Journal of International Management 14 (2008) 12 27

Better the devil you don't know: Types of corruption and FDI in transition economies
Alvaro Cuervo-Cazurra
Sonoco International Business Department, Moore School of Business, University of South Carolina, 1705 College Street, Columbia, SC 29208 USA Received 31 January 2006; received in revised form 31 December 2006; accepted 28 February 2007 Available online 14 February 2008

Abstract Corruption has a negative impact on foreign direct investment (FDI). However, transition economies show high levels of corruption and also high levels of FDI. I argue that it is not the level but rather the type of corruption that affects FDI in transition economies. Pervasive corruption, or corruption that is widely present, acts as a deterrent to FDI because it increases the known costs of investing, while arbitrary corruption, or corruption that is uncertain, does not have such a deterring influence because it becomes part of the uncertainty of operating in transition economies. In transition economies, investors prefer to deal with an unknown evil arbitrary corruption rather than a known one pervasive corruption. 2008 Elsevier Inc. All rights reserved.
JEL classification: F21; F23; D73; K42; P37 Keywords: Corruption; Foreign direct investment; Institutions; Transition economies

I analyze the influence of corruption on foreign direct investment (FDI). Corruption, the abuse of public power by government officials for private gain, acts as an irregular tax on business that increases costs and distorts incentives to invest (Shleifer and Vishny, 1993; Wei, 2000a), creating additional uncertainty regarding the costs of operation in the country (Kaufmann, 1997; Rose-Ackerman, 1999). Accordingly, many empirical studies of corruption have found a negative influence on foreign direct investment (FDI) (e.g. Cuervo-Cazurra, 2006, in press; Habib and Zurawicki, 2002; Lambsdorff, 2003; Voyer and Beamish, 2004; Wei, 2000a, 2000b). Paradoxically, however, transition economies have high levels of corruption and have also received large amounts of FDI. This creates an empirical anomaly that appears to challenge existing theoretical arguments. One potential resolution to this challenge is the argument that, in contrast to other countries, in transition economies corruption enables the replication of the market mechanisms that are absent in situations of excessive or poorly designed
I thank the Guest Editors Andrew Delios, Klaus Meyer and Modestas Gelbuda, three anonymous reviewers and Annique Un for their helpful suggestions. The Center for International Business Education and Research at the University of South Carolina provided financial support. The United Nations, the Organization for Economic Cooperation and Development, and the World Bank graciously made data available. I am responsible for all errors. Tel.: +1 803 777 0314; fax: +1 803 777 3609. E-mail address: acuervo@moore.sc.edu.

1075-4253/$ - see front matter 2008 Elsevier Inc. All rights reserved. doi:10.1016/j.intman.2007.02.003

