The Internationalization of State Owned Enterprises: The Impact of Political Economy and Institutions. Saul Estrin. Department of Management,

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1 The Internationalization of State Owned Enterprises: The Impact of Political Economy and Institutions Saul Estrin Department of Management, London School of Economics Klaus E. Meyer Department of Management, China Europe International Business School Bo B. Nielsen Department of Strategic Management and Globalization Copenhagen Business School Sabina Nielsen Department of International Economics and Management Copenhagen Business School This version October 31, 2012 Acknowledgements: This paper was written while Saul Estrin was on leave at the Department of Strategy and Entrepreneurship at London Business School. The authors would like to thank Harry Barkema, Sumon Bhaumik, Mike Peng and Daniel Shapiro for useful discussions around these issues. Any remaining errors are their own. 1

2 The Internationalization of State Owned Enterprises: The impact of Political Economy and Institutions Abstract State owned enterprises (SOEs) play different roles in different societies. Integrating political economy and institutional perspectives, we argue that the globalization of SOEs is driven by each country s political economy that shapes economic institutions, which, in turn, influences the strategies of SOEs. Specifically, we suggest that state ownership reduces a firm s degree of internationalization, but this effect is moderated by the configuration of political and institutional factors of the home country. We find evidence for our theoretical model in our empirical analysis over a unique dataset of 3087 of the largest companies of the world, representing 47 countries. Keywords: state-owned enterprises, internationalization, institutions, political economy, Tobit regression. 2

3 Introduction Globalization has greatly increased the diversity of corporate players in the global economy. In 1970, over 65% of worldwide FDI flows originated from the USA and the UK, with most of the remainder originating from other countries with similar free market economies. Hence, most theorizing on multi-national enterprises (MNEs) has been based on a profit-maximizing and market based logic. However, over the past decades, the share of the USA and the UK in global FDI flows declined to 23% in 2010, while new players increased their share, including Japan in the 1980s, France in the 1990s and emerging economies such as China from about 2005 onwards. 1 This diversification of origins of MNEs has increased the heterogeneity of institutional arrangements and economic systems from which these MNEs originate. This heterogeneity has a number of consequences for the types of firms that emerge. First, in a free market economy, private ownership of business is the norm, and state ownership is rare, especially after the global privatization wave of the 1980s and 1990s (Vickers& Yarrow, 1992, Estrin, Hanousek, Kocenda, & Svejnar, 2009). Even so, state-owned enterprises (SOEs) continue to play an important role in many countries, either to complement the market in social democratic economies (Hall& Soskice, 2001, Redding 2005) or as a guiding agent for economic development, as in for example Singapore and China (Fligstein& Zhang, 2011, Lin, 2011, Redding & Witt, 2009, Tipton 2009). Second, the role of SOEs varies substantially across countries because SOEs are political as well as economic actors that are owned by the government and hence subject to multiple, and sometimes conflicting, pressures from the political and economic spheres. Consider two polar cases as illustration. EU competition policy is designed around the ideal 1 FDI data in this paragraph have been obtained by analyzing the UNCTAD FDI database. 3

4 that no firm should receive undue subsidies, regardless of its ownership (Brenner 2011, Morgan 2009); SOEs should act as if they are private enterprises. On the other end of the spectrum, SOEs may be strategically deployed to achieve the political objectives of the owner, for instance a national or provincial government (Buckley et al., 2007; Cui & Jiang, 2012; Wang, Hong, Kafouros & Wright, 2012b). Hence, the actions of an SOE on the global stage depend on how it is embedded in the political economy of its home country. In this study, we are interested in a particular type of SOE, namely companies that are listed on the stock market, but have a government entity as their majority shareholder. These listed SOEs display characteristics of both the state and private sectors. Because the majority owner is the state, they may be motivated by objectives other than profits, and these are determined through a political process. Moreover, depending on the country specific political economy and institutional arrangements, agency problems between the state as owner and managers of SOEs are likely to emerge. At the same time, private shareholders typically financial investors create pressures for the firm to act more like a profit-oriented private firm. This constellation can lead to so-called principal-principal conflicts (Dharwadkar, George, & Brandes, 2000; Young et al., 2008) that affect SOE performance, attitude toward risk and hence their internationalization strategies (Carcia- Canal & Guillén, 2008, Chen & Young, 2010). To assess the impact of state ownership on internationalization, we develop the literature on SOEs to address three questions. First, how does the state as owner actually govern its enterprises, and how are these influenced by the political economy and institutional context? Second, in what ways do the differing objectives of SOEs and private 4

