The Moderating Role of FDI Motives and Embeddedness on the Performance of Foreign and Domestic Firms in Emerging Markets

Abstract

Foreign firms entering emerging markets are usually assumed to be superior to the domestic competitors in the host country. Their superior firm specific advantages (FSAs) allow them to outcompete incumbent rivals and to internalize the gains from foreign direct investment (FDI) entirely. Most of these results are based on resource or efficiency seeking FDI. More recently, the motive for FDI in these markets has shifted to market seeking. A consequence of this shift is the need for foreign firms to get deeper embedded in the institutional environment of the host country. The institutional environment of emerging markets is considerably different from developed countries. Coping with the institutional obstacles of a host country can be assumed to moderate the ability of a foreign firm to exploit its FSAs. We analyze the impact of the firm's degree of embeddedness on its performance in emerging markets using the World Bank’s Enterprise Survey Manufacturing Sector Module data on 15,715 firms from 78 emerging markets. We use the degree of localization of sourcing and sales to measure the degree of embeddedness in the host country market. We find that both dimensions are subject to a reversed U-shaped function. That is, by extending the degree of local sales and local sourcing up to a certain percentage, a firm can realize positive performance growth by becoming more embedded into the emerging market, but beyond this point, the performance impact is negative. We also find that foreign firms involved in local sales seem to lose part of their ability to exploit their ownership advantages as compared to foreign firms that export their production.