Research Highlights
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State Ownership Effect on Firms’ FDI
Ownership Decisions under Institutional
Pressure: A Study of Chinese Outward
Investing Firms
Lin Cui, The Australian National University
Fuming Jiang, Curtin University
This study investigates the effect of Chinese state ownership on foreign direct
investment (FDI) ownership. We argue that state owned-firms are more politically
affiliated with the home-country government and more dependent on homecountry institutions for resources. Constituents in the host-country perceive that
those dynamics limit the effectiveness of Chinese SOEs. We also argue that firms
operating under such resource-dependence and political perceptions tend to
conform to rather than resist home- and host-country pressures. We tested our
hypotheses using primary data on 132 FDIs made by Chinese firms from 2000 to
2006, and found that when the state entities held higher equity shares in the firm,
home regulatory, host regulatory, and host normative pressures exerted stronger
pressure on firms to choose joint-ownership structures.
External Institutional Pressures
Three major external institutional pressures affect FDI decisions. First, within
the home-country, firms are subject to the home government’s regulatory restrictions
on outward FDI. In emerging economies such as China’s, home-country capital
control of outward FDI is prevalent. Similar regulatory restriction may also re-emerge
in advanced economies, as governments attempt to impose exit barriers in certain
domestic industries. Second, when firms undertake FDI, they are subject to host-country
regulatory restrictions on inward FDI. Governments worldwide impose different degrees
of restrictions on inward FDI to protect their domestic industries and national interests.
While direct bans on inward FDI are increasingly rare, restrictions still discriminate
against FDI firms. Third, FDI operations expose firms to pressures from host-country
industries and stakeholders. Such pressures depend on how willingness of local players
to tolerate different norms exercised by FDI firms.
The Effects of State Ownership
State ownership increases a firm’s resource-dependence on its home institutions
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and negatively affects its image in the host’s
institutional environments. Therefore state ownership
moderates the effects of external institutional
pressures on FDI ownership decisions. In this study
we examine whether state ownership strengthens
or weakens the effects of the three types of external
institutional pressures determining whether Chinese
firms choose joint- or sole-ownership structures
in their FDIs. The state ownership effect is so
multifaceted that we first discuss its potential effect
on FDI ownership decisions. We then examine
state ownership for its moderating effect on FDI
ownership decisions under external institutional
pressures.
State ownership direct effects on FDI
Government support can grant firms resource
advantages in their overseas investments. Apart
from received government supports, perceived
government backing also differentiates SOEs from
other firms in terms of FDI strategic choices. When
making strategic decisions, SOEs managers may
factor in the possibility that further support will be
available in unexpected adverse circumstances. As a
result, a higher level of state ownership can increase
the likelihood of sole-ownership FDI.
An opposite direct effect of state ownership
emerges from the political perspective. Being a part
of the home-country institutions, SOEs may have
noncommercial objectives driven by the state’s
political interests and influencing FDI ownership
decisions. The Chinese government encourages firms
to engage in collaborative FDI to channel foreign
countries’ natural, financial, and technological
resources back to the domestic economy. A jointownership structure is considered an efficient way to
achieve such objectives. The host-country, however,
often perceives the state-driven objectives as nonbeneficial, or even harmful. Consequently the hostcountry will impose higher institutional barriers that
pressure Chinese SOEs to assume ownership and
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control in their investment, which also increases
the likelihood of joint-ownership FDI. Given those
opposing effects, we control for the direct effect of
state ownership in our analyses.
State Ownership and Home
Regulatory Institutions
Like many other emerging-economy
governments, the Chinese government exerts
regulatory restrictions on outward FDI to safeguard
state assets, to prevent capital flight, and to align
direct outward FDI with national interests. Such
regulatory restrictions are implemented through
an administrative system in which the Ministry of
Commerce is authorized as the primary government
organization responsible for approving and
administering outward FDIs. Its main purposes are to
exercise capital control on outward FDI and to direct
outward FDI activities to adhere to the government’s
international investment strategies. For example,
the government attempts to direct outward FDI to
acquire foreign technology and natural resources.
It also imposes restrictions on the use of foreign
exchange to prevent potential problems related to
capital flight.
Individual firms are likely to encounter
varying levels of home regulatory restriction, as
the administrative system is evolving constantly
across industries to keep pace with China’s rapid
development of outward FDI and changes in
industrial policy. Home regulatory restriction has
a two-fold impact on FDI ownership decisions.
