Internationalization and survival of foreign subsidiaries of emerging economy multinationals

ACKNOWLEDGEMENTS

I would like to thank my guide and Thesis Supervisor Associate Prof. Andrew
Delios for his guidance and his interest in this area of research. From the
beginning, Prof. Andrew motivated me to explore the possibilities within the topic
and guided me during the research process. He was very supportive and
encouraged me to think in the right direction. As my Thesis Supervisor and the
Head, Department of Business Policy, Prof. Delios helped me in accessing
relevant resources related to the literature review and gave key suggestions
regarding the process of research which were very helpful.

In addition, I would like to thank Assoc. Prof. Peter Hwang, A/P Sai Yayavaram,
Assoc. Prof. Vivien Lim Kim Geok, Assoc. Prof. Nitin Pangarkar, Assoc. Prof.
Ishtiaq Pasha Mahmood and A/P Soh Pek Hooi for their advice and invaluable
suggestions. I am grateful to Dr. Abhirup Chakrabarti for conducting lectures on
statistics. I am grateful to all my friends and would like to extend a special thanks
to:Angeline, Ruan Yi, Zhou Nan, Wang Pengji, Yuan Lin, Xu Weiwei, Issac, Cao
Yi, Kelvin, Sankalp, Zhonghua and Phillip.

I am also thankful to my husband for his kind and encouraging words and
emotional support throughout the coursework and research work. I would like to
express my heartfelt gratitude to my parents for their help in conducting fieldwork
and collecting data in India. I am also grateful to officials at the Indian Embassy

i


(Singapore), and India Investment Center (India) for information regarding the
data sources and their insights on the topic.

I would like to acknowledge the support I received from the National University

of Singapore in the form of the research scholarship and Fieldwork Funding
Award from the Asia Research Institute (ARI) National University of Singapore.
Most importantly I would like to express my gratitude to the IT staff, library staff
and office staff especially Ms. Hamidah Bte Rabu, Ms. Ang Chin Teng at the
Ph.D. office and Ms. Wendy Ng and Ms. Teo Woo Kim and Ms. Jenny See at the
Department of Business Policy. I thank them for their constant support and
assistance.

I am grateful to the examiners for taking out time from their hectic schedule to
read and examine the thesis. Last but not the least, I would like to thank the
National University of Singapore for creating a conducive research environment
with an excellent network of libraries and a friendly atmosphere.

ii


SUMMARY
Survival of foreign ventures of multinational firms forms an interesting and
significant part of international studies; however, most of the contribution in this
area emanates from studies conducted in the developed country context. This has
led to a lack of understanding of the factors expected to influence the survival of
foreign subsidiaries of multinational firms from emerging economies. Along with
this empirical gap, the internationalization of firms from emerging economies
especially Third World countries represents a theoretical puzzle arising from the
application of the conventional theories of FDI to the phenomenon of Third World
Multinationalism. This research obtains its theoretical framework from this debate
arising from the application of the theories of FDI to this phenomenon.

The study explores the factors expected to influence survival, especially firm
specific resources such as affiliation to a business group, which originate due to

the institutional environment of the home country. It explores the location specific
variables and the interaction between the location and firm specific resources that
evolve due to the institutional environment of the country-of-origin.

It

studies

the

institutional

environment,

which

contributed

to

the

internationalization of Indian firms and tries to understand the benefits accrued by
affiliation to a business group. Business Groups form an important part of
emerging economies. Business group affiliated firms internationalize due to
several reasons like exploration of new resources and the exploitation of existing
iii


resources and capabilities. The study tests whether business group affiliation- a

domestic firm specific resource is transferable internationally.

The study employs Cox regression to conduct the data analysis. This technique is
suitable for discrete time or grouped time event history analysis and addresses the
problems of duration dependency and time varying covariates. The raw data for
the study was obtained from the annual records published by the India Investment
Center. This data is substantiated with data obtained from electronic databases and
annual reports. The longitudinal dataset of foreign ventures of Indian firms that
are investing abroad and internationalizing their operations from the mid 1980s
until date consists of 110 firms with 377 cases of FDI through joint ventures,
acquisitions, and wholly owned subsidiaries. The dataset provides information on
the year of formation of the foreign subsidiary, year of exit as well as parent firm
size, industry of the parent firm, country level variables amongst others.

