Formal Institutional Distance and Innovation from OFDI: Evidence from China

Abstract

Recent years have seen Outward Foreign Direct Investment (OFDI) become a dominant resource for firms from emerging markets to enhance their innovation capability and achieve sustainable development. However, affected by the COVID-19 epidemic and anti-globalization, multinational enterprises (MNEs) from developing countries, especially OFDI enterprises whose main purpose is knowledge seeking, have suffered. In the face of investment constraints, improving the investment efficiency is an urgent issue for MNEs in developing countries. The formal institutional distance (FID) between home and host countries has challenged MNEs to make adjustments according to the business environments of the host countries, which largely shape the innovation benefits of OFDIs. To investigate such an important, but under-studied, issue, this paper specifically examines the impact of the FID on improving the innovation capabilities of OFDIs secured by Chinese firms. We disentangle the effect of the FID on OFDI R&D resource acquisition and its moderating effect on the relationship between OFDI R&D resource and innovation performance theoretically. We use the Worldwide Governance Indicators (WGI) to measure the FID. Based on a sample of Chinese firms that invested in 28 host countries from 2003 to 2017 and via linear regression and threshold regression methods, we found that the FID has a crucial negative effect on OFDI R&D resource and has a significant negative moderating effect (threshold effect) on the relationship between OFDI R&D resource and innovation performance (i.e., when the FID is lower than the threshold, then the FID has a considerable negative moderating effect, whereas the effect would be less influential if the FID surpassed the threshold). Our findings highlight the importance of considering the FID when choosing OFDI destinations, especially when the firm invests with the aim of strengthening its innovation capability.