Home country institutions as predictors of FDI in India.

• Author: Collins, Jamie D.

INTRODUCTION

The international business literature has traditionally drawn upon internalization theory (Buckley and Casson 1976) and transaction costs economics (TCE) (Williamson 1985; Yiu and Makino 2002) as primary explanations of foreign direct investment (FDI) levels. Several authors (Oliver 1997; Hoskisson et al 2000; Peng 2001) have argued that international business research should involve multiple theoretical perspectives and emphasized the value of considering the influence of institutions on FDI. Direct investment in a foreign market is a primary example of a business activity influenced by institutional factors of home countries as well as those of host countries.

In this study, we utilize an institutional perspective to assess the country-level drivers of FDI in India. Unlike prior international business literature that has largely emphasized the roles of host characteristics in attracting FDI, our study focuses on the effects of FDI-origin country (i.e., home country) factors on the FDI flow. We argue that the overall level of institutional development within a home country (from which FDI originates) must be considered when investigating drivers of Indian FDI. Comparisons between home country environments reveal that direct investments into India tend to flow from home countries with highly developed institutional environments. Our study is one of a very small number focused on the impact of institutional factors on inbound FDI (Bevan et al 2004; Trevino and Mixon 2004).

Further, while the literature has emphasized the importance of institutional environment as a whole, we argue that a fine-grained analysis of the effects of particular institutional components on FDI is necessary and meaningful. Because institutional environments are complex, we attempt to appropriately capture this complexity by considering components of institutional environment (namely, regulative, cognitive and normative) individually as well as jointly and further examine which component has a greater impact on FDI. Such an endeavor extends our collective understanding of the factors influencing FDI by investigating the relationship between in-bound FDI in India and the level of development of different institutional components in the home countries from which these FDI flows originate.

We test our arguments using a sample of FDI in India from 1996 to 2000. We selected India as our research setting because of its rapid growth in FDI inflow. In the World Investment Report 2006, UNCTAD has indicated that FDI flows into India rose from less than $280 million in 1992 to nearly $5.60 billion in 2002, sustaining its position as the largest recipient in South Asia. India's market potential, improved economic performance, growing competitiveness of multiple industries and the impetus of recent liberalization measures were factors attracting more FDI into the country (WIR 2006). Given the size and rapid growth of FDI in India, a systematic analysis of the linkages between FDI and the characteristics of source countries will provide insights into the roles of home country factors in the vast foreign investment in this country.

The remainder of this paper is organized as follows. We first briefly review literature pertaining to the role of institutions in supporting foreign investment flows. A finer-grained examination of various components of an institutional environment is then presented; hypotheses are proposed regarding influences of different institutional factors on FDI levels. Empirical analysis follows the hypothesis development. The paper ends with a discussion of implication of our findings and possible future research avenues to be pursued.

HOME COUNTRY INSTITUTIONAL MUNIFISCENCE

Institutions have long been argued to underpin market-driven economic systems and support advancement of less-developed economies (Kogut and Spicer 2002; North 1990; Uhlenbruck 2004). The institutional environment within a particular country encompasses the 'rules of the game' for firms operating within that country (Bevan et al 2004; Gaur and Lu 2007; Peng 2001). Adherence to or congruence with the institutional environment serves not only to protect firms from formal, economic penalties, but also to create legitimacy, which serves to advance the firm's current and future performance by engendering the broad support of the proponents of the institutional environment (Dacin et al 2002; Meyer and Rowan 1977; Zucker 1987). Thus, firms frequently make decisions in response to the institutional forces placed on them by employees, consumers, regulatory agencies and other stakeholders (Hoskisson et al 2000; Powell 1998).