5 firms affect the process of company internationalization? Third, how does the stateownership facilitate or constrain access to resources of firms seeking to internationalize? Our main lenses to approach these issues are the institutional and political economy perspectives, which we seek to integrate. The institutional perspective investigates the rules and regulations governing decision makers in businesses, and their impact on strategies and operations of individual firms (Meyer& Peng, 2005; Peng; Wang & Jiang, 2008). In the context of SOEs, the agency relationships between owners and management of SOEs play a critical role as they shape decision makers incentives and hence the strategies they advocate. The political economy approach takes a step further back, to consider the processes determining the institutions and explaining how they work. In our context, political economy is concerned with the linkage between the political system of a country and the actions of politicians operating under these rules, including how they interact with, and what rules they establish for, business (Acemoglu& Robinson, 2012; 2005; Jensen, 2006; Pagano & Volpin, 2005; Przeworski & Limongi, 1993). These two lines of research are related as the political system shapes the institutions governing enterprises (Williamson, 2000) but they have not previously been brought together to explain a specific business phenomenon. In this paper, we focus on the phenomenon of the listed SOEs, which are simultaneously subject to the political economy of a country as well as market forces. We investigate the political economy and institutional home country influences on SOE internationalization across a variety of countries, thereby providing a major departure for international business research. Until recently, studies of international operations of SOEs were fairly limited apart from a few qualitative studies in the late 1970s (Mazzolini, 1979, Vernon, 1979). Recently, scholarly interest has focused on the increasing role of 5

6 Chinese MNEs that are partially or fully state-owned, and becoming major global players (Chen& Young, 2010; Cui & Jiang, 2012; Morck, Yeung & Zhao, 2008; Ramasamy, Yeung & Laforet, 2012; Wang, et al., 2012b; Zhang, Zhou & Ebbers, 2010). Only two recent empirical papers study internationalization of SOEs from other countries, namely Spain (Garcia-Canal & Guillén, 2008) and Norway (Knutsen, Rygh & Hvem, 2011). Thus, a major challenge for the study of SOEs is to move beyond the case of China, which may or may not be a special case, and to investigate SOEs from a larger range of source countries. This will allow us both to develop general theory on internationally operating SOEs, and to assess the generalizability of the findings of the flourishing China-focused stream of research. By integrating insights from institutional and political economy perspectives, we develop a theoretical framework and test hypotheses using a new dataset of 3087 firms derived from information about the largest 5000 listed firms in the world in We find that SOEs, on average, are less internationalized, but this effect is positively moderated by the institutional development at multiple levels of informal institutions, governance institutions and resource access. We thus contribute to the international business literature in the several ways. First, we integrate the political economy and institutional perspectives to advance the theory of the MNE to the acknowledged, yet rarely systematically investigated relationship between home country political economy and MNEs (Luo, Xue & Han, 2010; Stopford & Strange, 1991). This approach is particularly relevant to listed SOEs that operate at the intersection of political and economic spheres. Second, building on Williamson s (2000) framework of institutions, we provide a theoretically grounded analysis of internationalization of listed SOEs; a phenomenon previously addressed only in single context studies (Chen& Young; 6

7 2010, Cui & Jiang, 2012; Garcia-Canal & Guillén, 2008; Knutsen et al., 2011). Third, we are probably the first study to investigate the contextual moderators of state-ownership on firm strategies. Fourth, our empirical results grounded in a large unique dataset provide novel evidence of the patterns of internationalization of state owned MNEs, notably the moderating influence of political economy factors and institutions. Political Economy and Institutions of SOE Governance Listed SOEs have both private and state entities as owners, and hence they are political actors as well as economic actors. They are political actors because they have been established or nationalized by representatives of the state to pursue political objectives. They are also economic actors as they participate in the market economy by creating economic value, by competing for customers and by being traded on stock exchanges. To understand this dual role, we integrate political economy and institutional perspectives. Political economy is a branch of economics that investigates how the rules and incentives operating within the political system of a country impact on the actions of political decision makers (Acemoglu& Robinson, 2012; 2005; Jensen 2006). A particular focus are the rules that law-makers establish for economic actors, such as corporate governance (Pagano& Volpin, 2005), enterprise subsidies (Robinson& Torvik, 2009) and the policies toward inward foreign investors (Penrose, 1968; Jensen, 2006). Political and economic systems are interconnected in that political actors set the rules for economic actors while economic actors aim to influence political actors, through lobbying (Hillman, Zardkoohi & Bierman, 1999), corporate donations, or corrupt practices (Cuervo-Cazurra, 2006). For example,, political systems of winner-takes-all democracy tend to be associated with free markets, while proportional representation democracy, which entails political 7

