literature review

Comparative Institutional Analysis and Institutional Complexity

Christina L. Ahmadjian Hitotsubashi University

ABSTRACT For multinational corporations (MNEs), the ability to navigate institutional complexity is a key to success or failure. MNEs face a complex landscape of national institutional differences in the countries in which they do business, and decisions on how to respond to these differences are very much strategic ones, reflecting agency and management skill. To understand how institutional complexity affects MNE behaviour, it is necessary to examine how institutions vary on a national or societal level and how these affect firm structure and capabilities in both home and host countries.

Keywords: comparative institutional analysis, institutional complexity, institutional theory, multinational corporations

INTRODUCTION

How institutional differences affect MNEs has long been an important research topic in international business studies. Researchers have examined how the distance between home and host country culture and institutions affects the decision of an MNE to enter a market and how conflicting legitimacy pressures in home and host markets affect MNE structure and behaviour (Kostova and Zaheer, 1999; Rosenzweig and Singh, 1991; Xu and Shenkar, 2002). The empirical research that dominates this field, how- ever, tends to rely on relatively simple representations of institutional differences and MNE responses to them. For example, single indicators such as dimensions of culture (Kogut and Singh, 1988) or type of legal system (La Porta et al., 1998) often represent institutional differences, and discrete measures of mode of entry tend to capture MNE responses to these institutional differences. This approach enables large-scale cross- national studies, but it does not capture the complexity of institutions that distinguish national systems (Jackson and Deeg, 2008) or the wide range of behaviours that a firm can adopt in response to such complexity (e.g., Oliver, 1991).

Address for reprints: Christina L. Ahmadjian, Graduate School of Commerce and Management, Hitotsubashi University, 2-1 Naka, Kunitachi City, Tokyo 186-8601, Japan ([email protected]).

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Journal of Management Studies 53:1 January 2016 doi: 10.1111/joms.12178

In this essay, I explore how insights from Comparative Institutional Analysis (CIA) contribute to a deeper understanding of MNE responses to national institutional com- plexity, that is, competing and potentially incompatible prescriptions from multiple insti- tutional logics (Greenwood et al., 2011). The CIA approach to understanding national diversity strives to identify, classify, and explain the distinctive configurations of institutions that characterize national business systems. These approaches go by various monikers, including Varieties of Capitalism (Hall and Soskice, 2001a) and National Business Sys- tems (Whitley, 1992, 1999). While various approaches differ in such aspects as the num- ber of distinct systems of capitalism, the specific institutions that define and distinguish these systems, and the mechanisms by which institutions combine into distinctive config- urations, they share a fundamental assertion that national institutional systems shape the strategy, structure, and fundamental assumptions of firms.

Several aspects of the CIA perspective make it particularly relevant to understand- ing how MNEs face institutional complexity. It considers institutions at the national level and highlights the link between national institutional context and the capabilities of firms, considering institutions as enablers and determinants of comparative institu- tional advantage. What is highly relevant for the study of MNEs and institutional com- plexity is that it considers institutions not as single, stand-alone entities, but as complementary configurations that support comparative institutional advantage. The CIA perspective further enriches our knowledge of how institutions determine a MNE’s competitive advantage by showing how MNEs must navigate institutional com- plexity, not only to gain acceptance and legitimacy, but also to preserve comparative institutional advantage. Furthermore, it suggests that adapting and adjusting to institu- tions in a host country requires a response not simply to a single institution, but to an entire system.

The objective of this essay is to utilize the CIA perspective to better understand MNEs, as well as to demonstrate how it can enrich the organizational institutionalism (OI) approach to institutional complexity. While both the CIA and OI perspectives address how organizations deal with institutional complexity, the two perspectives con- sider institutions at different levels: OI focuses on the field, which is defined as ‘a commu- nity of organizations that partakes of a common meaning system and whose participants interact more frequently and fatefully with one another than with actors outside the field’ (Scott, 1995, p. 56), while CIA focuses on the national system. Furthermore, CIA views institutions in their role of organizing economic activity, while in OI institutions have a broader role in social life. Yet, despite this difference in emphasis, the core ideas from CIA, that institutions exist in complementary configurations and can be a source of comparative advantage, can also be used to inform an OI approach.

