Journal of Business Research 95 (2019) 220–231

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Journal of Business Research

journal homepage: www.elsevier.com/locate/jbusres

Foreign direct investment comovement and home country institutions T

a b c,⁎
Donghua Chen , Xin Yu , Zhou Zhang
a
Nanjing University, School of Business, Nanjing 210093, China
b
The University of Queensland, Business School, Brisbane, Australia
c
University of Regina, Faculty of Business Administration, Regina, SK S4S0A2, Canada

A R T I C LE I N FO A B S T R A C T

JEL classification: We use a hand-collected dataset of firm-level foreign direct investment in China to examine the impact of home
G30 countries' institutional elements on the investment comovement between foreign and domestic firms. We find
G38 that foreign firms from countries with well-developed financial markets or a strong rule of law experience less
G18 comovement with Chinese domestic firms. Our evidence also suggests a contingency impact between the two
P20
channels of home country institutions; the capital markets effect exists only for foreign firms from countries with
Keywords: strong rule of law, whereas the rule-of-law effect holds only for firms from countries with well-developed fi-
Investment comovement nancial markets. Finally, we show that firms from countries with better institutional quality exhibit greater
Foreign direct investment (FDI)
investment efficiency than firms from countries with weaker institutions.
Home country institutions

1. Introduction supply-side constraints in FDI sourcing countries have little effect on

The rapid growth of foreign direct investment (FDI) across devel-
oped and emerging market countries is a remarkable phenomenon of
globalization. FDI activities can be viewed from two main perspectives:
one focuses on multinational corporations (MNCs) as suppliers of FDI
(Antras, Desai, & Foley, 2009; Eiteman, Stonehill, & Moffett, 2015) and
the other, on host countries as recipients of FDI (Driffield & Love, 2007;
Franco, 2013; Haskel, Pereira, & Slaughter, 2007; Javorcik, 2004;
Shroff, Verdi, & Yu, 2014). These perspectives agree that host-country-
specific factors, including high political risk and corruption, weak in-
vestor protection, inconsistent government policies and regulations,
and large cultural differences, can create barriers that deter MNCs from
making FDI decisions (Filatotchev, Strange, Piesse, & Lien, 2007; Glynn
& Abzug, 2002; Lee & Chang, 2009; Mauro, 1995; Rodriguez,
Uhlenbruck, & Eden, 2005). In contrast, there are fewer studies on how
FDI home country factors affect FDI activities (Cuervo-Cazurra, Luo,
Ramamurti, & Ang, 2018; Luo, 1998; Pan, 2003; Wang, Clegg, &
Kafouros, 2009).
In this study, we examine foreign investment from the perspective
of home country institutions, with a large unique hand-collected dataset
with FDIs in China from 47 countries. Specifically, we investigate how
the investment activities of foreign firms are influenced by the quality
of home country institutions. Our analysis thus fills the gap in prior
studies, which primarily focus on the supply-side effect from MNCs and
the demand-side effect from host countries, and implicitly assume that
foreign firms' investment decisions.
To test the influence of home country institutions on foreign in-
vestment, we examine whether an investment comovement pattern
exists between foreign firms and domestic firms, and how such a pat-
tern is related to the foreign firms' home country institutions. If the
market is efficient, all publicly available information will be in-
corporated into resource prices, and only firms that invest relying on
firm-specific private information will be able to obtain abnormal re-
turns. Those creative firms will push stagnant firms out of the mar-
ketplace and stimulate economic growth (Morck, Wolfenzon, & Yeung,
2005). However, since accessing complete information is virtually im-
possible, and information asymmetry can be more pronounced across
borders, some firms may imitate other firms due to a lack of managerial
effort to acquire information (Knyazeva, Knyazeva, Morck, & Yeung,
2008) or because of government intervention (Chen, Khan, Yu, &
Zhang, 2013). The constraints of insufficient access to capital and weak
legal protection may further amplify the deficiency in investment de-
cisions. These factors collectively can cause firms to exhibit investment
comovement at the industry level or at the country level.
Since corporate investment decisions and capital allocation in an
economy are significantly influenced by underlying institutional factors
(Wurgler, 2000), we anticipate that the variation in institutional quality
across FDI home countries leads to different investment comovement
between foreign and domestic firms in the host country. We propose
two hypotheses about how home country institutions can influence

⁎
Corresponding author.
E-mail addresses: dhchen@nju.edu.cn (D. Chen), x.yu@business.uq.edu.au (X. Yu), zhou.zhang@uregina.ca (Z. Zhang).