The study has three main findings. The firm specific resource-business group
affiliation- was not found to be significant and has no effect on the rate of exit of
foreign subsidiaries of emerging economy multinationals. The development stage
of the host country was found to be significant indicating that the rate of exit of
the foreign subsidiary depends on the development stage of the host country. The
interaction of firm specific resources and development stage of the host country
was found to be significant indicating that the rate of exit of business group
affiliated firms depends on the development stage of the host country. The
empirical results lend sufficient support for the central ideas of the research.
iv


TABLE OF CONTENTS
ACKNOWLEDGEMENTS ...................................................................................i
SUMMARY .......................................................................................................... iii
LIST OF FIGURES ........................................................................................... viii

LIST OF TABLES ............................................................................................. viii
CHAPTER 1 INTRODUCTION ..........................................................................1
1.1 Background ........................................................................................................3
1.2 Objectives ..........................................................................................................5
1.3 Contribution .......................................................................................................6
1.4 Organization of Chapters ...................................................................................8
CHAPTER 2 LITERATURE REVIEW..............................................................9
2.0 Terminology.......................................................................................................9
2.1 Review of literature on Third World Multinationals .......................................11
2.2 Theoritical Aspects ..........................................................................................13
2.2.1

Review of Theory of Monopolistic Advantages....................................13

2.2.2

Business Group Affiliation ....................................................................21

2.2.3

Review of Ownership-Location-Internalization Paradigm....................18

2.3 The Institutional Environment and Indian Multinationals...............................21
2.4 Survival related studies ....................................................................................24
2.5 Summary ..........................................................................................................27
CHAPTER 3 HYPOTHESES DEVELOPMENT.............................................30
3.1 Business Group Affiliation and Survival of Subsidiaries ................................30
3.2 Host Country Development Stage and Survival of Subsidiaries .....................33
v

3.3 Interaction between firm specific resources & Development stage of the host
country ...................................................................................................................34
3.4 Other Factors....................................................................................................35
3.4.1

Organizational Learning ........................................................................36

3.4.2

Time Related Variables..........................................................................37

CHAPTER 4 DATA AND METHODOLOGY.................................................39
4.1 Data and Sample .............................................................................................. 39
4.2 Description of Variables .................................................................................. 41
4.2.1Dependent Variable ....................................................................................... 41
4.2.2 Independent Variables .................................................................................. 43
4.2.3 Control Variables .......................................................................................... 45
4.3 Methodology .................................................................................................... 47
4.3.1 Model Specification for Cox Regression......................................................50
4.3.2 Model Statistics............................................................................................. 53
i)

Interpretation of the Coefficient Estimates ................................................53

ii)

Interpretation of Model Estimates .............................................................55

CHAPTER 5 RESULTS......................................................................................56

5.1 Results for Model.............................................................................................56
5.1.1

Model Statistics......................................................................................56

5.1.2

Coefficient Statistics ..............................................................................57

5.1.3

Control Variables ...................................................................................58

5.2 Results for Hypotheses ....................................................................................59

vi


5.2.1

Results for Hypothesis 1 ........................................................................59

5.2.2

Results for Hypothesis 2 ........................................................................61

5.2.3

Results for Hypothesis 3 ........................................................................62

5.3 Summary ..........................................................................................................63
CHAPTER 6 CONCLUSION.............................................................................64
6.1 Theoretical Implications of the Study..............................................................64
6.2 Limitations of the Research .............................................................................68
6.3 Future directions for Research .........................................................................70
REFERENCES.....................................................................................................91

vii


LIST OF FIGURES

Figure 1

Foreign Direct Investment by emerging economy multinationals

Figure 2

Framework indicating the relationship between the covariates.

Figure 3

LML plots

Figure 4

Plots showing comparison of Cum. Survival and Hazard Rates.

LIST OF TABLES

Table 2.1

Summary of Literature on Third World Multinational Firms

Table 4.1

List of Symbols and description of Variables

Table 4.2

List of Studies related to Survival

Table 4.3

Hypotheses with expected signs

Table 4.4

Correlation Matrix of Variables in Cox Regression Analysis

Table 5.1

Results for Cox Regression Analysis

Table 5.2

Summary of Results for Hypotheses

viii

CHAPTER 1

INTRODUCTION

CHAPTER 1
INTRODUCTION
This study examines the relationship between firm specific resources shaped by
the characteristics of the home country institutional environment and the
subsequent survival of the international venture (joint ventures, wholly owned
subsidiary, or acquisitions) of firms from less developed countries (LDCs). The
research also examines the effect of the development stage of the host country and
the interrelationship between the development stage of the host country and firm
specific resources and their influence on the survival of the foreign venture.