First, it pressures firms to follow the practices that
have been historically approved by the government.
Specifically, during the 1990s when Chinese outward
FDI started emerging significantly, the administrative
approval process generally required firms to adopt
the joint-venture mode. Second, while all outward
FDI projects are subject to government approval,
projects that involve substantial Chinese capital
contribution create greater concerns about capital
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flight and foreign exchange demands, and therefore
are subject to more strenuous screening processes.
Accordingly, Chinese firms find it relatively easier to
obtain government approval if the proposed outward
FDI is co-funded, ideally with Chinese equity, than
if it is fully funded by the Chinese investing firm.
Those Chinese home-government pressures
affect SOEs. Chinese firms with high levels of
state ownership depend heavily on the home
country government for critical resources and
police support. These firms, especially large SOEs,
rely on their relational ties with the government
to obtain monopolistic advantages in the home
market, and to receive preferential supports when
they internationalize. Therefore, state ownership
moderates the effect of home-country regulatory
restrictions on outward FDI on a firm’s FDI
ownership decision, in that the greater the stateentity equity share , the more likely perceived homecountry regulatory restrictions on outward FDI
will persuade the firm to choose a joint-ownership
structure.
State Ownership and Host
Regulatory Institutions
FDI firms are subject to host-country
government regulatory restrictions; that is, formal
laws, regulations, and rules to safeguard national
interests and maximize local benefits from inward
FDI. For example, foreign investors can be subject
to various degrees of discriminatory and restrictive
policies that impose difficulties in acquiring FDI
ownership, limit their access to local resources,
require mandatory exporting, and interfere with other
operational matters.
Such regulatory restrictions force FDI firms
to try to equalize their market rights with those
of local firms. They can reduce their exposure to
regulatory restrictions by forming joint ownerships
with local firms, because host regulations are
more relaxed for joint-ownership business than for
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exclusively foreign-owned business. While host
regulatory restrictions on inward FDI exert pressure
to opt for a joint-ownership structure, Chinese
state ownership can alter the firm’s response to the
pressure. Host-country institutions perceive that
firms with concentrated state ownership are not only
business entities but are also political actors. As a
result, host-country regulatory institutions scrutinize
them more strictly, especially in relation to their
potential influence on the local economy. They
suspect that Chinese SOEs carry political objectives
that will be detrimental to shareholders’ commercial
interests. Chinese SOEs can also be criticized for
being heavily government-subsidized, both directly
and indirectly. Thus, state ownership in Chinese
investing firms can stimulate politically sensitive
and public concerns in host countries, and provoke
negative reactions from politicians and the public.
Th erefo re, s tate o wn ers h ip mo d er ates
restriction effects on FDI ownership. The greater the
state share of equity in the firm, the more likely hostcountry regulatory restrictions on inward FDI will
cause firms to choose joint-ownership structures.
State Ownership and Host Pressures
to Conform
FDI firms are challenged to meet social
expectations that the host countries deem
appropriate. First, they may become victims of
social stereotyping and discriminatory standards.
Joint ownership structure can reduce risk exposure
by sharing risks among partner firms. Second, firms
are challenged to adjust their business practices in
accordance with the host systems. A local business
partner, by bringing knowledge of the host country’s
practices and cultural norms, can facilitate the
learning process.
Host country constituents perceive two specific
negative political images in Chinese state ownership.
First, the image of Chinese state power can override
their business images. Many Chinese FDIs involve
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intergovernmental negotiations between the Chinese
and host-country governments, which further gives
the FDI firms images of being under state power.
Carrying the burdensome image of having noncommercial objectives and unfair advantages makes
it extremely difficult for the investing firm to create
positive perceptions about its practice and culture.
Second, state ownership is also associated with the
image of bureaucratic practice and inefficiency; that
is, state ownership can influence the appointment
of former bureaucrats as top management personnel
in Chinese firms although they typically lack
professional business and management backgrounds.
Such managerial arrangements reduce operational
efficiency and damage firm performance. Although
Chinese SOEs are increasingly and substantially
transforming their operations and management,
the outcome is still too weak to change the general
image. As a result, a Chinese investing firm with
substantial state ownership would find it difficult
to attain host-country legitimacy. So, under hostcountry normative pressure to attain local legitimacy,
an SOE is more likely to conform to host-country
normative pressure and dilute its foreign image by
choosing joint ownership.