A. Cuervo-Cazurra / Journal of International Management 14 (2008) 1227

13

regulation (Huntington, 1968; Leff, 1989). Those firms that value time or access to goods more highly than others will pay the officials a bribe for such access (Lui, 1985). As a result, corruption in transition economies will act as grease to facilitate transactions and could have a positive influence on levels of FDI inflows. An alternative idea is that it is not the level of corruption but rather the type of corruption that deters or facilitates FDI in transition economies. Corruption has a negative influence on FDI because it increases costs and uncertainty. However, different types of corruption have a different influence on FDI in transition economies. To examine this idea, I distinguish between pervasive corruption corruption that is certain and widespread and arbitrary corruption corruption that is uncertain (Rodriguez et al., 2005). I propose that pervasive corruption is a strong deterrent to FDI in transition economies because it creates an additional, known cost to foreign investors. In contrast, arbitrary corruption does not act as a deterrent because it merely creates higher uncertainty in the investment, uncertainty that is already prevalent in transition economies, since transition countries have unclear rules to govern business operations. The implication of this line of thinking is that managers dislike corruption abroad. However, when they have to deal with it, managers prefer an unknown evil in the form of arbitrary corruption, over a known one in the form of pervasive corruption. Theoretically, this paper goes beyond traditional studies of corruption and FDI that have found that corruption reduces FDI (Wei, 2000a), discussing how this relationship may change depending on the context of a firm's operation. Additionally, this paper examines how types of corruption have a differential influence on FDI, going beyond the influence on entry mode discussed in earlier literature (Uhlenbruck et al., 2006). All in all, the paper contributes to the emerging literature on the influence of institutions on the development of countries (Acemoglu and Johnson, 2005; Djankov et al., 2002; La Porta et al., 1998; North, 1990) and on their influence over foreign investors (Bevan et al., 2004; Delios and Henisz, 2000; Henisz, 2000). This paper illustrates the benefits of going deep into the analysis of one dimension of institutions, the lack of strong institutions that corruption represents, identifying how the influence of corruption and the type of corruption have a varying influence on FDI across host countries. In so doing, this paper highlights how analyzing transition economies can yield new insights into management issues (Meyer, 2001b). 1. Corruption, FDI and transition economies Corruption refers to the exercise of public power for private gain. In this paper, I focus on public corruption or corruption in government, where a public employee, elected or not, uses the position in government to obtain private benefits (for reviews of the literature on corruption see Bardhan, 1997, and Svensson, 2005). There are incentives for corruption whenever an official has discretion over the distribution of a good or the avoidance of a bad to the private sector (Rose-Ackerman, 1999). The official has an incentive to ask for a bribe and increase his or her income in exchange for a good that has little cost to him or her; the official is merely allocating a good owned by the government (Shleifer and Vishny, 1993). However, the firm also has an incentive to offer a bribe or accept paying a bribe to obtain benefits that would not be accessible without corruption, such as being granted a contract, or avoid having to comply with regulations or taxes (Boddewyn, 1988; Boddewyn and Brewer, 1994). 1.1. FDI and corruption: sand or grease There exist two views of corruption: one negative (corruption as sand), where corruption reduces FDI because it increases costs and uncertainty, and another positive (corruption as grease), where corruption increases FDI because it helps avoid the costs of operating in an environment characterized by poorly-developed regulations. These two views have been presented as competing arguments. One way to solve the apparent theoretical contradiction in these arguments is to argue that they operate in different situations. Specifically, corruption may act as sand in countries that have established market institutions, while corruption may act as grease in transition economies that have not yet established appropriate market institutions. 1.1.1. FDI and corruption as sand The negative view of corruption, or sand in the wheels of commerce, highlights how corruption creates additional costs and uncertainty for investors, leading to a reduction in FDI. Corruption becomes an additional tax on investors (Shleifer and Vishny, 1993; Wei, 2000a). It requires firms to devote human and financial resources to manage bribes, although these resources could be invested more profitably in other uses (Kaufmann, 1997). The existence of the opportunity to extract bribes induces government officials to create additional bureaucratic controls and regulations

