The Effects of Home Country Political and Legal Institutions on Firms' Geographic Diversification Performance

• Date: 01 May 2016
• Author: Asda Chintakananda,Brian Roy Tan
• DOI: http://doi.org/10.1002/gsj.1117
• Published date: 01 May 2016

THE EFFECTS OF HOME COUNTRY POLITICAL AND

DIVERSIFICATION PERFORMANCE

BRIAN ROY TAN

1

and ASDA CHINTAKANANDA

2

*

1

B.R.I.T. Management Consulting, Singapore

2

National Institute of Development Administration, Bangkok, Thailand

Plain language summary: Managers of multinational firms often view the political and

legal environment as an important driver of international performance. However, this

view is normallydirected toward the hostcountry rather than the political andlegal envi-

ronment within the hom e country. This study focuses on the home countryenvironment and

finds that a stable political environment increases the effectiveness of a firm’s overseas ex-

pansion efforts, even as it reduces overall firm performance. Meanwhile, an effective legal

environment at home strengthens the effectiveness of a firm’s overseas expansion efforts

and overall firm performance. As such, the origin of a firm matters, as it influences a firm’s

ability to be successful. This has broad implications for managers and policy makers.

Technical summary: This study proposes that we need to examine jointly the direct and

indirecteffects of home country politicaland legal institutions on the performance of geo-

graphicallydiversified firms. Wecontend that home country political stability and regula-

tory effectiveness work through different mechanisms in influencing firms’performance

directly and indirectly through their geographical diversification strategies. Specifically,

we hypothesize that home country political stability directly reduces firm performance,

but positively moderates the relationship between geographicdiversification and perfor-

mance. Meanwhile,we hypothesize that home countryregulatory effectivenessdirectly en-

hances firm performance and positively moderates the relationship between geographic

diversification and performance. The findings, based on more than 33,000firm-year ob-

servationsfrom 33 home countries, support ourhypotheses on home country politicalsta-

bility and regulatory effectiveness. Copyright © 2016 Strategic ManagementSociety.

INTRODUCTION

A number of studies have investigated how home

country location inf luences the performanc e of

geographically diversified firms (e.g., Wan and

Hoskisson, 2003; Chakrabarti et al., 2007; McGahan

and Victer, 2010).Some studies found that firms from

developed home country locations gain higher perfor-

mance from geographic diversification (Wan and

Hoskisson,2003), while other studies foundthat firms

from less developed home country locations gain

higher performance from geographic diversification

(Chakrabarti et al., 2007). The lack of consensus in

the field may be because many studies focused on

broad institutional constructs conceptualized at the

Keywords: geographic diversification; location; home country;

political institutions; legal institutions

*Correspondence to: Asda Chintakananda, National Institute of

Development Administration, 118 Moo 3, Serithai Road,

Bangkapi, Bangkok 10240, Thailand. E-mail: asda.chi@nida.ac.th

[Correction added on 28 July 2016, after first online publication:

Errors were introduced to the hypotheses numbers on page

119 –the errors have been corrected in this current version.]

Global Strategy Journal

Global StrategyJournal, 6:105–123 (2016)

Published onlinein Wiley Online Library (wileyonlinelibrary.com). DOI: 10.1002/gsj.1117

Copyright © 2016 Strategic Management Society

LEGAL INSTITUTION S ON FIRMS’GEOGRAPHIC

country level or usedconstructs such as political insti-

tutions and legal institutions i nterchangeably. Recent

studies have suggested that differences in home coun-

try characteristics affect the ability of geographically

diversified firms to utilize and exploit their assets

(Holburn and Zelner, 2010; Batjargal et al., 2013)

and have suggested that these home country institu-

tions also directly affect firm performance and indi-

rectly affect firms’geographic diversification

performance (Peng et al., 2008; Cuervo-Cazurra,

2011; Kirca et al., 2012). Thus, while existing research

has demonstrated that home country matters (Dunning

and Lundan, 2008; Dunning, 2009; McGahan and

Victer, 2010), a greater understanding of how specific

home country institutions influence the performance

of geographically diversified firms can help further

the literature.

