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Emerald Article: Why MNCs tend to concentrate their activities in their home region Joachim Wolf, Till Dunemann, William G. Egelhoff

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To cite this document: Joachim Wolf, Till Dunemann, William G. Egelhoff, (2012),"Why MNCs tend to concentrate their activities in their home region", Multinational Business Review, Vol. 20 Iss: 1 pp. 67 - 91 Permanent link to this document: http://dx.doi.org/10.1108/15253831211217215 Downloaded on: 12-10-2012 References: This document contains references to 98 other documents To copy this document: permissions@emeraldinsight.com

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Why MNCs tend to concentrate their activities in their home region

Joachim Wolf
University of Kiel and Institute for World Economy, Kiel, Germany

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Till Dunemann
University of Kiel, Kiel, Germany, and

William G. Egelhoff
Graduate School of Business, Fordham University, New York, New York, USA
Abstract
Purpose The current paper seeks to analyze to what degree theories from different elds of social science are able to explain the home-region orientation of MNCs. This is necessary since there has been only a relatively narrow, economics-oriented explanation for such an orientation. Design/methodology/approach The analysis is based on a thorough review of the literature that refers to a MNCs home-region orientation and on different theories from the social sciences. Findings The paper shows that several theories from economics, psychology, and sociology are able to explain an MNCs home-region orientation. Research limitations/implications The paper contributes to the development of a more multi-faceted explanation of why MNCs generally prefer a home-region orientation. The paper derives propositions that are consistent with each theory. These propositions can be tested empirically in subsequent research studies. Originality/value The paper discusses a number of different theories and streams of research that can be used to conceptually explain and gain insight into the phenomenon of a home-region orientation for MNCs Keywords Multinational corporations, Home-region orientation, International business theory, Organizational culture, International business Paper type Literature review

Introduction In the heart of the academic eld of international business/international management (IB/IM) there are numerous concepts that refer to MNCs having distributed their activities to many countries or even worldwide. For instance, rst, Bartlett and Ghoshals (1989) model of the transnational solution rests on the assumption that, since the 1980s, many industries became global and that many MNCs compete on a worldwide basis. Thus, according to this view, MNCs have to implement a transnational solution an organizational form where the MNC establishes highly interdependent worldwide units (Bartlett et al., 2004, pp. 346 et seq.). Second, in a similar vein, earlier models of worldwide organizational structuring (Stopford and Wells, 1972; Egelhoff, 1988) presume that, within MNCs, there are high interdependencies among subsidiaries located in different regions of the world. Third, one could also refer to the concept of global mindset (Murtha et al., 1998), which argues that there is a growing need for managers with a global cognitive perspective

Multinational Business Review Vol. 20 No. 1, 2012 pp. 67-91 q Emerald Group Publishing Limited 1525-383X DOI 10.1108/15253831211217215

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(Kedia and Mukherji, 1999). And nally, fourth, it is obvious that the literature on the cultural adjustment of managers mainly refers to managerial positions in countries and markets which differ signicantly from the home country of the respective MNC. These are all examples of IB/IM theory, which have in common the presumption of highly internationalized MNCs with wide geographical spread and heterogeneity. Despite this widespread global perspective, empirical research conducted by Rugman (2000, 2005) and Rugman and Verbeke (2004, 2005) provides considerable evidence that most MNCs do not distribute their activities in such an even manner across the globe. Using an extended version of Ohmaes (1985) classication of Triad regions consisting of North America, Europe, and Asia, Rugman (2005) as well as Rugman and Verbeke (2004) showed that 320 of the 365 Fortune 500 rms they studied obtained at least 50 percent of their sales from the Triad region containing the parent headquarters. Thirty-six rms were either bi-regional (less than 50 percent of sales from the home region and more than 20 percent of sales from a second Triad region) or host-region oriented (over 50 percent of sales from a Triad region other than their own). Only nine of the 365 rms were global (at least 20 percent of sales from each Triad region). Several other studies have conrmed these basic ndings. Delios and Beamish (2005) analyzed the FDI location of 1,229 Japanese MNCs. Although this study distinguished between seven geographic regions (Asia, Africa, Europe, the Middle East, North America, Oceania, and South America), it found that 58.3 percent of the Japanese MNCs have at least 50 percent of their foreign subsidiaries in the home region (Asia). It is interesting to notice that in the sub-group of highly internationalized MNCs (rms with 50 or more foreign subsidiaries), the percentage is basically unchanged (56.1 percent). Grosse (2005) conducted an in-depth case study on ten major nancial institutions. He found that eight of them generated more than 60 percent of their income in the Triad region where they are headquartered. One of the remaining institutions (HSBC) earned the bulk of its income in two regions (Asia and Europe), which is explained by its historical orientation towards Asia. For the ING group, North America was the main income source. Overall, this study shows that while each of these nancial institutions articulated global intentions, at least eight of them were not really global. Yin and Choi (2005) explored the patterns of inward FDI into China, and they found that the overwhelming majority of such investments stem from Asia. This is interesting to notice, since one might expect that in rapidly growing emerging economies, a more even distribution across investor regions might exist. According to these studies, most MNCs have largely concentrated their activities within their home regions. Recently, further empirical studies have been conducted in order to test the validity of Rugman and Verbekes regionalization thesis. Dunning et al. (2007) tested the regionalization thesis on the basis of macro-data. They introduced the Revealed-Investment-Comparative-Advantage index (RICA index) in order to measure the extent to which, relative to its share of the world direct investment stock, a countrys outward investment in a number of culturally different geographic regions is above or below that average (p. 178). They calculated this index for 25 countries from different regions on the basis of a distinction between six regions that are culturally and institutionally relatively close. Their analysis broadly conrmed the micro data offered by, for example, Rugman and Verbeke (2004). While the

