Institutional distance, host country and international business experience, and the use of parent country nationals

Institutional distance, host country and

international business experience, and the use of

parent country nationals

Naoki Ando, Faculty of Business Administration, Hosei UniversityYongsun Paik, College of Business Administration, Loyola Marymount UniversityHuman Resource Management Journal, Vol ••, no ••, 2012, pages ••–••

This study examines how the institutional distance between a host country and a home countryinfluences foreign subsidiary staffing, and how overseas business experience moderates the effect ofinstitutional distance. Hypotheses regarding the effect of institutional distance on foreign subsidiarystaffing are empirically tested using a sample of 2,980 foreign subsidiaries of Japanese firms. This studyshows that although the ratio of parent country nationals to subsidiary employees decreases when firmsface greater institutional distance, the absolute number of parent country nationals assigned to thesubsidiary increases. This study also shows that firms with more overseas business experience replacehost country nationals with parent country nationals when there is greater institutional distance.Contact: Professor Naoki Ando, Faculty of Business Administration, Hosei University, 2-17-1Fujimi Chiyoda-ku Tokyo 102-8160, Japan. Email: [email protected]_201 1..20

INTRODUCTION

Cross-country differences have been argued to influence decisions by multinationalcorporations (MNCs) regarding whether they staff foreign subsidiaries with parentcountry nationals (PCNs) or host country nationals (HCNs) (Xu et al., 2004; Brock et al.,

2008; Wilkinson et al., 2008). Cross-country differences in institutions, in particular, haverecently drawn the attention of researchers as such differences significantly influence strategicdecisions (North, 1990; Kostova and Zaheer, 1999; Scott, 2008). Institutional dissimilaritybetween a host country and a home country presents challenges to MNCs when they seeklegitimacy within the local institutional context (Kostova and Zaheer, 1999; Xu and Shenkar,2002). Institutional dissimilarity may also reduce the MNC’s effectiveness in controlling foreignoperations and transferring knowledge to foreign subsidiaries (Kostova, 1999; Kostova andZaheer, 1999). Despite the increasing attention on institutions in the international businessliterature, it is relatively unknown how MNCs staff foreign subsidiaries to deal with thechallenges caused by institutional dissimilarity, that is legitimacy, control and knowledgetransfer (Xu et al., 2004; Gaur et al., 2007). These three issues require MNCs to accommodateconflicting requirements. Previous studies assumed that MNCs deal with one requirement atthe expense of the others when staffing foreign subsidiaries (Xu et al., 2004; Gaur et al., 2007).We overcome this assumption by proposing that, to deal with incongruous requirements fromlegitimacy, control and knowledge transfer, MNCs manipulate two staffing practices, that is theratio of PCNs to foreign subsidiary employees (the PCN ratio) and the absolute number ofPCNs assigned to a foreign subsidiary (the number of PCNs). Previous studies have extensivelyfocused on the PCN ratio as a proxy for foreign subsidiary staffing (e.g. Tan and Mahoney, 2006;Wilkinson et al., 2008). Determining the number of PCNs assigned to a foreign subsidiary,however, is also an important issue for MNCs (Beamish and Inkpen, 1998; Delios andBjörkman, 2000) because the PCN ratio and the number of PCNs may have different

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doi: 10.1111/j.1748-8583.2012.00201.x

HUMAN RESOURCE MANAGEMENT JOURNAL, VOL •• NO ••, 2012 1

© 2012 Blackwell Publishing Ltd.

Please cite this article in press as: Ando, N. and Paik, Y. (2012) ‘Institutional distance, host country and international business experience, and theuse of parent country nationals’. Human Resource Management Journal doi: 10.1111/j.1748-8583.2012.00201.x

implications for legitimacy, control and knowledge transfer. By manipulating the two staffingpractices, MNCs may effectively respond to incongruous requirements arising frominstitutional distance. The main premise of this study is that, while the legitimacy issue ishandled more effectively through the PCN ratio, the control issue is handled through thenumber of PCNs, and knowledge transfer requires the use of both staffing practices.

The next section reviews the literature on foreign subsidiary staffing and institutional theory.Then, the hypotheses explaining the relationship between institutional distance and foreignsubsidiary staffing are developed. These hypotheses are tested using a sample of 2,980subsidiaries of Japanese firms. After reporting the results of the empirical analysis, theimplications, as well as limitations and directions for future research, are discussed.

LITERATURE REVIEW

Foreign subsidiary staffing

Previous studies have argued that PCNs play a critical role in control and knowledge transfer.PCNs control foreign subsidiaries in congruence with the goals and interests of parent firmsbecause they better understand, assimilate and internalise the values and beliefs of the parentfirm and are more committed to the parent firm’s goals (Gong, 2003a; Paik and Sohn, 2004;Belderbos and Heijltjes, 2005; Collings et al., 2007). The other important role of PCNs isknowledge transfer to foreign subsidiaries (Delios and Björkman, 2000; Gaur et al., 2007;Widmier et al., 2008). They work as an effective mechanism to transfer knowledge between theparent firm and foreign units because tacit knowledge is embedded in the organisation’smembers (Wang et al., 2009). In contrast, HCNs are more knowledgeable about local contexts(Harzing, 2001; Widmier et al., 2008), and are more capable of addressing local idiosyncrasiesassociated with the cultural, economic, political and legal environments (Tarique et al., 2006).Using their in-depth indigenous knowledge, HCNs can effectively respond to and handle theconditions and requirements of the host country.

