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Strategic Management Journal

Strat. Mgmt. J., 25: 10271043 (2004)


Published online in Wiley InterScience (www.interscience.wiley.com). DOI: 10.1002/smj.412
DOES COUNTRY MATTER?
SHIGE MAKINO,
1
* TAKEHIKO ISOBE
2
and CHRISTINE M. CHAN
3
1
Department of Management, Chinese University of Hong Kong, Shatin, N.T.,
Hong Kong
2
Department of Commerce, University of Marketing and Distribution Sciences, Kobe,
Japan
3
School of Business, University of Hong Kong, Pokfulam, Hong Kong
Previous studies have explored the predictors of business unit performance in multiple-business
rms and investigated the extent of the effect of industry, corporate, and business unit on the
performance of a business unit. These studies have focused almost exclusively on examining
performance differences within a single country, thus treating country effects as external to
business unit performance. In contrast, this study focuses on multinational corporations and
examines the extent to which country effects explain the variation in the performance of foreign
afliates. Our ndings show that country effects are as strong as industry effects, following
afliate effects and corporate effects. Our results also suggest that corporate and afliate
effects tend to be more critical in explaining the variation in foreign afliate performance
in developed countries, whereas country and industry effects are more salient in developing
countries. Copyright 2004 John Wiley & Sons, Ltd.
INTRODUCTION
Scholars have explored the sources of performance
differences among multiple-business rms. Re-
search building on the industrial organization eco-
nomics (IO) perspective suggests that the indus-
try structure is the primary determinant of a rms
long-term protability, and hence this structure pre-
dicts that a variation in business unit performance
is greater between, rather than within, industries.
In contrast, research building on the resource-based
view of the rm (RBV) suggests that a rms re-
sources and capabilities are the primary source of its
sustainable competitive advantages and that a varia-
tion in business unit performance is greater between
rms, rather thanbetweenindustries. Althoughthese
Keywords: foreign afliate performance; country effect;
corporate strategy; international diversication
*Correspondence to: Shige Makino, Department of Manage-
ment, Chinese University of Hong Kong, Shatin, N.T., Hong
Kong. E-mail: makino@baf.msmail.cuhk.edu.hk
studies have signicantly advanced our understand-
ingof theantecedents of rmperformance, theyhave
tended to focus on rms with diversied business
units in a single-country context, treating country
effects as external to rm performance. Meanwhile,
scholars intheeldof international business (IB) and
international management (IM), while recognizing
the contributions of IOand RBV(Peng, 2001), have
highlighted the importance of economic, political,
social, cultural, and institutional differences across
countries and claimed that countries do matter in
explainingthevariationinbehavior andperformance
of multinational corporations (MNCs). However,
few scholars have investigated exactly how much
country differences, other than the differences in
industry and foreign rm attributes, can actually
explain the variation in behavior and performance of
MNCs. This study shifts the focus of research from
multiple-business rms to MNCs and examines how
much country effects explain the variation in foreign
afliate performance.
Copyright 2004 John Wiley & Sons, Ltd. Received 24 May 2002
Final revision received 10 January 2004
1028 S. Makino, T. Isobe and C. M. Chan
In this study, a foreign afliate refers to an
independent organizational unit wholly or partially
managed and controlled by a foreign rm in a host
country. Building on previous studies, we exam-
ine country, industry, corporate, afliate, and year
effects on foreign afliate performance, using a
variance component analysis. Following Bowman
and Helfat (2001), we dene each level of effect
as follows:
Country effects derive from differences in the
average returns to individual foreign afliates
within each different host country.
Industry effects derive from differences in the
average returns to individual foreign afliates
within each different industry.
Corporate (multinational corporation, henceforth
MNC) effects derive from differences in the
average returns to individual foreign afliates
within each MNC.
Afliate effects derive from differences in the
average annual returns to each different foreign
afliate.
Year effects derive from differences in the aver-
age returns to individual foreign afliates in
each observation year.
This study used a comprehensive database of
foreign afliate performance. Our database con-
sists of a panel of over 5,183 foreign afliates,
established by 616 Japanese MNCs in 159 busi-
nesses (industries), in 79 host countries, over a 6-
year period (19962001). Our study revealed that
country effects are as strong as industry effects,
following afliate effects and corporate effects.
The study also highlighted the differences in insti-
tutional environments between developed coun-
tries (DCs) and less developed countries (LDCs)
and found that corporate effects tend to be more
critical in explaining the variation in foreign afl-
iate performance in DCs, whereas country and
industry effects are more salient in LDCs.
The paper is organized as follows. First, we
briey review previous studies and then discuss
why country matters in explaining the variation
in foreign afliate performance. In the second
section, we discuss the sample, the measures, and
the empirical model used in the analyses. In the
third section, we present our results and their
implications for future research.
LITERATURE REVIEW
To explore the antecedents of rm performance,
previous studies have estimated the effects of
industry, corporate, and business level on business
unit performance, measured by return on assets
(ROA) in a single-country context. Early studies
found that the largest portion of the variance in
business unit performance was explained by busi-
ness unit effects, followed by industry effects, and
then by corporate effects (Rumelt, 1991; McGa-
han and Porter, 1997). Rumelt (1991) has pro-
vided consistent results showing that business unit
effects and industry effects accounted for 46.3 per-
cent and 8.3 percent, respectively, and corporate
effects accounted for 0.8 percent. McGahan and
Porter (1997) produced similar ndings, showing
that business unit (segment-specic) effects and
industry effects accounted for 31.7 percent and
18.6 percent, respectively, and corporate effects
accounted for 4.3 percent. Using value-based
measures (residual income and market-to-book
value) instead of accounting ratios, such as ROA,
Hawawini, Subramanian, and Verdin (2003) gen-
erally found consistent results.
Some recent studies have extended this line of
research by incorporating new variables. Chang
and Hong (2002) incorporated the business group
effects in their analyses using a sample of Koreas
Chaebol member rms. They found substantial
business group effects, which tended to be smaller
in large business groups and to decrease over
time. Walker, Madsen, and Carini (2002) exam-
ined the effects of institutional changes on rm
heterogeneity and, hence, performance differences
among rms. They used the changes created by
price deregulation in the U.S. airline industry to
capture institutional changes and found that per-
formance heterogeneity was larger among new
entrants than among incumbents following dereg-
ulation.
Recently, researchers have begun exploring the
antecedents of cross-country differences in rm
performance. Khanna and Rivkin (2001) exam-
ined the performance effects of business groups
in emerging markets and found substantial dif-
ferences in group protability across countries.
Brouthers (1998) studied the performance of 167
Fortune 500 manufacturing MNCs and showed
that the country-specic variables and industry-
specic variables as well as the interaction of coun-
try and industry variables were signicantly related
Copyright 2004 John Wiley & Sons, Ltd. Strat. Mgmt. J., 25: 10271043 (2004)
Does Country Matter? 1029
to cross-national differences in MNC protabil-
ity. Yip (1991) studied the performance of busi-
ness units (return on investment) using the PIMS
(Performance Impact of Market Strategy) database
in the United States and Europe, and reported
that continental businesses (those businesses with
continental scope) in the United States were more
protable than those in Europe, and regional busi-
nesses (those businesses with regional scope) in
