The impact of institutional distance on the international diversity–performance relationship
Introduction
One of the most important research themes in the area of international business (IB) has been the study of the international diversity–performance relationship. A special issue on this topic in Management International Review effectively demonstrates the continued interest of IB scholars in this research theme over the last 40 years. Work by Brock, Yaffe, and Dembovsky (2006), Chang and Wang (2007), Chari, Devaraj, and David (2007), Contractor, Kumar, and Kundu (2007), Hitt, Bierman, Uhlenbruck, and Shimizu (2006), Pangarkar (2008), and Thomas (2006) all go on to portray the critical importance of the topic to IB scholars and practitioners.
Our study has been motivated, in part, by the ongoing debate that surrounds the international diversity–performance research (Contractor, 2007, Hennart, 2007). Our study derives further motivation from the increasing importance given to ‘contexts’ in IB research (Meyer, 2006, Witt and Lewin, 2007). In the particular case of the international diversity–performance research, it is only recently that contextual factors, such as the country of origin, have been considered in the theoretical and empirical frameworks (Elango and Sethi, 2007, Ruigrok et al., 2007). The application of the contextual factors can be extended in scope since scholars so far have only looked at the context from the perspective of the home country. For example, scholars have, either, empirically examined firms from contexts other than the typical developed countries like the U.S., UK and Japan (Capar and Kotabe, 2003, Contractor et al., 2007, Nachum, 2004, Thomas, 2006), or included a home country in their conceptual and empirical investigation (Elango and Sethi, 2007, Ruigrok et al., 2007). This presents a gap in research, since the firms under the international diversity–performance investigation are global and, as a consequence are present in multiple host countries. The nature of markets, both in host as well as in home countries, is important in determining the scope (geographic and product) of the firm (Peng & Delios, 2006) as well as the scope of its long-term performance. Without taking into consideration the context of the host country, particularly the differences between the host and home country contexts, into the international diversity–performance model, conceptualization and thereby findings remain incomplete.
We seek to fill this research gap by incorporating the effect of institutional distance (distance between the home and host country institutional contexts) into the international diversity–performance model. This study brings institutional distance into the conceptual framework as a moderator between international diversity and firm performance. Institutional distance is a measure of cross-country differences (Kostova & Zaheer, 1999) and refers to “the extent of similarity or dissimilarity between the regulatory, cognitive, and normative institutions of two countries” (Xu & Shenkar, 2002, p. 608). Institutional theory is the foundation of institutional distance. It perceives institutional environment as the key determinant of firm structure and behavior (DiMaggio and Powell, 1983, DiMaggio and Powell, 1991, Scott, 1995). Most of the international diversity–performance research is positioned from the perspective of the resource-based theories, transaction cost economics or organizational learning theories. Our study makes a contribution to existing literature on international diversity–performance research by adopting an institutional theory perspective focusing on how differences in institutions in home and host countries affect performance of internationally diversified firms. Our study also contributes to the increasing importance and applicability of institutional theory to explain firm strategy and behavior in the international context. Prior studies have looked into problems in transfer of organizational knowledge and practices due to differences in institutional contexts (Kostova, 1999, Kostova and Roth, 2002), effects of institutional distance on firm strategies pertaining to choice of country, entry mode, ownership (Xu et al., 2004, Xu and Shenkar, 2002) and on survival of foreign subsidiaries (Gaur & Lu, 2007) as well as on subsidiary staffing policies (Gaur, Delios, & Singh, 2007). We extend this body of work by focusing on the role that institutional distance plays in moderating the performance consequences of international diversity.
The conceptual model of our study is presented in Fig. 1. The two major research questions that we seek to address through this conceptual framework are the following:
- (1)
Does an increase in international diversity enhance firm performance? and
- (2)
What is the role of institutional distance (regulative and normative distances) in explaining the relationship between international diversity and firm performance?
The rest of the paper is organized in the following manner: First, we provide an overview of the conceptual framework using an institutional theory perspective. Next, we develop hypotheses concerning the two major research questions. Then, we discuss the methodology (data collection, measurement of variables, and research design) adopted for this study. We present the results of our empirical analyses next. Finally, we discuss the implications of our findings for scholars and practitioners and provide limitations of the study along with some future research directions.
Section snippets
Institutions and institutional contexts
Institutions have been defined generally as the rules of the game in a society, “the formal or informal constraints that shape human interaction” (North, 1990). Scott (1995) introduced the concept of a three-dimensional country institutional context, comprised of regulatory, normative and cognitive dimensions. Regulative or legal aspects of institutions most commonly take the form of regulations; they guide organizational action by force or threat of legal sanctions. Organizations accede to
International diversity and firm performance
International diversity is perceived as a critical element in corporate strategy and a means for sustainability and growth. Because of its importance, researchers have dedicated considerable efforts to investigating its performance implication (Contractor, 2007). Corporate performance can be improved by international diversity since it increases sales in foreign markets and diversifies the risk of home country economic downturn. International diversity can also lower costs through economies of
Sample
To be included in our sample, a firm had to be ranked on the Fortune Magazine's Global 500 company list in Year 2004. All these companies had to publish their financial data and report figures partially or wholly to a government agency. We relied on two major data sources: Hoover's (a D&B Company) and Mergent Online (formerly Moody's). For unavailable data points, a firm's financial annual report obtained from Mergent Online provided supplementary information. Data collected are for the fiscal
Results
Descriptive statistics and correlations are provided in Table 4. Base model, with only the control variables, indicates that there was a significant relationship between firm leverage ability and performance. This finding is consistent with prior studies (Li, 2007). Results from the regression Models 2, 3 and 4 supported Hypothesis 1 that an inverted-U shape relationship between international diversity and firm performance existed, though the squared term of international diversity was
Discussion
Ruigrok et al. (2007) and Bausch and Krist (2007) demonstrated the importance of moderating factors in shaping the international diversity–firm performance curve, particularly the institutional contexts of home and host countries. Our approach in this present study was to focus on the moderating effect of institutional distance. The curvilinear (inverted-U) relationship between international diversity and firm performance was found in this study, albeit with a weak significance level. This
Conclusion
Our study contributes to existing literature on international diversity and performance by adopting an institutional theory perspective and investigating the moderating role of institutional distance on the proposed relationship. In this regards our study is unique and novel. However, there are some limitations, which future researchers can build on for further development of this area of research. First, this study used the number of foreign subsidiaries and number of countries as measurement
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