Legitimacy Spillovers and Political Risk: The Case of FDI in the East African Community

• Author: Charles E. Stevens,Aloysius Newenham‐Kahindi
• Published date: 01 February 2017
• DOI: http://doi.org/10.1002/gsj.1151
• Date: 01 February 2017

LEGITIMACY SPILLOVERS AND POLITICAL RISK:

THE CASE OF FDI IN THE EAST AFRICAN

COMMUNITY

CHARLES E. STEVENS

1

*and ALOYSIUS NEWENHAM-KAHINDI

2

1

Department of Management, Lehigh University, Bethlehem, Pennsylvania,

U.S.A.

2

Edwards School of Business, University of Saskatchewan, Saskatoon,

Saskatchewan, Canada

Research summary: In order to successfully invest abroad, firms must consider how

their actions will affect their acceptance by host country stakeholders such as the gov-

ernment and host society. When perceived as more legitimate, firms will likely experi-

ence less political risk; greater illegitimacy will likely result in more political risk.

Importantly, such stakeholders often form similar opinions about firms from the same

home country—resulting in legitimacy spillovers within a given host environment

across similar firms. Moreover, stakeholders in one country form opinions of firms

based on their actions in other countries, resulting in across-country legitimacy spil-

lovers. This article examines legitimacy and illegitimacy spillovers encountered by Chi-

nese, American, Indian, and European firms in East Africa, which resulted in

differences in their acceptance and their political risk.

Managerial summary: Although the literature has begun to consider how firms’

legitimacy affects their po litical risk, the role of legi timacy spillovers has not bee n

addressed. Using the legit imacy-based view of political r isk and the literature on

cognition and social judgme nts, we develop theory about how within-country and

across-country spillove rs of legitimacy (or illegiti macy) based on firms’home coun-

try origins can affect thei r political risk. We exami ne the case of FDI in six East

African countries that have ex perienced a rapid increase in for eign investment

despite the presence of pol itical risk. This case shows ev idence of legitimacy spil-

lovers resulting in syste matic variation in firms’poli tical risk. Moreover, we find an

important role for modera ting factors such as the medi a, historical ties, and dis-

tance between countries . Copyright © 2016 Strategic Man agement Society.

INTRODUCTION

The global strategy literature has long noted that

firms’host country political environments can have

unexpected and adverse impacts on firm profitabil-

ity, a phenomenon known as political risk

(Boddewyn, 2005; Brewer, 1985; Simon, 1984).

Political risk is a worldwide phenomenon, but it is

particularly pervasive in developing countries

(Khanna and Palepu, 1997). Although political risk

has numerous antecedents, researchers taking a

legitimacy-based view (LBV) of political risk have

increasingly begun to consider the relationship

between firms’legitimacy and the political risk that

they face (Bucheli and Kim, 2015; Bucheli and Sal-

vaj, 2013; Stevens, Xie, and Peng, 2016).

Keywords: legitimacy; spillovers; political risk; Africa; FDI

*Correspondence to: Charles E. Stevens, 621 Taylor Street,

Bethlehem, PA 18015, U.S.A. E-mail: ces213@lehigh.edu.

Copyright © 2016 Strategic Management Society

Global Strategy Journal

Global Strategy Journal, 7:10–35 (2017)

Published online in Wiley Online Library (wileyonlinelibrary.com). DOI: 10.1002/gsj.1151

However, like much of the extant research on polit-

ical risk, these legitimacy-based works have

focused primarily on explaining a firm’s political

risk in a given host country context based on its

own actions or attributes in that context. Yet, legiti-

macy spillovers can occur between firms or

between different contexts (Kostova and Zaheer,

1999). Legitimacy spillovers have been found to

influence issues such as firms’market entry rates

(Dobrev, Ozdemir, and Teo, 2006), access to

resources (Li, Yang, and Yue, 2007; Romanelli and

Khessina, 2005), and choice of entry mode (Yiu

and Makino, 2002). However, it is unclear how

legitimacy spillovers may affect firms’political

risk. This is an intriguing gap in the literature, as

legitimacy spillovers imply that a firm’s political

risk in one host country could be affected by other

firms’actions or actions undertaken in other host

countries. The purpose of this article is to address

this limitation in the literature.