Europe were more protable than those in the
United States. While these studies have made a sig-
nicant contribution in demonstrating whether or
not and how much rm performance varies among
home country environments, they have provided
limited insights regarding how much the perfor-
mance of foreign afliates of MNCs differs among
host countries.
One notable exception is the study by Christ-
mann, Day, and Yip (1999). This study used a
sample of 99 observations of foreign subsidiaries
owned by four MNCs (two American and two
European) in the consumer packaged goods indus-
try, operating across 37 host countries. The authors
used several contextual variables to measure the
characteristics of the host country, the industry,
the subsidiary, and the corporation, and used the
gross margin of each subsidiary as a performance
measure. They concluded that country character-
istics were by far the most important determinant
of subsidiary performance, followed by the indus-
try structure (in each host country), the subsidiary
strategy, and corporate characteristics. Although
this study is one of the very few that have directly
examined the relative inuence of the host country
on subsidiary performance, the generalizability of
the results is questionable for two major reasons.
First, the study examined only four MNCs in a
single industry, making the generalizability of the
results to other MNCs and industry contexts dif-
cult. Second, the study is cross-sectional in nature
and does not capture the changes in performance
across time. This may be a critical aw, as sub-
sidiary performance may change from year to year,
in varying degrees across countries.
In a separate stream of research, researchers
have investigated the relationship between geo-
graphic scope and corporate performance (see
Goerzen and Beamish, 2003, for a review of the
research). These studies have used different de-
nitions of the geographic scope and different mea-
surements of performance and, therefore, provided
mixed results regarding the impact of the extent
of the geographic scope on the performance of
the MNC. Furthermore, these studies have primar-
ily examined the aggregate effects of an MNCs
international operations on MNC performance at
a corporate level, and provided few insights as to
how the differences in the host country lead to the
variation observed in foreign afliate performance.
WHY COUNTRY MATTERS
Most existing studies have investigated the source
of business unit performance of domestic rms.
Although a few recent studies have begun inves-
tigating how much country matters in explaining
foreign afliate performance, both theoretical and
empirical investigations remain limited. Below we
attempt to explain why we need to consider coun-
try effects as a determinant of foreign afliate
performance.
Parent rm effect vs. country effect
A foreign afliate can be considered as an inte-
grated part of its parent rm in that its core
resources are transferred from the parent rm.
However, it can also be considered as a local
rm in that it utilizes local human and physi-
cal resources, uses local infrastructure, competes
with indigenous rms, and complies with local
laws and regulations. In this sense, a foreign afl-
iate is neither perfectly integrated with, nor per-
fectly independent of, the parent rm (Ghemawat,
2003). Research on whether the variation in for-
eign afliates performance can be more fruitfully
explained by differences in parent rm attributes
or by differences in host country attributes is there-
fore required.
Proponents of the view that differences between
the parent rms are the major sources of the
variation in foreign afliates performance tend
to argue that the key performance determinant is
derived from the parent rms rm-specic advan-
tage (FSA). The FSA comes from a rms unique
resources that create value and the competitive bar-
riers it operates within that cannot be easily emu-
lated by its indigenous rivals. These resources take
two general forms. One form of such resources
and skills covers a wide range of rm-specic
capabilities and properties, such as patented design
and processes, or the know-how that is shared
among employees of the rm (Caves, 1996). The
Copyright 2004 John Wiley & Sons, Ltd. Strat. Mgmt. J., 25: 10271043 (2004)
1030 S. Makino, T. Isobe and C. M. Chan
other form of resources involves the corporate-
wide capabilities that facilitate collective learn-
ing among subunits within a rm (Bartlett and
Ghoshal, 1989; Prahalad and Hamel, 1990; Birkin-
shaw, 1997). The general conclusion of this view
is that foreign afliates established by parent rms
with the FSA attain a better performance compared
to indigenous rivals in a host country. However,
the transfer of the FSA from a parent rm to its
foreign afliate across borders is often difcult and
costly due to the tacit element of the assets on
which a parent rms FSA is being based, the orga-
nizationally embedded barriers between a parent
and its foreign afliates, and the distance in insti-
tutional proles between the home and the host
countries (Teece, 1977; Kogut and Zander, 1993;
Lyles and Salk, 1996; Kostova, 1999). As parent
rms differ in their capabilities to transfer ef-
ciently the tacit components of their resources and
know-how to foreign afliates operating in differ-
ent institutional environments (Isobe, Makino, and
Montgomery, 2000; Martin and Salomon, 2003),
these capabilities represent another form of the
FSA that contributes to the variation in foreign
afliate performance.
Proponents of the view that host country dif-
ferences are the major determinant of the varia-
tion in foreign afliate performance highlight the
economic outcomes derived from the exploitation
of location-specic advantage (LSA). The LSA
comes from the differences in factor costs among
countries (i.e., capital, labor, and land) that help to
make rms investment there advantageous (Dun-
ning, 1988). This view suggests that foreign afli-
ates might achieve different levels of performance
due to the differences in the LSA among the host
countries where they operate, even when they are
owned by the same parent rm. Unlike the FSA,
the LSA is available to any rm operating in the
same country (location), and hence does not make
a unique contribution to performance when the
rms operate in the same country (location). Even
so, exploitation of the LSA may be necessary for
rms to avoid sustaining disadvantages over their
rivals (Ghemawat, 2003).
Some forms of the LSA are, however, specic
to particular individual rms or a group of rms
in a host country. Such advantage is referred to as
a location-bound rm-specic advantage (LFSA).
The LFSA comes from rm-specic resources
owned by rms operating in a particular location
(country) (Rugman and Verbeke 1992, 2001; Dun-
ning, 1995, 1998; Makino and Delios 1996). The
LFSA differs from the FSA in that it is possessed
only by rms in a specic location. It also dif-
fers from the LSA in that it is possessed only by
specic rms in a location. Firms can build their
own FSA by gaining access to the LFSA in a host
country by forming an alliance with, or acquiring
a part or all of, the local rms that own the LFSA.
1
In sum, foreign afliates can achieve a supe-
rior performance by capitalizing on a parent rms
FSA, LSA, and LFSA. It should be noted that a
parent rms FSA is just one source of its afliate
performance. Explaining the variation in foreign
afliates performance merely by the difference
in the FSA among parent rms may be insuf-
cient to understand the sources of foreign afliate
performance in the international business context
because the variation in foreign afliate perfor-
mance may also arise due to differences in LSA
and LFSA across host countries.
Industry effect vs. country effect
As in the case of parent rm effect, industry is
neither perfectly independent nor perfectly inte-
grated across countries (Ghemawat, 2003). The
key issue in examining the industry effect in a
cross-country context is, therefore, to examine
whether the variation in the performance of for-
eign afliates can be explained more fruitfully by
differences in industry attributes or by differences
in host country attributes. Most previous studies,
which examined the variation in business unit per-
formance among industries in a particular national
context (the United States), implicitly assume that
the variation in business unit performance within
and between industries is constant across countries.
There are two approaches in explaining how
the differences in country attributes could inu-
ence an industry. The rst approach lies in the
theory of comparative advantage, a dominant con-
ceptual underpinning in trade theory. The main
