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Munich Personal RePEc Archive

Comparative performance of foreign

affiliates and domestic firms in the Indian

machinery industry

Pradeep Kumar Keshari

18. May 2013

Online at http://mpra.ub.uni-muenchen.de/33076/

MPRA Paper No. 33076, posted 20. May 2013 21:12 UTC

http://mpra.ub.uni-muenchen.de/33076/http://mpra.ub.uni-muenchen.de/33076/http://mpra.ub.uni-muenchen.de/

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Comparative Performance of Foreign Affiliates and Domestic Firms in the Indian Machinery

Industry

Abstract

The objective of this paper was to empirically examine the differences in the relative characteristics,

conducts and performance of two ownership groups of firms, foreign affiliates of MNEs (Fs! anddomestic firms ("Fs!, in the context of #ndian machinery industry (#M#! during the period $%%%&%' to

$%%&%)* For this purpose, we applied three alternative techni+ues, namely, univariate statistical

method based on elch-s t.test comparing the mean value of a variable between two groups of firms,the multivariate linear discriminant analysis and dichotomous logit and probit models* The common

and significant findings of the statistical analysis suggest that Fs have the greater technical efficiency,

firm si/e, export intensity, intensity of import of intermediate goods and intensity of import ofdisembodied technology but the lower advertisement and mar0eting intensity and financial leverage*

These findings also give some indications about the +uality of F"# that has come to the #M# during the

aftermath of economic reforms* First, it seems that the superior resources and capabilities of Fs

confer them higher technical efficiency (but not overall performance or the monopoly power! andexport intensity in relation to "Fs* 1econd, as the intensity of import of intermediate goods in Fs is

significantly higher than that of "Fs, the former group tends to have fewer lin0ages with domestic

suppliers of intermediate goods including capital goods, raw material, components and spare parts* #nother words, "Fs with their activities in the #M# are providing higher lin0ages with the indigenous

suppliers* Third, the combined results on higher expenses on import of intermediate goods and import

of foreign technology by Fs and no difference in gross profit margins between Fs and "Fs point outthat the Fs are probably engaged in the transfer of profits to the MNE system through intra.firm

trade* This aspect, however, re+uire further research which is beyond the scope of this study* Fourth,

despite the higher import of intermediate goods and disembodied technologies, Fs are not spending

higher amounts on 23" towards adaptation or&and absorption of the imported technology andindigeni/ation of the imported inputs* s a result, 23" intensities of Fs and "Fs are the same* Thus,

we conclude that our empirical analysis supports the proposition that the Fs and "Fs differ in terms

of the many aspects of conducts and performance in the #M#*

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Comparative Performance of Foreign Affiliates and Domestic Firms in The Indian Machinery

Industry

Pradeep Kumar Keshari'

1 Introduction

The issue of divergence in the conducts and performance of Foreign ffiliates of Multinational

Enterprises (Fs! and "omestic Firms ("Fs! has considerable importance for the policy and decision

ma0ers in the host developing countries and for the researchers interested in the study of Multinational

Enterprises (MNEs! as a separate field of en+uiry* 4ne of the major reasons for the recent interest in

this topic is that the world over governments in their respective countries are underta0ing substantial

effort and devoting large amounts of resources in the promotion of inward foreign direct investment

(F"#! through its major vehicle the MNEs* This is based on the belief that Fs are superior to "Fs in

terms of their holding of firm.specific assets (F1s! and several measures of performance such as

efficiency and exports (5obrin $%%6!* Therefore, locating more Fs in the host developing economies

may lead to direct benefits on account of increased number of firms with superior F1s and

 performance* 7esides, the presence of Fs in the host developing economies may indirectly cause

 benefits to "Fs through hori/ontal and vertical lin0ages and by improving their efficiency level and

export performance through increased competition and 0nowledge spillovers (1meet $%%8 and 9:rg

and 9reenaway $%%;!*

#n view of the above, it is important to understand the origin, nature and the direction of the

differences between Fs and "Fs and the effects foreign ownership of the firms have on a host

developing economy, particularly to its domestic sector* The extant literature suggests that the

differences in the characteristics of Fs and "Fs and the impacts of the presence of Fs in terms of

generating lin0ages and 0nowledge spillovers are contextual, i*e*, country or industry specific

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characteristics, conducts and performance, which could enable a firm to fall in one of the ownership

categories, Fs or "Fs, in an industry* 1pecifically, the objectives of this study are to empirically

examine@ a! the differences in Fs and "Fs in terms of the major aspects of characteristics, conducts

and performance of a firm which are captured by the several variables@ firm si/e (1A!, age (9E!,

financial leverage (=EB!, advertisement and mar0eting intensity (M#!, capital intensity (CD#!,research and development intensity (2"#!, intensity of import of disembodied technology (MT#!,

intensity of import of intermediate goods used for production (M#!, export intensity (#!, technical

efficiency (TE! and gross profit margin (9DM!*

 b! The determinants of probability of the firms to appear as Fs in terms of the above firm.level

variables, while controlling for the sub.industry level influences so as to 0now if MNE affiliations

ma0e significant difference between the two ownership groups of firms*

The plan for the rest of the study is as follows* #n section.$, we define #M# and briefly discuss

the reasons for selection of #M# for this study* 1ection. reviews the relevant literature and formulates

various hypotheses on individual aspects of discriminating characteristics of "Fs and Fs and

 probability of a firm to fall in the category of Fs (or "Fs!* 1ection.; identifies major characteristics

of the data, sample and period selected for the study* 1ection.6 explains the statistical methods and

econometric procedures used for the study* 1ection. analyses, discuses and compares the results

obtained from the use of group mean t.test, =inear "iscriminant nalysis (="! and the estimation of

 binary outcome probabilistic (probit and logit! models* 1ection.) presents the summary and

conclusions of the study*

! Indian Machinery Industry"The Focus of #tudy

5eeping in view the contextual nature of the benefits of F"#, we selected only one industry that

is the #M# . a medium&high technology industry of an emerging economy. for this study* 1election of

only one industry enabled us to reduce heterogeneity across industries arising out of differing product

 profiles, levels of product differentiation, industry specific policies, tax and tariff rates, levels of

 bac0ward and forward integration, capital intensity, levels of technological capabilities, export

orientations, etc* Focusing on only one industry also reduces heterogeneity in F"#, including the typesand motives of F"#*

#M# represents manufacture of machinery and equipment n.e.c* that is the division $8 in

 National #ndustrial Classification@ ll Economic ctivities.$%%8 (N#C.$%%8!* The division.$8

comprises two types of machinery producing industries, namely, general.purpose machinery (or group

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$8'! and special purpose machinery (or group $8$! at three digit level of classification* e thus define

#M# as the amalgamation of these two groups of industries*

The major reasons for the selection of #M# inter alia were the following@ a! 7eing a major part

of the capital goods industry, it can be the important source of innovations and higher value addition* #t

generally has higher margins and growth prospects as compared to the mature low.technologyindustries, in which intense competition has shrun0 margins and lowered growth prospects* 7eing a

technology and s0ill intensive industry, it could also generate significant intra.industry and inter.

industry externalities and lin0ages*

 b! #M# is relatively under.studied, especially in terms of micro level impact of F"# on its

 performance* 7esides, there exists no firm.level study to the best of my 0nowledge that employs

common sample of panel data for the recent period and uses sophisticated econometric methods for

simultaneous examination of several important aspects of comparative behaviour and performance of

"Fs and Fs in the #M#*

c! Machinery industry produces higher value.added products, acts as an important source of

innovation and creates strong forward and bac0ward lin0ages, therefore, the growth of this industry

was considered important by the #ndian policy ma0ers*

d! long with the adoption of outward oriented growth strategy and economic reform measures

implemented since the year 'GG', #M# has been exhibiting certain problems including inade+uate

technological capability, lac0 of international competitiveness, global mar0eting and customer

orientations, management and operational inefficiencies, higher propensity to import than the domestic

 production, etc* (C## $%%), E#M 7an0 $%%8!*

e! #M# has received lower level of F"# compared to the other closely related medium&high.tech

industries (vi/* electrical machinery and transport e+uipment! in the post.reform period*  s a

conse+uence, during the period of study, Fs as a group constituted only about $% per cent in the

aggregate sales of this industry whereas Fs- shares are +uite high in the other closely related

industries, for examples, ;' per cent in the automobile and auto ancillaries and ;$ per cent in the

electrical machinery*;

6#ata on cumulative inflow of *#' in 'ndia during +ugust 1331 to !uly &/ show that7 i) the share of manufacturing sectorconstituted about 58 $er cent of cumulative inflow of *#' of about 9s. &15 million (or "S# 5.: billion) in the country; ii) within the manufacturing sector electrical and electronic e