8 actors having to make compromises and strengthening groups other than the single largest one, tend to be associated with stronger welfare states. For example, Pagano and Volpin (2005) found majoritarian election systems to be associated with stronger shareholder protection and weaker labor protection. On the other hand, political systems of less effective democratic control allow government s greater discretion in using national resources such as SOEs for political or personal ends. The interplay between the institutions of the political and economic systems thus determines the place of SOEs in society, and the rules by which SOEs are governed. Political economy ideas have influenced scholars of the MNE such as Stopford and Strange (1991) but there has been little systematic application of the political economy perspective to MNEs from the home country perspective and stateowned MNEs in particular. We build on the approach of Acemoglu and Johnson (2012) who argue that the differences in levels of income and wealth between countries are explained by two factors. The first is institutional; the relationship between inclusive political and economic institutions, such as strong property rights, high general levels of education and clear incentives for innovation, economic growth and prosperity. The second is the political economy processes which underlie the selection of inclusive institutions, which Acemoglu and Johnson (2012) contrast with the emergence of extractive institutions that focus on ensuring the sustained wealth of the elite. Inclusive institutions are designed in particular to enhance the efficiency of markets and to reduce uncertainty (North, 1990; Peng et al., 2008). Williamson (2000) categorizes institutions into a four level hierarchy, each level placing constraints on the ones below. He places informal institutions (customs, traditions and religious norms), at the top of the 8

9 hierarchy because these are the deepest rooted and the slowest changing. Formal institutions are located at the second level; the key rules of the game that relate to property rights that are stable and effectively enforced. Weak property rights generate profound uncertainty in the business environment. Williamson s third level is governance, which shapes the way that individuals interact, aligning the governance structure they adopt with the types of transactions. He places particular emphasis on private governance; for instance the nexus of formal and informal arrangements underlying the provision of finance and the development of supply and distribution networks. The three previous levels all affect the fourth; resource allocation, including corporate strategies and decisions. International business scholars have frequently analyzed the impact of such institutions in host countries on for example the inflow of foreign direct investment (e.g. Bevan, Estrin & Meyer, 2004; Globerman & Shapiro, 2002) and foreign investors entry mode (Meyer, 2001; Meyer, Estrin, Bhaumik, & Peng, 2009). However, there has been less focus on how internationalization is influenced by institutions in the country of origin, including the form of ownership, notably the distinction between state-owned and private firms. We also lack understanding of how institutions in the country of origin affect the strategies of outward investments. We develop such a country of origin perspective by analyzing the political economy and institutions of the home country. Therefore, we develop the political economy literature to consider the objectives that such SOEs might follow in different political environments, and integrate this with elements of the institutional and governance literatures in order to shed new light on the internationalization behavior of SOEs. Private listed firms normally have as their primary objective shareholder value maximization. In 9

10 contrast, listed SOEs are subject to more complex objectives introduced by the duality of ownership. We thus first explore the political economy underlying the government becoming involved in running enterprises in the first place, which allows us to predict a direct effect on SOE internationalization. This direct effect is subject to pressures of institutions created by the political economy of the home country; in particular informal institutions, formal and governance institutions and the state s access to resources. Figure 1 summarizes these arguments, which will be further detailed in the following sections. *** Figure 1 about here *** Objectives of SOEs In a purely free market conceptualization, in which markets operate costless and without frictions, there is no role at all for the state in the economy. In this textbook world of general equilibrium of perfectly competitive markets (see e.g. Estrin, Laidler & Dietrich, 2012), the state either does not need to exist at all, or is limited to securing the efficiency of markets through enforcements of rules and laws. However, in practice markets are not all perfect and there is a role for active government intervention to remedy market inefficiencies (Atkinson& Stiglitz, 1980). This suggests that SOEs should only serve specific purposes where pure market outcomes are considered either inefficient or socially undesirable. For example, SOEs may operate in industries with natural monopolies such as railway networks, electricity distribution, or the provision of public goods (Aharoni, 1981; Estrin, 2002; Vickers & Yarrow, 1992). The purpose of state involvement in these sectors is strictly to overcome inefficiencies of domestic markets, and hence international activities are rarely part of their primary objectives. This vision of SOEs is consistent with Acemoglu and Robinson s (2005) inclusive institutions. 10

11 A related vision of the role of the state derives from social democracy, which views the state as being concerned with the distribution of income as well as with economic efficiency. The objective of the state is seen as benign; to maximize social welfare, which is to be achieved not only through attaining the highest economic efficiency but also by ensuring some degree of equality in the distribution of income and more importantly of opportunity (for a review, see Przeworski & Limongi, 1993). There may well be a trade-off between efficiency and equality in the allocation of resources, and social democratic governments will sometimes use taxation or capital allocation to support social rather than economic objectives. In such a context, the government may also own firms as a tool to attain social goals for example to ensure employment in less developed regions, higher wages for disadvantaged groups, or the direct enactment of social policies in the workplace. A third vision attributes the state a direct role in economic development. For example, SOEs may pool resources for very large projects that private investors would be unable or unwilling to finance. Such SOEs played a major role in industrialization drives or infrastructure construction projects in many developing countries throughout the 20 th century (Prebisch, 1950, Kohli, 2004). Similarly, SOEs in the mining and oil and gas industries play a key role in mobilizing resources for economic development, either by marketing a nation s resources abroad, or by accessing resources outside the country. Thus, SOEs from for example China and Thailand invest overseas to secure the national supply of oil, gas, coal and other natural resources (Meyer& Thaijongrak, 2013, Ramasamy et al., 2012). An extreme version of this view derives from the Marxist tradition, now largely discredited but with an enormous legacy, and views the state as the embodiment of the will of the people (Kornai, 1990) and as the guardian of national economic growth. In these state 11