arguments in traditional trade theory are based
on two assumptions. First, countries differ in the
availability of factors of production such as land,
labor, and capital. The prices of these factors vary
1
Foreign direct investment with the purpose of building FSA
is often referred to as strategic-asset seeking FDI. See Makino,
Law, and Yeh (2002) for a review of the research on strategic-
asset seeking FDI.
Copyright 2004 John Wiley & Sons, Ltd. Strat. Mgmt. J., 25: 10271043 (2004)
Does Country Matter? 1031
across countries due to the differences in their
relative abundance in specic countries. Second,
industries differ in the intensity with which dif-
ferent factors of production are used. The rela-
tive production costs (production costs of goods in
one industry relative to other industries) therefore
vary across countries due to the differences in the
prices of the factors of production available across
countries. In particular, the theory proposes that a
country can produce goods relatively cheaply in
an industry that uses relatively intensively the fac-
tor with which the country is relatively abundantly
endowed. A country is said to have a comparative
advantage in such an industry and tends to special-
ize in and export the outputs of the goods produced
in that industry. After the opening of trade, if there
were no complete specialization in any country,
the factor prices will eventually become identical
(both relatively and absolutely) in both countries.
2
The second approach is pronounced in the theory
of the competitive advantage of nations, developed
by Porter (1990). Porter argues that countries differ
not merely in terms of naturally inherited factors
of production, as traditional trade theory insists.
Porter instead argues that productivity in a partic-
ular industry varies across countries because coun-
tries have different capabilities to create, upgrade,
and sustain the innovation and technology that
enhance the competitive advantages of indigenous
rms over foreign rms in an industry. Porter calls
such distinct capabilities of a country the compet-
itive advantage of nations.
3
In essence, the theory
highlights the importance of a country as a home
base for the technology development and inno-
vation from which rms employ their advantages
to compete against foreign rivals in domestic and
foreign markets. Firms based in particular coun-
tries can achieve a superior performance in distinct
industries because these countries have greater
capacity to help their rms improve and innovate
faster than foreign rivals in a particular industry.
The above discussions suggest that the indus-
try effect on foreign afliates performance is
inevitably country-bound because countries differ
in the availability of factors of production, which
2
This conclusion derives from two assumptions: the two coun-
tries share the same production technology; and markets are
perfectly competitive.
3
The capability of a country that upgrades and enhances inno-
vation and technology development has also been referred to
as national innovation systems (Nelson, 1993) and country
capability (Kogut, 1991).
inuences the relative production costs across
industries within a country. As countries also dif-
fer in their capability, the competitive advantage
of the indigenous rms over foreign rms can
be enhanced within a particular industry. If we
can assume that the variation in foreign afli-
ates performance is a function of both the vari-
ation in the production cost across industries in
a host country and the variation in the compet-
itive advantage of foreign afliates across coun-
tries in an industry, we could argue that the the-
ory of comparative advantage provides a useful
framework for understanding why patterns in the
inter-industry distribution of foreign afliates per-
formance would vary across countries and change
over time, and the theory of competitive advantage
would show why patterns in the intra-industry dis-
tribution of foreign afliates performance would
vary across countries and change over time. A
single-country study of the industry effect there-
fore cannot separate the effect of industry from
at least two country-specic effects: the country-
specic effect that systematically inuences the
variation in foreign afliates performance across
industries in each country and the country-specic
effect that inuences the variation in foreign afl-
iates performance across countries in an industry.
To examine precisely the industry effect on for-
eign afliates performance, a multi-country study
is needed to examine the country effect separately
from the industry effect.
National institutions and the country effect
The foreign afliates performance is not only
inuenced by country attributes but also by institu-
tions in the host country environment. Institutions
are dened as the rules of the game in a soci-
ety or country, including both formal (i.e., polity,
property rights, and contracts) and informal rules
(e.g., conventions, norms of behavior, and codes of
conduct) (North, 1990). These rules are humanly
devised constraints that structure political, social,
and economic relationships. Institutions, together
with the technology employed, determine transac-
tion and production costs and therefore the prof-
itability of engaging in economic activities (North,
1990).
The effects of institutions on the performance
of rms, however, vary across countries because
institutions are developed and sustained in path-
dependent and highly localized processes in a
Copyright 2004 John Wiley & Sons, Ltd. Strat. Mgmt. J., 25: 10271043 (2004)
1032 S. Makino, T. Isobe and C. M. Chan
country. Khanna and Palepu (1997) suggest that
the institutional environment in an emerging econ-
omy is typically characterized by underdeveloped
capital markets, the lack of reliable market infor-
mation, extensive state intervention in business
operations, and the lack of effective mechanisms to
enforce contracts. Such institutional voids make
market transactions less efcient and create more
uncertainty in trade in less developed economies
than in developed economies. National differences
in cultural values also lead to differences in eco-
nomic growth. Countries that stress Confucian
dynamism and group cohesion have a better eco-
nomic performance than other countries that do not
(Franke, Hofstede, and Bond, 1991). Similarly, in
countries that have strong norms of civic cooper-
ation and high levels of trust that facilitate eco-
nomic activities (Knack and Keefer, 1997), rms
can lower the cost of monitoring and enforcing
contracts and hence improve their performance (La
Porta et al., 1997). As the stability and efciency
of such institutions determine the costs of doing
business in a given country, the performance of
rms varies signicantly across countries (North,
1990; Westney 1993; Zaheer and Zaheer, 1997;
Bergara, Henisz, and Spiller, 1998; Kostova and
Zaheer, 1999; Delios and Henisz, 2000; Henisz,
2000).
In addition to their effect on local rms, such
institutions also affect the performance of foreign
afliates in a host country. Although host countries
can provide investment incentives (e.g., corporate
tax reduction and investment subsidies) and create
a business climate (e.g., with an effective judicial
system) that attracts foreign direct investment by
MNCs to facilitate efcient operation, the host
country government may also adopt formal rules
like local investment regulations and ownership
restrictions to impede the foreign afliates prot
opportunities by constraining their participation in
local competitions and their favorable access to
local resources (Fagre and Wells, 1982; Lecraw,
1984; Contractor, 1990). The government may
also change the structure of taxations, regulations,
and agreements that penalize foreign operations.
For example, the host country government may
opportunistically expropriate the assets of foreign
afliates (Henisz, 2000) or local competitors may
request the government to take actions that favor
them at the expense of foreign afliates (Henisz
and Williamson, 1999). This unstable institutional
environment poses a threat to foreign afliates and
hence increases the costs of ownership in the host
country.
Foreign afliates are not only subject to the
inuences of the host country institutional envi-
ronment but also those of home country insti-
tutional environment and thereby face different
sources of institutional pressure to which they must
conform (Rosenzweig and Singh, 1991; Westney,
1993; Scott, 1995; Kostova and Zaheer, 1999).
One source of institutional pressure comes from
an external pressure to conform to local demands
in the host country, and another from an internal