The phenomenon of internationalization of domestic firms from less developed
countries termed as ‘Third World Multinationals’ (Scheman 1973; Heenan and
Keegan, 1979; Wells, 1983) or ‘emerging economy multinationals’ was first noted
in the early seventies. An extensive review of the extant literature on Third World
Multinationals reveals that while several studies have been conducted to
determine the pattern of FDI, the competitive advantages of Third World
Multinationals, and their motivations to internationalize, few empirical studies
examine the subsequent survival of the foreign subsidiaries (Wells, 1998) of these
‘unconventional multinationals’(Giddy and Young, 1982).

Therefore, this study responds to the call for empirical research on the factors
expected to influence the survival of foreign ventures of multinationals from
emerging economies and extends the scope of survival related studies to the
emerging economy context.

1


CHAPTER 1

INTRODUCTION

Furthermore, Yeung (1999) notes that most of the studies of TNCs from emerging
economies do not have an explicit theoretical underpinning. This study tries to
overcome this by discussing and applying the conventional theories of FDI to the
overseas expansion and internationalization of Third World Multinationals to
determine the role of firm specific resources, which evolve due to the institutional
environment of the home country. This study applies the conventional theories of
FDI to the expansion and internationalization of third world multinationals to
determine the role of firm specific resources, which arise due to the institutional
environment of the home country. Business Group affiliation is one such firm
specific advantage that develops due to the institutional environment of the home
country.

Multinational firms from emerging economies do not possess absolute or
monopolistic firm specific advantages (Erramilli, Agarwal and Kim, 1997) and
therefore their firm specific advantages differ from those of developed country
ownership specific advantages. Prior literature on Third World Multinationals
(Heenan and Keegan, 1979; Kumar, 1982; Wells 1983, Yeung 1988) depicts a
picture of firms, which apparently do not possess an absolute monopolistic
advantage like proprietary technology, unique production knowledge, or brand
name, which may motivate their entry into other countries. Third World
multinationals possess a range of firm-level advantages like labor intensive and
small-scale

manufacturing,

low cost

of

establishment and

production,

conglomerate identity and machinery and managerial skills customized to the less
developed country environment.

2


CHAPTER 1

INTRODUCTION

The research studies the role of the development stage of the host country and its
influence on the survival of foreign ventures of emerging economy firms.
According to Itaki, 1991 firm specific advantages of a firm may be contingent on
the location of the foreign subsidiaries. I expect that firm specific resources of
these firms will be contingent on the development stage of the host country and
their interaction will affect the probability of survival of foreign ventures of firms
from an emerging economy. I test the effect of firm specific resources and the
development stage of the host country on a sub-sample of foreign ventures of
Indian firms using event history modeling for longitudinal data.

The event history modeling technique used for the data analysis is the Cox
Regression, which is suitable for discrete longitudinal event data analysis when
the number of tied observations is few (Allison, 1984). This technique allows for
the inclusion of time constant and time varying covariates expected to influence
the duration of survival as well as duration dependency and the discrete or
grouped nature of the data. This research extends the scope of survival studies to
the internationalization of firms from an emerging economy context i.e.
specifically to the internationalization of Indian firms. The next section elaborates
upon the background for the research.

1.1 Background

Foreign Direct Investment by multinational firms from emerging economies
(LDCs and NICs) forms the backdrop of this study. Scheman (1973), Heenan and

3


CHAPTER 1

INTRODUCTION

Keegan (1979) and Wells (1983) identified the Third World Multinational
phenomenon and pioneered the study of these multinational firms from less
developed countries (LDCs) in the early 1970s. Since then domestic firms from
several emerging economies such as India, China, Brazil, Mexico, Argentina etc.
have emerged as participants in outward FDI. The increase of FDI activity from
less developed countries (LDCs) has raised several issues of interest such as how
well the traditional theories of FDI explain the rise of these TNCs and what their
competitive advantages are (UN Report, 1993). Foreign Direct investment by

firms from less developed countries constituted 12% of the global FDI outflows in
2002 (UN Report, 2003) and has witnessed a steady increase in the past few
decades. FDI from developing countries, while a small fraction of global flows,
has increased more rapidly (14% p.a.) than outflows from industrialized countries
(10% p.a.).This increase in investment by Third World Multinationals is also
known as the Third Wave of FDI (Industry & Energy Dept. Working Paper,
1989).

