Institutional Distance and the Multinational Enterprise
Author(s): Dean Xu and Oded Shenkar
Source: The Academy of Management Review, Vol. 27, No. 4 (Oct., 2002), pp. 608-618
Published by: Academy of Management
Stable URL: http://www.jstor.org/stable/4134406
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&Academy of Management Review
2002,Vol. 27, No. 4, 608-618.
NOTE
DISTANCEAND THE
INSTITUTIONAL
ENTERPRISE
MULTINATIONAL
DEANXU
Peking University
ODED SHENKAR
The Ohio State University
We draw from the recently developed construct of institutional distance to propose a
framework that explains foreign direct investment by the multinational enterprise. We
decompose the institutional distance between the host and home countries into
distances on the regulative, normative, and cognitive dimensions of institutions, and
match these with firm-level attributes to produce propositions regarding host country
selection and foreign market entry strategies.
In this note we focus on a newly developed
measure of cross-country differences-institutional distance (Kostova, 1999;Kostova & Zaheer,
1999)-to explain multinational enterprise (MNE)
behavior. Institutional distance is the extent of
similarity or dissimilarity between the regulatory, cognitive, and normative institutions of two
countries (Kostova, 1996).It is derived from institutional theory-a nonefficiency perspective in
which institutional environment is seen as the
key determinant of firm structure and behavior
(DiMaggio & Powell, 1983, 1991;Scott, 1995).We
focus on the MNEbecause of the key role it plays
in the global economy (e.g., over one-third of
international trade consists of transfer among
MNE units) and because of its interface with
multiple institutional environments. The MNE
literature has shown "a growing appreciation of
the importance of the institutional context and
of the patterns in the way MNEs respond to that
context" (Westney, 1993:60).
This appreciation of institutions was preceded by a dominance of economic theories attributing competitiveness to variables ranging
from industry structure (Porter, 1990)to location-
We thank Christine Oliver for helpful comments on earlier versions of this paper, as well as the editor and three
anonymous reviewers for constructive suggestions. Thanks
also go to group participants of the 2000AMRTheory Development Workshop: Tatiana Kostova, Mark Sharfman, and
Davina Vora.
608
specific advantages (Buckley & Casson, 1986;
Dunning, 1980;Hennart, 1982;Hill & Kim, 1988).In
a departure from economic explanations, Kogut
(1991) credited competitiveness to national differences in organizing principles and societal
institutions. This coincides with the internationalization process model, in which internationalization is viewed as a series of incremental adjustments to changes in the firm and its
environment. The main variable in this model,
"psychic distance," is "the sum of factors preventing the flow of information from and to the
market" (Johanson & Vahlne, 1977: 24)-for example, differences in language, education, business practices, culture, and development.
Using Hofstede's (1980) classification of culture, Kogut and Singh (1988)formed a "cultural
distance" index that has become the proxy of
choice for national differences (Barkema, Bell, &
Pennings, 1996; Brouthers & Brouthers, 2001;
Hennart & Larimo, 1998;Li, Lam, & Qian, 2001).
This index, however, does not capture the complexity of cross-country differences; in particular, it neglects the critical role of societal institutions in articulating, disseminating, and
arbitrating cultural and social cues. Applied to
the realm of foreign direct investment (FDI), it
fails to yield consistent empirical evidence
(Shenkar, 2001).
Institutional distance provides an alternative
explanation for MNE behavior. The construct
has been linked so far to two aspects of MNE
2002
Xu and Shenkar
operations: (1) the establishment of legitimacy
in the host country (Kostova & Zaheer, 1999)and
(2) the transfer of strategic orientations and organizational practices from the parent firm to
the foreign subsidiary (Kostova, 1999). In this
paper we extend the treatment of institutional
distance to the realm of MNEstrategy, focusing
on two critical steps in the FDI process: (1) host
country selection and (2) foreign entry strategy.
These aspects are key ingredients in the FDI
decision since they pertain to location and internalization choices (Buckley & Casson, 1976,
1998)and directly impact the external and internal legitimacy of the MNE.
We first decompose the institutional distance
construct into three component parts and match
each with a set of firm-level attributes to explain
MNE country choice strategy. We then discuss
the effect of each part on entry and ownership
mode in the host country.
