’s annual report for the financial year 2011
2012 was then downloaded from company websites. It is interesting to note that Russian companies tend to have two separate annual disclosures: one for the financial statements and the other for ‘other’ annual disclosures. From each annual report, information on the accounting standard used as a basis of preparation of consolidated financial statements was hand-collected and the country of incorporation was confirmed from the annual report to ensure that the sample companies were from the BRIC countries. Data on segment disclosures, both in the notes to financial statements and narrative section of the annual reports, were hand-collected from each downloaded annual report. Specifically, based on previous studies examining segment reporting practices, information regarding the number of reportable operating segments, number of geographic segments and proportion of foreign revenue on total revenue were collected from notes to the financial statements, usually under the heading segment reporting. For narrative disclosures, the location and nature of segment information being discussed in the annual report were collected from sections outside the financial statements (i.e. narrative ‘other’ part of the annual report). As mentioned previously, these disclosures are voluntary in nature: that is, segment information discussed as part of the annual report, but outside the notes to the financial statements would be considered as narrative disclosures.

RESULTS We first consider whether the sample BRIC companies prepare their financial statements according to IFRS or local GAAP (see Table 2). As

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Table 2.

Accounting Standard Adopted by BRIC Companies.

Country (n)

IFRS

Local GAAP

Brazil (50) Russia (47) India (47) China (44) Total (188)

50 36 1 30 117 (62.23%)

2 46 14 62 (32.98%)

IFRS/US GAAP 9

9 (4.79%)

expected, all Brazilian companies have indicated that they prepare their consolidated financial statements in accordance with IFRS. Not surprisingly, all but one Indian companies have identified IndAS and/or Indian GAAP as the basis of preparation. For Chinese companies, 14 out of 44 companies identified CAS as their reporting standards and the remaining companies adopted HK IFRS as the basis of preparation of financial statements.3 Surprisingly, the majority of the sample Russian companies (95.74%) prepared their financial statements in accordance with IFRS and/or US GAAP. As mentioned previously, this may be due to the fact that companies with available English annual reports are likely to be those listed on foreign stock exchanges and, as such, they provide English financial statements in accordance with IFRS.4

Number of Reportable Operating Segments and Geographic Segments Table 3 shows that, on average, the sample BRIC companies have 2.91 operating segments, with Chinese companies having the highest reported number of segments (3.84) and Indian companies the lowest number of segments (2.32). A Brazilian company, Abril Educacao SA, has reported the highest number of segments: 11 segments based on business areas were reported for the financial year ending 2012. As expected, the majority of sample companies have more than one reportable segment; overall, 50 out of the 188 sample companies (26.60%) have one reportable segment only (see Table 3). In terms of each country, China has the lowest number of companies with one reportable segment (20.45%)5
this is not surprising, given that Chinese companies have the highest average number of operating segments. We also consider the proportion of foreign sales to total sales: on average, the sample BRIC companies have 18.49% of total sales being derived

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Table 3.

Average Number of Reported Operating Segments.

Country (n)

Mean

Maximum

# of Companies with One Segment Only (%)

Foreign Sales/Total Sales (%)

Brazil (50) Russia (47) India (47) China (44) Total (188)

2.60 2.98 2.32 3.84 2.91

11 9 8 9 11

16 (32.00) 10 (21.28) 15 (31.91) 9 (20.45) 50 (26.60)

10.45 15.94 33.72 13.83 18.49

Table 4.

Basis of Reportable Operating Segments and Disclosure of Geographic Segments (GS).

Country (n)

Geographic

Business

Brazil (50) Russiaa (47) India (47) China (44) Total (188)

2 33 3 34 1 46 2 30 8 (4.25%) 143 (76.01%)

Geographic/ Business

# Firms Recognizing GS

# of GS

15 7 0 12 34 (18.09%)

50 (100%) 21 (44.68%) 30 (63.83%) 44 (100%) 145 (77.12%)

1.90 4.19 2.50 2.36 2.50

a

Three Russian companies did not identify the basis of segments as part of the ‘significant accounting policy’ section: all three companies had only one line of business and one geographic location, Russia.

from foreign activities. The percentage of foreign sales is highest for companies originating from India and lowest for Brazilian companies. Table 4 shows the basis of identifying operating segments by the sample BRIC companies. Generally speaking, segments can be identified either by business/product lines or by geographic locations. In addition, the management approach prescribed by IFRS 8 also allows companies to identify their reportable segments based on a combination of business and geographic segments. This is evident in relatively higher number of Brazilian and Chinese companies using such a basis. As seen from Table 4, the identification of reportable operating segments is commonly based on business lines (76.01% overall). In addition, for Indian companies, where only one company follows IFRS, 46 out of 47 companies use business lines as the basis for reportable segments. Out of the 188 sample companies, 145 companies (77.13%) also disclosed information in regard to geographic locations of their operations. For example, companies operating in more than one country disclosed

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geographic segment information regardless of whether their operating segment is based on geographic segments. Interestingly, all Brazilian and Chinese companies disclosed additional geographic segment information. For these companies disclosing geographic information, there are, on average, 2.5 geographic segments.6 Next, we consider whether the following six firm-specific factors
percentage of foreign sales, state ownership, IFRS adoption, foreign listing, auditor type and industry sector
are associated with the number of reportable operating and geographic segments. Percentage of foreign sales (FORSALE%) is computed by foreign sales divided by total sales, which are obtained from the segment reporting notes. State ownership (STATEOWN) is a dummy variable coded 1 if the majority ownership is by the government, 0 otherwise. IFRS adoption (IFRS) is a dummy variable coded 1 if company has adopted IFRS, 0 otherwise. FORLIST is a proxy for foreign listing coded 1 if company has a listing on a foreign stock exchange, and auditor type (BIG4) is coded 1 if company has a big 4 auditor, 0 otherwise. We expect percentage of foreign sales and state ownership to have a positive association with the number of segments reported since companies with foreign sales activities and state ownership are likely to have more operating segments as they would tend to be larger in size. Table 5 reports descriptive statistics. Table 6 reports results from the multivariate analysis on the association between the number of operating segments reported and the above Table 5. Variable

Descriptive Statistics.

n

Mean

Min

Max

S.D.