12 communist systems, such as the former Soviet Union, private ownership was outlawed, with resource allocation and social objectives largely determined by direct fiat through central planning. Since the fall of the Berlin Wall in 1989, few countries have maintained such an economic system. However, countries transitioning from planning to a market economy have often retained a vision of the state as the entity responsible for driving future economic development. This has brought such countries, like China or Vietnam, into line with other historically market oriented economies mainly in Asia, such as Singapore, whose political traditions have also been based on a vision of the state as guiding the process of economic development, though working with the institutions and incentives of a market system rather than replacing them with central direction (Tipton, 2009). These state capitalist economies also give major roles to SOEs, though differently from the case of the social democratic state. In SOEs in this context, profit maximization may be supplemented not only by social and political objectives, but by broader national development objectives. In sum, different historical legacies and political processes across countries lead to variations in the number of SOEs, and in the balance of objectives between them. Countries heavily focused to free market principles have very few SOEs, and these largely emulate the behaviors of private firms, including with respect to internationalization. The situation in more social democratic economies is more complex, depending on the precise reasons why firms are in state ownership (natural monopolies as against large spill-over benefits for example) and the balance of pressures to follow efficiency or social objectives. For example, some SOEs may be specifically set up to create employment, such as entities created to Roosevelt s New Deal in the USA in the 1930s. More commonly, it may be a secondary objective that becomes more emphasized when the organization faces economic pressures 12

13 and the suggestion that it needs to cut costs. Political actors invariably aim to protect employment in their community, and thus are in particular opposed to activities that would generate employment abroad rather than at home. These political pressures affect private firms to a lesser degree, and reduce SOEs relative drive to internationalize. More generally, to the extent that SOEs aim to satisfy social objectives, for example by creating employment, these will be attained by operating primarily within the home country. Similar factors apply in state capitalist countries, though the social versus efficiency trade-offs are further supplemented by trade-offs between the imperatives of growth and efficiency. One can conceive of a variety of ways in which internationalization may be a strategy for development that a state seeks to implement through its SOEs. In state capitalist economies, pressures for social aims, such as job creation and maintenance, may be offset by political pressures to internationalize to attain development targets, such as access to natural resources (Wang et al., 2012b). Even so, for reasons of governance discussed below, SOEs are rarely the most efficient firms, and therefore not the ones most able to compete on international markets. As such, they are therefore unlikely to be the favored instruments for the state to internationalize the economy, even in state capitalist countries. We therefore propose a reduced drive to internationalize in SOEs because the pursuit of social objectives will not, on balance, be offset by the state objective of development through trade. These arguments, however, make the implicit assumption that the state itself takes an inclusive rather than extractive form, in the Acemoglu and Robinson (2005) sense. Extractive states could emerge from a free market system; political economy studies suggest that extractive elites might exploit a large state, including SOEs, for their own purposes, 13

14 including for the extraction of rents. Moreover, extractive states have emerged from former socialist economies; perhaps Belarus and Uzbekistan are examples. In these cases, the objectives of the SOEs become to buttress the political and economic power of the ruling political elites. As such, they seem likely to be primarily political rather than economic institutions, and hence even less likely to internationalize than SOEs in inclusive states. In order to exclude as far as possible SOEs purely serving extractive objectives from our analysis, we focus on SOEs that are not purely organs of the state. Thus, to be considered in our analysis, a firm has to be listed on the stock market; and hence be an independent commercial entity that has degrees of both private and state ownership (though majority state ownership). These listed SOEs encompass a wide range of organizations that blend both business and political objectives. In other words, they are expected to generate profit for shareholders, but they also have a more or less explicit mandate to support political objectives, either social or developmental (Chen& Young, 2010; Garcia-Canal & Guillén, 2008). Governance of Listed SOEs As noted above, the fundamental difference between SOEs and private firms rests in their objectives: while the former pursue broad sets of more or less clearly defined objectives, the latter focus exclusively on profits and shareholder wealth maximization. The two types of objectives combine and conflict in SOEs that are listed on the stock market and hence are jointly owned by private investors and by the state. In these listed SOEs the governance problem of SOEs is moderated by the influence of private shareholders. In particular, with potentially conflicting shareholder objectives, managers may be able to exploit the lack of clarity in company objectives to ensure an easy 14