THEORY:A BRIEFREVIEW
INSTITUTIONAL
Contemporary institutional theory (Scott, 1995)
indicates that, in order to survive, organizations
must conform to the rules and belief systems
prevailing in the environment (DiMaggio &Powell, 1983;Meyer & Rowan, 1977),because institutional isomorphism, both structural and procedural, will earn the organization legitimacy
(Dacin, 1997; Deephouse, 1996; Suchman, 1995).
The theory has been supported in unitary, domestic environments and with organizations
such as public schools (Rowan, 1982) and day
care centers (Baum & Oliver, 1992). It has received less support in complex environments
with multiple institutional demands (Meyer,
Scott, & Strang, 1987)and where strategic choice
is vital (Oliver, 1991).
Three streams of research in institutional theory have established the basis for theory development in the realm of MNEstrategy. The first is
the emerging focus on the interjection of institutional forces and strategic responses. This
stream reflects a realization that an organization can only gain legitimacy from some source(s), based on its adopted practices (D'Aunno,
Sutton, & Price, 1991), and that its discretion in
responding to institutional forces is influenced
by such contextual variables as uncertainty
(Goodrick & Salancik, 1996). This approach fits
well with the MNE's environment of high uncertainty and multiple demands. Response to insti-
609
tutional and competitive forces in this stream
balances strategic similarity and differentiation
(Deephouse, 1999).It is best represented by Oliver's (1991) model of strategic responses to institutional forces, and has been applied to issues ranging from work-family (Goodstein, 1994;
Ingram & Simons, 1995)to MNE strategies (Tsai
& Child, 1997).
The second stream is research on industry
creation and on firms facing a new institutional
environment-conditions that are akin to those
of an expanding MNE. Aldrich and Fiol (1994)
examined strategies that founders can pursue in
seeking sociopolitical legitimacy and reshaping
institutional environments. Haveman (1993)
tested the hypothesis that organizations will follow similar and successful counterparts into
new markets. In an earlier study Singh, Tucker,
and House (1986)found that the lack of institutional support experienced by young organizations was found to be an important reason for
the "liability of newness"-a metaphor later extended in the MNEliterature to include the "liability of foreignness" (Zaheer, 1995).
If we view the MNEas a network of subsidiaries situated in different environments, the third
relevant research stream is that involving interorganizational relationships. Most institutional
theory studies have been conducted at the industry (Baum & Oliver, 1992;Holm, 1995),line of
business (Tsai & Child, 1997), and profession/
task (Gupta, Dirsmith, & Fogarty, 1994) levels.
However, in one line of research, scholars have
conducted their studies at the interorganizational (Galaskiewicz & Wasserman, 1989; Oliver,
1988),state, or national (e.g., Dacin, 1997;Rowan,
1982) levels of analysis. Their work recognizes
that a firm may be situated in multiple institutional fields (Hoffman, 1999) and operate under
multiple institutional pressures (D'Aunnoet al.,
1991;Oliver, 1991).Some of these pressures are
local in origin; others are national (Rosenzweig
& Singh, 1991; Thomas & Meyer, 1984; Zucker,
1987), leading to "collective action" (Meyer &
Rowan, 1977: 360) typical of all organizations in
a nation. This is critical to the applicability of
institutional theory to the MNE, which operates
in multiple institutional environments and under diverse institutional pressures (e.g., that of
the host and that of the home countries). In turn,
it implies that institutional theory may explain
one of the fundamental issues for the MNE: the
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Academy of Management Review
dual pressures for global integration and local
orientation (Westney, 1993).
In recent years institutional theory has been
shown to have the potential to make a significant and direct contribution to research on
MNEs. Rosenzweig and Singh (1991) proposed
that the relative influence of home and host
country institutional environments was dependent on a set of contextual, strategic, and structural variables. Some of their propositions were
tested in subsequent studies on MNE human
resource management (Rosenzweig & Nohria,
1994), organizational practices of international
trading rooms (Zaheer, 1995), and MNE entry
mode choice (Davis, Desai, & Francis, 2000).
DISTANCEAND THEMNE
INSTITUTIONAL
Based on Scott (1995),Kostova (1996)developed
a new construct-institutional distance-referring to the extent of dissimilarity between host
and home institutions. Kostova and Zaheer
(1999)then proposed that the larger the institutional distance, the more difficult it is for the
MNEto establish legitimacy in the host country
and to transfer strategic routines to foreign subsidiaries (Kostova, 1999).In other words, a large
institutional distance triggers the conflicting demands for external legitimacy (or local responsiveness) in the host country and internal consistency (or global integration) within the MNE
system. Balancing these conflicting demands
has been a key challenge for the MNE(Bartlett &
Ghoshal, 1989; Fayerweather, 1969; Prahalad,
1975;Westney, 1993).
