Does Social Trust in Host Countries Reduce the Uncertainty of Firm International Diversification? Taking the Ownership Structure of Chinese Foreign Subsidiaries as an Example

Lei Wei; Chen Yan; Wu Qiong

doi:doi:10.16538/j.cnki.fem.20211015.101

Summary

Based on the development of social trust literature, this study differentiates between out-group social trust and in-group social trust, and reveals their diverse impacts on the ownership structure of foreign subsidiaries. It proposes that out-group social trust and in-group social trust in host countries affect the transaction costs and uncertainties faced by foreign subsidiaries and hence affect their ownership structure. In specific, in host countries where out-group social trust is high, foreign subsidiaries face a lower level of transaction costs and uncertainties in associating and collaborating with local stakeholders. Therefore, parent firms are more likely to hold a higher level of ownership control in foreign subsidiaries. However, in host countries where in-group social trust is high, foreign subsidiaries face a higher level of transaction costs and uncertainties as local firms and other stakeholders are more exclusive and discriminate against foreign members. As a result, parent firms are more likely to give up part of ownership control in foreign subsidiaries in exchange for local support and resources.

Furthermore, we propose that cultural distance and transnational experience of parent firms are important boundary conditions for the social trust effect of host countries. In host countries where cultural distance is high, foreign subsidiaries are more dependent on out-group social trust to overcome the transaction costs and uncertainties intensified by cultural distance. Meanwhile, cultural distance also worsens the exclusion effect of in-group social trust and increases the transaction costs and uncertainties faced by foreign subsidiaries. As a result, cultural distance reinforces both the positive effect of out-group social trust and the negative effect of in-group social trust on parent firms’ ownership control in foreign subsidiaries. Regarding the moderating role of the international experiences of parent firms, for parent firms with richer experiences, their foreign subsidiaries are more skilled in collaborating with local stakeholders, and hence rely less on out-group social trust to reduce transaction costs and uncertainties. Meanwhile, richer experiences also enable foreign subsidiaries to better cope with transaction costs and uncertainty associated with exclusion induced by in-group social trust. As a result, the international experiences of parent firms attenuate both the positive effect of out-group social trust and the negative effect of in-group social trust on parent firms’ ownership control in foreign subsidiaries.

Using the social trust data from World Values Survey and the data on 6921 foreign subsidiaries founded by Chinese listed firms from 2009 to 2018, we find that out-group social trust in host countries is positively related to parent firms’ ownership control in foreign subsidiaries while in-group social trust is negatively related to it. In addition, cultural distance strengthens both the positive effect of out-group social trust and the negative effect of in-group social trust. The international experiences of parent firms weaken the negative effect of in-group social trust, yet empirical results do not lend support to its moderating role on the effect of in-group social trust. We also use a country’s lowest temperature and ethnic diversity as the instrumental variables of social trust to address potential endogeneity issues. By revealing the theoretical mechanism through which social trust in host countries affect the control of foreign subsidiaries, this study not only enhances the understanding of normative institution as well as its impact on corporate international strategies, but also provides practical implications for Chinese firms to evaluate the normative institutions in host countries and scientifically design the ownership structure of foreign subsidiaries.