Institutional Outsiders and Insiders: The Response of Foreign and Domestic Inventors to the Quality of Intellectual Property Rights Protection

• Author: Theodore A. Khoury,Luis Alfonso Dau,Alvaro Cuervo‐Cazurra
• Date: 01 August 2014
• DOI: http://doi.org/10.1002/gsj.1079
• Published date: 01 August 2014

INSTITUTIONAL OUTSIDERS AND INSIDERS: THE

RESPONSE OF FOREIGN AND DOMESTIC

INVENTORS TO THE QUALITY OF INTELLECTUAL

PROPERTY RIGHTS PROTECTION

THEODORE A. KHOURY,1ALVARO CUERVO-CAZURRA,2* and

LUIS ALFONSO DAU2

1School of Business Administration, Portland State University, Portland,

Oregon, U.S.A.

2D’Amore-McKim School of Business, Northeastern University, Boston,

Massachusetts, U.S.A.

We analyze how the quality of intellectual property rights (IPR) protection in developing

countries impacts patent applications. We extend institutional economics to proposethat firms

vary in their interpretation of institutions, specifically arguing that foreign and domestic

inventors respond to different institutional signals because of their different positions as

institutional outsiders and insiders. Thus, we propose that foreign inventors, as institutional

outsiders, respond more positively to the quality of IPR protection in countries with more

democratic political systems, whereas domestic inventors, as institutional insiders, respond

more positively to the quality of IPR protection in countries with higher quality legal systems.

Copyright © 2014 Strategic Management Society.

INTRODUCTION

We analyze how the quality of intellectual property

rights (IPR) protection in developing countries

affects patent applications by domestic and foreign

inventors. The quality of IPR protection strongly

influences patenting activity within a country

because it provides the basic incentives for inventors

to create inventions and recover R&D costs (Levin

et al., 1987) and determines to what degree firms

must engage in monitoring against the unlawful

exploitation of their inventions by others (Zhao,

2006). As the foundation of the national innovation

system, governments need to uphold the quality of

IPR protection in order to encourage the ongoing

pursuit of innovation (Geroski, 1995; Levin et al.,

1987); this is particularly important because

relatively few companies invest in R&D

(Cuervo-Cazurra and Un, 2010). Although firms can

use internal mechanisms such as segmentation,

secrecy, or complexity to protect innovation (Quan

and Chesbrough, 2010; Zhao, 2006), we focus on the

external protection granted by institutions. Within

developing countries, where formal institutional

voids are more commonly present (Cuervo-Cazurra

and Genc, 2008, 2011; Khanna and Palepu, 1997,

2010), there exists less IPR protection (Lerner, 2000)

and firms and their inventors historically patent less

(Furman, Porter, and Stern, 2002; Penrose, 1973;

WIPO, 2011). Moreover, the views of foreign and

domestic inventors differ. From the foreigner per-

spective, such voids in IPR protection represent the

relative quality of IPR in reference to what is likely

a more advanced economy standard. In contrast, this

Keywords: institutions; intellectual property rights; patents;

legal system; political system

*Correspondence to: Alvaro Cuervo-Cazurra, D’Amore-

McKim School of Business, Northeastern University, 313

Hayden Hall, 360 Huntington Avenue, Boston, MA 02115,

U.S.A. E-mail: a.cuervocazurra@neu.edu

Global Strategy Journal

Global Strat. J., 4: 200–220 (2014)

Published online in Wiley Online Library (wileyonlinelibrary.com). DOI: 10.1002/gsj.1079

Copyright © 2014 Strategic Management Society

view of the institutional environment is not neces-

sarily shared by domestic enterprises (Godfrey,

2011).

Therefore, we seek to extend institutional eco-

nomics (North, 1990) to argue that foreign and

domestic inventors ultimately perceive the quality

of IPR protection and complementary institutions

differently and, accordingly, engage in different

innovation strategies. Although the quality of IPR

protection can be qualified based on objective infor-

mation, we propose that the judgment of and reac-

tion to that information is based on each actor’s

unique perception and interpretation of these institu-

tions (Heikkila and Gerlak, 2013). We explain this

by introducing an institutional insider versus out-

sider perspective and arguing that the perception of

the quality of IPR reform varies between foreign and

domestic inventors.