https://doi.org/10.1016/j.jbusres.2018.10.023
Received 24 June 2017; Received in revised form 7 October 2018; Accepted 9 October 2018
Available online 21 October 2018
0148-2963/ © 2018 Elsevier Inc. All rights reserved.
D. Chen et al.
investment activities: the capital markets effect and rule of law effect.
The capital markets hypothesis predicts that foreign firms from coun-
tries with well-developed financial markets can flexibly access capital
markets at home and in the host country; they are less financially
constrained and can invest at their discretion, resulting in lower
comovement with host country firms. Similarly, foreign firms from
countries with a strong rule of law may exhibit lower comovement in
investments with host country firms because of the stringent protection
of property rights and better quality of contract enforcement in the
home countries.
To test these hypotheses, we construct a hand-collected dataset that
contains more than 120,000 FDI firm and year observations in China for
the 2000–2011 period. We find statistically and economically sig-
nificant investment comovement between foreign firms and Chinese
domestic firms. More importantly, the investment comovement is not
homogenous across FDI home countries. We show that foreign firms
with better quality home institutions (either capital markets or rule of
law) exhibit less comovement with Chinese domestic firms, strongly
supporting the predictions of both hypotheses.
We further examine whether there is a contingent effect between
the two channels of home institutional quality. We find that the capital
markets effect exists only for countries with better rule of law, whereas
the rule-of-law effect exists only for countries with well-developed fi-
nancial markets. Furthermore, when home countries have an abundant
capital supply but weak rule of law, investment comovement between
foreign and Chinese domestic firms increases. We also find that foreign
firms from countries with better-quality home institutions are less likely
to deviate from the expected level of investment, indicating that their
low investment comovement with Chinese domestic firms reflects effi-
cient investment activities.
The rest of the paper proceeds as follows. Section 2 provides a lit-
erature review and testable hypotheses. Section 3 contains the data and
sample descriptions, while Sections 4 and 5 report the empirical ana-
lyses. Section 6 presents a discussion, followed by the conclusions in
Section 7.
2. Literature review and hypotheses development
In this section, we first discuss inward FDI in China. We then review
the literature on FDI and develop testable hypotheses.
2.1. FDI in China
China has experienced remarkable economic growth over the past
three decades. These decades have also been the golden age for FDIs in
China (Lau & Bruton, 2008). According to the United Nations Con-
ference on Trade and Development (UNCTAD) data, the inflow of FDI to
China was only $57 million in 1980, lower than other major emerging
markets. By 2014, China had become the world's largest FDI recipient
country; FDI inflow grew to $128.5 billion, far ahead of Brazil ($62.5
billion), India ($34.4 billion), and Russia ($21.0 billion). By the end of
2014, more than 230,000 foreign enterprises had been approved by the
Chinese authorities (China Statistical Yearbook, 2015).
There are high friction costs for inward FDI as the Chinese gov-
ernment has imposed many cumbersome and restrictive rules on how
foreign firms can invest in China. For example, the government imposes
tight controls on the funds flow into and out of China. For certain na-
tional “strategic” industries, foreign firms must form a joint venture and
transfer technology to local partners to enter the market. Furthermore,
Chinese capital and product markets are characterized by a lack of
publicly available information, a high degree of government interven-
tion and local protectionism, a limited supply of funds, and quick
changes in the direction of government policies. These market im-
perfections can result in managers of foreign firms expending less effort
to acquire private information and instead relying on resources avail-
able in their home countries, if such resources exist.
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Journal of Business Research 95 (2019) 220–231
2.2. Research context: capital market development and rule of law in China
The capital market in China was established in the early 1990s and
has grown rapidly in size and depth. However, due to its short history,
the Chinese capital market is still largely dominated by the banking
sector, and the stock market plays a less important role in providing
direct financing to firms (Allen, Qian, Zhang, & Zhao, 2012). To capture
the degree of capital market development across FDI home countries,
we use the ratio of stock market capitalization to GDP (Capital market),
obtained from World Bank data. A high ratio indicates well-developed
capital markets. Following Demirgüç-Kunt and Levine (1996), we also
use an alternative and more comprehensive measure of stock market
development (Stock market) that incorporates both the size and liquidity
of the stock market. China ranks 22nd in Capital market and 16th in
Stock market compared with the other 47 countries in our sample.
China has been criticized for government intervention and weak
legal protection of property rights (Gul, Kim, & Qiu, 2010; Pistor & Xu,
2005). Following prior studies (Daske, Hail, Leuz, & Verdi, 2008;
Faccio, 2006; Faccio, Masulis, & McConnell, 2006), we use the rule of
law variable constructed by Kaufmann, Kraay, and Mastruzzi (2009).
This index reflects the quality of contract enforcement, property rights,
police, and the courts. China has a low rule of law rating, ranking 38th
among our sample countries.
2.3. Investment comovement of FDI
The neoclassical theory of investment suggests that corporate in-
vestment is a firm-level idiosyncratic activity in a frictionless market.
However, actual corporate investment may comove across firms for
different reasons. For instance, investment activity can be correlated
with the business cycle (Carpenter & Levy, 1998). The industry-level
investment opportunity can also lead to investment comovement
among firms in the same industry (Guiso & Parigi, 1999). Firms may
follow policy guidance from the government (Chen et al., 2013) or
simply imitate other firms due to their own lack of managerial effort to
acquire information (Knyazeva et al., 2008). Prior studies have also
shown that investment comovement has a negative effect on firm per-
formance (Chen et al., 2013; Knyazeva et al., 2008). Therefore, higher
investment comovement indicates that when making investment deci-
sions, firms rely more on public information than on private informa-
tion, which results in investment inefficiency. Next, we discuss how two
of home country institutions—capital markets and rule of law—are
associated with investment comovement between foreign firms and
domestic firms. We also summarize our hypotheses in Fig. 1.
2.3.1. The effect of capital markets in the home country
Prior studies have highlighted the positive impact of financial
markets on promotion of economic growth (Bekaert, Harvey, &
Lundblad, 2005; Henry, 2000; Wurgler, 2000). Firms in countries with
well-developed financial markets benefit from a more favorable finan-
cing environment with easily available funds and lower cost of capital.
These firms, therefore, experience better firm-level financing flexibility
(Love, 2003; Love & Zicchino, 2006). It is also expected that there are
more investors in these countries, resulting in better risk sharing.
Wurgler (2000, p.189) thus highlights that “…financial development
helps a country take better advantage of its investment opportunities.”
FDIs in a given country are affected by the capital supply in both
home and host countries (Desbordes & Wei, 2017). Greene, Hornstein,
and White (2009) argue that multinationals have access to multiple
capital markets and this advantage allows them to bypass the liquidity
constraints in local markets. Desai, Foley, and Hines (2004) suggest that
local borrowing costs are higher in host countries with weak creditor
rights protection. For FDIs, especially in emerging markets, access to
capital from home countries with better financial development helps
overcome any financial constraints in local markets (Desai, Foley, &
Forbes, 2008) and makes better use of capital markets that are likely
D. Chen et al.
Fig. 1. The conceptual model.
unavailable to local firms (Desai, Foley, & Hines, 2006). Chen et al.
(2013) find that the impact of government intervention on investment
comovement is significantly less pronounced for foreign firms than for
Chinese state-owned firms, indicating that foreign firms are less likely
to be affected by local markets than domestic firms. On the other hand,
FDI firms from countries with under-developed capital markets are less
able to reap comparative advantages from their home country. They
also face more difficulty raising funds to cover the substantial upfront
fixed costs (Desbordes & Wei, 2017). These unfavorable conditions may
cause firms to under-utilize external capital, make suboptimal invest-
ments, and forgo value-enhancing projects.
Based on this discussion, we predict that foreign firms from coun-
tries with well-developed capital markets experience less comovement
with Chinese domestic firms because they have the flexibility to access
both their home capital market and the Chinese capital market for the
required capital and invest at their discretion to fully utilize the private
information. In contrast, firms from countries with less developed ca-
pital markets are more financially constrained and more exposed to the
restrictions of the Chinese domestic capital market. Thus, they face fi-
nancial frictions similar to those of Chinese domestic firms, leading to
higher comovement between them. We label this hypothesis the capital
markets effect and propose the following hypothesis:
Hypothesis 1. The investment comovement between foreign firms and
Chinese domestic firms is negatively associated with the level of capital
market development in the home countries.
2.3.2. The effect of rule of law in the home country
The literature has indicated that institutional quality is important
for economic development. Effective laws protect the interests of min-
ority investors and allow funds to be allocated more efficiently (La
Porta, Lopez-de-Silanes, Shleifer, & Vishny, 1997), resulting in lower
policy risks and positively affecting firms' propensity to invest in prof-
itable projects (Boubakri, El Ghoul, & Saffar, 2015). The literature has
also shown the importance of the legal protection of FDI hosting
economies. A well-established rule of law in host countries enhances
FDI entry (Lu, Liu, Wright, & Filatotchev, 2014), while a weak legal
environment deters inward FDI (Mauro, 1995; Wei, 2000) and increases
the likelihood that firms making FDIs choose to enter via wholly owned
subsidiaries rather than local partners (Rodriguez, Siegel, Hillman, &
Eden, 2006).
In contrast to the impact of host country institutions, the literature
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Journal of Business Research 95 (2019) 220–231
suggests that the quality of home institutions also affects FDI activities.
Chari, Ouimet, and Tesar (2010) argue that firms from developed
countries can extend the benefits of better home institutional quality
through foreign acquisitions. Mingo, Junkunc, and Morales (2018)
suggest that firms from countries with well-developed institutional
environments should be more used to operating in foreign markets with
strong regulatory institutions. Cui and He (2017) also show that the
power of the home country state affects FDI location choice. In contrast,
firms domiciled in countries with weak rule of law are exposed to a
higher risk of asset expropriation and, consequently, are more moti-
vated to shelter cash and invest less in their home markets (Caprio,
Faccio, & McConnell, 2013); instead, they invest more in foreign mar-
kets. Prior studies on institutional escape also find that firms invest
abroad in an attempt to overcome the weaknesses in institutional
quality at home when political stability and regulatory quality are low
(Dai, Eden, & Beamish, 2017; Le & Zak, 2006), taxation is high (Collier,
Hoeffler, & Pattillo, 2001), and firm-level needs and institutional con-
straints are misaligned (Witt & Lewin, 2007).
Overall, foreign firms from countries with a higher quality of rule of
law can benefit from strong institutions in the home countries and,
therefore, make more efficient investments. Their corporate decisions
will be guided under more advanced and systematic policies, influenced
and required by home legal standards, compared to Chinese domestic
firms. Based on this line of argument, we predict that foreign firms from
countries with a strong rule of law should exhibit lower investment
comovement with Chinese domestic firms. We term this conjecture the
rule of law effect and propose the following hypothesis:
Hypothesis 2. The investment comovement between foreign firms and
Chinese domestic firms is negatively associated with the quality of rule
of law in the home countries.
2.3.3. The contingent effects
The capital market and rule of law effects are not mutually ex-
clusive. The rule of law effect has both a direct and an indirect influence
on investment activities. On the one hand, the legal environment in
home markets directly affects corporate investment because firms from
countries with a strong rule of law should be more disciplined and
guided by higher home-country standards. On the other hand, home
legal standards indirectly influence investment activities as legal in-
stitutions can influence the cost of contracting and, consequently, fa-
cilitate financial development and reduce the cost of financing
D. Chen et al.
(Demirgüç-Kunt & Levine, 2005; Hail & Leuz, 2006; La Porta et al.,
1997; Wurgler, 2000).
Following this line of argument, we investigate whether the effect of
home capital market development on FDI investment activities is con-
tingent on the rule of law in home countries. Alfaro and Hammel (2007)
argue that the effectiveness of financial integration in economic growth
is contingent on countries' institutional settings. In countries with weak
institutions but high financial integration with global markets, cross-
border capital mobility can increase the possibility of financial crises
due to misallocation of resources. Kose, Prasad, Rogoff, and Wei (2006)
suggest that institutional quality affects the allocation of capital. One
example they offer is that weak country-level governance and an
abundant capital supply were core reasons for the 1997 Asian crisis.
We, therefore, expect that the capital market effect exists only in
countries with a strong rule of law; improved financial development in
home countries decreases investment comovement between foreign and