This essay begins with a brief overview of the CIA perspective, highlighting how its notions of comparative institutional advantage and institutional complementarities can better inform our understanding of MNEs and institutional complexity. In the second half of the essay, I employ concepts from the CIA perspective to develop propositions on how national-level systems of institutions are likely to affect MNE responses to insti- tutional complexity in their host markets. The intention is not to develop a definitive framework to explain MNE responses to national institutional systems, but rather to illustrate ways in which key insights of the CIA perspective can offer a systematic

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approach to understanding MNEs and institutional complexity, as well as to stimulate further research.

COMPARATIVE INSTITUTIONAL ANALYSIS AND SYSTEMS OF CAPITALISM

The CIA approach draws from a broad range of disciplines, including economics, politi- cal science and sociology. Rather than a single integrated framework, it can best be seen as an overarching category of several streams of theoretical and empirical inquiry. Sev- eral useful overviews provide insights into each specific stream and how they differ (Jackson and Deeg, 2008; Hotho, 2014; Morgan et al., 2010). The various CIA approaches address similar questions: Why do capitalist or national business systems dif- fer so greatly around the world? How and why do they group into distinctive clusters? What are the sources of competitive advantage for a country? Will national business sys- tems converge to a single model over time, or will these differences remain?

The CIA approach finds answers to these questions in the distinctive institutional sub- systems that comprise national business systems, including employment systems, systems of training and skill development, corporate governance and financial systems, forms of inter-firm relations, state policy and the nature of authority. The CIA approach high- lights institutional complementarities between these sub-systems and how they can give rise to competitive advantages for MNEs.

National Business Systems as Sets of Complementary Institutions

A key insight of the CIA perspective, which differentiates it from other approaches to institutions and the MNE, is that a national business system is a cluster of complemen- tary institutions whose effect and influence cannot be understood in isolation from each other. Institutions include formal rules that order an economy and taken-for-granted notions of how firms relate to their stakeholders and their environment.

The notion of complementarity centres around the idea that one institution enhances the efficiency of another (Aoki, 1994; Milgrom and Roberts, 1992), and that the comple- mentary fit between institutions in a national system leads to comparative institutional advantage (Amable, 2003; Crouch, 2010; Crouch et al., 2005; Hall and Gingerich, 2009). The notion that a national business system consists of a configuration of comple- mentary institutions suggests that change is difficult, since change in one institution does not necessarily lead to change in others, and may simply destabilize the entire system (Hall and Soskice, 2001a). At the same time, the multiplicity of institutions can provide materials for innovation and recombination, and the resulting new configurations of institutions may be a source of innovation (Crouch, 2005).

To understand this notion of complementarity in more specific terms, the contrasting examples of the Japanese automotive industry and Silicon Valley are informative. In Japan, a bank-centred financial system supports long-term relationships with employees and suppliers, enabling firms to set long-term goals and give precedence to employees over shareholders when allocating returns (Aoki, 1994). In Silicon Valley, market-based compensation aligns the interests of entrepreneurs with shareholders. Flexibility and

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responsiveness to markets take precedence over long-term relationships. This system is supported by low rates of unionization and employment protection laws that favour employers.

Institutional complementarity has several implications for how MNEs deal with insti- tutional complexity. One is that institutions exist in complementary configurations, that is, formal and informal institutions, market- and non-market institutions, and rules and taken-for-granted assumptions are intertwined in non-random ways. The OI literature acknowledges the multiplicity of institutions and has recently focused attention on how organizations facing multiple ‘institutional logics’ (Friedland and Alford, 1991; Thornton et al., 2012) cope with contradictory and overlapping institutional prescrip- tions (for reviews see Battilana and Lee, 2014; and Greenwood et al., 2011). It has not considered, however, the notion of complementarity between institutions as constituting a societal logic.

Another implication of institutional complementarity is that an MNE’s response to an institutional setting in a host country is not a single decision, but a set of decisions that must be made across a set of institutions. Using Oliver’s (1991) framework, the question of whether to choose acquiescence, compromise, avoidance, defiance, or manipulation must be asked for multiple institutions simultaneously. The possibility of different responses to different institutions has the potential to lead to new hybrids, innovative forms and practices (Crouch, 2005).