geographical distribution of outward FDI is somewhat more dispersed than that found by Rugman and Verbeke, Dunning et al.s (2007) analysis shows that not only the largest, but also the smaller companies have a considerable home-region orientation. Rugman and Oh (2007) conducted a longitudinal analysis of MNCs sales and assets. They found that, for the period 2001-2005, both in the areas of sales and assets, the relationship between MNCs home-region activities and rest-of-world activities remained relatively stable. Thus, neither in the area of sales, nor in that of assets, is there a trend towards a decline of MNCs home-region orientation. Osegowitsch and Sammartino (2008) retested the data of Rugman and Verbeke. They conducted a robustness check of Rugman and Verbekes ndings. They found that, even if Rugman and Verbekes 50 percent threshold for home-region rms is abandoned and, instead, the host-region threshold is set to 20 percent, 15 percent, or 10 percent, at least 54.8 per cent of the MNCs under study have to be classied as home-region oriented. Moreover, these authors longitudinal analysis (a comparison of the values for the years 1991 and 2001) shows that the home-region oriented MNCs at both points of time were the largest group. Collinson and Rugman (2008) focused on the 64 Japanese MNCs that belong to the worlds largest 500 rms. Based on sales and asset gures, they found that 57 of these MNCs have over 80 percent of their sales and foreign assets in their home region. Lee and Rugman (2009) showed that Korean new international ventures are born regionally, not globally. And Rugman et al. (2009) found that over 85 percent of the large North American rms they studied have their supply chains within North America. Flores and Aguilera (2007) studied the target locations of FDIs for US-American MNCs in the years 1980 and 2000. The results show that at both points of time, the majority of FDI recipients is based in Europe and in countries outside the Triad. Yet, this study stands relatively alone in questioning the regionalization thesis. Furthermore, there are important limitations to this study, in that it focuses only on FDIs occurring at two specic points of time (1980 and 2000); it counts the number of FDI and not its volume; and it does not weight FDI relative to the size of the investment countries (Asmussen, 2009). As a group, these subsequent studies reveal that the strength of the regional effect is somewhat dependent upon the threshold values between the four categories introduced by Rugman and Verbeke. As a consequence, they call for a re-adjustment of some of the threshold values. Yet, what is not altered by the subsequent studies is the fact that the vast majority of the MNCs have 50 percent or more of their sales and assets in the Triad region where they are headquartered. This means that the majority of US-American MNCs are mainly active in the NAFTA, the bulk of European MNCs are mainly active in the EU, and most Asian MNCs are mainly active in Asia and the ASEAN region. Furthermore, early attempts at longitudinal analysis show that during the most recent years, MNCs orientations towards their home regions have remained stable. Such empirical support for a strong home-region orientation differs signicantly from the more global assumptions that underlie numerous IB/IM theories and concepts. Although there is strong empirical evidence for the home-region orientation, none of the studies that document and support this phenomenon offer a comprehensive, multifaceted rationale for it. Only the work of Rugman (2005) and Rugman and Verbeke (2004, 2005), using arguments from transaction-cost economics, provides a promising starting point for such a general theory (this will be presented later in the

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paper). Delios and Beamish (2005) stop short of developing such theory, since the focus of their paper is to analyze if MNCs with different orientations (home-region, . . . , global) vary with respect to their strategic assets and with respect to their performance. Grosses (2005) study mainly attempts to deliver a rich description of the ten nancial institutions, and it also lacks a comprehensive explanation for MNCs home-region orientation. In the paper, Grosse points out that nancial services have historically been highly regulated and largely domestic (p. 141). He further mentions that the nancial institutions studied follow a differentiation strategy and that they therefore have to offer high-quality services that are often local in nature. In their work on the regionalization of Chinas economy, Yin and Choi (2005) argue that not only the transaction cost reasons identied by Rugman and Verbeke (2004), but also further factors hinder a global orientation for Chinese rms. First, they argue that China is still a closed state-capitalist economy with highly localized markets. Second, only two Chinese cities have unambiguously created strong location advantages. And third, they state that there are traditionally strong cultural and social ties among China, its neighboring countries, and the Southeast Asian countries. Summarizing the rationales offered in Grosse (2005) and Yin and Choi (2005), it becomes clear that they explain the home-region orientation predominantly with industry-specic factors and region-specic cultural factors. As a consequence, they do not offer a more general theory that is applicable to different industries, different host-countries, and MNCs of different sizes and historical backgrounds. The development of a more general theory is important for several reasons. First, the robustness of the home-region orientation among MNCs is impressive. While the positioning of the category threshold values might inuence the relative sizes of the groups of bi-regional, host-regional, and global MNCs (Aguilera et al., 2008), the dominance of the home-region oriented MNCs is relatively insensitive to changes in these values. Thus, this element of Rugman and Verbekes ndings has not been challenged in the literature. Furthermore, a comparison of older statistical data sets (e.g. Stopford et al., 1980) with recent statistical material (e.g. recent World Investment Reports) shows that many of the MNCs that are currently home-region oriented have been international for a long time. This suggests it is unlikely they will change in the near future from a home-region orientation to a global orientation. Thus, the existing strong home-region orientation of numerous MNCs does not seem to be a second best solution (Ethier, 1998a) or limitation which will be altered within the foreseeable future. Instead, it is likely that the home-region orientation is a more stable phenomenon that needs to be more fully explained by IB/IM theory. This view is supported by the fact that most of the referenced studies have focused on the largest rms in the world. If the majority of these large rms are home-region oriented, it seems reasonable to expect that the phenomenon will be even more pronounced among smaller MNCs. The present paper aims to further the development of a more multifaceted explanation of the home-region orientation. To accomplish this we will discuss and contrast theories from different elds of the social sciences that seem to inform the subject. The desired result is a more differentiated view of the home-region orientation one that can explain how MNC context might inuence whether an MNC will be more home-region or global in its orientation. Recent critiques of the regional thesis (Stevens and Bird, 2004; Aguilera et al., 2008; Osegowitsch and Sammartino, 2008) can be

