Cultural distance and the choice between wholly owned subsidiaries and joint ventures

Journal of Business Research 66 (2013) 2252–2261

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Journal of Business Research

Cultural distance and the choice between wholly owned subsidiaries and joint ventures☆ Cristina López-Duarte ⁎, Marta M. Vidal-Suárez University of Oviedo, Faculty of Commerce, Tourism and Social Sciences, Av. Luis Moya, 33203, Gijón, Spain

a r t i c l e

i n f o

Article history: Accepted 1 January 2012 Available online 25 February 2012 Keywords: Foreign direct investment Cultural distance Hofstede Schwartz GLOBE project Political risk Wholly owned subsidiary Joint venture

a b s t r a c t Most empirical research on the choice between joint ventures and wholly owned subsidiaries analyzes the role of cultural distance in an isolated way. This study explores the potential influence of some factors related to the diversity among countries that are traditionally associated with cultural distance but not explicitly included in measurements of cultural distance. Different approaches to and measurements of cultural distance are used in this analysis. This study examines the potential existence of a moderating or intensifying effect of third variables on the role played by cultural distance. The results confirm the contingent role of host country risk on the choice between equity joint ventures and wholly owned subsidiaries. © 2012 Elsevier Inc. All rights reserved.

1. Introduction The cultural distance (CD) between the home and host countries of a foreign investment is a variable traditionally considered in the literature dealing with the choice between joint ventures (JVs) and wholly owned subsidiaries (WOSs), starting with Gatignon and Anderson (1988) and Kogut and Singh (1988). The choice between JVs and WOSs arises once the foreign firm decides to enter the host market through an equity foreign direct investment (FDI), that is, once the firm decides to grow abroad by investing equity and setting up a subsidiary in the target country. A second decision must then be made: whether to share the ownership of such an affiliate with other firms (equity joint venture) or to maintain full ownership (wholly owned subsidiary). The literature on international business analyzes the role that CD plays in this choice; nevertheless, the empirical evidence is inconclusive. The recent and exhaustive revision of the literature by Dow and Larimo (2009) presents contradictory results—see also Brouthers and Brouthers (2001), Shenkar (2001), Harzing (2003), and Tihanyi, Griffith, and Rusell (2005) for additional reviews.

☆ Financial support from Spain's Ministerio de Ciencia y Tecnología (Project: ECO 2009-07786) is gratefully acknowledged. Comments by Enrique Loredo, University of Oviedo and Belén González, University of Oviedo, to an earlier draft were helpful in revising the paper. The authors alone are responsible for all limitations and errors that may relate to the paper. ⁎ Corresponding author. E-mail addresses: [email protected] (C. López-Duarte), [email protected] (M.M. Vidal-Suárez). 0148-2963/$ – see front matter © 2012 Elsevier Inc. All rights reserved. doi:10.1016/j.jbusres.2012.02.017

The study here contributes new empirical evidence by analyzing the influence of some differences between the home and the target in the form of geographical distance and differences dealing with language and economic development. The study explores the potential existence of an interaction effect between CD and third variables, in particular, a variable related to the formal environment of the host country: its political risk (PR). Therefore, the study focuses on the role that the target's formal and informal environment plays on the choice between WOSs and JVs. The empirical analysis uses a database covering 302 investments made between 1989 and 2003 by listed Spanish companies whose shares are traded on the Madrid Stock Exchange. These investments are located in 27 different countries, endowing the sample with a high degree of diversity related to cultural distance regarding Spain, other forms of distance between countries and host countries' political risk. This diversity, together with the fact that the home country is Spain, constitutes an additional advantage of this paper, as most empirical evidence on the choice of ownership structure tends to show a US bias, in which the US is the home or host country of investments (Brouthers & Brouthers, 2001). As Lau (2003) and Wei, Liu, and Liu (2005) state, patterns of internationalization and entry mode seem to differ depending upon some characteristics of the home and/or host countries. Following this introduction, Section 2 presents a review of the literature on the choice between WOSs and JVs. This review is based on Transaction Cost Theory (TCT) and focuses on the analysis of the relationship between cultural distance, political risk and investment choice. It reviews the concept and measurement of cultural distance while introducing the analysis of other factors conditioning the