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f! 1ince machinery industry is categorised as the medium& high technology industry, the MNEs

could contribute in this industry in a better way either by setting up 9reenfield ventures or by offering

latest technology, management and mar0eting expertise, international business contacts and mar0et

intelligence*

g! The shifting base of machinery and e+uipment production from the developed to developingcountries has provided major opportunities of production and exports from technologically advanced

countries of the developing economies li0e China, #ndia, 1outh 5orea, etc* The countries li0e China

and 1outh 5orea respectively share ) per cent and ; per cent in the worldHs total production of

machinery* Iowever, #ndia-s share in world-s total production machinery is still insignificant '*; per

cent, indicating ample scope for expansion in its mar0et share* (E#M 7an0 $%%8!*

$* The %iterature& 'ypotheses and (ariables

The eclectic theory of F"# suggests that Fs and "Fs may differ in terms of their competitive

advantages based on the ownership or access to monopolistic advantages, possession of a bundle of

scarce, uni+ue and sustainable resources and capabilities  and competence to identify, evaluate, and

harness resources and capabilities from throughout the world and to integrate them with their existing

resources and capabilities ("unning $%%%!* This literature also points out that the competitive

advantages of Fs over "Fs are partly generic but partly context specific (#bid!*

More specifically, the recent literature suggests the following factors to be generally important

in creating the overall differences in the characteristics of Fs and "Fs* First, Fs generally have

 privileged access to two types of superior F1 of MNE* The first category of assets is named as

technology type assets including machinery and e+uipments and s0illed labour who operate them* The

technology.type assets can easily spillover to "Fs from Fs and the latter may lose competitive

advantage derived from these assets in a short span of time* Iowever, the Fs can maintain their

competitive advantage based on transaction-type F1 for much longer period or until the "Fs also

 become multinational in their reach (=all and Narula $%%;!*

1econd, Fs may be more flexible and aggressive in utilising the F1s, not being hindered by

the inertia that derives from being integrated into the local system, and associated path dependent

 political and social obligations (ang and Ju $%%)!*

Third, Fs may speciali/e in a narrow range of activities and operate at a higher end of industry

re+uiring better technology, s0ills and 4MDs* Thus, the characteristics of the industry segments may be

important in determining their presence*

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Fourth, MNEs may have ac+uired indigenous firms having better F1s and displaying better

 performance (than the average "Fs in the industry! in terms of 23", exports, productivity and

 profitability performance (7ella0 $%%;a!* This implies that the FsH superiority in their average

 performance may partly stem from the superiority of the ac+uired "Fs*

Fifth, to the extent positive gaps exist between developed and developing countries in terms of

corporate culture, level of technology, factor endowments and productivity, these gaps may also reflect

in the conducts and performance of Fs with head+uarters in the developed countries and "Fs based in

the developing economies (7ella0 $%%;a!*

1ixth, by combining location.specific advantages and wor0ing in the institutional set up and

 policy environment applicable to a host country, Fs may develop their uni+ue set of advantages by

enhancing and modifying the F1s received from the MNEs* The institutional perspective of business

strategy emphasi/es that the resource endowment of the host economy and its institutional framewor0

moderate the characteristics of Fs, facilitates the development of their resources and capabilities and

even generate new capabilities and new mar0ets opportunities, especially in the emerging economies

(Meyer et al* $%%G!* 2ugman and Berbe0e ($%%'!, for example, argue that export from a particular F

may arise from affiliate specific regional advantages that are grounded in F1 ac+uired from both the

 parent and location.bound advantages*

"uring the decades of 'GG%s and $%%%s, there has been a growth in empirical literature on

relative performance of Fs and "Fs in the manufacturing sector of developed and developingeconomies* These studies have mostly used firm.level data and econometric methods* #n the case of

developed countries, there have been a few important studies surveying relatively recent literature on

the subject* e focus here on the findings of two important surveys* The first one, >ungnic0el-s ($%%$!

edited volume of studies, compares the behaviour of Fs and "Fs in a number of European countries*

1econd one, 7ella0Hs ($%%;! survey, based on the 6; studies mainly using firm.level data in panel

framewor0, compares the various aspects of performance chiefly for the industries based in the

developed* The research papers in >ungnic0el-s ($%%$! edited volume (e*g* 7ella0 and Dfaffermayr

$%%$! predominately address both the theoretical and methodological issues associated with

comparison between Fs and "Fs* They also empirically tests the differences between Fs and "Fs in

terms of selected indicators, such as productivity, wages and 23"* >ungnic0el ($%%$! arrives at two

major conclusions@ First, the real difference in behaviour and performance lies between Fs and uni.

national "Fs and not between Fs and multinational "Fs* 1econd, the comparison between Fs and

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"Fs is inherently context specific, and hence there are different finding in different countries,

industries, etc*

7ella0 ($%%;! reports that@ a! the superior economic performance of Fs over "Fs is observed

in the areas of productivity, technology, wages, s0ills and growth rates but mixed results in case of

 profitabilityK b! the performance gap, however, disappears when firm and industry characteristics arecontrolledK c! the gap is more perceptible between Fs and uni.national "Fs than between the Fs and

multinational "Fs in a host country* "espite the availability of plenty of studies, we find that the most

of the scholars focus on one or a few aspects of firms- characteristics and performance at a time in a

study* There are of course few studies that have tried to examine the differences between Fs and "Fs

in terms of the several aspects of firms- characteristics in a single framewor0* e now turn towards

these studies*

Two noteworthy #ndian studies, 5umar ('GG'! and 2ay and 2ahman ($%%!, have examined the

differences in many aspects of firms- behaviour and performance by using the statistical techni+ue of

linear discriminant analysis (="!* 5umar ('GG'! empirically examines the issue of differences in the

relative conducts and performance of Fs and "Fs in the ; #ndian industries for the early 'G8%s* The

finding of this study reveals that the Fs are more vertically integratedK have higher access to fundK

operate at larger scalesK employ more s0illed personnelK earn higher profit marginK and have product

differentiation advantage over their domestic rivals* 7ased on these results, 5umar ('GG'! concludes

that the Fs- possession of significantly higher amount of intangible assets (compared to "Fs! enables

them to pursue non-price mode of rivalry  including product differentiation strategies for maximising

the revenues from these assets* This study, however, is dated and uses aggregated firm.level data for an

ownership category in an industry* #n such types of studies, the use of firm.level (or sometimes plant

level! data is considered appropriate (7ella0 and Dfaffermayr $%%$!*

#n a relatively recent firm.level study, 2ay and 2ahman ($%%! evaluate the discriminating

conducts of foreign and local enterprises mainly in terms of innovative activities and in establishing

lin0ages with the domestic (or foreign sector! sector*6 The study uses a stratified random sample of 8

firms, each one with at least 2s* ;% crore of annual sales turnovers for the year 'GG)&G8, belonging to

the #ndian chemical, electronics and transport e+uipment industries* The findings of this study suggest

5 The study measures innovatory activities by 9A# intensity, im$ort of foreign disembodied technology, and $roductdifferentiations through advertising; ca$tures inter4firm forward linkages by distribution outlays as a ratio of net sales turnover,e%$ort intensity; a$$ro%imates backward hori=ontal linkages by $urchase of finished goods as a $ercentage of sales and im$ortof finished goods as $ercentages of net sales; measures backward vertical linkages by value added as a $ercentage of net salesand im$ort of raw materials e%$enditure as a $ercentage of net sales.

/

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that@ a! Fs spend more on import of disembodied technologies than "FsK b! they however do not

significantly differ in terms of 23" intensity, indicating that Fs do not ma0e efforts to adapt their

technologies to the #ndian conditionK b! Fs foster bac0ward hori/ontal lin0ages with local suppliers of

final goods but ma0e less efforts to develop bac0ward vertical lin0ages* lthough 2ay and 2ahman-s

($%%! study uses firm.level data, it excludes performance aspects and does not include #M# in thescope of their study* Moreover, they are unable to control industry or sub.industry level influences on

the categorical dependent variable capturing the foreign or domestic ownership, probably due to the

limitation of ="*

7ased on the above discussions, we can formulate the following hypothesis constituting the

core of the analysis*

 FAs and DFs differ in terms of certain aspects of their conducts and performance due to the

ownership of or access to firm specific assets and their effective utilisation in the context of IMI *

and&or 

he firms with certain characteristics are more li!ely to appear as FAs than DFs

Iowever, the individual aspects of firm characteristics, conducts and performance between Fs

and "Fs are e+ually important* Therefore, we need to have sub.hypotheses on li0ely differences on the

individual aspects* Further, we predict that the li0elihood of a firm to appear as Fs (or "Fs! also

depends on the relative characteristics of various sub.industries of the #M#* Ience, the following sub.

