Does Foreign Direct Investment Matter to Domestic Entrepreneurship? The Mediating Role of Strategic Alliances

ABSTRACT

This study investigates the impact of foreign direct investment (FDI) on domestic entrepreneurship in a host country by analysing a unique panel dataset of FDI and startup rates in Korean industries. It finds that FDI with a time lag has a positive effect on the startup rate, implying that inward FDI promotes domestic entrepreneurship. It shows that the strategic alliances moderate the relationship between FDI and the startup rate, depending upon the types of FDI and alliances. Both intra- and inter-industry alliances enhance the positive effect of foreign greenfield investment, while inter-industry alliances mitigate the effect of foreign acquisition.

KEYWORDS:

• Foreign direct investment (FDI)
• entrepreneurship
• strategic alliances
• knowledge transfer
• spillover effect
• competition effect

JEL Classifications:

• L26
• M13
• F23

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

1 In general, FDI is classified into two entry modes. Foreign greenfield investment involves setting up a new venture, including building plants or new firm creation in the host country to produce goods and services. Foreign acquisition, including mergers and acquisitions (M&A) and cross-border acquisitions, refers to the acquisition of an existing domestic firm’s ownership share. The two modes have different economic impacts and investment goals (Raff, Ryan, and Stähler 2009). The entry mode choice primarily depends on the investing firms’ resources, skills, and industrial factors (Dikova and Brouthers 2016; Klier et al. 2017).

2 ‘Strategic alliances’ refer to agreements characterized by the commitment of two or more firms to reach a common goal, entailing the pooling of their resource and activities for their success in competition with other rivals (Teece 1992; Das and Teng 2000; Grant and Baden-Fuller 2004). They embrace a range of collaborative activities such as cooperative R&D, supply-buyer partnerships, outsourcing agreements, collaboration in new product development and marketing, shared manufacturing and cross-distribution.

3 Specifically, regarding the FDI effect, ‘knowledge transfer’ and ‘knowledge spillover’ are distinct concepts with different meanings. Knowledge transfer takes place through market mechanisms, while the existence of knowledge spillover is related to externalities. Empirical studies on FDI have ignored the conceptual distinction between intentional knowledge transfer and unintentional knowledge spillover (Smeets 2008). Blalock and Gertler (2008) and Javorcik and Spatareanu (2008) showed that many of the estimated FDI effects are more likely to be related to knowledge transfer than knowledge spillover.

4 For example, FDI entry modes are related to the different nature and goals of foreign firms. Klier et al. (2017) showed that greenfield investment is the preferred mode when foreigners or foreign parent firms have superior and more knowledge-based resources (e.g., technology), while acquisition is often used when foreign parent firms try to require host-country-specific experience.

5 The comparison between competition and spillover effects has been frequently discussed in the literature on innovation and entrepreneurship (Cohen 2010; Plummer and Acs 2014). In contrast, it has been less examined in the FDI literature, which has usually focused on the spillover effect. Exceptionally, Chang and Xu (2008) analysed the relative size of the spillover and competition effects to explain the differences in survival rates between foreign entrants and local firms, among foreign entrants, and among local firms. However, no empirical studies have discussed the relative dominance between the two effects and a moderating factor influencing the dominance to explain the net effect of FDI on domestic entrepreneurship.

6 Statistics Korea has provided the Business Demography Statistics since 2006. Detailed data of the Business Demography Statistics at the two-digit KSIC level for all the sample industries have been available since 2011. The data regarding the number of startups and incumbents in the industries were provided at the one-digit KSIC level during the period 2006–2010. Accordingly, this study analyzes the data for the period 2011–2017.

7 Similar to existing studies (e.g., De Backer and Sleuwaegen 2003; Sun, Lee, and Hong 2017), this study considers a certain period of time during which FDI is likely linked to new firm creation via potential mechanisms and channels. For example, entrepreneurship is primarily concerned with the process of the discovery, evaluation, and exploitation of opportunities for entrepreneurial activity (Shane and Venkataraman 2000). The process takes a certain amount of time. Hence, this paper’s empirical analysis is done on the set of previous FDI variables.

8 This is not only because, in general, cross-sectional dependence is likely to be frequent in the panel data with a relatively large number of cross-sectional units and a small number of time series (De Hoys and Sarafidis 2006) but also because industry-level startup rates are likely to be correlated across industries due to inter-industry spillover. The existing studies regarding the effect of FDI on domestic entry did not consider the existence of the cross-sectional dependence, but this study is the first to specifically address this problem in the empirical methodology.

9 Qualitatively opposite results are obtained when current FDI is used instead of previous FDI. Current FDI has a significantly negative impact on the startup rate, regardless of the FDI entry mode, implying that FDI could temporarily discourage domestic entrepreneurship due to the dominance of FDI’s competition effect over its spillover effect. The results are available from the authors upon request.