Recognising the unique circumstances that demand the competence of either PCNs orHCNs, previous studies have examined why MNCs assign PCNs to foreign subsidiaries basedon various perspectives, such as control and coordination (Belderbos and Heijltjes, 2005),knowledge transfer (Delios and Björkman, 2000), and learning (Xu et al., 2004; Widmier et al.,2008; Wilkinson et al., 2008). A review of previous studies indicates that cross-country differencehas been one of the most researched factors affecting foreign subsidiary staffing. Based onagency theory, Gong (2003a) found that cultural distance is positively associated with theassignment of PCNs to foreign subsidiaries and emphasised the use of PCNs for controlpurposes. In stark contrast, Widmier et al. (2008) found that cultural distance is negativelyassociated with the assignment of PCNs and emphasised the need to adapt to culturally distantenvironments. Although the literature has extensively focused on cultural distance to examinethe effect of cross-country difference, cultural distance may capture limited aspects of cross-country difference and may not completely encompass its complexity (Xu and Shenkar, 2002;Xu et al., 2004; Gaur et al., 2007). Therefore, we situate cultural distance in the much broadercontext of cross-country differences to examine the more comprehensive impact of cross-country differences on foreign subsidiary staffing.

Institutional distance

Institutions are defined as the rules of the game in a society or the humanly devised constraintsthat shape human interaction (North, 1990). Institutions establish stable structures that facilitate

Institutions, experience and expatriate assignment

HUMAN RESOURCE MANAGEMENT JOURNAL, VOL •• NO ••, 20122


economic transactions and reduce transaction costs in uncertain and complex environments(North, 1990; Chan et al., 2008). One stream of research in international management groundedin institutional theory has focused on institutional voids in emerging economies (Khanna andPalepu, 2000; Chan et al., 2008). Institutional voids increase the costs of conducting market-basedtransactions and lead firms to prefer relationship-based, personalised exchanges (Peng, 2003).

Another stream of research grounded in institutional theory concerns institutionaldissimilarity between a host and a home country (Kostova and Zaheer, 1999). The degree ofdissimilarity in formal and informal institutions between two countries is termed institutionaldistance (Kostova and Zaheer, 1999; Xu and Shenkar, 2002). Institutional distance between ahost and a home country presents a challenge to foreign firms in establishing and maintaininglegitimacy in the host country (Kostova and Zaheer, 1999; Xu and Shenkar, 2002) because theyare forced to use structures and practices that are perceived to be appropriate within the localcontext (DiMaggio and Powell, 1983; Scott, 2008). Great institutional distance also increases theuncertainty perceived by foreign firms about local institutional environments, and an increasein perceived uncertainty raises the need for control over foreign subsidiaries (Gaur et al., 2007).Another challenge facing foreign firms concerns the difficulty in transferring organisationalpractices and knowledge (Kostova, 1999). When institutional distance is great, theorganisational practices of a foreign firm may conflict with the institutions of the host country,thus making it difficult for a firm to transfer organisational practices (Kostova, 1999; Broutherset al., 2008).

Previous studies have examined how legitimacy seeking, the need for control andknowledge transfer affect foreign subsidiary staffing. For example, Xu et al. (2004) argued thatforeign firms emphasise the establishment and maintenance of legitimacy at the expense ofcontrolling foreign subsidiaries. Using a sample of 2,199 foreign subsidiaries of Japanese firms,they found that institutional distance is negatively associated with the PCN ratio, as predicted.Conversely, Gaur et al. (2007) emphasised the importance of control and knowledge transferunder the condition of great institutional distance, and found a positive association betweeninstitutional distance and the PCN ratio using a sample of 11,063 foreign subsidiaries ofJapanese firms. A review of previous studies indicates that they focused on the PCN ratio asa proxy for foreign subsidiary staffing and assumed that firms deal with one issue caused byinstitutional distance at the expense of others. Overcoming the limitations of the previousstudies, this study proposes that firms simultaneously respond to the inconsistent requirementsarising from legitimacy seeking, the need for control and knowledge transfer by employingdifferent staffing practices. We believe that the absolute number of PCNs assigned to a foreignsubsidiary deserves attention as an alternative staffing practice (Beamish and Inkpen, 1998;Delios and Björkman, 2000). While the number of PCNs mainly relates to the staffing of keypositions at a foreign subsidiary, the PCN ratio affects staffing in the overall workforce (Lamand Yeung, 2010). A staffing practice that influences the key positions of a foreign subsidiarymay have different implications for the subsidiary than a staffing practice that influences theoverall workforce. The literature has not treated and examined the PCN ratio and the numberof PCNs separately. This study incorporates the two practices of foreign subsidiary staffing anddevelops hypotheses regarding the distinct effect of legitimacy, control and knowledge transferon these two staffing practices.

HYPOTHESES DEVELOPMENT

In host countries with great institutional distance from the home country, MNCs experiencedifficulty in establishing legitimacy and controlling foreign subsidiaries (Kostova and Zaheer,

Naoki Ando and Yongsun Paik



1999; Xu and Shenkar, 2002). In institutionally distant countries, MNCs face the challenge ofaccommodating local regulations, norms and cognition that are different from their homecountry. Failure to respond to the institutional pressures that require MNCs to accommodatethese differences results in a lack of legitimacy in the context of local institutions (Scott, 2008).At the same time, because of uncertainty and unfamiliarity arising from institutional distanceand the resulting information asymmetry between headquarters and foreign subsidiaries,MNCs may not fully understand and may misinterpret the actions and behaviours of HCNmanagers, which often causes the MNCs to regard HCNs as opportunistic (Gong, 2003a; Brocket al., 2008). To minimise such uncertainty, MNCs may need to increase the level of control overforeign subsidiaries (Gong, 2003a; Wilkinson et al., 2008). Thus, MNCs need to simultaneouslydeal with legitimacy and control issues in institutionally distant countries.