# of operating segments # of geographic segments FORSALE%a

188 188 173

2.91 1.93 0.18

1 0 0

11 12 1

1.922 1.982 0.261

STATEOWN IFRSb FORLIST BIG4

188 188 188 188

a

No

Yes

143 62 124 37

45 126 64 151

15 companies did not disclose information on whether there were any foreign sales: results do not change significantly when FORSALE% variable for these companies are substituted with 0%. b For the purpose of multivariate analysis, nine Russian companies adopting US GAAP are included as part of IFRS adoption group.

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Table 6.

Regression Results
Number of Operating Segments Reported.

Model 1 (Whole Sample) Variable

Model 2 (Firms with More than One Reportable Segment)

Std. err.

t

p-value (two-tailed)

(Constant) FORSALE% STATEOWN IFRS FORLIST BIG4

3.252 1.488 0.992 0.252 −0.295 0.365

0.503 0.603 0.352 0.392 0.327 0.435

6.470 2.467 2.816 0.642 −0.903 0.841

0.000 0.015 0.005 0.522 0.368 0.402

Energy Consumer Others

−0.126 −0.486 −0.430

0.361 0.444 0.479

−0.349 −1.096 −0.898

0.727 0.275 0.370

N F stats (p-value) Max VIF R-squared

172 2.433 (0.016) 1.487 0.106

Variable

Coef.

Std. err.

t

p-value (two-tailed)

(Constant) FORSALE% STATEOWN IFRS FORLIST BIG4

4.205 0.717 1.130 −0.263 −0.553 0.694

0.549 0.632 0.373 0.426 0.345 0.464

7.660 1.134 3.030 −0.619 −1.602 1.496

0.000 0.259 0.003 0.537 0.112 0.137

Energy Consumer Others

−0.106 0.248 −0.216

0.376 0.529 0.511

−0.281 0.469 −0.423

0.779 0.640 0.673

F stats (p-value) Max VIF R-squared

127 2.036 (0.048) 1.387 0.120

HELEN KANG AND SIDNEY J. GRAY

Coef.

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firm-specific variables. When using the entire sample (Model 1), we find that, as expected, both the percentage of foreign sales (F = 1.488, p = 0.015) and state ownership (F = 0.992, p = 0.005) are positively associated with the number of operating segments reported. Surprisingly, when looking only at companies with more than one operating segment, only state ownership is positively associated (F = 1.130, p = 0.003).7 As expected, IFRS adoption is not associated with the number of operating segments reported and neither are foreign listing, auditor type and industry sector. Table 7 considers the association between the number of geographic segments reported and firm-specific variables. Using the whole sample (Model 3), percentage of foreign sales is positively associated with the number of geographic segments (F = 3.117, p = 0.000). State ownership, however, is not associated. When looking at companies with more than one geographic segment (Model 4), percentage of foreign sales is again positively associated with the number of geographic segment reported.

Narrative Disclosures of Segment Information Next, we consider whether narrative disclosures of segment information vary across the BRIC countries. We specifically consider the type and location of such voluntary disclosures. For the purpose of our analysis, the narrative sections are defined as those sections in the annual report which are not part of the financial statements. In most cases, these sections come prior to the financial statements in the annual report, with the exception of Russian companies; as previously mentioned, these companies tend to have two separate annual publications (financial statements and other disclosures) and, as such, other disclosures are analysed for narrative segment disclosures. Since one of the benefits of the management approach is having comparability and consistency between segment disclosures in the notes to the financial statements and the management commentary, we expect narrative disclosures, if any, to be consistent with reported operating segment information. Table 8 shows the number of companies with narratives on segment information and the location of these narratives outside the financial statements. In summary, most sample companies (77.13%) have engaged in narrative reporting in order to disseminate segment information. In terms of each BRIC country, 85.11% of the sample Indian companies have engaged in narrative disclosure practices,8 followed by Brazilian companies (80.0%)

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Table 7.

Regression Results
Number of Geographic Segments Reported.

Model 3 (Whole Sample) Variable

Model 4 (Firms with More than One Geographic Segment)

Std. err.

t

p-value (two-tailed)

(Constant) FORSALE% STATEOWN IFRS FORLIST BIG4

1.672 3.117 0.194 0.486 −0.167 −0.103

0.492 0.591 0.345 0.384 0.320 0.426

3.396 5.271 0.562 1.266 −0.522 −0.242

0.001 0.000 0.575 0.207 0.603 0.809

Energy Consumer Others

−0.302 −0.825 0.173

0.353 0.435 0.469

−0.854 −1.897 0.370

0.394 0.060 0.712

N F stats (p-value) Max VIF R-squared

172 4.627 (0.000) 1.487 0.184

Variable

Coef.

Std. err.

t

p-value (two-tailed)

(Constant) FORSALE% STATEOWN IFRS FORLIST BIG4

1.705 3.038 0.046 0.848 −0.268 −0.203

0.641 0.738 0.435 0.497 0.403 0.541

2.661 4.116 0.106 1.708 −0.666 −0.374

0.009 0.000 0.916 0.090 0.507 0.709

Energy Consumer Others

−0.436 −1.272 0.109

0.439 0.617 0.597

−0.994 −2.062 0.183

0.322 0.041 0.855

F stats (p-value) Max VIF R-squared

127 3.001 (0.004) 1.387 0.168

HELEN KANG AND SIDNEY J. GRAY

Coef.

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Table 8.

Narrative Disclosures of Segment Information.

