DISTANCE MATTERS: LIABILITY OF FOREIGNNESS, INSTITUTIONAL DISTANCE AND OWNERSHIP STRATEGY

Abstract

The costs of doing business abroad (CDBA) is a well-known concept in the international business literature, measuring the disadvantages or additional costs borne by multinational enterprises (MNEs) that are not borne by local firms in a host country. Recently, international management scholars have introduced a second concept, liability of foreignness (LOF). There is confusion in the two literatures as to the relationship between CBDA and LOF, as evidenced in a recent special issue on liability of foreignness (Journal of International Management, 2002). We argue that LOF stresses the social costs of doing business abroad, whereas CDBA includes both economic and social costs. The social costs arise from the unfamiliarity, relational, and discriminatory hazards that foreign firms face over and above those faced by local firms in the host country. Because the economic costs are well understood and can be anticipated, LOF becomes the core strategic issue for MNE managers. We argue that the key driver behind LOF is the institutional distance (cognitive, normative, and regulatory) between the home and host countries, and explore the ways in which institutional distance can affect LOF. We operationalize our arguments by showing how institutional distance and liability of foreignness can provide an alternative explanation for the MNE’s ownership strategy when going abroad.