Summary

Summary - Doing Business in Emerging Markets

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Vrije Universiteit Amsterdam (VU)

This summary covers all the required readings for the Doing Business in Emerging Markets course. It is a summary that highlights the key points of each article and will give you enough information to pass the course.

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Uploaded on December 11, 2023
Number of pages 41
Written in 2023/2024
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emerging markets
doing business in emerging markets

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Vrije Universiteit Amsterdam (VU)
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Bedrijfskunde: International Management
Course
(E_BA_DBEM)

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Doing Business in Emerging Markets

Reading One - Hoskisson: Strategy in Emerging Economies
Introduction
An emerging economy can be defined as a country that satisfies two criteria: (1) a rapid pace of economic
development and (2) government policies favoring economic liberalization and the adoption of a free-market
system. The rapid and widespread adoption of market-based policies by emerging economy governments raises
important issues for the strategies adopted by private enterprises, both domestic and foreign. In addition,
privatization is one means of placing pressure on former public enterprises to effect major changes in their
strategies as they adapt to the competitive pressures of a market-based and open economy. At the same time as
domestic policies are becoming more market-oriented, emerging economy governments are opening their
countries to foreign markets and joining regional trading associations. Enterprise strategies in emerging
economies are facing strong environmental pressures for change, yet this change is neither smooth, automatic,
nor uniform across different markets.

Three Perspectives on Strategy in Emerging Economies
An Institutional Theory Perspective. Institutional theory emphasizes the influences of the systems
surrounding organizations that shape social and organizational behavior. Institutional forces affect organizations’
processes and decision making. The role of institutions in an economy is to reduce both transaction and
information costs through reducing uncertainty and establishing a stable structure that facilitates interactions.
Many emerging economy firms facing change were influenced by existing institutional realities. Institutions can
also facilitate strategy, allowing enterprises to react to and play a more active role in an institutional
environment if firms have an adaptive ability that allows them to move beyond institutional constraints.
A Transaction Cost Economics Perspective. Transaction costs economics studies the firm-environment
interface through a contractual or exchange-based approach. Where the transaction costs of markets are high,
hierarchical governance modes will enhance efficiency, although hierarchical modes can have their own
bureaucratic costs. Therefore, the rational governance choice requires a trade-off, at the margin, between the
transaction costs associated with the market mode, a firm’s need for control, and the governance costs of
hierarchy. Organizations will dominate markets as a governance structure in the presence of high uncertainty,
large asset-specific investments, and infrequent transactions among small numbers of agents. Measurement and
enforcement are two critically important transaction costs in emerging economies. High transaction costs
suggest a preference for hierarchical governance structures over the private market. Opportunistic behavior,
normally reduced by contract law, trust, or reputation, is also much more likely under such circumstances.
Hybrid structures dominate both markets and hierarchies as the most efficient solution in emerging markets.
Furthermore, transaction cost economics may also explain the higher incidence of unrelated diversification and
countertrade in emerging economies. Like transaction cost economics, agency theory suggests that a firm is a
“nexus of contracts.” According to agency theory, managers are expected to comply with the interest of external
owners of private enterprises, but it is difficult for those owners to ensure that managers do comply. Since it is
difficult to specify ex ante contracts with managers that accommodate all possible future contingencies,
asymmetric information between managers and external investors increases monitoring costs and enables
managers to pursue their own goals. In the context of emerging economies in terms of internal governance,
blockholders will enhance performance through improved monitoring and through enabling foreign owners to
introduce new capital and Western experience in transition economies.
A Resource-Based Perspective. The central questions addressed by the resource-based view concern why firms
differ and how they achieve and sustain competitive advantage. Heterogenous capabilities give each firm its
unique character and are the essence of competitive advantage. Resources are based in a context and, depending
on characteristics of that context, a focus on resources could create strategic inflexibility and core rigidities for a
firm that would lead to negative returns. Firms have to manage the social context of their resources and
capabilities in order to generate rents. Resources for competitive advantage in emerging economies are, on the
whole, intangible. However, they are not necessarily product-market-based. Multinational enterprises that are
able to manage the circumstances in emerging economies reap the benefits of first mover advantages; these
include being the first participants in new product markets, reputation effects, and the economic advantages of
sales volume and of preemptive domination of distribution and communication channels. In emerging
economies, however, such advantages are difficult to establish without good relationships with home

, Doing Business in Emerging Markets

governments. Furthermore, in emerging economies, local competitors may have developed capabilities for
relationship-based management in their environment that substitute for the lack of institutional infrastructure. In
essence, a firm must understand the relationship between its company assets and the changing nature of the
institutional infrastructure as well as the characteristics of its industry. In so doing, the emerging economy firm
may be able to become an aggressive contender domestically or globally by using its resources as sources of
competitive advantage.