Institutions as a Source of Competitive Advantage

Another key insight of the CIA perspective is that these complementary institutional configurations shape a firm’s strategy, innovation, internal structure and external rela- tionships. As a result, firms have distinctive capabilities that vary across nations. When MNEs compete internationally, these capabilities become competitive advantages, or, in the terminology of CIA, comparative institutional advantages (e.g., Casper and Whitley, 2004). Firms that emerge in countries with one sort of institutional system are likely to look different and compete in different ways from those that emerge in countries with other systems.

For example, national systems that encourage long-term employment, skill develop- ment and relational finance through banks will give rise to firms that take a long-term perspective, train their employees in firm-specific skills, and collaborate closely and over the long term with other firms. These national systems are more likely to excel at incre- mental innovation. National systems that encourage equity finance through the stock market, provide little job security, fund general skills training, and encourage arms- length relationships between firms will give rise to firms that take a short-term perspec- tive, emphasize financial metrics, respond flexibly to changes in technology and environ- ment, and specialize in more radical innovation (Hall and Soskice, 2001b). According to this line of reasoning, the emphasis on kaizen, or continuous improvement, and steady incremental innovation in the Japanese manufacturing industry, is rooted in the Japa- nese institutional context (Aoki, 1994). In contrast, the discontinuous and radical inno- vation of Silicon Valley, with its short-term focus and flexible, ever-changing

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relationships, is rooted deeply both in the US system and in institutions particular to Sil- icon Valley (Saxenian, 1990).

Different streams of theory in the CIA perspective see this link between institutional context and capabilities in somewhat different ways. The Varieties of Capitalism (VOC) (Hall and Soskice, 2001a) perspective places particular emphasis on systems of skill for- mation and emphasis on long-term relationships, while the National Business Systems perspective (Whitley, 1999) focuses on how these institutions affect the nature of coordi- nation within the firm. However, various perspectives share the notion that different institutional systems give rise to systematic differences in types of firm innovation and capabilities.

International business research on MNEs and institutions tends to focus on institu- tions as barriers to be overcome or avoided. The concept of institutional distance (Berry et al., 2010; Kogut and Singh, 1988; Xu and Shenkar, 2002) highlights differences in institutions as barriers to international expansion by MNEs and key determinants of the entry decision and mode (Henisz and Delios, 2001). Additional research suggests that non-conformity with host country institutions is a possible danger to firms, the costs of which need to be minimized (Peng, 2002, 2003; Zaheer, 1995). Although research on administrative heritage (Bartlett and Ghoshal, 1989) emphasizes the influence of the home country in an MNE’s strategy and organization, it does not highlight this as a par- ticular source of competitive advantage.

The CIA perspective, in contrast, holds that institutions are not only constraints, but can be enabling factors for MNEs and that capabilities derived from the institutional context in which an MNE originates provide distinctive comparative advantages when it goes abroad (Jackson and Deeg, 2008b; Meyer et al., 2011; Regn�er and Edman, 2014). In this case, the institutions that count are the home country institutions, and the ability to maintain this institutional advantage in the face of a host country with very different institutions is a critical issue for the MNE. Thus, answering the question of how MNEs interact with the institutions of a host country has much to do with the comparative institutional advantage that the MNE derives from its home country.

Relational Versus Arms-Length Systems

The notion of institutional complementarities is related to a distinctive thesis of the CIA perspective; namely, that national systems of institutions can be clustered into distinct groupings that share common characteristics and similar types of comparative institu- tional advantages. A significant area of divergence among different streams of theory within the CIA perspective is the number of distinct groupings and the method of deter- mining them. Yet, all of these streams share the idea that we can obtain a deeper under- standing of national systems of institutions, and their origins and dimensions of difference, through comparative analysis of these clusters or types of business system.

The CIA perspective distinguishes between two types of systems: those in which eco- nomic transactions tend to be arms-length and governed by the market, which I refer to in this essay as ‘arms-length’, and those that depend more on long-term relationships, which I refer to as ’relational’. For example, The VOC literature contrasts Liberal Mar- ket Economies (LME) and Coordinated Market Economies (CME) (Hall and Soskice,

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2001a). LME systems are characterized by arms-length transactions, reliance on market forms of coordination, short-term time-horizons, and general rather than firm-specific skills. CME systems feature close relationships, non-market forms of coordination, long- term time horizons and firm-specific skills. Whitley (1999) posits six different systems, as he casts a wider net across countries (in contrast with Hall and Soskice’s primary focus on Europe and the USA). Among these systems, he contrasts the arms-length nature of Anglo-Saxon economies, which he calls ‘compartmentalized’, with the more highly coordinated economies of Germany (‘cooperative’) and Japan (‘highly coordinated’).

