State ownership effect on firms' FDI ownership decisions under institutional pressure: a study of Chinese outward-investing firms

TLDR: In this article, the effect of state ownership on Chinese firms' foreign direct investment (FDI) ownership decisions is investigated, and the authors argue that state ownership creates the political affiliation of a firm with its home country government, which increases the firm's resource dependence on home-country institutions, while also influencing its image as perceived by host-country institutional constituents.

Abstract: This study investigates the effect of state ownership on Chinese firms’ foreign direct investment (FDI) ownership decisions. It adopts a political perspective to extend the application of institutional theory in international business research. Specifically, it examines firms’ heterogeneous responses to external institutional processes during foreign market entry, while taking into consideration the political affiliation of firms with the external institutions. We argue that state ownership creates the political affiliation of a firm with its home-country government, which increases the firm's resource dependence on home-country institutions, while at the same time influencing its image as perceived by host-country institutional constituents. Such resource dependence and political perception increase firms’ tendency to conform to, rather than resist, isomorphic institutional pressures. We tested our hypotheses using primary data for 132 FDI entries made by Chinese firms during 2000–2006, and we found that the effects of home regulatory, host regulatory and host normative pressures on a firm to choose a joint ownership structure were stronger when the share of equity held by state entities in the firm was high.

Figures

TABLE 3 Descriptive Statistics and Pearson Correlations

TABLE 2 Institutional Pressure Constructs

FIGURE 1 State Ownership Effect on FDI Ownership Decisions

TABLE 5 Tobit Regression of FDI Ownership Structure

TABLE 4 Logistic Regression of FDI Ownership Structure

TABLE 1 Sample Firm and FDI Location Distribution in Comparison with Population

Full text

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State Ownership Effect on Firms’ FDI Ownership Decisions under Institutional Pressure: A
Study of Chinese Outward Investing Firms
Lin Cui
Research School of Management
ANU College of Business and Economics
The Australian National University
Canberra, ACT 0200, Australia
Tel: +61 2 612 56190
Fax: +61 2 612 58796
Email: lin.cui@anu.edu.au
Fuming Jiang*
School of Management
Curtin Business School
Curtin University
Perth, WA 6845, Australia
Tel: +61 8 9266 1136
Fax: +61 8 9266 7897
Email: fuming.jiang@curtin.edu.au
* Correspondent author
This paper was accepted in December 2011 for publication in
Journal of International Business Studies

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State Ownership Effect on Firms’ FDI Ownership Decisions under Institutional Pressure: A
Study of Chinese Outward Investing Firms
Abstract
This study investigates the effect of state ownership on Chinese firms' foreign direct investment (FDI)
ownership decisions. It adopts a political perspective to extend the application of institutional theory
in international business research. Specifically, it examines firms' heterogeneous responses to external
institutional processes during foreign market entry, while taking into consideration the political
affiliation of firms with the external institutions. We argue that state ownership creates the political
affiliation of a firm with its home country government, which increases the firm's resource-
dependence on home country institutions, while at the same time, influences its image as perceived by
host country institutional constituents. Such resource-dependence and political perception increase
firms' tendency to conform to, rather than resist, isomorphic institutional pressures. We tested our
hypotheses using primary data of 132 FDI entries made by Chinese firms during 2000-2006, and we
found that the effects of home regulatory, host regulatory, and host normative pressures on a firm to
choose a joint ownership structure were stronger when the share of equity held by state entities in the
firm was high.