interpreted as a call for a more differentiated view of the home-region phenomenon. We believe that the substantial empirical support for the home region phenomenon requires a stronger, more multifaceted conceptual explanation than presently exists. Such understanding is necessary to fully exploit the research and attention that has been focused on this subject. The remainder of the paper is divided into six sections. First, we more fully discuss what is meant by the construct home-region orientation. Then we evaluate Rugman and Verbekes (2004) explanation of the home-region orientation, which is based on transaction costs economics and currently dominates the IB/IM literature. Subsequently, three main sections introduce seven different theories and discuss their relationship to home region orientation. These theories are systems of thought that are well established in economics and business administration, psychology, and sociology. The range of disciplines is important, since it helps to cover the undoubtedly complex set of reasons that cause MNCs to concentrate their activities within the home region. At the end of each section, after having discussed the respective theory, we will develop a specic proposition that can be tested in subsequent research. Moving empirical research in this direction should ultimately lead to more specied and multifaceted theory about the home region orientation. In the papers nal section we will attempt to compare and summarize the insights provided by the different theoretical perspectives. Understanding the concept of home-region orientation Before proceeding we want to further discuss the concept of home-region orientation, since it is potentially confusing. In the IB/IM literature there is no uniform or single typology for grouping countries into regions. In addition to geographic proximity, economic proximity, cultural proximity, and institutional proximity have all been suggested as clustering criteria (Aguilera et al., 2008). This heterogeneity in the literature is mirrored by the regional grouping behavior of rms. MNCs tend to group their target markets according to their own, rm-specic preferences, and this has led to a variety of regional grouping typologies. Within the IB/IM literature, Ohmaes (1985) grouping of countries into the Triad (North America, Europe, Japan) has been the dominant typology. Each region is geographically connected and has high economic importance. Rugman and Verbeke (2004) use this typology in their conceptualization of a home-region orientation, and this paper will do the same. Consistent with this, the concept of a home region is dened as that Triad region where the headquarters of an MNC is located. An MNC is home-region oriented if it has a signicant amount of its activities (sales, assets) in the home region. The IB/IM literature has intensively discussed whether the home-region orientation should be conceptualized as a categorical variable (an MNC is home-region oriented if it has at least 50 percent of its sales or assets in the Triad region where it is headquartered) or as a continuous variable where different degrees of home-region orientation can occur. It has been argued that the categorical approach is problematic (Stevens and Bird, 2004), since it requires specication of the threshold values which demarcate the categories or groups. It is unclear how threshold values can be derived from theory. As a result of this conceptual problem, we will deviate from Rugman and Verbeke (2004) and treat home-region orientation as a continuous variable. Thus, we

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dene an MNCs home-region orientation as its tendency to concentrate activities in countries which belong to the Triad region of its headquarters. Rugman and Verbekes transaction cost economics explanation of home-region oriented MNCs Prior to introducing a broader spectrum of economic, psychological, and sociological theories, we want to recapitulate the key elements of Rugman and Verbekes transaction cost economics based explanation of MNCs home-region orientation. We want to summarize this explanation, since it dominates the present discussion within this eld of study. Furthermore, we present it here because it is then easier to understand in which way and to what extent the following theories differ from the dominant existing theory of home-region oriented MNCs. Rugman and Verbekes explanation of MNCs home-region orientation (Rugman, 2005; Rugman and Verbeke, 2004, 2005, 2007) rests on the assumption that the geographical scope of an MNC is a result of its ability to connect its rm-specic advantages in a useful manner with country-specic advantages provided by foreign locations (Rugman and Verbeke, 2005). Firm-specic advantages stem from the MNCs exclusive ownership of specic capabilities, for example unique process technologies or marketing- or sales-related skills (Rugman, 2005). Country-specic advantages rest outside of the MNC; they are rooted in the stock of resources available at the respective foreign location (e.g. natural resources, human capital, technologies, institutional factors, customer demand, or other strategic assets) (Rugman and Oh, 2007). Thus, an MNCs success does not result from the mere existence of rm-specic advantages. Instead, it stems from the MNCs ability to adjust its rm-specic advantages to the conditions that exist in the respective host market (Rugman and Verbeke, 2005). Based on this basic thought, Rugman and Verbeke (2007) argue that many MNC rm-specic advantages are of a shape which allows MNCs to exploit them more easily in the respective rms home region. In the home region, these advantages tend to have a higher deployment and exploitation potential than in other regions of the world. Rugman and Verbeke (2007) argue that this is especially true for advantages created in the downstream elements of MNCs value chains (marketing and sales). Often, MNCs downstream advantages are very location-specic and therefore of limited value to customers in other regions (Rugman and Verbeke, 2004). Rugman (2005) illustrates this with the example of Wal-Mart. He argues that in the home region, this rms brand name has a much higher value than in other regions of the world. Another example is the French retailer Carrefour, whose hypermarket concept has tended to be more successful in Europe than elsewhere in the world. In contrast, advantages created in the upstream elements of the value chain (e.g. sourcing or production), tend not to be so region-bound (Rugman and Verbeke, 2004). Overall, Rugman and Verbeke conclude that for many MNCs, many host regions tend to have immense liabilities of regional foreignness, which make it difcult for the MNC to act in these places as effectively as in its home region (Rugman and Verbeke, 2007). Because of these liabilities of regional foreignness, transaction costs occur in regions outside of the home region that are much higher than the costs in the home region (Rugman, 2005). These additional transaction costs are caused by rigidities that stem from the administrative heritage of the rm, difculties in implementing the increased socialization required to extend elements of the rms culture to foreign markets, and difculties in decomposing the