pressure imposed by the parent rm to sustain con-
sistency (Rosenzweig and Singh, 1991; Westney,
1993; Kostova and Zaheer, 1999). Conforming to
external pressure by imitating local institutional-
ized practices may increase the legitimacy and the
likelihood of survival of foreign afliates. How-
ever, imitation does not necessarily make rms
more efcient (DiMaggio and Powell, 1983). It
may actually limit the efcient transfer of the prac-
tices and routines on which the parent rms FSA
is based from the parent rm to its foreign afliates
and hence affect the economic outcomes of their
business activities. Besides, the distance in cultural
and social orientations between the institutional
environments of the home and the host country
creates a barrier to social networks in local busi-
ness communities, thus limiting the chance of gain-
ing access to the intangible assets and know-how
shared among particular local rms and favorable
transactions with particular local rms and gov-
ernment authorities (Kogut, 1991; Chen and Chen,
1998; Ghemawat, 2001; Peng and Luo, 2000; Luo,
2001).
In sum, the above brief review suggests that
foreign afliates performance varies not only
between parent rms and between industries, but
also between host countries that have different
comparative and competitive advantages and pro-
vide different institutional environments to foreign
afliates. The question examined in this study is
how much country differences actually explain the
variations in foreign afliate performance.
METHODOLOGY
Sample
Our data are derived from the Trend Survey
of Overseas Business Activities (hereafter Trend
Copyright 2004 John Wiley & Sons, Ltd. Strat. Mgmt. J., 25: 10271043 (2004)
Does Country Matter? 1033
Survey). The Trend Survey has been conducted
annually by the Ministry of Economy, Trade and
Industry of Japan. The Trend Survey includes
foreign afliates of the following three types: (1) a
foreign afliate in which one or more Japanese
corporation(s) has invested capital of 10 percent or
more (a subsidiary); (2) a foreign afliate in which
another afliate, funded more than 50 percent by
a Japanese corporation(s), has invested capital of
more than 50 percent in total (a sub-subsidiary);
and (3) a foreign afliate in which a sub-subsidiary
and one or more Japanese corporation(s) have
invested capital of more than 50 percent in
total. We used six annual reports of the Trend
Survey in the period 19962001 to compile our
panel dataset, which includes the information for
over 12,000 total cases of the foreign afliates
partially or wholly owned by Japanese parent rms
over 6 years. The average response rate of the
survey conducted in the observation period was
60.9 percent.
We excluded some cases from the original
dataset. First, Bowman and Helfat (2001)
suggested that inclusion of single-business rms
would mask corporate effects in multiple-business
rms. Following this suggestion, we excluded
the cases of single-host country MNCs (i.e.,
MNCs that have only one foreign afliate)
in each year from the sample. Second, to
make cross-country and cross-industry comparison
possible, we focused only on the cases of host
countries and industries where at least one foreign
afliate existed over the entire observation period.
Third, we excluded cases lacking the complete
information necessary for the analysis. The nal
sample consisted of 28,809 foreign afliateyear
cases, which included 5183 foreign afliates that
were partially and wholly owned by 616 Japanese
parent rms in 159 industries and in 79 host
countries. A summary of the data description is
provided in Table 1.
Our study differs from previous studies in a
number of ways. First, this study focuses on for-
eign afliates performance as a primary unit of
analysis, whereas previous studies have focused
almost exclusively on business unit performance
in a single-country context (with a notable excep-
tion of Christmann et al., 1999). Second, our
study focuses on the performance of foreign afl-
iates of Japanese rms, whereas previous stud-
ies have focused on U.S. rms to examine the
corporate effects on subunit performance. Finally,
our study includes both manufacturing and non-
manufacturing industries, whereas previous studies
tended to focus on either manufacturing indus-
tries (Schmalensee, 1985; Rumelt, 1991) or non-
nancial industries only (McGahan and Porter,
1997). In sum, our study is comparable to, or
even more comprehensive than, previous studies
in terms of the scope of analysis (i.e., in cov-
erage of host countries and industrial sectors, in
range of years, and in the number of parent rms
and subunits included), and is unique in terms of
the choice of foreign afliates performance as a
primary unit of analysis, the inclusion of country
effects variables, and the use of non-U.S. based
data.
Variables
We used six independent, categorical variables in
our analyses. The country effect variable denotes
differences among 79 host countries in which for-
eign afliates are located. We also control for
a broader regional effect among host countries.
Research suggests that developed countries (DCs)
and less developed countries (LDCs) differ not
only in terms of their level of economic devel-
opment but also in terms of the rm-specic capa-
bilities of indigenous rms (e.g., Lecraw, 1977;
Kumar and McLeod, 1981; Lall, 1983; Wells 1983)
and the institutional environments (e.g., Khanna
and Palepu 1997, 2000). In order to control for
a broader regional effect, we classied the host
countries into four regional groups: small LDCs
(SLDCs), large LDCs (LLDCs), newly emerg-
ing economies (NIEs), and DCs for cross-regional
comparison of each level of effects on foreign afl-
iates performance.
Our industry effect variable denotes the dif-
ferences among 159 industries in which foreign
afliates operate. The industry classication of the
foreign afliates is based on the list of indus-
tries reported in the Trend Survey. It should be
noted that there is no consensus regarding the
criteria for dening the scope of an industry.
Schmalensee (1985) and Rumelt (1991) dene
industry along the lines of business (LOB) reported
in the Federal Trade Commission (FTC) data.
McGahan and Porter (1997) use a 4-digit SIC,
which contains multiple lines of business. LOB
is a broader category than the 4-digit SIC, which
falls into the range between 3- and 4-digit SIC
(Bowman and Helfat, 2001). The scope of the
Copyright 2004 John Wiley & Sons, Ltd. Strat. Mgmt. J., 25: 10271043 (2004)
1034 S. Makino, T. Isobe and C. M. Chan
Table 1. Sample description and methods used
Schmalensee (1985) Rumelt
a
(1991) McGahan and Porter (1997) Our study
Data source Federal Trade
Commission Data
Federal Trade
Commission Data
Compustat METI Trend
Survey
Denition of subunit Business unit Business unit Business unit Foreign afliate
(segment)
Denition of
performance
ROA per business ROA per business ROA per business ROS per
foreign
afliate
Types of industry Manufacturing Manufacturing Non-nancial All
Denition of industry Line of business
dened by FTC
data
Line of business
dened by FTC
data
4-digit SIC Line of
business
dened by
METI
Survey
Origin of the
corporations
(parent rms)
U.S. U.S. U.S. Japan
Number of
corporations
(parent rms)
456 457 7003 616
Number of industries 242 242 628 159
Number of host
countries
79
Number of subunits 1775 1774 12,296 5183
Year included 1975 19741977 19811994 19962001
Total number of
observations
(subunit-year)
1775 6932 58,132 28,809
Analytical method OLS (ANOVA) Variance component; Variance component; Variance
ANOVA ANOVA component
a
Results reported in the column under the caption Sample A in Table 3, presented in Rumelt (1991).
industry classication adopted in the Trend Sur-
vey is similar to the LOB dened in the FTC
data. A list of the countries and industries included
in our analyses is provided in Appendix 1 and
Appendix 2.
The afliate effect variable denotes the differ-
ences among 5183 foreign afliates. The corpo-
rate effects variable denotes differences among
616 MNCs (parent rms) based in Japan. We also
included the countryindustry interaction effects
variable in the model. The time effects variable
denotes differences during the 6 years of the obser-
vation period (19962001).
Our dependent variable represents foreign afl-
iate performance. We measured the foreign afli-
ate performance by a foreign afliates return on
sales (the ratio of pre-tax return over the total
sales of an afliate). Most previous studies have
used ROA as a primary performance measure
(e.g., Schmalensee, 1985; McGahan and Porter,
1997; Rumelt, 1991). The ROA can be broken
down into two components: the return on sales
and asset turnover