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perceived environmental distance between countries and studying the existence of an interaction effect between CD and PR. Section 3 presents the methodology and data features and Section 4 presents the findings. Section 5 offers conclusions, limitations and suggestions for future research. 2. Literature review Transaction Cost Theory is a particularly suitable framework to analyze the role that external uncertainty plays in the internationalization process of firms as well as on the choice of the mode of investment—Zhao, Luo, and Suh (2004) and Brouthers and Hennart (2007) show that TCT is effective in explaining investment processes in international contexts that present a high level of external uncertainty. The cultural distance between two nations reflects existing differences in certain values, norms and behavioral rules between them (Shenkar, 2001). In the case of foreign investments, CD relates to the external uncertainty associated with the informal environment of the host country (Delios & Henisz, 2003; Henisz & Delios, 2002; Slangen & Van Tulder, 2009). These differences increase the liability of foreignness or the difficulties that the investing firm must overcome when it seeks to develop its activities in a new country. Although this source of external uncertainty arises as a decisive factor conditioning the choice between JVs and WOSs, the existing literature does not give definitive conclusions (Brouthers & Brouthers, 2001; Harzing, 2003; Shenkar, 2001). One possibility is that the investing firm prefers to invest through a joint venture to gain access to local knowledge and contacts related to the host country's informal environment. Because these are specific assets, the foreign investor may decide to share the project with a local partner who provides access to these specific resources. Among the most recent studies, Chang and Rosenzweig (2001); Yiu and Makino (2002); Tatoglu, Glaister, and Erdal (2003); Pak and Park (2004); Tsang (2005), and Quer, Claver, and Andreu (2007) show a preference for JVs over WOSs in high cultural distant contexts. However, greater cultural distance leads to higher transaction costs when cooperating with a local partner; thus, foreign investors may prefer to invest through a WOS to avoid these costs. Following Hennart (1988) and Erramilli and Rao (1993), the costs derived from negotiating a JV contract increase as cultural distance does: differences related to values, norms and behavioral rules make it more difficult to search for potential partners and complicate the negotiation process and the later enforcement of contracts. Investing through a WOS makes it unnecessary to cooperate with a partner whose decision and behavioral rules are not well known or understood by the foreign investor. Fisher and Ranasinghe (2001), Chen and Hu (2002), Tsang (2005) and Kim and Gray (2009) have recently presented empirical evidence supporting the foreign investors' preference for WOSs when investing in highly culturally distant host countries. Finally, Rajan and Pangarkar (2000), Luo (2001) and Demirbag, Tatoglu, and Glaister (2009) conclude that the CD between the two countries does not significantly affect this choice, while other papers show different results depending on the type of cooperative ventures (López-Duarte & García-Canal, 2002). Two main factors underlie the contradiction in the results: (I) existing studies on the choice between JVs and WOSs do not pay attention to some factors having to do with the diversity among countries that are associated with CD but are not explicitly included in its measurements (Demirbag, Tatoglu, & Glaister, 2007, 2009; Demirbag et al., 2009; Harzing, 2003); (II) most empirical studies analyze the effect of cultural distance on the investment mode choice in an isolated way, thus ignoring the moderating/intensifying effect of third variables on the role played by CD (Brouthers & Brouthers, 2001; Brouthers & Hennart, 2007; Cho & Padmanabhan, 2005).

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2.1. Cultural distance: traditional and recent approaches 2.1.1. Hofstede's approach The international business literature has traditionally used the cultural distance concept by Hofstede (1980, 2001) and the index by Kogut and Singh (1988) to measure the extent to which different cultures are similar or different. Hofstede (1980, 2001) defines culture as a set of “collective mental programs” shared by a group of people, with these programs differing from one group to another. Culture is thus what distinguishes one group from another. National culture refers to programs in which the identified group of people shares the same national environment. The studies by Hofstede (1980, 2001) identify and measure four main cultural dimensions: power distance, uncertainty avoidance, individualism and masculinity. Two new dimensions have been identified and measured in subsequent studies (Hofstede & Bond, 1988; Hofstede, Hofstede, & Minkov, 2010): long-term orientation and indulgence versus restraint. Power distance is the extent to which the less powerful members of institutions and organizations within a country expect and accept that power is unequally distributed. The power distance dimension thus refers to how a specific society handles inequalities. Uncertainty avoidance is the extent to which the members of a culture feel threatened by uncertain or unknown situations. When uncertainty avoidance is high, people seek to reduce uncertainty and limit risk by imposing rules and systems to bring about order and coherence; in other words, they have a need for structure. Individualism refers to people's behavior towards the group. Individualism pertains to societies in which the ties between individuals are loose—everyone is expected to look after him or herself. Collectivism, as its opposite, pertains to societies in which people need to belong to a group and have loyalty to the group. A high value in the individualism dimension implies that individual objectives and personal autonomy are more highly valued than socialization or commitment to collective activities. Masculinity pertains to societies in which social gender roles are clearly distinct; femininity pertains to societies in which social gender roles overlap. In a masculine society, there exists a stress on values traditionally associated with the masculine role (e.g., competition, success, wealth, ambition and performance goal orientation), whereas in a feminine society, there exists a stress on relationships, life skills and social performance. Long-term orientation (the Confucian dimension) stands for the fostering of virtues oriented towards future rewards, particularly perseverance and thrift. On the contrary, short-term orientation stands for the fostering of virtues related to the past and present. Indulgence versus restraint: Indulgence stands for a tendency to enable the relatively free gratification of basic and natural human desires associated with enjoying life and having fun. Restraint reflects a conviction that such gratification needs to be regulated by strict social norms. The Kogut and Singh index is based on deviation along these cultural dimensions: i ¼ n h
 i CDj ¼ ∑ Iij −Iis =Vi =n i¼1 where CDj is the cultural distance of the jth country from the home country; Iij represents the index of the ith cultural dimension and the jth country; s represents the home country and Vi represents the variance of the index of the ith dimension; and n is the number of cultural dimensions. 2.1.2. Schwartz's approach Schwartz (1994, 1999) and Siegel, Licht, and Schwartz (2008) analyze different types of values by considering three issues faced by