15 life for themselves and their employees (see Vickers & Yarrow, 1988; Shleifer & Vishny, 1994). Weaknesses in corporate governance thus can cause inferior performance to what might be achieved under private ownership, and thus reduce the ability of an SOE to compete in international markets. The problem arises from the asymmetry of information held by managers and owners; outside owners can never have full access to the information about corporate performance that is in the hands of managers. Thus, it is hard for them to establish whether poor results are a consequence of unforeseen circumstances or managers exploiting firm profits for their own purposes. Whenever ownership and control are separated, firmspecific rents can be used to satisfy management s aim for example, lower effort or managerial power, via the size of the firm rather than profits. However, a private ownership system places effective limits on their discretionary behavior, via external constraints from product and capital markets, and perhaps also the market for managers, which will place value on previous performance (see Estrin & Perotin, 1991). It is hard for the state to replicate such market-based constraints. Even listed SOEs are not fully subject to private capital market disciplines, so the market-based governance mechanisms cannot be substituted for in full. SOE leaders often operate in a partially separated managerial labor market and do not compete in the wider one. Moreover, though the government s ownership stake is concentrated, the state often lacks does not have the capacity in the supervisory ministries to undertake the necessary scale and quality of monitoring. In consequence, weak monitoring of managers and the absence of external constraints can give management considerable discretion to follow their own private objectives rent absorption, asset stripping, employment, or social targets. 15

16 Thus, agency theory suggests that, under such conflicting governance, managers are distracted from the focus on economic efficiency. These agency problems are exacerbated when there are multiple types of owners, each with potentially differing objectives. Managers can exploit the lack of clarity about the aims of the firm to satisfy their own objectives. This situation has been characterized as principal-principal conflict (Dharwadkar, George, & Brandes, 2000; Young et al., 2008). Moreover, the presence of shareholders with different objectives may affect the SOEs attitude to risk, and hence their internationalization strategies (Chen& Young, 2010, Garcia-Canal & Guillén, 2008). The particular way that these agency problems play out in practice depends on the role of the state and the institutional arrangements in the home country. For example, in free market economies the state as owner may simply seek to maximize profits, and therefore resolve the principal-principal problem by allowing private owners to control management. This appears to have been the case following the nationalization of banks such as Lloyds TSB and RBS in the UK post-2008, where the state appears not to have any specific mechanisms to ensure governance in pursuit of its own, as against private sector, interests. This approach, however, assumes that the interests of private owners and the state are perfectly aligned. A closely related issue is the softness of budget constraints arising with the political determination of resource allocation: managers benefit from an implicit guarantee to cover the losses of an SOE. This acts as a further source of incentive problem, since managers do not have to bear the consequences of their own actions. All of these factors suggest that SOEs are likely to be less efficient than their (purely) private counterparts because they face additional problems of agency and governance. In 16

17 consequence, they will be less competitive than privately owned counterparts and therefore less able to develop capabilities or ownership advantages (Dunning, 1993) that would be transferable to be exploited abroad, and which are a key driver for international growth (Kirca et al., 2012). Moreover, the lesser degree of competition faced by SOEs in their home environment also reduces their opportunities to learn how to engage in the kind of competitive environments they are likely to encounter in the global economy. This lack of suitable capability would thus reduce the ability of SOEs to internationalize. In addition, decision makers in SOEs may have highly bureaucratic decision-making processes and incentive schemes that discourage the taking of risk. However, international growth is a high risk activity. The inherent risk averse behaviors of SOEs can thus be expected to reinforce the negative effect of the lack of capabilities on the scope of internationalization strategies. Moreover, SOEs will often face pressures to pursue not only economic objectives but to align their strategies to political imperatives of the government at the time that usually have a domestic character; only in emerging state capitalist economies and in special sectors such as the mining industry do they also involve international scope. Hence, we propose that after controlling for levels of development and possible industry specific effects, SOEs will have fewer international activities: Hypothesis 1: SOEs exhibit a lower degree of internationalization than privately owned enterprises (POEs). Home Country Institutions as Moderators While the objectives of SOEs can be expected to lead to a lower degree of internationalization compared to private firms, these objectives and their implementation also vary greatly with political and institutional differences between countries. Moreover, 17

18 the political economy literature highlights that institutions and political arrangements do not evolve independently, but are intimately related (Acemoglu& Johnson, 2005, Pagano & Volpin, 2005), and hence moderate the relationship between state ownership and internationalization. We therefore consider the moderating impact of political and institutional arrangements and follow Williamson (2000) in commencing with the highest order informal institutions before considering formal institutions, governance and resource allocation. However, as formal institutions and governance institutions are closely associated both conceptually and empirically, we merge them into a single construct to offer a more parsimonious model. Informal Institutions Perhaps the most important informal institution, especially when considering the process of economic development, is corruption. Corruption can occur within all economic systems. However, because it is associated with the activities of the state the definition of political corruption is the abuse of public power, office, or resources by elected government officials for personal gain (for reviews see Bardhan, 1997; Svensson, 2005) - the possibilities for corruption expand with the scope of state activities. Thus state ownership is likely to be associated with corruption, not because individuals working for SOEs are more corruptible than those working for private firms but because the increased opportunities for corruption. While several studies examine the role of corruption for foreign direct investment (FDI), the vast majority of these studies focus on the role of corruption in the host country and its (mostly) negative association with inward FDI (for reviews, see Cuervo-Cazurra, 2006; 2008). Much less is known about the role of home country corruption for outward FDI. Cuervo-Cazurra (2006) investigated the sensitivity of FDI to host country corruption 18