Faced with this situation, MNCs are expected to accommodate these conflicting needs bypaying close attention not only to the ratio of PCNs to foreign subsidiary employees but alsoto the absolute number of PCNs assigned to a foreign subsidiary. We propose that MNCsdetermine an optimal ratio of PCNs to deal with legitimacy issues, and an optimal numberof PCNs assigned to the subsidiary to deal with control issues. In institutionally distantcountries where regulations, norms and cognition are radically different from the homecountry, foreign subsidiaries will risk failure unless they adapt themselves to local institutionsand establish legitimacy within the local institutional context (Xu et al., 2004; Scott, 2008). Toadequately meet legitimacy requirements, MNCs need to make themselves appear more localby increasing the ratio of HCNs to subsidiary employees. The localisation of the workforceenhances the MNC’s acceptability and resultant legitimacy within the local context (Kostovaand Zaheer, 1999). Reliance on more HCNs makes it possible for an MNC to betterunderstand, interpret and evaluate local legitimising requirements because an increased HCNratio motivates HCNs to mobilise their knowledge about local institutional environments forthe MNC (Kostova and Zaheer, 1999; Xu et al., 2004). Thus, by increasing the HCN ratio andportraying themselves as less foreign, MNCs effectively address legitimacy issues (Xu et al.,2004).

Dissimilarities in regulations, norms and cognition between the host country and the homecountry make it difficult for MNCs to monitor and interpret the behaviour of foreignsubsidiaries, as well as to obtain complete and accurate information about subsidiary actionsand performances (Gong, 2003a). HCNs may act opportunistically by exploiting theinformation asymmetry (Tan and Mahoney, 2006; Paik and Ando, 2011), which increases theneed to control foreign subsidiaries (Gaur et al., 2007). PCNs may be used to reduce informationasymmetry between the parent firm and the foreign subsidiary because they can bettercommunicate with the parent firm through social ties and shared assumptions (Björkman et al.,2004). In addition, PCNs will enhance the parent firm’s control over foreign subsidiariesbecause they are more committed to achieving the parent firm’s goals and act in a way that iscongruent with the goals and the interests of the parent firm (Gong, 2003a; Paik and Sohn, 2004;Belderbos and Heijltjes, 2005; Collings et al., 2007). Effective control may require a certainnumber of PCNs who are in charge of different areas of foreign operations (Bonache andBrewster, 2001). Thus, MNCs are likely to increase the number of PCNs and assign them topositions in diverse areas to enhance control over the foreign subsidiary in an institutionallydistant country (Gaur et al., 2007; Lam and Yeung, 2010).

The other challenge that MNCs face when there is great institutional distance concernsknowledge transfer to foreign subsidiaries (Kostova, 1999). Knowledge and organisationalpractices developed in the home country context may be difficult to transfer to institutionallydistant countries because they are often inconsistent with institutions of the host country




(Kostova, 1999; Brouthers et al., 2008). For knowledge transfer to successfully occur, it is criticalthat MNCs acquire in-depth local knowledge to adapt the home country-based organisationalpractices to local contexts (Jensen and Szulanski, 2004; Brouthers et al., 2008). Thus, MNCsoperating in institutionally distant countries may use the lower PCN ratio because the closeinvolvement of HCNs in the foreign subsidiary facilitates HCNs’ recontextualisation ofknowledge and organisational practices in accordance with the local context (Kostova, 1999;Law et al., 2009). Yet, MNCs also need to maintain a relatively large number of PCNs in theforeign subsidiary to facilitate and ensure the transfer of tacit and uncodified knowledge, as thistype of knowledge is embedded in an individual and can only be transferred throughmentoring and personal training by PCNs (Wang et al., 2009).

In summary, when there is great institutional distance, MNCs decrease the PCN ratio toovercome a lack of legitimacy while they increase the number of PCNs to enhance control overforeign operations. To effectively implement knowledge transfer under the condition of greatinstitutional distance, MNCs decrease the PCN ratio but increase the number of PCNs.Therefore, we posit the following hypotheses:

Hypothesis 1a: The greater the institutional distance between a host country and a homecountry, the lower the ratio of PCNs to foreign subsidiary employees.

Hypothesis 1b: The greater the institutional distance between a host country and a homecountry, the greater the number of PCNs assigned to the foreign subsidiary.

Firms learn how to manage overseas operations in unfamiliar environments throughoperational experience in various countries (Wilkinson et al., 2008). Increased overseasexperience incrementally improves a firm’s capability to deal with unfamiliar environments(Kostova and Zaheer, 1999; Wilkinson et al., 2008), and such capabilities acquired throughexperiential learning can be applied to new locations and can help MNCs understand andaddress local idiosyncrasies (Johanson and Vahlne, 1977; Kostova and Zaheer, 1999). Similarly,through operational experience in a particular host country, MNCs acquire knowledge andcapabilities that enable them to better understand and address conditions specific to thecountry (Gaur et al., 2007; Wilkinson et al., 2008). As a result of reduced uncertainty through theaccumulation of international and host country experience, the need to rely on PCNs to manageoverseas operations decreases (Gong, 2003a; Tan and Mahoney, 2006). Consistent with thisargument, previous studies have reported the negative association between international andhost country experience and the assignment of PCNs (Xu et al., 2004; Tan and Mahoney, 2006;Wilkinson et al., 2008). Therefore, we posit the following hypotheses:

Hypothesis 2a: The greater the international experience of the parent firm, the lower theratio of PCNs to foreign subsidiary employees.

Hypothesis 2b: The greater the host country experience of the parent firm, the lower the ratioof PCNs to foreign subsidiary employees.

Hypothesis 3a: The greater the international experience of the parent firm, the fewer PCNsassigned to the foreign subsidiary.

Hypothesis 3b: The greater the host country experience of the parent firm, the fewer PCNsassigned to the foreign subsidiary.

As a firm’s capability to deal with institutions dissimilar to the home country advances withinternational and host country experience, legitimacy issues become of less concern to thefirm (Gaur et al., 2007). Exploiting their capabilities to deal with unfamiliar institutions,




internationally experienced firms are more capable of sensing, understanding and conformingto the features of local institutions and their legitimising requirements (Kostova and Zaheer,1999). Firms with substantial host country experience also better recognise and handlelegitimising requirements specific to the host country institutions (Gaur and Lu, 2007;Wilkinson et al., 2008). Thus, for firms with substantial international and host countryexperience, the relative advantage of HCNs over PCNs in dealing with legitimacy issuesdecreases, which, in turn, raises the PCN ratio (Gaur et al., 2007).