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rm and its knowledge base into national units that adapt to individual country market environments (Collinson and Rugman, 2008). While Rugman and Verbekes argument for a home-region orientation is substantial, there appears to be room to expand upon it and improve it. At present the argument is quite general, a common characteristic of transaction cost-based explanations. One might argue that the strength of the transaction cost-based explanation lies more in an ex-post analysis of rm behavior and less in an ex-ante specication of the consequences of specic types of rm behavior. Also, the constructs of rm-specic advantages and country-specic advantages are very broad categories which do not clearly specify which aspects of MNCs and their host country environments need to be considered in the analysis. Moreover, the nature of the required relationship between rm-specic advantages and country-specic advantages is vague and in need of further specication. Finally, empirical studies have shown that arguments beyond those of transaction cost economics are necessary to more fully understand MNCs international expansion behavior (Aharoni, 1966; Henisz and Delios, 2001). Thus, when it comes to identifying the causes of a home-region orientation in MNCs, a more varied set of arguments and rationales seems likely to expand and enrich our understanding of this phenomenon. Thus, in the following sections, we want to look for further theories which could deliver arguments why and under which conditions so many MNCs concentrate their activities on the home region. Additional economic theories that explain a home-region orientation Economists have long studied the regional concentration of business, and regional economics (spatial economics) has developed as an important eld of study. Within this stream of research, theories about the new regionalism, the new economic geography, and the knowledge economy offer potential insight into the home-region orientation of MNCs. The theory of the new regionalism The new regionalism is a politically induced process that began in the early 1990s. At that time several free trade and integration agreements with a regional focus were implemented. Prominent examples include the North American Free Trade Agreement (NAFTA), agreements among the European Union countries (EU), among the former Communist states of Central and Eastern Europe (CEE), and among certain countries in South America (Mercosur). It is important to distinguish the logic of the new regionalism from the logic of the old regionalism. The new regionalism is based on reducing tariffs and trade barriers within a region, while the old regionalism was based on creating barriers that restricted the ows of trade and investment into a region (Pomfret, 2007). Under the new regionalism, such liberalization has signicantly stimulated international trade and FDI within the affected regions (Paas, 2003). As an example, in the early 1990s the economically under-developed, former Socialist countries of Central and Eastern Europe abandoned their anti-market restrictions and created a regional environment more conducive to international trade. As a result, many MNCs from developed countries began to invest heavily in these countries, as they saw new markets within and among these countries emerging. In a similar manner, the creation of NAFTA led to many MNCs making signicant FDIs into

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Mexico. There is also evidence that regional trade and integration agreements motivate investments from less developed countries into the developed countries that are party to the respective regional agreement (Ethier, 2001). According to the logic of new regionalism, there are various incentives for MNCs to concentrate the bulk of their business activities within the boundaries of a regional integration agreement. First, because of the reduced importance of trade barriers, the costs associated with geographical distance and degree of familiarity tend to become relatively more important (Ethier, 1998b). These costs are minimized when an MNC conducts most of its activities within a regional trade and integration agreement (Greenaway and Milner, 2002). Second, the economically weaker parties to regional trade agreements tend to compete vigorously for FDI and try hard to make themselves attractive to would-be investors. They even engage in economic and social reforms in order to create local comparative advantages, which in turn attract FDI ows from other parties in the region (Ethier, 1998b). In summary, the new regionalism argument provides a macro-economic explanation for MNCs home-region orientation. According to this argument, regional trade and integration agreements are especially attractive for developing countries and MNCs located within a region. Both intra-regional trade and intra-regional FDI are stimulated by such agreements, and the two tend to reinforce each other. As a result, an intra-regional concentration of economic activity tends to develop in most MNCs (Ethier, 2001). This line of reasoning supports the following hypothesis: H1. An MNCs degree of home-region orientation will be positively related to the degree of economic liberalization which existed in its home region at the time foreign investment decisions were made.

The theory of the new economic geography The theory of the new economic geography attempts to explain why economic concentrations or agglomerations occur. Such agglomerations vary from a concentration of restaurants in a given neighborhood to the concentration of certain industries in certain countries or regions of the world. The new economic geography explains such geographic concentrations of economic activity in terms of agglomeration and dispersion forces, which are opposed to each other. It argues that associated with these forces there is a process of circular causation, which intensies the strength and speed of the concentrating of economic activity. An important foundation for the new economic geography is Marshalls (1922) earlier work on the physical concentration of business rms. Marshall concluded that physical concentration is related to three phenomena. First, an agglomeration of business rms at a specic location leads to a larger labor market for employees offering specic skills. As a consequence, the business rms are able to select their employees from a larger pool of candidates and the latter have better chances of nding a job. Second, the agglomeration of businesses causes an extensive supply chain of specialized products and services needed by the businesses to develop. As a result the businesses are better supported by local suppliers within the region, which improves their efciency. And third, signicant technology spillover effects occur due to the intensive exchange of information among rms within the agglomeration. The theory of the new economic geography (Krugman, 1991) extends the above line of

reasoning and describes the spatial agglomeration of business rms occurring within the opposing forces of agglomeration and dispersion. The interaction of these two sets of forces causes business rms to either concentrate their activities around a specic location or disperse them across multiple locations. Within this theory, the forces for agglomeration are derived from three consequences of centralization: market size effects, condensed labor market effects, and effects stemming from increasing returns in production. Business rms strive for backward linkages; they prefer locations with good access to large markets in order to realize signicant economy-of-scale-effects, which in turn allow bigger and more manifold production processes. At the same time, there are forward linkages, since the large markets allow a local production of intermediate goods, leading to a decrease in the cost of adjacent products. The argument concerning concentrated labor markets is largely the same as that offered by Marshall (1922). Concentrating both the demand for labor and the supply of labor at the same location benets both employees and employers. The effects of increasing returns in production correspond to the previous technology spillover effects. An intensied exchange of knowledge emerges within an agglomeration, and this facilitates both a reduction of production costs and an improvement in production quality. According to the new economic geography, the three agglomeration forces reinforce each other, which results in a kind of circular causation (Fujita and Mori, 2005, p. 134). As the locally concentrated business rms offer a greater number of better quality products, more consumers and employees crowd into the region. As a result, the region is able to sustain an even greater number of rms with yet a higher level of spatial concentration (Fujita, 2007). Countering the above drive toward concentration is a set of forces that encourage the dispersion of economic activities. These forces result from the immobility of certain factors of production, conditions that lead to increased location costs, and a variety of external effects. Natural resources, land, and human capital tend to be immobile, and as a result, the value chains of resource-based and labor-intensive industries are often spatially dispersed. As concentration of economic activity in a region increases, the costs of real estate and labor often rise. This in turn encourages the dispersion of certain activities. Increasing concentration can also be associated with a variety of negative external effects, including higher crime, more trafc congestion, and greater environmental pollution (Krugman, 1998). Such forces also encourage the dispersion of some activities. While most economic agglomerations probably tend to occur not at the Triad region level, but at a more geographically local level, we believe that the new economic geographys arguments explaining this phenomenon are also relevant to understanding the home-region orientation for MNCs. The more economic agglomerations that are relevant to an MNCs businesses exist within the MNCs home region, the more the MNC will be able to source its inputs and sell its outputs within the home region. Thus, it is reasonable to expect that MNCs will tend to locate the bulk of their activities either within or close to existing relevant agglomerations. If most of the existing relevant agglomerations already lie within the same broad region as the MNCs home country, the attraction to invest and grow within existing agglomerations (and the forces favoring agglomeration) will become natural drivers of a home-region orientation for MNCs. This supports the following hypothesis:

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H2.