Country (n)

# Companies with Narratives

MD&A Only

Other Locations

More than One Location

Brazil (50) Russia (47) India (47) China (44) Total (188)

40 (80.0%) 37 (78.7%) 40 (85.11%) 28 (63.64%) 145 (77.13%)

26 17 18 11 72 (49.66%)

7 6 14 6 33 (22.76%)

7 14 8 11 40 (27.59%)

and by Russian companies (78.70%). Finally, only 63.64% of Chinese companies have discussed segment information outside the financial statements. In fact, this is the exact opposite to the number of reportable segments, where companies from China have the highest number of segments, followed by Russia, Brazil and India. In addition, while most segment disclosures are located in the company’s MD&A section of the annual report, quite a few companies (27.59%) also discuss segment information in more than one location, usually in addition to the MD&A section (see Table 8). Other locations include letters to shareholders, corporate strategy, mission statements and, in some cases, disclosures were also found under a specific heading ‘segment performance’. We also consider the types of segment information being disclosed in narrative disclosures (not tabulated). As expected, most commentaries are on operating results (i.e. revenues and expenses) for each segment, and these are mostly consistent with what has been reported as part of the notes to the financial statements. That is, the management (as part of the MD&A) discusses and give detailed comments on accounting numbers of each segment, including profit, assets and capital expenditures, reported as part of the notes to the financial statements. In addition, a number of companies have also disclosed discussion and comments on corporate strategies and how risks are being managed for each segment. For example, for each segment identified, one Chinese company discloses discussion and analysis from the Board of Directors concerning the future development of the company, including competition in the industry and development trends, as well as market outlook, including risks related to operating models (China COSCO Holdings Ltd., AR 2012; p. 29). Another interesting example of narrative disclosures on segment information is in regards to information about the company’s employees in

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each segment. One Chinese company reports, as part of the analysis of the staff, the proportion of staff employed by business segments (China Longyuan Power Group, AR 2012; p. 84). It is also interesting to note that some of these business segments are disaggregates of reported operating segments.9 Commentary on the company’s human capital and its relation to operating segments is also apparent in the disclosures of a Brazilian company, which reports on clients, customers and types of services being provided in each segment, such as the number of calls received by the call centre (Duratex Fullar AR 2012; p. 40). Companies have also engaged in disclosures of forward-looking information. For example, an Indian company discloses potential reforms which may be required affecting each operating segment, ‘as this would have a direct impact on the sector’s commercial viability and ultimately on consumers and generators’ (Tata Power Co Ltd, AR 2012; p. 40). Another popular narrative disclosure is on the strategy of the company and how it may impact in respect of each segment. A Brazilian company considers segments as part of the business strategy and as opportunities to increase market penetration, relying on its network of partners and members (Multiplus SA, AR 2012; p. 19). A Russian company also identifies a business segment, ‘Processing and sale of oil and petroleum products’ as one of the main strategic priorities of the vertical integration and long-term sustainable development of the Company through increasing the production and sale of highly competitive finished products (Tatneft OAO, AR 2011; pp. 7
38). In summary, a majority of the sample BRIC companies have discussed segment information as part of their narrative reporting, mostly in line with segment disclosures as required by accounting standards. That is, it supports one of the benefits of the management approach; consistency between management commentary (i.e. narratives in MD&A) and segment information in the notes to the financial statements.

CONCLUDING REMARKS In recent years, segment reporting has attracted much attention as one of the unresolved issues in the context of international financial reporting practices. This is perhaps due to the complex nature of segments, which is an issue very much relevant and applicable to the strategic decisions of multinational companies, both in developed and emerging economies.

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In addition, it has been noted that segment reporting involves the disclosure of potentially sensitive information to stakeholders and also to competitors. Issues in financial reporting have become a topical issue in the context of the BRIC countries. One of the reasons why segment reporting may be of increasing relevance to these countries is because the top companies from the BRIC countries are increasingly engaging in activities that involve more than one business/product and/or geographic location. It is also interesting to note that, while IFRS convergence is a matter of importance in all four BRIC countries, as of 2014, only Brazil and, to some degree, Russia have adopted IFRS mandatorily. In this paper, we examined the segment disclosure practices of 188 of the largest BRIC companies. We considered both what is being reported as part of notes to the financial statements (as per the disclosure requirement of the relevant standard), and also in the company’s narrative section in the annual report. Our results show that the standard of reporting by the majority of BRIC companies is high and generally consistent with IFRS. The identification of operating segments is commonly based on business lines though most companies also report additional geographic information. As expected, operating segment disclosures are positively associated with the extent of internationalization (percentage of foreign sales) and majority state ownership. Of significant interest too is our finding that while companies from China have the highest number of operating segments reported in notes to the financial statements and India the lowest, substantially more Indian companies engage in narrative reporting about segment information than Chinese companies. That is, the number of operating segments is not necessarily positively associated with narrative disclosure practices. Our findings have implications for companies in other emerging markets that are looking to expand internationally and to attract foreign investment in that majority practice by companies in the large BRIC economies indicates the likely benefits of providing segment quantitative disclosures consistent with IFRS and/or additional voluntary narrative information. Such information will better inform current and potential investors about companies’ strategic performance and the risks involved thus reducing the barriers to future investment. There are naturally some limitations to our study. We have only examined the largest companies in each BRIC country and, given that data needed to be hand-collected, we were only able to study a small number of companies per country. This has implications in terms of limiting the generalizability of our results. Future research could usefully examine the

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practices of a wider range of companies within each of the BRIC countries. This research could also be extended to cover other important emerging markets such as South Africa, Indonesia, Malaysia and so on.

NOTES 1. Our expectation is based on India being the common-law country with the highest investor protection ranking and Brazil being the most transparent (out of the four BRIC countries). 2. Given that we are interested in narrative disclosures of segment information, outside of the financial statements, only companies with a full version of the annual reports were selected for the current study. That is, any company with either Form20F (US) or concise annual report was discarded from the final sample. 3. Chinese companies listed on the Hong Kong Stock exchange are permitted to adopt HK IFRS for preparation of financial statements. 4. In addition, some of the sample companies may be public interest entities. 5. We also calculate the average number of operating segments using only the companies with more than one reportable segment. The average and the country ranking do not change substantially. 6. Not surprisingly, 127 out 188 companies (67.55%) carried out operating activities in more than one geographic location (not tabulated). For the purpose of this study, having a different geographic segment is defined as having operations in different countries, not in different cities within one country. 7. As a sensitivity analysis, we substitute STATEOWN with country dummies (not tabulated)
results remain unchanged: the CHINA dummy is positively associated with both the number of operating and geographic segments. This is due to most of the Chinese companies having state ownership. 8. This is especially interesting given that 46 out of 47 Indian companies have prepared their financial statements using the local GAAP, rather than IFRS. 9. In total, there are five business segments identified as part of narrative disclosures. In contrast, there are three reported operating segments in notes to the financial statements.