return
sales

sales
asset

. In this study,
we focused on the return on sales (ROS), the
rst component of the ROA in the above for-
mula. We used the ROS, rather than the ROA,
because asset turnover, the other component of
ROA, may vary signicantly across host coun-
tries due to differences in the market value of the
asset (capital) among countries and may not cor-
rectly reect the economic performance achieved
through the economic activities of the foreign
afliates.
Analysis
Following previous studies (e.g., Rumelt, 1991;
McGahan and Porter, 1997; Chang and Hong,
2002), we employed a variance component anal-
ysis to examine the sources of foreign afliate
performance. To examine the variance components
of foreign afliate performance, we estimated the
Copyright 2004 John Wiley & Sons, Ltd. Strat. Mgmt. J., 25: 10271043 (2004)
Does Country Matter? 1035
following random effect model:

t ijkl
= +
i
+
j
+
k
+
l
+( )
jk
+
t
+e
itjkl
In the above formula,
t ijkl
denotes the return
on sales of the ith foreign afliate, in the jth
industry, in the kth country, which is afliated
with the lth MNC (parent rm).
t ijkl
is described
as a linear combination of the grand mean ,
the afliate effects
i
, the industry effects
j
, the
country effects
k
, the corporate (MNC) effects

l
, the interaction between industry and country
effects
jk
, the year effects
t
, and the error term
e
itjkl
. All independent variables and the error term
are treated as random effect variables. The variance
component of the foreign afliate performance is
decomposed as follows:

=
2

+
2

+
2

+
2

+
2

+
2

+
2
e
We employed the MIXED Procedure in the SAS
Program to analyze the above model, and the
model was estimated with the restricted maximum
likelihood method.
RESULTS
Table 2 provides the variance component estimates
of the independent effects and the percentages of
the total variance in foreign afliate performance
explained by the independent effects. Model 1
examined the country effects, the industry effects,
the corporate effects, the afliates effects, and the
year effects on foreign afliates performance. The
results indicate that the afliate effects (31.4%)
were the most important determinant of the foreign
afliates performance, followed by the corporate
effects (10.8%), the industry effects (6.9%), the
country effects (5.5%), and the year effects (0.1%).
These results indicate that corporate effects had
a substantial impact on foreign afliates perfor-
mance, which accounted for over 10 percent of
the total variance. The results also suggest that the
country effects are almost as large as the industry
effects. Similar to previous ndings that business
unit effects had the greatest impact on business
unit performance, our study shows that the afliate
effects had the greatest impact on foreign afliates
performance, accounting for over 30 percent of the
total variance. The year effects had little impact
on performance.
4
All the effect variables, except
the year effects, were statistically signicant at the
p < 0.0001 level.
Model 2 includes the countryindustry interac-
tion effects variable. The results suggest that the
interaction effects explained 10.5 percent of the
total variance. Model 3 includes both the inde-
pendent and the interaction variables. The estimate
for the interaction effects (7.5%) was larger than
that for the country effects (4.3%) and the industry
effects (5.0%). This nding suggests that industry
and country effects jointly, rather than indepen-
dently, inuence foreign afliates performance.
Panel A in Table 3 provides a description of the
data and Panel B presents the results of the vari-
ance component analyses. The results show several
noticeable patterns. First, the country effects were
greater in the LDCs than in more advanced coun-
tries, such as NIEs and DCs. The results indicate
that in the SLDCs and the LLDCs the country
effects accounted for 7.7 percent and 6.2 percent of
the variance respectively, whereas they accounted
for only 4.4 percent in the NIEs and 3.6 percent
in the DCs. Second, the industry effects were also
more important in the SLDCs and the LLDCs than
in the NIEs and the DCs. The results show that the
industry effects accounted for 8.8 percent in the
SLDCs and 7.6 percent in the LLDCs, whereas
they accounted for 6.7 percent in the NIEs and
5.5 percent in the DCs. These results suggest that
the effects derived from external environmental
conditions (i.e., country and industry effects) are
more salient in less advanced economies than in
advanced economies. Third, the corporate effects
are more than twice as important in the NIEs
(11.3%) and the DCs (13.4%) than in the SLDCs
(4.8%) and the LLDCs (8.3%), suggesting that cor-
porate effects matter more in advanced economies
than in less advanced economies. Finally, afliate
4
To draw realistic inferences from the analyses, we also took the
advice of Brush and Bromiley (1997) and calculated a square
root value for each variance component estimate. The relative
impact of afliate effects became much smaller, whereas the
impact of country effects, industry effects, and year effects
became much larger, compared to the impact of the original
estimates. For example, the results show that the impact of
afliate effects presented in Model 1 in Table 2 dropped from
31.4 percent to 26.8 percent after the square root of the estimates
was taken, and those impacts of country effects, industry effects,
and corporate effects increased from 5.5 percent, 6.9 percent,
and 10.8 percent to 11.2 percent, 12.6 percent, and 15.7 percent,
respectively. The order of the relative impact of each level of
effect was consistent with the results reported in Table 2.
Copyright 2004 John Wiley & Sons, Ltd. Strat. Mgmt. J., 25: 10271043 (2004)
1036 S. Makino, T. Isobe and C. M. Chan
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Copyright 2004 John Wiley & Sons, Ltd. Strat. Mgmt. J., 25: 10271043 (2004)
Does Country Matter? 1037
Table 3. Variance components by regions
(A) Descriptions of the data
Small LDCs Large LDCs NIEs DCs
Number of rms 82 228 489 504
Number of industries 55 106 137 146
Number of host countries 43 5 9 22
Number of subunits (foreign afliates) 273 565 1855 2490
Total number of observations 1496 3095 10,297 13,921
Year included 19962001 19962001 19962001 19962001
(B) Variance components
Small LDCs Large LDCs NIEs DCs
Estimate % Estimate % Estimate % Estimate %
Year 0.09 0.2 0.07 0.1 0.07 0.1 0.05 0.1
Foreign afliate 13.26 23.1 13.05 24.1 13.81 25.2 15.41 28.2
Corporate 2.75 4.8 4.51 8.3 6.22 11.3 7.34 13.4
Country 4.43 7.7 3.38 6.2 2.39 4.4 1.97 3.6
Industry 5.07 8.8 4.11 7.6 3.67 6.7 2.99 5.5
Error 31.78 55.4 29.14 53.7 28.62 52.3 26.88 49.2
Total 57.38 100.0 54.26 100.0 54.78 100.0 54.64 100.0
N 1496 3095 10,297 13,921
effects were slightly greater in the NIEs (25.2%)
and the DCs (28.2%) than in the SLDCs (23.1%)
and the LLDCs (24.1%). These results suggest
that the effects derived from internal conditions,
especially the corporate effect, are more salient
in advanced economies than in less advanced
economies.
DISCUSSION
This study examines the sources of the variation in
foreign afliate performance, using a large longi-
tudinal sample, with a particular interest in investi-
gating the relative importance of country effects on
foreign afliates performance. The results of the
analyses have several implications. First, our nd-
ings suggest that country does matter for foreign
afliates performance. The evidence supports the
core argument in the conventional international
business literature and the institutional theory:
those national contextual factors do inuence rm
behavior and economic performance. Our ndings
also show that country effects have as great an
impact on foreign afliates performance as do
industry effects. It implies that the choice of host
country is at least as important as the choice of
industry in determining foreign afliates perfor-
mance. While much previous research has used IO
and RBV as conceptual foundations to explain the
determinants of business unit performance, it had
failed to identify country-specic conditions that
inuence rm behavior and performance, treating
the country effect as a constant when, in fact,
it has a signicant impact on business unit per-
formance. Future research needs to incorporate
country effects as an additional determinant of
rm behavior and performance into the theory to
advance our understanding of the antecedent of
rm performance.
Second, our results show some noticeable pat-
terns in the variations in each level of effects on
foreign afliates performance. Interestingly, our
results show that the external effects (country
and industry effects) are more important in less
advanced countries (the SLDCs and LLDCs) than
in advanced countries (the NIEs and DCs). In