14

A. Cuervo-Cazurra / Journal of International Management 14 (2008) 1227

with the sole objective of generating an opportunity for more bribes, further increasing the costs to a firm (De Soto, 1989; Krueger, 1993). Moreover, the payment of a bribe creates additional uncertainty because it does not ensure that the promises are delivered upon. Since bribery is illegal, investors do not have recourse to the courts to ask for the fulfillment of the promise, as they do in the case of contracts. The result of these increases in cost and uncertainty that corruption generates is a reduction in the level of FDI coming into a country. Empirical research has found that corruption has a negative impact on FDI: Wei (2000a) analyzed bilateral FDI from 12 developed countries to 45 destination countries and found that corruption negatively impacted FDI; Wei (2000b) confirmed the negative relationship between corruption in the host country and FDI after taking into account government policies towards FDI. Habib and Zurawicki (2002) analyzed bilateral FDI flows from 7 developed countries to 89 countries and found that both the level of corruption in the host country and the difference in levels of corruption in the home and host countries have a negative impact on FDI. Lambsdorff (2003) studied investments in 54 countries and found that corruption has a negative impact on foreign investments. Voyer and Beamish's (2004) analysis of Japanese FDI found that corruption has a negative impact on FDI per capita in developing nations. Cuervo-Cazurra's (2006) analysis of FDI inflows into 106 host economies found that corruption has a negative influence on FDI inflows, but that while investors from countries that have signed the OECD Convention on Combating Bribery of Foreign Public Officials in International Transactions are further deterred by corruption, investors from countries with high levels of corruption are less deterred by corruption. In addition to reducing FDI, corruption induces firms to change the mode of entry and select joint ventures over wholly owned operations (Smarzynska and Wei, 2000; Uhlenbruck et al., 2006). In sum, corruption negatively affects FDI because it increases the cost and uncertainty of operating in the country. Therefore I present the following baseline hypothesis: H1a. Corruption has a negative impact on FDI. 1.1.2. FDI and corruption as grease Although corruption is rarely justified on ethical grounds, some scholars view corruption in positive terms as grease in the wheels of commerce. Corruption is seen as facilitating transactions and speeding up procedures that would otherwise not happen or happen with more difficulty (Huntington, 1968). As such, corruption is a way to introduce market procedures in an environment of excessive or misguided regulation, bringing competition into what is otherwise a monopolistic setting (Leff, 1989). Supply and demand equalize, and the firm with the lowest costs is able to offer the highest bribe to win a contract or permit. A variation of this argument is that investors who value time or access to an input more than others will pay a bribe to reduce their time queuing for the input (Lui, 1985). Bribes can introduce efficiency in such situations. The possibility of extracting a bribe induces the official to speed up services to serve as many customers as possible. The bribe provides an incentive to the official as the issuance of permits becomes a piece-rate payment system. Although sparse, a few pieces of empirical research have not found a negative relationship between corruption and FDI. For example, Wheeler and Mody (1992) do not find a significant correlation between risk and foreign investment by US firms. The measure of risk includes corruption, but it may be an imperfect measure of corruption. Hines (1995) found that corruption in the host country does not appear to affect the growth of inward FDI, with the exception of US investors. High-growth corrupt countries had higher levels of growth of inward FDI than high-growth countries that are less corrupt. However, US investors reduced the growth of their investments into corrupt countries after the passage of the Foreign Corrupt Practices Act banning bribery of foreign officials. Henisz (2000) found that corruption tends not to affect the investments of US multinational enterprises (MNEs). However, in some of the specifications, corruption had a positive influence on the probability of investing abroad, although this was not explained. Transition countries are moving from an economic system of public ownership and governmental allocation of resources to an economic system of private ownership and market allocation of resources. This transition requires the development of new institutions that did not exist before such as private property rights protection, contractual legislation, and capital markets and the dismantling of previous institutions (Aslund et al., 1996; Blanchard, 1997; Brada, 1996; Sachs, 1996; Svejnar, 2002). In this process, there are no clear rules of behavior or institutions to guide investors (Meyer, 2001a; Peng, 2000). These economies have institutional frameworks that are only partially reformed public ownership and a command economy are partially disrupted while private ownership and a market economy are not fully implemented creating high transaction costs (Meyer, 2001a).