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Price, M. M. (1994). Emerging stock markets: A complete investment guide to new markets around the world. New York, NY: McGraw-Hill. The IASB Agenda Paper 6B. (2013). Post-implementation review of IFRS 8: Review of academic literature to December 2013. Retrieved from http://www.ifrs.org/Meetings/Meeting Docs/Trustees/2013/April/AP3Civ_DPOC_PIR.pdf. Accessed in November 2013. The IASB Project Report and Feedback Statement. (2013). Post-implementation review: IFRS 8 operating segments. Retrieved from http://www.ifrs.org/Current-Projects/IASBProjects/PIR/IFRS-8/Documents/PIR-IFRS-8-Operatihg-Segments-July-2013.pdf. Accessed in November 2013. The World Bank. (2013). Protecting investors. Retrieved from http://www.doingbusiness.org/ data/exploretopics/protecting-investors. Accessed in November 2013. Transparency International. (2012). Corruption perceptions index. Retrieved from http:// cpi.transparency.org/cpi2012/results/. Accessed in November 2013.

ARE CHINESE CEOS STEWARDS OR AGENTS? REVISITING THE AGENCY
STEWARDSHIP DEBATE Helen Wei Hu and Ilan Alon ABSTRACT Purpose
Stewardship theory is an emergent approach for explaining leadership behavior, challenging the assumptions of agency theory and its dominance in corporate governance literature. This study revisits the agency and stewardship theories by seeking to answer whether chief executive officers (CEOs) in China are committed stewards or opportunistic agents. Design/methodology/approach
Based on 5,165 observations of 1,036 listed companies in China over the period 2005
2010, the results suggest that the corporate governance mechanisms developed from the agency theory in the West are not necessarily applicable in the Chinese context. Findings
This study supports the stewardship theory in its findings that empowering CEOs through the practice of CEO duality and longer CEO tenure have a positive effect on firm value in China. Additionally, the positive relationships between CEO duality, CEO tenure and firm

Emerging Market Firms in the Global Economy International Finance Review, Volume 15, 255
277 Copyright r 2014 by Emerald Group Publishing Limited All rights of reproduction in any form reserved ISSN: 1569-3767/doi:10.1108/S1569-376720140000015011

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value are strengthened by the number of executive directors on the board, and weakened by the number of independent directors on the board. Practical implications
One size does not fit all. Leadership behaviors in China do not follow the agency assumptions inherent in Western practices, rather they favor the conditions of positive leadership expressed by the stewardship theory. Assuming that the motivations of managers in emerging markets such as China are similar to those in the West may lead to a poor fit between governance policies and the institutional context. Originality/value
As one of the few studies to connect the theoretical debate between the agency and stewardship theories, this study presents new evidence to support the stewardship theory, thereby strengthening its theoretical importance and relevance in corporate governance literature. Keywords: Corporate governance; CEOs; agency theory; stewardship theory; China

INTRODUCTION The quality of leadership, more than any other single factor, determines the success or failure of an organization. (Fiedler, Chemers, & Mahar, 1976, p. 2)

Fiedler et al.’s (1976) quotation, from more than three decades ago, resonates today. Think of the effect that the following leaders had on their organizations: Andy Grove (former Intel CEO), Jack Welch (former General Electric CEO), Jeffrey Skilling (former Enron CEO), and Richard Fuld (former Lehman Brothers CEO). The question of how to create conditions that align leaders’ behaviors with the interests of other stakeholders in an organization has been the focus of a great deal of corporate governance literature, and the development of recent legislation in the United States and abroad. In an attempt to prevent events such as the failure of Enron, Lehman Brothers, and American International Group (AIG), corporate governance structures that emphasize ensuring that leaders’ power is monitored have gained popularity among researchers and legislators in the West (Fama & Jensen, 1983a, 1983b; Sarbanes
Oxley Act, 2002). When developing corporate governance standards in China and other emerging markets, two notable debates emerge. First, the long-standing debate over the applicability of Western governance models (assuming they

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do in fact work) in emerging and transitional markets (Alon, Child, Li, & McIntyre, 2011; Globerman, Peng, & Shapiro, 2011). This debate questions whether governance mechanisms from the United States can be fruitfully employed in China, where the institutional structure, culture, legal environment, political system, and economic development are starkly different. Second, the debate about whether managers’ behaviors are “opportunistic” according to the agency theory (Fama & Jensen, 1983b; Jensen & Meckling, 1976) or “pro-organizational” as argued by the stewardship theory (Davis, Schoorman, & Donaldson, 1997; Donaldson & Davis, 1994). The “agency versus stewardship” debate was examined empirically by Donaldson and Davis (1991) based on 321 US companies in the 1980s, as well as by Tian and Lau (2001) based on 113 Chinese companies in the 1990s. Although both studies found stronger support for CEO behavior that is guided by the stewardship theory than CEO behavior guided by agency theory, the stewardship theory continues to be considered relatively unconvincing (Doucouliagos, 1994; Frank, 1994) and agency theory is often the predominant theory in corporate governance research and policy development. To hone the debate, we revisit the agency and stewardship theories by asking: “Can the relationship between CEO governance and performance be sufficiently modeled using the agency perspective advocated in the West? Or does stewardship theory provide a better alternative explanation?” While these questions are specific, they may inform important debates in the literature relating to the applicability of Western theories to emerging markets such as China, and the increasing challenge to agency theory as a dominant explanatory model relating to governance and performance. To address these research questions, we examine internal governance mechanisms that either control or empower top executives in a sample of CEOs in China. In doing so, this study makes a significant contribution to the literature in at least two ways. First, despite its importance, research on stewardship theory in corporate governance literature is sparse (Clarke, 2007). As one of the few studies joining the theoretical debate between the agency and stewardship theories (e.g., Donaldson & Davis, 1991; Tian & Lau, 2001), this study presents new evidence to support the stewardship theory, thus strengthening its theoretical importance and relevance in the governance literature. Second, our results suggest that the corporate governance mechanisms developed from the agency theory in the West are not always applicable in the Chinese context: this has important implications for practice (Alon et al., 2011). Given China’s rapid economic development and increased internationalization, the understanding of the

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characteristics of Chinese CEOs and their leadership styles are important to practitioners doing business in China and, increasingly, to those interacting with Chinese companies outside China.