In an arms-length system, relationships with employees, buyers, suppliers, or pro- viders of capital tend to be short term and transactional, protected by contracts, over- seen by clear rules, and marked by transparent information disclosure. This system is flexible and responsive to changing market conditions. It is particularly effective in industries in which speed and ability to adjust to dramatic volatility are important. In a relational system, complementary institutions support the creation of long-term relation- ships that enable economic transactions through non-market mechanisms. A relational system combines, for example, an employment system with low labour mobility and long-term skill development within firms with a financial system characterized by rela- tional finance through bank loans. Relational systems tend to have less infrastructure for promoting transparency and information disclosure, since relationships are sufficient for information sharing. Such systems emphasize the development of specific assets by firms that are difficult to redeploy and lead to inflexibility, but also to high levels of knowledge sharing and skill development.

SOME PROPOSITIONS ON MNEs AND INSTITUTIONAL COMPLEXITY

As noted earlier, the CIA perspective emphasizes that an MNE’s approach to institu- tional complexity involves the consideration of institutions of both the host and home countries. Furthermore, it makes it clear that MNEs face systems of complementary institutions, adding both to the intricacy of managing institutional complexity as well as to the potential for innovation. Drawing on these concepts from the CIA perspective, I develop propositions around how home and host country institutions affect an MNE’s response to institutional complexity and how this differs across relational and arms- length systems. In developing and illustrating these propositions, I use examples pre- dominantly of US and Japanese (and to a lesser extent German) MNEs and their responses to institutional complexity in each other’s countries. US and Japanese MNEs exemplify firms embedded in contrasting arms-length and relational systems. There is a long research tradition on MNEs from both countries that offers rich empirical evidence from which to draw.

Comparative Institutional Advantage and Market Entry

The starting point for understanding the response of MNEs to institutions in host mar- kets is the notion of comparative institutional advantage. The resources and capabilities deriving from features of an MNE’s home market give it a comparative advantage that firms from other institutional contexts cannot easily imitate. This suggests that a key

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factor in an MNE’s response to institutional complexity is to preserve this comparative institutional advantage.

As the international business literature points out, there are various reasons for firms to expand abroad. Exploiting internal resources in new markets is one reason (Chang, 1995; Dunning, 2001; Erramilli et al., 1997; Makino et al., 2002). Another motivation is to learn – to gain knowledge and capabilities only to be found outside of one’s home market (Bartlett and Ghoshal, 1989; Dunning, 2001; Kogut and Zander, 1993). This is likely to be a critical determinant of whether an MNE chooses to adapt to a local institu- tional system or not (Luo, 2002). Thus, the response of MNEs to institutional complexity is related to whether the firm expands abroad to exploit its capabilities or to acquire new capabilities.

Capability Exploitation and Market Entry

When an MNE’s objective in expanding abroad is exploiting its own capabilities, it is likely to maintain the attributes derived from the system in which it emerged. In this case, MNEs will be less likely to adapt to the local institutions, and rather will maintain the internal and external organizational systems derived from their home institutions from which they gain competitive advantage (Luo, 2002).

For a MNE from a relational system, its comparative advantage lies in its close relationships with employees, suppliers, and financial institutions. For an MNE from an arms-length system, the flexibility that comes from lack of these obligations is its source of advantage. If an MNE is entering a new market for the purpose of exploiting its prior comparative institutional advantage, it is likely to hold onto this no matter what behaviour is prescribed by the institutional system of the host country.