19 and found it to be modified by the country of origin of the FDI. His findings that host country corruption results in relatively higher FDI from other countries with high levels of corruption point to the importance of home country corruption for internationalization behavior. To the best of our knowledge, the role of home country corruption in relation to internationalization of SOEs has thus far not been studied systematically. As a high level institution (Williamson, 2000), corruption can be viewed as independent from state ownership; however, it may moderate the impact of state ownership on internationalization. If the home country institutional environment is highly corrupt, then bureaucrats may view SOEs as an opportunity to extract rents, and attempt to organize them in ways that enhance the potential for bribery. Such rents can for the most part only be obtained if the SOE is operating in the domestic economy; international activities are outside the scope of the bureaucrats. Indeed, being accustomed to bribery and other ways of circumventing contracts and rules of law may discourage such SOE managers from effectively entering into business transactions abroad; particularly in countries where the level of corruption is lower (Cuervo-Cazurra, 2008). Hence, corrupt bureaucrats are likely to be opposed to internationalization because the rents that they can extract are predominantly domestic, and international operations are not under their control. The more corrupt is the bureaucratic system, including the SOEs, the stronger is this motivation of bureaucrats to keep firms focused to the domestic economy. Hence: H2: The higher the freedom from corruption, the less negative is the relationship between state ownership and internationalization. Institutions of Corporate Governance The institutional arrangements with the most profound impact for the governance of SOEs 19

20 are probably the operations of domestic capital markets. These rely especially on Williamson s (2000) second level of institutions, formal institutions, and notably property rights. In private firms, capital markets serve both as benchmarks to assess corporate performance and as basis for incentive schemes such as stock option plans that help overcoming principal agent conflicts (Fama& Jensen, 1983; Filatotchev & Wright, 2011). Moreover, as capital markets become more liquid, they can more easily support the market for corporate control that represents one of the key governance mechanisms for privately owned enterprises, as well as for publicly listed SOEs. Moreover, governance arrangements are likely to be more effective when capital markets are more developed, because there will be more external agents evaluating company performance and there will be more competition in the market for the shares of SOEs. This resolution of certain aspects of the agency problems of SOEs is strengthened since well-developed stock markets also imply that managers may be incentivized through the use of share ownership or stock options. Hence, scale and liquidity of the capital market influence the balance of enterprise objectives between profits and social ones. Thus, the governance problems of SOEs relative to private ones will be increasingly addressed as the capital market becomes more developed. This implies that SOEs are under higher pressures to improve efficiency and to develop resources that enable competition in competitive markets, which also provide a foundation for international growth. Hence, barriers to internationalization deriving from agency differences to private firms will be reduced. Moreover, with the increased transparency provided by capital markets SOEs are increasingly likely to be assessed against private firms, which provide strong incentives to emulate their strategies. Hence, capital market development is likely to reduce the negative 20

21 effect of SOE on internationalization: H3: The more developed the domestic capital markets, the less negative is the relationship between state ownership and internationalization. Institutions governing resources access Williamson s (2000) lowest tier of institutions is resources available to firms, and we now consider how state-ownership might facilitate or constrain the access to resources. It has frequently been argued that SOEs may enjoy an (unfair) advantage over private firms, because they enjoy preferential access to certain critical resources (Nee, 1992). These resources may also be important when developing operations internationally. The extent to which a government actually provides such benefits depends on both the political ideology and the government s ability to provide resources. In the European Union, which follows free market principles in this respect, government support conflicts with the principles of competition policy. This explicitly rules out national government providing subsidies to firms, including SOEs (Morgan, 2009). Although in practice there are exceptions and disputes as to what constitutes an unfair protection, it is fair to assume that subsidies are more limited in some countries than in others. On the other hand, in state capitalist economies, such supports can be very important. They can include for example (1) explicit or implicit state guarantees that facilitate access to financial resources, including both direct subsidies and indirect benefits such as bank loans from state-controlled banks (Buckley at al., 2007; Luo et al., 2010; Zhang et al., 2010), (2) preferential access to protected domestic markets that allow SOEs to generate cash flow, and/or (3) preferential access to information and research provided by government-associated agencies and research institutes (Kotabe, Jiang & Murray, 2011). In free market and social democratic 21