INSTITUTIONAL BACKGROUND China has experienced many institutional changes and developments as a result of its reforms over the past three decades. Before the launch of the “open door” policy in 1978, most of its production and industrial organizations were owned by the state and were known as state-owned enterprises (SOEs). The institutional setting under the centrally planned system meant that CEOs were government stewards appointed by the state. They were responsible for achieving the production targets without having a great deal of managerial autonomy. The first SOE reform began in 1985 when SOEs were granted “legal person” status with greater independence, as well as accountability, for their corporate performance (Schipani & Liu, 2002). To integrate the SOEs into a market-economy system further, in 1993, the Chinese government began to transform SOEs into “modern enterprises” and gave the CEOs of firms 14 managerial rights, including the right to make production decisions, set strategic directions, and manage company personnel (Broadman, 2001). This was indeed the beginning of a new period for Chinese CEOs, as it represented a stark contrast to their previous limited role as civil servants. Moreover, the establishment and development of the stock market in China, and the associated initial public offerings of many SOEs made profit maximization a clear priority, even for SOEs. This shift in priorities deepened corporate reform and widened the economic freedoms in the Chinese business environment (Schipani & Liu, 2002). In conjunction with the SOE reforms, the development of diversified forms of enterprise ownership, including privately owned and foreigninvested enterprises, was promoted by the government. This has not only nurtured entrepreneurship, and promoted employment and competition, but it has also fostered the growth of the private sector by assisting the China’s development of a market system (Broadman, 2001). Given China’s rapidly growing market, coupled with relatively weak external governance mechanisms, CEOs of both SOEs and private enterprises may have encountered tough competition and potentially greater opportunities for self-seeking activities. Therefore, leaders of Chinese enterprises may see themselves as stewards of their firm in society as much as self-serving agents.

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LITERATURE REVIEW AND DEVELOPMENT OF HYPOTHESES Agency theory is one of the dominant paradigms in corporate governance research. Agency theory views people as rational individuals who seek to maximize their own interests (Fama & Jensen, 1983a, 1983b). The “separation of ownership and control” and imperfect contracts create conflicts of interest between owners and managers of a company; this conflict is known as the “principal (owners)
agent (managers)” problem (Fama & Jensen, 1983a; Jensen & Meckling, 1976). Emerging economies, such as China, have experienced different types of agency problems. Unlike AngloAmerican firms, the ownership structure in Chinese firms is highly concentrated. This concentration may reduce the “principal
agent” problem between shareholders and managers, but it creates conflicts of interests between controlling and minority shareholders; this is termed the “principal
principal” problem (Young, Peng, Ahlstrom, Bruton, & Jiang, 2008). Furthermore, the principal
agent problem may also co-exist in SOEs because they are run either by politicians or professional managers who, given the separation of ownership and control in these SOEs, can exhibit agency behaviors (Cuervo-Cazurra, 2006; Gao, 2010). Stewardship theory, by contrast, challenges the presumption of selfserving human behavior posited by the agency theory, instead holding the view that managers are stewards of their organizations (Donaldson & Davis, 1994). Under stewardship theory, the “model of man” is based on a steward whose behavior is prioritized to favor pro-organizational, collectivistic behaviors over individualistic, self-serving behaviors (Davis et al., 1997). Managers often develop a strong sense of belonging to an organization and are motivated by intrinsic rewards (Arthurs & Busenitz, 2003; Mael & Ashforth, 1992). Studies demonstrate that the influences of Confucianism such as loyalty, paternalism, and collectivism are consistent with stewardship theory, and remain prevalent in the modern Chinese market economy (Cheung & Chan, 2008; Hofstede, Van Deusen, Mueller, & Charles, 2002). Given the two theories have contrasting perceptions of human behavior, we focus on the governance practices that represent the opposite views held by the agency and stewardship theories. Specifically, we propose competing hypotheses supporting each of these theories to illustrate how the power of CEOs in the form of CEO duality and CEO tenure affects firm value, and how these effects are moderated by the composition of the board of directors. That is, we make predictions that focus on monitoring and controlling

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CEOs’ behavior from the agency theory and that advocate the empowerment of CEOs from the stewardship theory. By doing so, we aim to find a theoretical paradigm that can better fit the current reality of corporate governance in China.

CEO Duality CEO duality is an important attribute of corporate governance that is often used to reflect a CEO’s power in an organization and their subsequent contribution to firm performance (Daily & Dalton, 1993; Westphal & Zajac, 1995). Agency theorists argue that when a CEO is also the board chairman, the separation of roles between decision management and decision control disappears (Fama & Jensen, 1983b). As such, the CEO becomes more powerful, which results in self-seeking behavior; consequently, the firm has a more serious agency problem (Jensen, 1993). In addition, CEO duality leads to a powerful CEO but a relatively weaker board (Bebchuk & Fried, 2004). This weakening means that the directors of the board may not be able to perform their monitoring roles effectively, and will be less forceful when challenging the CEO (Daily & Dalton, 1993; Pearce & Zahra, 1991). If unchallenged, over time, the CEO-chairman may pursue unsound strategies that are harmful to organizational performance, as has been reported in many studies (Chen, Cheung, Stouraitis, & Wong, 2005; Rechner & Dalton, 1991). Opponents of CEO duality have proposed that the separation of the CEO and board chairperson position will help improve firm performance. However, proponents of the stewardship theory disagree. They advocate CEO duality on the basis that leaders can be good stewards and that having more control of organizational resources and better communication at different organizational levels means they can deliver superior firm performance. Davis et al. (1997) argue that for CEOs who are stewards, proorganizational actions are best facilitated when the corporate governance structures grant them more authority and discretion. Structurally, this situation is attained more readily if the CEO concurrently chairs the board. Empirically, Donaldson and Davis (1991) and Coles, McWilliams, and Sen (2001) have found that firms with CEO duality achieved better performance. Others have shown that leaders who have a good reputation and are considered pro-organizational for upholding corporate goals, values and the purpose of the firm are acknowledged as effective leaders (Huang & Snell, 2003). Furthermore, proponents of the stewardship theory