A. Cuervo-Cazurra / Journal of International Management 14 (2008) 1227

15

As a result, in transition economies corruption may have a positive influence on FDI. To be clear, corruption will still increase costs and uncertainty. However, the additional costs and uncertainty of corruption may be compensated by the benefits that it provides in terms of bypassing regulations and institutions that were designed for a previous system but have not yet been dismantled (Boddewyn, 1988; Boddewyn and Brewer, 1994). Bribery helps introduce market mechanisms and missing incentives. Those investors who are willing to pay more for the required permits will provide a bribe to the bureaucrat to facilitate the issuance of the permit (Lui, 1985). These incentives and mechanisms are distorted and imperfect, but this may still be preferable to having to deal with the obsolete institutions and regulations that are still in place in the newly-forming economic system. The experience of a BBC correspondent in Moscow in the early 1990s, Andrew Harding, illustrates how corruption provides incentives and solves the limitations of misplaced institutions in a transition economy: It took me two hours to reach the front of the queue. But when I got there I was ready. I had a wad of roubles in one hand, and a packet of fine coffee beans stuffed in a pocket. It was November 1991 and I was seconds away from my very first Russian bribe. The woman behind the counter, of the giant state-run Soviet travel agency, did not look up from her magazine. But somehow, through the top of her severely coiffed head, she managed to imply that she was ready to hear me. I had mentally rehearsed this moment standing in the queue. In one suave, Bond-like movement I would slip what was in those days rare and expensive coffee over the counter. The woman would nod imperceptibly, and then announce that, yes, after all, there was actually one seat available on the next flight to Kiev. [] At that time everyone seemed to need a backhander, waiters, policemen, basically any official. And who could blame them. The regular economy didn't work. Salaries were worth nothing. Bribery was the grease which kept the rusty Soviet state from jamming altogether. (BBC News, 2000). In sum, in transition economies, the benefits that corruption provides in terms of bypassing misplaced institutions may compensate for the additional costs and uncertainty it creates. As a result, corruption may not act as a deterrent to investors because helps them deal with the misplaced regulations. Hence, I argue that: Hypothesis 1b. Corruption has a smaller negative impact on FDI in transition countries than in other countries. 1.2. FDI and type of corruption: costs or uncertainty There are multiple types of corruption. Rose-Ackerman (1978) distinguishes between bribery to deviate from the application of existing rules or laws, and bribery to change exiting rules or create new rules or laws. Shleifer and Vishny (1993) distinguish between corruption without theft, where the official provides the government with the price of the good and only pockets the additional bribe, and corruption with theft, where the official pockets the whole payment made by the firm. They also distinguish between organized corruption, where the payment of the bribe ensures the delivery of the goods, and disorganized corruption, where the payment of the bribe does not ensure this. Elliot (1997) separates petty corruption, where unelected bureaucrats complement their salaries with small bribes in exchange for expediting permits or foregoing regulations, from grand corruption, where elected politicians allocate contracts or subsidies to the firm that provides them with an adequate bribe. An alternative classification is the distinction between pervasive corruption, where the firm will encounter corruption whenever it deals with government officials, and arbitrary corruption, where the firm faces uncertainty regarding the request for and type of bribes and the delivery of the promised services (Doh et al., 2003; Rodriguez et al., 2005). Unlike other classifications, this one operates at the country rather than at the transaction level. The distinction between pervasive and arbitrary corruption has been shown to influence the entry mode used by MNEs (Uhlenbruck et al., 2006). I follow a different route, instead analyzing the impact of pervasive and arbitrary corruption on FDI inflows. 1.2.1. FDI and pervasive and arbitrary corruption I argue that the distinction between pervasive and arbitrary corruption can be viewed as separating the two challenges that corruption creates for investors: additional costs and additional uncertainty of operating in the country.

16

A. Cuervo-Cazurra / Journal of International Management 14 (2008) 1227

Pervasive corruption can be viewed as representing the known cost of corruption. An investor going to a country with pervasive corruption should expect to be asked for bribes, both by public employees to process paperwork and by politicians to obtain government contracts. This increases the costs of operating in the country. Moreover, this increase in costs is not a one-time event, such as paying to obtain a government contract. Instead, the firm will continuously have to pay to operate in the country and have permits renewed, contracts enforced, or customs procedures cleared. As a result, investors in countries with pervasive corruption may avoid or reduce their investments there, because the increase in costs may render potential investment projects unprofitable. Therefore, I argue that: H2a. Pervasive corruption has a negative impact on FDI. Arbitrary corruption can be viewed as representing the uncertainty associated with corruption. The foreign investors will know that when it enters a country with arbitrary corruption it may or may not be asked for bribes. Additionally, the payment of a bribe may or may not necessarily result in the promised services being delivered. In a country with arbitrary corruption, even when the investor has been asked for and paid a bribe to a government official, it does not know whether the government official will deliver on the promise made. Arbitrary corruption includes what Shleifer and Vishny (1993) term disorganized corruption, where different elements of the state bureaucracy demand bribes independently from one another. As a result, the payment of a bribe to one government official does not prevent another from asking for a different bribe for the same services, or blocking the delivery of the service unless the additional kickback is paid. The investor's lack of knowledge of being asked for a bribe, coordination in the demand for bribes, and in the delivery of the services, increases the uncertainty of operating in the country. Investors cannot plan in advance the costs of operating in the foreign country; they cannot estimate the probability of being asked for a bribe or the potential cost of the bribe. As a result, they will reduce their investments and limit their exposure. Hence, I argue that: H2b. Arbitrary corruption has a negative impact on FDI. 1.2.2. FDI and pervasive and arbitrary corruption in transition economies I argue that pervasive and arbitrary corruption may have different influences on FDI in transition economies than the general influences discussed before. Specifically, pervasive corruption in transition economies increases the known cost of operating there, further discouraging FDI. A firm that enters a transition economy with pervasive corruption will face an additional cost of operating there in the form of known demand for bribes by government officials and civil servants. These bribes will increase the cost of operating in the transition economy, which already has high costs arising from its institutional problems (Meyer, 2001a). In a transition economy with pervasive corruption, the transition process results in new opportunities for government officials to ask for bribes, since it is not clear what rules and regulations apply; previous rules may still be on the books while new rules are being developed and applied. As a result, an investor that faces pervasive corruption in a transition country will face an increased known cost of operating in the transition economy in the form of a widespread demand for bribes and little recourse to established rules and institutions to limit such demands. In response to these additional costs and lack of clear institutions, the investor will reduce investment further. Thus, I propose that: H3a. Pervasive corruption has a larger negative impact on FDI in transition countries than in other countries. In contrast, arbitrary corruption in transition economies may not act as an additional deterrent to foreign investors. Arbitrary corruption increases the uncertainty of operating in transition economies, since the demand for bribes and the outcome of bribe payments is difficult to predict. This increase in uncertainty adds to the already high level of uncertainty in transition economies (Meyer, 2001a; Peng, 2000). However, arbitrary corruption merely represents less knowledge about the cost of operation, rather than the known additional cost that pervasive corruption represents. Investors that have decided to invest in transition economies are already aware of the high level of uncertainty of operating there. If the high level of uncertainty of operating in transition economies has not already deterred them, the additional uncertainty regarding corruption is not likely to play an additional role in their investment decision, since it is not quantifiable. Hence, I propose that: H3b. Arbitrary corruption has a smaller negative impact on FDI in transition countries than in other countries.