While Kostova and Zaheer stopped short of developing the strategic implications of institutional
distance, their approach has a direct bearing on it.
If institutional distance affects MNElegitimacy in
the host country and the transfer of routines to the
subunit, then it should be a key determinant of FDI
decisions. To develop this angle, we first decompose institutional distance into its three component parts-regulative, normative, and cognitive
distances-and
then discuss the implications of
the three for two strategic decisions: country
choice and entry strategies. Country choice in
terms of institutional distance has direct implications for local legitimacy of the MNE. Entry strategy indicates the extent to which the MNE internalizes its foreign subsidiary (Buckley & Casson,
1976, 1998); it pertains to the level of legitimacy
resulting from being internally consistent within
October
the MNE system. Thus, country choice and entry
strategy channel the external and internal isomorphic pressures exerted on the MNEfor conformity
and legitimacy.
According to Scott (1995), the three pillars of
institutions are distinct-a division that has
been validated empirically (Busenitz, Gomez, &
Spencer, 2000).The regulative pillar rests on the
setting, monitoring, and enforcement of rules. It
is based on instrumental logic and uses legal
sanctioning as the basis of legitimacy. The normative pillar prescribes desirable goals and the
appropriate means of attaining them; legitimacy is rooted in societal beliefs and norms.
The cognitive pillar highlights internal representation of the environment by actors; legitimacy is anchored in cultural orthodoxy. We suggest that each of the three pillars produces its
own measure of institutional distance and that
these measures vary in terms of their implications for MNE behavior. For example, property
rights are more sensitive to regulative distance
because they are anchored in legal provisions,
whereas differentiation strategies are more susceptible to cognitive distance because they
might violate national symbols. Finally, normative distance may undermine import of MNEpractices that deviate from societal expectations.
Institutional Distance and Country
Choice Strategies
The MNE literature proposes that FDI strategies are shaped by the resource advantage,
strategy, and structure of the parent firm (Collis,
1991; Dunning, 1980; Ghoshal & Nohria, 1989;
Hill, Hwang, & Kim, 1990;Rosenzweig & Singh,
1991; Tallman, 1991). These parent firm attributes provide a basis for strategic decisions
with respect to a foreign market. We argue that
the choice of host country, in terms of institutional distance, must be matched to firm-level
attributes such that the legitimacy of the foreign
subsidiary in the host country is established
and the transfer and sustainability of competitive advantage are ensured. Once a host country
has been targeted, entry strategies must be
matched with institutional
distance to that
country in order to enhance competitive advantages resulting either from a small institutional
distance or from the ability to mitigate the negative impact of a large distance.
2002
Xu and Shenkar
The firm-level variables discussed
below,
while not an exhaustive list, are representative
of those resource, strategic, and structural attributes. The source of competitive advantage is
possibly the most important strategic determinant for firms in a competitive market place.
Global strategy is the guiding principle for
and often distinMNEs' global operations
guishes firms with similar competitive advantages. Organizational diversity identifies differences across the firm's constituencies, capturing
the firm's interface with the environment (input
and output) and in its internal operations.
Source of competitive advantage. Scholars
have long argued that the MNE operating overseas incurs special costs (Hymer, 1976; Kindleberger, 1969). It must overcome the "liability of
foreignness" (Zaheer, 1995), either by transferring firm-specific competitive advantages to a
foreign subsidiary (Dunning, 1981, 1988) or by
utilizing the host country-specific advantages of
the subsidiary (Kogut, 1991; Porter, 1990). Firmspecific competitive advantages have been preroutines
sumed embedded in organizational
(Barney, 1991; Reed & DeFillippi, 1990) or strategic practices (Kostova, 1999). Correspondingly,
researchers have discussed host country-based
competitive advantage in terms of local practices in human resources management and control, among others (Rosenzweig & Nohria, 1994;
Zaheer, 1995). An MNE may gain competitive advantage over local firms via its routines or over
other MNEs by conforming to local practices.