domestic firms only when home countries also have adequate legal
protection. In contrast, when home countries have a weak rule of law,
sound financial development will increase investment comovement
between foreign and domestic firms, because without sufficient legal
protection and stringent legal standards, the abundant capital supply in
the home country may lead to misallocation of resources. We develop
hypotheses on this contingent effect as follows:
Hypothesis 3A. The investment comovement between foreign firms
and Chinese domestic firms is negatively associated with the capital
market development of the home countries when those countries have a
strong rule of law.
Hypothesis 3B. The investment comovement between foreign firms
and Chinese domestic firms is positively associated with the capital
market development of the home countries when those countries have a
weak rule of law.
The rule of law effect may also be contingent on the level of fi-
nancial market development. Foreign firms from countries with less
developed financial markets lack a competitive advantage in access to
capital and will rely heavily on the host countries for financing; con-
sequently, the rule of law in home countries may have no significant
impact on investment activities. In contrast, foreign firms from coun-
tries with well-developed capital markets rely more on the home
country for financing and, consequently, will be more constrained by
higher home legal standards. Therefore, we expect that a strong rule of
law in home countries decreases investment comovement between
foreign and domestic firms only when home countries have well de-
veloped financial markets. We predict this contingent effect as follows:
Hypothesis 4. The investment comovement between foreign firms and
Chinese domestic firms is negatively associated with the rule of law in
the home countries when those countries have well developed capital
markets.
Meanwhile, we expect that the investment comovement between
foreign firms and Chinese domestic firms is not associated with the rule
of law quality when the home countries have less developed capital
markets.
3. Data and research methodology
3.1. Data collection
Our data source is the Chinese National Industrial Enterprise Census
database provided by the Chinese National Statistics Bureau. The
census data cover all industrial enterprises with sales exceeding 5
million RMB in China. Our sample differs from studies that focus only
on publicly listed firms as ours covers both listed and non-listed firms,
as well as domestic and foreign firms. Foreign firms are defined as those
with invested capital completely or partially from foreign entities or
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Journal of Business Research 95 (2019) 220–231
individuals. We first use ownership information in the census database
to identify foreign firms. However, the census database does not reflect
information regarding the FDI's country of origin. We then collect home
country information from the Chinese Ministry of Commerce (CMC)
website, a labor-intensive process because of our large sample size.1 We
manually enter the name of each foreign firm covered in the census
database into the CMC's inquiry form to obtain the detailed registration
information of those firms, including the address, registered capital,
and country/region of origin.
Our initial sample spans the period between 2000 and 2011.
Observations in 2009 are excluded from our sample because the data
items in 2009 do not contain enough information to calculate capital
investment.2 We have 300,634 observations after merging the census
information with the manually collected home country information. To
remain in the final sample, we further require firms to report financial
and ownership information needed for the firm-level analysis (see the
details of the variables in Appendix A) and to have home country ca-
pital market and rule-of-law variables available. We further remove
data from countries with less than 50 observations because the in-
vestment comovement measure may be biased due to the low number
of observations. There are 248,005 observations remaining after these
two steps. We find that 49.75% of the observations are from Hong
Kong. To avoid the dominant influence of observations from a single
region, we exclude the observations from Hong Kong in the main em-
pirical analysis but discuss the results including Hong Kong observa-
tions in the robustness check section. The final sample consists of
124,607 observations (23,317 foreign firms) from 47 countries. The top
three FDI home countries are Japan (28.57% of the total observations),
the United States (18.85%), and South Korea (13.7%). Few foreign
firms are from emerging markets. The number of foreign firms has
monotonically increased over the years, except when the global fi-
nancial crisis interrupted FDI activities worldwide in 2008.
3.2. Variable definitions and empirical methodology
Following Djankov, La Porta, Lopez-de-Silanes, and Shleifer (2008),
we use the ratio of stock market capitalization to GDP (Capital market)
to measure the capital markets effect. This measure can capture the
capital markets effect because market-oriented institutions are more
transparent and have better investor protection than bank-oriented
institutions (Ali & Hwang, 1999; Antoniou, Guney, & Paudyal, 2008).
Due to the lack of price signals, bank-oriented financial systems can
inhibit efficient flow of external financing to the newest, most in-
novative endeavors (Beck & Levine, 2002; Hsu, Tian, & Xu, 2014; Rajan
& Zingales, 2001). Therefore, stock markets can more effectively allo-
cate capital to creative firms than bank-dominated capital markets
(Levine & Zervos, 1998).
The Rule of Law index (Rule of law) was constructed by Kaufmann
et al. (2009) and has been widely used in prior literature (e.g., Daske
et al., 2008; Faccio, 2006; Faccio et al., 2006; Popli, Akbar, Kumar, &
Gaur, 2016). This variable reflects “the extent to which agents have
confidence in and abide by the rules of society, and in particular, the
quality of contract enforcement, property rights, the police, and the
courts, as well as the likelihood of crime and violence” (Kaufmann
et al., 2009, p.6). Estimates yield the country's score on the aggregate
indicator in units of a standard normal distribution (e.g., ranging from
approximately −2.5 to 2.5).
The sample observations are categorized into 39 industries using the
first two digits of the industry code. Our investment comovement
measure is computed between foreign firms and Chinese domestic firms
in the same industry. A firm may have the same or opposite directional
1
http://www.fdi.gov.cn/1800000121_10000159_8.html.
2
The change values in 2010 are calculated between the data in 2008 and
2010.
D. Chen et al.
change in investment compared to Chinese domestic firms. Following
Chen et al. (2013) and Knyazeva et al. (2008), we use the following
regression model to measure the investment comovement between
foreign firms and Chinese domestic firms:
ΔInvestmenti, t = α + β1 ΔInvestment _indi, t + f (control variables ) + εt
where the dependent variable, ΔInvestmenti,t, is the change in invest-
ment of foreign firm i in year t. As discussed above, our sample contains
a large proportion of unlisted firms with less detailed information dis-
closure than publicly listed firms. For example, unlisted firms do not
report cash flow statements in the census data. Investment is thus cal-
culated as the change in gross fixed assets divided by total assets in the
previous year. ΔInvestment_indi,t is the change in investment from year t-
1 to year t for Chinese domestic firms in the same industry, measured by
the median value in the corresponding industry. If a foreign firm in-
creases (or decreases) investment in a specific year and domestic firms
in the same industry exhibit the same directional change, the coefficient
β1 is positive, indicating that foreign firm investments comove with that
of domestic firms. The advantage of using this regression model to
measure comovement is that it captures not only the direction but also
the magnitude of comovement; a higher value of β1 implies more in-
vestment comovement between foreign firms and domestic firms.
We use the following regression (2) to distinguish the different
impacts of home country institutions on investment comovement:
ΔInvestmentt = α + β1 ΔInvestment _indt + β2 Home Institutiont
+ β3 ΔInvestment _indt × Home Institutiont + f (Control variables )
+ f (Country, Industry, Year ) + εt
where ΔInvestmentt and ΔInvestment_indt are defined as above. We omit
the firm subscript i for brevity. Home Institution refers to one of two
variables—Capital markets or Rule of law. Our primary interest is the
coefficient of β3.
We include several firm-level control variables. Foreign capital is the
percentage of paid-in capital from foreign investors. The home in-
stitution effects may have greater influence on investment activities
when foreign investors have a higher proportion of ownership. The
expected sign of Foreign capital is unclear as its effect on investment is
contingent on the quality of home country institutions. Cash is the ratio
of cash over total assets. Cash can be positively or negatively associated
with the change in investment. On the one hand, firms with more cash
may have fewer financial constraints and therefore invest more. On the
other hand, high cash holdings may be a sign of a peak in productivity
and profitability and may result in less investment. ROA is the return on
assets in the prior year; we expect more profitable firms to invest more.
Tangibility is the ratio of property, plant, and equipment over total as-
sets. We expect a positive coefficient for Tangibility because firms with
greater tangibility need to invest more to upgrade their fixed assets.
Firm size is the logarithm of total assets. We expect investment to be
positively associated with firm size because large firms should have
more financial resources to invest. Debt is defined as total liabilities
over total assets; its predicted sign is not clear. Concern about liquidity
risk may drive highly leveraged firms to reduce investment, whereas
the tax shield benefit may encourage firms to increase investment.
ΔSales is the annual sales growth rate, which is expected to be positively
correlated with changes in investment.
We also control for several institutional factors of home countries
that may influence the extent of investment. The first one is political
stability, measured by the Political Stability and Absence of Violence
index (Political stability), one dimension of the Worldwide Governance
Indicators (WGI). This index measures “perceptions of the likelihood
that the government will be destabilized or overthrown by un-
constitutional or violent means, including politically-motivated vio-
lence and terrorism” (Kaufmann et al., 2009, p.6). Le and Zak (2006)
find that political instability is the most important reason for capital to
Journal of Business Research 95 (2019) 220–231
flow out of a country. The second factor is the Control of Corruption
index of the WGI (Corruption control), which captures “perceptions of
the extent to which public power is exercised for private gain, including
both petty and grand forms of corruption, as well as ‘capture’ of the
state by elites and private interests” (Kaufmann et al., 2009, p.6). The
third factor is the Government Effectiveness index of the WGI (Gov-
(1) ernment effectiveness), which measures the quality of public services.
The literature suggests various types of institutions and the im-
portance of identifying institutional distance (Berry, Guillén, & Zhou,
2010; Cui & He, 2017; Ly, Esperança, & Davcik, 2018). Since many of
these dimensions, such as culture distance (Popli et al., 2016), geo-
graphic distance, and use of common language (Contractor, Yang, &
Gaur, 2016), are stable over time, we include country fixed effects to
control for country-level characteristics (Hsu et al., 2014; Rajan &
Zingales, 1998). We also use year and industry dummies to control for
fixed year and industry effects, respectively. We further employ robust
standard errors with clustering by firm to avoid cross-sectional de-
pendence in the panel data. To alleviate the impact of outliers, we
winsorize the data at the 1% and 99% levels for all variables except
home institutional factors.
3.3. Summary statistics
Table 1 reports the summary statistics for our country- and firm-
level variables. In Panel A, we show that the mean values of ΔInvestment
and ΔInvestment_ind are both positive, suggesting that both foreign firms
and domestic firms exhibit an increase in investment on average. The
two variables of the quality of home institutions show large variations,
(2) allowing us to examine their different effects on investment comove-
ment. The mean value of Foreign capital is 71.8%, indicating that foreign
investors contribute 71.8% of the paid-in capital on average. We also
check ownership characteristics and identify state-owned enterprises
(SOEs) as those with at least 50% of their paid-in capital contributed by
the state. Only 1.8% of the sample observations are SOEs, suggesting
that the remainder (98.2% of the observations) are controlled by pri-
vate entities. Because of the low proportion of SOEs, we do not include
SOE as a control variable in the regression tests. Panel B presents the
correlation matrix. ΔInvestment is positively and significantly correlated
with ΔInvestment_ind (correlation coefficient is 0.396), suggesting a
significant comovement in investment between foreign firms and Chi-
nese domestic firms.
4. Empirical results
We conduct the empirical tests in three steps. We first investigate
the extent to which home country institutions affect investment
comovement. We then analyze the contingent effects of capital markets
and rule of law. Last, we gauge the linkage between home institutions
and investment efficiency.
4.1. Tests of home institutional effects
We run the regression model (2) and report the results in Table 2.
Column 1 reports the baseline regression results excluding country-
level variables. The coefficient of ΔInvestment_ind is 0.660 and sig-
nificant at the 1% level, indicating that when the average domestic
firm's investment increases by 10 percentage points, foreign firms in the
same industry exhibit an increase in investment of 6.6 percentage
points. This finding suggests a statistically and economically significant
investment comovement between foreign firms and domestic firms.
In columns 2 and 3, we separately introduce home institutional
variables into the regression. We find that the interaction terms be-
tween ΔInvestment_ind and home institutional variables, Capital market
and Rule of law, are both significantly negative, supporting the pre-
dictions of H1 and H2. Specifically, the coefficient on ΔIn-
vestment_ind × Capital market is −1.044 (t = 3.41), consistent with the
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Table 1
Summary statistics.
Panel A Descriptive statistics