In the case of IPR reform, we propose that foreign

and domestic inventors interpret the quality of asso-

ciated institutions that ensure IPR protection differ-

ently and, thus, react to the quality of IPR protection

differently. Specifically, we discuss two ideas. First,

we argue that foreign inventors respond more posi-

tively than domestic investors to the quality of IPR

protection in developing countries by filing more

patent applications. The reason is that foreign inven-

tors, as institutional outsiders, interpret the quality of

IPR protection as a signal of the government’s will-

ingness to protect patents; in response to this signal,

they file more patent applications. In contrast,

domestic inventors, as institutional insiders, may

have a better understanding of the ability of the

developing country government to actually imple-

ment its commitment to IPR protection and, thus,

may be more skeptical, reacting less positively.

Second, we propose that, in addition to interpret-

ing the quality of IPR protection differently, foreign

and domestic inventors differ in interpreting the

signals provided by the quality of complementary

institutions—the political and legal systems of

developing countries. Hence, we posit that foreign

inventors’ response to the quality of IPR protection

will be more positive in a country with a more demo-

cratic political system. The reason is that foreign

inventors, as institutional outsiders, view a more

democratic system in a developing country as more

likely to ensure fairness and minority rights and,

thus, view it as more committed to implementing

IPR protection for foreigners. In contrast, we argue

that the response of domestic inventors to the quality

of IPR protection will be more positive in a country

with a stronger legal system. The reason is that

domestic inventors, as institutional insiders, may

better understand the limitations in the developing

country of the defense of IPR and, thus, will be more

likely to seek patent protection when the application

of laws appears to be fairer and more efficacious.

These ideas contribute to the global strategy lit-

erature in two ways. First, they contribute to a better

understanding of the boundary conditions of institu-

tional economics (North, 1990) by considering the

interpretive view of institutions by different eco-

nomic actors. We question the implicit assumptions

that institutions are exogenous and objectively

viewed and propose that unique groups of economic

actors perceive the same institutions differently

(Hodgson, 2006). Thus, by addressing how prevail-

ing complementary institutions are uniquely inter-

preted when embarking on innovation strategies,

depending on the actor’s perspective, this article fur-

thers a situational view of institutions and further

complements previous research focused on individu-

ally determined (Markman, Balkin, and Baron,

2002) or culturally derived (Hayton, George, and

Zahra, 2002; Shane, 1992) influences on strategic

behavior. Future work studying the impact of insti-

tutions on firm behavior should take into account the

firm’s potentially unique view of a country’s institu-

tions, because its interpretation of and response to

institutional quality can differ depending on whether

the perspective is taken from an insider or an out-

sider view.

Second, these ideas contribute to a better under-

standing of global innovation strategy by discussing

how different actors undertake innovation strategies

in developing countries. Foreign and domestic firms

differ markedly in their innovation strategies (Un,

2011; Un and Cuervo-Cazurra, 2008). This article

extends previous work that has focused on how insti-

tutions can prompt more innovation (Furman et al.,

2002) and how the quality of IPR protection is a

requisite for inducing inventors to patent (Levin

et al., 1987) by introducing the idea that patent

applications in developing countries depend on the

unique interpretation of the quality of IPR protection

and complementary political and legal institutions

by institutional insiders and outsiders. Institutions

complement each other in their support of innovation

(Nelson, 1993) and that complementarity differs

depending on the perception of the institutions by

inventors.

From a policy perspective, these ideas offer valu-

able insights to the debate on whether developing

Institutional Outsiders and Insiders 201

Copyright © 2014 Strategic Management Society Global Strat. J., 4: 200–220 (2014)

DOI: 10.1002/gsj.1079