Internationally experienced firms have developed a pool of PCNs who are capable ofperforming tasks in institutionally distant countries (Paik and Sohn, 2004). Similarly,operational experience in the host country develops PCNs who are knowledgeable aboutinstitutional idiosyncrasies specific to the country (Harzing, 2001; Widmier et al., 2008). Theseinternationally competent PCNs perform more effectively as a knowledge transfer vehiclebecause they are capable of recontextualising knowledge of the parent firm to accommodatelocal institutional requirements (Wang et al., 2009). A large pool of internationally competentPCNs lowers the need to maintain a high ratio of HCNs for the purpose of recontextualisingknowledge. At the same time, the improved availability of internationally competent PCNs willenable firms with substantial overseas experience to assign more PCNs to the foreignsubsidiary to enhance knowledge transfer.

A pool of internationally competent PCNs enables firms to increase the number of PCNs forthe control purpose under the condition of great institutional distance. In response to institutionaldistance, firms with substantial overseas experience can assign the requisite number of PCNswho can exert a control function. Firms with less overseas experience, however, lack a pool ofinternationally competent PCNs. As a result, they fail to increase the number of PCNs in responseto institutional distance, although increased institutional distance requires that more PCNs beassigned to a foreign subsidiary for effective control (Gaur et al., 2007; Lam and Yeung, 2010).

To summarise, for firms with substantial international experience and host countryexperience, the advantage of HCNs over PCNs in legitimacy building and knowledge transferunder the condition of great institutional distance decreases. In addition, the improvedavailability of internationally competent PCNs through international and host countryexperience enables firms to increase the number of PCNs assigned to the foreign subsidiary forknowledge transfer and control under the condition of great institutional distance. Therefore,we posit the following hypotheses:

Hypothesis 4a: The negative relationship between institutional distance and the ratio ofPCNs to foreign subsidiary employees becomes weaker as firms accumulate internationalexperience.

Hypothesis 4b: The negative relationship between institutional distance and the ratio ofPCNs to foreign subsidiary employees becomes weaker as firms accumulate host countryexperience.

Hypothesis 5a: The positive relationship between institutional distance and the number ofPCNs assigned to the foreign subsidiary becomes stronger as firms accumulate internationalexperience.

Hypothesis 5b: The positive relationship between institutional distance and the number ofPCNs assigned to the foreign subsidiary becomes stronger as firms accumulate host countryexperience.

The relationships hypothesised in this study are summarised in Figure 1.




METHOD

Sample

The hypotheses are tested using a sample composed of foreign subsidiaries of Japanese firms.These subsidiaries were identified from a CD-ROM version of the 2008 Kaigai ShinshutsuKigyo Soran (Overseas Japanese Companies Data) compiled by Toyo Keizai Shimposha. Thedatabase provides data on 21,317 foreign subsidiaries of Japanese firms in which a Japaneseparent firm has at least 10 per cent equity ownership. The initial sample included foreignsubsidiaries of Japanese manufacturers. Non-manufacturers were excluded from the initialsample because they may face unique challenges when managing foreign subsidiaries(Brouthers and Brouthers, 2003; Bouquet et al., 2004). Thus, the foreign subsidiary staffing ofnon-manufacturers may be affected by different factors than manufacturers. In addition, toremove the influence of possible conflicts among Japanese parent firms, foreign subsidiariesthat were established by more than one Japanese parent firm were excluded from the sample.The data on foreign subsidiaries and parent firms were primarily collected from KaigaiShinshutsu Kigyo Soran and the Nikkei NEEDS database that was compiled by Nihon KeizaiShimbun. Because of missing data in the databases, the final sample consisted of 2,980 foreignsubsidiaries of Japanese manufacturers operating in 41 countries.

Measures

The hypotheses test the distinct effects of the independent variables of interest on the twostaffing practices separately. The PCN ratio of the foreign subsidiary was operationalised as aproportion of PCNs to foreign subsidiary employees. The number of PCNs assigned to theforeign subsidiary was operationalised as a count of PCNs in the subsidiary, which waslog-transformed after adding one to the score.

FIGURE 1 Hypothesised frameworks

−

+

−

Hypotheses 4a and 4b

Hypothesis 1aInstitutional distance The PCN ratio

International experience

Host country experience


−

+

+


Hypothesis 1bInstitutional distance The number of PCNs

International experience

Host country experience





Institutional distance is the degree of dissimilarity in institutions between two countries(Kostova, 1999; Gaur and Lu, 2007). Several instruments have been developed to measureinstitutional dissimilarity using data sources, such as the World Competitiveness Yearbook,Country Risk Ratings and International Country Risk Guide. Chan et al. (2008), for example,measured the degree of institutional development with 12 national institutional characteristicsfrom four data sources. Similarly, Xu et al. (2004) measured regulative institutional distance withseven items from one data source, while Gaur et al. (2007) measured the distance with sevenitems from two data sources. As these measures used a small number of indicators to capturecomplex institutions, only limited aspects of institutions may be captured. This study used datafrom the World Bank’s Governance Indicators, which are based on several hundred variablesdrawn from 37 separate data sources constructed by 31 organisations (Kaufmann et al., 2005).Consequentially, the Governance Indicators encompass the broadest range of institutionalissues (Dikova, 2009; Slangen and van Tulder, 2009). By measuring institutional distance basedon the Governance Indicators, a lack of comprehensiveness in other measures can be overcome.Governance Indicators consist of six institutional dimensions: voice and accountability, politicalinstability and violence, government effectiveness, regulatory burden, rule of law, and controland corruption. To operationalise institutional distance, this study used Kogut and Singh’s(1988) approach to cultural distance. Formally, this study used the following formula:

Institutional Distance jij ih

ii

I I=

−( )⎧⎨⎩

⎫⎬⎭=∑1

6

2

21

6

σ

where institutional distance j is the institutional distance between the host country j and Japan,Iij is country j’s score of the ith institutional dimension, Iih is Japan’s score on the ith institutionaldimension, and σ i

2 is the variance of the ith institutional dimension. To examine the validityof this proxy, correlation analyses were conducted between the institutional distance measureof this study and other measures used in previous studies. The analyses demonstrated that theinstitutional distance variable of this study is significantly and highly correlated with othermeasures [r = 0.844, p < 0.001 for the measure by Chan et al. (2008), and r = 0.739, p < 0.001 forthe measure by Xu et al. (2004)].