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every society: the individual-group relationship, individuals' responsible social behavior and the relationship between humankind and the natural and social worlds. Based on these value types, Schwartz identifies three dichotomous dimensions that express opposite resolutions for each of these issues: embeddedness/autonomy, hierarchy/egalitarianism and mastery/harmony. The embeddedness/autonomy dimension concerns the relationship between the individual and the group. One pole of this dimension, embeddedness, describes cultures in which individuals identify with the group and share a way of life. In contrast, autonomy represents a cultural emphasis on the individual's independence. Each individual is viewed as unique and is encouraged to express his/her uniqueness. The hierarchy/egalitarianism dimension refers to the different means of guaranteeing individuals' responsible behavior and bringing about cooperative activity in society. One solution to this problem is hierarchy, a system that is based on power differences and ascribes roles to individuals. This system supports social power, authority, humility and obedience. The opposite solution for this issue is egalitarianism, a system that encourages individuals to voluntarily cooperate with others and recognize them as moral equals. This system supports equality, social justice, responsibility and honesty. The mastery/harmony dimension concerns the relationship between humankind and the natural and social world. Mastery refers to the cultural emphasis on mastering, changing and exploiting the natural and social environment to foster personal or group interests. In contrast, harmony refers to individuals' interest in accepting the world as it is and their desire to fit in the natural and social environment, rather than changing or exploiting it. 2.1.3. GLOBE's approach The recent GLOBE project (House, Hanges, Javidan, Dorfman, & Gupta, 2004) analyzes cultural differences, taking as its basis societies rather than countries. This is relevant because, in some countries, there are strong subcultures based on the ethnicity of origin, language, or geography; in South Africa or Canada, for instance, two significantly different cultures can be found, depending on the language spoken or individuals' ethnicity. The GLOBE project assesses nine attributes or cultural dimensions to both societal and organizational cultures: assertiveness, institutional collectivism, in-group collectivism, future orientation, gender egalitarianism, humane orientation, performance orientation, power distance and uncertainty avoidance. Assertiveness is the degree to which societies encourage individuals to be tough and competitive. Individuals in societies with high assertiveness tend to have a “can-do” attitude and be dominant, even aggressive, in their relationships. Institutional collectivism refers to the degree to which societal institutions support and reward collective action and encourage the collective distribution of resources. In-group collectivism is the extent to which individuals of a country take pride in their membership in groups (family, sports team or company, for example). Power distance and uncertainty avoidance are similar to the constructs of the same name used by Hofstede. Gender egalitarianism is the degree to which a society minimizes gender role differences. Performance orientation is the degree to which societies encourage individuals to performance improvement and excellence. Future orientation is the degree to which individuals in a society plan and invest for the future. Humane orientation is the degree to which individuals in a society take care of the needs of other people, especially those of the weak and vulnerable. A society with a high humane orientation encourages individuals to be altruistic, generous, caring and kind to others. This project measures cultural dimensions related to both values and practices for each society. Values are measured through answers

to “should be” questions, whereas practices are measured through answers to “as is” questions. 2.2. Informal environment: other forms of distance between nations Most empirical studies on the choice of investment mode do not pay attention to some factors related to the diversity among countries that are not explicitly included in the CD concept (Dow & Larimo, 2009). Therefore, it becomes advisable to revisit the notion of “psychic distance” (Johanson & Vahlne, 1977; Johanson & WiedersheimPaul, 1975) and to incorporate other environmental measurements that make a country seem similar (dissimilar) to the home market. Some recent papers analyze the influence of some of these factors. Most of these papers follow the theoretical framework provided by Institutional Theory—see, for instance, Delios and Beamish (1999), Davis, Desai and Francis (2000), Meyer (2001), Lu (2002), Tatoglu et al. (2003), Meyer and Nguyen (2005) and Dow and Larimo (2009). This theory focuses on institutional differences as a main factor conditioning the choice of investment mode. As Yiu and Makino (2002) and Demirbag et al. (2007, 2009) note, these differences are likely to influence transaction costs. Economic and industrial differences between the home and host countries constitute a first factor to be taken into account. These differences influence communication processes between the foreign investor and the local partners and introduce additional risk into international transactions. In this way, these differences increase the costs and difficulties associated with these transactions. Language differences are also a relevant factor conditioning perceived environmental distance. The existing literature analyzing the role of language on internationalization patterns—see Demirbag et al. (2007) for a review—points to this factor as one of the main sources of conflict in international business administration: in multinationals that show a high degree of linguistic diversity, language can emerge as a source of power for some individuals and lead to factions within the firm. Although cultural and linguistic kinship (or distance) are clearly connected (Laulajainen, Abe, & Laulajainen, 1993), language diversity between countries may condition the perceived cultural distance between them through “cultural accommodation” or “ethnic reinforcement” processes (Harzing, 2005; Harzing & Maznevski, 2002). Among others, studies by Laulajainen et al. (1993), Dow and Karunaratna (2006), Demirbag et al. (2007) and Harzing and Feely (2008) provide evidence of the influence of language distance on different internationalization decisions. A third factor is geographical distance. Although this is highly correlated with cultural distance for some pairs of countries, this is not always the case (Harzing, 2003). For example, the cultural distance between Spain and Latin American countries is low, while there is great geographical distance between them. In contrast, the cultural distance between Spain and some of its European neighbors is fairly high. Although the existing literature has analyzed the influence of geographical distance on the role played by different subsidiaries in a multinational's network (Harzing & Noorderhaven, 2006) or in market selection (Dow & Karunaratna, 2006), this factor remains mostly neglected in the literature on investment mode choice. Some of these forms of distance between countries may relate highly with cultural distance (Demirbag et al., 2009; Harzing, 2003). Therefore, it becomes particularly relevant to include these differences in the analysis: in studies that do not include them, the cultural distance variable may act as a proxy for these differences. 2.3. The moderating/intensifying effect of the formal environment on the role played by cultural distance When making a foreign investment, the foreign investor must deal with a second source of external uncertainty: the host country's formal environment. This refers to the risk that the investing company