contrast, the internal effects (corporate and afl-
iate effects), especially corporate effects, are far
more important in advanced countries (the NIEs
and DCs) than in less advanced countries (the
SLDCs and LLDCs). These ndings suggest that,
with respect to the variation in foreign afliates
performance, internal inuences matter more in
advanced economies and external inuences matter
Copyright 2004 John Wiley & Sons, Ltd. Strat. Mgmt. J., 25: 10271043 (2004)
1038 S. Makino, T. Isobe and C. M. Chan
more in less advanced economies. One possible
explanation for this nding is that countries with
advanced economies are more integrated in terms
of market transactions, infrastructure, institutional
rules and enforcement mechanisms, and hence,
internal effects (corporate and afliate effects)
tend to play a relatively more salient role than
external effects (country and industry effects) in
explaining foreign afliates performance. In con-
trast, in less advanced economies, where mar-
ket transactions, infrastructure, institutional rules
and enforced mechanisms are underdeveloped, the
external conditions vary signicantly among coun-
tries, and hence, external effects tend to play a
relatively more salient role than internal effects
in explaining foreign afliates performance. One
interesting extension of the study is to exam-
ine how the relative importance of external and
internal inuences changes over time, as national
economies become more integrated and as rms
activities become more globalized across coun-
tries. To investigate this issue, a further study
needs to measure interdependence as well as dis-
tance across countries and the rms dependence
on foreign operations and examine their impact on
foreign afliates performance.
Third, our ndings indicate that the interaction
between the industry and country effects had a far
greater impact on foreign afliates performance
than the independent impact of these effects. This
evidence suggests that industry and country effects,
jointly rather than independently, inuence for-
eign afliates performance. One interpretation of
this evidence is that the relative importance of the
industry (country) effects may vary signicantly
across host countries (industries). Previous studies
(e.g., Schmalensee, 1985; Rumelt, 1991; McGahan
and Porter, 1997) have analyzed industry effects
on the business unit performance in a single coun-
try context (i.e., the United States). However,
these studies provide limited insights regarding the
extent to which the observed industry effect is spe-
cic to, or independent of, a particular national
context. Kogut, Walker, and Anand (1997), for
example, highlight the country specicity of an
industry structure and suggest that patterns of inter-
industry diversication would vary across coun-
tries because country-specic institutions inuence
the structural opportunities and resources needed
to diversify into new businesses. To understand
correctly industry effects on the business unit per-
formance, therefore, a future study should examine
the industry effects in cross-national contexts and
identify both location-specic and non-location-
specic effects of an industry across national envi-
ronments.
Finally, our ndings indicate that corporate
effects are twice as great as both industry and
country effects and are far greater than those
corporate effects reported in previous studies of
multiple-business rms (Brush and Bromiley,
1997; Bowman and Helfat, 2001). One possible
explanation for the observation of this relatively
large corporate effect is that MNCs may need
to develop, and may signicantly differ in their
possession of, several key MNC-specic capabil-
ities that are not assumed in domestic multiple-
business rms. For example, Kogut (1985) argues
that MNCs need to develop strategies to manage
the interplay between competitive and compara-
tive advantage along a value-added chain. Ghe-
mawat (2003) argues that MNCs have the capa-
bility to aggregate their FSA through horizontal
foreign direct investment and the capability to
arbitrate their LSA through vertical foreign direct
investment. Similarly, Henisz (2003) suggests that
MNCs may vary in their capabilities to manage
the institutional idiosyncrasies in host countries.
As MNCs need to possess these additional rm-
specic capabilities, the corporate effect on perfor-
mance is more salient in the context of an MNC
than in the case of domestic rm. An important
extension of this study is therefore to investigate
which MNCs are more (or less) likely to bene-
t from an international expansion of operations,
and why.
Our study has several limitations. First, we
do not examine why there are variations in for-
eign afliate performance across different levels
of observation. We merely show how much each
level of effect can explain the variation in for-
eign afliates performance. Although there have
recently been case studies of the effects of national
attributes on economic performance in emerging
economies (e.g., Kapur and Ramamurti, 2001),
more research is needed to extend this line of
study. To develop a more ne-grained research to
cross-national comparisons of rm performance,
future studies may adopt a multi-site, multi-source
research methodology (Harrigan, 1983) to spec-
ify key country-specic factors, such as country
capabilities, institutional rules, and enforcement
mechanisms, and examine their impact on foreign
afliates performance.
Copyright 2004 John Wiley & Sons, Ltd. Strat. Mgmt. J., 25: 10271043 (2004)
Does Country Matter? 1039
Second, as we have focused exclusively on
MNCs originating in a single home country, name-
ly Japan, our ndings may not be generalizable to
other home country contexts. Recent studies have
suggested that home country conditions signi-
cantly inuence rms international market diver-
sication strategies (e.g., Anand and Kogut, 1997;
Wan and Hoskisson, 2003). A simultaneous exam-
ination of both home country and host country
effects on foreign afliates performance might be
an interesting and important addition to the exist-
ing line of research on performance antecedents.
Third, our study did not control for the entry
modes of foreign afliates. Some descriptive stud-
ies in the international business literature indicate
that subsidiary performance and survival tend to
vary among foreign afliates with different modes
of entry. For example, Woodcock, Beamish, and
Makino (1994) found that foreign afliates estab-
lished through the acquisition of local rms tended
to attain a less successful nancial performance
than those established through greeneld entry.
Similarly, Makino and Beamish (1998) found that
joint ventures took on different forms of owner-
ship structure according to their partners nation-
ality and afliatedness, and each form varied in
nancial performance and likelihood of survival.
Furthermore, Luo (2002) suggested that the rela-
tionship between the choice of entry mode and
performance depends on the primary motivation
of market entry (capability exploitation and capa-
bility building) and the threats of environmental
hazards in host countries. A future study should
control for entry mode in its analyses.
Finally, our analyses may be subject to aggre-