sections summarises the theoretical arguments and the findings of empirical literature pertaining to the

individual aspects of relative conducts and performance of Fs and "Fs and accordingly forwards

testable hypothesis for this study*

Capital Structure or Financial Leverage )%*(+

Capital structure determines a firmHs value and refers to the way a company finances its assets

through some combination of debt and owned fund* Therefore, capital structure of a firm is represented

 by various measures of financial leverage (e*g* long.term debt to networth or long.term debt to total

assets!* 1ince the seminal wor0 of Modigliani and Miller ('G68!, alternative theories of capital

structure have been developed which include trade.off theory, the pec0ing order theory and the agencytheory* 7esides, a plethora of empirical research has been done to identify the determinants of

corporate capital structure and financial leverage* These researchers have identified firm si/e, age,

growth prospects, profitability and retained earnings, volatility in earning, tangibility of assets

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(proportions of fixed assets in total assets!, non.debt tax shield (N"T1! , asymmetry in information

and agency cost, ban0ruptcy, business and foreign exchange ris0s, as the major determinants of

corporate capital structure and financial leverage (0htar and 7arry $%%G!*

s the Fs and "Fs may differ in respect of some of these determinants of capital structure (or

financial leverages!, we expect Fs and "Fs to differ in terms of financial leverage* #n comparison to"Fs, Fs being part of MNE system are expected to have lower volatility in their earnings and

increased access to international capital mar0et, both of which, in turn, would enable Fs to sustain a

higher level of debt without increasing their default ris0 (1hapiro 'GGK Eiteman et al* 'GG8, pp* 68.

%!*

#n contrast to the above, the following arguments suggest financial leverage in Fs to be lower

than that in "Fs@ First of all, as per the MyersHs ('G8;!  pec!ing order theory of capital structure, if a

firm is more profitable, it is more li0ely that it would finance its assets more from the internal sources

(e*g* retained earnings which is part of networth or owned fund of a firm!, which is easier, readily

available and more cost effective than the external sources* s Fs are expected to be more profitable

than the "Fs, the former may retain lower financial leverage* 1econdly, the financial and fiscal

expertise coupled with multinationalisation enables better utili/ation of taxation regulations across

countries and reduction in tax liabilities in MNEs, implying Fs can have higher N"T1 than the "Fs

(1ingh and Iodder $%%%!* s the tax benefits of maintaining higher leverage are relatively less

valuable for firms with higher N"T1, the Fs (i*e* firms with higher N"T1! are expected to have

lower financial leverage than "Fs* Finally, firms with higher agency costs of debt are expected to have

lower debt levels (>ensen and Mec0ling 'G)K "ou0as and Dant/alis $%%!* Fs- agency costs are

expected to be higher relative to "Fs due to higher auditing costs, language differences, and varying

legal and accounting systems (7urgman 'GG!* #n sum, since the some determinants of capital structure

vary between Fs and "Fs, the former may have different capital structure than the latter*

There exist several empirical studies comparing capital structure of MNCs and "Fs but all of

them are based on the experience of the developed countries* These studies apanK =ee and 5wo0 ('G88!, 7urgman ('GG!, Iomaifer et al* ('GG8!, Chen et al* ('GG)!,

Ch0ir and Cosset ($%%'! and "ou0as and Dant/alis ($%%! for L1? report that Fs are less leveraged

than the "Fs* Mittoo and Ahang ($%%8!, however, find that the Canadian MNEs have higher financial

leverage relative to their domestic counterparts* study by 0htar ($%%6! did not find significant

8 +s $er the accounting $ractice, the interest on debt is deducted before arriving at net $rofit while dividend is deducted after net $rofit.Since the cor$orate ta% is deducted before arriving at net $rofit, financing through e

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difference in level of leverage between ustralian MNCs and stralian "Fs* Ience, the majority of the

studies report Fs to be less leveraged than "Fs*

#n view of the above reasoning and findings, we hypothesi/e in the context of #M# that@ i! Fs,

as compared to "Fs, will be less financially leveraged, and ii! firms with lower value of financial

leverage shall have the higher probability to appear as the Fs*Firm's Size )#,+

The si/e of a firm is a complex variable and may reflect the influence of several factors,

including the amount of resources owned by a firm* Firm si/e is an indicator of managerial and

financial resources available in the firm, and to the extent that excess resources are available, a firm

will loo0 for opportunities for expansion (Denrose 'G6G!* 7esides capturing amount of resources owned

 by a firm, the large si/e acts as an advantage in attracting bigger clients, gathering and processing of

information, achieving economies of scale and scope in production and mar0eting, exerting political

 pressure and winning favours from the government (Mueller 'G8, p*'G!* s substantial resources and

sun0 cost are involved in establishing and operating in a foreign location, Fs are li0ely to be larger

than "Fs* 1ome studies in East sian countries have found that Fs tend to be relatively large in

comparison to "Fs (see 2amstetter 'GGGaK Ta0ii and 2amstetter $%%!*

e hypothesise that i! the average si/e of Fs would be greater than that of "Fs, and ii! firms

with greater si/e have probability to appear as Fs*

Firm's Age )A-*+

The oldest and biggest firms in the #M# are a few public sector enterprises set up by the 9o#

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Choice of Technique )CAPI+

The choice of techni+ue (or technology! of production used by a firm in an industry is generally

captured by its capital intensity* Theoretically, all the firms belonging to an industry, by reasons of

common technology, are expected to operate with the same level of capital intensity* Iowever, the

capital intensity of Fs may be higher than that of "Fs for the following reasons* First, "Fs economi/eon use of capital (than labour! in developing countries because they generally face higher cost in

raising capital (than Fs! in the external mar0et* The opportunity for accessing capital for "Fs based in

a developing country is mostly limited to the domestic mar0et, while Fs have better capabilities and

opportunities to raise capital and spread ris0 globally* Iowever, capital is normally expensive in the

domestic mar0et of the developing countries* Therefore, "Fs have to rely more on expensive capital

 being available in the domestic mar0et* Even if "Fs of a developing country can access capital from

the international mar0et, they have to normally pay higher rate of interest or service charges than that

 paid by the Fs* "ue to the better corporate image of MNE system, "Fs are sometimes crowded out

 by Fs even in their own domestic mar0et* Ience, cost of raising capital domestically or

internationally is generally higher for "Fs in relation to Fs* 7esides, Fs can also access cheaper

internal sources of credit (e*g* the cash flow of the MNE.networ0! without paying a ris0 premium

(4ulton 'GG8!*

1econdly, the MNEs originating in the developed countries have comparative advantage in

 producing capital.intensive goods* Therefore, their Fs may have affinity towards more capital

intensive industries or more capital.intensive segments of an industry* MNE critics often allege that

Fs do not adapt their capital.intensive techni+ue of production to the labour abundant conditions of

developing countries (>en0ins 'GG%!* The reasons being that@ i! Fs are able to pass on the higher cost

of inappropriate technology to the customers due to their mar0et power, ii! there may not be ade+uate

demand for the product so as to justify the FHs investment in adjusting the product to the comparative

advantage of the host developing country (>en0ins 'GG%!*

Earlier empirical researches have focused maximum on the choice of techni+ue aspect of the

comparative behaviour of foreign and local firms in the developing countries* 7ased on a survey of a

large number of empirical studies pertaining to the developing countries, >en0ins ('GG%! report mixed

results but find considerable evidence about Fs to be more capital intensive than "Fs in the

manufacturing sector of =atin merican countries, #ndia, Da0istan, 1outh 5orea and 5enya* Ie

concludes that when local and foreign firms are often in direct competition, producing similar products

at similar scale of output, both ownership groups tend to employ e+ually capital.intensive techni+ues*

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There are not many studies examining the issue of choice of techni+ues for the period of 'GG%s and

$%%%s* Iowever, the studies by 2amstetter ('GG;, 'GGGa! for Thailand and other East sian countries

and Ngoc and 2amstetter ($%%;! for Bietnam suggests Fs to be relatively more capital intensity than

"Fs*

e hypothesise that the capital intensity of Fs would be higher than that of "Fs and morecapital.intensive firms will have greater probability to appear as Fs in the #M#*

 Research and Development Intensit ).DI+

MNEs are well suited for technological innovations and commerciali/ation of technology

generated by other agencies (e*g* research laboratories, universities, etc*! because they have easier and

larger access to financial resources and firm.specific assets, the ability to tap the global mar0et for

scientific and technical personnel, and to organi/e 23" and to utilise technological assets worldwide

("unning $%%%!* 4verwhelming literature on the internationali/ation of innovative activities suggests

that the MNEs tend to conduct little 23" outside their home base* The MNE literature (see e*g*