To provide a concrete example, a Japanese auto manufacturer going into the USA is likely to retain as much of its system of long-term assurances to employees and close sup- plier relationships as it can, since this is a key source of comparative advantage (Nishigu- chi, 1994). In fact, Japanese auto manufacturers expanding into the USA have maintained as much of their system as possible (Adler and Cole, 1993; Florida and Ken- ney, 1991; (Kenney and Florida, 1995; Womack et al., 1990). In contrast, financial insti- tutions from the USA going into Japan have tried to preserve their own systems of sales, product development, and employment (Edman, 2016; Ono, 2007; Zaheer, 1995). Of course, there may be limits to the ability of firms to preserve and maintain all elements of the system that brought comparative advantage: for example, regulations may differ (Rosenzweig and Nohria, 1994) and local attitudes may be hard to change (Saka, 2004). The general objective, however, will be to avoid adapting to new institutions when this will detract from the original source of comparative advantage.

Proposition 1: MNEs entering a new market for the purpose of capability exploitation are less likely to adapt their organizational practices to local institutional systems.

According to the CIA perspective, institutions are a means of coordination –it is through institutions that firms manage transactions, create knowledge, and organize

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employees (Morgan, 2001, 2009; Whitley, 2001). Non-adaptation to a local institu- tional context means that an MNE must find a way to transfer or reproduce the insti- tutions of its own system in a new location. MNEs from a relational system will have a form of coordination that relies on relationships and long-term ties, knowledge is more likely to be tacit, and decisions made through long-term discussion and deliber- ation with stakeholders (Whitley, 2001). MNEs from arms-length systems, in contrast, are likely to avoid these types of long-term, committed relationships to maintain flexibility. When going abroad for capability exploitation, both types of firm must establish relationships with partners, in a different institutional context, that support their own methods of coordination.

These different ways of recreating home institutions in the host market are apparent in the ways Japanese and US firms expand abroad. Japanese firms rely to a greater extent on expatriates than US firms, for example (Johansson and Yip, 1994; Tung, 1982). Japanese firms may look for employees who are culturally similar, if available, through Japanese ethnicity (Lincoln et al., 1978) and transplant relationships with sup- pliers, financial institutions and other business group members (Belderbos and Sleuwae- gen, 1996; Florida and Kenney, 1991; Hawawini and Schill, 1993; Kenney and Florida, 1995; Martin et al., 1994).

Proposition 2: MNEs from a relational system entering a new market for the purpose of capability exploitation will strive to recreate existing relationships with suppliers, employees, and providers of finance.

Note that the above proposition does not differentiate between arms-length and rela- tional host markets. An MNE from a relational system with a capability exploitation strategy is likely to try to recreate existing relationships in similar ways, regardless of whether the host market is relational or arms-length. Coordination based on relation- ships must be built and nurtured over time. In fact, for an MNE from a relational system, entering another relational system where coordination of the economy occurs through a well-established set of relationships that does not include outsiders may be even more dif- ficult than entering a market-based economy where there is a greater degree of flexibility and openness in partner choice.

An MNE from an arms-length system has a particular challenge in entering a rela- tional system because of the difficulty in recreating arms-length relationships in sys- tems where most actors are tied in long-term relationships. One way to overcome this challenge is to appeal to potential employees or suppliers who are not part of the relational system, such as the outliers or inhabitants of the periphery. American multinationals in Japan have long taken advantage of skilled female labour who have historically been left out of the permanent employment system of large Japanese firms. This strategy has also borne fruit in other countries, as documented by Siegel and colleagues (2014) in their research on Korea. Alternatively, they may attempt to recreate their own conditions with a pool of employees who then constitute a sepa- rate labour market, as Ono (2007) shows in his work on employment in foreign firms in the Japanese financial sector.

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Proposition 3: MNEs from an arms-length system entering a relational system for the purpose of capability exploitation will strive to develop ties with actors that are marginalized from the existing system.

MNEs may try to make a relational system more favourable and flexible through lob- bying activities. For example, an arms-length system MNE might lobby for changes in employment laws, or laws around finance and governance. An example of such lobbying can be seen in the activities of the American Chamber of Commerce in Japan, which actively lobbies the Japanese government on behalf of US firms. The Commerce has taken a particular interest in corporate governance reforms, including the introduction of independent directors and elimination of cross-shareholdings. These moves aimed to reduce the reliance on relationships and to make firms more transparent and flexible. Another example is the effort by foreign invest firms makes Japanese corporate governance practices more consistent with their own interests (Ahmadjian, 2007; Jacoby, 2007).

Proposition 4: MNEs from an arms-length system entering a relational system for the purpose of capability exploitation are likely to use lobbying behaviour to change the rules of a relational system.