This study includes two variables representing overseas experience. International experiencewas measured by the sum of the years operating subsidiaries overseas. The number ofoperating years in the host country was subtracted when the international experience score ofeach parent firm was linked with a foreign subsidiary in the host country. Host countryexperience was measured by the sum of the years operating subsidiaries in the host country.Both were log-transformed for analysis.

Several control variables were included in the analysis. Cultural distance was incorporatedto control for host country effects. Previous studies argued that cultural distance affects a firm’sdesired level of control over foreign subsidiaries (Gong, 2003a; Wilkinson et al., 2008). UsingHofstede’s (2001) four cultural dimensions, Kogut and Singh’s (1988) approach was used tomeasure cultural distance. In addition, geographical distance was controlled for becausefrequent visitors or commuter assignments may be an alternative to long-term assignments ofPCNs when the location of foreign subsidiaries is close to the home country (Collings et al.,2007). Geographical distance was operationalised by minimum flight time between the capitalcity or economic centre of the host country and Tokyo. The shorter the flight time, the morefrequently visitors are likely to be sent. Scores of minimum flight time were log-transformed foranalysis. This study also incorporated host countries’ gross domestic product (GDP) per capitabased on purchasing power parity to control for the costs associated with the assigning of PCNsand hiring of HCNs. In general, the costs of assigning PCNs to foreign subsidiaries are higher




than hiring HCNs (Bonache Pérez and Pla-Barber, 2005; Collings et al., 2007). These costs mayaffect decisions on foreign subsidiary staffing.

To control for the parent firm level effects, the research and development (R&D) intensity,the foreign sales ratio and the size of the parent firm were included. R&D-intensive firms mayuse more PCNs to mitigate the perceived risk of opportunistic behaviours by local firms andmanagers (Bonache Pérez and Pla-Barber, 2005). The R&D intensity of the parent firm wasmeasured by the ratio of R&D expenditure to total sales. As firms increase their internationalexposure, more PCNs may be required to manage expanded overseas operations (Benson et al.,2009). The foreign sales ratio of the parent firm was used as a proxy for the degree of the firm’sinternationalisation and was calculated as the ratio of foreign sales to total sales. Because largefirms may possess a pool of PCNs deployable to foreign subsidiaries (Delios and Björkman,2000), the size of the parent firm was controlled for. It was measured by the number ofemployees, which was log-transformed.

To control for the foreign subsidiary level effect, the ownership structure of the foreignsubsidiary was incorporated. A large share of ownership in the foreign subsidiary indicatesgreater resource commitment of the parent firm, which represents the desire for controlassociated with increased investment risk (Widmier et al., 2008). Ownership structure wasmeasured by the percentage of equity ownership possessed by the Japanese parent firm. Inaddition, to control for industry-specific effects, 13 dummy variables representing the parentfirm’s industry were incorporated.

RESULTS

The descriptive statistics and correlation coefficients of the variables are shown in Table 1. Theaverage PCN ratio was 11.5 per cent, and the average number of PCNs assigned to a foreignsubsidiary was four. Japanese parent firms, on average, had 88 per cent equity ownership in theforeign subsidiary. The mean values of subsidiary age and employees were 15.6 and 308,respectively, and the average number of parent firm employees was 13,503. The parent firms’industries included electric and electronic products (28.6 per cent), machinery (19.3 per cent),chemical (13.3 per cent), automobile (8.3 per cent) and precision equipment (4.9 per cent),among others. The correlation coefficients in Table 1 were low overall. All of the varianceinflation factor scores were considerably smaller than the conventional cut-off value of 10,indicating that a severe multicollinearity problem is not present.

A Tobit regression was employed when the PCN ratio was the dependent variable becauseit was truncated at the values of 0 and 1. When the number of PCNs was the dependentvariable, an ordinary least squares (OLS) regression was employed. Tables 2 and 3 report theresults for the Tobit and OLS regressions, respectively. Models 1 and 4 include moderators andcontrol variables, while Models 2 and 5 add institutional distance to Models 1 and 4,respectively. The interaction terms are added in Models 3 and 6 using the mean-centringtechnique. The explanatory power of all the models was acceptable.

Model 1 tests Hypotheses 2a and 2b, which predict the negative association betweeninternational and host country experience and the PCN ratio. The results show that these twotypes of overseas experience are significantly and negatively associated with the PCN ratio(p < 0.001 for both experience variables), supporting Hypotheses 2a and 2b. Hypothesis 1apredicts that institutional distance is negatively related to the PCN ratio. Model 2 shows thatinstitutional distance has a significantly negative impact on the PCN ratio (p < 0.001). Alikelihood ratio test indicated that adding the institutional distance variable significantlyincreases the explanatory power of the model compared with Model 1 (p < 0.001). These results




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lend support to Hypothesis 1a. Model 3 tests Hypotheses 4a and 4b, which predict thatinternational experience and host country experience positively moderate the relationshipbetween institutional distance and the PCN ratio. The results show that the two interactionterms are positive and significant for the PCN ratio (p < 0.001 for both interaction terms). Alikelihood ratio test also demonstrated that incorporation of the two interaction terms resultsin a significant increase in model fit over Model 2 (p < 0.001). These results support Hypotheses4a and 4b. Figures 2 and 3 are graphical presentations of the results for interaction terms, withmean + 1 standard deviation representing a high level of experience and mean - 1 standarddeviation representing a low level of experience. As shown in Figures 2 and 3, the slopes for