Castellani and Aanfei $%%, Chapter.' and "achs et al* $%%8! offers the following explanations for the

centrali/ation of the major part of 23" activities at the head+uarters of MNEs and for conducting only

a minor part of 23" activities by Fs in the host countries*

First of all, 23" generated products and firm.specific assets, including new products or

 processes, are mostly created and tested at the respective head+uarter locations of MNEs due to@ a! the

 person embodied nature of 0nowledge, b! the high level of uncertainty associated with the

development and testing of new products&processes, c! the strong complementarities between the

0nowledge base of MNEs and the technological competency of the home.based innovation system, d!

the economies of scale and scope in 0nowledge production*

1econdly, Fs have privileged access to the stoc0 of technology and 23" laboratories located

at their respective head+uarters* Therefore, Fs need to underta0e only asset exploiting 0ind of 23"

activities, involving minor expenditure for absorbing the technology and adapting intermediate goods

obtained from the MNE systems and for customisation of final products to the peculiarities of local

demand, regulations and standards of the host countries*

Thirdly, since technology is a main source of competitive advantages of MNE system,

centralisation of 23" activities at home location enables maintenance of secrecy and avoidance of

lea0ages to their competitors* Fourthly, MNEs by centrali/ation of 23" avoid coordination costs and

 principal.agent problem, which would result if 23" activities are located in different countries*

1&

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Finally, there could be a lac0 of scientific infrastructure and highly s0illed manpower, particularly in

the developing countries, re+uired for the 23" activities*

1ince the 'GG%s, however, MNEs have been shifting 23" activities from their respective

head+uarters to the locations of their Fs in select developing countries, including #ndia and China due

to a set of push and pul factors (LNCT" $%%6 and 1iddharthan $%%G!* #t is also reported that the Fsare complementing the traditional asset exploiting   23" activities with asset augmenting   23"

activities (Castellani and Aanfei $%% and 1iddharthan $%%G!* The asset augmenting  23" activities

re+uire decentrali/ation of 23" functions of MNE system for exploiting the technological advantages

(e*g* 23" infrastructure and uni+ue accumulated 0nowledge and inexpensive and high +uality s0illed

wor0ers! available in the high.tech laboratories and industries of the host countries (5uemmerle 'GGG!*

Thus, the asset augmenting   strategies re+uire Fs to spend more on 23" in their respective host

countries in addition to what is re+uired for the asset exploiting  23" strategies*

"espite the recent trend in the decentrali/ation of 23" activities a large number of empiric%al

studies, relating to both the developed as well as developing countries, reveal that Fs are not more

23" intensive than "Fs* #n most of the 4EC" countries Fs are characteri/ed by lower 23"

intensities as compared to the "Fs (4EC" $%%6!* #n a study of five small European countries (ustria,

"enmar0, Finland, Norway and 1weden!, "achs et al* ($%%8! find no difference in 23" intensity of

Fs and "Fs* #n a study on major developing countries of East sia and =atin merica, msden

($%%'! found that more the foreign ownership less the depth and breadth of 23"* #n the case of #ndian

manufacturing sector, overwhelming evidences suggest that the 23" intensity of Fs is not more than

that of "Fs

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technologies can be assimilated, absorbed and used for production purpose with some amount of in.

house technological efforts on the part of firm*

#t is normally expected on the basis of F"# theories that Fs should spend less or minimum

amount on import of technology, since they have access to technologies generated within the MNE

system at free or marginal cost* 4n the other hand, "Fs should have higher propensity to importdisembodied technology than Fs* The reason is that the "Fs with their limited resources and expertise

are generally incapable of generating new technologies on their own on account of high investment

and sun0 cost involved in 23" and ris0 of failure and appropriation associated with the development

of new technologies* Therefore, "Fs generally prefer to import the foreign technologies often available

with MNE system, even if the latter do not sell the latest technologies and put several conditions and

restrictions on the use and absorption of technology*

firm in the #M# generally uses complex technologies for manufacturing machineries and

e+uipments* Technological capability of a firm in this industry is determined by product design and

development capabilities and advanced engineering s0ills* s the "Fs in this industry could not

develop these capabilities through in.house 23", they have depended extensively on import of capital

goods and disembodied technologies for building their technological capabilities* 4n account of

automatic approval of foreign technological collaboration agreements and lifting of restrictions on

terms of payments and conditions for import of technology in the aftermath of reforms, the firms in #M#

have been heavily depending on import of disembodied technology via foreign technological

collaboration agreements (refer to Chapter. of this thesis!* #n fact, #M# received highest number of

approvals for the foreign technological collaboration agreements during ugust 'GG'. >uly $%%) (#bid!*

The empirical literature on transfer of technology in developing countries suggests that Fs

tend to spend more on import of disembodied technology than "Fs

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#t is thus hypothesi/ed that Fs spend greater amount on import disembodied technologies than

that of "Fs and firms with higher intensity to import disembodied technology will have greater

 probability to appear as Fs in #M#*

 Advertising and "ar#eting Intensit )AMI+

dvertising and mar0eting tactics and 23" are considered as the two major elements of non. price strategies followed by MNEs for differentiating their products and competing with their rivals*

Fs are expected to follow more intensive advertising and mar0eting strategies to promote sales of

their products than what is followed by "Fs* gainst this logic, one may also expect Fs to be

 pursuing less intensive advertising and mar0eting strategies than those adopted by "Fs in the #M# for

the following reasons@ i! #n the international as well as #ndian mar0et, brand e+uity of products sold by

Fs and corporate image of MNE system may have already been established and thereby MNE system

to which Fs belong may be well 0nown as a reputed supplier of producer goods* Therefore, it may

not be necessary for Fs to spend substantial amount on current advertising and mar0etingK ii! Fs

may be concentrated in segments of machinery industry, which may not re+uire substantial advertising

and mar0eting campaign for the enhancement of sales* #nstead, these segments may depend more on

increased efforts towards 23" for product differentiation and adaptation*

4nly a small number of empirical studies have compared advertising intensity of Fs and "Fs

in the industrial sector and findings of these studies are not conclusive (>en0ins 'GG%K 5umar and

1iddharthan 'GG)!* Iowever, most of these studies do not control for other firm or industry.specific

characteristics while comparing the advertising intensity of "Fs and Fs (>en0ins 'GG%!* dvertising

and mar0eting, a phenomenon associated with imperfectly competitive mar0et, are used as a means to

reduce the scope and effectiveness of price competition by creating product differentiation and strong

goodwill for the firm* dvertising and mar0eting are widely accepted as the most effective methods of

 product differentiation among firms in consumer goods industry* #n a producer goods industry li0e

machinery industry, advertising and mar0eting expenses related to selling of goods may be less

important in creating product differentiation* e, therefore, capture product differentiation advantage

of a firm in machinery industry partly by its advertising and mar0eting intensity (M#! and rest by

23" intensity*

#n view of the above arguments, we feel that the M# of "Fs and Fs may not differ

significantly in the #M#*

 $%port Intensit )/I+

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Fs have the following advantages over "Fs in underta0ing exports (9reenaway and 5neller

$%%), 5neller and Disu $%%)!@ First, FsH access to superior technology and organisational and

management practices leads to higher productivity8,  cost competitiveness, better +uality and +uic0

delivery of their products and after sale services* 1econdly, production and mar0eting networ0 of the

MNE system itself provides an outlet for the intermediate and final products of Fs* Thirdly, entry inthird country export mar0et re+uires incurring sun0 cost* 1ince MNEs are better placed than "Fs in

terms of financial resources and have already incurred major part of sun0 cost by virtue of

multinational scope of their operation, Fs may find it easier (than "Fs! to penetrate in the

international mar0et, particularly in the mar0ets with high barriers to entry or of highly differentiated

and technologically sophisticated products* Fourthly, Fs are better e+uipped to resist protectionist

 pressures in their home countries in such a way as to favour imports from their affiliates (Ielleiner

'G88!*

gainst the above arguments, there are the following reasons to believe that the export intensity

of Fs may not be more than that of "Fs* First of all, a MNE operates with the help of its worldwide

networ0 so as to maximise the global profits but not necessarily the profits of its individual subsidiaries

(Iymer 'G)!* Thus, a parent MNE, which has control over its Fs, may not allow them individually

to maximise exports and profits resulting from exports, if these are expected to reduce the MNE-s

global profitability* This is sometimes accomplished by under pricing the exports from MNE affiliates

to parent firm or to other affiliates in the MNEHs networ0*

1econdly, technology transfer and financial agreements between the MNEs and their Fs often

include restrictive clauses controlling the export behaviour of the latter* 27# ('G86! study on #ndian

manufacturing sector has pointed out high incident of restrictive clauses either totally prohibiting or

strongly limiting the latter-s exports* Thirdly, if the nature of F"# is mar0et see0ing, export intensity of

Fs and "Fs may not differ significantly (Nayyar 'G)8!* Fourthly, if Fs suffer from higher cost of

 production relative to their parents and others affiliates in the parents networ0, their ability to export

would be limited (bdel.Male0 'G);!* This may happen if Fs are greatly affected by liability of

 foreignness and Fs are unable to develop Fs specific advantage*

Most of the older empirical studies examining the export performance of Fs vis " vis "Fs in

the manufacturing sector of developing countries have shown mixed results and used divergent and

unsatisfactory methodologies of comparing Fs and "Fs (refer to Casson and Dearce 'G8) and >en0ins

'GG% the surveys of literature!* The recent studies on developing countries which mostly use firm.level

2*inding in this indeed shows that *+s are more technically efficient than #*s.