India is one of the few semi-industrialized countries that serve as an important
source of FDI (Encarnation, 1982). The growth of Indian MNEs began in the
1950s. The first Indian multinational was established in 1956 by a leading
business house in Ethiopia. The number of approvals for joint ventures, wholly
owned subsidiaries and other forms of investments has been steadily increasing
since then. Indian Multinationals operate in a wide range of industries, including
engineering products, textiles, pharmaceuticals, paper and pulp, cement and
turnkey projects, in addition to financial and non-financial services (Agarwal and

4


CHAPTER 1

INTRODUCTION

Weekly, 1982). The internationalization of firms from countries with large and
unexplored domestic markets was influenced by the institutional environment.

The liberalization of the protectionist economy in the 1990’s exerted further
pressure on Indian firms to seek opportunities overseas since inward FDI in
several sectors was permitted. The institutional environment of the Indian

economy also contributed to the formation of large business groups. Legislation
controlling the competitive environment contributed to the internationalization of
Indian domestic firms. The key objectives of this study is to examine the survival
of foreign operations of Third world Multinationals with a focus on firm specific
resources and development stage of the host country.

1.2 Objectives
The main objectives of this study are delineated here. Firstly, the research
examines whether a firm specific resource like business group affiliation accrues
an ownership specific advantage on internationalizing firms from an emerging
economy and assists in the survival of their foreign investment.

Secondly, the study explores the relationship between the development stage of
the host country and the rate of exit of foreign subsidiaries.

Lastly, the research tries to determine whether development stage of the host
country and firm specific resources are inter-related. This aspect can be
considered important in the case of internationalization of emerging economy

5


CHAPTER 1

INTRODUCTION

firms since ownership advantages of these firms are neither absolute nor
monopolistic (Erramilli, Agarwal and Kim 1997; Wong, 1985) like those of firms
from developed economies.

1.3 Contribution

This research contributes to the study of firm specific resources such as business
group affiliation. Business groups form an integral part of the emerging economy
business scenario and have been studied by several authors with respect to their
precedents like ownership and antecedents like performance etc. (Qian, 2005).
However not a great deal of research has been conducted on the effect of business
group affiliation on the internationalization and survival of foreign affiliates.
Therefore, this study contributes to the extant literature on international
diversification of business groups and non-business group firms by considering
the influence of business group affiliation and whether this decreases the cost of
foreignness when firms expand internationally.

The study also examines the influence of the interaction of firm specific
advantages and development stage of the host country and whether it influences
the survival of foreign subsidiaries of emerging economy multinationals.

Empirical studies on the survival of foreign ventures of multinational firms from
emerging economies are few in number. This study helps in filling this empirical
gap. Wells (1998) notes that the literature on Third World Multinational

6


CHAPTER 1

INTRODUCTION

Enterprises suffers from the fact that the rapid growth and rapid change in
investment was occurring as research was being carried out. Therefore, there is no

sense of which types of firms ‘survive’. A study of this nature contributes to the
literature on emerging economy multinationals and responds to the call for more
research on the subsequent survival of foreign subsidiaries of Emerging Economy
Multinationals.

Hoskisson et al. (2000), White (2002) emphasize on the need for more research in
the emerging economy context. Wright et al. (2005) identify four strategic options
of research: entry of firms from developed countries to other developed countries,
domestic firms competing within their own economies and firms from developing
countries entering developed and emerging economies (Figure 1). They note that a
great deal of emphasis has been laid on the first two strategic options, and call for
attention to the last option.

They assert that for strategy research to flourish and make a lasting contribution in
this area there is a need to consider the extent to which theories and
methodologies used to study strategy in mature, developed economies are suited
to the unique social, political, and economic environment as well as firm
characteristics of emerging economies.

Therefore, the study contributes to the theoretical aspects by discussing the views
of several authors regarding the application of the theories of FDI in explaining
the phenomenon.