TABLE 2 Result of Tobit regressions – the ratio of PCNs

Model 1 Model 2 Model 3

b SE b SE b SE

Institutional distance -0.035*** 0.004 -0.037*** 0.004Institutional distance* 0.019*** 0.004International experienceInstitutional distance* 0.014*** 0.004Host country experienceInternational experience -0.038*** 0.007 -0.036*** 0.007 -0.037*** 0.007Host country experience -0.052*** 0.008 -0.055*** 0.007 -0.060*** 0.007Cultural distance -0.002 0.004 -0.003 0.004 -0.003 0.004Geographical distance 0.027*** 0.007 -0.007 0.008 -0.009 0.008GDP per capita 0.406* 0.168 1.209*** 0.192 1.234*** 0.190Ownership 0.002*** 0.000 0.002*** 0.000 0.002*** 0.000R&D intensity -0.001 0.002 -0.001 0.002 -0.002 0.002Overseas sales -0.001*** 0.000 -0.001*** 0.000 -0.001*** 0.000Parent size 0.016*** 0.005 0.019*** 0.005 0.021*** 0.005Industry dummy 1 0.035 0.019 0.031 0.018 0.033 0.018Industry dummy 2 0.022 0.018 0.021 0.018 0.020 0.017Industry dummy 3 0.007 0.018 0.003 0.017 0.001 0.017Industry dummy 4 0.005 0.021 0.007 0.020 0.005 0.020Industry dummy 5 0.000 0.024 -0.004 0.024 -0.004 0.023Industry dummy 6 0.095** 0.033 0.096** 0.032 0.097** 0.032Industry dummy 7 0.046 0.030 0.051 0.029 0.052 0.029Industry dummy 8 -0.033 0.029 -0.031 0.029 -0.033 0.029Industry dummy 9 0.026 0.025 0.024 0.025 0.025 0.025Industry dummy 10 -0.017 0.024 -0.017 0.024 -0.017 0.024Industry dummy 11 -0.021 0.030 -0.025 0.030 -0.025 0.029Industry dummy 12 0.070* 0.029 0.065* 0.029 0.061* 0.028Industry dummy 13 0.110* 0.043 0.112** 0.043 0.107* 0.043Constant -0.022 0.036 0.041 0.036 0.044 0.036Log likelihood 25.211 60.270 76.103Chi square 313.65*** 383.77*** 415.43***n 2980 2980 2980

*** p < 0.001, ** p < 0.01, * p < 0.05.GDP, gross domestic product; PCN, parent country national; R&D, research and development; SE, standard error.




high experience are less steep than those for low experience. For the curves in Figure 2, theaverage marginal effect of institutional distance on the PCN ratio was -0.02 for firms with highinternational experience and -0.04 for firms with low international experience. For the curvesin Figure 3, the average marginal effect of institutional distance on the PCN ratio was -0.01 forfirms with high host country experience and -0.02 for firms with low host country experience.These marginal effects indicate that the negative effect of institutional distance on the PCN ratiodecreases with international and host country experience. Note that because the Tobit model isnot linear, curves were drawn in the figures.

TABLE 3 Result of OLS regressions – the number of PCNs

Model 4 Model 5 Model 6

b SE b SE b SE

Institutional distance 0.051*** 0.015 0.045** 0.015Institutional distance* 0.026* 0.013International experienceInstitutional distance* -0.026 0.014Host country experienceInternational experience -0.177*** 0.025 -0.180*** 0.025 -0.178*** 0.025Host country experience -0.068* 0.027 -0.064* 0.027 -0.069** 0.027Cultural distance 0.012 0.016 0.013 0.015 0.013 0.015Geographical distance -0.124*** 0.024 -0.076** 0.028 -0.091*** 0.028GDP per capita 4.930*** 0.589 3.754*** 0.679 3.829*** 0.679Ownership 0.007*** 0.001 0.007*** 0.001 0.007*** 0.001R&D intensity -0.003 0.006 -0.003 0.006 -0.003 0.006Overseas sales 0.001 0.001 0.001 0.001 0.001 0.001Parent size 0.226*** 0.017 0.222*** 0.017 0.227*** 0.017Industry dummy 1 -0.073 0.066 -0.068 0.065 -0.076 0.065Industry dummy 2 0.017 0.062 0.018 0.062 0.011 0.062Industry dummy 3 0.092 0.062 0.097 0.062 0.093 0.062Industry dummy 4 0.165* 0.073 0.162* 0.072 0.148* 0.072Industry dummy 5 -0.122 0.083 -0.116 0.083 -0.126 0.083Industry dummy 6 0.362** 0.117 0.360** 0.117 0.334** 0.117Industry dummy 7 0.073 0.105 0.065 0.105 0.067 0.105Industry dummy 8 -0.014 0.102 -0.018 0.102 -0.032 0.102Industry dummy 9 0.066 0.089 0.069 0.089 0.057 0.089Industry dummy 10 0.031 0.086 0.031 0.086 0.019 0.086Industry dummy 11 0.031 0.105 0.037 0.105 0.011 0.105Industry dummy 12 -0.142 0.103 -0.134 0.102 -0.156 0.102Industry dummy 13 -0.159 0.154 -0.163 0.153 -0.204 0.154Constant -0.758*** 0.124 -0.844*** 0.127 -0.828*** 0.126F 31.52*** 30.79*** 28.80***R-squared 0.190 0.193 0.196n 2980 2980 2980

*** p < 0.001, ** p < 0.01, * p < 0.05.GDP, gross domestic product; OLS, ordinary least squares; PCNs, parent country nationals; R&D, research anddevelopment; SE, standard error.