MNCs from regions with a greater level of relevant agglomeration will tend to be more home-region oriented than MNCs from regions with a lower level of relevant agglomeration.

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The theory of the knowledge economy The theory of the knowledge economy argues that the sourcing, processing, and exploiting of knowledge is a key task for all rms (Dunning, 2000). Nowadays, in all industries the capability to combine different types of knowledge, for example in order to develop new products or to explore new markets, is the most crucial success factor for business rms. According to this theory, the availability and location of knowledge is crucial to understand how industries and rms evolve. Thus, the availability of knowledge-stocks rather than that of physical assets has to be studied to understand such evolutionary processes (Nelson and Winter, 1982). The contribution this theory makes to the explanation of the home-region orientation of MNCs begins with the observation that economically relevant knowledge is seldom possessed by a single rm (Dicken, 1999). As a result, most MNCs are engaged in complementary cooperation with other rms and institutions in their environments. The level of such inter-dependency and cooperation increases as MNCs are forced to deal with reduced product life cycles, more frequent innovation, and increasing R&D intensity (Cantwell and Janne, 1999). The more knowledge-intensive an MNCs products and processes are, the more crucial such co-operations become. MNCs have to be present in regions where public research units, networks of suppliers, rms with complementary competencies, key customers, or other knowledge-intensive rms are located (Sheehan and Grewal, 2000). Thus, most agglomerations of business rms occur in these regions. Such agglomerations allow the network partners to specialize in certain knowledge-intensive processes and, as a consequence, to increase their effectiveness (Tallman et al., 2004). The intense knowledge exchange in these agglomerations leads to circular causation similar to that described above, where such knowledge exchange among rms facilitates and encourages even more knowledge exchange. In such knowledge networks, the member rms benet from knowledge spillovers. They are able to feed on the innovations of other institutions. Spillover effects are especially important to smaller and medium-sized network partners. Although they usually do not possess signicant R&D units, they, nevertheless, contribute considerably to the development of new industries. Examples of such network effects especially exist in the biotechnology and information technology industries (Audretsch, 2000). In such networks, knowledge spillovers are common because the rms have developed capacities which allow them to absorb and use the technologies and ideas of other rms (Cohen and Levinthal, 1990). Empirical studies have shown that knowledge-related networks are most effective when there is little geographical distance between the member rms. If the geographical distance is low, then the difculty, the time requirements, and expenses of information exchange are also low (Lester and McCabe, 1993). Physical proximity allows face-to-face communication, enabling rich information processing (Daft and Lengel, 1986) and the transfer of tacit knowledge. It facilitates the development of social capital, which also contributes to the transfer of knowledge among rms (Cohendet et al., 1999).

Finally, physical proximity stimulates unintended knowledge spillovers, which become yet another source of innovation (McCann and Simonen, 2005). Knowledge generation is very unevenly distributed across the globe. In 2006 more than 80 percent of patents were led in a small number of countries, all located within the Triad. Japan accounted for 29.3 percent of all patents, the USA for 21.3 percent, Korea for 14.1 percent, Germany for 7.7 percent, China for 3.6 percent, and France for 3.5 percent (World Intellectual Property Organization, 2008). This is at least a partial indicator of where certain types of economically relevant knowledge are generated. The concentration of these sources is important, because several studies have shown that technology spillovers are usually very local (Jaffe et al., 1993; Eaton and Kortum, 1999; Branstetter, 2001). This means that technical knowledge does not diffuse quickly to economic actors located far away from the location where the knowledge was originally generated. Research shows that this pattern of localized knowledge spillovers exists across a wide variety of technological elds, applies to both university-generated as well as corporate-generated knowledge, and has become even stronger over time ( Jaffe et al., 1993). In a more recent study, Keller (2002) further found that with every additional 1,200 km distance there is a 50 percent drop in technology diffusion. Bottazzi and Peri (2003) found a strong geographic decay in their analysis of technology diffusion between European regions. These and other studies indicate that knowledge spillovers tend to be highly localized in particular regions and countries (Keller, 2004). Thus, both the literature on knowledge networks and the literature on knowledge spillovers emphasize the strong linkage between low geographic distance and various types of effective knowledge transfer. This supports the following broad hypothesis: H3a. The more knowledge intensive an MNC is, the more it will pursue a home-region orientation.

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It is also likely that different activities within an MNC are associated with different requirements for knowledge transfer. Knowledge generated in the upstream parts of the value chain (such as R&D knowledge) often tends to be more widely applicable and valuable than knowledge generated in downstream parts of the value chain (such as sales and marketing knowledge) (Porter, 1986). To the extent that this is true, one would expect upstream activities like R&D to reect more of a home-region orientation than downstream activities like sales and marketing. While not fully tested, there is already some empirical support for this logic. Hakanson (1992), Hakanson and Nobel (1993), Granstrand (1999), and Ambos (2005) have shown that for European MNCs, nearly half of all foreign R&D units are located in other European countries. And Fischs (2001) study of German MNCs found that the foreign R&D budgets were much more concentrated within Europe than were foreign sales. This line of reasoning supports the following hypothesis: H3b. The more knowledge-interdependent activities of an MNC will pursue more of a home-region orientation than the less knowledge-interdependent activities.

Psychological theories that explain a home-region orientation Psychological factors can potentially inuence the home-region orientation of MNCs via the strategic decision makers that operate inside these rms. In this section we

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want to consider two different theories for a home-region orientation that are based on psychological factors. The rst involves the concept of psychic distance and argues that MNCs generally attempt to minimize the levels of psychic distance existent within a rm. The second is based on escalating-commitment theory.

