Greenfield or Acquisition Entry? The Roles of Policy Uncertainty and MNE Legitimacy in Host Countries

• Date: 01 August 2013
• Published date: 01 August 2013
• DOI: http://doi.org/10.1111/j.2042-5805.2013.01056.x
• Author: Arjen H.L. Slangen

GREENFIELD OR ACQUISITION ENTRY?

THE ROLES OF POLICY UNCERTAINTY AND

MNE LEGITIMACY IN HOST COUNTRIES

ARJEN H.L. SLANGEN*

Department of Strategic Management and Entrepreneurship, Rotterdam

School of Management, Erasmus University Rotterdam, Rotterdam,

The Netherlands

Political constraints shortages in host countries facilitate policy changes and, hence, imply

policy uncertainty for multinational enterprises (MNEs). I examine how such uncertainty

influences MNEs’ choice between wholly owned greenfield and full acquisition entry by

combining real options and MNE legitimacy theory. I arguethat acquisitions require MNEs to

buy the needed external assets immediately upon entry while greenfields allow them to buy

these assets sequentially, causing greenfieldsto temporarily have a real options advantage over

acquisitions if policy uncertainty resolves unfavorably after the initiation of an entry. I expect

the value of this advantage and, hence, the likelihood of greenfield entry, to increase with the

level of policy uncertainty. I also expect this increaseto be smaller for subsidiaries with greater

expected legitimacy, since greatersubsidiary legitimacy reduces the chance of adverse shifts in

policy preferences and, therefore, the threat posed by a given political constraints shortage. I

find support for most of these expectations in a sample of 172 foreign entries by Dutch MNEs,

measuring policy uncertainty by Henisz’s reverse-coded POLCON index and a subsidiary’s

expected legitimacy by its planned autonomy level, its parent’s host country experience, its

industry’s expected performance, and its parent country’s religious closeness. I conclude that

the POLCON index is an incomplete indicator of the policy threats faced by MNEs because it

does not account for subsidiaries’ legitimacy. Copyright © 2013 Strategic Management

Society.

INTRODUCTION

In any given country, firms experience policy uncer-

tainty because governmental policies toward them

may unexpectedly change at some point. Such

uncertainty is an important part of a country’s insti-

tutional environment (Dunning and Lundan, 2008;

Mudambi and Navarra, 2002) and a function of the

country’s level of political constraints on policy

changes. In countries where such constraints are low

(such as those where legislative branches lack veto

power over policy changes proposed by the execu-

tive branch), firms generally face high policy uncer-

tainty because they can be confronted with sudden

policy changes any moment (Delios and Henisz,

2000; Henisz, 2000b). Because such changes may be

unfavorable, policy uncertainty poses a threat to

firms.

This threat is especially real for subsidiaries of

foreign multinational enterprises (MNEs), since

such subsidiaries are generally more likely to

become subject to unfavorable policies than are local

firms (Delios and Henisz, 2000; Hymer, 1976). At

some point, established or new governments may,

for instance, decide to raise income or other taxes for

Keywords: acquisitions; establishment mode choice; green-

fields; MNE legitimacy; policy uncertainty

*Correspondence to: Arjen H.L. Slangen, Department of Stra-

tegic Management and Entrepreneurship, Rotterdam School of

Management, Erasmus University Rotterdam, P.O. Box 1738,

3000 DR Rotterdam, The Netherlands. E-mail: aslangen@

rsm.nl

Global Strategy Journal

Global Strat. J., 3: 262–280 (2013)

Published online in Wiley Online Library (wileyonlinelibrary.com). DOI: 10.1111/j.2042-5805.2013.01056.x

Copyright © 2013 Strategic Management Society

individual or groups of foreign-owned subsidiaries,

impose quota or local content requirements on

them, or even expropriate their assets (Bunn and

Mustafaoglu, 1978; Delios and Henisz, 2000;

Mudambi and Navarra, 2002; Slangen and

Beugelsdijk, 2010).