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perceives in the formal institutional environment of the host country. Existing literature has traditionally measured this risk using the concept of political risk—see Ahmed, Mohamad, Tan, and Johnson (2002) and Zhao et al. (2004) for exhaustive reviews of the influence of international risk on the choice of investment mode. PR is defined as the likelihood of an unfavorable change in the governmental regime of the country and/or an unfavorable change in its policies (Henisz, 2000). A higher volatility associated with the target country is associated with a greater difficulty for the foreign investor of obtaining, interpreting and organizing the necessary information to successfully carry out an investment (Delios & Henisz, 2003). Once again, when analyzing the influence of this factor on the choice of investment mode, two opposing theoretical perspectives arise. The first is that foreign investors may prefer equity joint ventures over wholly owned subsidiaries when the formal external environment is highly uncertain: by investing through a JV, the foreign investor limits its commitment of resources on the host country and shares risk with (at least) a second partner. Additionally, JVs are more flexible as entry modes than WOSs, as JVs can be more easily dissolved: the foreign investor's partial commitment in the FDI facilitates future disinvestment when unfavorable changes take place in the formal environment. The second theoretical perspective states that volatility in the host country's formal environment may make it impossible for the foreign investor to anticipate all contingencies or to negotiate and enforce cooperative agreements (Agarwal, 1994; Brouthers & Brouthers, 2001). As Meschi and Riccio (2008) note, an increase in host country risk can alter the subtle balance of contributions, roles and benefits between local and foreign partners. Therefore, in highly uncertain formal environments, foreign investors will prefer wholly owned subsidiaries over joint ventures. In spite of the existence of two contradictory theoretical approaches, empirical evidence related to the effect of political risk on this choice is quite conclusive: the meta-analysis by Zhao et al. (2004) shows the scarce probability of investing through a WOS in contexts of high risk—see also Akhter and Lusch (1988); Hill, Hwang, and Kim (1990); Agarwal and Ramaswami (1992); Kim and Hwang (1992); Erramilli and Rao (1993); Aulakh and Kotabe (1997); Delios and Beamish (1999); Arora and Fosfuri (2000); Delios and Henisz (2000); Henisz (2000) and Shrader, Oviatt, and McDougall (2000). However, a few studies exist that show a nondecisive influence of host country risk on investment mode choice (Nakos & Brouthers, 2002; Pinho, 2007) and/or point to the existence of a moderating effect of third variables in the relationship between country risk and mode of investment (Slangen & Van Tulder, 2009; Tsang, 2005). Studies analyzing the effect of external uncertainty on the choice between WOSs and JVs have traditionally analyzed uncertainty coming from the formal environment (political risk) or the informal one (cultural distance) in an isolated way, thus ignoring the moderating/intensifying role that third variables can play (Harzing, 2003). Moreover, the moderating/intensifying effect of each one of these two variables on the role that the other one plays remains almost

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unexplored in the literature. The papers by Agarwal (1994) and Brouthers and Brouthers (2001) represent two empirical attempts to analyze the interaction effect between cultural distance and political risk on the investment mode choice. Whereas the former fails to find significant results regarding this effect, the latter finds a preference for wholly owned subsidiaries in international contexts characterized by both high political risk and high cultural distance. As the authors state, these results may be contingent on the analyzed investments, as the study focuses on entry decisions made by Western companies in five Central and Eastern European countries. As mentioned above, the empirical literature has produced conclusive results proving that foreign investors prefer JVs over WOSs when investing in countries where the level of political risk is high. Therefore, one of the proposals related to cultural distance (the preference for WOSs over JVs) becomes less likely when the host country's formal environment carries a high degree of political risk. When host country risk is high and cultural distance increases, foreign investors should prefer investing through JVs rather than through WOSs to avoid the multiplying or interaction effect of both sources of external uncertainty.

3. Empirical analysis 3.1. Database and methodology The database collects investments made through joint ventures and wholly owned subsidiaries between 1989 and 2003 by listed Spanish companies whose shares are traded on the Madrid Stock Exchange. As outward foreign direct investment was not definitively liberalized in Spain until the end of the 80s, the database collects all investments made by listed Spanish companies up to 2003. Following the application of different filters, the final sample is composed of 302 entry decisions. These investments were made by 63 different firms and are located in 27 different countries—see Table 1 for a breakdown of host countries. Investments located in host countries that pose legal constraints to full ownership by foreign investors and those related to privatization processes were eliminated from the database, as in both cases the foreign investor is not free to choose the mode of investment. The second part of the 90s accounts for a very high volume of investments. Latin America is the host region that received the highest volume—over 30% of entry decisions in the database—followed by the European Union and other OECD countries. In terms of industry, different kinds of services account for more than 70% of the collected investments (see Table 2). In particular, banking and financial services and regulated services account for more than half of the investments in the database—the regulated industries category groups activity sectors that were traditionally regulated and have been increasingly deregulated in recent decades, such as air transport, communications and energy. Within the manufacturing category, the majority of investments are related to the food and beverage, textile and machinery industries.

Table 1 Breakdown of host countries. Host country

Investments

Investing firms

Host country

Investments

Investing firms

Host country

Investments

Investing firms

Argentina Australia Austria Brazil Canada Denmark Finland France Germany

47 1 7 21 5 3 1 17 20

14 1 6 13 2 2 1 12 16

Greece Hungary Ireland Israel Italy Japan Korea Mexico Netherlands

1 3 2 1 16 2 1 35 7

1 3 2 1 10 2 1 17 4

Philippines Poland Portugal Russia Singapore Switzerland U. Kingdom USA Venezuela

6 5 39 1 1 1 15 35 9

5 4 15 1 1 1 13 18 6

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Table 2 Breakdown of industries. Industry

