The role of psychic distance in entry mode decisions: Magnifying the threat of opportunism or increasing the need for local knowledge?

• Published date: 01 May 2020
• DOI: http://doi.org/10.1002/gsj.1309
• Date: 01 May 2020
• Author: Douglas Dow,Daniel Baack,Ronaldo Parente

RESEARCH ARTICLE

The role of psychic distance in entry mode decisions:

Magnifying the threat of opportunism or increasing

the need for local knowledge?

Douglas Dow

1

| Daniel Baack

2

| Ronaldo Parente

3

1

Melbourne Business School, The University of

Melbourne, Carlton, Victoria, Australia

2

Department of Marketing, Daniels College of

Business, University of Denver, Denver, Colorado

3

Department of Management and International

Business, Florida International University

& FGV-EBAPE, Miami, Florida

Correspondence

Ronaldo Parente, Florida International

University & FGV-EBAPE, 11200 SW 8th

Street –MANGO 437, Miami, FL 33199.

Email: rcparent@fiu.edu

Research Summary: With respect to entry mode deci-

sions, psychic distance may play two contradictory roles.

On one hand, the transaction cost perspective is con-

cerned with opportunism. Psychic distance magnifies the

threat of opportunism, which encourages higher levels of

control by foreign firms. Conversely, the new internaliza-

tion perspective emphasizes the role of complementary

assets controlled by local entities. Distance increases the

need to access local knowledge, which encourages firms

to seek joint ventures. By adopting an experimental

approach and measuring managers' a priori perceptions

of distance, this article contributes to the literature by pro-

viding a more sophisticated approach for discriminating

between these effects. The results indicate that distance

magnifies the need for firms to access complementary

assets; however, distance does not appear to magnify the

threat of opportunism.

Managerial Summary: This article explores the role that

psychic distance (i.e., differences across countries in cul-

ture, language, religion, etc.) plays in how firms enter for-

eign markets. Specifically, do they prefer wholly owned

subsidiaries (WOS) or do they prefer to form joint ven-

tures (JV) with local players? One perspective argues that

firms are concerned about potential partners in a foreign

market taking advantage of them; thus, they will prefer

the greater control a WOS offers. Conversely, firms may

simply recognize that these differences put them at a dis-

advantage and prefer a JV as a way to gain local knowl-

edge. Our experiments indicate that the latter explanation

dominates. When entering very different countries, man-

agers seem to prefer JVs in order to access key local

knowledge.

Received: 28 March 2017 Revised: 8 February 2018 Accepted: 10 February 2018

DOI: 10.1002/gsj.1309

Copyright © 2018 Strategic Management Society

Global Strategy Journal. 2020;10:309–334. wileyonlinelibrary.com/journal/gsj 309

KEYWORDS

entry mode, experiment, new internalization theory,

psychic distance, transaction cost theory

1|INTRODUCTION

The choice of foreign operation modes is a complex issue. Not only is there a broad range of possible

alternatives (e.g., exporting, licensing, non-equity alliances, wholly owned subsidiaries, joint ven-

tures, greenfield investments and acquisitions), but firms often use multiple modes at any given time,

and these modes typically evolve over time (Benito, Petersen, & Welch, 2009). Whenever a firm

makes such choices, the process may typically involve a substantial capital investment, will certainly

necessitate a great deal of senior management time and effort, and will be relatively hard to reverse.

As a result, such decisions have attracted a substantial amount of investigation in the international

business (IB) literature.

This article focuses on a particular aspect of one such decision: how various forms of cross-

national differences or distances

1

influence entry mode choices—that is, the choice of whether a for-

eign subsidiary should be a wholly owned subsidiary (WOS) or an equity joint venture (EJV) with a

local partner. This specific issue is arguably one of the most heavily investigated aspects of foreign

operation modes (Shaver, 2013). Indeed, there are at least four published meta-analyses on the issue

(Magnusson, Baack, Zdravkovic, Staub, & Amine, 2008; Morschett, Schramm-Klein, & Swoboda,

2010; Tihanyi, Griffith, & Russell, 2005; Zhao, Luo, & Suh, 2004); yet, the empirical results con-

cerning the distance-entry mode relationship are, at best, equivocal and inconsistent. The four afore-

mentioned meta-analyses have analyzed 36, 72, 38, and 55 independent samples, respectively, and

found at most “only a small main effect”(Magnusson et al., 2008, p. 527).

We argue that these equivocal results may be due to a combination of theoretical and methodo-

logical issues. At the theoretical level, one difficulty is that large distances between markets may play

two counter-opposing roles in an entry mode decision (Brouthers & Brouthers, 2001; Slangen & van

Tulder, 2009). What we will refer to as the classic transaction cost perspective argues that multina-

tional enterprises (MNE) will tend to enter distant markets via WOS. This perspective builds directly

on Williamson's (1975) transaction cost economics (TCE) thesis and was first applied to the interna-

tional entry mode decision by Anderson and Gatignon (1986). It predicts that the ambiguity and com-

munication difficulties brought about by large distances between markets combine with high asset

specificity and information asymmetry,

2

making it difficult for parent firms to monitor and control

local partners; thus, exposing them to opportunistic behavior (e.g., Zhao et al., 2004). Anderson and

Gatignon (1986) refer to this as internal uncertainty. In response to this form of uncertainty, it is

1

For the purposes of this paper, the term distance does not refer to geographic distance (i.e., miles or kilometers), but to a broad set of

differences between countries that are variously referred to as cultural distance, psychic distance, sociocultural distance, or institutional

distance.

2

A great deal of the transaction cost literature (e.g., Zhao et al., 2004) uses the term asset specificity in such instances; however,

Brouthers and Hennart (2007) note that the concept of information asymmetry provides a more convincing argument. For brevity, we

shall use the term asset specificity but acknowledge the ongoing debate on this issue.

310 DOW ET AL.