A. Cuervo-Cazurra / Journal of International Management 14 (2008) 1227

17

2. Research design 2.1. Sources of data I drew FDI data from the United Nations Conference on Trade and Development (UNCTAD) country profiles (UNCTAD, 2005). This database provides the widest coverage of bilateral FDI inflows available, although it does not have data for all countries. I complemented this database with information on FDI from the OECD (2005), which has been the usual source of data in other studies. I analyze FDI data from 1999 because it provides a wide coverage of countries. As I discuss below, analyzing data for 1998 and 2000 yields similar results. Data on corruption comes from two separate sources. The general indicator of the level of corruption comes from Transparency International (2005). I derived the indicators of pervasive corruption and arbitrary corruption using data from the World Business Environment Survey (WBES) of the World Bank (World Bank, 2006), following the method used by Uhlenbruck et al. (2006). Data used in the control variables has diverse sources. Data on the countries' size (GDP, population) and GNI per capita came from the World Bank's World Development Indicators (2005). I derived information on geographic characteristics of the countries from the Central Intelligence Agency's World Factbook (2005). I gathered information on languages from the Factbook and Gordon (2005). I derived data on colonial histories from the Factbook and from Encyclopedia Britannica (2005). My data on FDI limitations came from Heritage Foundation's Index of Economic Freedom (2005). The number of host countries I analyze is constrained by the availability of data on the measures of corruption and on FDI inflows. Appendix A lists the countries analyzed. I follow the International Monetary Fund (2005) classification of economies to identify those countries that are considered transition economies. 2.2. Variables and measures Table 1 provides a summary of the variables and measures. The dependent variable is the natural log of FDI inflows from a home country to a host country, measured in US$ million and using the average foreign exchange rate for the year. The independent variable of interest is corruption in the country. I use two different measures. The first is the overall level of corruption in the country using the indicator developed by Transparency International (2005).1 This indicator has been used in previous research (e.g. Habib and Zurawicki, 2002; Uhlenbruck et al., 2006). This indicator runs from 10 (low) to 0 (high). I subtract the original index from 10 to rescale the indicator so that a higher number indicates higher corruption and a lower number indicates lower corruption. The second measure of corruption is the type of corruption: pervasive or arbitrary. I replicate the measures developed by Uhlenbruck et al. (2006), by using data from the World Business Environment Survey of the World Bank (World Bank, 2006). Pervasive corruption measures the likelihood that a firm will encounter a demand for bribes when dealing with the government in obtaining permits or licenses, settling taxes, gaining government contracts, dealing with custom services, dealing with courts or judges, or dealing with law enforcement agencies. Arbitrary corruption measures the uncertainty regarding the demand for bribes in terms of knowing in advance the amount of the bribe, being asked for an additional bribe once a bribe has been paid, or getting the service delivered after paying for a bribe. I rescale the measures to facilitate interpretation by subtracting the indicators from 6 so that they run from 1 (low) to 6 (high). In addition to studying the impact of corruption on FDI, I am particularly interested in understanding how this relationship changes depending on whether corruption occurs in a transition economy or not. To do this, I multiply an indicator that marks a host country as a transition economy, with the level of corruption in the country. The coefficient of this product measures the additional influence on FDI that the corruption in a transition country has above and beyond the general influence of corruption on FDI. I include an indicator of transition economies to capture other characteristics of transition economies that influence FDI beyond corruption and the other controls. This procedure was inspired by Wei's (2000a) analysis of the differential reaction to corruption in a host country by US investors. I control for other variables that may affect the relationship between corruption and FDI following the logic of gravity models. The theoretical basis of gravity models in the study of FDI is the proximity-concentration hypothesis (Brainard, 1997; Horstmann and Markusen, 1992). The gravity model has demonstrated its usefulness in explaining
1

