2.2 Institutional Theory
2.2.2 Failure in Formal Institutions and Informal Institutions
Failure in Formal Institutions: Failure in formal institutions is often not dis-cussed in the literature on institution theory in IB studies especially with regards to how it precipitates informal institutional pressures and its effect on entry strat-egies and timing of entry. Recently, IB scholars have begun to see the importance of this area of study with a recent call for IB studies to study how conflict, securi-ty, and political risk influences international business in challenging times. For example, Bader and Schuste (2014) showed the importance of expatriate social networks in ensuring the psychological well-being of expatriates in terrorism en-dangered countries. Terrorism is mostly attributed to institutionally failed states (Landis 2013). Such attributes among others, for example, instability in govern-ment policies, political risks and changes in the political system occur as a result of a failure in formal institutions. Failure in formal institutions precipitates infor-mal institutional pressures on MNEs and thus should influence MNEs entry strat-egies and timing of entry.
Failure in formal institutions usually arises as a result of instability in government policies that affects business activities, changes in the political system, including changes of government and widespread corruption in government (Miller 1992;
Abidde 2009: 25; Baek 2011; Al Khattab, Al-Yatama, Al Khattab & Aldehayyat
2012). They are often referred to as political instability (Child & Marinova 2014) or “political risks” defined as the impediments that multinationals may face as a result of political decisions and activities of governments or other bodies (Howell
& Chaddick 1994; Bremmer 2005). Failure in formal institutions could precipitate undemocratic rule, corruption, social unrest and conflicts, terrorism and wars that reduce foreign direct investments in host countries.
Empirical evidence suggest that firms include terrorism and other political risks assessment in decision making on which international markets to enter, in locat-ing and managlocat-ing foreign operations (Abadie & Gardeazabal 2003; Czinkota, Knight, Liesch & Steen 2005; Li, Tallman & Ferreira 2005; Wernick 2006) and also in deciding entry mode choice (Brouthers 1995).
The relationship between corruption and/or country risks/political risks and entry mode choice is inconclusive as studies have shown positive, negative and no rela-tionship. In their study on the influence of international risk on entry mode strate-gy, Brouthers (1995) found that firms will prefer high control entry mode in less risk market and low control or independent entry mode in high risks markets.
Lopez-Duarte and Garcia-Canal (2004) studied the choice between IJVs and ac-quisitions in foreign direct investments. Their findings suggest that high country risks influence the managerial decision for pure partial acquisition because they serve as appropriate entry mode to deal with high risks countries. Driffield, Mic-kiewicz, Pal and Temouri (2010) found that greater absolute and relative corrup-tion increases the likelihood of IJVs to deal with local corrupcorrup-tion. Smarzynska and Wei (2002) showed that high corruption leads to the preference for joint ven-tures. Demirbag, Glaister and Tatoglu (2007) explored institutional perspective and showed that in an environment with high political pressures and greater cor-ruption differences between the home and host countries, MNEs will select IJVs compared to a wholly owned subsidiary (WOS).
Tekin-Koru (2006) studied foreign investments from 88 countries of origin estab-lished in Turkey. The study found that high corruption distance (the difference in the level of corruption in the investor’s home country and the host country) leads to preference for WOS. Uhlenbruck, Rodriguez, Doh and Eden (2006) showed that pervasive corruption leads to the preference of WOS; arbitrary corruption leads to the preference of IJVs. Duanmu (2011) showed that the higher corruption distance it is between home countries of foreign firms and China, the higher prob-ability their MNEs choose WOS over IJVs. Asiedu and Esfahani (2001) showed that the impact of corruption on the choice between WOS and IJVs is insignifi-cant.
The reasons for these contradictory findings could be that these studies gave at-tention to the nature of corruption rather than the magnitude, arbitrariness or the degree of ambiguity surrounding corrupt transactions (Karhunen & Ledyaeva 2012). It could also be that these studies did not take into cognizance that firms do not remain passive to institutional pressures but rather responds to such corrupt environment. Firms can respond to institutional pressures by leveraging their fi-nancial and relational resources in promoting non-corrupt policy (Karhunen &
Kosonen 2013). They could also respond to institutional pressure by compromis-ing and cooperation (Aklamanu 2014), avoidcompromis-ing, defycompromis-ing and manipulatcompromis-ing host country institutional pressures (Oliver 1991).
