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FOREIGN INVESTMENT DECISIONS OF WESTERN CANADIAN FIRMS by ABDUL WAHAB M.B.A., University of Karachi, 1964 M.B.A., Indiana University, 196 7 A THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF DOCTOR OF PHILOSOPHY in THE FACULTY OF COMMERCE AND BUSINESS ADMINISTRATION (Marketing Division) We accept this thesis as conforming to the required standard THE UNIVERSITY OF BRITISH COLUMBIA December, 1977 Abdul Wahab, 1977 In presenting this thesis in partial fulfilment of the requirements for an advanced degree at the University of British Columbia, I agree that the Library shall make it freely available for reference and study. I further agree that permission for extensive copying of this thesis for scholarly purposes may be granted by the Head of my Department or by his representatives. It is understood that copying or publication of this thesis for financial gain shall not be allowed without my written permission. Department of The University of British Columbia 2075 Wesbrook Place Vancouver, Canada V6T 1W5 - ii - ABSTRACT An earlier study of the foreign investment decision process of U.S. firms by Aharoni had suggested the dominance of behavioural charac• teristics over criteria based on economic theories in determining such decisions. His research did not however, provide strong analytical proofs and part of the intellectual derivation for this study was the search for such proof. This was combined with the effort to bring into the field of knowledge some information about an under-reported sub-sample of foreign investors, namely firms from Western Canada. The main structure of the research model consisted of six iden• tified stages in the foreign investment decision process. In turn, six sets of variables were developed which corresponded to each of these stages: awareness through initiating forces, investigation, commitments, negotiations, uncertainty, and the final decision. To test the research model five hypotheses were developed. The first hypothesis corresponding to stage one contended that endogenous initiating forces are more important in creating awareness of foreign direct investment opportunities than exogenous initiating forces. The second hypothesis relating to stage two claimed that those who conduct a sequential investigation will judge the subjectively estimated cost of that investigation to be significantly higher than those who do not con• duct a sequential investigation. The third hypothesis concerning stage three stated that the extent of investigation and the degree of commitments are positively related. The fourth hypothesis relating to negotiations in stage four and - iii - uncertainty in stage five said that there exists a positive relationship between the extent of negotiations and the amount of uncertainty. The fifth hypothesis corresponding to stage six claimed that in those cases where the decision has been made to invest abroad, there will be strong initiating forces, more investigation, greater degree of commitments, greater extent of negotiations, and smaller amount of uncertainty than in those cases where the decision has been made not to invest abroad. The hypotheses were tested against data collected on 89 decisions. The data supported all the hypotheses excepting the first part of the last hypothesis which said that the initiating forces will be stronger in the case of positive decisions. This was explained in terms of the presence of intervening variables such as investigation, commitments, negotiations, and uncertainty. The research has implications for home and host country and the theory of the firm. Profit is shown as an important consideration in the investment decisions. Resource-based firms are led by the location of resources and they have a desire to internalize the source of supply and demand. Some of the areas for further research are: a comparison of foreign and domestic investment decisions and a study of buying and financing practices of Canadian firms that invest abroad. J. W. C. Tomlinson - iv - Table of Contents Page I. INTRODUCTION 1-17 A. The Importance of Foreign Direct Investment 1 B. The Meaning of Foreign Direct Investment 2 1. Control 2. Flow of Funds and Direct Investment 3. Technology and Management 4. Initial and Ongoing Direct Investment C. Historical Growth and Distribution of Direct Investment 5 1. Portfolio Investment 2. Foreign Direct Investment (a) Size and Growth (b) Geographical Distribution II. A SURVEY OF FOREIGN DIRECT INVESTMENT THEORIES 18-56 A. The Issues in Foreign Direct Investment 18 B. The Maximization Theories 21 1. The Classical Economic Theory 2. Investment Theories (a) Rate of Interest or Cost of Capital (b) Capacity Utilization Theory 3. The Theory of Growth of the Firm 4. The Monopolistic