7


CHAPTER 1

INTRODUCTION

1.4 Organization of Chapters

This study has been divided into 6 chapters. The first chapter introduces us to the
phenomenon to be studied and the objectives, background and contribution of the
study. It also outlines the structure of the thesis and the organization of the
chapters. Chapter 2 reviews and summarizes the previous literature on Third
World multinationals describing their comparative advantages, the application of
conventional theories of FDI, the institutional environment and advantages of
business group affiliation. It also summarizes previous studies pertaining to Indian
multinationals and empirical research on survival of firms from developed
economies. The literature review concludes with the theoretical framework for the
research. Chapter 3 develops and states the hypotheses based on the theoretical
framework developed in the previous chapter. Chapter 4 describes the data and
the research methodology of the study, elaborates on the measures used for the
dependent, independent, and control variables. It concludes with a description of
the model and coefficient statistics. The fifth chapter is used to discuss the results
of the empirical analysis obtained by testing the hypotheses stated in Chapter 3.
Chapter 6 concludes the study by summarizing the findings and discussing the
theoretical implications of the study and directions for future research.

8


CHAPTER 2

LITERATURE REVIEW

CHAPTER 2
LITERATURE REVIEW
This chapter provides the theoretical framework for the study by reviewing the

literature on the theories of Foreign Direct Investment and relevant literature
concerning firm specific advantages conferred by Business Group affiliation and
their influence on the internationalization and survival of firms from an emerging
economy. Besides the literature on the theoretical discussions regarding the
conventional theories of FDI: the Theory of Monopolistic Advantage (Hymer
1960) and the Ownership-Location-Internalization paradigm (Dunning 1981) and
their applicability to Third World Multinationals I also review the literature on
‘Third World Multinationals’ and the literature on the survival of foreign
subsidiaries of firms.

The literature review has been subdivided into Sections 2.1 to 2.5 for ease of
comprehension. The chapter concludes with the summary outlining the conceptual
underpinnings of the study, which form the basis for the development of
hypotheses in Chapter 3.

2.0 Terminology

The term ‘Third world multinationals or Third World Multinational Enterprises
(TWMNE)’ has gained wide usage in literature (Yeung, 1994).The term is used to
describe firms which originate in countries with GNP less than 3000 USD per
capita or less developed countries (LDCs). Yeung (1994) states that though the

9


CHAPTER 2

LITERATURE REVIEW

title ‘Third World Multinational’ has gained wide prevalence in literature, a

relatively neutral term ‘Developing Country Transnational’, defined as ‘domestic
enterprises headquartered in developing countries which control assets and/or
exert influence in the decision making process of one or more cross-subsidiaries
under and/or (sic) affiliates’ is better suited to describe such firms. Due to the
rapid growth rate of these economies, researchers also describe these countries as
‘Emerging Economies’ and multinational firms from these countries can be
termed as ‘Emerging Economy Multinationals’ (Ghemawat and Khanna, 1998).
These firms are also referred to as ‘Latecomers’ since they represent the Third
wave of Industrialization (Industry and Energy Department, Working Paper,
1989) or as ‘Dragon Multinationals’ (Mathews, 2001). In this research, the terms
‘Third World Multinationals,’ and ‘Emerging Economy multinationals’ will be
used interchangeably to describe MNEs from LDCs.

The term ‘internationalization’ refers to either all the stages of FDI including
incremental stages like exporting or one particular stage of investment of FDI for
instance exporting, setting up of joint ventures, acquisitions or wholly owned
subsidiaries (Vardaraj, 1987). Giddy and Young (1982) describe these MNEs as
‘Unconventional Multinationals’ and delineate the characteristics that distinguish
these ‘deviate multinationals’. They distinguish the FDI from these countries in
terms of (1) Source of FDI (2) Size of FDI, and (3) Level of technological
advancement of the firm. According to the authors, these firms differ from
developed country multinationals since the size of FDI is usually smaller, the
sources of FDI are more diffused and encompass a number of small and low-

10


CHAPTER 2

LITERATURE REVIEW

income countries, and the technological intensity of these firms is not comparable
to that of developed country multinationals.

Most of the literature in this area dwells on explaining the phenomenon of this
‘unconventional FDI’ (Giddy and Young, 1982) and describing the comparative
advantage and motivations for globalization. A few authors have examined the
relevance of the contemporary theories of foreign direct investment to this
phenomenon of ‘reverse direct investment’ (Jun, 1997). The following section
discusses the literature and theoretical arguments of this literature.