Using the indicator of corruption available at the World Bank (Kaufmann et al., 2003) generated similar conclusions.

18

A. Cuervo-Cazurra / Journal of International Management 14 (2008) 1227

Table 1 Variables, measures, and sources of data Variable Dependent variable Independent variables of interest Ln FDI inflows Host country corruption Host country pervasive corruption Measure Log of FDI inflows into the country in the year in millions of US$ Indicator on the level of corruption in the host country, from 0 (low) to 10 (high) (10 minus the original score for corruption) Indicator of the level of pervasive corruption in the host country, from 1 (low) to 6 (high) (composite of need to make extra, unofficial payments (1) to public officials to get licenses, (2) to deal with settlement of taxes, (3) to gain government contracts, (4) to deal with customs services, (5) to deal with courts or judges, and (6) to deal with law enforcement agencies) Indicator of the level of pervasive corruption in the host country, from 1 (low) to 6 (high) (composite of firm (1) knowing in advance how much an unofficial payment will be, (2) being asked by another agent for an unofficial payment after having paid the unofficial payment, and (3) having the service delivered as agreed after paying the unofficial payment) Natural log of gross domestic product in millions of US$ Natural log of the number of inhabitants in the host country Gross national income per capita in power purchasing parity terms, US$ thousands Indicators of capital flows and foreign direct investment, from 1 (very low barriers to foreign investment) to 5 (very high barriers to foreign investment) Increase in consumer prices, percentage Indicator that the host country is an oil producer, 1 or 0 Indicator that the host country is a transition economy, 1 or 0 Natural log of gross domestic product in millions of US$ Indicator on the level of corruption in the host country, from 0 (low) to 10 (high) (10 minus the original score for corruption) Natural log of the greater circle distance between the centers of the home and host country in miles Indicator that the none, one, or both home and host countries are landlocked, 0, 1, or 2 Indicator that the none, one, or both home and host countries are island nations, 0, 1, or 2 Dummy indicator of the existence of a common border between the home and host country, 1 or 0 Dummy indicator of the existence of a common language between the home and host country, 1 or 0 Dummy indicator that the home and host country were ever under a colonial relationship, 1 or 0 Source UNCTAD (2005) and OECD (2005) Transparency International (2005) WBES, World Bank (2006) and Uhlenbruck et al. (2006)

Host country arbitrary corruption

WBES, World Bank (2006) and Uhlenbruck et al. (2006)

Control variables

Ln host country GDP Ln host country population Host country GNI per capita Host country FDI limitations Host country inflation Host country oil producer Host country transition economy Ln home country GDP Home country corruption Ln distance Landlocked Island Common border Common language Colonial link

World Development Indicators database, World Bank (2005) World Development Indicators database, World Bank (2005) World Development Indicators database, World Bank (2005) Heritage Foundation (2005)