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INTRODUCTION
Institutional theory has enriched our understanding of firms’ international business strategies. Prior
studies found that external institutional constraints and pressures can influence firms’ strategic
choices in foreign direct investment (FDI) (Brouthers, 2002; Chan & Makino, 2007; Meyer, Estrin,
Bhaumik, & Peng, 2009; Yiu & Makino, 2002). Beyond the ‘top-down’ effects (of institutions on
organizations) that have dominated early studies (Scott, 2005), researchers also attempt to explore the
role of firms in their institutional environments and the subsequent heterogeneous firm responses to
external institutional pressures (Kostova, Roth, & Dacin, 2008; Oliver, 1991).
When studying firm response to external institutional pressures, prior studies recognize firms
as active agents who have the potential of reconstructing the rules and norms of their institutional
fields (DiMaggio, 1988; Oliver, 1991; Scott, 2005). The basic premises of these studies are that firm
self-interests may not align with those of the institutions, and that firms are driven by their self-
interests to influence the institutional processes. While these assumptions apply to firms who are
structurally separate from external institutions, they may not hold for firms who are themselves a part
of the institutions, in particular, the state-owned enterprises (SOEs). SOEs are, by definition, assets of
home country governments, which make them a part of their home country institutions. Such an
affiliation does not exempt firms from external institutional pressures; rather, it changes the nature of
firms’ responses to the pressures. For instance, while pursuing their business objectives, SOEs can be
required to serve the political mandates of the state and align their interests with the home institutions
rather than challenge these interests (Scott, 2002; Zhang, Zhou, & Ebbers, 2011). Because of their
affiliation with the home institutions, when they invest overseas, SOEs can be perceived by host
country institutions, not simply as business entities, but also as political actors (Globerman & Shapiro,
2009; He & Lyles, 2008). Such a perception can pose challenges to SOEs’ institutional processes in
host countries (Luo & Rui, 2009; Peng, Wang, & Jiang, 2008). The political nature of the institutional
processes SOEs engage in is not captured by the existing theory that views firms as active agents in
their institutional environment (e.g., Oliver, 1991). SOEs as political affiliates are different from
active agents in that their responses to institutional pressures are not solely motivated by self-interests,

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but also the interests of the institutions they are affiliated with. Existing theory does not adequately
explain the influence of political affiliation on firms’ responses to external institutional pressures.
In this study, we explore the role of state ownership in firms’ institutional processes in home
and host countries. Specifically, we examine the effect of state ownership on the strengths of external
institutional pressures that influence firms’ FDI ownership decisions. We focus on firm’s FDI
ownership decision as it is arguably one of the most important strategic decisions firms face when
conducting FDI. Firms make FDI ownership decisions by choosing between a joint ownership
structure and a sole ownership structure in their foreign affiliates
1.
The result of this decision has long-
term consequences and significant performance implications on firms (Brouthers, 2002; Brouthers &
Hennart, 2007).
We advance a political perspective to examine the effect of state ownership on firms’ FDI
ownership decisions under home and host country institutional pressures. We argue that state
ownership creates a political linkage between a firm and its home country institutions which allows
the firm to be resource-dependent on the home institutions, and also influences the image of the firm
as perceived by host country institutions. Both the resource-dependence and political image have
consequences on the firm’s response to external institutional pressures. A firm’s conformity to
institutional pressures is a function of external dependence (DiMaggio & Powell, 1983). The more a
firm is dependent on the institution that exerts the pressure, the more likely it will conform to, rather
than resist, that pressure (Oliver, 1991). Firms also vary in their abilities to gain institutional
legitimacy without being isomorphic. Firms who can create a positive image (as perceived by
institutional constituents) about the firms’ internal routines, structures and norms can gain legitimacy
through negotiation (Kostova et al., 2008; Westney, 1993); whereas firms whose images are
negatively perceived will be more subject to isomorphic pressures due to the lack of an alternative
legitimizing mechanism. Based on these consequences of political affiliation, we contend that state
ownership can influence firms’ responses to external institutional pressures, or in other words, state
ownership moderates the effects of external institutional pressures on firms’ FDI ownership decisions.

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We choose Chinese outward FDI as the empirical context to study the moderating effect of
state ownership. The Chinese context provides two advantages for this study. First, while the Chinese
economy has become increasingly diverse and plural (Rugman & Li, 2007; Tan & Tan, 2005), state
owned or controlled firms remain the dominant force in the country’s outward FDI (Chen & Young,
2010; Morck, Yeung, & Zhao, 2008). The prevalence of state ownership and the variation of the level
of state ownership in individual Chinese firms allow us to capture its effect in firms’ decision-making.
Second, the institutional environment of Chinese outward FDI is dynamic and diverse, which makes it
an ideal context to test our hypotheses. Chinese outward FDI spreads in over 170 countries with
various institutional conditions. Moreover, Chinese government’s policies towards outward FDI
change constantly (Luo, Xue, & Han, 2010), and that creates different home institutional pressures
across time and industries.
The main contribution of this study is two-fold. First, this study contributes to institutional
theory and its application in international business research. Scott (2005) notes that institutional
theory should be advanced from the prevailing top-down models of institutional effect towards the
understanding of institutional process that incorporates both institutional influence and firm
responses. Theoretical development is underway to explain the heterogeneous firm responses to
institutional pressures. Prior studies focus on firms that are structurally separate from institutions, who
are able to make strategic responses (Goodrick & Salancik, 1996; Oliver, 1991) or even challenge the
boundary of institutional field (Kostova et al., 2008). Our study extends this theoretical development
to firms that are structurally affiliated with institutions. Their abilities and willingness to influence or
challenge the institutions can be hindered due to the resource-dependence on home country
government as well as political liability in the host countries. Accordingly, we advance a political
perspective to study the effect of state ownership on firms’ responses to external institutional
pressures.
Second, this study also contributes to the empirical research on the internationalization of
emerging economy firms, especially those from China. The surge of Chinese outward FDI has
attracted academic attention to investigate the characteristics of Chinese firms and their institutional

Frequently asked questions

Q1. What are the contributions in this paper?