MNEs often limit the threats stemming from

policy uncertainty by entering countries with low

political constraints through equity joint ventures

(JVs) with local organizations rather than through

wholly owned subsidiaries (WOSs) (Delios and

Henisz, 2000; Henisz, 2000b; Hill, Hwang, and

Kim, 1990). Such JVs generally limit policy threats

because, all else equal, they enable MNEs to

commit less resources to a country and, hence, exit

it at lower costs if governmental policies change

unfavorably (Hill et al., 1990; Reuer and Tong,

2005). Furthermore, JVs are less likely than WOSs

to become subject to unfavorable policies because,

in the case of JVs, such policies also hurt local

equity partners, which themselves may be state

owned (Delios and Henisz, 2000; Yiu and Makino,

2002).

However, MNEs frequently want to have full

ownership over their foreign subsidiaries despite

high policy uncertainty (Feinberg and Gupta, 2009),

for instance because they want to prevent their pro-

prietary knowledge from leaking to JV partners (Hill

et al., 1990). This raises the question whether MNEs

that prefer WOSs also have an entry strategy at their

disposal that allows them to limit the threats stem-

ming from policy uncertainty. Using real options

theory, I argue that MNEs preferring WOSs can

limit the threats stemming from policy uncertainty

through their establishment mode choice, in particu-

lar by entering through greenfield start-ups rather

than through acquisitions. The reason, I argue, is

that greenfields temporarily give MNEs the option

to exit at relatively low costs or interrupt the asset

purchase process if unfavorable policy changes

occur, giving greenfields a real options advantage

over acquisitions (cf. Brouthers and Dikova, 2010).

Since policy makers can more easily realize unfa-

vorable policy changes if there are fewer political

constraints, greater shortages of such constraints

increase policy threats for MNEs and, hence, the

value of the real options advantage of greenfields

over acquisitions. Therefore, I hypothesize that

policy uncertainty stemming from political con-

straints shortages has a positive effect on the likeli-

hood that MNEs choose greenfield over acquisition

entry.

Using Kostova and Zaheer’s (1999) ‘theory of

MNE legitimacy’ I also expect policy uncertainty’s

positive effect on the likelihood of greenfield entry to

be weaker for prospective subsidiaries that will

likely be seen as more legitimate by local policy

makers. The reason is that policy preferences toward

more legitimate subsidiaries are less likely to shift

adversely at a given political constraints shortage,

reducing the threat posed by that constraints short-

age and, hence, lowering the value of the real options

advantage of greenfields at that policy uncertainty

level. I argue that a subsidiary’s expected legitimacy

is a function of: (1) its planned autonomy level; (2)

its parent’s host country experience; (3) its indus-

try’s expected performance; and (4) its parent coun-

try’s religious closeness, leading me to hypothesize

that these factors mitigate the negative impact of

policy uncertainty on the likelihood of greenfield

entry.

I test these hypotheses on a sample of 172 WOSs

built or acquired by Dutch MNEs in 33 foreign

countries, using Henisz’s (2000a) reverse-coded

POLCON index to measure policy uncertainty stem-

ming from political constraints shortages. Most

hypotheses are supported, confirming that policy

uncertainty increases the value of the real options

advantage of wholly owned greenfields over full

acquisitions, and that this increase is smaller for

more legitimate subsidiaries for which adverse shifts

in policy preferences are less likely.

I make several noteworthy contributions to the

international strategy literature. First, I take the

novel approach of combining real options reasoning

with insights from MNE legitimacy theory, thereby

advancing our theoretical understanding of the deter-

minants of MNEs’ establishment mode choices.

Second, by showing that the effect of political con-

straints shortages on such choices depends on a sub-

sidiary’s expected legitimacy, I show that the

POLCON index is an incomplete indicator of the

policy threats MNEs face in host countries. Finally,

while prior entry mode studies have applied real

options theory to the choice between entry modes

involving different foreign ownership levels (Chi

and McGuire, 1996; Li and Li, 2010; Li and

Rugman, 2007; Brouthers, Brouthers, and Werner,

2008), I apply it to the choice between rival full

ownership modes, i.e., wholly owned greenfields and

full acquisitions. This novel application, which was

recently introduced by Brouthers and Dikova (2010),

allows for the identification of real options advan-

tages other than those of JVs.

Policy Uncertainty, Legitimacy, and Establishment Mode Choice 263

Copyright © 2013 Strategic Management Society Global Strat. J., 3: 262–280 (2013)

DOI: 10.1111/j.2042-5805.2013.01056.x