Kostova (1999) argues that since organizational practices are shaped by the institutional environment, successful transfer of these practices
from the parent firm to the foreign subsidiary
depends on the distance between the host and
home environments: the larger the distance, the
more difficult the transfer. Among the three pillars of institutions, the normative component,
which defines organizational goals and objectives as well as the appropriate ways to pursue
them, has direct bearing on organizational practices. To the extent that MNEs' routines are not in
violation of host country laws and regulations,
regulative distance will not have much impact
on the MNE whose competitive advantage lies
in those routines. While a government may outlaw a certain routine to keep an MNE out (e.g.,
the attempt to prohibit Avon's direct selling in
China), this is not a common occurrence. Similarly, cognitive distance will have little impact
611
on investment by the routine-driven MNE,except
where the routines constitute a symbol challenging host country identities. The transfer of
MNE routines, therefore, is mainly constrained
by the normative distance between the host and
home countries.
If a large normative distance makes the transfer of organizational routines difficult, the MNE
with strong, firm-specific, routine-based competitive advantages will invest in host countries
with a normative institutional environment similar to its own. MNEs that invest in normatively
distant markets are more likely to lack strong,
routine-based competitive advantages but intend for their subunits to imitate local practices
(Rosenzweig & Nohria, 1994;Zaheer, 1995). The
latter firms are less constrained by normative
distance when making FDI but may purposefully choose to enter normatively distant markets where their freedom to adapt will confer a
competitive advantage over MNEs from the
same home country that will not adapt.
Proposition 1: Other things being
equal, the MNE with routine-based
competitive advantages is more likely
to enter markets that are normatively
adjacent, whereas the MNE with host
country-based competitive advantages is more likely to enter markets at
a greater normative distance.
Global strategy. MNE strategies have often
been encapsulated as ranging from "global" to
"multidomestic" (Ghoshal & Westney, 1993;Porter, 1986),or from high to low integration. Global
strategy (or high integration) implies that the
MNEconcentrates production and management
in one location to reap scale economies and
exercise control. Multidomestic strategy (or low
integration) implies that foreign subsidiaries focus on local markets, carry out production and
marketing locally, and exercise significant autonomy (Ghoshal & Westney, 1993).Rosenzweig
and Singh (1991)argue that foreign subsidiaries
in multidomestic industries are more dependent
on local resources and, hence, have a greater
need to gain legitimacy locally. In contrast, MNE
affiliates in global industries are more dependent upon other MNE units for know-how, technology, capital, and personnel and, hence, are
more subject to institutional pressures from the
parent firm.
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An important theme in the strategy literature
is that firms will seek out market niches that
match their strategic thrust (Miller, 1988;Porter,
1980).In the case of the MNE,the level of global
integration is determined by the structural characteristics of its industry (Kobrin, 1991; Porter,
1986), as well as home country characteristics
(Duysters & Hagedoorn, 2001);the adopted strategy, in turn, will influence the choice of host
market (Ohmae, 1985).A logical extension of the
above arguments is that MNEs with a global
strategy will invest in host countries where institutional distance is small; otherwise, they
will encounter difficulties in parent-subsidiary
cooperation. In contrast, MNEs with a multidomestic strategy have the latitude of investing in
institutionally distant markets, since they do not
rely as heavily on parent-subsidiary coordination and are less concerned with institutional
conflict within the MNE. They may, however,
enjoy a competitive advantage over their competitors, who cannot make similar adjustments,
in countries where institutional distance is
large.
The key distance between institutional environments here is that pertaining to prescribed
normative. Cognitive disbehavior-namely,
tance will also have some impact where global
strategy is perceived to be a symbolic challenge
to local orthodoxy (e.g., cultural industries in
France). Differences in the regulative environment, in contrast, will not have much impact on
market choice, because such differences are
codified and built into the MNE's routines. The
one exception may be where regulative requirements are perceived to undermine core strategy-for example, where the host country rules
require mandatory technology transfer that conflicts with the MNE'sproprietary strategy.
Proposition 2: Other things being
equal, the MNEwith a global strategy
is more likely to enter markets that are
adjacent normatively and cognitively,
whereas the MNEwith a multidomestic strategy is more likely to enter markets that are institutionally distant on
the same dimensions.