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data and econometric techni+ues indicate Fs to be more export oriented than "Fs*   These studies

include 2amstetter ('GGGa and 'GGGb! on selected East and 1outh East sian CountriesK 1un ($%%G!,

"u and 9irma ($%%)! and Fung et al* ($%%8! for Chinese manufacturingK =ut/ and Talavera ($%%;! on

L0raineK >ensen ($%%$! on DolandK 2asiah ($%%6! for textiles and garments, food and beverages and

metal engineering firms in 5enyaK 2asiah ($%%;! for electronics exporting firms in Malaysia,Dhillipines and ThailandK Chudnovs0y and =ope/ ($%%;! for ME2C41L2 countriesK Ngoc and

2amstetter ($%%;! for BietnamK 2asiah and Mala0olunthu ($%%G! for electronics exporting firms in

MalaysiaK ignaraja ($%%8a! for a sample of clothing firms in 1ri =an0aK Correa et al* ($%%)! for

Ecuador* 5umar-s ($%%6! literature survey on #ndian studies reveals statistically insignificant difference

in the export performance of Fs and "Fs during pre.reform period in majority of the cases*G

#ndian studies pertaining to post.reform period report mixed results* Employing a cross.section

spline regression method, Chhibber and Majumdar ($%%6! concludes when property rights devolves

une+uivocally to foreign owners (i*e* with majority ownership of e+uity! the #ndian firms display

higher export orientation* #n the case of #ndian information technology sector, 1iddharthan and Nollen

($%%;! report that the export intensity of Fs is greater than that of "Fs* 7haduri and 2ay-s ($%%;!

firm.level study provides wea! evidence on Fs to be more successful in exporting than the "Fs in

#ndian pharmaceutical industry but find no difference in export intensity of Fs and "Fs in the case of

electrical&electronic industry* Lsing 4=1 method, 2asiah and 5umar ($%%8! report Fs to be better

than "Fs in terms of export intensity in automotive parts industry* 2ay and 2ahman ($%%! and 2ay

and Benai0 ($%%8!, however, came to the conclusion that Fs are less export intensive than the "Fs

 belonging to the chemicals, electronics and transport e+uipment industries*

#n view of the above discussions, we hypothesi/e that@ i! Fs are more export intensive than

"Fs, and ii! more export intensive firms shall have greater probability to appear as Fs*

 Intensit of imported Intermediate &oods )MI+

firm can procure capital goods, raw material, components and spare parts locally or import

the same* #n the former case, the firm creates bac0ward lin0ages, which helps in building additional

capacities for production of raw material, components and other intermediate inputs, etc* in the host

economy* #t is said that the Fs have fewer lin0ages with the host economy than the "Fs as the former

on the average maintains the higher intensity of imported intermediate goods (M#! than the latter based

in the same industry* 7ased on the literature on F"# and import of MNEs, the following explanations

for higher import orientation of Fs over "Fs can be offered*

39efer to +$$endi%41 of ha$ter4/ for details about the studies conducted during the $re4reform $eriod.

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First of all, Fs normally perceive the reliability and +uality of supply in the host developing

country to be inferior* Therefore, they prefer to source their input re+uirements including machinery,

raw material and components from the MNEs system including parent and its affiliates (2ugman 'G8',

Iennart 'G8!* The use of imported and superior raw materials and capital e+uipments ensures better

+uality of products leading to barriers to entry (or mobility! through differentiation advantage (2ay andBenai0 $%%'!* The importance of +uality factors may be more important in the context of machinery

industry, since the efficiency of the user industries of machinery industry largely depends on the

+uality, reliability, durability, precision and overall efficiency of machineries and e+uipments supplied

 by the machinery industry*

1econdly, even if cost, +uality and reliability of supplies are the same, a MNE affiliate may

 prefer to obtain inputs from its parent or parent-s networ0 so that the parent can capture supplier-s

 profits and utili/e economies of scale in production and distribution* 7esides, continuing to import

intermediate inputs provides opportunities for transfer pricing which may be lost with local sourcing

(>en0ins 'GG%!*

Thirdly, it is possible that the MNE may have preferential access to relevant raw material and

machinery used for the production and may be operating in a product segment, which has less vertical

lin0ages in the host-s mar0et* Finally, MNEs may have interest in maintaining high import content to

 please home country trade unions and the governments respectively worried about jobs and about trade

deficits or loss of production and employment to a foreign country (Nat0e and Newfarmer 'G86K Nat0e

'G8)!*

#n the high technology industry such as machinery, "Fs may also depend on imports for

sophisticated machinery, capital goods and other critical inputs but they are less li0ely to be tied to the

overseas supplier* They will attempt to indigenise the imported items as soon as possible so that they

can capture the suppliers- profits* #n case the inputs are available in the local mar0et, "Fs may procure

the inputs from the local producers to ensure the timely supply rather than bothering too much about

+uality of the supply* Further, the "Fs may not prefer importing because they may not be well e+uipped

to bear or tac0le the uncertainty of exchange rate fluctuations and hassles of importing from the

international mar0et about which they obviously have less information than a MNE* Furthermore, "Fs

normally operate on the lower end of the industry that may not re+uire such sophisticated technologies,

capital goods and raw materials, etc* for which they have to depend heavily on import*

The majority of the earlier studies in developing countries reveal that the Fs are more import

intensive than "Fs (>en0ins 'GG% and 1iddharthan and 5umar 'GG)!* The latest studies on #ndian

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manufacturing sector and the literature survey therein

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Fifth, MNEs follow superior corporate governance practices as compared to "Fs* Therefore,

the top managements in Fs may be under higher pressure to perform and show better efficiency than

the management of "Fs, especially after MNEHs ta0eover of a local firm through a strategic

investment*

1ixth, Fs have access to financial capital of MNE system, which ma0es financing of the business of Fs easier and cheaper compared to that of "Fs*

1eventh, as compared to "Fs, Fs generally employ and retain highly s0illed wor0ers by

 paying them higher wages and by constantly upgrading their s0ills through regular trainings and

exposure to best.practices in the industry*

Eighth, since the MNEs have global outloo0, they are able to respond +uic0ly to the changes in

the policy environment, emerging opportunities and locational advantages of a country* For instances,

they may invest and divest plants fre+uently, achieve better match between locational advantages and

F1s, cherry pic0 plants&firms with above average productivity in an industry* This is almost

impossible by uni national "Fs and possible to a much lesser extent by newer MNEs head+uartered in

a developing country*

 Ninth, the gap in the productivity&efficiency between the home country of a F and the host

country may be reflected in the gap in productivity&efficiency of Fs and "Fs* Thus, the TE of Fs

may also be higher than "Fs because Fs are lin0ed to MNEs head+uartered in the developed home

country and "Fs are based in a developing host country li0e #ndia* #t may be noted that the average

labour productivity of #ndian manufacturing firms are lower compared to the other countries of

emerging mar0et economies (=a0shmanan, et al* $%%)!*

1everal studies pertaining to the period 'GG%s and $%%%s for the developing countries report

Fs to be more productive than "Fs

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ThailandK Menon ('GG8! and 4guchi ($%%$! for MalaysiaK 5onings ($%%'! for 7ulgaria and 2umania?

suggest that F are not more productive than "Fs*

#n this study, we capture the efficiency by a measure technical efficiency which for a given firm

(in a given year! is defined as the ratio of its mean output (conditional on its level of factor inputs and

firm effects! to the corresponding mean output if the firm utili/es its levels of inputs most efficiently(7attese and Coelli'GG$!* This measure of technical efficiency by design has values between /ero and

one* The method and derivation of technical efficiency is explained in ppendix.'*

&ross rofit "argin )-PM+

The reasons for higher profitability in case of Fs compared to "Fs may be the following

(>en0ins 'G8G!* First of all, as discussed in the last sub.section, Fs may enjoy higher technical

efficiency&productivity* 1econdly, Fs may face favourable demand conditions for their products in

developing countries whether they enter into an existing industry (either through 9reenfield venture or

ac+uisition! or an entirely new industry* #n the case of an existing industry, Fs may set price initially

in line with the higher average costs generally prevailing in the industry* 1ince Fs have cost

advantage over existing "Fs, the former enjoy surplus profits* #n the case of a new industry, where the

demand conditions are +uite favourable in relation to supply, Fs would be able to charge a high price

and thereby earn higher rate of profit*

Thirdly, customers of developing countries may also perceive products of MNEs as superior in

terms of non.price attributes such as +uality, technological sophistication, reliability, durability, just.in.