This study posits that ‘origins matter,’and that the

institutional environment that stems from a firm’s

home country location will have a significant in-

fluence on its philosophy as well as its ability to

conceptualize, plan, and implement its geographic di-

versificationstrategy successfully. The specificity of a

firm’s home country location might also explain why

clusters of firms from specific countries develop

national advantages (Porter, 1990, 1998). By under-

standing how specific institutional constructs affect a

firm’s performance directly or indirectly through its

corporate strategy, firms are better able to guard

against potential biases or negative influences and le-

verage off specific advantages that may be afforded

to them through their institutional legacy.

Drawing on the resource-based view (Barney,

1991) and transaction cost economics (Williamson,

1971), we argue that home country political and legal

institutions play different roles in influencing how

firms extract value and exploit their assets. Specifi-

cally, we contend that development of home country

political institu tions leads to greater ‘political stability’

and directly reduces firm performance by reducing

rent capture from growth opportunities. However,

we believe that political stability will positively mod-

erate firms’geographic diversification-performance

relationship by enabling firms to better focus on the

complexity of their geographic diversification strate-

gies. For regulatory institutions, we contend that the

development of legal institutions leads to increased

‘regulatory effectiveness’and directly enhances firm

performance by reducing transaction costs and en-

hancing firms’recombination of resources and assets.

Similarly, we believe that regulatory effectiveness

positively moderates the geographic diversification-

performance relationship by allowing firms to carry

over home countryadvantages derived from enhanced

regulatory effectiveness.

We test our hypotheses using more than 33,000

firm-year observations from 33 homecountries across

nine years. Our sample of countries covers all conti-

nents and cultural cluster s (Javidan et al., 2006)

and allows us to identify sub stantial institutional dif-

ferences and determine the me chanisms through

which political stability and regulatory effectiveness

affect the performance of geo graphically diversified

firms.

Our study contributes to the literature by exam-

ining how the mechanisms of political and legal

institutions, directly and indirectly, affect the per-

formance of geographically diversified firms. By

doing so, we answer the call for theoretical devel-

opment of more detailed measures to capture the

richness and complexity of the factors affecting the

geographic diversification-performance relationship

(Aoki, 2001; Oetzel et al., 2001; Wiersema and

Bowen, 2011). We also extend existing research on

the effect of home country institutions on geographic

diversification by presenting cross-sectional evidence

from a wide sample of diverse countries, which

enables us to claim a higher level of generalization.

In the following sections, we briefly review the

literature on home country institutions and firm

performance. Next, we build our theory on the di-

rect and indirect effects of home country political

stability and regulatory effectiveness on firm per-

formance. We then present our methodology, re-

sults, and implications for future research and

practice.

Throughoutthis study, we define geographic diver-

sification as the dispersion of a firm’s cross-border

sales in different geographic locations (Jacquemin

and Berry, 1979)and measure firm performance using

the accounting pro fitability mea sure of a firm’s return

on assets (ROA). As firms diversify geographically,

additional funds are required to purchase additional

assets to increase manufacturing capabilities, and ad-

ditional resourcesare needed for new marketing,oper-

ation, and distribution initiatives for their foreign

markets. The firms’effectiveness in these endeavors

will influence their returns from their use of resources

and assets, so ROA is a relevantmeasure that captures

this effect. Moreover, ROA is a widely used measure

in research on geographic diversification and firm per-

formance (Wan and Hoskisson, 2003; Bausch and

Krist, 2007; Chakrabarti et al., 2007; Chacar et al.,

2010).

106 B. R. Tan and A. Chintakananda

Copyright© 2016 Strategic ManagementSociety Global StrategyJournal, 6:105–123 (2016)

DOI: 10.1002/gsj.1117