Prelims

Study Background

As the world becomes more and more globalized, distance separating countries seems to disappear (Cairncross, 1997; Friedman, 2005; O‘Brien, 1992). According to the International Monetary Fund (IMF), globalization can be defined as “the increasing integration of economies around the world, particularly through the movement of goods, services, and capital across borders” (IMF, 2008, p. 2). IMF (2008) to add: “globalization implies that information and knowledge is dispersed and shared” (p. 2). Some scholars consider that globalization has led to the “death of distance” (Cairncross, 1997) or to the “end of geography" (O‘Brien, 1992). Friedman (2005), in his book, uses the expression “the world is flat" that reflects the erasure of national borders and the full integration of world economies. In opposition to this view, some reputed scholars note that foreign direct investments (FDI) are primarily undertaken in host regions geographically and institutionally closer to the home country (Cantwell, 2009; Rugman & Oh, 2013). It follows that countries are more regionally integrated than globally integrated (Rugman & Verbeke, 2007). In his book “World 3.0: Global Prosperity and How to Achieve It,” Ghemawat (2011) considers that the world is “semiglobalized": borders, differences, and distances still matter. Ghemawat suggests that the world can be described neither as not integrated nor as fully integrated. In the DHL Global Connectedness Index 2014, Ghemawat and Altman (2014) affirms that “the levels of globalization are much lower than the levels one would expect to see if borders and distance had ceased to matter. They are also significantly lower than most people’s intuitions” (p. 13). Thence, distances still matter in the internationalization process of firms.

As noted by Nachum and Zaheer (2005), “distance is fundamental in international business (IB) theory, and implicitly or explicitly occupies a central position in all its subfields” (p. 747). Distance between two countries is a multidimensional concept, including not only a geographical dimension but also other dimensions related to the culture, the administrative, political, and economic aspects as shown by Ghemawat (2001) and its “CAGE” framework, as well as by Berry, Guillen, and Zhou (2010) and their nine dimensions of cross-national distance. In the last decade, Van Tulder (2010) notes that the research tends to be oriented toward the institutional and governance distance between countries. Many scholars have emphasized the role of institutions in the internationalization process of firms (Cantwell, Dunning, & Lundan, 2010; Dunning & Lundan, 2008; Van Hoorn, & Maseland, 2016). Recent articles in IB analyze institutions as a factor impacting FDI, especially from emerging countries, ¹ whereas others focus on the role of institutions in the foreign entry mode choice. ² Culture, that can be considered as an informal institution, is also widely analyzed in recent IB papers. ³ As discussed, distance and institutions play an important role in IB. Thus, this book focuses more precisely on an aggregation of these two fundamental concepts, namely institutional distance (ID). A concise literature review on ID highlights different research fields in IB (see Table 1). The main research fields focus on the analysis of the relationship between ID and FDI location choice, as well as ID and entry modes. However, these studies report several weaknesses. The diversity of conceptualization and operationalization of ID leads to mixed results. Additionally, the studies in entry mode primarily focus on the ownership mode. Solely few studies investigate the relationship between institutional distance and establishment mode. A majority of studies investigate the effect of ID on location and entry mode choices for the manufacturing sector, neglecting the effect for the services sector, also noted by Morschett, Schramm-Klein, and Swoboda (2010). Moreover, based on a meta-analysis of 72 studies on entry mode choice, Morschett et al. (2010) suggest to “investigate the combined effect of different variables based on a multi-theoretical framework” (p. 72). For example, in a recent paper, Shaver (2013) suggests to investigate more deeply to what extent past entry mode choices can impact present and future entry mode choices. This study attempts to fill in the gaps found in the literature, notably: to clearly argue the choice of ID measures, to distinguish between determinants of location and entry mode choice in manufacturing and services sectors, to consider the effect of ID on entry mode not only in terms of ownership choice but also in terms of establishment choice, and finally to empirically integrate the effects of variables based on different theoretical streams (especially organizational learning and network/cluster approaches).