time delivery and after.sales service even if they may not mind paying higher than mar0et price for the

same* Finally, as explained by 5umar ('GG%!, Fs and "Fs constitute two different strategic groups in

#ndian manufacturing sector* Further, the group of Fs enjoys greater protection from mobility

 barriers'$  and thereby attain greater profitability on account of mar0et power, notably in the

0nowledge.based industries*

Empirical evidence concerning the existence of profitability differential between "Fs and Fs

is mixed but in majority of the cases Fs outperform the "Fs in terms of profit performance* >en0ins

('G8G! in his survey concluded that Fs do enjoy higher profitability (than the "Fs! based in the

manufacturing sector of the developing countries, mainly on account of their productivity advantages

and higher demand for their products* Iowever, these studies are +uite dated and use rudimentary

methods of comparisons* 7ella0-s ($%%;! survey includes more recent studies which employ

1&Mobility barriers are defined as entry barriers, which not only im$ede fresh entry to the industry but also restrict inter strategic grou$mobility of the e%isting firms. Thus, firms in a $articular strategic grou$ may not only enCoy $rotection from new entrants to theindustry but also from e%isting firms belonging to other strategic grou$s in the same industry (umar 133).

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econometric methods for comparing the profit performance of Fs and "Fs* Iowever, he too finds

mixed results* Ie explains the reasons for mixed results in terms of differences in the +uality of data

used across the studies and rent shifting through the use of transfer pricing mechanism adopted by the

MNEs*

1ome studies in the context of East sian countries

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firm.level performance variables, namely, TE and 9DM* 1econd, firms with higher TE and 9DM may

have greater probability to appear in the group of Fs than in the group of "Fs*

 Inde% of "ar#et Concentration )IMC+

Iymer ('G)! stresses that the MNEs are prevalent in concentrated mar0ets where the few

firms command major share of the sales (Caves 'GG, chapter ;!* #n such mar0ets, sellers are not priceta0ersK and the best response of each seller is conditional upon the actions of other sellers* =all ('G)8 3

'G)G! and others suggest that the operations of Fs are li0ely to increase the industrial concentration in

the long.run and thereby they may be found mostly in the concentrated industries* The following

factors are considered chiefly responsible for this phenomenon@ (i! inefficient small firms may exit or

merge in the face of increased competition from Fs having competitive advantage over "FsK (ii! Fs

may use their privileged access to financial resources to outlast their rival by resorting to price and non.

 price warfare, and predatory practices* The distortions in mar0et for firms considerably favour MNEs

in buying out of local companies (Newfarmer 'G8!K (iii! the conducts of Fs may have an indirect

effect on concentration by stimulating defensive amalgamations among "Fs and raising barriers to

entry for new entrants*

The TC# approach of F"#, however, seems to suggest that entry of MNEs creates more

competition and brea0downs the existing oligopolistic structure, particularly in the developing

countries* Therefore, it is more li0ely that Fs are present in less concentrated and more efficient

industries* Ience, it is difficult to predict whether firms in a concentrated industry or sub.industry will

have more (or less! probability to observe as Fs*

#M# constitutes $; product groups which differ amongst each other in terms of the level of top

four.firm sellers concentration ratios* firm in #M# may predominantly operate in one or in a few of

these product groups* 1ome of these product groups may have more presence of Fs while other may

have less* To examine the relationship between mar0et concentration and probability of the firms to

appear as Fs, we have devised a firm.specific index of mar0et concentration (#MC!, which is a

weighted average of the four.firm sellersH concentration ratios of each of the product groups in which a

sample firm predominantly operates*

 Su!(Industr Level Influences

To minimi/e the industry.level influences on the probability of a firm to appear as F, we have

selected a single industry, the #M#* Jet, this industry covers several sub.industries, which may differ

among each other in terms of product profile, demand conditions, and the barriers to entry stemming

from the technological sophistication, choice of techni+ues of production, level of product

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differentiations, minimum efficient scale of production and initial capital re+uired for setting up plant,

gestation period, etc* The sub.industries may also differ in terms of productivity, profitability and

growth prospects, etc*

MNEs are better placed due to their asset advantages (than "Fs! to overcome barriers to entry

in a host country industry* #t is also observed that the MNEs are more attracted towards industries withfour characteristics, notably, high levels of 23" relative to salesK large share of professional and

technical wor0ers in their wor0 forcesK products that are new and &or technically complexK products

with high levels of differentiations created through advertising, mar0eting and other means (Mar0usen

'GG6, LNCT".#2 $%%6!* Ience, a firm has probability to appear as Fs, it belong to a sub.industry

of #M# with higher barriers to entry and with above characteristics* To capture sub.industry specific

characteristics, we construct ) sub.industry specific dummy variables (1#"',P,1#")! corresponding to

the ) sub.industries (1#',P,1#)!* The sub.industry 1#% acts as the reference industry*

The method of construction of firm and year.specific TE is explained in ppendix.' and

measurements of remaining variables are explained in the ppendix.$*

0 Period& Data and #ample

The specific time period of our study covers seven financial years (FJ! $%%%&%' to $%%&$%%)*

"uring this period #ndia has become one of the most attractive destinations for F"#* There has been no

major change in policies affecting the #M#* Jet, the first ; years of this period were characteri/ed by

slow growth in the #M# and the remaining period was mar0ed by a significantly higher growth

compared to the first period* Empirically, this suggests that we should control for time effect in the

 proposed econometric analysis* The period of study is also important from the point of view of #ndian

companies adopting better accounting standards, which has made the presentations and descriptions of

financial statements more detailed, transparent, accurate and uniform across the firms* s our study

uses firm.level data originally sourced from the annual reports of the companies, these developments

add additional feature to our study over the studies that have used data pertaining to the period prior to

the year $%%%*

e obtained basic data on a number of financial and non.financial parameters for each year of

the study for designing various indicators to capture conducts and performance of a firm for carrying

out the empirical exercise* The major portion of this data and information was sourced from the

D24E11 database . an electronic database on information about the financial statements and various

other aspects of #ndian firms designed by the Centre for Monitoring the #ndian Economy (CM#E!* "ata

sourced from the D24E11 was supplemented and sometimes cross chec0ed by obtaining relevant

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information from additional sources and publications, namely  #ombay $toc! %xchange Directory&

 Annual 'eports of some companies,  (apital )ine *le  (another electronic database! or even by

 personally contacting the companyHs representatives in the case of some doubt on data.  e also

ac+uired data from CM#E-s Industry Mar!et $i+e and $hare chiefly for constructing a variable on the

index of mar0et concentration* e also used some price deflators for which data was collected fromvarious publications of the 9overnment of #ndia (9o#!* For each year of analysis, we compiled relevant

 product&industry.wise data on ,holesale rice Index  (base year 'GG.G;! from the D# series

 published by the 4ffice of Economic dvisor (4E!, 9o#* 1imilarly, we accessed year.wise data on

the All India (onsumer rice Index umbers /0eneral1 for Industrial ,or!er  (base year 'G8$! from

the =abour 7ureau, 9o#* ith the help of compiled data, we designed appropriate firm.level and sub.

industry level indicators*

e extracted a list of all firms belonging to the #M# available in D24E11 database* e

included all those firms in the sample for which data on each of the relevant variables were available

for at least $ years of the ) financial years of the study* Further, we deleted sic0 companies, i*e*, the

companies with negative networth in a financial year, mainly with a view to remove outlier effect from

the analysis* These exclusions left us with a usable sample of unbalanced panel of ')) firms with G

observations* The si/e of overall sample (as well as the si/e of each sub.sample of "Fs and Fs! varies

from year to year during the period $%%%&%' to $%%&%) of the study* s a result, we have an

unbalanced panel of firms with total number of observations over $%%%&%' to $%%&%) aggregating to

G including $' for sub.sample of Fs and )6 for sub.sample of "Fs* The number of all firms

observed in each year is lower than ')), ranging from '$; to ';; in the various years of the study*

"espite sample si/e being smaller than that of the D24E11 database, share of sample firms

in respect of some aspects of corporate financial indicators (say sales turnover or net worth! of the #M#

during the period of the study ranges from per cent to G% per cent depending on the individual

aspects of financial indicators* #n particular, sample firms in aggregate over $%%%&%' to $%%&%)

covered 8 per cent of sales turnover, G% per cent of gross profit, 86 per cent of net worth, ); per cent

of gross fixed assets, G per cent of total assets, per cent of foreign exchange earnings and ); per

cent of foreign exchange outgo of all the firms belonging to the machinery industry as classified in the