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Psychic distance theory As applied to MNCs, the concept of psychic distance has been dened as all factors which prevent or disturb the ow of information between the respective MNC and its markets (Johanson and Wiedersheim-Paul, 1975, p. 308). More specically, it reects MNC managers perceptions of differences in business-relevant characteristics between the home and host countries (Brewer, 2007). Many factors have been identied as inuencing psychic distance, including: . culture, language, religion, education, political system (Dow and Karunaratna, 2006); . business practices, stage of economic development (Chetty and Campbell-Hunt, 2004); . legal system (Dow, 2000); and . general level of trust (Swift, 1999). Numerous studies have linked the concept of psychic distance to the internationalization patterns of MNCs (for a summary, see Brewer, 2007). Using the dimensions that underlie the concept of psychic distance, recent studies have been able to explain in a signicant way the volume and location of MNCs international activities (Dow and Karunaratna, 2006). Thus, there is empirical evidence that MNC managers prefer to invest in foreign locations that minimize the levels of psychic distance. It has been shown that several of the factors mentioned above as dimensions of psychic distance co-vary systematically with the geographical distance between countries. In the Dow and Karunaratna (2006) study, differences between the countries in education, industrial development, level of democracy, religion, and three of Hofstedes (1980) cultural dimensions were positively associated with the geographic distance between countries. Thus, the general preference of MNC managers to minimize psychic distance within an MNC will also tend to steer MNCs toward a home-region orientation. H4a. The greater managers perceptions of the psychic distance between the home region and other regions, the more the respective MNC will be home-region oriented.

Since Asian countries are likely to be more distant from European and North American countries than the latter are from each other in terms of psychic distance, one might expect the home region itself to inuence the propensity toward a home-region orientation: H4b. When other factors are controlled for, Asian MNCs will tend to be more home-region oriented than European or North American MNCs.

The dynamic theory of MNC internationalization developed at Uppsala University (Johanson and Vahlne, 1977) argues that: . MNC managers are risk adverse; . limited knowledge about foreign markets is a signicant hurdle to international expansion; . MNCs have to acquire most knowledge themselves, since experiential knowledge is the critical kind of knowledge ( Johanson and Vahlne, 1977, p. 28); and . MNCs tend to advance incrementally into foreign environments, starting with psychologically closer countries, accumulating host country knowledge as they proceed. Since the dynamic theory of MNC internationalization does not have a natural endpoint, where international learning and expansion stop, the home-region orientation could be just an intermediate stage in an MNCs international evolution and development. Studies by Chang (1995) and Barkema et al. (1996) found that MNCs expand internationally in a step-by-step manner and are increasingly becoming more global. They found no evidence of the home-region orientation being a boundary or limit to further geographic expansion. To the extent that this true, it and the dynamic theory of MNC internationalization would support the following hypothesis: H4c. The greater the international experience of an MNC, the more global will be its orientation and the less it will exhibit a home-region orientation.

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Escalating-commitment theory A further insightful explanation for MNCs home-region orientation might be taken from escalating-commitment theory. Although this theory uses both psychological and economical arguments, we categorize it as a psychological theory since it mainly draws on behavioral aspects of decision-making. Escalating commitment describes a situation where a rms decision makers hold on to existing actions or patterns of development, although these have not yet led to a maximal level of success or are unlikely to do so in the future (Brockner, 1992). Research has shown that escalating commitment is of particular relevance in the area of strategic decision-making (Schwenk, 1984), such as the selection of international market entry forms. Furthermore, there is evidence of decision makers tending to invest more resources in strategies that take a negative course. Also, they are more likely to invest above-average amounts of resources in the original strategy if they are responsible for it. In this case, the managers reinvest resources even though the strategy has obviously led to negative consequences. And nally, they tend to invest to a very high extent in adjacent investments if relevant feedback information stems from the external environment (Staw, 1981). As stated above, escalating-commitment theory heavily draws on psychological arguments to explain these observed patterns of behavior. Among these arguments, the theory refers to human beings tendency towards self-justication processes (Festinger, 1957). In many rms, a constant behavior (a steady behavioral pattern) is more appreciated than a change of course often associated with managerial weakness (Staw, 1981). Studies have shown that in group decision-making, these effects are even

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more pronounced than in individuals decision-making, since dynamic processes might occur in group decision-making (Bazerman et al., 1984; Whyte and Fassina, 2007). Based upon this, a turning away from the current plan of action is rather unlikely since groups aim to reach and perpetuate unanimity. Often, groups confronted with negative feedback do not change their strategies and actions, so as to not endanger their unity. Instead, they continue their existing course of action in the belief of we can turn this thing around (Bazerman et al., 1984, p. 144). IB/IM literature presently hints that the phenomenon of escalating commitment can play an important role in the decision-making of MNCs managers. For instance, Bartletts (1986) concept of the administrative heritage argues that MNCs strategies are highly inuenced by the respective rms historical conditions. Thus, MNC managers do not fully adjust their rms behavior to the context of the rm. Malnights (1995) in-depth case study research on Eli Lilly showed that in the 1980s, this rms management periodically spoke of large global opportunities, but it did not show a strong motivation to change its traditional ethnocentric strategy. Additionally, Prahalad and Bettis (1986) emphasize the importance of group phenomena in MNCs. They point out that in MNCs top management teams, there often is some kind of a traditionally grown dominant logic guaranteeing a stability of decisions and actions over time. The existence of escalating commitment is based on four conditions: (1) a realized initial investment into an action has not yet led to success; (2) the managers decide to invest additional resources into the same action; (3) the possibility for managers to stop this action generally exists, but would lead to a loss of the conducted investments; and (4) it is unclear whether additional investments will help to realize the achieved goal (Brockner, 1992). A comparison of these conditions of escalating commitment with MNCs home-region orientation shows that indeed it can be interpreted as the outcome of an escalating-commitment process. Early hints of this view can be found in Aharonis (1966) work. He showed that international managers often shy away from extending their rms international investments, although this might be economically reasonable. Frequently, international managers overestimate the risks and underestimate the chances associated with FDIs. More specic to the phenomenon of MNCs home-region orientation, Delios and Beamish (2005) delivered evidence that MNCs with home-region-oriented strategies performed worse than those with host-regional-oriented, bi-regional, or global strategies. This pattern existed independently from the performance measure used (Tobins Q, ROS, or ROA). Thus, it can be said that MNCs with a home-region orientation are confronted with a more negative feedback than MNCs with other regional orientations (as it is argued by the escalating-commitment theory). With respect to the second condition (to invest additional money in the current strategy), Rugman and Oh (2007) have shown that nearly all home-region oriented MNCs have maintained their high degrees of home-region orientation over time. The third condition applies to MNCs home-region orientation since MNCs as long as they own sufcient resources are free to invest in numerous countries of the world. Fourth, international investments especially