Capability Acquisition and Market Entry

MNEs also expand abroad to gain new knowledge and capabilities. In this case, adher- ence to existing practices and the recreation of home market institutions will not be neces- sary; rather, it will be critical to adapt to local institutions and practices. One of the most important ways to gain capabilities is through partnership with local companies and hiring expert local employees who are well networked. Both of these strategies are likely to require that the subsidiary of an MNE conforms to local institutions, in particular employ- ment practices and notions about the nature of business relationships. If an MNE remains on the social periphery by hiring peripheral employees bringing in its own relationships, as we saw in the previous section, it will not be able to achieve its objective.

MNEs from relational economies in particular have been found to change their prac- tices in new institutional settings for the purpose of learning (Kogut and Chang, 1991; Lane, 2001). An example of adaptive learning is Sony’s development of film production capability through its purchase of Columbia Pictures. Sony, after overcoming substan- tial problems in the beginning, chose to organize and operate its film business, Sony Pic- tures, as essentially a Hollywood film company. This meant hiring from the same pool of film executives, contracting in the same way with actors, production companies, and others. Sony entered this business to diversify into content to support its electronic devices and acknowledged that its own capabilities in innovation and production of elec- tronics, very much rooted in Japanese institutions, were not suited for film production.

Proposition 5: MNEs entering a new market for the purpose of capability acquisition are more likely to adapt to local institutional systems.

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This strategy of adaption to facilitate capability acquisition requires some level of decou- pling. In other words, it will be necessary to manage the subsidiary as a separate entity with organizational structures and practices that are different from those of the home country. The ability to maintain this decoupled structure and successfully transfer knowledge is likely to differ between MNEs from a relational and an arms-length sys- tem. For an MNE from an arms-length system, where coordination is based largely on financial metrics and arms-length transactions, it will be much easier to manage and coordinate subsidiaries with very different structure and practices than for an MNE from a relational system, where coordination depends to a large degree on relationships and tacit understandings forged over a long time (Whitley, 2001).

Furthermore, for capability acquisition to be effective, the knowledge gained must be incorporated into the larger organization (Kogut and Zander, 1992). In relational sys- tems, coordination comes through long-term relationships, wide discussion, and tacit understandings, which make it hard to incorporate knowledge from the outside (Mor- gan, 2009; Whitley, 2001). Firms from arms-length systems that give subsidiaries more autonomy, manage through more explicit financial metrics, and emphasize explicit knowledge, are better able to incorporate and share that knowledge. For this reason, incorporating a subsidiary that adheres to a very different institutional system is particu- larly difficult in a firm from a relational system.

The struggles of Japanese financial institutions to learn from global practices and incorporate new knowledge and skills into the company as a whole have been well docu- mented (e.g., Morgan et al., 2003). In order to attract and retain top bankers and clients, Japanese financial institutions created subsidiaries that adhered to US and UK organi- zational practices and systems in finance but were decoupled from their main business (Morgan et al., 2003). This approach of maintaining radically different systems proved difficult to maintain. For example, Nomura Securities acquired Lehman Brothers’ Euro- pean and Asian businesses for virtually nothing after Lehman’s failure but struggled to integrate Lehman personnel who were accustomed to US-style incentives and careers.

For MNEs from both relational and arms-length systems with a strategy to acquire capabilities, adapting to an arms-length system should be easier than adapting to a rela- tional system. Arms-length systems are relatively easy to access for new entrants because relationships tend to be transactional, short-term, and with clear rules and information disclosure that can be spelled out in contractual arrangements. In contrast, adapting to a relational system, especially as an outsider, requires an understanding of the local rules of the game that may not be communicated clearly and openly. Relationships also need to be built over an extended period of time. The general difficulty of building these rela- tionships is likely to discourage MNEs from entering relational systems for the purpose of capability acquisition.

Proposition 6: MNEs are more likely to enter arms-length markets than relational markets for the purpose of capability acquisition.

If national systems consist of complementary institutions, as posited by CIA, then success requires adaptation not to just one institution, but rather to a whole set. Within a national system, different rates of adaptation, or partial change in some but not other

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components of the institutional configuration, can be a source of institutional change and innovation (Crouch, 2010; Streeck and Thelen, 2005). For an MNE, the decision of which institutions to conform or adapt to is key in addressing institutional complexities across national systems.