FDIs

%

Manufacturing Banking and financial services Regulated services Other services

84 67 112 39

27.8 22.2 37.1 12.9

3.2. Dependent variable Several binomial logistic regression models have been estimated. The dependent variable, mode of entry, is a dichotomous variable that takes the value 1 when the investment has been made through a WOS and 0 otherwise. Following previous research, a firm's ownership share over 95% of equity is defined as full ownership and ownership share in the 10–95% is defined as shared ownership. Ownership shares under 10% have not been included in the database, as they can be understood as portfolio rather than direct investments. In these models, the likelihood that the investment is made through a wholly owned subsidiary is explained by the independent variables defined below. 3.3. Independent and control variables 3.3.1. Independent variables The cultural distance between Spain and each host country has been measured through different variables based on Hofstede's, Schwartz's and GLOBE's (practices and values) cultural dimensions; the Kogut and Singh Index has been used to integrate individual dimensions. The study here includes two different models based on Hofstede's dimensions: one based on the four initial dimensions and a second one based on six dimensions. The economic development distance variable seeks to approach differences in economic development between Spain and the host countries collected in the database. It has been measured as the ratio of each host country's Gross Domestic Product (GDP) to Spain's GDP in each year of the period (both measured in constant 1990 dollars). The annual GDP growth rate for each host country has also been included. Information on both variables has been obtained from reports by the World Bank. The linguistic distance variable seeks to approach the existence of a barrier or linguistic diversity between Spain and the host nations. This variable is based on the scale of language diversity proposed by Dow and Karunaratna (2006), which is based, in turn, on Grimes and Grimes (1996). This is a 5-point scale that focuses on the differences and similarities between languages, grouping them in families, branches within families and further into sub-branches. This scale has been slightly modified to take into account the particularly high incidence of the English language within Spain. The geographical distance between Spain and each host country has been measured through the flying distance between the capital of Spain and the capital of each host country; this variable has been introduced in logarithmic form in the model. When dealing with political risk, we have followed two different steps: first, we have measured it using Euromoney Risk Ratings over the period of study. Euromoney ratings are annual country risk ratings that account for political risk. These ratings use a scale from 0 (lowest stability or highest possible risk) to 100 (lowest risk). To make it easier to interpret coefficients relative to this variable, we have transformed this variable into 100—Euromoney Risk Rating. In this way, a higher value of the PR variable represents higher host country political risk. Then, to facilitate the analysis of the interaction effects between CD and PR, the latter variable has been transformed into a dichotomous variable that takes the value 1 when the host country is riskier than Spain in the year of investment and

0 otherwise. A second measurement of political risk has been considered to check for the robustness of our study: the annual panel POLCON V by Henisz (2000). Different interaction effects between each of the CD variables and the PR variable have been estimated. With the aim of increasing the interpretability of these interaction effects and avoiding multicolinearity problems, CD and PR variables have been mean centered. The mean value of each new centered variable is thus 0. 3.3.2. Control variables Several control variables have been included in the analysis to control the effect of some factors on the choice between WOSs and JVs. First, different variables related to investing firms' characteristics have been included, in particular, their size and experience. The size of the investing firms has been measured through their market capitalization calculated on December 31 of the year preceding the investment. A logarithmic transformation of this variable has been calculated, as the market capitalization of publicly traded companies is widely accepted as a proxy for size; see, for instance, McConnell and Nantel (1985); Chan, Kensinger, Keown, and Martin (1997); Chen, Ho, Lee, and Yeo (2000) and Merchant and Schendel (2000). Regarding each investing firm's experience, a variable has been introduced collecting its experience with regard to each host country. Investing in a country enables a firm to gain experience and knowledge regarding that country; according to Chang and Rosenzweig (2001), the firm increases its familiarity with the host country's culture. Such familiarity, in turn, diminishes the effect of cultural distance. On the contrary, when the foreign firm carries out its first investment in the host country, thus lacking such experience and familiarity, the effect of cultural distance is more noticeable. Therefore, the experience related to each host country that is accrued by the foreign investor arises as a factor influencing internationalization decisions—see, for instance, Morck and Yeung (1991); Chang (1995); Ueng, Kim, and Lee (2000) and Delios and Beamish (2001). For the analysis, this experience has been measured as the number of months between the first investment in the host country made by the investing company and the investment collected in the database. Information on previous investments made by each company has been obtained from corporate reports. The number of months, rather than the number of years (most frequently used in the literature), has been accounted to more precisely measure the Spanish firms' experience, bearing in mind the high time concentration of Spanish outward foreign direct investment flows. Industry dummy variables have also been included in the model to control the potential influence of industry on the choice between WOSs and JVs. Table 3 shows the correlations matrix of the variables. Pairwise correlations among the different cultural distance indices show that not all of them are equally and significantly correlated. Both indexes, based on Hofstede's dimensions, are highly correlated with the Schwartz and GLOBE indexes (higher than 0.5 in almost all cases). In the same way, the two GLOBE indexes (values and practices) are significantly correlated at 0.65. However, the Schwartz index shows a particularly low correlation with GLOBE practices (0.14) and just a moderate correlation with GLOBE values (0.36). Some of these results are consistent with existing literature—see, for instance, studies by Drogendijk and Slangen (2006) and Larimo and Dow (2009), focusing on Dutch and Nordic firms, respectively. In contrast, other results are quite different: for instance, the pairwise correlation between both GLOBE dimensions is low in Larimo and Dow (2009). These results provide additional empirical evidence of an only partial overlap between the three cultural frameworks; they also confirm the existence of very large differences depending on which country is used as reference when estimating cultural distances. Pairwise correlations between cultural distance variables and variables related to other environmental differences show interesting

0.4 0.48 0.3 0.45 0.2 0.42 9.3 0.91 3.0 2.68

− 0.05 0.18** − 0.19** − 0.17** − 0.08 − 0.17** − 0.17** 0.01 − 0.17** 0.07 1 − 0.16** 0.26** − 0.01 0.24** 0.43** − 0.21** 0.06 0.18** − 0.30** 1

3.5 0.47

0.26** − 0.45** 0.37** 0.13* 0.04 0.65** 0.60** 0.02 1

2.3 1.37

Tables 4a, 4b and 4c report results from different logistic regression models. Regressions have been estimated using different measures of cultural distance and political risk. Due to the high pairwise correlation between the variable related to economic development distance and different variables related to cultural or geographical distance, estimations were repeated excluding the former. In the same way, taking into account the high pairwise correlation between the variable related to linguistic distance and both GLOBE indexes, new models were estimated excluding the linguistic distance variable. Because the results remain robust across different models, the authors have opted to keep all variables in estimated models.

Econ. Dist.

