Categorizing the Liability of Foreignness: Ownership, Location, and Internalization‐Specific Dimensions

• Published date: 01 November 2016
• DOI: http://doi.org/10.1002/gsj.1140
• Author: Nan Zhou,Mauro F. Guillen
• Date: 01 November 2016

CATEGORIZING THE LIABILITY OF FOREIGNNESS:

OWNERSHIP, LOCATION, AND INTERNALIZATION-

SPECIFIC DIMENSIONS

NAN ZHOU

1,2

*and MAURO F. GUILLEN

3

1

China Minsheng Bank,Beijing, China

2

Nankai Business School, Nankai University, Tianjin, China

3

Lauder Institute, Management Department, Wharton School, University of

Pennsylvania, Philadelphia, Pennsylvania, U.S.A.

Plain language summary: This study explains the different types of additional costs faced by

multinational firms when they invest abroad. We identify product adaptation cost,

discrimination cost, governance cost, and appropriation hazard as important sources of the

difficulties that multinationals face. We then link each of these costs to different dimensions

of cross-national distance, including economic, cultural, demographic, political, and

administrative distance. Finally, we show that the importance of these different distance

dimensions differ when multinationals invest abroad for different reasons including market

seeking, efficiency seeking, knowledge seeking, and natural resource seeking.

Technical summary: This study bridges the literature on the liability of foreignness (LoF)

and cross-national distance.Following the ownership-location-internalization paradigm,

we categorize the LoF into three dimensions: ownership-specific LoF, location-specific

LoF, and internalization-specific LoF, each of which reduces a specific advantage of the

multinational firm. We first define the three dimensions of the LoF and then argue that

each dimensionis related to differenttypes of costs. We furtherexplain that differenttypes

of costs are associated with different dimensions of cross-national distance, and firms

face different types of the LoF and associated costs when they conduct different types of

foreign direct investment. We test these hypotheses in the context of Chinese listed firms

investing abroad, finding support for most of the predictions. Copyright © 2016 Strategic

Management Society

INTRODUCTION

The concept of theliability of foreignness (LoF)is the

backbone of the fields of international strategy and

international business. Stephen Hymer was one of

the first scholars to recognize that multinational

enterprises (MNEs) face extra costs when doing

business in foreign countries compared with local

competitors because of their lack of familiarity with

local conditions (Hymer, 1960; Hymer, 1976). The

LoF is commonly defined as ‘the costs of doing

business abroad that result in a competitive disadvan-

tage for an MNE subunit …broadly defined as all

additional costs a firm operating in a market ov erseas

incurs that a local firm would not incur’(Zaheer,

1995: 342–343).

The LoF has great impact on multinationals.

Previous studies have found that it influences the

internationalization strategy of multinationals, includ-

ing the entry mode and performance implications of

internationalization (Chen, 2006; Mezias, 2002).

Given the importance of the LoF in global strategy,

Keywords:liability of foreignness;foreign entry; distance;China;

OLI paradigm

*Correspondence to: Nan Zhou, China Minsheng Bank, No.13

Zhichun Road, Hang Nan Building, Beijing, China, 100083.

E-mail: zhounan38@hotmail.com

Global Strategy Journal

Global StrategyJournal, 6:309–329 (2016)

Published onlinein Wiley Online Library (wileyonlinelibrary.com). DOI: 10.1002/gsj.1140

Copyright © 2016 Strategic Management Society

scholars have tried to understand its various aspects,

such as its definition, source, and how to overcome it

(Eden and Miller,2004; Mezias, 2002; Zaheer, 1995).

Because the LoF is a complex concept, one key

stream within the LoF literature is to identify different

types of the LoF. For instance, Eden and Miller

(2004) broke down the LoF into three specific

hazards: unfamiliarity hazards, discrimination

hazards, and relational hazards. Our article falls into

this literature by introducing a new categorization of

different types of the LoF.