22 economies such support tends to be more subtle and indirect, including for example support through diplomatic services that help opening doors and gaining access to key decision makers (Knutsen et al., 2011). 2 These political economy factors determine to what extent a government will use its resources to assist in the internationalization of its firms. The government s ability to provide resources depends on the resources that it has at its disposal. The most liquid such resources that can also be invested overseas, and are under control of the state are the accumulated currency reserves of the country, themselves an outcome of past economic policies. A government which has high reserves is in a much stronger position to use SOEs to reinvest its funds. In the fact, the large currency reserves create pressure to identify suitable overseas investment targets to avoid sharp currency appreciation. 3 Moreover states that have accumulated reserves as result of past trade surpluses and a strong currency are in a better position to use their domestic resources to acquire assets abroad, because acquisition targets appear relatively cheap. Hence: H4: The higher the country s accumulated currency reserves, the less negative the relationship between state ownership and internationalization. Methodology Sample and Data The initial sample for this study was drawn from the Worldscope database and included the world s 5000 largest firms based on sales in This sampling was purposeful as we sought to include all large publicly listed enterprises (regardless of ownership) in order to ensure a comprehensive but representative population of firms from a variety of countries 2 This claim of SOEs having preferential access to resources is particularly advanced by opponents of Chinese MNEs operating in North America (for critical reviews see Globerman & Shapiro, 2009; Peng, 2012). 3 Sovereign wealth funds are a special case of this form of SOE, but they are not listed SOEs and therefore not part of this study. 22

23 and industries with both private and public ownership structures in order to maximize variability in our data. Thomson One Banker was the source for firm level data, except for the ownership data, which came from the Orbis database. Country level data was obtained from the Heritage Foundation and the World Bank. Due to missing data on some variables, our sample size was reduced to 3087 firms based in 47 countries, of which 143 were SOEs. Variables and Measures The dependent variable, firm degree of internationalization was measured as foreign sales to total sales ratio (FSTS). As we are primarily concerned with entities where the state has a majority ownership stake, state-owned enterprise (SOE) was operationalized as enterprises with more than 50% state ownership as indicated in the Orbis database. Market capitalization or market value was measured as the share price times the number of shares outstanding as a percentage of GDP (World Bank, 2010). Freedom from corruption is an index composite of rule of law, limited government, regulatory efficiency, and open markets based on the 2010 Index of Economic Freedom published by the Heritage Foundation. Currency reserves is the total reserves held by a country, including holdings of monetary gold, special drawing rights, reserves of IMF members held by the IMF, and holdings of foreign exchange under the control of monetary authorities (World Bank, 2010). Finally, we controlled for the development of the domestic economy via GDP per capita. Industry variables were measured based on 3-digit SIC codes. Industry concentration is an indication of the number and relative power of firms in an industry. It was measured as the percentage of sales accounted for by the top four firms within an industry. Industry growth was measured as the annual compound growth rate, calculated by taking the n th root of the total percentage growth rate, where n is the number of years in the period being 23

24 considered (Dean& Meyer, 1996). We also controlled for resource-based industries, operationalized as a dummy variable for industries with SIC codes smaller than Following prior studies, product diversification was measured using the entropy measure of firm diversification (Hoskisson et al., 1993; Palepu 1985). The entropy values were calculated with the formula Σ p i ln(1/p i ) where P is the percentage of segment sales of the total firm sales and (1/P) is used as a weight to account for the importance of each business segment. The literature suggests that differences exist in the way internationalization affects performance of large vs. small firms (Lu& Beamish, 2001). We therefore controlled for firm size measured as the logarithm of employees. As the firm s own resources and capabilities constitutes a key driver of internationalization (Kirca et al., 2012), we included R&D expenditures in the analysis. However, since this variable was missing for a relatively large proportion of the sample, we followed prior research (e.g. Greene, 2003; Singh, 2008)and recoded all missing values of R&D with 0 and added a dummy variable indicating whether data on R&D was available or not. Table 1 provides descriptive statistics (means and standard deviations) and correlations between the variables in our regression analysis. Freedom from corruption and GDP per capita appear highly correlated (0.88). Therefore, we conducted a variance inflation factor (VIF) analysis to assess multicollinearity. The analysis generated as a highest value 5.58, which is well below the recommended benchmark of 10 (Hair et al., 1995). Table 1 about here Analysis Given the nature of our dependent variable, degree of internationalization, which is subject to left-censoring (firms that decide not to internationalize abroad may have only domestic 24

25 activities; the degree of internationalization has a limit value of zero), we used a Tobit (Tobin, 1958) model to estimate our equations. Conventional regression techniques, like OLS, can provide inconsistent parameter estimates when applied to data that include a large proportion of limit observations; it may yield a downwards-biased estimate of the slope coefficient and an upwards-biased estimate of the intercept (Greene, 2003: 764). A Tobit model is specified as follows: Y * i = X i β +Ɛ i where Ɛ i ~ N(0,σ 2). Y * is a latent variable that is observed for values greater than 0 and censored otherwise. The observed Y is defined by the following measurement equation: Y i = Y * if Y * > 0 0 if Y * 0 Results Table 2 provides our main results of the Tobit estimations. Model 1 shows the base equation with only the control variables included. Model 2 shows the partial analysis including all direct effects and model 3 is the full model with all interactions. Table 2 about here With respect to Hypothesis 1 we find that the direct effect of state ownership on firm internationalization is negative and significant at P<0.001 level (Model 2). Even after including the moderating effect (Model 3), the result is still negative but significant only at P<0.05 level. Hence, we find support for the hypotheses but also indications that this effect is critically moderated. We use the full model (Model 3) to assess our hypotheses regarding the moderating effects. In accordance with Hypothesis 2 we find that freedom from corruption has a strong 25