Organizational diversity. Organizational diversity may be defined as the degree of difference across key organizational
inputs (e.g.,
and employees),
shareholders
outputs (e.g.,
product lines), and internal operations (e.g., cor-
October
porate culture and decision making). Diversity
means an organization is not dependent on a
single resource source (Pfeffer & Salancik, 1978)
and is open to influences by multiple stakeholders (Evan &Freeman, 1988)and institutional constituents (Oliver, 1991). It also implies that the
organization is open to diverse operational
modes. Kondra and Hinings (1998) suggest that
organizations within an institutional field are
likely to apply institutional pressure on deviants. We propose that diversity in the institutional field will reduce isomorphic pressure on
deviant members. Thus, Miller and Chen (1995)
found that the diversity of a firm's social context
(such as its product market) leads to nonconformity to norms. Similarly, DiMaggio and Powell
(1983)argued that the extent to which an organizational field is dependent on a single source of
resources influences the level of isomorphism in
the field.
The MNE system has been regarded as an
institutional field that exerts institutional pressures on its subunits (Kostova & Zaheer, 1999;
Rosenzweig & Singh, 1991;Westney, 1993).One
can argue that high diversity across the MNE
system reduces the level of institutional pressure that the MNE,as an institutional field, can
impose on a foreign subsidiary. In other words,
high diversity raises the MNE'stolerance toward
different institutional rules and norms exhibited
in the foreign subsidiary. The subsidiaries of a
less diversified MNE, in contrast, will show
strong conformist tendencies. To avoid institutional conflict between local norms and its own,
therefore, the firm with lower diversity will tend
to invest where the institutional rules and norms
are similar to those of the home country-that is,
where institutional distance is small. Evidence
shows that cross-national expansion is negatively related to performance in nondiversified
firms (but positively related in highly diversified
firms), because, among other factors, such firms
lack an organizational structure appropriate for
the information-processing demands of very different environments (Hitt, Hoskisson, & Kim,
1997).
Kondra and Hinings (1998) note that within an
institutional field, response to deviations of
other organizations takes a coercive or a mimetic form, which is associated with the regulative or cognitive pillar, respectively. We suggest, however, that the two become relevant at
different phases. Regulative distance is the
Xu and Shenkar
2002
most relevant in the input phase, because it
determines the "rules of the game," which, once
established, constrain the resources that can be
deployed in the subsidiary (e.g., limits on expatriates). In the output phase, cognitive distance
is the most applicable, since it is associated
with symbols that are most likely linked to the
identity of a finished product. Further, in the
transformational phase, the normative pillar becomes relevant, because social norms influence
the legitimacy of the organizational practices
employed.
Proposition 3: Other things being
equal, the MNE with low diversity is
more likely to enter institutionally adjacent markets than the MNE with
high diversity.
Institutional Distance and Foreign
Entry Strategies
Entry mode: acquisition versus greenfield investment. Most studies on foreign entry strategy
have followed a transaction cost approach (Hennart & Park, 1993; Hennart & Reddy, 1997) or
learning approach (Barkema et al., 1996;
Barkema & Vermeulen, 1998). Typically, entry
strategy is related to the extent to which the
MNEinternalizes its overseas operations (Buckley & Casson, 1976)and, hence, the level of internal control and consistency (Gatignon &
Anderson, 1988; Hill et al., 1990). Meanwhile,
country differences are viewed as a barrier to
obtaining local knowledge, making it difficult
for the MNE to manage its foreign subsidiaries
on its own or to enlist the help of a local partner
efficiently (Hennart&Larimo, 1998).With respect
to the choice between acquisition and greenfield investment, empirical evidence indicates
that MNEs tend to set up new ventures rather
than acquire existing firms when country differences are substantial (Cho & Padmanabhan,
1995; Kogut & Singh, 1988), since these differences magnify implementation problems in acquisitions (Barkema & Vermeulen, 1998).
Kostova (1999) suggests that large institutional distances constitute a barrier to transferring organizational practices from the parent
firm to the foreign subsidiary. Implicitly, such
transfer, as well as the resulting internal consistency, will be more difficult to achieve if the
subsidiary is a locally acquired firm. Local firms
613
that have been institutionalized in the host
country environment will have difficulty obtaining legitimacy within the MNE when the two
institutional environments are materially different. In contrast, a newly established subsidiary
may be viewed as the MNE'sdescendant. Compared to locally acquired subsidiaries, start-up
ventures may also be more receptive to the parent's routines. The MNE, therefore, will tend to
enter institutionally distant markets via greenfield investment in order to avoid intraorganizational conflict and difficulty in integrating the
foreign subsidiary.