0.01 − 0.61** 0.29** 0.20** 0.35** 0.05 0.40** 1

2.6 0.63

GLOBE values

0.21** − 0.57** 0.57** 0.51** 0.36** 0.65** 1

0 0.47

GLOBE Pract.

0.21** − 0.57** 0.63** 0.41** 0.14* 1

0 0.85

Schwartz

0.05 − 0.13* 0.54** 0.52** 1

0 1.12

16.4 33.24

Host country Exp. Geogr. Dist Ling. Dist.

4. Results and discussion

Table 4a Logistic regression estimates of investment mode choice (WOSs = 1). Political risk based on Euromoney rankings—continuous variable. Model 3 Model 4 Model 5 Model 2 Model 1 GLOBE Hofstede Hofstede Schwartz GLOBE practices value 4 dimens. 6 dimens. Constant Political risk Cultural distance

4.01 .01 (.02) .57⁎⁎

4.79 .01 (.02) .88⁎⁎⁎

Cultural distance ∗ political risk Economic development distance Linguistic distance

(.24) −.02⁎ (.01) −.05 (.35) .25⁎⁎

0 0.63

0.16** − 0.32** 0.86** 1

Hoftede 6

Geographical distance Host country experience

0 0.76 0 0.49

Manufacturing Other services Model X2 Correctly classified (%) − 2loglikelihood R2 Nagelkerke ⁎⁎ p b 0.1.

0.3 0.46

0.25** − 0.57** 1 − 0.18** 1

Size Financial services

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 Mean SD

1

Hofstede 4 Wholly owned sub.

Political risk

GDP growth rate

Table 3 Correlations matrix.

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results. While both GLOBE measurements seem to approach linguistic differences among countries (the correlation between the LD variable and both GLOBE indexes is higher than 0.6), it becomes clear that Schwartz's cultural dimensions collect almost no information about such differences (the correlation is less than 0.1). Something similar seems to happen with the remaining variables related to economic or geographical differences between countries. It becomes clear that CD variables may act as proxies for these differences when they are not explicitly included n the analysis. Meeting expectations, the economic development distance variable correlates highly with variables relating to political risk. This variable also shows a high pairwise correlation with the geographical distance variable, which is because most Spanish FDIs in emerging countries are located in Latin America, whereas most of the investments in highly developed countries are located in the European Union.

− 0.08 − 0.20** 0.04 0.01 0.05 0.05 0.06 0.17** − 0.04 − 0.08 − 0.08 − 0.09 − 0.27** − 0.21** − 0.24** − 0.30** 1 0.1 0.34 − 0.25** 0.13* − 0.18** − 0.11 − 0.07 − 0.11 − 0.09 − 0.03 − 0.18** 0.29** 0.20** 0.15* 0.58** − 0.41** − 0.48** 1 0.09 0.10 0.05 0.06 − 0.06 − 0.08 − 0.11* − 0.14* − 0.04 − 0.15* 0.00 0.00 0.14* 1 − 0.21** 0.21** − 0.14* − 0.04 − 0.06 − 0.16** − 0.16** − 0.08 − 0.12* 0.21** 0.30** 0.21** 1 0.01 0.08 − 0.01 0.08 0.17** − 0.00 0.08 − 0.03 − 0.02 0.21** − 0.02 1

0.24** − 0.08 0.12* 0.05 0.09 0.15** 0.16** 0.03 0.25** − 0.12* − 0.15** − 0.09 − 0.55** − 0.33** 1

Finance Size GDP growth

Manufac

Reg. ind

Other services

C. López-Duarte, M.M. Vidal-Suárez / Journal of Business Research 66 (2013) 2252–2261

(.30) −.03⁎⁎ (.01) −.02 (.35) .24⁎⁎

4.20 .01 (.02) .08 (.15) −.03⁎⁎⁎ (.01) −.34 (.35) .55⁎⁎⁎

2.08 −.01 (.02) .18 (.30) −.00 (.01) −.02 (.36) .24⁎

(.11) −.81 (.58) .01 (.01) .10 (.07) −.39 (.24) .97⁎⁎

(.11) − 1.07⁎ (.62) .01 (.01) .09 (.07) −.37 (.24) .94⁎⁎

(.15) −.74 (.59) .01 (.01) .06 (.06) −.40⁎ (.24) 1.02⁎⁎

(.13) −.15 (.55) .00 (.01) .07 (.06) −.41⁎

(.41) .96⁎⁎ (.48) −.12 (.58) 57.41⁎⁎⁎ 75.8 310.53 0.25

(.41) .96⁎⁎ (.48) −.11 (.58) 57.97⁎⁎⁎ 75.2 309.97 0.25

Standard errors are in parentheses. ⁎ p b 0.1. ⁎⁎ p b 0.05. ⁎⁎⁎ p b 0.01.

3.74 −.00 (.02) .61 (.48) −.04⁎ (.02) −.13 (.34) .13 (.15) −.66 (.59) .01 (.01) .08 (.06) −.36 (.24) 1.05⁎⁎⁎