Variable N Mean Std. Q1 Median Q3

ΔInvestment 124,607 0.019 0.374 −0.052 −0.0002 0.092

ΔInvestment_ind 124,607 0.032 0.090 −0.002 −0.001 0.000
Capital market 124,607 0.099 0.042 0.070 0.097 0.121
Rule of law 124,607 1.291 0.718 1.136 1.326 1.625
Foreign capital 124,607 76.9% 0.289 50.0% 93.9% 100%
Cash 124,607 0.147 0.343 0.033 0.138 0.295
Tangibility 124,607 0.317 0.231 0.146 0.276 0.441
ROA 124,607 0.080 0.154 0.003 0.046 0.128
Firm size 124,607 10.570 1.481 9.519 10.431 11.511
Debt 124,607 0.602 0.501 0.314 0.527 0.748
ΔSales 124,607 17.7% 0.446 −6.70% 14.9% 27.7%
Political stability 124,607 0.638 1.529 0.435 0.850 0.999
Corruption control 124,607 1.302 0.923 1.180 1.317 1.737
Government effectiveness 124,607 1.446 0.882 1.231 1.522 1.647
Deviation 128,812 0.457 0.498 0.000 0.000 1.000
Slack 128,812 0.754 4.233 0.053 0.397 1.252
Loss 128,812 0.216 0.412 0.000 0.000 0.000