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maintain that CEO duality can promote unified and strong leadership with a clear sense of strategic direction, thereby improving firm performance (Brickley, Coles, & Jarrell, 1997). Two competing hypotheses can be derived from the agency and stewardship theories: Hypothesis 1a. As per the agency theory, CEO duality is negatively associated with firm performance. Hypothesis 1b. As per the stewardship theory, CEO duality is positively associated with firm performance.

CEO Tenure Drawing on the agency theory, Hill and Phan (1991) suggest that a longer CEO tenure tends to encourage a more entrenched CEO who has higher managerial autonomy and therefore, more opportunity to pursue selfinterest. Likewise, Hambrick and Fukutomi (1991) argue that long tenure may lead to a lack of organizational change because long-tenured CEOs are often over-committed to their paradigms. As has been argued, this can be harmful because failing to address the changing needs of a competitive environment may ultimately result in a decrease in firm value (Miller, 1991). In addition, long-tenured CEOs have considerable influence over the selection and composition of their board of directors (Prevost, Rao, & Hossain, 2002). Mintzberg (1983) notes that over time, CEOs tend to recruit and promote people who have similar views to their own, and discharge dissidents, thereby homogenizing the firm. The power that comes with long CEO tenure may consequently render the board ineffective in monitoring managerial opportunism, and facilitate the CEO’s pursuit of self-interest. In contrast, stewardship theory argues that because managerial skills and knowledge are scarce, not easily transferable and difficult to replicate, CEOs with relatively long tenures can possess unique, non-transferable firm-specific and industry-specific knowledge, and therefore contribute effectively to the firm (Castanias & Helfat, 1991; Govindarajan, 1989). In addition, CEO tenure is a psychological and situational factor that can affect the CEO’s degree of stewardship behavior. According to Davis et al. (1997), a longer tenure with a firm may allow the CEO to identify more closely with the firm and develop a stronger sense of belonging. Therefore, the bonding between individual self-esteem and corporate prestige, coupled with the knowledge and abilities a CEO will have acquired during long

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tenure, adds value to the organization and enhances firm performance (Donaldson & Davis, 1991; Kor & Mahoney, 2000). In accordance with these two contrasting theories, we hypothesize the following: Hypothesis 2a. As per the agency theory, CEO tenure is negatively associated with firm performance. Hypothesis 2b. As per the stewardship theory, CEO tenure is positively associated with firm performance.

Moderating Role of Board Composition: Independent Directors A board of directors is granted the legal authority to hire, fire, and reward a CEO in the interest of maximizing shareholders’ wealth (Organisation for Economic Co-operation and Development [OECD], 2004). Agency theory holds that board independence is the key to performing this function effectively and ensuring self-serving managers are monitored (Jensen & Meckling, 1976). This is because independent directors have strong motivation to maintain their reputations, as well as increased objectivity, which allows them to be more effective in monitoring and controlling management (Dalton, Daily, Ellstrand, & Johnson, 1998; Fama & Jensen, 1983a). Researchers have frequently reported that a board with a greater number of independent directors is more vigilant than a board with fewer independent directors (Hermalin & Weisbach, 2003; Kroll, Walters, & Wright, 2008) and is better able to reduce management perk consumption (Brickley & James, 1987). In addition, such a board has been found to enhance CEO turnover-performance sensitivities (Kato & Long, 2006), and protect shareholder interests more effectively (Pearce & Zahra, 1991; Tian & Lau, 2001). Although CEOs can accumulate power through duality and tenure, an independent board can effectively reduce such power by monitoring and confronting costly executive decisions (Kroll et al., 2008). For these reasons, agency theorists argue that a significant presence of independent board directors leads to greater monitoring efficacy, thus reducing the possibility of CEOs’ pursuit of private interests at the expense of the firm. In contrast to agency theory, stewardship theory argues that an outsider-dominated (or independent) board discourages managers’ proorganizational behavior (Argryis, 1964; Davis et al., 1997). Stewardship theory argues that the optimal governance structure is one that authorizes CEOs to act and allows CEO
board coordination to be achieved in the

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most effective manner (Donaldson, 1990). Thus, according to the stewardship theory, a board with a significant number of independent directors may not be efficient. Researchers such as Baysinger and Hoskisson (1990) argue that independent directors tend to evaluate and reward management based on the firm’s short-term financial figures, which can affect the CEO’s focus on the firm’s long-term development. Further, a greater amount of independent directors increases power and discretion at the board level, which can undermine CEOs’ pro-organizational behaviors and lower their motivations, thus becoming counter-productive to the firm (Donaldson & Davis, 1991). Given, again, the competing views of both theories, we hypothesize the following moderating effect: Hypothesis 3a. As per the agency theory, more independent directors weaken the negative relationship between CEO duality and firm performance. Hypothesis 3b. As per the agency theory, more independent directors weaken the negative relationship between CEO tenure and firm performance. Hypothesis 3c. As per the stewardship theory, more independent director weakens the positive relationship between CEO duality and firm performance. Hypothesis 3d. As per the stewardship theory, more independent directors weaken the positive relationship between CEO tenure and firm performance.

