Cultural diversity and performance of multinational enterprises
Ph.D candidate: John Fan Zhang
Supervisors: Professor Bart Frijns and Professor Alireza Tourani-Rad
Cultural diversity (CD) of an multinational enterprise (MNE) changes over time as it expands overseas, exerting both positive and negative influences on firm performance. On the one hand, cultural diversity may bring new ways of thinking, improving decision quality. It can also introduce culture-specific knowledge that MNEs need, adding economic value to MNEs (Pieterse et al., 2013).
On the other hand, cultural diversity may create frictions, such as communication barriers of understanding and acceptance in an organization. These frictions cause difficulties for parent firms to make informed decisions and to evaluate subsidiary performance (Roth & O'Donnell, 1996).
Moreover, when cultural diversity is high, competencies and skills may not be transferred smoothly, this may lead to higher transaction costs (Gómez-Mejia & Palich, 1997). These viewpoints suggest that the performance of MNEs, to a certain extent, depends on the degree of cultural diversity.
Gómez-Mejia and Palich (1997) develop a theoretical framework for measuring the potential impact of cultural diversity on operating and financial performance of MNEs. Based on a sample of 442 Fortune 500 firms over 1985-1989 and 228 firms over 1990-1994, the authors are unable to find a significant relation between cultural diversity and firm performance. Antia, Lin, and Pantzalis (2007) extend Gómez-Mejia and Palich (1997)’s work and show that cultural diversity has a negative effect on firm valuation, suggesting that cultural diversity sets more obstacles than brings benefits to MNEs. Hutzschenreuter and Voll (2008) find no significant relation between cultural diversity and firm performance. However, the irregularity and massiveness added cultural distance per unit of time significantly hurt firm performance. De Jong and Van Houten (2014) extend the study of Gómez- Mejia and Palich (1997) by introducing an interaction term between internalization and cultural distance. They that when the degree of internalization is low, a higher CD exerts negative impacts on firm performance; whereas when the degree of internalization is high, This negative relationship does not necessarily exist.
While the above studies built a foundation for examining the impact of cultural diversity on firm performance, these results should be interpreted as a first step. This is because they do not consider causality, i.e. whether firm performance shapes cultural diversity, or cultural diversity affects firm performance. This is an example of endogeneity. In many cases, endogeneity leads to unreliable and even reverse qualitative inference (Roberts & Whited, 2013). However, endogeneity is inevitable in
the relation between cultural diversity and firm performance for two reasons. First, a better past firm performance may lead to a higher degree of current cultural diversity. Zahra, Ireland, and Hitt (2000) use 2-year lagged ROE and sales growth as measures of firm performance, finding that firm performance is positively related to the breadth of international diversification. Chang (1995) uses a sample of Japanese firms that expand into the U.S. market during the period 1976-1989, finding that those firms had strong competitive advantages over Japanese local firms prior to their overseas expansions. Furthermore, Clarkin (2007) and Shane (1996) offer evidence that previous superior performance is a motivation for franchise companies to expand abroad.
Second, CD may be related to other unobserved factors as a consequences of internationalization.
Internationalization means the extent to which a company is involved in overseas operations (Root, 1994). The process of internationalization brings various shocks that can affect firm performance and CD may related to these shocks. On the one hand, when MNEs expand their business overseas, they are likely to enter into culturally distinct markets directly due to attractive growth opportunities and scarce resources (Malhotra & Sivakumar, 2011). On the other hand, some firms gradually expand to culturally distant markets after they learn from early experiences in different cultures and accumulate foreign experiences (Barkema et al., 1996). Therefore, the degree of internationalization and CD can change simultaneously.
This study makes contributions to the existing literature in the following ways. First, it provides new evidence on the relation between cultural diversity and firm performance. As both firm performance and cultural diversity are dynamically determined, this study addresses this potential endogeneity issue by using GMM model. Secondly, this study contributes to internationalization researches.
Existing literature that investigates the relationship between internationalization and firm performance draws a mixed conclusion. By focusing on the role of cultural diversity, this study looks into the effect of internationalization from a new perspective.
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