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The Impact of Institutional Differences: Strategic Orientation Differences Between Two Emerging Markets Garry Bruton Texas Christian University Neeley School of Business Fort Worth, Texas 76129 USA G.Bruton@tcu.edu ChungMing Lau Chinese University of Hong Kong Department of Management Shatin, N.T. Hong Kong cmlau@cuhk.edu.hk Yuan Lu Chinese University of Hong Kong Department of Management Shatin, N.T. Hong Kong Yuri Rubanik Quality Laboratory Moscow Federal Institute of Electronic Technology Moscow, Russia Submitted to the Asia Academy of Management Conference, 2004, Shanghai, China. May 2004 We would like to acknowledge the assistance of Rosanna Lo in data analysis. This project is partially funded by RGC CERG (CUHK4310/01H), Hong Kong SAR. 1 The Impact of Institutional Differences: Strategic Orientation Differences Between Two Emerging Markets ABSTRACT It has been widely recognized that institutions can impact the individual strategic actions of firms in wide ranging concerns such as diversification and exit. This research demonstrates that institutions can also impact the underlying strategic orientation of firms which leads to those strategic decisions. The institutional setting in two of the leading emergent markets, Russia and China, leads to differences in strategic orientation which in turn impact the resulting performance of high technology startups in these countries. Key Words: Strategic orientation Institutions Hi-tech ventures 2 The Impact of Institutional Differences: Strategic Orientation Differences Between Two Emerging Markets Institutions shape the behaviors of individuals, and in turn organizations, in subtle but pervasive ways (Scott, 1995). It has argued that that a better understanding of institutions can provide a powerful tool for researchers to comprehend the differences that exist between firms in different nations (Hoskisson, Eden, Lau, & Wright, 2000; Scott, 2002). Part of the explanatory power of institutions is due to the belief that institutional differences ultimately produce differences in strategic actions by firms (Peng, 2003). In seeking to understand institutions and their impact researchers have commonly focused their examination on whether there are differences in specific strategic actions in various institutional environments. For example, researchers have examined specific strategic actions such as diversification (Kogut, Walker, & Anand, 2002), or foreign direct investment and ownership levels (Delios & Henisz, 2000) and venture capital industries (Bruton & Ahlstrom, 2003) in different institutional settings. These researchers typically assume that any differences in the specific strategic actions are due to the institutional differences. But, it is possible that the institutions are not directly impacting the different strategic actions themselves, but instead are impacting even more fundamental concerns which in turn produce the differences in strategic actions as outcomes. Understanding this deeper perspective on institutions would allow broader statements about institutions and their impact to be made. Thus, rather than examining each individual strategic action broader implications for a variety of strategic actions could be hypothesized. Thus, there is a need for researchers to not simply focus simply on each given strategic action, but 3 instead they should seek to gain a deeper understanding of the underlying impact of institutions which lead in to turn to various strategic choices. Such an underlying set of factors that impact the strategic choices of a business is the strategic orientation of the firm (Venkatraman, 1989). To date, it is not clear if a fundamental issue like strategic orientation will differ systematically in different institutional environments. Therefore, this research will examine how the institutional environment shapes strategic orientation in businesses. In preparing to examine strategic orientation it is recognized that there is a strong need for organizational researchers to better understand the impact of institutions in emergent economies (Peng, 2003; Scott, 2002). It is also increasingly recognized that the nature of the change in emergent markets provides the opportunity for researchers to obtain fresh insight into what circumstances, to what extent, and in what ways institutions matter (Peng, 2003). Therefore, this research will examine the impact of institutions on strategic orientation in emergent economies. Most prior research employing institutional research have examined firm actions in single countries (ie., Bansal & Clelland, 2004; Bruton & Ahlstrom, 2003; Khanna & Palepu, 2000) or sought to explain why firms from one nation act differently in various parts of the world (ie., Kostova & Roth, 2002; Lu, 2002). However, a richer understanding about the role of institutions can be obtained by comparing the resulting impact of institutions on strategic domains in different markets. Russia and China are two emergent markets which are transitioning from central control to market mechanisms. As will be detailed later in the manuscript the two nations have chosen different paths to reform their economies. As a result of the similar beginnings but different paths to 4 reform the two nations offer a natural experiment setting to examine the impact of institutions (Lawrence, Winn, & Jennings, 2001). Therefore, the study will examine the strategic orientation of firms in these two nations. There can be considerable heterogeneity in the environments of emergent markets (Hitt, Ahlstrom, Dacin, Levitas, & Svobodina, 2004). The ability to contrast a single type of business, high technology startups, in two transitional economies will help to control part of this heterogeneity. Prior research has not extensively applied institutional theory to entrepreneurial settings (Busenitz, Gomez, & Spencer, 2000), so this investigation will provide new insight to this important domain. In summary, there are three contributions of this study to the literature. First, the study provides the first insights how institutions can shape strategic orientation – a key factor in the strategic choices made by a firm. Secondly the study expands the understanding of emergent markets; this understanding is based on two of the key emergent markets in the world today, Russia and China. Finally, the study