Moderating Role of Board Composition: Executive Directors Executive directors who are members of both the board and the management team are generally viewed unfavorably by agency theorists. According to agency theory, lack of independence from the CEO is the main weakness of executive directors. One of the board’s roles is to supervise and evaluate top management performance, especially that of the CEO, and executive directors are unlikely to perform this task objectively and effectively (Hermalin & Weisbach, 2003). Weisbach (1988) notes that in addition to insiders’ loyalty to their CEO, executive directors may worry about the consequences of evaluating the CEO harshly, and this will affect the objectiveness and fairness of their judgment of the CEO. Furthermore,

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a board with a significant number of executive directors can increase the power of CEO, and therefore, weaken the overall monitoring efficiency of the board. For example, Coles et al. (2001) demonstrate that when a firm’s CEO has long tenure, a high proportion of executive directors leads to a reduction in firm performance. Conversely, stewardship theory argues that an insider-oriented board should be encouraged to motivate CEOs’ pro-organizational behavior, and that this will better serve the interests of shareholders (Argryis, 1964; Davis et al., 1997). Given executive directors work with the company CEO on a daily basis and have developed loyalty to the CEO over time, their participation in the board can enhance the CEO’s autonomy. Stewardship theory holds that executive directors’ strong knowledge of the business means that they can work with the CEO to focus on the firm’s long-term growth instead of short-term profit maximization. Therefore, empowering a CEO through a more insider-oriented board is promoted by the stewardship theory. As such, we hypothesize the following moderating effect: Hypothesis 4a. As per the agency theory, more executive directors strengthen the negative relationship between CEO duality and firm performance. Hypothesis 4b. As per the agency theory, more executive directors strengthen the negative relationship between CEO tenure and firm performance. Hypothesis 4c. As per the stewardship theory, more executive directors strengthen the positive relationship between CEO duality and firm performance. Hypothesis 4d. As per the stewardship theory, more executive directors strengthen the positive relationship between CEO tenure and firm performance.

METHODOLOGY Sample This study examines all manufacturing firms listed on the Shanghai Stock Exchange (SZSE) and the Shenzhen Stock Exchange (SHSE) as of

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December 31, 2010, and a total of 1,036 publicly listed companies were identified. Data were collected from the Chinese Stock Market and Accounting Research Database (CSMAR) over the period 2005
2011, and individuals holding the formal title of either General Manager or Chief Executive were identified as CEOs. Due to a time-lag design in all the models, the data for all the independent variables (e.g., CEO duality, CEO tenure, board composition) and control variables were collected for the period 2005
2010, and dependent variables (i.e., performance ratios) were collected for the period 2006
2011. After excluding missing cases and outliers, the final sample consisted of 5,165 firm-year observations. We performed non-sampling-bias tests to examine whether the excluded cases had caused a selection bias; using mean comparison t-tests, no significant results were found, suggesting there was no sampling bias.

Measurements Dependent Variables Following prior studies of Chinese firms, we used both forwardlooking market-based measures such as Tobin’s Q, and backward-looking accounting-based measures such as return on equity (ROE) to examine firm performance. Tobin’s Q was employed to measure the market value of equity and debt of a firm to the replacement cost of its assets (Agrawal & Knoeber, 1996). We followed prior research such as Wei and Varela (2003) and Hu, Tam, and Tan (2010) to use “total liabilities” as the “replacement costs of total debt,” and “book value of total assets” as the “replacement costs of total assets” in calculating the market value of Chinese companies’ debt. Additionally, ROE was employed as a primary measure of a firm’s profitability (Peng, Zhang, & Li, 2007; Stickney & Weil, 1994). To build on previous research, we examined two variables (i.e., Tobin’s Q and ROE) that are frequently used as performance indicators of Chinese listed companies (see Peng, 2004; Wei & Varela, 2003). Independent Variables The independent variables used in this study were CEO duality and CEO tenure. Following Peng et al. (2007), “duality” refers to a company’s CEO concurrently holding the position of chairman of the board. Duality was coded as a dichotomous variable with “1” standing for “duality” and “0” for “non-duality.” “Tenure” refers to the number of years that the CEO had held the position in the company (Conyon & He, 2012). With the

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introduction of independent directors in 2003 (CSRC, 2001), a Chinese board is now composed of three mutually exclusive director groups: executive directors, non-executive directors, and independent (non-executive) directors. In China, non-executive directors are directors who are often affiliated with, or the representatives of, the company’s large shareholders (Hu et al., 2010; Peng, 2004). Since these directors are neither fully independent nor company executives, they are excluded from this study. As a result, “independent directors” (ID%) and “executive directors” (ED%) are used as moderators in this study, and refer to the percentage of independent directors on the board, and the percentage of executive directors on the board, respectively.

Control Variables Two sets of control variables were employed in this study. The first set consisted of firm-level control variables including firm size, age, leverage, net profit margin, ownership concentration, SOE, and board size. These variables have been commonly used in prior studies because they can affect a firm’s financial performance. “Firm size” was measured by the natural logarithm of the company’s total assets at the end of each year, and “firm age” was measured by the number of years since incorporation (Peng et al., 2007). “Debt
asset ratio” (DAR) is a leverage ratio that assesses a company’s ability to obtain external funding, whereas “profit margin” (ProMargin) measures a company’s ability to generate internal funding (Lien, Piesse, Strange, & Filatotchev, 2005). To differentiate whether firms were SOE or private, we included a SOE dummy variable, which equaled “1” if the company was state owned and “0” otherwise (Kato & Long, 2006). “Ownership” was measured by the percentage of shares owned by the largest shareholder of the listed company (Hu et al., 2010). “Board size,” another important control variable in the governance research, was used to measure the total number of directors on the board (Hu et al., 2010). The second set of control variables consisted of CEO-level variables: CEO age, CEO gender, CEO pay, and CEO ownership. “CEO age” was continuous and measured in years, and “CEO gender” was measured by a dummy variable valued at “1” if the CEO was male and “0” if female. Both variables have been found to have important effects on both CEO and firm performance (Kato & Long, 2006). Consistent with Conyon and He (2012), “CEO pay” (RMB 000s) was measured by the total cash compensation the CEO received in a given year. Since CEO shareholding is rather low in China, a dummy variable was used to measure “CEO ownership”

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(CEOOwn) with a value of “1” if the CEO held company shares in the given year and “0” otherwise (Peng, Li, Xie, & Su, 2010).