(.40) .97⁎⁎ (.48) −.17 (.58) 56.08⁎⁎⁎

(.24) 1.06⁎⁎⁎ (.40) .90⁎ (.48) −.22 (.57) 47.18⁎⁎⁎

(.40) 1.02⁎⁎ (.48) −.17 (.57) 51.32⁎⁎⁎

74.5 311.86 0.24

73.5 320.76 0.21

72.8 316.61 0.22

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The Chi 2 of estimated models is statistically significant at 99% in all cases and different observations are satisfactorily classified at percentages ranging from 72.5% to 76.2%. This implies an at least 15% improvement over the chance rate which is 58.1% in this study—the chance rate equals a 2 + (1 − a) 2, where a is the proportion of WOSs in our sample (29.8% ). The results in Tables 4a, 4b and 4c show that CD does not always play a relevant role in the choice of investment mode in an isolated way but does play a role through its interaction effect with political risk. Regarding the variables measuring other differences related to the informal environment, one variable seems to play a key role on the choice of investment mode: the LD variable shows a positive and statistically significant coefficient across different models. The coefficient of the LD variable is statistically significant in models based on Hofstede, Schwartz and GLOBE values; in contrast, it shows no statistical significance when cultural distance is measured through the GLOBE values index. These results indicate a preference for wholly owned subsidiaries when investing in host countries whose majority language is different from Spanish. This result is in line with Arora and Fosfuri (2000) and Harzing and Feely (2008); in contrast, Dow and Larimo (2009) find that linguistic distance does not statistically influence this choice. When investing through a JV, the potential role the local partner plays in reducing external uncertainty critically depends on his/her relationship with the foreign investor. This relationship is, in turn, language dependent. Language diversity between the two partners may not only hinder successful communication between them but also emerge as a critical source of conflicts related to the choice of the functional language of the venture, the creation of factions within the venture and the use of language by some individuals as a source of power, thus modifying the intended hierarchy of the venture—see Tallman and Shenkar

(1994) and Luo (2001) for an exhaustive review. Therefore, when language diversity exists, foreign investors prefer to invest through WOS and avoid collaborating with a local partner. Variables relating geographical distance and distance relate to economic development do not show robust results, as they are statistically significant only in some estimated models. The results regarding the distance related to economic development are in line with Demirbag et al. (2009) but not with Dow and Larimo (2009). In a similar way, geographical proximity seems to play a key role in the outward foreign investment by firms coming from different countries, such as China or Korea (Buckley, Clegg, Cross, Liu, Voss, & Zheng, 2007; Fung, García-Herrero, & Siu, 2009). In summary, other forms of distance not explicitly embedded in cultural distance frameworks influence the investment mode choice and condition the role played by CD. However, it seems that not all forms of distance are equally relevant, at least in the case of Spanish foreign investors. When referring to the host country's formal environment, the results clearly point towards the existence of a moderating/intensifying effect of political risk in the role CD plays on this choice: the interaction effect between the two variables shows a negative and statistically significant coefficient when using all cultural distance measurements except for GLOBE practices (see Tables 4a and 4b). Although there are few studies using the three different frameworks to measure cultural distance between countries, it seems particularly interesting that they usually show a consistent performance between frameworks using Hofstede, Schwartz or GLOBE values, but a differentiated performance for GLOBE practices—see Larimo and Dow (2009) for a review. These results provide strong support for the role of PR as a moderator of the influence of cultural distance on the choice between wholly owned subsidiaries and joint ventures: when political risk is high

Table 4b Logistic regression estimates of investment mode choice (WOSs = 1). Political risk based on Euromoney rankings—dummy variable.

Constant Political risk Cultural distance Cultural distance ⁎ political risk Economic development distance Linguistic distance Geographical distance Host country experience GDP growth rate Size Financial services Manufacturing Other services Model X2 Correctly classified (%) − 2loglikelihood R2 Nagelkerke Standard errors are in parentheses. ⁎ p b 0.1. ⁎⁎ p b 0.05. ⁎⁎⁎ p b 0.01.

Model 1 Hofstede (4)

Model 2 Hofstede (6)

Model 3 Schwartz

Model 4 GLOBE practices

Model 5 GLOBE values

2.83 −.21 (.54) .35 (.27) −.98⁎ (.50) −.22 (.34) .26⁎⁎

3.32 −.34 (.52) .61⁎⁎ (.29) − 1.37⁎⁎ (.55) −.25 (.34) .22⁎

2.26 −.99** (.48) −.02 (.16) − 1.21⁎⁎⁎ (.37) −.88⁎⁎ (.38) .49⁎⁎⁎

2.46 −.71 (.54) .01 (.33) −.15 (.49) −.23 (.34) .23⁎

(.12) −.35 (.38) .01 (.01) .09 (.07) −.39 (.24) .97⁎⁎

(.12) −.45 (.41) .01 (.01) .09 (.07) −.39 (.24) .93⁎⁎

(.15) .14 (.43) .01 (.01) .07 (.06) −.37 (.24) .99⁎⁎

(.14) −.19 (.36) .01 (.01) .08 (.06) −.38 (.24) 1.11⁎⁎⁎

3.39 −.56 (.49) .51 (.49) − 1.46⁎ (.80) −.37 (.33) .08 (.15) −.35 (.37) .01 (.01) .08 (.06) −.37 (.24) 1.04⁎⁎⁎

(.41) .99⁎⁎ (.50) −.14 (.58) 58.33⁎⁎⁎

(.41) .98⁎⁎ (.49) −.17 (.58) 59.82⁎⁎⁎ 76.2 308.12 0.26

(.41) 1.02⁎⁎ (.50) −.29 (.59) 61.98⁎⁎⁎

(.40) 1.01⁎⁎ (.49) −.18 (.57) 48.73⁎⁎⁎

(.40) 1.04⁎⁎ (.49) −.17 (.58) 53.46⁎⁎⁎

75.8 305.95 0.26

74.5 319.21 0.21

73.2 314.48 0.23

73.8 309.60 0.25

C. López-Duarte, M.M. Vidal-Suárez / Journal of Business Research 66 (2013) 2252–2261 Table 4c Logistic regression estimates of entry mode choice (WOSs = 1). (Political risk based on the annual panel POLCON V by Henisz (2000)—dummy variable). Model 3 Model 4 Model 5 Model 2 Model 1 GLOBE Hofstede Hofstede Schwartz GLOBE practices value 4 dimens. 6 dimens. Constant Political risk