increases the understanding of hi-tech entrepreneurial settings. Specifically, the paper builds the understanding of how institutions impact strategic orientations in hi-tech start-ups, a topic that has received limited investigation in the past. To lay the groundwork for these contributions the paper will initially lay the theoretical understanding of institutional theory and emergent markets. From this theoretical grounding the paper will then establish testable hypotheses for the research. The implications of the results of the empirical tests are then discussed. This discussion will conclude with future research directions and needs. Conceptual Framework 5 Institutional Foundations Firms are embedded in a framework of norms, value and rules of exchange (Fligstein, 1996). These norms, values, and rules of exchange are institutions which in turn shape the firm’s actions in subtle but pervasive ways (Scott, 1995; 2002). Some of these institutions can be shaped by the government through regulations and rules that they establish. However, other institutions are more fundamental and difficult to change are shaped by the culture of the region or country. In post communist nations one of the key sets of institutions which shape behavior are those legacy of communism (Steen, 2002). The institutions that are from this communist legacy that continue to shape behavior in these societies today include the bureaucracy that still largely manages the administrative structure in these countries, most key individuals in leadership positions are still predominately from the communist party1, and the general culture of the people that evolved over the several generations that lived under communism remains and continues to shape individual experiences. The two largest communist nations, Russia and China, shared a common economic foundation until economic liberalization occurred in the 1990s. In large measure this was because historically the Russian government was central to the formation of the communist party in China and provided the economic model which Chairman Moa initially modeled the Chinese economy (Fairbank, 1992). As a result, there was great similarity in the foundation and approach to central control in these two economies. 1 To illustrate President Putin previously was part of the KGB or the secret police in the Soviet Union, the predecessor to Russia. 6 This common economic foundation from the legacy of communism makes Russia and China a natural laboratory to contrast the changes in the economic institutions in the two different nations (Lawrence et. al., 2001). Each nation has some unique dimensions of their economies that developed over time. However, the basic foundation of each nation was largely the same. Thus, if the two nations approached economic liberalization differently the impact of those different changes should be discernable. Since the 1990s the two nations have taken substantially different approaches to economic liberalization. Both nations have increasingly moved from central control of the economy to a market oriented approach. However, the Russian approach has been described as a shock approach to economic transition (Benn, 2001). The government tried to quickly move to a market economy. The result has been that the nation has decentralized political control, few central policies, and relative weakness in enforcing the rules that are generated (Hitt, et. al., 2004). The shock approach to the economic transition in Russia resulted in the perception of the nation as in economic chaos (Benn, 2001). This perception had a substantial impact on the leadership in China. The conscious choice in China in response to this perceived chaos was to pursue a more evolutionary economic transition to market mechanism (Li, 1998). The result has been that the nation has maintained strong political control and instituted some strong central policies (Naughton, 1996). For example, the government still maintains some industries as pillar industries and will not allow foreign competition or ownership in these industries they consider critical (Chen & Lau, 2000). These policies are largely still not debatable and the government maintains strong control in these industries. 7 In contrast the shock economic approach of the Russians resulted in the central government having less control over the economy. Even when the government has sought to assert central government over the economy these directives have not necessarily been followed. In recent months there has been some change in this approach with President Putin increasingly seeking to assert control over the economy through active use of the police. For example, business leaders are asked to follow the government’s direction on a variety of issues or face arrest typically for tax evasion. However, the business environment for entrepreneurial firms remains largely chaotic (Economist, 2004). Thus, Russia and China make a natural laboratory to explore the changes in the economies and their impact. The two nations started with very similar economic foundations but each has sought to liberalize its economy in different ways. Strategic Orientation The concept of strategic orientation has been in the strategic management literature for a considerable time (see Jauch & Osborn, 1981 as an example of such early work). The underlying belief in strategic orientation is that there are substantive strategic beliefs that underpin the strategic actions taken by the firm. These beliefs concern the basic thinking of the organization on concerns such as the scope of activities the firm is to pursue, where the firm is to operate, and how it is to operate. These philosophical underpinnings in turn will guide the strategic choices of the firm in many different domains. Thus, a business in making strategic choices will fundamentally be guided by its strategic orientation. Strategic orientation can then be understood as a cognitive understanding and interpretation of the external environment and internal resources, and 8 it represents the priority of resource allocation with long-term growth and shareholders’ wealth as the ultimate objective (Hitt, Dacin, Tyler, & Park, 1997; Lau, 1998). It represents how aggressive the firm wishes to compete in the market, and thus the willingness to explore and develop competencies, products, or markets. Some empirical studies have examined the