World Development Indicators database, World Bank (2005) Energy Information Administration (2006) International Monetary Fund (2005) World Development Indicators database, World Bank (2005) Transparency International (2005) CIA (2005) CIA (2005) CIA (2005) CIA (2005) CIA (2005) and Gordon (2005) CIA (2005) and Encyclopedia Britannica (2005)

bilateral FDI (Bevan and Estrin, 2004; Brenton, Di Mauro, and Lucke, 1999; Eaton and Tamura, 1995; Wei, 2000a, 2000b; Wei and Wu, 2001). It has also proven its usefulness in the generation of new theoretical insights into the behavior of MNEs, particularly the difficulties that firms face when they move abroad in terms of the cultural, administrative, geographic, and economic (CAGE) distances (Ghemawat, 2001). The barebones gravity model explains FDI flows based on indicators of the host country's size (GDP and population) and distance (geographic) between home and host countries (Linneman, 1966). To these, I add indicators of the common political and cultural backgrounds. Such a set of controls is common in studies of bilateral trade and bilateral FDI.

A. Cuervo-Cazurra / Journal of International Management 14 (2008) 1227

19

Accordingly, I control for three sets of variables: characteristics of the host country, characteristics of the home country, and common characteristics. First, I control for characteristics of the host country. In particular I control for its economic and demographic size because larger countries are more likely to attract FDI, since MNEs can achieve the necessary economies of scale (Linneman, 1966). I also control for the wealth of the population because this will attract FDI to serve these wealthy consumers (Uhlenbruck et al., 2006). I take into account the restrictions on FDI with a measure of such limitations (Wei, 2000b). I control for the country's inflation rate in order to take into account the uncertainty of operating in the country that is unrelated to corruption. High inflation creates challenges in strategic planning, forecasting of demand, and financing of operations.2 I also control for a country being an oil producer to take into account the fact that natural resources will attract more FDI; this is particularly important for transition economies.3 Finally, as discussed above, I use an indicator that the country is a transition economy to control for other influences that transition economies have on FDI beyond corruption and other general controls. Second, I control for the characteristics of the home country.4 I control for its size because large countries are the main sources of FDI. I control for the level of corruption of the home country to take into account investors' familiarity with corruption (Habib and Zurawicki, 2002). I control for other home country characteristics using dummy variables (Wei, 2000a). Third, I control for common characteristics between home and host country that affect FDI. I control for the geographic distance between the countries, which indicates the existence of transportation costs that would discourage trade and favor FDI (Linneman, 1966). This control is traditionally complemented with indicators that the country is landlocked or an island and a common border between countries, as these characteristics affect transportation costs and the likelihood of undertaking FDI (Frankel and Rose, 2002; Wei, 2000a). I control for cultural similarities using an indicator of the existence of a common language between the home and host countries; this facilitates the transfer of information across borders and FDI (Johanson and Vahlne, 1977). I control for similarities in administrative practices, which facilitate FDI, using indicators of the existence of a previous colonial relationship (Ghemawat, 2001). 2.3. Method of analysis I use a double-log model with quasi-fixed-effects and a one-year lag to analyze the data, as done by Wei (2000a). In the double-log model I apply natural logs to the dependent variable (FDI) and the independent variable (GDP, population, distance) to help make the error term close to homoskedastic (Wei, 2000a: 4). I use a quasi-fixed-effects specification whereby I control for the home country using a dummy indicator for each country. I do not include dummies for host countries because doing so would eliminate the possibility of estimating the impact of corruption on FDI. The dependent variable is measured at the end of 1999, while the independent variables are measured one year earlier to account for the time lag that occurs between the decision to invest and the actual FDI. Finally, because the logarithms only take positive numbers, I use a Tobit specification (Maddala, 1983; Tobin, 1958). To test Hypotheses 1a and 1b I use the following model specification: Ln FDIijt = 1 Host country corruption jt-1 + 2 Host country transition economy j Host country corruption jt-1 + Xijt-1 + ij where 1 and 2 are the parameters of interest, Xijt-1 is a vector of the control variables, is a vector of other parameters, and is the error term. Hypothesis 1a is supported if 1 is negative and statistically significant. Hypothesis 1b is supported if 2 is positive and statistically significant while 1 continues being negative and statistically significant. To test Hypotheses 2a, 2b, 3a, and 3b I use the following model specification: Ln FDIijt = 1 ' Host country pervasive corruption jt-1 + ' 2 Host country arbitrary corruption jt-1 + ' 3 Host country Host country transition economy j Host country pervasive corruption jt-1 + ' 4 Host country transition economy j arbitrary corruption jt-1 + X'ijt-1' + 'ij