Model 4 tests Hypotheses 3a and 3b, which predict the negative association of internationaland host country experience and the number of PCNs. The results show that the two types ofoverseas business experience are significantly and negatively associated with the number ofPCNs (p < 0.001 for international experience and p < 0.05 for host country experience),supporting Hypotheses 3a and 3b. Model 5 tests Hypothesis 1b, which predicts thatinstitutional distance is positively associated with the number of PCNs. The results show that

FIGURE 2 The interaction of institutional distance and international experience – the ratio of parentcountry nationals (PCNs)

PC

N r

atio

0 5Institutional distance

High international experienceLow international experience

FIGURE 3 The interaction of institutional distance and host country experience – the ratio of parentcountry nationals (PCNs)

PC

N r

atio


High host country experience

Low host country experience




institutional distance is significantly and positively associated with the number of PCNs(p < 0.001). A change in R-squared attributable to the addition of the institutional distancevariable is significant (p < 0.001). These results support Hypothesis 1b. Model 6 testsHypotheses 5a and 5b, which predict that international experience and host country experiencepositively moderate the relationship between institutional distance and the number of PCNs.The interaction term for institutional distance and international experience was positive andsignificant (p < 0.05), whereas the interaction term for institutional distance and host countryexperience was not significant. The increase in R-squared compared with Model 5 is significant(p < 0.01). These results support Hypothesis 5a but reject Hypothesis 5b. Figure 4 is a graphicalpresentation of the results for the interaction between institutional distance and internationalexperience with mean + 1 standard deviation representing a high level of experience, and mean- 1 standard deviation representing a low level of experience. The slope of high internationalexperience is steeper than that of low international experience. The marginal effect ofinstitutional distance on the number of PCNs was 0.16 for firms with high internationalexperience and 0.11 for firms with low international experience. These marginal effects indicatethat the positive effect of institutional distance on the number of PCNs increases withinternational experience. Note that the higher y-intercept of the line for low internationalexperience in Figure 4 is interpreted as showing the tendency for firms with low internationalexperience to assign more PCNs to a foreign subsidiary.

To check the robustness of the results reported above, we incorporated different sets ofcontrol variables and ran a series of Tobit and OLS regressions. Except for a slight change inthe significance level in some regression models, the coefficients for the variables of interestremained significant for different sets of control variables.

Among the control variables, the ownership structure of foreign subsidiaries and the size ofthe parent firm were significantly positive for both dependent variables. The foreign sales ratioof the parent firm had a significantly negative impact only on the PCN ratio. The GDP percapita was positively and significantly associated with both dependent variables, while

FIGURE 4 The interaction of institutional distance and international experience – the number of parentcountry nationals (PCNs)

Log

of n

umbe

r of

PC

Ns


High international experience

Low international experience




geographical distance had a significantly negative impact only on the number of PCNs. TheR&D intensity and cultural distance did not show any significance for either of the dependentvariables.

DISCUSSION AND CONCLUSION

Main findings

Grounded in institutional theory, this study examined how institutional distance influencesforeign subsidiary staffing. This study distinguished the two staffing decisions, and predictedthat legitimacy seeking, the need for control and knowledge transfer affect the two decisionsdifferently. The empirical analysis found that as institutional distance increases, Japanese firmsreduce the PCN ratio but increase the number of PCNs. This study also found that the negativeassociation between institutional distance and the PCN ratio weakens as Japanese firmsaccumulate international and host country experience. In comparison, the positive associationbetween institutional distance and the number of PCNs strengthens as Japanese firmsaccumulate international experience.

Implications

Firms seek legitimacy within local contexts and control of overseas operations to cope withgreat institutional distance (Xu et al., 2004). Previous studies contend that firms place a priorityon one issue at the expense of the other in their decisions regarding foreign subsidiary staffing(Xu et al., 2004; Gaur et al., 2007). When firms place a higher priority on gaining local legitimacy,they may rely more on HCNs at the expense of control (Xu et al., 2004). In contrast, when thefirms emphasise internal control, they may rely more on PCNs at the expense of legitimacy(Gaur et al., 2007). As the conflicting arguments suggest, previous studies reported inconsistentfindings regarding the effect of institutional distance on the assignment of PCNs. We believethat the results of this study may provide a clue to reconciling the seemingly contradictoryarguments and findings in existing studies. Rather than assuming that firms deal with one issueat the expense of others, we considered two staffing practices that capture different aspects offoreign subsidiary staffing and explicitly theorised different roles that these two practices mayplay in dealing with institutional distance.

This study found that institutional distance is negatively associated with the PCN ratio butpositively associated with the number of PCNs. The results imply that firms seek to resolvethe issues of legitimacy versus control with two staffing practices. The results support ourclaim that the PCN ratio is used to address legitimacy issues, while the number of PCNs isused to enhance control of foreign subsidiaries. While firms attempt to localise the overallworkforce to gain acceptability and legitimacy within the local context, they assign theincreased number of PCNs to tighten control over the foreign subsidiary. This means thatfirms attempt to balance legitimacy seeking with control enhancement by skilfullymanipulating the two staffing practices when there is great institutional distance. The findingsfrom this study imply that using only one of the two proxies may not adequately explain thecomplexity of foreign subsidiary staffing, and may draw an oversimplified conclusion thatfirms emphasise legitimacy seeking at the expense of effective control or vice versa.Incorporating the two staffing practices into the analysis will contribute to advancing ourunderstanding of the complex relationship between institutional distance and foreignsubsidiary staffing.

The empirical results demonstrate that the direct effect of international experience and hostcountry experience is negative for both the PCN ratio and the number of PCNs. Business




experience in various countries helps firms develop comprehensive knowledge to manageoverseas operations, while experience in a host country helps firms develop specific knowledgeabout the country (Johanson and Vahlne, 1977). Such general and specific knowledge decreasesuncertainty inherent in foreign operations, and thus lowers the need for PCNs to operateforeign subsidiaries. This study also examined the interactions of overseas business experienceand institutional distance. The results suggest that the two types of overseas experience lowerthe relative advantage of HCNs in dealing with institutional distance. Overseas businessexperience helps firms develop a pool of competent PCNs who have expertise in understandingand coping with unfamiliar institutions. These internationally competent PCNs successfullydeal with the legitimacy issues in the context of the local institutions and appropriately adaptthe parent firm’s knowledge to the local contexts (Kostova and Zaheer, 1999; Gaur et al., 2007).The increased availability of internationally competent PCNs seems to lessen the relativeadvantage of HCNs over PCNs under the condition of great institutional distance, and tomitigate the pressure to localise the workforce profile for legitimacy seeking and knowledgerecontextualisation.

