FOREIGN INVESTMENT DECISION-MAKING in TRANSITION ECONOMIES by OLGA GOLUBEVA

Foreign Investment Decision-Making in Transition Economies by Olga Golubeva School of Business Stockholm University FOREIGN INVESTMENT DECISION-MAKING IN TRANSITION ECONOMIES by OLGA GOLUBEVA Doctoral dissertation School of business Stockholm University 106 91 Stockholm FOREIGN INVESTMENT DECISION-MAKING in Transition Economies Abstract The purpose of this project is to describe and explain the foreign investment decision process in the uncertain and turbulent environment of transition economy. By getting an in-depth understanding of how decision-making works in the environment of transition economy, the study intends to contribute to the development of business administration theory in the area of foreign investment decision-making, particularly its application in the turbulent and uncertain world. Theoretical ‘blocks’, elaborated on the basis of literature study, include the following concepts: the framework of transition economy; initial motivation (or reasons) of companies to make foreign direct investments (FDI); investigation of the investment climate and information collection methods; project evaluation and investment decision criteria; risk assessment factors and risk reduction measures. Transition economy is defined in the study as ‘a non-planned, non-market economy’ where the new emerging market institutions coexist with the bureaucracy and hierarchy inherited from the old administrative system. Investment projects, therefore, should probably be seen as being under institutional influence from both the local (i.e. transition economy) and the Western investor’s home country environments. The empirical data presented in the paper also shows that it is necessary to establish the relevant economic, legal, political and social institutions in order to attract FDI. The study further includes the analysis of the main components and features of transition economies and their influence on FDI decision-making. One of the results of the study is that FDI decision-making in transition economies is largely consistent with different theoretical approaches suggested in the literature. On the other hand, the empirical support obtained for different theoretical approaches is often questionable and opened to alternative interpretations. The presented project suggests that theoretical perspectives do not preclude each other, but rather have a complimentary character. The study attempts to contribute to the mainstream FDI theories through a firm-level approach based on the case studies. Two in-depth case studies are presented in the paper: Ericsson’s direct investments in Russia and Vattenfall’s investments in the Baltic countries. A formal questionnaire based on the parameters of theoretical ‘blocks’ was created and 25 top executives from Ericsson and Vattenfall who participated in FDI decision-making were surveyed. The empirical investigation took place during the period 1997 - 1998 with partial updating of the cases during the year 2000. The study shows that where companies confront stable environments, investment decision routines and procedures will be less necessary and important than where market uncertainty is high. The strong appreciation of the local business partners for properly done investment calculations increases the importance of capital budgeting in transition economies more than in developed market economies. SCHOOL OF BUSINESS STOCKHOLM UNIVERSITY FOREIGN INVESTMENT DECISION-MAKING IN TRANSITION ECONOMIES by OLGA GOLUBEVA Besides, traditional investment appraisal methods provide managers with an ‘objective’ or ‘materialistic’ feedback for the decision-making in the rapidly changing uncertain environment. On the other hand, the study emphasises the importance of strategy over financial techniques and argues that FDI decisions in transition economies should be based on methods consistent with the company’s long-term objectives. In case of permanent changes, new approaches as well as better co-ordination of traditional techniques with strategic, political, historical, geographical and cultural issues are required. Ericsson’ s direct investments in Russia are presented in the paper in connection with other factors: the company’s historical involvement in Russia, marketing strategy, human resource development, privatisation and restructuring of the telecommunication sector in Russia, etc. Nordic Electric Power Co- operation (Nordel), the EU’ s decision in 1996 to create an internal electricity market in Europe, Baltic ring study, future plans to privatise the energy companies in the Baltic countries, etc., are the framework to present the second case. An application of project evaluation and risk assessment techniques for broader and more complicated environments shows that investment decision-making is probably as much, if not more, a social, political and cultural technology as an economic one. The study argues then that the rational choice decision-making model often co-exists with alternative models elaborated in social science - limited rationality, political and garbage can. According to the empirical data, the investment decisions are largely based on intuition, business experience and judgement, personal contacts with representatives from the local country, and these investment criteria are inevitable and acceptable in a situation of total chaos and permanent change. The right chosen partner, for example, is one of the major criteria for the success of the investment project in a transition economy. One of the outcomes of this study is that the revitalised form of investment decision- making will differ rather markedly from much of what has gone before: less emphasis on the quantitative aspects of capital budgeting, more on the qualitative aspects of companies and investment environment. The project also argues that determinants, approaches and criteria of investment activity in transition economies are largely consistent with patterns observed in other parts of the world. A few specific environmental conditions of transition economies, however, are shown in the study to affect the pattern of FDI decision-making. The level of turbulence is still different compared to the developed market economies due to uncertainties and unpredictibilities associated with environment of transition economies. Other major differences are the large power distance with authoritarian leadership, strong hierarchy and bureaucracy as well as the vital role of personal contacts in transition economies. It is not clear, however, if these features of transition economies should be seen as inherited from the past communist system or as an alternative way to organise the economic actors through networks, a way that is natural and appropriate for the majority of Asian societies. Key words: FDI, transition economy, initial motivation (or reasons) for FDI, capital budgeting methods and investment decision criteria, investigation of investment climate and information collection methods, risk assessment and risk reduction measures, decision-making models, case studies, survey method. School of Business Research Reports No. 2001:11 © Olga Golubeva. All rights reserved. ISBN 91-7265-299-3 ISSN 1400-3279 Printed by Akademitryck 2001 SCHOOL OF BUSINESS STOCKHOLM UNIVERSITY FOREIGN INVESTMENT DECISION-MAKING IN TRANSITION ECONOMIES by OLGA GOLUBEVA ACKNOWLEDGMENTS & PREFACE This research paper is a result of hard and enjoyable work at School of business, Stockholm University (SoB, SU) which provided me with an opportunity to conduct my postgraduate studies. First of all, my sincere gratitude goes to my supervisors, Dr. Jan-Erik Gröjer and Dr. Jens Lindberg for guidance and support throughout the study. I have been privileged to benefit from their experience in science, business and life. Research is mysterious phenomena. There is no substitute for actually writing - all the preparation in the world does not save a researcher from having to put words on paper. There is nothing more frustrating than sitting down nearby a table and looking into a computer screen without being able to write… ”When the writing is not going well, we probably have nothing (yet) to say”, - explained Wolcott (1990, p. 21). Unfortunately, I have not found a formula to make writing an easy task. The real learning can only take place in doing. My deep gratitude goes to opponents of the intermediate versions of the paper : Dr. Olle Högberg, Dr. Li Malmström, Doctoral candidate Nils Bagelius (all SoB, SU), Dr. Mats Edenius (Stockholm School of Economics), Dr. Erik Bergström (SoB, SU and Institute for Economy at the Uddevalla University), Dr. Carl Fey (Institute of International Business, Stockholm School of Economics), Dr. Bestrat Tesfaye (University in Södertörn), who substantially contributed to the research through their valuable insights and comments. Another challenge of being a researcher is probably the necessity to communicate with the audience : colleagues, students, business people and other interested parties. As Dey (1993, p. 237) points out, ”what you cannot explain to others, you do not understand yourself”. Of course, producing an account of our analysis is not just something we do for an audience. It is also something we do for ourselves. Thanks to colleagues inside and outside the School of business with whom I have had stimulating discussions on my topic as well as on the problems of research in general: Prof. Pierre Guillet de Monthoux, Prof. Kaj Sköldberg, Dr. Addri De Ridder, Dr. Bo Green, Dr. Cecilia Bergström, Dr. Tom Hemming, Dr. Ali Yakhlef (all from

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