In this article, we augment the LBV by examin-

ing the following research questions about legiti-

macy spillovers: (1) how within-country spillovers

(e.g., when the legitimacy of a firm is affected by

the legitimacy of other firms from the same home

country) can affect political risk; and (2) how

across-country spillovers (when firms’legitimacy

in one country may transfer to another country)

affect political risk. To answer these questions, we

draw upon the literature on legitimacy judgments

of organizations (Bitektine, 2011; Kostova and

Zaheer, 1999; Tost, 2011) to discuss why such spil-

lovers may arise and subsequently affect firms’

political risk. We use the case of foreign direct

investment (FDI) in the East African Community

(EAC) to illustrate how firms’actions in a host

country may collectively establish or harm their

legitimacy (Suchman, 1995) which, in turn, affects

the risk they experience in that country. Then, we

examine how these firms’legitimacy (or lack

thereof ) in one country affects them as they expand

into other countries in the EAC.

This study contributes to the global strategy lit-

erature in at least three specific ways. First, by con-

sidering within-country legitimacy spillovers, we

increase our understanding of how firms may bene-

fit from the legitimacy, or be penalized by the ille-

gitimacy, of other similar firms. This augments the

traditional political risk literature, which has tended

to consider legitimacy and political risk on a firm-

by-firm basis. Second, by acknowledging the role

of across-country legitimacy spillovers, we can

better understand how firms’efforts to build legiti-

macy and mitigate political risk in one location can

have positive effects on their subsequent interna-

tional expansion efforts or how illegitimacy can

spread across national borders, hampering these

efforts. This further develops the political risk liter-

ature, which tends to examine political risk within

a single host country context at a time, by better

understanding how political risk in one country

may be affected by events outside that country.

Finally, by shining the spotlight onto Africa, we

examine FDI and political risk in an under-

researched region that is of increasing importance

for global strategy researchers and practitioners

alike (Acquaah, Zoogah, and Kwesiga, 2013;

George et al., 2016; Mellahi and Mol, 2015;

Walsh, 2015; Zoogah, Peng, and Woldu, 2015).

The article proceeds as follows: we start by

reviewing the literature on political risk, paying

particular attention to the legitimacy-based perspec-

tive on the phenomenon. We then develop theory

by discussing legitimacy spillovers (Kostova and

Zaheer, 1999) and the impact we expect them to

have on firms’political risk. We use the case of

FDI in EAC countries to illustrate and discuss these

relationships in an important, real-world context.

This case allows us to examine and discuss our

proposed relationships in detail, augment these pro-

posed theoretical relationships based on our find-

ings, and mitigate alternative explanations

(e.g., corruption). We conclude with a discussion

of the implications of our study for theory, practice,

and public policy.

BACKGROUND LITERATURE

Political risk refers to the phenomenon whereby

firms invest in a foreign country and experience

unexpected, adverse impacts on their performance

due to the host country political environment. Polit-

ical risk may arise due to the host government,as

governments may engage in such actions as rene-

ging on contracts, expropriating firm assets, or pla-

cing unexpected restrictions on transfers of money,

people, or goods (Brewer, 1985; Vernon, 1971).

Political risk may also arise due to the host society,

through such actions as protests, boycotts, terror-

ism, and riots (Boddewyn, 2016; Czinkota et al.,

2010; Simon, 1984). Political risk results in billions

of dollars of lost revenue each year for the subsidi-

aries of multinational enterprises (MNEs) (Henisz

Legitimacy Spillovers and Political Risk 11

Copyright © 2016 Strategic Management Society Global Strategy Journal, 7:10–35 (2017)

DOI: 10.1002/gsj