those in locations being regionally and culturally far away from the home country are typically associated with high levels of risk. And nally, it has to be argued that MNCs international investment decisions are usually made by top management teams. According to escalating-commitment theory, the possibly resulting group processes raise the likelihood that group dynamic processes occur which lead to little changes in MNCs location decisions. As a consequence, it is likely that MNCs geographical extension will be a slow process: H5. MNCs development from a home-region orientation towards a global orientation is a slow (longsome) process. The effect of the amount of a MNCs international experience on its home-region orientation is low.

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Sociological theories for the explanation of MNCs tendencies towards a home-region orientation Like escalating-commitment theory, sociological theories argue that MNCs home-region orientation is not necessarily the outcome of rational decision processes. Instead, MNCs home-region orientation is explained on the basis of social interaction processes inside and outside of the MNC and as an aftermath of historical processes. Here, population ecology and neoinstitutional theory deliver arguments. Population ecology Population ecology (Hannan and Freeman, 1977; McKelvey, 1982) perceives MNCs as part of a population of rms acting in a common setting (e.g. in a specic industry or technological environment). MNCs belonging to the same population develop similar competencies (e.g. management skills, innovation processes, analytical techniques, patterns of behavior). These competencies tend to be quite persistent, since MNCs personnel (e.g. employees qualications and skills) and material investments (e.g. technical infrastructure) are context- and business-specic and since, in the case of a switch of business behaviors, signicant sunk costs will have to be written off. Thus, turning to new competencies and implementing new behavioral patterns will be difcult. Instead, MNCs tend to have stable patterns of behavior, rooted in the early stages of MNCs development (Stinchcombe, 1965). Viewed from this perspective, MNCs tend to be home-region oriented, since, during their earlier phases of existence, they accumulated competencies, techniques, and behavioral patterns that have proven themselves in the region in which the MNC originated, and since it is generally unclear if these competencies will be of similar value in other regional settings. Yet, if the level of inter-regional business activity in a population increases over time which, according to population ecology, will be a slow process this change will occur more via a selection process than an assimilation process (Hannan and Freeman, 1984). Indeed, studies have shown that rms from different world regions vary with respect to their basic patterns of interpretation and behavior, and converge very slowly over time. For instance, Nonaka (1994) has shown that Japanese and Western business rms differ considerably in their process of organizational knowledge creation. The GLOBE project (Javidan et al., 2006) revealed that leadership patterns are very different in US-American, European, and Japanese rms. Egelhoff and Frese (2011) uncovered that in spite of the globalization of the world economy, US-American, Japanese, and German managers possess different views of the market mode and the planning mode as alternative ways of rm

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coordination. And, with respect to the speed of assimilation processes, Duysters and Hagedoorn (2001) discovered that even MNCs active in highly competitive and globalized markets possess strategy and organization parameters typical of their home region, and that over time, there is only little isomorphism among these rms. Thus, based on population ecology, we expect: H6. If, in the population of MNCs, the degree of home-region orientation decreases over time, this will rather be the consequence of a selection process than an assimilation process.

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Neoinstitutional theory Neoinstitutional theorys basic assumption is that managers are not able to judge reliably the economic effectiveness of their rms strategies and actions (DiMaggio and Powell, 1983). As a result, they do not consistently attempt to formulate their strategies and actions around the criteria of economic success. Instead, they heavily refer to the expectations of the social environment. They take these expectations as primary reference points for their own decision-making and action (Meyer and Scott, 1983). This theory also argues that managers take the previous behavior of rms in their immediate inter-organizational eld as a model for their rms own behavior, since the reference rms behavior gives a semblance of social legitimacy to the rms own behavior (DiMaggio and Powell, 1983). This limited rationality also exists among MNC managers. Like their colleagues from domestic rms, they face strong pressures stemming from the social (institutional) environment surrounding them. Actors in the institutional environment may inuence the MNC in question by sanctioning or promoting a certain type of behavior. MNCs managers especially have to consider the peculiarities of the institutional environment of the host country. Along this reasoning, Henisz (2003) identied the skill in liaising with host governments as an important success factor for multinational operations. MNCs able to operate in the idiosyncratic institutional contexts of the respective host countries tend to be more successful than MNCs without such competencies. This result is complemented by empirical ndings showing that the level of a host countrys institutional uncertainty is an important predictor of MNCs international location decisions (Henisz, 2003). More generally, it was found that in many MNCs environments there are strong institutional pressures for global expansion (Levy, 1995; Henisz, 2003). Given these globalization pressures, at a rst glance, it seems that neoinstitutional theory does not offer arguments for MNCs home-region orientation. Yet, this theory also argues that the relative importance of institutional pressures in comparison to the technical pressures varies from industry to industry (Scott, 1992). Whilst in the manufacturing industry the environment poses stronger technical demands, rms such as banks, hospitals, and utilities are viewed as being subject to strong demands of the institutional environment (Scott, 1992). While suppliers, customers, and competitors are main actors within MNCs technical environment, political parties, unions, state regulations, etc., are key players of the institutional environment. Since these actors often are less globalized than actors in the technical environment and since the institutional environment is more legally regulated than the technical environment (Oberg et al., 2004), MNCs facing strong pressures from the institutional environment will globalize their business activities

more slowly than MNCs where technical demands are the main reference points for the formulation of strategies and actions. Thus, we expect: H7a. MNCs from different industries vary in terms of their degree of home-region orientation.