D24E11 database* Considering the fact that D24E11 covers almost entire corporate sector, our

sample with such shares on the individual aspects of financial indicators can be considered as the good

representative of the corporate sector of #M#*

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Table.' summarises the descriptive statistics of individual variables used in the study* The

descriptive statistics include mean, standard deviations (overall, between and within!, minimum and

maximum values of each variable* The table reveals that the FC" as well as all the sub.industry

specific dummy variables have no within group variation in their respective data* To 0now the severity

of multicolinearity problem associated with the sample, we obtained the matrix of correlationcoefficient between a pair of regressors and variance inflation factor (B#F! '* s a rule of thumb if the

 pair.wise or /ero.order correlation coefficient between two regressors is high, say, in excess of %*8%,

multicolinearity is considered as a serious problem (9ujarati $%%;, p* 6G!* gain, as a rule of thumb,

if the B#F of a variable exceeds '% that variable is deemed highly collinear (9ujarati $%%;, p* $!* #n

view of these rules of thumb the values of B#F and correlation coefficient did not reveal any serious

multicolinearity problem*

#tatistical and *conometric Methods

There exists variety of methods that can be used for examining the issues set out in the

objectives of the study* The most rudimentary method involves the univariate group mean comparison

techni+ue that compares one characteristic at a time while ignoring a large number of other

discriminant factors* Therefore, it would be appropriate to extend&enrich and compare the findings of

univariate analysis with the results obtained from multiple variable techni+ues* The multiple variable

techni+ues have advantage over univariate analysis for the former can consider an entire profile of

characteristics common to relevant firms* To classify or ma0e predictions in situations having

dichotomous categorical dependent variable, empirical researchers have mainly employed and

estimated three types of multivariate models, namely, linear discriminant analysis (="!, logit and

 probit regression models*

1 2nivariate Method of Analysis

The first step of this techni+ue involves classification of an observation into one of the several a

 priori groupings based on certain criteria (e*g* the two groups of Fs or "Fs in our study are based on

the criterion of at least $ per cent e+uity holding in a company by the foreign promoters!* '; #n the

second step, the value of mean and standard deviation of a variable representing particular

characteristic of a firm is calculated for the each group* Finally, a suitable statistical techni+ue is used

16 D'* shows the s$eed with which variances and covariance increase and can be defined as D'* 1@(14r&&6 ), where r&&6  is thecoefficient of correlation between F &  and F 6. 't is called variance inflating factor because it shows how the variance of anestimator is inflated by the $resence of multicolinearity. 'f there is no colinearity between F & and F 6 D'* will be 1. ?hen r &&6a$$roaches 1, D'* a$$roaches infinite. (0uCarati &:, ha$ter 1).

1: The grou$s could be more than two also in a discriminant analysis.

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for testing the significant difference in mean value of a particular variable between the two groups* The

univariate means comparison method may provide important clues about differences in conducts and

 performance of Fs and "Fs* To compare each aspects of conduct and performance of two groups of

firms in a univariate framewor0, we conduct elch-s t.test using two.samples having une+ual

variances* To conduct this test we first of all need to calculate mean and standard deviation ofindividual variables for each sub.sample of Fs and "Fs* Thereafter, we are to obtain t.statistics with

the help of 1TT software These statistics are used with t.distribution to test the null hypotheses (Io!

for each variable that the difference in mean between the groups of Fs and "Fs is /ero (using a two.

tailed test! against the alternative hypothesis (Ia! that the groups have different means* #n other words@

I%@ mean (F! Q mean ("F! R diff R % against Ia@ diff S R %

e preferred to use two.tail test because of the possibility that mean of a variable for Fs may be less

or more than that of "Fs* The tests yields p.value that may (or may not! provide evidence sufficient to

reject null hypothesis*

6*$ The Empirical Models of Multivariate nalysis

The linear discriminant function used for the discriminant analysis and the empirical e+uations

corresponding to the theoretical models of =", logit and probit, as detailed in the ppendix.$, are

 presented below@

 )inear Discriminant Function

A R b%  b'9DMit  b$ TEit  b 2"#it  b; MT#it  b6 M#it  b CD#it  b) 1Ait  b8 9Eit  bG =EBit

b'% #it  b'' M#it  b'$ #MCit  b' 1#"'it ,P,b'G 1#")it   ('!

 )ogit regression

Dr R E (FC"it R'U ! R '&

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criteria* The e+uation ('! is estimated for ="* E+uation $ (or ! and ; represent logit and probit

models respectively in which Dr R E (FC"it R'U ! denotes conditional expectation of FC"it given (a

vector of explanatory variables! or conditional probability that a firm will appear as F given * The

logit model is expressed in two forms, notably by non.linear e+uation ($! and linear e+uation (!* #n

e+uation , the odd ratio Dr&('.Dr! shows the ratio of the probability that a firm will appear as F to the probability that a firm will not appear as F*

The probabilistic models (notable the logit model! are considered as the better substitutes of

discriminant analysis* Jet, the estimation results of the probabilistic models are interpreted in a slightly

different manner than that of ="* The probabilistic models, both logit as well as probit regression

models, relate a +ualitative dependent (usually dichotomous! variable to a set of continuous and&or

categorical independent variables* Drobit model uses a normal cumulative distribution function (C"F!,

whereas the logit model employs logistic C"F, to model such relationships between a dichotomous

dependent variable and the independent variables* #n case of this study, both the models estimate the

 probability of observing a firm in the group of Fs (or "Fs!* Thus the positive sign of the estimated

coefficient of an independent variable in these models will denote that the variable increases the

 probability of the firm to appear as F*

Each one of the three models is estimated with the help of unbalanced sample of pooled data on

individual variables used in the model* Lse of pooled data set of cross.section firms over a period of

time provides us with a larger number of data points* Therefore, it increases the degrees of freedom and

reduces the co.linearity among explanatory variables and, hence, improves the efficiency of

econometric estimates* The panel data models, besides the improving efficiency of econometric

estimates, enable us to disentangle the unobserved heterogeneity (or individual effect! from the data,

which remain constant over time* Estimation of panel data models re+uires that there should be within

group variation in the dependent variable for ade+uate number of groups* "espite the superiority of

 panel data models we are restricted to use only the pooled data model, as our data on FC" does not

have any within group variation* The absence of within group variation in FC" also prevented us from

using year.specific dummy variables*

3 .esults

31 2nivariate Analysis

Table.$ summari/es the results on mean, standard deviation and tests of e+uality of group

means of Fs and "Fs with respect to '' firm specific variables representing various firm.level

characteristics including conducts and performances* T.statistics in respect of each variable is obtained

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 by applying the formula explained in section 6*'* Thereafter, we test the null hypothesis that the

difference in mean value of each variable between the two group of Fs and "Fs would be /ero* The

null hypothesis is rejected in the case of G variables* The results indicate that Fs, as compared to "Fs,

on an average achieve greater technical efficiency (TE!, gross profit margin (9DM! and export

intensity* s compared to "Fs, Fs spend higher portion of their revenue on research and developmentas well as on import of intermediate goods and disembodied technology* s the 23" activity and use

of imported technology re+uire higher level of s0ill, we may assume that s0ill intensity of Fs are

greater than that of "Fs* These results probably suggest that Fs do have firm.specific ownership

advantage over "Fs in terms of technology* #n relation to "Fs, Fs on an average spend less portion of

their revenue on advertising and mar0eting* #n other words, "Fs spend more towards creation of

 product differentiation advantage* #n comparison to "Fs, Fs are also bigger in terms of their si/e of

their operation* 2esults on relative 9E and CD# indicate that Fs and "Fs do not significantly

differ in terms of years of operations and choice of techni+ue* s compared to "Fs, Fs are also found

less financially leveraged, implying that the latter finance their operations more from owned fund than

from the borrowed*

s the univariate analysis places emphasis on each individual characteristic independently from

the others, it is imperative to build upon the findings of univariate analysis and combine several

characteristics in a meaningful predictive model* The next two sub.sections of this chapter underta0e

this tas0 with the help of =" and by estimating probabilistic models*

3! %inear Discriminant Analysis

Iaving developed various alternative multivariate models of relative characteristics of FCs and

"Fs, we first examine the results obtained from ="* =" was performed by using 1D11 Q the

 popular software for statistical and econometric analysis* Table. reports the results related to the

suitability of the =" in three panels, , 7 and C* Danel shows that the eigenvalue and canonical

correlation statistics are %*;'' and %*6 respectively, suggesting that the =" model is satisfactory at

discriminating between the characteristics of Fs and "Fs* The il0sH lambda statistics of %*)' shows

that only $G per cent variance in discriminant scores is explained by the differential characteristics of