Panel B Correlation matrix

1. 2 3 4 5 6 7 8 9 10 11 12 13

1. ΔInvestment 1.000
2. ΔInvestment_ind 0.396*
3. Foreign capital −0.015* −0.045*
4. Cash −0.142* −0.341* 0.012*
5. ROA −0.008* 0.000 −0.010* 0.048*
6. Tangibility −0.010* −0.078* 0.106* 0.231* −0.082*
7. Firm size −0.044* −0.145* 0.027* −0.044* −0.008* 0.042*
8. Debt 0.174* 0.429* −0.006* 0.132* −0.155* 0.168* −0.136*
9. ΔSales 0.116* 0.076* 0.004 −0.019* −0.078* −0.014* 0.031* 0.063*
10. Capital market −0.035* −0.086* −0.002 0.052* 0.006* −0.003 0.070* −0.023* 0.015*
11. Rule of law 0.003 −0.001 −0.031* 0.010* 0.002 −0.019* 0.071* 0.004 −0.001 0.341*
12. Political stability 0.025* 0.060* 0.010* −0.020* −0.004 0.012* 0.029* 0.021* 0.000 0.046* 0.134*
13. Corruption control 0.043* 0.106* −0.049* −0.019* 0.000 −0.025* 0.085* 0.050* 0.011* 0.378* 0.461* 0.211*
14. Government effectiveness 0.025* 0.053* −0.003 −0.024* 0.009* −0.016* 0.052* 0.009* 0.000 0.334* 0.282* 0.047* 0.333*

Pearson correlation coefficients and their levels of significance. * represents the 5% significance level.

prediction that the investment comovement between foreign and Chi-
nese domestic firms is lower for firms from countries with better de-
veloped home capital markets. The coefficient on ΔIn-
vestment_ind × Rule of law is −0.031 (t = 1.97), supporting the
prediction that the investment comovement between foreign and Chi-
nese domestic firms is lower for firms from countries with better quality
rule of law. In column 4, we include both Capital market and Rule of law,
as well as all control variables, in the regression. The interaction terms
ΔInvestment_ind × Capital market and ΔInvestment_ind × Rule of law both
remain significantly negative. Most of the remaining control variables
are statistically significant and their coefficients have signs as expected.
For example, the coefficient of Tangibility is positive and significant at
the 1% level, indicating that firms with greater tangibility tend to invest
more. We also find that firms with a higher sales growth rate exhibit an
increase in investment.
Since foreign firms in our sample are predominantly from developed
countries, we conduct a robustness check. Motivated by the literature
on the interplay between home and host country institutions (Mingo
et al., 2018), we examine whether H1 and H2 still hold if we separate
the sample into countries with better or worse capital market devel-
opment or rule of law relative to China. This exercise is to alleviate the
concern that the findings are largely driven by developed economies
and to see to what extent our implications are reflected in countries
with very weak institutional quality. We expect that firms from coun-
tries with lower quality home institutions than China's have a higher
level of investment comovement with Chinese domestic firms and vice
versa. We run seemingly unrelated regressions (SUR) for the samples
split by home institutions relative to China and present the results in
Table 3. The “Low” (“High”) group includes firms from countries with
an institutional index lower (higher) than China. The results show that
the coefficients of ΔInvestment_ind are significantly positive in all col-
umns, suggesting the existence of investment comovement for foreign
firms from countries with both better and poorer quality home in-
stitutions. In addition, the coefficients of ΔInvestment_ind in the “Low”
group (Columns 1 and 3) are all substantially larger than those in the
“High” group (Columns 2 and 4). The chi-squared test shows that the
differences between the two groups are significant at the 1% level
under Capital market and at the 10% level under Rule of law. The weaker
significance for Rule of law (p = 10%) is possibly due to the dis-
proportionately small sample size of the “Low” Rule of law group (only
2.7% of the total sample). Overall, this robustness check result suggests
that foreign firms with weaker home country institutions than China's
tend to have greater investment comovement with Chinese domestic
firms than foreign firms with home country institutions stronger than
China's, providing additional support for the predictions of H1 and H2.
4.2. Tests of contingent effects
Since capital markets and rule of law effects are not mutually ex-
clusive, we examine the contingent effects next. We divide our sample
into “Low” (“High”) groups for firms from countries with the index of
Rule of Law lower (higher) than the median value. The results are re-
ported in Table 4. The coefficient of ΔInvestment_ind × Capital market in
the “Low” group is significantly positive, while it is significantly

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Table 2
Home-country institutions and investment comovement.
Pred. sign (1) (2) (3) (4)

ΔInvestment_ind + 0.660*** 0.772*** 0.701*** 0.798***

(12.17) (12.49) (12.10) (12.65)
ΔInvestment_ind × Capital market − −1.044*** −0.903***
(−3.41) (−2.81)
Capital market −0.098** −0.117***
(−2.35) (−2.74)
ΔInvestment_ind × Rule of law − −0.031** −0.030*
(−1.97) (−1.76)
Rule of law 0.005*** 0.005**
(2.65) (2.50)
Foreign capital ± /- −0.001 −0.001 −0.001 −0.001
(−0.66) (−0.68) (−0.53) (−0.69)
Cash ± /- −0.007*** −0.007*** −0.007*** −0.007***
(−3.00) (−2.80) (−3.02) (−2.84)
Tangibility + 0.028*** 0.028*** 0.028*** 0.028***
(7.24) (7.30) (7.43) (7.31)
ROA + 0.005 0.005 0.003 0.005
(0.74) (0.74) (0.57) (0.75)
Firm size + 0.001** 0.001** 0.001** 0.001**
(2.17) (2.16) (2.13) (2.14)
Debt ± /- 0.001 0.001 0.001 0.001
(0.59) (0.60) (0.43) (0.62)
ΔSales + 0.057*** 0.057*** 0.057*** 0.057***
(19.89) (19.87) (19.85) (19.87)
Political stability −0.001* −0.001** −0.001*
(−1.75) (−1.97) (−1.86)
Corruption control −0.003* −0.004** −0.003**
(−1.92) (−2.23) (−2.10)
Government effectiveness 0.001 0.001 −0.001
(0.10) (0.17) (−0.35)
Constant 0.016 0.051* 0.097*** 0.044
(0.55) (1.70) (3.78) (1.45)
Country fixed effects Yes Yes Yes Yes
Year fixed effects Yes Yes Yes Yes
Industry fixed effects Yes Yes Yes Yes
N 124,607 124,607 124,607 124,607
Adj. R2 0.170 0.170 0.170 0.170