The results of Model 6 indicate that firms with high international experience tend to increasethe number of PCNs in response to an increase in institutional distance more than those withlow international experience do. The less steep slope for low international experience inFigure 4 implies that firms with less international experience have difficulty assigning therequisite number of PCNs to deal with increasing institutional distance. In comparison, thesteeper slope for high international experience in Figure 4 implies that firms with moreinternational experience can increase the number of PCNs in response to institutional distance.This is possible because firms with high international experience have a greater availability ofinternationally competent PCNs. Previous studies have assumed that PCNs are capable ofcontrolling foreign operations and transferring organisational practices without consideringtheir expertise in addressing local institutions (Tan and Mahoney, 2006; Wang et al., 2009).However, the results of this study may suggest that PCNs can effectively function as a meansof control and knowledge transfer only if they possess the capabilities to deal with institutionaldissimilarities (Paik and Sohn, 2004; Wang et al., 2009). Future studies need to recognise that thecompetence of PCNs varies across firms’ levels of international business experience, and needto avoid the simplistic assumption that all PCNs are capable of control and knowledge transferunder any condition.

Among the four interaction terms examined, the interaction between host country experienceand institutional distance was insignificant for the number of PCNs. Host country experiencedevelops PCNs who have knowledge specific to the host country. They effectively implementknowledge transfer, which may encourage firms to assign more PCNs to the foreign subsidiary.In comparison, learning through operations in the host country mitigates uncertainty associatedwith institutional distance. This may reduce the necessary level of control, and hence maydecrease the requisite number of PCNs for the control purpose. These two opposite forces mayoffset each other, which may cause the interaction term to be insignificant.

Firms operating in institutionally distant countries face the challenge of simultaneouslyestablishing local legitimacy and tightening control of foreign operations. To survive ininstitutionally distant countries, firms may, on the one hand, place importance on the legitimacyissues and decrease the PCN ratio. On the other hand, firms may place importance on thecontrol issues and increase the number of PCNs. This study suggests that firms maysimultaneously handle the conflicting requirements by manipulating the two staffing practices.This study also suggests that firms may effectively meet these conflicting challenges over thelong run by developing internationally competent PCNs. The benefits derived from assigning




PCNs to institutionally distant countries will outweigh the cost of expatriation as firmscontinue to develop internationally competent PCNs who can effectively meet the conflictingchallenges of legitimacy, control and knowledge transfer issues (Bonache Pérez and Pla-Barber,2005; Wang et al., 2009).

Limitations and directions for future research

The results presented herein are subject to limitations. The sample for this study consists ofJapanese manufacturers, which limits the generalisability of the findings. Future research mayreplicate this study using data sets consisting of firms from other countries. Regarding thepersonnel that make up a foreign subsidiary, this study used a relatively simplistic distinctionbetween expatriate PCNs and HCNs due to the limitations of the data. HCNs may have workexperience at the parent firm and be sent from the parent firm to foreign subsidiaries, whilePCNs may have lived overseas and been hired locally by a foreign subsidiary. These managersmay have competencies that are usually possessed separately by PCNs and HCNs. We also didnot consider third country nationals (TCNs) as a staffing option for MNCs. TCNs can beeffectively socialised into the parent firm, be better informed about the institutionalenvironments of the host country and be a lower cost staffing option (Collings et al., 2010).Future research may examine how these managers affect foreign subsidiary staffing and whatroles they play in foreign subsidiaries. In addition, although this study referred to the skills ofinternationally competent PCNs, they were not incorporated into the empirical analysis. Thisstudy did not consider the strategic role of foreign subsidiaries either. To advance ourunderstanding of foreign subsidiary staffing, future studies may further investigate how thespecific characteristics of PCNs and the role of foreign subsidiaries jointly affect staffingdecisions.

This study only considered the two staffing practices at the workforce level, although MNCsmay manipulate other staffing practices to deal with legitimacy, control and knowledge transferissues caused by institutional distance. For example, manipulating the staffing composition oftop or senior management could be an alternative way to address these issues. Whether thestaffing composition of the top or senior management is homogeneous or heterogeneous interms of staff nationality may affect control, coordination, learning, innovation, organisationalidentification and emotional conflict (Gong, 2003b). These influences of staffing compositionmay eventually affect the performance of foreign subsidiaries (Gong, 2003b). Future studiesmay consider foreign subsidiary staffing at a top or senior management level and address howthe staffing composition at a higher management level affects the management of a foreignsubsidiary. Another limitation of this study is concerned with the operationalisation ofinstitutional distance. This study used the Governance Indicators primarily because they aremore comprehensive than other indices. Although our measure is based on the comprehensiveindex, it may capture limited aspects of complex institutions. Thus, future research may furtherimprove operationalisation of institutional distance.

The sample size of this study was 2,980. A large data set may make it easier to findstatistically significant relationships. Thus, the practical relevance of the results derived fromthis empirical study is subject to limitation. Previous studies that examined the relationshipbetween institutional distance and foreign subsidiary staffing also used large samples. Forexample, the sample size of Xu et al. (2004) was 2,199, while that of Gaur et al. (2007) was 12,997.The results of this study replicated Xu et al. (2004) with regard to the main effects ofinstitutional distance. In terms of interaction effects, this study obtained results similar to Gauret al. (2007). However, to verify the validity and practical relevance of the findings from thisstudy, it is desirable to employ methods other than analysis of a large sample, such as in-depth




case studies, in future research. Further, because this study used cross-sectional data, theinterpretation of causal relationships presented in the empirical study is subject to limitations.Finally, this study did not incorporate variables related to foreign subsidiary performance.Future research may examine how foreign subsidiary staffing affects subsidiary performance.

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Documents

Institutional distance, host country and international business experience, and the use of parent country nationals