2.1 Review of literature on Third World Multinationals

The bulk of literature on Third World Multinationals (Wells, 1983) or firms from
less developed countries (Kumar 1982) has been growing since the 1970’s and
reflects the interdisciplinary nature of the research (Yeung, 1994). The focus of
the studies conducted in this field of research has been on explaining the
multinational activity and pattern of investment of firms from low income or less
developed countries (LDCs), their motivations for internationalization and the
competitive advantages of these firms as compared to local firms and developed
country MNEs. A majority of these articles and books used primary data and
qualitative methods to describe the phenomenon of Third World Multinationalism
and focused on describing the comparative advantage of such firms. Critically
assessing the articles and books by several authors on various areas related to
emerging country multinationals, Yeung (1999) has presented a clear and concise

11


CHAPTER 2

LITERATURE REVIEW

picture of the Third World Multinational phenomenon. Since the inclusion of an
in-depth review of the literature is not feasible in this section, the extant literature
based on the collection of studies by Yeung (1999) has been summarized in Table
2.1 attached to the end of this document.

A few authors (Ghymn 1980; Chen 1983; Giddy and Young 1982; Kumar 1982;
Wong, 1985; Vardaraj, 1987; Yeung 1999) have examined the relevance and
application of contemporary theories of foreign direct investment to this
phenomenon of ‘reverse direct investment’ (Jun, 1997). Macroeconomic models
like the 4-stage investment model which relate outward and inward investment to
the stage of development of the country developed by Dunning’s (1981) and the
technological accumulation model (Tolentino, 1993), location-specific advantage
theory (Lall, 1982; Giddy and Young, 1982) provide adequate explanations for the
phenomenon. However, several authors question whether conventional theories of
FDI are adequate to explain the overseas expansion of these ‘non-conventional’
MNEs, or whether new paradigms are warranted (Giddy and Young, 1982;
Ghymn 1980; Chen, 1983). Ghymn (1980) states that there is no simple theory to
explain the dynamics of the Third World Multinational phenomenon and several
studies offer only partial explanation. Chen (1983) notes that a careful synthesis of
the theories related to FDI is required to explain the phenomenon of
internationalization. Vardaraj (1987) notes that most of the theories of Foreign
Direct Investment focused on explaining the internationalization by developed
country firms from an economic viewpoint. Giddy and Young (1982) embark on a
re-examination of the theories of FDI and their application to Third World

12

CHAPTER 2

LITERATURE REVIEW

Multinationals. Interpreting the existing theory, they examine the conventional
theory of the growth of the MNE and its application to Third World
Multinationals.

Since this study is based on the theoretical debate surrounding the emergence of
Third World Multinationals, I discuss the application of some conventional
theories

to

these

‘unconventional

multinationals’

and

the

theoretical

underpinnings of the research.

2.2 Theoretical Aspects

2.2.1 Review of Theory of Monopolistic Advantages

Hymer’s dissertation forms the building block for explaining outward FDI by
firms. The monopolistic advantage theory of FDI advanced by Hymer (1960)
states that multinationals must possess a rent yielding asset (for example,
production know-how) which gives them a competitive edge over firms in their
home markets, as well as over indigenous firms abroad. Firms must possess a
monopolistic advantage in the form of a brand, proprietary R&D or technological
advantage. This advantage moreover should be transferable internationally.

Erramilli, Agarwal and Kim (1997) and Lall (1982) note that the application of the
theory of monopolistic advantage is not as straightforward to developing country
multinationals since the advantages which they posses are not the same as those
possessed by developed country firms. Erramilli, Agarwal and Kim (1997)

13


CHAPTER 2

LITERATURE REVIEW

suggest that MNEs from developed countries possess firm specific advantages that
differ from the firm specific advantages of developing country firms; in that, firm
specific advantages possessed by developing country firms are not absolutely akin
to those of firms from developed countries. While developed country firms obtain
their advantages from their size, experience, and technological and marketing
superiority, developing country firms possess a varied set of advantages of
indigenous technology, adaptive and low cost production facilities, skilled work
force and marketing and sales prowess. Wong (1985) terms these advantages as

‘oligopolistic advantages’ since they are diverse and many in number rather than
an absolute or monopolistic advantage.