26 positive moderating effect on the SOEs-internationalization relationship (β=0.01, p<0.001). This supports our argument that under conditions of low corruption (informal institutions), SOEs are more likely to internationalize (or less unlikely to internationalize compared to POEs). Hypothesis 3, which proposed a positive moderation of market capitalization on the focal relationship, also received support (β=0.00, p<0.05), suggesting that formal institutional governance mechanisms increase the likelihood of SOEs internationalization. Finally, hypothesis 4 predicted a positive moderation of institutional access to resources on the SOE-internationalization relationship. This hypothesis also obtained strong support (β=1.17-7, p<0.001) in support of our theory. Together, the results provide strong evidence in support of our theoretical framework as outlined in figure 1; while SOEs internationalize significantly less than POEs, on balance, this relationship is conditioned in important ways by the unique configurations of political and institutional environments of the home countries from which these SOEs originate. As robustness test we also ran these regressions including the moderating effects one at a time. These regressions resulted in moderating effects signed in the same direction as in the full model, and at equal or higher levels of significance. As further robustness tests, we substituted some of the moderating effects with other measures for the same theoretical construct. For example, in accordance with our theory we used the protection of intellectual property rights in place of freedom from corruption to gauge the role of formal institutions, and we found the results to be substantially identical. However, as these two variables are highly correlated (r=0.94), we were unable to include them simultaneously in the full model of our analysis. These results are available from the authors upon request. 26

27 With respect to control variables, we note in particular positive and highly significant effects of R&D intensity (β=0.02, p<0.001) and resource-based industries (β=0.18, p<0.001). These results may be interpreted as testimony of the importance of access to valuable resources in order to create transferable ownership advantages when investing abroad (Dunning, 1993, Kirca et al., 2012), irrespective of ownership. R&D intensity indicates that on balance, firms that invest in building innovative capabilities may be better positioned to reap the benefits of international competition. Moreover, resource-based industry sectors, such as mining, oil and gas, also emerge as highly internationalized. Discussion Our results shed novel insights on the phenomenon of globalization of SOEs. We started from the observation that SOEs play different roles in different societies, which are driven by the political economy shaping the institutional framework under which SOEs work. Following Williamson (2000), we distinguished between different hierarchies of institutions. This approach led us to distinguish between informal institutions (e.g. corruption levels), governance institutions (e.g. stock market development), and state access to resources (e.g. currency reserves). Our empirical tests not only show support for the individual hypotheses, but demonstrate that the effects of these three levels are complementary in explaining how the degree of SOE internationalization is conditioned by the political and institutional context of the home country. Implications for theory The integration of political economy and institutional perspectives pushes forward our understanding of how MNEs are embedded in their home country, and why it matters for international business. Traditional work on the MNE makes an implicit assumption that the 27

28 home context has a neutral effect, and that internationalization is driven by firm-specific resources (Kirca et al., 2012), though resources of the home country have recently been recognized as a source of such firm-specific resources (Nielsen& Nielsen, 2010; Wan, 2005; Wan & Hoskisson, 2003). Some scholars of specific contexts have also pointed to government policy as a means to help firms mobilize resources, for example in Japan in the 1960s/1970s (Ozawa, 1985) and China in the 2000s (Buckley et al., 2007, Wang et al., 2012b). Yet, there is little theorizing on how specific home country political institutions interact with MNEs of different ownership types in driving internationalization. The actual relationship of home governments and MNEs outward investment is considerably more complex, as has been recognized by some scholars (Stopford & Strange, 1991), but rarely analyzed systematically. To this end, our political economy perspective proposes that the role of home governments may indeed be varying across different types of home economies, in particular with respect to state-owned MNEs. The political economy of a country shapes the institutions under which SOEs operate, and thus both the resource they may potentially exploit and explore abroad, and the incentives to do so. This political economy perspective thus provides an important indication of the linkage between home country political and institutional influences on the globalization of domestic SOEs. Our study is among the first to systematically investigate these influences. Based on 3000 listed firms across 47 different economies, of which 143 had majority state ownership, we provide the first large-scale, multi-country test of the Williamson (2000) multi-level hierarchy of institutions. Our results provide strong evidence for the moderating effects of home country political institutions on the propensity of listed SOEs to internationalize. This focus on a specific breed of SOEs that are subject to potentially conflicting motives and 28