outcomes of different strategic orientations. For example, Veliyath and Shortell (1993) found that prospectors perceived greater market research competencies, key personnel involvement, and innovativeness in the planning process than defenders and they were better performers. Rajagopalan and Finkelstein (1992) found that firms with more discretionary strategic orientations offer higher, and more outcome-based, compensation to the senior management than firms with less discretionary strategic orientations. The antecedents and dimensionalities of strategic orientations, however, are relatively under-studied. Venkatraman (1989), in his effort to construct and validate a measure of strategic orientation, identified the component parts of strategic orientation. He identified six key dimensions of strategic orientation through an extensive examination of the strategic management literature. The first of these dimensions of strategic orientation included the aggressiveness of the business, or the willingness of the business to take actions to improve the market position of the firm. The second dimension of strategic orientation is analysis, or the efforts of the firm to have internal consistency in the firm’s efforts to achieve stated objectives. For example, it is widely argued that firm’s need to have control, reward, and management systems that are consistent with each other in order to achieve the firm’s goals in a efficient and effective manner. 9 The third dimension of the strategic orientation according to Venkatraman (1989) was defensiveness. This element focuses on willingness to take actions that will prevent other firms from attacking it. The defensiveness of the firm turns on preventing openings to competitors on the basis of cost of quality. The fourth dimension of the strategic orientation is the futurity or orientation towards the future and would include the willingness of the firm to invest in research and development and the long term perspective of the firm. The fifth dimension of strategic orientation is how proactive the firm is in its strategic actions. This dimension addresses the willingness of the firm to continuously search for new opportunities. Lastly, the last dimension of strategic orientation according to Venkatraman (1989) is the dimension of how much risk the firm can tolerate. This dimension addresses the willingness of the firm to take risks. It is arguable after a review of the six elements that make up strategic orientation that an understanding of these dimensions for a firm (or a set of firms in an industry) that the fundamental approach of that firm (or set of firms) to strategic action can be obtained. Thus, individual strategic actions such as diversification, new ventures, organizational renewal or exit can be seen as an outcome of the strategic orientation. From an understanding of strategic orientation of the firm we will then be able to build a framework to understand a wide range of different strategic actions in the firm. The integration of strategic management with entrepreneurship studies has a promising future, as argued by recent studies (Dess, Lumpkin, & McGee, 1999; Hitt & Ireland, 2000). The orientation of entrepreneurs is one of the intersection areas of these two fields. In the literature, several cross-cultural socio cognitive models of new venture 10 creation (Busenitz & Lau, 1996; Mitchell, Smith, Seawright, & Morse, 2000) were proposed. These models suggested that new venture decisions and growth intentions of firms are functions of the owner or chief executive’s social context and personal variables, as well as understanding and interpretation of the environment. That is to say, their orientation is a result of the institutional forces they embedded in (Lau & Busenitz, 2001). Hence, a focus on entrepreneurial start-ups in a transitional economy context from an institutional perspective offers the appropriate lens to understand the dimensionalities and consequences of strategic orientations. Hypothesis Institutions is argued to impact the individual strategic actions of a firm such as diversification (Kogut, Walker, & Anand, 2002), or foreign direct investment and ownership levels (Delios & Henisz, 2000). If, as argued here, strategic orientation is a more fundamental concept and in fact the strategic actions such as diversification are decided by the firm’s strategic orientation, then it is reasonable to expect institutions to have an impact on strategic orientation. Scott (2002) suggested that China has a distinctive set of institutional characteristics that differ from the West. This is due to both historical and cultural reasons. Child (1994) and Walder (1995) also illustrated that the newly emerged organization forms and government units in China were built on and incorporated the institutional elements of the old, and followed paths different from the west. Russia, on the other hand, represented the institutions in the West. Following this idea, and that of the different economic reform approaches taken, Hitt et al. (2004) found that Russian and 11 Chinese had different preferences for joint venture partners. The differences in these orientations were largely due to institutional paths. Therefore, it is hypothesized: Hypothesis 1: Institutional differences in Russia and China result in differences in the strategic orientations of firms in the two nations. One of the differentiating characteristics of strategic management is the belief that the concern of the discipline is how the given strategic actions impact the performance of the organization (Dess et al., 1999). Thus, if there are differences in strategic orientation in the two emergent markets, whether this leads to differences in performance is an important concern. This is particularly a concern since the two nations offer such starkly different approaches on how to transform an economy from central control to a market mechanism. The shock treatment experienced in Russia had significant social costs. If this form of transformation produces no better opportunities for firms, or perhaps worst, it calls into question the rational for such an approach. Entrepreneurial firms often do not offer good financial measures of performance. This is particularly true of high technology firms (Bruton & Rubanik, 2002). High technology concerns often have high levels of initial expense as they seek to bu