RESULTS Table 1 presents the means and standard deviation along with the correlation matrix of the variables. The correlation between each independent variable is below 0.7 and the variance inflation factor (VIF) scores of these variables are below 2, suggesting no evidence for collinearity in this study (Tabachnick & Fidell, 2001). An ordinary least squares (OLS) regression method was used, which sought to minimize the sum of squared distances of the data points to the regression line (Eye & Schuster, 1998). Regression results are presented in Tables 2 and 3. Table 2 presents the results for Tobin’s Q and ROE. Table 2 (Models 1 and 3) shows the results of testing for hypotheses 1a
2b by regressing Tobin’s Q and ROE on the control variables and the two independent variables over the full sample size. In Models 1 and 3, we found a statistically significant positive relationships between CEO duality and firm performance, which supports hypothesis 1b. We also found a statistically significant positive relationships between CEO tenure and firm performance, which supports hypothesis 2b. Both hypotheses 1b and 2b are derived from the stewardship theory, thus suggesting that our main-effect models provide support for the stewardship theory over the agency theory. Models 2 and 4 of Table 2 report the results for hypotheses 3a
4d, which tested the interactive relationships between CEO duality, tenure and board composition variables. Model 2 tested the moderating effect, using Tobin’s Q as the dependent variable. The results demonstrate that the interactive effect between CEO tenure and independent directors is negatively and significantly related to Tobin’s Q, and the interactive effect between CEO duality and executive directors is positively and significantly related to Tobin’s Q. These findings support the view of stewardship theory as presented in hypotheses 3d and 4c. However, we did not find significant interactive relationships between CEO duality and independent directors, and CEO tenure and executive directors, to Tobin’s Q. That is, neither the agency nor the stewardship theories are supported by these interaction effects. In Model 4, we used ROE as the dependent variable. As opposed to Model 3, we did not find any significant interactive effects between CEO duality, tenure, and firm performance when using independent directors as the moderator.

Table 1. Variables 1. Tobin’s Q 2. ROE (%) 3. Firm size 4. Firm age 5. DAR 6. ProMargin 7. SOE 8. Ownership 9. BOD size 10. CEO age 11. Gender 12. CEOOwn 13. CEO pay 14. Duality 15. Tenure 16. ID (%) 17. ED (%) Mean SD

Descriptive Statistics and Correlation Matrix.

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

1.00 0.20** −0.35** 0.02 0.30** −0.04** −0.15** −0.03* −0.11** −0.04** 0.00 −0.03* 0.03* 0.12** 0.04** 0.02 0.05**

1.00 −0.03** 0.01 0.63** −0.04** −0.02 0.02 −0.01 −0.01 0.00 −0.01 0.00 0.03* 0.03* 0.02 0.06**

1.00 0.11** −0.11** 0.06** 0.31** 0.23** 0.30** 0.13** 0.04** 0.06** 0.25** −0.14** 0.02 0.00 −0.06**

1.00 0.07** −0.03* 0.13** −0.28** −0.01 0.05** −0.01 0.03* 0.02 −0.08** 0.07** −0.01 0.02

1.00 −0.05** −0.03* 0.03* −0.03** −0.03* 0.01 −0.05** −0.02 0.01 0.03 0.05** 0.05**

1.00 0.03 0.02 0.03** 0.00 0.03* 0.02 0.02 0.01 0.01 −0.02 −0.90**

1.00 0.19* 0.22** 0.07** 0.04** −0.07** −0.07** −0.23** −0.01 −0.06** −0.03

1.00 −0.03** 0.02 0.00 −0.13** −0.04** −0.04** −0.07** 0.05** −0.02

1.00 0.04** 0.00 −0.02 0.08** −0.12** 0.00 −0.27** −0.02

1.00 0.07** 0.06** 0.11** −0.05** 0.12** −0.03** −0.01

1.00 −0.01 0.04** 0.00 0.04** −0.01 −0.05**

1.00 0.12** 0.10** 0.07** −0.03* −0.02

1.00 0.05** 0.15** 0.02 −0.01

1.00 0.04** 0.06** −0.01

1.00 0.02 −0.01

1.00 −0.02

1.00

10.76 19.93

21.44 1.20

11.24 4.57

0.58 1.95

0.57 2.22

0.57 0.50

0.95 0.23

0.52 0.50

3.30 1.32

35.82 4.85

32.37 11.83

2.20 3.04

* p < 0.05; ** p < 0.01. Two-tailed. N = 5,165 firm-year observations.

38.11 15.52

9.25 1.88

48.87 7.62

368.72 574.52

0.18 0.38

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Are Chinese CEOs Stewards or Agents?

Table 2.

Regression Analysis of Firm Performance on CEO Duality, Tenure and Board Composition. Tobin’s Qa

Control variables Firm size Firm age DAR ProMargin SOE Ownership BOD size CEO age Gender CEOOwn CEO pay Main effect hypotheses Duality Tenure

Model 1

Model 2

Model 3

Model 4

−0.93*** 0.04*** 0.38*** −0.01** −0.20* 0.02*** 0.01 0.01 0.15 0.01 0.01***

−0.78*** 0.03*** 0.15*** −0.03 −0.23** 0.01*** 0.00 0.00 0.18 0.08 0.01***

−0.69* −0.15*** 1.70*** −0.01 −0.51** 0.01 −0.08* 0.02* −0.68* 0.53 0.01**

−0.16 −0.11*** 2.54** −2.97** −0.57*** 0.01* −0.02 0.01 −0.36 0.36* 0.01**

0.70 0.52**

0.16* 0.98**

0.87* 6.49*

0.39*** 0.06*

Moderating hypotheses ID% ED% ID%×duality ID%×tenure ED%×duality ED%×tenure Adjusted R2 F value N (company-year)

ROEa

−0.03 −0.09** 0.06 0.01 0.20* 0.03*

0.07*** −0.02 −0.02 −0.01** 1.44*** 0.01 20.97 25.39*** 5129

25.23 38.53*** 5128

33.15 12.40*** 4974

45.29 26.71*** 4973

a Tobin’s Q and ROE were measured for year t + 1, all other variables, for year t. All models included year dummies, which are not reported.*p < 0.05; **p < 0.01; ***p