Understanding institutional variation is a key element of the growing literature that deals with the process of globalization and development. Moreover, institutional quality is a key driver of economic growth and rising living standards. It is clear that some institutions aid economic development (Peng 2003; Peng and Heath 1996); other institutions, like corruption, harm firm performance and the broad economy (Uhlenbruck et al 2006; Doh et al 2003). The implications of institutional variation are central to economic development of nations. Understanding the influence of institutions is central to management research and to the broader goals of research in business-related disciplines (Uhlenbruck et al 2006).

Institutional theorists argue that, in addition to an economic environment, firms exist in a social environment (Peng and Heath 1996; Rodriguez et al 2005). Institutions can be considered as conventions that have been awarded rule-like status by members of a society (Xu et al 2004; Meyer and Rowan 1977). Institutional theory predicts that organizations comply with norms, rules and procedures of their environment to overcome uncertainty and gain legitimacy, and thus, access to resources.

To advance our understanding of the nature of institutions, Scott (1995) developed a framework in which institutions are argued to be either: regulative, normative or cognitive. Regulative institutions are official laws, regulations and policies which govern the conduct of business in a focal country. These regulatory institutions are the common focus of institutional economics-related research (North 1990; Xu et al 2004). Regulative institutions function by coercing individuals and firms into compliance through formal penalties. Normative institutions represent the values and norms that delineate socially-appropriate ways of behavior. Normative institutions deal with shared understandings and meanings that are collectively held within a society. Normative institutions provide information about the nature of appropriate firm actions, the types of actions valued by a society, and how these actions should be pursued (Yiu and Makino 2002). Normative institutions often manifest through accepted authority systems such as professional societies (Ahlstrom and Bruton 2006). Examples of normative institutions include the appropriateness of adjusting investment strategies in response to government corruption (Rodriguez et al 2005; Collins and Uhlenbruck 2004), the acceptance of women in professional circles (Baughn et al 2006) and the importance placed on rights of workers in international markets (Egels-Zanden and Hyllman 2007; Morrison 2001).

Cognitive institutions provide the frames or scripts through which individuals derive meaning from and interpret symbolic representations of the world. Cognitive institutions are shared perceptions of the boundaries and viability of any particular activity (Berger and Luckmann 1966) and "internalized symbolic representations of the world" (Scott 1995) built upon established cognitive structures in a society by which actors interpret and make sense of their world (Yiu and Makino 2002). Cognitive institutions encourage compliance because they are taken for granted as "the way things are done" (Oliver 1997; Shenkar 2002). Individuals' judgments about appropriate actions are affected by their judgments about similar actions that fall into the same cognitive category. Over time, the judgments are institutionalized and become taken-for-granted beliefs and values about appropriateness in those contexts. This leads organizational decision makers to pursue familiar courses of action which have already been legitimated by others in their field (DiMaggio and Powell 1991; Greenwood and Hinings 1996). Formal education is one of the most common ways in which cognitive institutions are diffused within a society (Powell 1998; Sine et al 2005). Examples of cognitive institutions include a strong emphasis on investor and shareholder rights, the legitimacy of entrepreneurship as a source of wealth creation, and foreign investment as an avenue for firm growth (Hitt et al 2006; Sine et al 2005). Other examples of cognitive institutions include: the use of personal and professional networks to benefit the firm (Uhlenbruck et al 2006; Wright et al 2002), the competitive benefit of maintaining harmony between collaborating firms, the usefulness of minimal disclosure of information to parties outside the firm (Ahlstrom and Bruton 2006).

The construct of institutional distance (Kostova 1999; Kostova and Zaheer 1999) was developed to explain MNE behavior in the face of complex institutional demands when making investment decisions across multiple host markets. Institutional distance is the extent of similarity or dissimilarity between the regulatory, cognitive, and normative institutions of two countries. Institutional distance has been argued to be the primary theoretical explanation of MNE selection of host countries and their foreign market entry strategies (Westney 1993; Xu and Shenkar 2002; Yiu and Makino 2002). It has frequently been argued that the greater the institutional distance between the home and host countries, the more difficult it will be for a firm to successfully establish operations in a target country (Kostova...