Because there are legitimacy costs arising from non-adaptation, MNEs are likely to retain only institutions and practices that they see as the most important to their core competences (under strategies of capability exploitation). Which institutions will take precedence? These may be institutions that are supported most strongly by powerful actors, or institutions that provide a base for others (Amable, 2003). It is also plausible that certain institutions are more central to comparative institutional advantage than others.

In the case of relational systems, long-term relationships with employees and suppliers are likely to be key to developing comparative advantage. For example, in the case of Japanese auto manufacturers in their expansion to the USA, the core competitive advantage was the production system, with its emphasis on close relationships and devel- opment of firm-specific skills and trust with both employees and suppliers. Thus, Japa- nese companies, when they are moving abroad for capability exploitation, are likely to maintain their employment system as much as possible, while tolerating hybrid subsidia- ries that combine more market forms of financing with long-term employment. The core competence in the arms-length system is coordination through financial metrics and flexibility of labour and relationships with business partners. The core competence of US banks in Japan, for example, was introducing innovative new products (Edman, 2016). Success in selling new products requires quick adaptation to markets and close relationships are actually a hindrance. Similarly, on the trading floors, speed, aggressive- ness of traders, and financial metrics and incentives were key to success (Zaheer, 1995).

Entry into foreign markets involves choices along a set of activities in the value chain (Bartlett and Ghoshal, 1989; Jonsson and Foss, 2011; Rosenzweig and Nohria, 1994). These different activities are, more or less, tightly linked to comparative institutional advantage, and adaptation is likely to be related to how important the practice is to comparative institutional advantage (Gamble, 2010). Japanese auto firms abroad, for example, are most likely to resist adaptation in manufacturing employment practices, but more likely to adapt in sales and marketing functions because they are less critical to their comparative institutional advantage. For US banks in Japan, in contrast, the sales and marketing function may be more critical to comparative institutional advantage, in turn leading to resistance in adaptation in these functions.

Proposition 7: MNEs will preserve operating characteristics in functions that are key to their comparative institutional advantage while adapting in more peripheral areas when expanding into a new market for the purpose of capability exploitation.

DISCUSSION

The CIA perspective offers insights into how MNEs navigate institutional complexity and also into the very nature of institutional complexity itself. Complementary configu- rations of institutions on a national level are a source of comparative institutional

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advantage. Preserving this comparative institutional advantage is a critical consideration for MNEs in deciding how to adapt to institutional differences in foreign markets.

Comparative Institutional Advantage and Legitimacy

The notion that institutions matter to MNEs in their expansion abroad is not new, but the CIA perspective provides a different take on why institutions matter. In the OI liter- ature, institutions are a source of legitimacy. In the CIA perspective, institutions are a coordinating mechanism. While both CIA and OI perspectives are based on a close attention to institutions, the notion of legitimacy, which is prominent in OI, scarcely appears in CIA. Instead, institutions provide the very structure for how firms accomplish their goals, determining how firms establish and manage relationships, and, through this, produce goods and services. The cost of non-conformance to institutions, in a CIA perspective, is not simply loss of legitimacy, but, at worst, an inability to function.

This suggests that when MNEs move abroad, the question of dealing with institu- tional complexity is not simply one of legitimacy or external pressure, but about how the firm actually goes about its business. A firm from a relationship-based system going into an arms-length market faces not only different conceptions of legitimacy, but also a fundamental question of how to manage employees, suppliers, financial institutions and other firms in a way that maintains its comparative institutional advantage. Conforming to local institutions may mean giving up the comparative institutional advantage that took it globally in the first place.

This does not mean that legitimacy is unimportant. However, it suggests that there is a tradeoff between the costs of illegitimacy and the maintenance of advantage (Zaheer, 1995). There are likely to be ways to maintain legitimacy, while maintaining difference, through approaches to legitimacy enhancement that do not require isomorphism (Kostova et al., 2008). Researchers in international business have begun to examine these tradeoffs and the costs and benefits of forgoing legitimacy, but this angle has yet to take a prominent role in OI research. More attention to these tradeoffs may reveal that the OI perspective has placed too much emphasis on legitimacy, or at least on the importance of isomorphism as a source of legitimacy.