The choice between acquisition and greenfield investment is seldom influenced by legal
issues; laws and regulations rarely distinguish
between these two types of investment. The external legitimacy problem arises, however, at
the normative level, where an acquisition involves a change from current practices that creates a conflict with host institutions. An acquisition is especially acute at the cognitive level,
because a takeover of existing operations is often viewed as a blow to national sovereignty
and is a painful reminder of the loss of competitiveness. Acquisitions are often questioned in
terms of their contribution to the national wellbeing, given the sometimes lack of new capital
injection and downsizing of ongoing operations
with adverse consequences on employment (see
GM's takeover of Daewoo, for instance).
Proposition 4: Other things being
equal, an MNEis more likely to enter a
foreign market via acquisition where
normative and cognitive distances are
small and via greenfield investment
where normative and cognitive distances are large.
Ownership strategies. In the literature scholars have extensively discussed ownership mode
(joint venture versus wholly owned subsidiary)
and equity share in a joint venture as control
mechanisms
& Anderson,
1988;
(Gatignon
Makino & Beamish, 1998). Greater control is associated with enhanced resource commitment
and higher risk (Delios & Beamish, 1999). Higher
levels of intercountry differences, such as a
large cultural distance, require higher levels of
cooperation in the form of equity involvement by
local partners (Contractor & Kundu, 1998; Kim &
Hwang, 1992; Kogut & Singh, 1988).
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Academy of Management Review
From an institutional perspective, firms will
refrain from investing in markets that are institutionally distant, because business activities in
those markets require conformity to institutional
rules and norms that conflict with those of the
home country. When they do enter distant markets, firms will choose the lower levels of control
and resource commitment commonly associated
with a joint venture (Agarwal & Ramaswami,
1992;Anderson & Gatignon, 1986;Hill et al., 1990)
so as to lower the risk of institutional conflicts.
Given a large institutional distance, the MNE
will encounter difficulties in obtaining legitimacy in the host country (Kostova & Zaheer,
1999)and in transferring routine-based competitive advantages (Kostova, 1999).Equity involvement by local partners may partially compensate for those difficulties by mobilizing local
legitimacy and by enabling the MNE to rely
more on host country-based competitive advantages as a substitute for transferring MNEpractices internally (Makino & Delios, 1996;Shan &
Hamilton, 1991).Research suggests that external
legitimacy is more important to the MNE than
internal consistency in countries with very different institutional environments (Rosenzweig &
Nohria, 1994;Zaheer, 1995).
The most regulated aspect of FDI is that of
whole or majority versus minority control. Even
in today's liberalized investment environment,
many nations block whole or majority foreign
ownership in "strategic" industries. Normative
and cognitive elements also impact the legitimacy of equity arrangements. For instance, joint
control may be considered less of a "sell-off"
and brings in a local mediator of foreign institutional pressures. However, such institutional
concerns tend to be already embedded within
the regulative sphere or may indicate risk to the
MNE in terms of future legal and regulative
changes.
Proposition 5a: Other things being
equal, an MNEis more likely to enter a
foreign market via a wholly owned
subsidiary or majority joint venture
where regulative distance is small
and via a minority joint venture where
regulative distance is large.
When it comes to level of control within the
same ownership category (majority or minority),
regulative distance becomes less important. Legal and regulatory systems are more likely to
October
limit foreign majority ownership than to distinguish, say, between a 51 percent and 90 percent
stake. Nor is it likely that the two levels of investment will be perceived differently at a cognitive, symbolic level. The higher level of control
will probably be translated, however, into further imposition of MNEroutines and practices in
a tacit fashion, as the bargaining power of the
local partner declines (Yan & Gray, 1994).
Proposition 5b: Other things being
equal, and within the same ownership
category, an MNE is more likely to
pursue high equity control over a joint
venture where normative distance is
small and low equity control where
normative distance is large.
DISCUSSIONAND CONCLUSIONS
In line with recent attempts to develop institutional theory in the international arena
(Brouthers & Brouthers, 2000; Davis et al., 2000;
Hoskisson, Eden, Lau, & Wright, 2000; Lu, 2002),
we extend, in this note, the "strategic responses"
perspective of the theory (Oliver, 1991) to the
MNE.In international business research, institutions have been regarded as part of the countrylevel environment. Scholars have emphasized
the effects of local isomorphism (Rosenzweig &
Nohria, 1994),foreignness (Zaheer, 1995),and institutional distance (Kostova, 1996)on firm survival and success. However, firms' responses to
different institutional pressures have not been
studied systematically-a gap we seek to fill
here. Further, the decomposition of institutional
distance into component parts serves other institutional theory applications-for
example,
the legitimacy of new firms and organizational
forms (Singh et al., 1986)that encounter different
challenges at the regulative, normative, and
cognitive levels.