Previous studies in this area usually lay out the

categorization without specifying its theoretical

foundation. This study adopts the ownership–

location–internalization (OLI) paradigm to categorize

the LoF into ownership-specific (O), location-specific

(L), and internalization-specific (I)LoF. Although the

OLI paradigm has been applied to explain various

aspects of internationalization (Du nning and Lundan,

2008a; Fiss andHirsch, 2005), it has not been adopted

to understand the LoF. Because the OLI paradigm is

one of the mostwell-accepted frameworksin the inter-

national business literature (Eden and Dai, 2011;

Portugal Ferreira et al., 2011), adopting the OLI para-

digm ensures that our categorization considers the

dominant factors t hat influence the internationaliza -

tion of multinationals. Further, the OLI paradigm

highlights the advantages that encourage firms to go

abroad. It corresponds well with the concept of the

LoF, which describes the disadvantages multina-

tionals face when they go abroad.

Empirically, many studies on classifying different

types of the LoF (Bell, Filatotchev, and Rasheed,

2012; Moeller et al., 2013) are largely theoretical

without providing measurementsor empirical support.

By measuring different dimensions of the LoF with

different dimensions of cross-national distance, our

study bridges the l iterature of the Lo F and cross-

national distance, which is a key variable determining

locational advantages and disadvantages in host coun-

tries relative tothe home country. These two concepts

are closely related to each other because large cross-

national distance between the host and home country

is usually associated with high LoF.

Similar to the LoF, cross-national distance is also

a complex concept with a multidimensional nature

(Berry, Guillen, and Zhou, 2010; Ghemawat, 2001).

Given the close relationship between cross-national

distance and the LoF and the fact that both concepts

are aggregated constructs with layers of components,

it makes sense to relate these two concepts by

categorizing different types of the LoF according to

different dimensions of cross-national distance.

Therefore, in this study, we match different types

of the LoF with different dimensions of

cross-national distance and examine their impact on

foreign entry location choice.

Related to the complex nature of the LoF, it is also

important to consider the fact that firms face different

types of the LoF under different circumstances. There

is a lack of consideration of firm heterogeneity when

examining different types of the LoF. Firms differ in

many aspects, such as their motivations to go abroad.

Therefore, it is unrealistic to assume that all firms face

the same type of the LoF regardless of the motivation

for foreign directinvestment (FDI). We argue that the

importance of each type of the LoF is not always the

same. We hypothesize that the impact of each type

of the LoF differs depending on whether the FDI is

market, efficiency, strategic asset, or natural resource

seeking.

To summarize, we answerthree research questions

in this study: (1) What are the different types of the

LoF?; (2) How do different types of the LoF relate to

different dimensions of cross-national distance?; and

(3) How do theyinfluence the choice of foreignentry?

We adopt the OLI paradigm as the theoretical founda-

tion of our categorization (Dunning, 1993; Dunning

and Lundan, 2008b). Empirically, we find support

for our hypotheses in the context of Chinese listed

firms investing abroad from 1999 to 2007.

By answering these three questions, this study

makes three contributions. First, it unifies the litera-

tures on the LoF and on cross-national distance. Both

are important concepts in international business and

management. However, the existing literature does

not integratethese two streams. We linkdifferent types

of the LoF to different dimensions of cross-national

distance. Creating such a connection helps us better

understand the nature of these two concepts and also

better explains the pattern of FDI both theoretically

and empirically. Besides bridging the literatures on

the LoF and cross-national distance, this study also

contributesto these two areas separately. Itcontributes

to the literatureon the LoF by introducinga new typol-

ogy to categorize different types of the LoF and

considering firm heterogeneity in examining the

effects of the LoF. Adopting the OLI paradigm to

categorize the LoF and measuring the categorization

by cross-national distance enable a systematic

approach to understand the LoF. Classifying the

impact of the LoF by foreign direct investment

motivationhelps us understand the distinctive difficul-

ties faced by multinationals when they go abroad.

310 N. Zhou and M. F. Guillen

Copyright©2016 Strategic ManagementSociety Global StrategyJournal, 6:309–329(2016)

DOI: 10.1002/gsj.1140