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Neoinstitutional theory also argues that for MNCs, prior decisions and actions by other rms provide legitimization and information to a decision marked by uncertainty. It was empirically shown that MNCs competitors and suppliers are highly relevant for such legitimization processes. For instance, it was found that the probability of locating a plant in a given country will be greater the greater the number of prior plant locations by other rms in the same industry, and the greater the number of prior plant locations by the rms suppliers (Henisz and Delios, 2001). Consistent with this nding, Guillen (2002) discovered that business group experience and imitation among rms from the same home-country industry increase the rate of foreign expansion. Thus, we expect: H7b. If the competitors and suppliers of an MNC are home-region oriented, this rm will also have a relatively strong tendency towards the home region.

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Comparison of the explanations and nal discussion The above discussion shows that a number of different theories and streams of research can be used to conceptually explain and gain insight into the phenomenon of a home-region orientation for MNCs. Each theory offers a different and largely complementary perspective of the home-region orientation. Together they comprise a richer, more complete picture of this well-known phenomenon. It is likely that most researchers pursuing the various streams of research are unfamiliar with the issues and arguments surrounding a home-region orientation. Similarly, it is probable that researchers responsible for the existing explanations of a home-region orientation are not specically familiar with these additional streams of research. In our view, this presents an opportunity to fruitfully bring these separate sets of knowledge together. Each of the seven additional theories discussed has led to one or more empirically testable propositions. Empirical research to date has focused more on dening and substantiating the home-region orientation as a meaningful phenomenon, rather than on exploring its causes and investigating its implications for international business. The present paper seeks to stimulate more research on the latter. Table I summarizes the results of our comparison of these theories. It contrasts them along the following ve criteria: (1) what drives a home-region orientation (a summary of what has already been discussed); (2) the focus of a theory, whether the primary drivers of a home-region orientation are seen as internal or external factors; (3) the assumptions a theory makes about the rationality of MNC managers decision making; (4) the general model of an MNCs managers employed by a theory (e.g. economic man, social man); and (5) the sustainability or permanence of the home-region orientation associated with the theory.

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Theory Internal and external factors Rational Rational Rational Economic man

Existing explanation of MNCs home-region orientation Transaction. . . the limited geographical reach of their rmcost economics specic advantages

New explanations of MNCs home-region orientation New . . . the liberalization of trade and business within regionalism regional free trade agreements New economic . . . the dominance of regional agglomeration forces geography over global dispersion forces; especially strong market size effects, labor market effects, and knowledge spillover effects Knowledge . . . (1) the agglomeration of knowledge creation economy within an MNCs home region; (2) the importance of knowledge networks; and (3) the local nature of knowledge spillovers Psychic . . . the co-variation of several drivers of psychic distance theory distance with the geographic distance between countries . . . MNC decision-makers tendency to hold on to Escalatingexisting actions, even if they are not successful commitment theory Population . . . the tendency for an MNCs sustainable Ecology competencies to be home-region specic External factors External factors External factors Internal factors Internal factors Rational Bounded rational Bounded rational Bounded rational

Internal and external factors Neoinstitutional . . . the MNCs reference groups not encouraging a External theory global presence of the rm factors

Table I. Comparison of explanations for a home-region orientation Assumptions about Focus of the MNC managers decision making theory General model of MNCs managers Sustainability or permanence of homeregion orientation Medium Economic man Economic man Medium Medium to high Economic man High Risk averse man Self-justifying man Not relevant to theory Not relevant to theory Social man High High Medium to high Medium to high

Why do MNCs tend toward a home-region orientation? Because of . . .

First, with regard to the foci of the theories, Table I shows that an MNCs tendency toward a home-region orientation can be explained in terms of both internal (rm-specic) factors and external factors. The internal factors that are important include are: (1) the home-region specicity of MNCs competencies; (2) the location of the rm-specic advantages within an MNCs value chain (upstream or downstream); (3) managers attitudes toward different regions; (4) the level of their international experience; and (5) their general exibility in decision-making processes. The external factors that are important are: (1) the degree of economic liberalization existent in an MNCs home region; (2) the size and differentiation of labor and customer markets within the home region; (3) the availability of knowledge needed by an MNC within the home region; and (4) industry characteristics. Second, Table I shows that not all theories consider an MNCs tendency towards a home-region orientation to be the result of a rational decision-making process. Instead, some theories see managers plagued by a limited rationality. Table I also shows that in addition to viewing managers as economic man, some of the theories emphasize that managers are risk adverse, self-justifying, and heavily inuenced by social peers. An interesting point here is that in several theories, the factor uncertainty plays a central role in the argument. It is especially important within the theories stemming from psychology and sociology. In order to cope with the uncertainty problem during an MNCs international expansion, its managers will tend to globalize slowly, adhere to previous decisions, and strive for social legitimization. Thus, an MNCs home-region orientation often seems to be the result of the social inuence exerted by groups in the MNCs environment. And third, Table I indicates that each theory contains arguments that suggest that the home-region orientation is likely to be a long-lasting phenomenon. For example, it will likely take decades for all regions of the world to reach a comparable level of economic liberalization. Thus, it is plausible that new regionalisms logic will hold for some time. In a similar vein, among the factors introduced by the new economic geography and the theory of the knowledge economy, it is likely that the markets for labor and knowledge will remain regionally differentiated for the foreseeable future. And arguments provided by psychic distance theory and escalating-commitment theory rely on characteristics of human beings that are likely to apply equally well to future generations of managers. Population ecology also emphasizes that an MNCs most stable advantages are likely to be home-region oriented. Thus, most MNC competencies seem to be too context-specic and stable to allow such MNCs an easy, quick path towards a global orientation. In general, sociological theories argue that this change process will be very slow and that it will occur largely from the replacement of home-region-oriented MNCs by MNCs that began as more global MNCs. Given these

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arguments, we believe that the majority of MNCs will be slow in overcoming their strong home-region orientation. In conclusion, we see a substantial opportunity to apply a variety of different theories to the phenomenon of the home-region orientation found in most MNCs. The existing research and literature (Rugman, 2000, 2005; Rugman and Verbeke, 2004, 2005) provides a strong foundation for such efforts. Future work should be narrower and deeper than the present article, which has sought to more broadly explore and dene the potential for such an extension of theory.
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