Corporate Governance and International Location Decisions of Multinational Enterprises

• Author: Bert Scholtens,Elmer Sterken,Lammertjan Dam
• DOI: http://doi.org/10.1111/j.1467-8683.2007.00649.x
• Date: 01 November 2007
• Published date: 01 November 2007

Corporate Governance and

International Location Decisions of

Multinational Enterprises

Lammertjan Dam*, Bert Scholtens and Elmer Sterken

This paper analyses international location decisions of corporations based on corporate gov-

ernance considerations. Using f‌irm level data on 540 Multinational Enterprises (MNEs) with

44,149 subsidiaries in 188 countries, we test whether f‌irms with relatively good governance

standards are more often located in countries with a weak governance system. We f‌ind empiri-

cal support for this hypothesis, especially for those corporations present in low-income

countries.

Keywords: Corporate governance, location behaviour, corporate social responsibility, multi-

national enterprises

1. Introduction

This paper analyses whether corporate

internationallocation decisions are driven

by differences in national governance systems.

For example, do multinational f‌irms look for

direct investment opportunities in countries

with weaker governance than at home?A f‌irm

that is confronted with high pressure from

stakeholders at home might f‌ind it attractive to

shift production to an economy with less strict

governance codes. In this way, domestic cor-

porate governance institutions might impact

international location choices in a f‌irm-specif‌ic

way. For instance, environmental and human

rights pressure groups’ actions with respect to

Royal Dutch and Nike have affected their cor-

porate governance codes as well as their inter-

national production and location decisions.

Firms that have weak corporate governance

codes might consider it more prof‌itable to

produce with capital intensive technologies in

a country with a well-structured governance

system. In general, economic theory on inter-

national location decisions argues that these

decisions depend on the one hand on a

number of standard factors (a comprehensive

theoretical discussion is given by Billington,

1999), but on the other hand also on institu-

tions, like the quality of environment, political,

legal, and social factors (Boddewyn, 1988).

In order to improve our understanding of

the role of institutions in general in Multina-

tional Enterprises’ (MNEs) location decisions,

we need insight into the impact of governance

institutions on location decisions. Firms that

e.g. are inclined to be relieved from share-

holder pressure may want to start or continue

business in economies with less strict codes.

Conversely, f‌irms with rather poor gover-

nance standards that want to start a project,

may be interested in locating in countries

with well-developed governance standards. It

remains an empirical issue to identify these

two views.

This paper starts with a brief review of the

literature on international location activity, the

candidate role for governance institutions and

the corporate performance-governance nexus

in section 2. As we show, there is relatively

little attention for the role of institutions like

governance in this literature so far. In section

3 we argue that in order to establish an active

role for governance, we need to know about

the interaction between corporate perfor-

mance and governance. Next, we describe

in section 3 the data and discuss the descrip-

tive statistics. In section 4 we present our

*Address for correspondence:

Department of Economics,

University of Groningen, PO

Box 800, 9700 AV Groningen,

The Netherlands. Tel: +31 50

363 6518; E-mail: l.dam@rug.nl

1330 CORPORATE GOVERNANCE

Volume 15 Number 6 November 2007

© 2007 TheAuthors

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methodology. Section 5 gives the analysis and

results. Finally, in section 6, we summarise and

conclude.

2. International location activity,

governance, and f‌irm performance

In this section, we review the literature on

international location decisions, the candidate

role of institutions in general and governance

in particular, and the impact of governance on

f‌irm performance.

International location decisions by MNEs

are complex corporate decisions. Two strands

of literature describe the main determinants

of location choice: the traditional theory on

Foreign Direct Investment (FDI) (see e.g.

Markusen, 1995) and the so-called new eco-

nomic geography (see e.g. Brakman et al.,

2001). The “traditional” theory focuses e.g. on

the role of local costs, access to production

factors, transportation costs, relative size and

market power. It is commonly believed that

so-called horizontal investments are more

likely in the case of large markets and high

transportation costs, while vertical invest-

ments arise when local costs are relatively low.