4.31 −.30 (.34) .74⁎⁎⁎

4.79 −.39 (.34) .86⁎⁎⁎ (.29) −.66 (.51) −.15 (.25) .24⁎⁎ (.11) −.73⁎

Size

(.23) −.71⁎ (.41) −.25 (.26) .21⁎ (.11) −.55 (.35) .01 (.01) .08 (.07) −.55⁎

Financial services

(.35) .89⁎⁎

Cultural distance Cultural distance ⁎ political risk Economic development distance Linguistic distance Geographical distance Host country experience GDP growth rate

Manufacturing Other services Model X2 Correctly classified (%) − 2loglikelihood R2 Nagelkerke

(.39) .01 (.01) .08 (.06) −.44⁎

3.80 −.13 (.32) .12 (.15) −.51⁎

2.36 .04 (.31) .17 (.24) −.67⁎

(.28) −.12 (.27) .37⁎⁎⁎ (.11) −.43 (.39) .00 (.01) .06 (.06) −.48⁎⁎

(.38) .10 (.24) .28⁎⁎ (.13) −.39 (.33) .00 (.01) .08 (.06) −.39⁎

(.24) .96⁎⁎

(.24) .97⁎⁎ (.40) .81⁎ (.48) −.25 (.57) 50.30⁎⁎ 74.2 317.64 0.22

(.40) .75 (.48) −.40 (.58) 58.04⁎⁎⁎

(.24) .88⁎⁎ (.40) .75 (.48) −.38 (.57) 55.54⁎⁎⁎

(.40) .72 (.48) −.36 (.57) 50.11⁎⁎⁎

74.5 309.54 0.25

75.8 312.40 0.24

75.5 317.82 0.22

3.59 −.08 (.32) .74 (.47) − 1.30⁎ (.68) −.19 (.28) .14 (.15) −.50 (.35) .00 (.01) .08 (.06) −.37 (.24) .91⁎⁎ (.41) .83⁎ (.48) −.28 (.57) 51.91⁎⁎⁎ 72.5 316.03 0.22

Standard errors are in parentheses. ⁎ p b 0.1. ⁎⁎ p b 0.05. ⁎⁎⁎ p b 0.01.

and CD increases, foreign firms prefer to invest through JVs rather than through WOSs. When the foreign investment's environment is characterized by both sources of external uncertainty, foreign investors show a preference for entry modes that provide higher flexibility and lower resource commitment and that enable risk-sharing with a partner that is familiar with the host country's formal and informal environment. To test the robustness of the results related to this interaction effect, regression models were repeated using a second measurement of political risk: the annual panel POLCON V by Henisz (2000), which approaches the degree of democracy or political freedom within a country. The results on the interaction effect between cultural distance and political risk are robust across different models (see Table 4c). Regarding industrial variables, the manufacturing and financial services variables show a positive and statistically significant sign in all estimated models. This is a robust result that suggests that Spanish firms competing in these industries prefer the mode of investment offering the greatest control when investing abroad. In contrast, neither the firm's host country experience nor its size shows statistical significance. Although they are not especially divergent from existing literature—see, for instance, Meyer (2001); Lu (2002) and Dow and Larimo (2009)—some of these results are quite challenging and represent a basis for new studies. As Brouthers, Brouthers, and Werner (2002) and Sánchez-Peinado, Pla-Barber and Hébert (2007) state, the role played by political risk and cultural distance on the choice between JVs and WOSs may differ between manufacturing and service firms. A split of a larger database into manufacturing and service industries would enable further exploration of this issue and the role of the interaction effect between the two sources of external uncertainty.

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5. Conclusions This study explores how different forms of distance between countries (economic, geographical and linguistic) may condition the role that cultural distance plays in the choice of investment mode. The paper also studies the potential existence of a moderating effect of third variables on the role CD plays. The analysis is based on different cultural frameworks. This study provides conclusive results relative to the need to include in the analysis other forms of distance between countries (not only the cultural distance) and the target country risk's contingent role. In particular, our results point towards language difference as a main factor driving the choice between WOSs and JVs. The results also hint at the existence of an interaction effect between informal and formal sources of external uncertainty (cultural distance and political risk), leading to a preference for JVs over WOSs when the environment is characterized by both high PR and CD. In such a context, foreign investors show a preference for entry modes that allow sharing risks with a second partner, provide high flexibility and imply a low commitment of resources. This study also provides new empirical evidence showing that (I) different cultural frameworks show only a partial overlap and that (II) when measuring cultural distance, there exist significant differences depending upon which country is used as reference. However, the particular features of the sample may somehow be influencing the outcomes. Just over half of the investments collected in the database are located in OECD countries and approximately 40% are located in Latin American countries. OECD countries carry a very low degree of political risk, while Latin American countries show a very low degree of cultural distance from Spain. It becomes advisable to carry out new studies including different home nations as well as host nations which are characterized by both high political risk and high cultural distance from the foreign investor's home country. Although necessary, this is not an easy task; for example, Buckley et al. (2007) and Kolstad and Wiig (2012) report Chinese foreign investment to be associated with high levels of political risk but low cultural and/or geographical distance, while Brouthers and Brouthers (2001) performed their analysis on host countries that shared cultural and political features. A split of a larger database into different host regions would also be interesting. Future research would be helpful that allow for a split of the database to analyze the differentiated effect of CD and PR on the choice of investment mode for manufacturing and service firms, as well as studies including a wider range of entry modes and thus enabling the use of different statistical techniques. Additionally, new studies developing an in-depth analysis of the reasons underlying each particular investment are also necessary. As some researchers have shown, problems derived from cultural or psychic distance can be offset by the benefits of accessing strategic assets or technological skills—see, for instance, Liu and Tian (2008) for the particular case of Chinese investment. Therefore, the study of the motives underlying the investment as a moderator to cultural distance arises as a particularly interesting issue for future research.

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