Data and Methodological Issues
Research on strategies in emerging market economies faces several issues. We review these below:
Theory Development. Theory development in emerging economies can be problematic. Research designs may
be misspecified as essential conceptual differences between developed and emerging economies are not taken
into account.
Sampling and Data Collection. Obtaining a representative sample of enterprises through conventional
sampling techniques can pose problems in emerging economies. Centralized data sources can become rapidly
outdated owing to the fast pace of economic growth and frequent policy changes. Data collection problems can
result from time and level differences. Problems of data collection and reliability of responses may be worsened
in emerging economies by the difficulties experienced by respondents in understanding terms and concepts
familiar to managers in developed market economies. From an institutional theory perspective, problems have
arisen in constructing a consistent set of institutional factors.
Performance Management. The measurement of the performance impact of strategies may be particularly
problematic in emerging economies. First, financial reporting may not be based on conventional developed
market standards. Second, even where relevant financial reporting legislation has been enacted, its enforcement
may be problematic.
Timing Issues.The essence of emerging economies is that they are dynamic and that it is necessary to take
account of changes in the institutional environment. With respect to strategic actions, distinctions need to be
made between short-term cost reduction strategies and longer-term “deep” strategic restructuring.
Heterogeneity of Emerging Market Economies. At present, there is no standard list of countries agreed to be
emerging economies, partly because the terminology itself is recent, and partly because the countries may have
had different starting points and have arrived at different stages in the process at any one point in time. In
addition, emerging market economies are not homogeneous, even within the same geographic region.

Overview of the Special Research Forum on Emerging Economics
Work Employing Multiple Perspectives:
● In emerging economies, market failures are caused by information and agency problems. As an
economy develops, new intermediaries reduce information asymmetries. As a result, internalization by
business groups allows better capital allocation than external markets and better internal labor market
management than is possible in a market where labor mobility is restricted owing to market failure.
● A regional industry’s competitiveness and a firm’s capabilities increase the likelihood of independent
development; however, greater numbers of rivals and suppliers lead to more frequent joint
development.
● It is argued that the large diversified business groups often found in emerging economies not only gain
resources through diversification but also because their groups have specialized knowledge. In
particular, these groups are argued to have specialized abilities in managing asymmetries between
inward and outward flows of foreign direct investment.
Work with a Primarily Institutional Perspective:
● Merger theory may need to take account of political, organizational, and cultural differences in
emerging economies acquisitions.
● Environmental scanning is an important part of the process by which organizations adapt to
discontinuities, complexities, and uncertainties in their environments.
● Social network theory suggests that better interpersonal connections between managers are positively
associated with improved performance.
Work with a Primarily Resource-Based Perspective

, Doing Business in Emerging Markets

● Group affiliated firms enjoy benefits from sharing resources with other member firms.
● The set and importance of partner selection criteria vary across emerging and developed market
contexts.

Conclusions
It is anticipated that as markets emerge, institutional theory first becomes most relevant, followed by transaction
cost theory/agency theory, and then by the resource-based view. Furthermore, it is crucially important to
understand the institutional context in researching emerging economies. The term “emerging economies”
suggests a process that takes place over a considerable period of time.

Reading Two – Mody: What is an Emerging Market?
Introduction
This paper argues that the acute trade-off between commitment and flexibility is not unique to sovereign debt,
instead, it is the defining characteristic of an emerging market. Early interaction with international markets
typically benefits from strong transaction-specific commitment. However, the goal is to grow out of
transactional commitments to achieve commitment though credible institutions. Institutional commitment allows
the benefits of flexibility, with the country’s “word” acting as the necessary assurance to behave responsibly.