Several firm level resources specific to Third World Multinationals have been
studied by researchers. According to Erramilli, Agarwal and Kim (1997) factors,
which arise due to the home country institutional environment, should be
considered in order to understand the competitive advantages of firms from
emerging economies. A further extension to their analysis is to incorporate
country-of-origin effects like family-ownership and operated conglomerates in
many Asian economies and corporate owned and operated businesses on one hand
and the effect of location on the other. Hoskisson et al. (2000) note that the
competencies of emerging economy MNEs develop in an environment of less
munificence, with a lack of strong market institutions, shortage of raw materials
and qualified manpower, poor access to technological inputs and poor intellectual
property rights. Firms from emerging economies overcome these problems related
to a poor institutional environment by organizing themselves into large diversified

14


CHAPTER 2

LITERATURE REVIEW

business groups. Business groups facilitate the allocation of product, capital, and
human resources in the absence of well-developed market institutions (Khanna
and Palepu, 1997).

2.2.2 Business Group Affiliation

Diversified Business Groups are an important feature of emerging economies.
These are defined as gatherings of formally independent firms under common
administrative and financial control (Khanna and Rivkin, 2001). Business groups
are a specific type of organization characterized by being (a) a collection of
legally separate firms operating in multiple strategically unrelated activities (b)
that are under common family ownership and control through a legal entity. In
addition to unrelated product diversification and familial control, some authors
(Peng, Lee and Wang, 2005) consider institutional relatedness an important
feature of Business Groups.

Ghemawat and Khanna (1998) explore some of the idiosyncratic characteristics of
the institutional environment of the Indian economy that led to the formation of
large business groups. According to the authors, the dominance of business groups
has continued through the 1990s, with companies affiliated to business groups
contributing up to 89% of the total sales and assets of over 4000 publicly listed
companies in the private sector. The authors suggest that policy distortions have
influenced the formation of business groups. They suggest that group structures
can evolve in response to such distortions, even ones that are not explicitly

15


CHAPTER 2

LITERATURE REVIEW

intended to encourage them. Some of the policies that they discuss are the
imposition of import controls in India in the fifties that forced trading-based firms
to enter new businesses. In the early 1960s, enforcement of licensing policies led
to significant additional diversification. The Industries Act (1951) required the

issuance of a license to set up a plant, to expand or relocate production, or to
introduce a new product.

The Monopolies and Restrictive Trade Practices Act (MRTP Act, 1969) was
enacted to control the dominance of a few large firms and encourage the smaller,
newer entrepreneurial ventures. The legislation required large firms to register as
MRTP Companies. The Monopolies and Restrictive Trade Practices legislation
(1969) forced large firms to expand into only prescribed priority sectors.
Throughout this period, regulatory restrictions on exit meant that if a group
entered an unprofitable business, it was forced to continue with it. This led to the
expansion of firms from one sector to another and formation of large groups,
controlled by a few families, which were diversified and controlled a major chunk
of the nation’s wealth.

Chang (2000) discusses in detail the domestic advantages that business group
affiliation confers on its affiliates. Some of these are (1) Sharing of Intangible
resources (2) Joint R&D expenses (3) Group wide Advertising (4) Crosssubsidization by either direct transfer of wealth or by subsidizing the transfer price
of intermediate goods (5) Investing in new ventures (6) Managerial talent and
other human resources. Hu (1995) studies the relationship between a firm’s

16


CHAPTER 2

LITERATURE REVIEW

domestic advantages and its advantages internationally. He studies the
transferability of firm specific resources that develop in the domestic context.

Wan (2005) notes the role of environmental differences amongst countries in the
study of international diversification. He describes economies as developed
economies, emerging economies, institution-driven economies and factor-driven
high growth economies as dissimilar country environments provide firms with
dissimilar country resources: factors (physical infrastructure: land, labor and
capital) and institutions (legal systems which provide resources for conducting
transactional activities between actors). Based on his framework he postulates that
the competitive strength of diversified firms are essentially institution based and
principally based on their capabilities in fostering social ties among a small,
closed group of economic or political actor. These capabilities are localized in
nature and are likely to dissipate in foreign countries because firms cannot transfer
their non-market capabilities to other countries.

Wright et al. (2005) suggest that business groups from emerging economies with
unrelated diversification engaged in exploration rather than exploitation of
knowledge in developed economies will be less successful than business groups
that are have a network structure or related diversification structure since a
decentralized structure is better suited to the emerging economies. Guillen (2000)
notes that many of the resources of large business groups may be situation specific
which evolve due to the relative underdevelopment of their home country.
However, anecdotal evidence (Encarnation 1982; Lall, 1982) suggests that

17