gation problems, which might come from two
sources. The rst source is the denition of indus-
try. In this study, the denition of a foreign
afliates industry was based on the respondents
judgment regarding the primary business of the
foreign afliate. Given that some foreign afl-
iates operations are integrated across multiple-
business activities (e.g., production and distribu-
tion of goods), there might be some cases in which
the boundaries of the industry are more broadly
specied than is the case in reality. The second
source of aggregation problems is our denition
of country. We did not capture regional differences
within a country in our analyses, treating a country
as a single location or region. Regional economists,
however, argue that regional differences might be
more salient within rather than between countries
(e.g., Krugman, 1991; Markusen, 1995). Similarly,
a recent study suggested that business performance
varies signicantly across subcultures within a
country (Lenartowicz and Roth, 2001). A future
study may wish to incorporate regional effects in
its analyses to examine whether regional effects
explain a larger portion of the variation in foreign
afliates performance than do country effects.
ACKNOWLEDGEMENTS
We thank Greg Dess, Anthony Goerzen, and
Mike Young for comments on earlier drafts, and
Paul Beamish and Richard Scott for their encour-
agement. We also thank Associate Editor Will
Mitchell and two anonymous reviewers for their
helpful comments and suggestions. The earlier ver-
sions of this paper have been presented in the
Annual Meeting of the Japan Academy of Interna-
tional Business Studies in 2002 and the Academy
of Management Annual Meeting in 2003. We thank
the participants of these meetings for their valu-
able feedback on our study. The work described in
this paper was partially supported by a grant from
the Research Grants Council of the Hong Kong
Special Administrative Region (Project No. HKU
7213/03H).
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1042 S. Makino, T. Isobe and C. M. Chan
APPENDIX 1: COUNTRY CLASSIFICATION
Small LDCs (43) Large LDCs (5) NIEs (9) DCs (22)
Argentina Madagascar Bangladesh Brunei Australia
Bahrain Myanmar Brazil Hong Kong Austria
Bermuda Nigeria China (P.R.C.) Indonesia Belgium
Cambodia Mariana Islands India Malaysia Canada
Cameroon Panama Pakistan Mexico Denmark
Chile Paraguay Philippines Finland
Colombia Peru Singapore France
Costa Rica Poland Thailand Germany
C ote dIvoire Puerto Rico Taiwan (R.O.C.) Ireland
Ecuador Romania Italy
Egypt Russia Korea
El Salvador Rwanda Luxembourg
Fiji Saudi Arabia Netherlands
Ghana Sri Lanka New Zealand
Greece Swaziland Norway
Guatemala Trinidad and Tobago Portugal
Hungary United Arab Emirates Spain
Iran Venezuela Sweden
Israel Vietnam Switzerland
Kenya Western Samoa Turkey
Kuwait Zimbabwe U.K.
Liberia U.S.A.
APPENDIX 2: INDUSTRY CLASSIFICATION
1. Agricultural crops 24. Agricultural chemicals 47. Nonferrous metals
2. Agricultural production livestock 25. Inorganic chemicals 48. Electric wires and cables
3. Agricultural services 26. Chemical preparations 49. Nonmetal products, NEC
4. Forestry 27. Organic chemicals 50. Fabricated structural metal
5. Fisheries 28. Compound purchased resins 51. Kitchen equipment
6. Metal mining 29. Medicinals 52. Bolts, nuts, rivets, & washers
7. Nonmetallic minerals 30. Soap & surface active agents 53. Metal cans
8. Bituminous & lignite mining 31. Cosmetics 54. Plumbing xture ttings & trim
9. Crude petroleum 32. Paints & printing ink 55. Metallurgy products
10. Natural gas 33. Photographic related materials 56. Knives
11. Food & kindred products 34. Chemical preparations, NEC 57. Metal products, NEC
products 35. Petroleum products 58. Engines
12. Beverages 36. Coal products 59. Turbines
13. Prepared feeds & organic 37. Glass 60. General industry machinery, NEC
fertilizers 38. Cement 61. Construction & mining machinery
14. Thread & spinning mills 39. Ceramic 62. Chemical machinery
15. Fabric mills 40. Stone, clay & glass products, 63. Industry robots
16. Knitting mills NEC 64. Machine tools & metal forming
17. Dyeing mills 41. Steel works 65. Farm machinery & equipment
18. Textile goods, NEC 42. Blast furnaces & steel mills 66. Textile machinery
19. Apparel products, NEC 43. Steel pipe & tubes 67. Food products machinery
20. Fabric mills, manmade 44. Cold-rolled steel sheet, strip, 68. Special industry machinery, NEC
21. Sawmills & wood products and bars 69. Industrial patterns
22. Pulp & paper mills 45. Iron foundries 70. Ball & roll bearings
23. Paper & applied products 46. Steel products, NEC 71. General machinery & equipment,
NEC
Copyright 2004 John Wiley & Sons, Ltd. Strat. Mgmt. J., 25: 10271043 (2004)
Does Country Matter? 1043
72. Duplicators 99. Electric lighting 131. Trucking
73. Calculators 100. Storage batteries 132. Water transportation
74. Word processors 101. Electric lamp bulbs and tubes 133. Air transportation
75. Ofce machines & equipment, 102. (Non)current-carrying wiring 134. Warehousing & storage
NEC devices 135. Transportation services
76. Commercial machinery 103. Electrical equipment & supplies, 136. Communications
77. Audio equipment NEC 137. Broadcasting stations
78. T.V. & radio communications 104. Motor vehicles 138. R & D-textile
equipment 105. Truck & bus bodies 139. R & D-chemical
79. Video equipment 106. Motorcycles 140. R & D-coal & oil
80. Household appliances, NEC 107. Car bodies 141. R & D-steel
81. Tapes & exible disks 108. Internal combustion 142. R & D-nonmetal
82. Electronic components & engines and parts 143. R & D-general machinery
accessories 109. Optical machinery 144. R & D-electric machinery
83. Electronic computers 110. Watches & clocks 145. R & D-transportation
84. Computer equipment, NEC 111. Medical instruments machinery
85. Telephone communications 112. Furniture & xtures 146. R & D-precious
equipment 113. Printing & publishing machinery
86. Radio communications equipment 114. Plastics materials & resins 147. R & D-software
87. Communications equipment, NEC 115. Tires & inner tubes 148. R & D-others
88. Electronic applied devices 116. Fabricated rubber products, NEC 149. Advertising
89. Measuring & controlling devices 117. Leather & leather products 150. Data processing, software
90. Semiconductors 118. Building constructors 151. Equipment rental &
91. Printed circuit boards 119. Construction repair leasing
92. Electron tubes 120. Heavy construction, NEC 152. Automotive rental and
93. Electronic & communication 121. Electric power leasing
equipment, NEC 122. Gas supply 153. Automotive repair &
94. Motors 123. Water supply services
95. Generators 124. Refuse systems 154. Equipment repair
96. Switchgear & switchboard 125. Retail 155. Holding & other
apparatus 126. Wholesale investment ofces
97. Electric transmission & 127. Eating & drinking places 156. Miscellaneous business
distribution equipment 128. Banking & insurance services
98. Electrical industrial apparatus, 129. Real estate and housing 157. Entertainment
NEC 130. Railroad transportation 158. Hotels & motels
159. Miscellaneous personal
services

NEC: Not elsewhere classied.


Copyright 2004 John Wiley & Sons, Ltd. Strat. Mgmt. J., 25: 10271043 (2004)