The analysis of the location and entry mode choice is not arbitrary. It is based on the REM model developed by Liuhto and Jumpponen (2003) and composed of three elements: R for reason to internationalize, E for environmental choice, and M for modal choice. The three questions underlying these elements are why, where, and how firms internationalize, as shown in Figure 1. As noted by Liuhto and Jumpponen (2003), the REM model is a “simplistic theoretical tool for the analysis of internationalization” (p. 23). In fact, it omits the what firms internationalize. This question refers to the value chain activities (i.e., inbound logistics, operations, outbound logistics, marketing and sales, and service) (Porter, 2008, p. 75). However, this aspect cannot be explained theoretically by institutional distance, the central variable of this study. Thus, this book will focuses on the impact of institutional distance on the two strategic decisions of location and entry mode, as in Xu and Shenkar (2002) – other determinants (e.g., the reasons to invest abroad) are considered as control variables.

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Figure 1.

REM Model.

In this context, the case of Switzerland is particularly relevant to analyze. First, Switzerland is listed in the top 20 home economies by outward FDI flows (UNCTAD, 2015b, p. 8). Its outward FDI stocks in 2014 amount to USD 1130614.7 millions (UNCTAD, 2015a), giving it a leading position compared to other world economies (see Table 2). UNCTAD (2004) proposes to introduce the Outward FDI performance index defined as “the world share of a country’s outward FDI as a ratio of its share in world GDP” (p. 16). Over the period 2010–2014, Switzerland reports a mean value of 5.93, listed in the top 20 of the OFDI performance index, just below Singapore (mean value: 6.79). ⁴ Switzerland exhibits a high OFDI performance compared to other developed countries.

Second, As we can see in Figure 2a, its outward FDI position indicates that Switzerland invested and still invests massively within its home region (i.e., European Union; EU). Its OFDI stocks in EU amount to nearly 50% of its overall OFDI stocks. This percentage has not changed significantly over the period 2005–2014. This study aims to understand whether institutional distance can be a significant factor explaining the regionalization of Swiss OFDI. Recent studies on Swiss OFDI focus primarily on OLI determinants (i.e., ownership, location, and internalization) to attempt to explain this trend (Arvanitis, Hollenstein, Ley, & Stucki, 2011; Arvanitis, Hollenstein, & Stucki, 2012).

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Figure 2.

Share of Swiss OFDI Stocks. (a) By World Region. (b) By Sector. Source: Author’s elaboration based on Swiss National Bank (2016).

Finally, Switzerland is also singular compared to other developed economies in terms of sectoral composition. In fact, an extensive part of its activities is services-based. This is also reflected in the sectoral composition of its outward FDI stocks (see Figure 2b). Most of the theories on internationalization focus on the determinants affecting the foreign production (i.e., primarily the industry/manufacturing sector). It would be interesting to analyze to what extent these determinants can explain OFDI in the services sector. Moreover, as reported by the Swiss Statistics Office in 2012, 66.1% of the total number of enterprises are microenterprises (fewer than 2 employees), 32.3% have from 2 to 49 employees, 1.3% have from 50 to 249 employees, and the rest (more or less 0.3%) have more than 250 employees and are considered as big firms. Big firms with a high level of internationalization (e.g., Nestle, ABB) contribute to a large extent to the Swiss OFDI stocks. However, small and medium enterprises (SMEs) are also involved in the internationalization process. Theoretically, the firm size differences can also impact the strategic behavior of internationalization. It would be interesting to test it empirically using the Swiss case.

This book contributes to the controversial debate about globalization and full integration of the world economies, giving evidence that institutional distance is still a new topic and matters in the internationalization process of Swiss firms. The structure of the book will be described in the next section.

Book Structure

The book is divided in four main chapters. In the following, the purpose and the conclusions of each chapter will be discussed to give the reader an overview of the contents. The thread throughout the book is “institutional distance.” The book has as its main objectives to answer the following questions:

• How can we define and measure “institutional distance”?

