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Learning across geographic space: Pro-market reforms, multinationalization strategy, and profitability

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Abstract

Building on economic geography and knowledge-based theory, I argue that pro-market reforms augment the profitability of firms by increasing their competitiveness and market knowledge. However, I propose that this effect is greater for firms that operate internationally, firms that operate in more advanced markets, and firms that become multinationals before reforms are implemented. This is because such firms acquire market knowledge abroad that they can use when responding to reforms at home, giving them a head-start advantage over other local firms. The analyses of a panel of the largest 500 Latin American companies from 1989 to 2008 provide support for these arguments.

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Notes

  1. I use the terms “country”, “market”, and “economy” interchangeably in this paper.

  2. Eriksson et al. (1997, 2000a), Eriksson, Majkgard, and Sharma (2000b) use the term “learning theory” to refer to the literature on how firms internationalize by learning. This literature encompasses the incremental internationalization (or Uppsala) model of IB (Johanson & Vahlne, 1977, 1990) and KBT (Eisenhardt & Santos, 2002; Grant, 1996) as it applies to firm internationalization. Furthermore, this literature complements and often overlaps with the EG literature on knowledge as applied to firms and MNEs (Alcácer & Chung, 2007; Cantwell & Mudambi, 2005; Mudambi, 2008; Mudambi & Swift, 2011). Furthermore, Kogut and Zander (1993) use the term “evolutionary theory” to refer to KBT as it applies to the MNE. I thus draw from all of these sources in this paper under the umbrella of KBT.

  3. MNEs from emerging and developing markets have grown from 3,800 in 1990 to 30,209 in 2010, representing an increase from 10.9 to 29.1% of all MNEs globally (UNCTAD, 1992, 2011).

  4. Given that a previous study has analyzed the effects of pro-market reforms on firm profitability empirically (Cuervo-Cazurra & Dau, 2009a), I do not hypothesize this relationship here, but control for it instead.

  5. Here, I provide a brief review of some of the extant literature on multinationality as it relates to knowledge and profitability in order to set it apart from this paper. – Multinationality and knowledge: KBT as applied to firm internationalization has focused primarily on the sequence by which a firm establishes international operations (Chang, 1995; Johanson & Wiedersheim-Paul, 1975; Kogut, 1983). This literature focuses chiefly on how the internationalization knowledge that firms accrue helps them be more successful with subsequent internationalization efforts (Johanson & Vahlne, 1977, 1990). This is centered on the notion of psychic distance, which “is defined as the sum of factors preventing the flow of information from and to the market” (Johanson & Vahlne, 1977: 24). These factors include the cultural, administrative, geographic, and economic differences that exist between markets (Ghemawat, 2001). According to this literature, psychic distance limits the ease and efficacy of knowledge transfer across borders, and limits the knowledge that the firm's managers have of the host market (Johanson & Vahlne, 1977, 1990). Because of these issues, and the notion that managers are risk averse, the model suggests that firms internationalize sequentially, starting with less psychically distant host markets and then moving to more psychically distant ones (Johanson & Vahlne, 1977, 1990). However, recent literature has argued that psychic distance may not always be detrimental to the firm, and may in some cases even be beneficial, noting that firms often do not internationalize sequentially (Knight & Cavusgil, 1996, 2004; Oviatt & McDougall, 1994, 1997; Rialp, Rialp, & Knight, 2005). Although related, this literature is different from the present project, in that it focuses primarily on the sequence of internationalization and exporting, whereas here I focus on how experiential knowledge obtained through multinationality enhances their responsiveness to reforms in their home market. – Multinationality and performance: There is an expansive and growing stream of research on the direct effects of the degree of firm multinationality (or multinationality experiential knowledge) on firm performance (for reviews, see Bausch & Krist, 2007; Hitt, Tihanyi, Miller, & Connelly, 2006; Verbeke, Li, & Goerzen, 2009). This stream has focused primarily on whether having a greater or lesser presence abroad is beneficial for the profitability of firms. The findings of this literature have been largely inconclusive (Verbeke et al., 2009), suggesting positive (Delios & Beamish, 1999; Doukas & Travlos, 1988; Errunza & Senbet, 1984), negative (Denis, Denis, & Yost, 2002; Geringer et al., 2000), U-shaped (Lu & Beamish, 2001), inverted U-shaped (Geringer, Beamish, & daCosta, 1989; Hitt, Hoskisson, & Kim, 1997), and sinusoidal-shaped (Contractor, Kundu, & Hsu, 2003; Lu & Beamish, 2004) relationships, and even no relationship (Brewer, 1981; Hennart, 2007; Morck & Yeung, 1991). This suggests the degree or amount of multinationality may not be the primary determinant of an MNE's performance, and that perhaps other factors of the firm's multinationality efforts are better predictors of its success (Hennart, 2007, 2011). Following this notion, other studies have suggested that the effects of multinationality on performance are moderated by several factors, such as the speed with which a firm internationalizes, the dispersion of markets entered, and the rhythm of internationalization (Vermeulen & Barkema, 2002). As such, the direct effects of multinationality experiential knowledge on firm profitability are as of yet unclear, and I thus make no predictions about them in this paper.