Informal Institutions: North (1990; 2005) defines informal institutions as the humanly devised pressures that are embedded in the shared norms, values and beliefs in a society. Informal institutional distance combines cognitive and norma-tive components of institutions in (Scott 1995). Cogninorma-tive components of institu-tions reflect the shared beliefs and percepinstitu-tions about what constitutes social reali-ty and meaning in a given sociereali-ty (Scott 1995). Thus, the cognitive component of institutions is pre-occupied with our notions of who we are and what ways of ac-tion make sense for us in a given situaac-tion (ibid). Pogrebnyakov and Maitland (2011) suggest that the cognitive component is morphologically close to culture.
It has also been referred to as cognitive-cultural component (Scott 2001; 2008).
Normative institutions are pre-occupied with formal rules that introduce prescrip-tive, evaluaprescrip-tive, and obligatory dimensions of social life (Scott 1995). They in-clude both values and norms. They impose constraints on social behavior, and so they do influence the way in which people do what they are supposed to do. Nor-mative institutions are carriers of institutionalized values and are organized in-formal structures, and co-optative relations linking the organization with salient external actors. (ibid) Studies have also used cultural distance measure to account for normative institutions (e.g. Delios & Henisz 2000; Yiu & Makino 2002).
Similar to previous research (e.g. Gaur & Lu 2007) the informal institutional en-vironment in this study is considered to include both normative and cognitive aspects in this study. The aspect of informal institution utilized in this dissertation is centered on cultural difference between the acquiring MNE and target firm.
This is similar to previous research on informal institutional dimension on entry mode choice (e.g., Yiu & Makino 2002; Estrin et al. 2009; Arslan 2011). Unlike other studies that have measured national cultural differences or business cultural distance or cultures open to foreign idea as a constructs for informal institutional environment, this study focuses on the manifestations of cultural issues and how they influence the choice of acquisition types. First, cultural issues manifest
themselves in the form contractual difficulties between the acquiring firm and the management of the target firm in reaching agreement on the acquisition (Jakobsen 2008). Second it manifests itself in difficulties in integrating the acquired firm and the parent MNE (Slangen 2006; Hennart & Slangen 2007; Ahammad &
Glaister 2011).
MNEs contractual difficulties in negotiating acquisitions in target countries is among many specific issues that influence the degree of equity commitment of multinationals in foreign market. Jakobsen (2008) suggest that partial acquisition is as a result of contractual difficulties in successfully closing acquisition deals with the target firm. He argued that it may result as sellers may perceive that the deal does not protect the interests of local owners and stakeholders alike. Contrac-tual difficulties are rooted in cultural differences (Drew 1997; Dina 2010). It has been argued that cross-cultural communication is more likely to fail, the higher the normative and cognitive distance between the organizations (Ionascu, Meyer
& Estrin 2004). Differences in scripts, schemas, norms or values hamper infor-mation sharing between individuals from different cultures and might restrain their ability to search for better alternatives. Consequently, in a cognitive and normative distant market, obstacles to negotiating with labor unions, local owners (e.g. family owners of private firms and other stakeholders) will rise dispropor-tionately and thus hinders parent firm from acquiring larger equities from ac-quired firms. (ibid) This has also been shown to increase the likelihood that the cross-border acquisition deal will not be completed because of the greater number of issues that are likely to be renegotiated (Dikova, Sahib & Van Witteloostuijn 2010).
It has also been shown that collective cultures that are concerned with self-face are more likely to opt for win-lose negotiations while individualistic culture would opt for integrative or win-win negotiations (McDevitt 2006). Negotiations involving collectivist vs. individualistic cultures could amplify the possibilities to search for better alternatives and could lead to partial acquisition at the time of market entry. For this reason, organizations are structuring earnout payments as options against contractual failures such that they acquire partial equity at the time of entry and pay the remaining equity over several years on pre-determined prices based on the performance of the target after 2-3 years during which they have gained more knowledge about the assets of the target firm.
In summary, in addition to regulatory aspects of institutions discussed in institu-tional-based view of strategy, transparency of regulatory institutions and failures in formal institutions do also influence entry mode choices. The extension offered in this section allows IB scholars to consider other aspects of formal institutions
that influence entry choices. More so, by extending the formal aspects of institu-tions and focusing on the issue-specific aspects of informal instituinstitu-tions that influ-ences acquisition strategies, it is believed that these measures will capture the multiple dimensions of institutional environment that influences entry strategies of multinationals in foreign markets. It is believed that this multidimensional framework proposed in this study will provide a better understanding of aspects of institutions that influence entry mode choice and aspects of the institutions MNEs respond to when entering foreign markets.