The framework endorsed in this paper is
clearly distinct from current theoretical streams
outside institutional theory and can be helpful
in complementing
these approaches. For instance, Gatignon and Anderson (1988) acknowledge that transaction cost theory accommodates
contrasting predictions regarding the impact of
high cultural distance on entry mode: the firm
will relinquish control in the face of low knowledge and high uncertainty, or it will internalize
in the face of agents whose intentions and ac-
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Xu and Shenkar
tions are poorly understood. By introducing the
concept of regulative distance, the approach we
propose here predicts when each of these
choices will occur. The MNE will choose low
control when the host environment presents a
regulative system very different from the one in
its home environment, but it will opt for full
ownership when the host system is more similar. This explains, for instance, the gradual shift
in U.S. investments in China from cooperative
ventures to wholly owned subsidiaries, as China's legal system incrementally adds U.S.-like
provisions.
Further development of our framework, therefore, can make theoretical contributions by calling attention to the dynamic nature of firms
(Penrose, 1959; Schumpeter, 1950) and institutions (North, 1990; Oliver, 1992). This approach
fits well with recent work on MNE subsidiary
evolution (Birkinshaw & Hood, 1998),but it goes
beyond in recognizing the duality of changes of
both firms and institutional environments. Indeed, because cultural distance has been taken
to be a static measure (Shenkar, 2001), institutional distance can help us better understand
changing national differences and the role of
dynamic firm capabilities in dealing with those
changes.
As hinted above, however, we propose that
institutional distance complements, rather than
replaces, the cultural distance construct. Neither
construct captures the full spectrum of national
differences with relevance to MNE foreign investment behavior. The inconsistent results reported for cultural distance's impact on foreign
investment launch, entry mode, and performance show that it may be too narrow a construct to capture the decisions of firm-level actors, but they do not compromise its underlying
role in those decisions (Shenkar, 2001).National
institutions add to the context that shapes "national character" and influences investment decisions (Hennart & Larimo, 1998).It is, hence, the
combination of both cultural and institutional
distance that offers the best hope for a comprehensive assessment of the tacit portion of the
environment.
Future research based on the present framework can be extended to other international
business areas-for
example, sequence and
of
entry, expatriate adjustforeign
performance
ment and performance, and receptivity toward
foreign brands. Regardless of application, mea-
615
surement challenges must be met. Institutional
distance has only recently been operationalized
(Busenitz et al., 2000; Kostova, 1996). Kostova
(1997)argues that a country institutional profile
is issue and country specific, which discounts
the necessity for eventual comparison. Here we
suggest learning from the "early mover"-the
cultural distance literature-which has grappled with those issues for over a decade. This
literature shows, for instance, that cultural distance may be asymmetric (Shenkar, 2001),which
suggests the need to distinguish between home
and host country specifics across institutional
environments as well.
Finally, while institutional distance constitutes one more challenge in obtaining legitimacy and transferring strategic practices, it also
introduces a new dimension on which the MNE
competes globally. From this perspective, the
MNE's advantage is rooted in its ability to link
institutional distance to its resources, strategy,
and structure, as well as to its FDIdecisions and
processes. Because these links are firm specific,
they constitute a competitive advantage that is
difficult to imitate. This is in line with Oliver's
(1996, 1997)argument that the institutional context and process of resource selection influence
the firm's heterogeneity, with competitive advantage derived from the ability to exploit the
uneven distribution of resources and institutional capital. For the MNE,asymmetrically embedded in its host and home environments, developing the capabilities to bridge institutional
distances is key to obtaining sustainable competitive advantage.
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Dean Xu is an assistant professor of strategic and international management at
Guanghua School of Management, Peking University, China. He received his Ph.D. in
strategy from Schulich School of Business, York University, Canada. His current
research interests include entry mode, diversification, and growth strategy in transition economies.
Oded Shenkar is the Ford MotorCompany Chair in Global Business Management and
professor of management and human resources at the Fisher College of Business, The
Ohio State University. He received his Ph.D. from Columbia University. His research
interests cover comparative and international management, including methodological issues and the management of international alliances.