  6. The Corporate Affiliations database categorizes member firms into subsidiaries, branches, affiliates, and divisions. The main distinction between these is that a subsidiary is a legally separate entity, whereas the others are not. In practice the differences between them are less clear, and are typically not consistent across companies. For the interests of this paper, I use the term “subsidiary” to refer to these interchangeably, because the goal is to ascertain the number of foreign operations of a given company in a given year.

  7. The literature provides several measures of pro-market reforms, or of related constructs (Cuervo-Cazurra & Dau, 2009a). Lora (2001) developed a measure of pro-market reforms for Latin America spanning the years 1985–1999. Morley et al. (1999) created a measure of pro-market reforms for Latin America for the years 1970–1995. The Heritage Foundation's measure of economic freedom is available from 1995 through the present for countries across the globe (Miller & Holmes, 2011). The Fraser Institute's measure of economic freedom is available for 1970–2000 at 5-year intervals, and annually after that for countries worldwide (Gwartney, Hall, & Lawson, 2011). Finally, Sahay and Goyal (2006) developed a composite measure of pro-market reforms by combining the measures developed by Morley et al. (1999) and the Heritage Foundation. Although this measure was originally provided for the period 1970–2004, it can easily be extended to the present using the latest data from the Heritage Foundation and following the guidelines set forth by Sahay and Goyal (2006). I use this index because it is the only one that comprises the entire period of analysis of this paper. This index has been found to have a high convergent validity with the other measures described above (Cuervo-Cazurra & Dau, 2009a).

  8. Several measures have been used in the literature to capture multinationality (Hennart, 2011). These include foreign sales over total sales (FSTS) (e.g., Buhner, 1987), foreign assets over total assets (FATA) (e.g., Sambharya, 1996), foreign income over total income (FITI) (e.g., Outreville, 2008), foreign employees over total employees (FETE) (e.g., Kim, Hwang, & Burgers, 1993), foreign dispersion of a company's sales (FD) (e.g., Hitt et al., 1997), host market diversity (HMD) (e.g., Goerzen & Beamish, 2003), number of foreign countries of operation (e.g., Lu & Beamish, 2004), and number of foreign subsidiaries (e.g., Makino et al., 2004). Even though each of these has its share of advantages and disadvantages, I use the latter two in this study, for several reasons. First, FSTS and FD typically capture not only subsidiary sales, but also exports. They are thus better measures of firm internationalization than of multinationality. Second, FSTS, FATA, FITI, FETE, and FD fail to capture the differences between the environments where a company operates. That is, these measures provide a lump figure for the international operations of a firm, but do not break it down by country. Third, data for most of these measures are limited for unlisted firms from developing countries, which represent a sizeable number of firms from Latin America. The number of foreign subsidiaries and countries avoid these issues by capturing only the multinationality of firms and not their exports, capturing the diversity of the environments in which they operate, and being available for the developing-country firms that are not publicly traded. Furthermore, given that these measures provide information on the location of international operations, they can be used to develop measures of upmarket multinationality as well. I therefore use the number of foreign subsidiaries and the number of foreign countries of operation, the former in the main analyses and the latter in the robustness test section. For a detailed review of the measures that have been used in the literature to capture multinationality, and their respective strengths and weaknesses, see Hennart (2011).