The dependent variable is ΔInvestment. Robust t-statistics based on standard errors clustered by firm are reported in parentheses. *, ** and *** represent the 10%, 5%
and 1% significance levels, respectively (2-tailed).

negative in the “High” group. The SUR estimation shows that the dif-
ference between the low and high groups is significant at the 1% level.
This result suggests that foreign firms from home countries with better
capital market development and better quality of rule of law exhibit
lower investment comovement with Chinese domestic firms. Con-
versely, when home countries have poorer quality of rule of law, better
financial development in the home countries increases investment
comovement between foreign and domestic firms. The results thus
support the predictions of Hypotheses 3A and 3B.
Next, we separate the sample into high and low groups by capital
market development (based on the median value of Capital market). The
results are reported in Table 5. Similarly, the “Low” (“High”) groups
include firms from countries with a capital market index lower (higher)
than the median value. In column 2, we find that the coefficient of
ΔInvestment_ind × Rule of law in the “High” group is significantly ne-
gative, consistent with Hypothesis 4. Meanwhile, the coefficient of
ΔInvestment_ind × Rule of law in the “Low” group is not significant at
any conventional level (Column 1), also consistent with our expecta-
tion. These results suggest that a strong rule of law in home countries
decreases investment comovement when home countries have highly
developed capital markets; the rule of law has no significant impact on
investment comovement for home countries with an under-developed
capital market. The SUR estimation shows that the difference between
the “High” and “Low” groups is significant at the 1% level. In summary,
the analysis of the contingent effects provides evidence supporting
H3A, H3B and H4.
4.3. Robustness tests
We perform several additional robustness tests in this sub-section.
To save space, the results are not tabulated but are available upon re-
quest.
4.3.1. An alternative measure of investment comovement
In our main empirical tests, we measure investment comovement
using the industry median values of changes in domestic firms' capital
expenditures. We repeat our main regressions in Tables 2 through 5
using the industry mean values. We find similar results compared to
those based on industry median values.
4.3.2. Alternative measures of home country institutions
We use an alternative variable for the capital markets effect
(Demirgüç-Kunt & Levine, 1996), which equals the sum of (standar-
dized indices of) market capitalization to GDP, total value traded to
GDP, and turnover (total value traded to market capitalization). Fol-
lowing Lu et al. (2014), we also use an alternative variable, the index of
Regulatory Quality constructed by Kaufmann et al. (2009), to measure
rule of law. This index captures “perceptions of the ability of the gov-
ernment to formulate and implement sound policies and regulations
that permit and promote private sector development” (Kaufmann et al.,
2009, p.6). We repeat all tests with these alternative measures of home
institutions and find that the results remain the same.
4.3.3. Observations from Hong Kong
In the main test, we exclude observations from Hong Kong to avoid

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Table 3 Table 4
Home-country institutions and investment comovement: relative to China. Home-country capital market development and investment comovement: con-
tingent on rule of law.
Capital market Rule of law
(1) “Low” rule of law (2) “High” rule of law
(1) Low (2) High (3) Low (4) High
ΔInvestment_ind 0.102 0.966***
ΔInvestment_ind 1.022*** 0.612*** 1.223*** 0.646*** (0.79) (13.56)
(6.86) (10.54) (3.46) (11.76) ΔInvestment_ind × Capital market 4.428*** −2.085***
Diff. in ΔInvestment_ind χ2 = 6.83*** χ2 = 2.65* (7.01) (−5.67)
Foreign capital −0.011** 0.003 −0.001 −0.001 Diff. in interactions χ2 = 79.53***
(−2.28) (1.29) (−0.06) (−0.55) Capital market −0.093 −0.273***
Cash −0.001 −0.009*** −0.018 −0.006*** (−0.65) (−5.06)
(−0.24) (−2.88) (−1.15) (−2.61) Foreign capital −0.013*** 0.003
Tangibility 0.029*** 0.029*** 0.066* 0.026*** (−2.77) (1.25)
(3.38) (6.29) (1.89) (6.94) Cash −0.022*** −0.001
ROA 0.048*** −0.014* 0.098** 0.002 (−4.00) (−0.30)
(3.77) (−1.80) (2.57) (0.28) Tangibility 0.050*** 0.022***
Firm size 0.003*** −0.000 0.005 0.001* (5.98) (5.12)
(3.30) (−0.58) (1.42) (1.87) ROA 0.026** −0.005
Debt 0.012*** −0.002 0.022 0.000 (2.43) (−0.72)
(2.87) (−0.85) (1.60) (0.16) Firm size 0.002** 0.000
ΔSales 0.053*** 0.058*** 0.107*** 0.055*** (2.13) (1.09)
(10.38) (17.81) (5.67) (19.16) Debt 0.005 −0.001
Political stability −0.004 −0.001** −0.006 −0.001* (1.42) (−0.37)
(−1.40) (−2.16) (−1.11) (−1.77) ΔSales 0.053*** 0.058***
Corruption control 0.001 −0.002 −0.006 −0.003* (9.57) (17.61)
(0.37) (−0.62) (−0.28) (−1.66) Political stability −0.006*** −0.001**
Government effectiveness −0.000 0.001 0.003 0.007*** (−2.79) (−2.30)
(−0.16) (0.63) (1.15) (3.36) Corruption control −0.003 0.023***
Constant 0.033 −0.022 −0.387* 0.033 (−1.62) (4.22)
(0.41) (−0.34) (−1.80) (1.12) Government effectiveness −0.000 −0.004
Country fixed effects Yes Yes Yes Yes (−0.19) (−0.49)
Year fixed effects Yes Yes Yes Yes Constant 0.089 0.107***
Industry fixed effects Yes Yes Yes Yes (1.13) (2.71)
N 36,460 88,147 3,367 121,240 Country fixed effects Yes Yes
Adj. R2 0.073 0.203 0.139 0.171 Year fixed effects Yes Yes
Industry fixed effects Yes Yes
The “Low” (“High”) group includes firms from countries with an institutional N 33,275 91,332
index lower (higher) than China. The dependent variable is ΔInvestment. Robust Adj. R2 0.139 0.186
t-statistics based on standard errors clustered by firm are reported in par-
entheses. *, ** and *** represent the 10%, 5% and 1% significance levels, re- The “Low” (“High”) Rule of law group includes firms from countries with an
spectively (2-tailed). institution index lower than (higher than or equal to) the median value of Rule
of law. The dependent variable is ΔInvestment. Robust t-statistics based on
standard errors clustered by firm are reported in parentheses. *, ** and ***
the dominant influence of observations from one single region. We
represent the 10%, 5% and 1% significance levels, respectively (2-tailed).
repeat all the tests including observations from Hong Kong and find that
the above results still hold.
quality should demonstrate more efficient investment activities than
companies from countries with weaker institutions. If our result points
4.3.4. Alternative definition of “foreign firms”
to this connection, then it will serve as supplementary evidence for the
In the previous analyses, we define foreign firms as those with in-
relationship between home institutions and investment comovement.
vested capital partially from foreign entities or individuals, while do-
We use the methodology of Biddle, Hilary, and Verdi (2009) and esti-
mestic firms are those without any foreign ownership. Some foreign
mate the likelihood of deviation from the expected level of investment.
firms in our sample have a foreign capital ratio of less than 50% and
Better investment efficiency means reduced overinvestment and un-
may therefore be less affected by their home institutions. We thus
derinvestment.
change the definition of “foreign firms” to those with more than 50% of
We first estimate the expected level of investment, which assumes
their capital from foreign countries. We also vary the definition of
that it is a function of growth opportunities.
“foreign firms” to include only those wholly owned by foreigners. We
find that our results hold under alternative definitions of foreign firms. Investmentt + 1 = β0 + β1 ∆Salest + εt (3)