Definition of emerging markets:
● The market of a developing country with high growth expectations
● Investments in these markets are usually characterized by a high level of risk and possibility of a high
return
● A sector within international stocks made up of developing countries, such as Kenya and China, where
economic and political conditions may be more volatile.
● Immature securities market in which there is not a long history of substantial foreign investments.

This paper makes four claims relating to the characterization of emerging markets and their policymaking
processes.
1. The high degree of volatility and their transitional character, with transitions occurring in economic,
political, social, and demographic dimensions.
2. The implication of the volatility and transition for a particularly acute trade-off between commitment and
flexibility in policymaking.
3. Commitment to a course of policy is desirable to attract productive investment but may not be credible;
flexibility is needed to respond to unexpected developments but is liable to abuse.
4. Rigid commitment with no flexibility is practically infeasible and flexibility is viable only when there
exists a broader underlying commitment to disciplined behavior through institutions that limit the
boundaries of discretion.
5. Hence, the major transition in emerging markets is from transaction-specific commitments to institutional
commitments.
6. Solutions to problems will only rarely be possible and efforts will be needed on many complementary
interlocking fonts.

As capital market interactions increase, hard commitments become increasingly difficult to sustain, and at the
same time, the greater flexibility appears more attainable.

Emerging Markets and their Policymaking Process
Volatility
The distinguishing volatility of emerging markets arises from many sources, including natural disasters, external
price shocks, and domestic policy instability. The key issue in assessing emerging market volatility is whether it
results from uncontrollable factors or is the consequence of the polity framework within which countries
operate.

, Doing Business in Emerging Markets

● Policy instability is seen to hurt growth severely.
● Constraints on policymaking that reduce actual or perceived arbitrariness can help

Transitional
Emerging markets are in transition in several senses:
● They are transitioning in important demographic characteristics, such as fertility rates, life expectancy,
and educational status.
● They are also transitioning in the nature and depth of their economic and political institutions
● They transition to greater interaction with international capital markets.

The combination of high volatility and the transitional features of emerging economies generate a real challenge
in policymaking. That challenge is the appropriate balance between commitment and flexibility, or between
rules and discretion. A sustained commitment demonstrates the willingness to stay the course despite the many
ongoing transitions.
→ Volatility will be dampened through policy actions and commitment.

However, the endemic volatility and the long-term transitions imply that a commitment may outlive its
usefulness and may even be rendered dysfunctional. A large shock may change the parameters in a manner that
the old commitment hurts rather than helps. The very volatility that emerging countries face often makes it
difficult to distinguish whether the sock is a consequence of external forces or the result of poor economic
policymaking.

A country’s choice of contractual terms will evolve over time from relatively hard commitment to greater
flexibility, though within a disciplining framework, in response to its own development and to developments in
the international economic environment.

Policymakers attempt to achieve credibility through commitments in particular contexts through specially
designed instruments, which is referred to as transactional commitments.

As hard commitments, or strict policy making rules, are relaxed, they need to be substituted by a conceptual
framework that creates the boundaries within which flexibility will operate. In other words, the discretion that
allows for flexibility requires the discipline of clearly articulated objectives and policymaking tactics → such
framework is referred to as institutional commitment

World Bank Guarantees
At the start of 1990, instead of mainly lending directly to sovereign borrowers, the Bank concluded that it could
also accelerate private lending by guaranteeing (partial) repayment of debt owed to private creditors.
Throughout the 1990, a succession of changes in Bank policies expanded the scope and facilitated the use of its
guarantee authority.

The World Bank guarantee is a mechanism for a country to temporarily raise the level of its commitments and
thereby establish a track record of meeting its obligations. The higher level of commitment lowers the costs of
borrowing on the guaranteed transaction but the greater benefit is long-term. The key is the ability to reduce the
formal level of commitment over time but retain credibility nevertheless.

The experience with the World Bank guarantee suggests that the Bank played a valuable role in easing the entry
of several emerging economies into international capital markets. Concerned by their volatility and transitional
nature of their economies, markets valued the additional commitment implied by World Bank guarantees.

Exchange Rate Regimes
A country’s choice of its exchange rate regime is motivated by a number of considerations, one of them is the
degree to which the regime ties the government’s hands and hence restrains it from being tempted into

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