  9. Frazier et al. (2004) caution that, in the presence of unequal error variance across groups (in this case across firm types), the results of multivariate analyses may be unreliable. I thus use Bartlett's test to confirm that the error variance is homogeneous, and James’ and Alexander's tests to verify that moderating effects are indeed present. These findings suggest that the data are suitable for multivariate analysis with categorical moderators.

  10. I am grateful to an anonymous reviewer for suggesting how to summarize all of the models using a general model specification, in place of presenting the full specification for each of the models.

  11. Sequential models were also estimated, but their results are not presented for the sake of page length. These include a model of the effect of only the control variables, as well as models for the direct effects of multinationality, upmarket multinationality, multinationality timing, exports, upmarket exports, and exports timing. The results of these models are consistent with those presented.

  12. Note also that I perform log-likelihood ratio tests to compare each of the nested models, and find that the less restrictive models provide a significantly better fit for the data than those that are more restrictive. This suggests that there is a significant improvement across models as the variables of interest are incorporated.

  13. The classification provided by Schiavon (2000) of the year when reforms began to be implemented in each country is as follows: Argentina 1990, Bahamas 1985, Barbados 1991, Belize 1985, Bolivia 1985, Brazil 1995, Chile 1975, Colombia 1990, Costa Rica 1988, Dominican Republic 1995, Ecuador 1995, El Salvador 1989, Guatemala 1992, Guyana 1989, Haiti 1995, Honduras 1990, Jamaica 1987, Mexico 1985, Nicaragua 1990, Panama 1992, Paraguay 1991, Peru 1991, Suriname 1995, Trinidad and Tobago 1987, Uruguay 1987, and Venezuela 1989.

  14. Data obtained from Compustat, LexisNexis, Mergent Online, AméricaEconomía, and other sources.

  15. I am thankful to an anonymous reviewer for suggesting the inclusion of these additional analyses. They follow directly from the rest of the paper, and provide a valuable symmetry, as the three exports variables (exports, upmarket exports, and exports timing) correspond with the three multinationality variables studied (multinationality, upmarket multinationality, and multinationality timing).

  16. The results of Models 5, 6, and 7 in Tables 5 and 6 indicate that the moderating effects of the three exports variables are marginally significant at the α = 0.10 level. One could therefore make the case that exports do indeed play an important knowledge-related moderating role, although a more limited one than multinationality. This would provide support for Hypothesis 4a but would not change the conclusions for Hypothesis 4b, which indicates that the moderating effect of multinationality is greater than that of exports. However, as suggested in the review process, I use the α = 0.05 level as the threshold for significance in the paper.

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Acknowledgements

Suggestions by the coeditors, Sjoerd Beugelsdijk and Ram Mudambi, as well as by the anonymous reviewers were very helpful in developing this article. This paper is based on my doctoral dissertation, and so I would especially like to thank my dissertation committee: Alvaro Cuervo-Cazurra (chair), Tatiana Kostova, Kendall Roth, and Jennifer Spencer. This work would not be possible without their training and support. I would also like to thank Nicholas Athanassiou, Joshua Ault, Amilcar Barreto, Diane Bulpett, Chuck Kwok, Harry Lane, Maria Lo Piccolo, Eduardo Lora, Matthew Mitchell, Kurt Norder, Julie Perreault, Robert Ployhart, Sheila Puffer, Ravi Ramamurti, Anna Revette, Anju Seth, Andrew Spicer, Stephen Tallman, Hildy Teegen, Annique Un, Ari Van Assche, and Christopher Zorn for their assistance with this paper. This project was partially funded by a research grant from Northeastern University's Center for Emerging Markets and the United States Department of Education's Bureau of International Education. Any errors are mine.

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    Luis Alfonso Dau

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Accepted by Sjoerd Beugelsdijk and Ram Mudambi, Guest Editors, 8 January 2013. This paper has been with the author for two revisions.

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Dau, L. Learning across geographic space: Pro-market reforms, multinationalization strategy, and profitability. J Int Bus Stud 44, 235–262 (2013). https://doi.org/10.1057/jibs.2013.5

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