• How can “institutional distance” impact FDI location and entry mode choices? – Set of general theoretical hypotheses

• Is “institutional distance” relevant in FDI location and entry mode choices of Swiss firms? – Empirical analysis specific to Switzerland

Chapter 1 presents a review of the different conceptualizations and measurements of ID used in previous IB studies. To avoid overlaps, this book will be based on North’s conceptualization between informal and formal ID (North, 1990). It also aims to calculate ID using different methods and compare their statistical properties. Based on these calculations, the institutional distance of Switzerland with others countries is illustrated. With respect to the informal ID, Switzerland is relatively similar to developed countries (i.e., European Union, North America, Australia, New Zealand, Japan) and relatively dissimilar to developing countries (i.e., Russia, China, India), as expected. With respect to the formal ID, Switzerland is very similar to developed countries (i.e., small formal ID) and very dissimilar to developing countries (i.e., large formal ID). Differences on informal and formal ID between Switzerland and other countries can potentially be relevant in FDI location and entry mode choices. ⁵

Chapter 2 posits the theoretical foundations of the relation between the institutional distance and the internationalization strategies of firms in terms of location and entry mode, primarily based on the concept of “liability of foreignness” (LOF) developed by Zaheer (1995). Due to the costs of entry in a foreign country, firms can be reluctant to undertake FDI in this specific foreign country (Kostova, 1997). ID, considered as one of the major causes of these costs, can impede FDI in particular locations (Eden & Miller, 2004; Gaur, Kumar, & Sarathy, 2011). However, institutional quality of the host country and firm-specific advantages of investing firms can reduce the negative impact of ID on FDI (Globerman & Shapiro, 2002; Ramachandran & Pant, 2010). We consider experience and network/cluster embeddedness as determinant firm-specific advantages that enhance learning in a firm. Based on these theoretical considerations, we posit a set of hypotheses tested in Chapters 3 and 4.

Chapter 3 tests the impact of the institutional distance on Swiss FDI location at a country-level using aggregate data from the Swiss National Bank (SNB) over the period 2007–2012. We consider a log-linear version of a gravity model estimated through fixed effect model (FE), random effect model (RE), and pooled ordinary least squares (OLS). The gravity model is estimated for the total sample and for two sectoral subsamples (i.e., manufacturing and services) to account for possible differences in strategic behaviors between manufacturing and services firms. For the total sample, the results indicate that informal ID impacts negatively and significantly the Swiss FDI location choice, whereas the coefficient for formal ID is negative but not statistically different from zero. For the services sample, informal and formal ID have a negative and significant impact on Swiss FDI location choice, institutional quality offsetting the negative formal ID effect. For the manufacturing sample, neither informal ID nor formal ID seem to have an effect on the Swiss FDI location choice, but institutional quality impacts positively and significantly the location choice. Irrespective to the sample considered, the findings show some significantly determinant control variables in the Swiss FDI location choice: the gross domestic product (GDP) of the home and host countries, the geographical distance, and the host country openness to FDI.

Chapter 4 is based on a survey on internationalization of Swiss firms undertaken at the end of 2014 in collaboration with KOF Institute, Zurich. Questionnaires were sent to 545 firms and 187 filled-out questionnaires were received (response rate: 34.31%). The purpose of this survey was to determine at a firm-level the motivations of location and entry mode choice and assess the role of experience and network/cluster embeddedness. The chapter is divided into two parts. The first part includes a descriptive analysis of the responses illustrating the general trends observed on Swiss firms’ internationalization. The second part deepens the analysis at an econometric level. The responses are transformed into variables and used as independent variables to explain the entry mode choice in terms of establishment and ownership. The equations are estimated through logit and probit models. For establishment choice, the findings indicate that formal ID decreases the probability to invest through greenfields and informal ID has no significant impact. For ownership choice, the results show that formal ID decreases the probability to invest through partial ownership, whereas informal ID increases this probability. The motivations, related to the seeking of specific intangible or tangible assets, increase the probability to invest through acquisitions and partial ownership.

Definition of Key Terms

This section provides a definition of the essential terms necessary to clearly understand the analysis. Table 3 lists these terms and gives a definition based on reliable sources.