This study investigates the effect of state ownership on Chinese firms ' foreign direct investment ( FDI ) ownership decisions. The authors argue that state ownership creates the political affiliation of a firm with its home country government, which increases the firm 's resourcedependence on home country institutions, while at the same time, influences its image as perceived by host country institutional constituents. 

Q2. What are the future works in this paper?

The authors identify several limitations of this study which lead to future research directions. In future research, the authors propose a more nuanced investigation of state ownership that simultaneously takes into account the non-linear and qualitative difference in the state share of equity, the level of government association of state ownership, and the type of state ownership holding entity. Future research could develop more objective measures based on factual rather than perceptual information. To address these sampling limitations, future research could employ a multi-country and multi-source sampling strategy to provide more generalizable findings. 

Q3. Why did Kostova and Roth (2002) suggest that when studying dynamics between institutions and organizations?

Kostova and Roth (2002) suggest that when studying dynamics between institutions and organizations, the measures for institutional variables should be anchored in the specific organizational practice under investigation, because institutional categories are domain- or issue-specific. 

Q4. What are the main purposes of the Chinese government’s outward FDI restrictions?

Outward FDI projects not in line with the government’s international investment and foreign exchange policies can be rejected or delayed in the approval procedure, thus creating regulatory pressure which constrains the FDI strategic choices of firms. 

Q5. What is the role of state ownership in the response of firms to home regulatory restrictions?

State ownership plays an important role in the responses of firms to home regulatory pressures, because state ownership determines a Chinese firm’s political affiliation and subsequently resource-dependence on the home country government, which intensifies the pressure on the firm to conform to home regulatory restrictions. 

Q6. What is the effect of state ownership on a firm’s local legitimacy?

Hypothesis 3: State ownership moderates the effect of host country normative pressure toattain local legitimacy on a firm’s FDI ownership decision, in that the greater the share of equity held by state entities in the firm, the stronger the positive effect of perceived host country normative pressure to attain local legitimacy on the likelihood of the firm choosing a joint ownership structure in its FDI. 

Q7. What is the effect of home regulatory restrictions on outward FDI?

Host country regulatory institutions apply formal laws, regulations and rules on foreign investors to influence their FDI activities so as to safeguard national interests and maximize local benefits from inward FDI. 

Q8. What is the effect of the political image of state ownership on foreign firms?

While research suggests that firms facing institutional pressures can engage in politicalnegotiation to establish a positive external image and thus attain legitimacy without having to conform to isomorphic pressures (Kostova et al., 2008), the negative political image of state ownership makes such negotiation processes extremely difficult, and at times impossible, to conduct. 

Q9. How does state ownership influence the institutional processes of a firm in the home country?

State ownership can influence the institutional processes of a firm in the home country by determining the political relationship with, and resourcedependence on, the home country institutions, and in the host country by creating a political image that changes the perception of the firm by host country institutions. 

Q10. What are the limitations of survey-based measures?

survey-based measures have their own limitations as they are less objective than archival index measures and may lead to a common method variance problem. 

Q11. What is the effect of host country normative pressure on a firm?

These results supported Hypothesis 3, which states that the greater the share of equity held by state entities in a Chinese firm, the stronger the effect of host country normative pressure on the firm to attain local legitimacy by choosing a joint ownership structure over a sole ownership structure in its FDI. 

Q12. What is the way to test the robustness of their models?

To check the robustness of their models, the authors followed prior studies that measure the outcome of FDI ownership decisions as a continuous variable using the percentage of equity ownership (Chan & Makino, 2007; Hennart, 1991). 

Q13. Why is the Chinese government imposing restrictions on outward FDI?

This is because, since the implementation of “Open-Door’ policy in early 1980s, the Chinese authorities had become familiar with the economic gains associated with the promotion of inward FDI in the form of joint ventures.