Besides these rather standard arguments,

public policy of course also affects location

decisions. The second strand of literature, the

new economic geography, focuses on spatial

imperfections that affect location choice and

performance. A f‌irm might want to be in a

region where competitors run a successful

business, but increased competition reduces

this attractiveness.

According to Blonigen (2005), the growth of

MNE activity in the form of foreign FDI has

grown faster than most other international

transactions in the last decades. Therefore it

is important to know what the determinants

of MNEs’ location decisions are. Empirical

research on factors thatdetermine FDI patterns

and the impact of MNEs on parent and host

countries is in its developing stage. As Bloni-

gen (2005) argues, the literature has shown

that it cannot simply be concluded that factors

such as exchange rates or tax policies have an

unambiguous general impact on FDI patterns.

Blonigen discusses that f‌irm-specif‌ic charac-

teristics, like the availability of intangible

assets, such as technologies or managerial

skills, are important, but typically hard to

measure, and so are problematic in empirical

studies. Using empirical proxies, like R&D

and advertising, reveals that f‌irms that lack

innovation, as compared to their peers, typi-

cally are engaged more in FDI (see Blonigen,

1997).

One can distinguish partial and general

equilibrium approaches to FDI and location

decisions.1In partial equilibrium models,

exchange rate effects, taxes, and tariffs are

used as determinants. For instance, if a cur-

rency appreciates, the price of a local project

will decrease for a foreign investor, but the

nominal return on the project’s probably will

not. Tax issues are most complicated and

empirical evidence of the impact of changes in

corporate and indirect tax rates is mixed at

least (see e.g. Desai et al., 2004). Trade protec-

tion might be another determinant of interna-

tional MNE location decisions. If a f‌irm can

avoid tariffs by substituting production for

exports, this would be a high-potential candi-

date determinant of location decisions.

Belderbos (1997) indeed f‌inds evidence of this

so-called tariff-jumping FDI.

Blonigen (2005) points at the potentially

valuable role of institutions as a determinant

of FDI, particularly for less-developed econo-

mies. For example, poor legal protection of

assets increases the chances of expropriation

of corporate assets, reducing the probability of

FDI. Poor quality of institutions also lowers

expected prof‌itability and, therefore, reduces

the probability of successful FDI. Blonigen

further argues that it is hard to f‌ind good

empirical proxies for institutions, since these

are typically hard to measure. Most measures

are composite indices developed from survey

responses from government off‌icials and busi-

nessmen familiar with the country involved.

This troubles cross-country comparability,

because the sampling of respondents might

differ per country. An exception is the direct

measurement of institutions like legal stan-

dards (see La Porta et al., 1997), which have

been extensively used in the literature on

f‌inance and development. Legal institutions

can be measured directly from legal codes, but

still are prone to interpretation issues if it

comes to details (like the measurement of

shareholder protection). Another problem in

the empirical literature that tries to estimate

the impact of the role of institutions on eco-

nomic variables is the fact that institutions

tend to change very slowly. This troubles

our country time series analysis and favours

a cross-sectoral approach (see for instance

Levine and Zervos, 1998, for an example in the

law and f‌inance literature). One of the institu-

tional variables used in some of the FDI litera-

ture is corruption: Wei(2000) for instance f‌inds

that FDI is negatively related to corruption, but

Wheeler and Mody (1992) do not f‌ind support

for the negative role of corruption.

Other examples of empirical partial loca-

tion studies are e.g. Basile et al. (2003) and

Yamawaki (2006) on FDI in the EU. These

studies estimate (conditional) choice models of

location decisions. The econometric specif‌ica-

CORPORATE GOVERNANCE AND INTERNATIONAL LOCATION DECISIONS OF MULTINATIONAL ENTERPRISES 1331

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