4.3.5. Alternative model specification
In the main tests, we control for industry and country fixed effects.
In an alternative model specification, we control for firm fixed effects
and find that the results are similar to those reported in Table 2.
5. Home country institutions and investment efficiency
The results in Section 4 show that foreign firms from countries with
better quality home institutions exhibit lower comovement with Chi-
nese domestic peers. Fisman and Love (2004) and Francis, Huang,
Khurana, and Pereira (2009) argue that well-developed financial sys-
tems and a better information disclosure environment contribute to
more efficient resource allocation. Thus, a direct implication of our
analysis is that foreign firms from countries with better institutional
where Investmentt+1 is the capital expenditures of firm i at year t + 1.
ΔSalest is the sales growth rate of firm i at year t. We estimate Eq. (3) for
each firm in a given year and the residual term represents the deviation
from the expected level of investment. We then sort observations based
on the yearly residuals. Firm-year observations in the bottom quartile
(i.e., the most negative residuals) are classified as “underinvestment” and
observations in the top quartile (i.e., the most positive residuals) are
classified as “overinvestment.” Observations in the middle two quartiles
are classified as the benchmark group.
To examine the association between the institutional quality of
home countries and investment efficiency, we run the following logistic
regression:

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Table 5 Table 6
Home-country rule of law and investment comovement: contingent on capital Home-country institutions and deviation from expected investment level.
market development.
Pred. sign (1) (2) (3)
(1) “Low” capital (2) “High” capital
market market Capital market − −1.181*** −1.139***
(−7.31) (−6.91)
ΔInvestment_ind 1.052*** 1.083*** Rule of law − −0.026*** −0.014
(6.53) (13.87) (−2.93) (−1.52)
ΔInvestment_ind × Rule of law 0.028 −0.330*** Foreign capital − −0.182*** −0.181*** −0.182***
(1.44) (−8.90) (−18.11) (−18.04) (−18.11)
Diff. in interactions χ2 = 78.85*** Firm size ± /- 0.001 0.000 0.001
Rule of law −0.001 0.008*** (0.13) (0.00) (0.16)
(−0.26) (2.64) Tangibility + 1.668*** 1.661*** 1.668***
Foreign capital −0.013** 0.001 (50.41) (50.35) (50.41)
(−2.49) (0.43) Slack + 0.004** 0.003** 0.004***
Cash −0.000 −0.009*** (2.56) (2.13) (2.58)
(−0.00) (−3.32) Loss ± /- −0.041*** −0.041*** −0.041***
Tangibility 0.051*** 0.026*** (−2.79) (−2.81) (−2.77)
(4.72) (6.40) Debt ± /- −0.106*** −0.104*** −0.106***
ROA 0.032** 0.002 (−6.64) (−6.52) (−6.65)
(2.01) (0.31) Political stability 0.003 0.004 0.003
Firm size 0.002 0.001 (0.76) (1.09) (0.84)
(1.61) (1.48) Corruption control −0.002 −0.010 0.002
Debt 0.011** 0.000 (−0.25) (−1.41) (0.26)
(2.04) (0.11) Government effectiveness −0.006 −0.016** −0.005
ΔSales 0.058*** 0.057*** (−0.87) (−2.32) (−0.70)
(8.04) (18.26) Constant −0.363*** −0.416*** −0.358***
Political stability −0.004* −0.001** (−7.17) (−8.30) (−7.04)
(−1.70) (−2.22) N 128,812 128,812 128,812
Corruption control 0.001 −0.011*** Pseudo R2 0.021 0.021 0.021
(0.73) (−2.97)
Government effectiveness 0.001 −0.001 The dependent variable Deviation equals 1 if the observation belongs to the
(0.34) (−0.27) underinvestment or overinvestment group and equals 0 for the benchmark
Constant −0.024 0.027 group. Robust t-statistics based on standard errors clustered by firm are re-
(−0.58) (0.83) ported in parentheses. *, ** and *** represent the 10%, 5% and 1% significance
Country fixed effects Yes Yes
levels, respectively (2-tailed).
Year fixed effects Yes Yes
Industry fixed effects Yes Yes
N 16,610 107,997 negative while the coefficient of Rule of law is negative, but not sig-
Adj. R2 0.133 0.176 nificant. This is likely because of the high correlation between Capital
market and Rule of law (0.341 as shown in Panel B, Table 1).
The “Low” (“High”) Capital market group includes firms from countries with an
institution index lower than (higher than or equal to) the median value of
Capital market. The dependent variable ΔInvestment is the change in capital 6. Discussion
expenditure of a foreign firm. Robust t-statistics based on standard errors
clustered by firm are reported in parentheses. *, ** and *** represent the 10%, Our study contributes to interdisciplinary research, including in-
5% and 1% significance levels, respectively (2-tailed). ternational business, management, and finance in several ways. First,
we build on prior research related to country-of-origin effects and
Deviationt = α 0 + α1 HomeInstitutionst + α2 Foreign capitalt strategic traits of FDI (Luo, 1998; Pan, 2003; Wang et al., 2009). Our
findings of significantly positive investment comovement between for-
+ α3 Firm sizet
eign firms and Chinese domestic firms provide additional support for
+ α4 Tangibilityt + α5 Slackt + α6 Losst + α 7 Debt + α8 Political stability
the literature on spillover effects in productivity and technology for
+ α 9 Corruption control + α10 Government effectiveness + εt
firms in FDI host countries (Bitzer, Geishecker, & Görg, 2008) and on
(4) enhancing domestic capital formation (Hejazi & Pauly, 2003). We also
add new evidence to the literature that examines the impact of home
where Deviation equals 1 if the observation belongs to the under-
and host country institutions on investment activities (Mingo et al.,
investment or overinvestment group and equals 0 for the benchmark
2018).
group. We omit the firm subscript for brevity. We expect the coefficient
Second, we contribute to the literature on institutional escapism
of α1 to be negative as better home institutions should promote in-
(e.g., Collier et al., 2001; Dai et al., 2017; Le & Zak, 2006; Witt & Lewin,
vestment efficiency and be reflected as less deviation from the expected
2007) by suggesting that firms from countries with weaker quality of
level of investment. Like Biddle et al. (2009), we include Slack, which is
rule of law are less likely to be investing in other countries for efficiency
the ratio of cash to property, plant, and equipment. Loss is a dummy
purposes and more likely doing so to escape from the poor legal in-
variable that equals 1 if operating income is negative and 0 otherwise.
stitutions in their home countries.
We also include the following control variables: Foreign capital, Firm
Third, many studies have documented the importance of home
size, Debt, Tangibility, Political stability, Corruption control, and Govern-
market environments on international expansion. For example, several
ment effectiveness.
studies show that pro-market reform increases corporate international
We run regression model (4) and report the results in Table 6. The
expansion (Luo & Tung, 2007; Singh, Pattnaik, Gaur, & Ketencioglu,
coefficient of Capital market (Column 1) and the coefficient of Rule of
2018). Literature also highlights the importance of synchronizing
law (Column 2) are both significantly negative, consistent with our
strategic responses with the changes in the external environment (Popli,
expectation that foreign firms from well-developed home capital mar-
Akbar, Kumar, & Gaur, 2017), as well as the influence of environmental
kets or from countries with a strong rule of law exhibit better invest-
uncertainty on corporate strategic choices (Mukherjee, Gaur, Gaur, &
ment efficiency. We also include Capital market and Rule of law together
Schmid, 2013). Our study extends this stream of literature by doc-
in Column 3. The coefficient of Capital market is still significantly
umenting that home market institutions significantly affect corporate