Advantage Theory 5. Exchange Risk and Securities Markets Imperfections Theories (a) The Exchange Risk Theory (b) The Securities Markets Imperfections Theory C. The Satisficing Theory 39 D. The Product Life Cycle Theory 43 —v - Page 1. ' The Background 2. The Assumptions 3. The Theory 4. The Explanatory Power of the Theory E. The Modern Imperialism Theory 52 III. THE RESEARCH MODEL 5 7-75 A. Aharoni's Research Design 58 1. The Sample 2. The Scope of Research 3. Research Methodology B. Aharoni's Research Findings 61 C. Weaknesses in Aharoni's Theory 72 IV. THE RESEARCH DESIGN 76-88 A. Objectives of the Study 76 B. The Hypotheses 77 C. The Operational Definitions 77 D. The Sample 85 E. The Methodology 86 V. THE RESEARCH FINDINGS 89-123 A. Initiationg Forces and Awareness of Foreign Direct Investment Opportunities 1. Initiating Forces (a) Endogenous Initiating Forces (b) Exogenous Initiating Forces 2. The Relative Importance of Individual Initiating Forces 3. A Comparison of Endogenous and Exogenous Initiating Forces B. Sequential Investigation and Subjectively Estimated Cost of Investigation - vi - Page 1. The Sequential Investigation 2. The Cost of Investigation 3. A Comparison of Sequential Investigation Cost with the Cost of Non-Sequential Investigation C. Relation between Intensity of Investigation and Degree of Commitments 9 8 1. Investigation Variables 2. Commitment Variables 3. The Test of the Hypothesis D. Relation between Extent of Negotiations and Amount of Uncertainty 10 7 1. The Negotiation Variables (a) Negotiations with Host Country Government (b) Negotiations with Host Country Banks (c) Negotiations with Partners 2. The Uncertainty Variables 3. The Relation between the Extent of Negotiations and Amount of Uncertainty E. Relation between Positive and Negative Decisions in Terms of Initiating Forces, Investigation, Commitments, Negotiations, and Uncertainty 116 1. Initiating Forces 2. Investigation 3. Commitments 4. Negotiations 5. Uncertainty VI. COMPARISON OF RESEARCH.FINDINGS WITH OTHER STUDIES 124-145 A. Initiating Forces and Awareness of Foreign Direct Investment Opportunities 124 B. Sequential Investigation and Subjectively Estimated Cost of Investigation 133 C. Relation between Intensity of Investigation and Degree of Commitments 135 D. Relation between Extent of Negotiations and Amount of Uncertainty 137 - vii - E. The Comparison of Positive and Negative Decisions VII. CONCLUSIONS, SUMMARY, IMPLICATIONS, AND AREAS FOR FUTURE RESEARCH A. Conclusions 1. Contribution of the Present Study 2. Areas of Differences 3. The Validity of the Behavioural Model B. Summary of the Study 1. The Research Model 2. The Hypotheses 3. The Sample and Methodology 4. The Research Findings C. Implications 1. Implications for Host Countries 2. Implications for Home Country 3. Implications for the Theory of the Firm D. Areas for Further Research Appendix Bibliography - viii - ACKNOWLEDGEMENTS Many thanks are due to Dr. J. W. C. Tomlinson, who, as chairman of my dissertation committee, guided me from the beginning of. this dissertation. Without his useful suggestions my dissertation would not have been completed. Dr. Tomlinson spent several weekends in minutely reading my drafts. I very much appreciate his assistance. The other members of my committee,-namely, Dr. Merle E. Ace, Dr. Herbert D. Drechsler, and Dr. S. M. Oberg were very helpful in offering useful comments and suggestions. I sincerely thank.them for their assistance. The suggestions of Dr. G. B. Hainsworth and Dr. Vance F. Mitchell, as members of my oral examination committee, were useful in clarifying the concepts I have used in this dissertation. Thanks are also due to Mrs. Sylvia Willie for offering her assistance. I sincerely thank the presidents and vice-presidents of the firms in British Columbia who spent their valuable time in answering my questions. I am very grateful to them for the information they provided about the foreign direct investment decisions of their firms. I also want to thank the Division of International Business Studies and the Faculty of Commerce and Business Administration for the financial assistance which enabled me to complete my dissertation. My children,- Wasimy Baber, and Shazia also deserve thanks for not putting demands on my time and for.praying for my success. Abdul Wahab - ix - dedicated to Razia (whose prayers, patience and love made this possible) - 1 - I. INTRODUCTION A. The Importance of Foreign Direct Investment One of the most significant and dramatic world trends of the post war period has been the rapid and sustained growth of foreign direct investment. According to an IMF estimate, the total foreign direct investment at book value in 19 74 was $216 billion, more than the combined gross national product of two-thirds of the