Research Method
In 2006, we collected data from a survey
targeting mainland Chinese firms with outward
FDI projects. The population was identified from
the 2005 Statistical Bulletin of China’s Outward
Foreign Direct Investment published by the Ministry
of Commerce of China, which indicates that, by
the end of 2005, approximately 5000 Chinese firms
had conducted outward FDI projects. The Chinese
government kept the list confidential, so we collected
the names manually from multiple sources published
by central and provincial Chinese governments.2 We
identified 588 firms with full contact details from
these sources. We then designed and targeted our
questionnaire for the top decision makers in Chinese
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outward investing firms. Respondents were senior
executives directly in charge of the firm’s outward
investment activities at the time of the last FDI entry.
We received 132 usable responses from
588 questionnaires sent. The firms represented
were top-ranking investing firms revealed in the
central government’s statistical bulletin, and those
approved by eight eastern provinces that collectively
contributed to more than 70% cent of the total
outward FDI flow of China. Altogether, the firms
represented the major forces of Chinese outward FDI
at the time of the survey.
FDI ownership decision. We used an equity
ownership share of 95% as the cut-off between
joint ownership and sole ownership structures. We
also used the percentage of equity ownership as an
alternative measure of FDI ownership decisions.
State ownership. We measured state ownership
as the total percentage of equity ownership by the
Chinese government and its agencies.
Institutional pressures. We used three
institutional variables. Home regulatory pressure was
measured by two questions related to outward FDI
approval and foreign exchange approval procedures
respectively. Host regulatory pressure was measured
by three items describing host country policy
pressure on inward FDI, foreign firm operation, and
equity-based market entry.
Control variables. We controlled for several
variables relating to firm capability, host industry,
and transaction cost.
Findings
Each firm reported its latest FDI entry up to
2006, yielding a sample of 132 independent FDI
entries. Among these, 53 had no state ownership,
36 were partially state-owned, and 43 were fully
state-owned, for a 45.38% average share of state
ownership. Industry distribution showed that 78
firms were in manufacturing; 15 were in natural
resource-related industries; and 39 were from other
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industries, particularly the service industry. Among
all entries, 52 had joint-ownership structures and
80 had sole-ownership structures. In the 52 jointownership cases, the Chinese investing firm had a
minority ownership in 11 cases, an equal (50-50)
ownership in 10 cases, and a majority ownership in
31 cases. Chinese ownership averaged 82.98% in the
132 FDI entries.
We tested our hypotheses using logistic
regression. Our dependent variable was given a
value of one if the focal FDI entry had a jointownership structure, and a value of zero if it had a
sole-ownership structure.
The results show that the greater the stateentity share of equity, the more likely home country
regulatory restrictions on outward FDI would
persuade the FDI firm to choose a joint-ownership
structure rather than a sole-ownership structure.
The interaction of host regulatory pressure and
state ownership was positive and significant: the
more equity state entities held, the more likely hostcountry regulatory restrictions on inward FDI would
persuade the FDI firm to choose a joint-ownership
structure rather than a sole-ownership structure.
Also, as expected, host normative pressure and state
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ownership had a positive and significant interaction.
These results support our third hypothesis, that the
greater the state-entity equity share, the stronger the
effect of host-country normative pressure to attain
local legitimacy by choosing a joint-ownership
structure over a sole-ownership structure.
Managerial Implications
From a managerial standpoint, our study
suggests that firms must consider their political
affiliations when formulating FDI strategies. The
political image associated with state ownership
requires group-level solutions. For example,
when an individual SOE incurs negative publicity,
public media may react with negative stereotyping
that impedes other SOEs in their image-building
efforts. To change host-country perceptions, SOEs
must engage in consistent and coordinated imagebuilding to maximize their benefits. The homecountry government may play a coordinating role in
identifying key efforts at country, regional and global
levels, and prevent individual firms from free-riding
on the positive images built through cooperative
efforts.
This version is based on the full article, “State Ownership Effect on Firms’ FDI Ownership
Decisions under Institutional Pressure: A Study of Chinese Outward Investing Firms ", Journal
of International Business Studies, 2012 (43), 264-284. Lin Cui (lin.cui@anu.edu.au) is associate
professor at ANU College of Business and Economics, The Australian National University.
Fuming Jiang (fuming.jiang@curtin.edu.au) is professor at Curtin Business School, Curtin
University.
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