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overseas investment efficiency.
Fourth, how institutional conditions in emerging markets influence
firm behaviors have been widely studied (Hoskisson, Wright,
Filatotchev, & Peng, 2013). For example, foreign companies are more
likely to invest in emerging markets with favorable institutional quality,
and in regions with strong economic, cultural, and historic ties with the
parent companies (Filatotchev et al., 2007). Similar results have also
been documented for cross-border acquisitions in emerging markets
(Lebedev, Peng, Xie, & Stevens, 2015). We extend this line of literature
by showing that FDI activities in emerging markets could be impacted
by a complex nexus of home and host countries' institutional elements.
Our study generates practical implications for policymakers and
managers. We show that institutional quality improves capital alloca-
tion not only in domestic markets (Beck & Levine, 2002; Hsu et al.,
2014; Rajan & Zingales, 2001), but also in foreign countries through
FDI outflows. This implies that it is important for policymakers to sti-
mulate capital market development and promote better legal environ-
ments, especially in emerging markets. At the same time, as firms in
emerging markets are intensifying their pace of globalization, it is cri-
tical for managers to have an in-depth understanding of inter-
nationalization strategies regarding their paths, processes, opportu-
nities, barriers, potential outcomes (Gaur & Kumar, 2010), and the
unavoidable intense competition between multinational firms from
developed and emerging markets (Estrin, Meyer, & Pelletier, 2018).
China, for example, is at a tipping point where FDI has changed from
inward flow to outward flow. This is not only due to the Chinese gov-
ernment's policy of promoting internationalization (Buckley et al.,
2007), but also to the unfavorable industry environment at home (Gaur,
Ma, & Ding, 2018). Furthermore, concentrated ownership and group-
application of Chinese companies encourage international diversifica-
tion (Gaur & Delios, 2015; Gaur, Kumar, & Singh, 2014). As our data
demonstrates, China ranks low in both institutional factors within the
global spectrum. Our findings of investment comovement and invest-
ment efficiency thus highlight the importance of improving the in-
stitutional environment at home.
7. Conclusion
We study the impact of home institutional quality on investment
activities of FDI. We find that foreign firms from countries with better
developed financial markets or stronger rule of law exhibit less
Appendix A. Variable definitions
Variables Definition
ΔInvestment Change in capital expenditure in year t. Capital expenditure is calculated as the change in gross fixed assets from year t-1 to
year t divided by total assets in year t-1.
ΔInvestment_ind The industry median of ΔInvestment for domestic firms.
Capital market The ratio of stock market capitalization to GDP.
Rule of law The index of Rule of Law.
Foreign capital The ratio of foreign paid-in capital to total paid-in capital.
Cash The ratio of cash over total assets.
ROA Operating income divided by total assets in year t-1.
Tangibility The ratio of net value of fixed assets over total assets.
Firm size The natural logarithm of total assets.
Debt The ratio of liabilities over total assets.
ΔSales The difference in sales between year t and year t-1, divided by sales in year t-1.
Political stability The index of Political Stability and Absence of Violence.
Corruption control The index of Control of Corruption.
Government The index of Government Effectiveness.
effectiveness
Deviation Equals 1 if the observation belongs to the underinvestment or overinvestment group and equals 0 for the benchmark group.
Slack The ratio of cash to property, plant, and equipment.
Loss Equals 1 if operating income is negative, and 0 otherwise.
229
Journal of Business Research 95 (2019) 220–231
investment comovement with Chinese domestic firms. We further find
that the capital markets effect exists only for foreign firms from coun-
tries with a strong rule of law, whereas the rule of law effect holds only
for foreign firms from nations with well-developed capital markets.
Finally, we show that foreign firms from countries with better institu-
tional quality exhibit more efficient investment activities than compa-
nies from countries with weaker institutions. These findings collectively
suggest that various dimensions of institutional elements, such as
supply of capital and the legal environment protecting capital alloca-
tion, should not be considered in isolation in managerial decisions and
policy making.
Our study has some caveats. Due to data unavailability, we do not
have detailed ownership information for our sample firms. The in-
formation about different types of ownership (e.g., a foreign govern-
ment or foreign institutional investors) and the degree of ownership
concentration may offer additional insights into the extent of invest-
ment comovement and its associated motives and economic con-
sequences. For instance, Stoian and Mohr (2016) argue that emerging
market firms need to possess certain strengths, such as ownership ad-
vantages, in expanding aboard to counteract the regulative voids at
home. In addition, our study only captures one side of the picture—the
comovement between FDI and the investment in Chinese domestic
companies (the “input” story). We do not have firm-level data to show
the extent to which the products produced from FDI are exported back
to home countries or consumed in the Chinese market (“output” story).
Such knowledge may enrich our understanding of the implications of
investment comovement. These limitations, however, point to new
avenues for future research.
Acknowledgements
We thank Dr. Naveen Donthu and Dr. Anders Gustafsson (Editors-in-
Chief), Dr. Sumit Kundu (Associate Editor), and two anonymous re-
viewers for many valuable comments and suggestions that have helped
us substantially improve the paper. Donghua Chen acknowledges fi-
nancial support from the National Natural Science Foundation of China
(Grant Number: 71372032). Xin Yu acknowledges financial support
from the National Natural Science Foundation of China (Grant Number:
71272101). Zhou Zhang acknowledges the financial support from the
Leaders Council Scholar and Dean's research grant at the University of
Regina.
D. Chen et al.
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Donghua Chen is the Professor of Accounting at the Business School, Nanjing University,
China. He received his Ph.D. in Accounting from Shanghai University of Finance and
Economics. His research interests include corporate governance, capital markets and
accounting information. Prof. Chen has published papers in journals including The
Accounting Review, Journal of International Business Studies, Journal of Banking and Finance,
Journal of Business Finance & Accounting, and Pacific-Basin Finance Journal.
Xin Yu is a Senior Lecturer at the Business School, University of Queensland, Australia.
She received her Ph.D. in Accounting from the Chinese University of Hong Kong. Her
research interests include corporate governance, corporate finance and accounting dis-
closure. Dr. Yu has published papers in journals including Financial Management, Journal
of Business Finance & Accounting, Accounting and Finance, Journal of Multinational Financial
Management, and Pacific-Basin Finance Journal.
Zhou Zhang is the Associate Professor in Finance at the Faculty of Business
Administration, University of Regina, Canada. He received his Ph.D. in Finance from the
University of Manitoba and he is a Chartered Financial Analyst (CFA). His research in-
terests are primarily in corporate finance areas with a focus on cross-country studies. He
has published papers in the Journal of Business Ethics, British Journal of Management,
Journal of Business Finance & Accounting, Journal of Corporate Finance, and Financial
Review.