Fs and "Fs* The il0sH lambda, however, is found significant* This indicates that we can reject the

null hypothesis that the Fs and "Fs have the same mean discriminant function scores and thereby

conclude that the overall model is discriminating*

Danel 7 assesses the contribution of each variable to the discriminant function* The results on

within group correlations between discriminant variables and standardised canonical discriminant

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functions indicate that variables 1#"$, 1#";, 1#"), 1#", CD# and 9E ma0e the lowest

contributions to discriminant function* e will see later that these variables are also found statistically

insignificant in explaining the dependent variable FC" in the probabilistic models* Thus, the selecting

a variable on the basis of its level of correlations with the discriminant function may be considered as a

good criterion for its inclusion in ="*Danel C presents the results on the test of e+uality of group covariance matrices assuming

multivariate normality* 7oxHs M test used for this purpose shows that the null hypothesis of e+uality in

the group covariance matrices can be strongly rejected* This may be due either to a failure of

multivariate normality or because the group covariance matrices are not e+ual* #n either case, the ="

approach, together with linear classification rule is inappropriate for estimating the model* #n the case

of large sample si/e, however, even small differences in covariance matrices may be found significant

 by 7oxHs M when in fact no substantial problem of violation of assumptions exists* Therefore, the

researchers also loo0 at the log of determinants of group covariance matrices* #f the group log

determinants are similar, a significant 7oxHs M for a large sample is usually ignored* 1ince this study

uses the large sample, we also analyse the values of log determinants, which turn out to be dissimilar

 between Fs and "Fs* Thus, we cannot ignore the significance of 7oxHs M and therefore consider the

use of =" less appropriate in the context of our study*

 Nevertheless, we present and examine the results of =" pertaining to the discriminating

characteristics of Fs and "Fs* #n particular, we examine the results of =" following the

Mahalanobis "istance (or "! s+uare procedure* Mahalanobis distance is the distance between a case

and centroid for each group of the dependent variable (Fs and "Fs! in attribute space (defined by the

independent variable!* case will have one Mahalanobis distance for each group and it will be

classified as belonging to the group for which its Mahalanobis distance is smallest* Thus, the smaller

the Mahalanobis distance, the closure the case is to the group centroid and more li0ely it is to be

classed as belonging to that group* 1ince Mahalanobis distance is measured in terms of standard

deviation from the centroid, a case which is more than '*G Mahalanobis distance units from the

centroid has less than %*%6 chance of belonging to the group represented by the centroid*

#n the stepwise procedure followed by 1D11, the variable that maximises the Mahalanobis

distance between the two closest groups is entered at each step* Table.; presents the results obtained

from the =" following the Mahalanobis " s+uare stepwise method* s in the case of Table., Danel

of Table.; shows that model is significant but does not fulfill the criteria of e+ual population

covariance matrices* Focusing on the results incorporated in Danel 7 of Table.;, we find that out of 'G

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variables included in the model only G variables. TE, 1A, #, M#, M#, MT#, =EB, 1#"' and 1#"6.

ultimately turn out to be significant discriminator between Fs and "Fs in the stepwise procedure*

Danel C reports the values of the estimated coefficients associated with each of these variables in the

discriminant functions of Fs and "Fs* e find that Fs as compared to "Fs are more technically

efficient, more export intensive and more intensive in terms of import of intermediate goods anddisembodied technology* Iowever, Fs are less leveraged and spend less as a share their sales on

advertising and mar0eting* Fs are also larger than "Fs* #t is to be noticed that =" does not find

9DM and 2"# to be a significant discriminator between Fs and "Fs* 4n the other hand, the univariate

analysis has found 9DM as well as 2"# of Fs to be greater than 9DM and 2"# of "Fs* Iowever, both

the univariate analysis and =" show that the 9E and CD# are not significant discriminators

 between Fs and "Fs*

e will see in the next section that, despite the unsuitability of =" for the sample used for this

study, the results obtained from =" are more or less similar to the results found from the estimation

of probit and logit models discussed in the next sections*

3$ Probit and %ogit models

7efore estimation of probit or logit models, we conducted several tests for detecting

heteros0edasticity associated with the variables used in the models* The results of these tests revealed

that the assumption of homos0edasticity is invalid* Thereafter, we estimate the probit and logit models

represented by the above e+uations by maximum li0elihood techni+ue with the help of 1TT

software* e also obtain heteros0edasticity.corrected standard errors by following hite.Iuber

method with the help of robust option available in the software*

Table.6 presents the results achieved by the estimations of the logit and probit models using the

maximum li0elihood methods* e may note at the outset that the estimated logit and probit models

offer similar results* The values of pseudo 2 $ show that both the logit and probit models achieve same

value of %*$, implying one cannot differentiate between these models on the basis of overall goodness

of fit* The values of ald chi$ and corresponding p.value of /ero suggests that the each (probit as well

as logit! model as whole is statistically significant, as compared to model with no regressors* Thus,

there is little to choose between probit and logit approaches*

The results on firm.specific variables show that the coefficients of 9DM, 9E, CD# and 2"#

are statistically insignificant* 4n the other hand, the coefficients of TE, 1A, #, M# and MT# are

 positive and significant and coefficient of =EB and M# are negative and significant in both the

models* Comparing the results of univariate analysis and =" against the results of probabilistic

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models, we find that@ a! 9DM and 2"# differ significantly between Fs and "Fs in univariate analysis,

while both are not found as discriminating factors between Fs and "Fs in ="* 9DM and 2"# also

do not impact the probability of a firm to appear as F in the presence of other variables in the both

types of the probabilistic modelsK b! 9E and CD# do not differ significantly between Fs and "Fs

in the univariate analysis, =" and the probabilistic modelsK c! the signs of the statistical significantcoefficients of TE, 1A, #, M#, MT#, M#, =EB are identical in every types of analysisK d! two sub.

industry specific dummy variables, 1#"' and 1#"6 appear as significant discriminators between Fs

and "Fs in =", but the coefficients of the same are observed statistically insignificant in both the

 probabilistic models*

s discussed earlier, the multivariate analyses based on probabilistic models are considered

more appropriate and theoretically sound, we thus consider the results obtained from the probabilistic

model to be the final* e therefore discuss these results elaborately and draw conclusions and policy

implications from the same* The estimation results of probit model on the factors that influence the

 probability of being a firm in foreign ownership also gives marginal effects (Table.6!* The marginal

effects are calculated for discrete change of dummy variable from % to ' at the sample means and

measured in terms of absolute value of a coefficient* mong the statistically significant explanatory

variables, the MT# has the greatest effects followed by M#, M#, TE, #, =EB and 1A in descending

order*

#ntensity of imported disembodied technology (MT#! with the highest positive marginal effect

indicate that the li0elihood of being F is the greatest for a firm that ma0es higher payment (as a ratio

of its sales! for import of foreign disembodied technology* These results are in line with the findings of

several #ndian studies cited in the section.$

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The second most important factor explaining probability of a firm to be in foreign ownership is

the advertising and mar0eting intensity (M#!* The significantly negative coefficients of M# observed

in the estimated probit and logit models show that the Fs spend less for creating product

differentiation advantage than "Fs* This result probably indicates that the already established

international image of MNEs and brand e+uity of their products are re+uiring Fs in the #M# to spendless on current advertising and mar0eting for creating product differentiation advantages* 7esides, the

Fs gain from the spillovers of the worldwide advertisements of their respective MNEs but do not

contribute monetarily for the same* nother reason cited by 2ay and 2ahman ($%%!, who do not find

 product differentiation to be a discriminator between Fs and "Fs, is that the threat from the entry of

large number of MNEs after liberalisation from 'GG' has forced oligopolistic "Fs to spend heavily on

advertising and mar0eting for the protection of their mar0et share*

The third factor is intensity of imported intermediate goods (M#!* The combined results on

higher intensities of import for intermediate good and disembodied technology can also be interpreted

as evidence of MNEs- indulgence in intra.firm trade at transfer prices for boosting their global profit*

#nflation of payment on royalty and technical fee by Fs has been used as good means for reducing

local taxes in the host country and transferring earned profit out of the host country (=ecraw 'G8,

7ella0 $%%;a!* 4ur finding on M# is in line with the recent findings in the #ndian studies

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minimise their tax burden and thereby show reduced profit, than they actually earn, may be responsible

for understating the profits of Fs and thereby the statistical insignificance of the coefficients of 9DM

in =" and probabilistic models* This is termed by 7ella0 ($%%;! as the accounting factor*

Dresumably, Fs are better at minimi/ing their tax burden than "Fs owing to the formersH affiliations

to the MNE system having better expertise and opportunities in terms of multinational networ0*Fourth, if opportunity cost of internally generated funds (i*e* retained earnings!