Complementarities and New Hybrids

The notion of institutional complementarity also brings new insights into the sources of variation in response strategies. If there are different institutions that make up a system, then the response to institutional complexities involves managing multiple institutions. Furthermore, if complementarities between institutions support a national institutional system, then the ‘violation’ of these complementarities, e.g., responding to one set of institutions and not others, can introduce either valuable changes or destabilize the system.

Certain elements of a system of institutions may be more central or important than others, thus leading to selective adaptation of some institutions. More research on the relative importance or priority of different elements of an institutional system would be useful. The idea that there are different layers and systems of institutions that can be adhered to separately, and in different combinations, also opens the possibility of

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different kinds of legitimacy seeking versus rationality seeking conformance and adapta- tion. This suggests that concerns of legitimacy and rationality can be intertwined with MNEs’ response to institutional complexity.

Arms-Length and Relational Systems

Central to the CIA perspective is the notion that institutions cluster into distinctive types of national business systems, which are then amenable to a comparative analysis. This contrasts with the OI approach in which institutions tend to be idiosyncratic and unique to the context. It also contrasts with the international business approach where institu- tions are generally measured as sets of indicators. A comparative analysis of national business systems facilitates an analysis of the sources of institutional differences and their consequence on MNEs and national economies.

The contrast between arms-length and relational systems exists in much of the CIA literature. While details are by necessity simplified and stylized, the contrast between these two approaches to coordination is very clear, and, as the propositions above show, can help in the analysis of MNE strategy and behaviour. Further research might explore other systems, such as those dominated by state or family-owned enterprises and how they influence the way in which MNEs deal with institutional complexity when they move abroad. How do the fundamental elements of coordination in these economies affect behaviour of local and foreign MNEs?

The propositions show that arms-length and relational origins have important implica- tions for how MNEs behave in international expansion, with troubling implications for MNEs from relational systems. They suggest that for MNEs from relational systems, capa- bility acquisition is difficult because integrating new knowledge from a distant system into a system that depends on relationships and tacit knowledge is a particular challenge. More- over, a relational system may put up fundamental barriers to learning from abroad. MNEs from relational systems may try to overcome these problems by combining features of differ- ent institutional systems, bringing together different organizational forms, or different con- ceptions of the nature of control and coordination (Djelic and Quack, 2008; Lane, 2001).

MNEs may also decouple completely by maintaining subsidiaries with completely dif- ferent systems and practices, as has been observed in the Japanese financial services industry (Morgan et al., 2003). There is little evidence that these attempts have been successful, however, and more research on ways in which MNEs from relational systems can organize for capability acquisition would be useful.

Evaluating and Responding to Institutional Complexities

The propositions suggested here are based on the assumption that MNE managers are well informed, rational, and skillful in dealing with institutional complexities. From everything we know about managers, this is not necessarily accurate. There is ample room for the possibility that managers make mistakes –in misjudging or misreading insti- tutional complexities, or failing to adapt or adapting in the wrong way.

In fact there are examples of misjudgement, such as in Westney and Sakakibara’s (1985) study of R&D activities of US and Japanese MNEs operating in each other’s coun- tries. In these cases, actions of firms diverged from their stated strategies. This suggests

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VC 2015 John Wiley & Sons Ltd and Society for the Advancement of Management Studies

that firms themselves may not always understand their sources of comparative institutional advantage. Thus, the lessons of a CIA perspective on institutional complexity are that managers should i) pay closer attention to the implications of institutional systems of home and host countries and resulting comparative institutional advantage, ii) consider the tradeoff between legitimacy and this advantage, and iii) be cognizant of the relative difficulties posed by each system in gaining and incorporating capabilities from abroad.

CONCLUSION

The CIA perspective makes it clear that institutions are not only a force to be resisted or adapted to, but are also, in complementary configurations that make up national busi- ness systems, sources of competitive advantage. This tradeoff between maintaining com- petitive advantage and fitting into new markets is one of the key dilemmas for MNEs. Institutions matter to MNEs –not only in terms of how they shape the host markets that MNEs enter, but in terms of how home market institutions shape MNEs themselves. When it comes to market entry and competing successfully across multiple markets, where an MNE is coming from is as important as where it is going.

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