2 3 4

I thank the special issue editors for suggesting controlling for uncertainty. I thank the anonymous reviewers for suggesting this control. I thank the anonymous reviewers for suggesting these controls.

20

Table 2 Summary statistics and correlation matrix Variable Mean Standard deviation 1. Ln FDI inflows 2. Host country corruption 3. Host country pervasive corruption 4. Host country arbitrary corruption 5. Ln host country GDP PPP 6. Ln host country population 7. Host country GNI per capita 8. Host country FDI limitations 9. Host country inflation 10. Host country oil producer 11. Host country transition economy 12. Ln home country GDP PPP 13. Home country corruption 14. Ln distance 15. Landlocked 16. Island 17. Common border 18. Common language 19. Colonial link 1 6.842 1.552 1 2 5.005 2.286 3 3.658 1.546 4 3.515 0.453 5 25.299 1.894 6 16.320 1.467 7 11.381 8.498 8 2.404 0.688 9 8.846 14.903 10 0.776 0.417 11 0.290 0.454 12 26.082 1.834 13 4.213 2.397 14 7.860 0.997 15 0.331 0.532 16 0.254 0.476 17 0.059 0.235 18 0.154 0.361 19 0.046 0.210

A. Cuervo-Cazurra / Journal of International Management 14 (2008) 1227

0.222 0.275

1 0.315 1

0.027

0.524 0.077

0.376 0.382 0.487 0.290 0.009

0.135

0.466 0.032 0.487

0.870 0.605 0.121

1 0.195 1 1 0.063 1 0.091 1 0.098 1

0.287 0.817 0.353 0.221 0.008 0.435 0.380

0.136 0.061

0.093 0.307 0.171 0.341 0.478

0.160 0.382 0.009 0.056 0.059 0.599

0.239 0.273 0.223 0.355

0.372 0.218

0.857 0.114 0.421 0.330 0.403 0.090 0.042 0.049 0.044 0.041

0.180 0.016

0.307 0.019 0.332

0.030

0.033

0.026

0.056 0.155

0.038 +

0.006

0.042 +

0.033

0.021

0.031

0.010

0.030

0.051 0.157

0.093 0.055 0.178 0.228 0.026 0.162 0.084 0.015 0.068 0.039 0.046 + 0.125

0.274 0.061 0.437 0.039 0.008 0.024 0.008 0.038 0.185 0.031 0.146 0.038

0.067 0.129 0.253 0.174 0.037 + 0.047 0.015 0.026 0.122 0.119

0.054 0.081 0.209 0.241 0.152 0.035 + 0.008 0.007 0.048 0.017

0.012 0.035 + 0.222 0.163 0.042 1 0.052 0.117 0.442 0.144 0.004 0.201 1 0.099 0.044 0.102 0.116 0.140 0.277 0.170 1 0.007 0.022 0.024 0.016 0.115 0.439 0.090 0.130 1 0.026 0.129 0.119 0.046 0.108 0.134 0.013 0.002 0.220 1 0.101 0.098 0.091 0.128 0.105 0.095 0.050 0.125 0.440 1

0.171 0.127 0.109

0.095 0.015

Significance levels: +p b 0.1, p b 0.05, p b 0.01, p b 0.001.

A. Cuervo-Cazurra / Journal of International Management 14 (2008) 1227

21

where ' 1, ' 2, ' 3, and ' 4 are the parameters of interest, X' ijt-1 is a vector of control variables, ' is a vector of other parameters, and ' is the error term. Hypothesis 2a is supported if '1 is negative and statistically significant. Hypothesis 2b is supported if '2 is negative and statistically significant. Hypothesis 3a is supported if '3 is negative and statistically significant while '1 is still negative and statistically significant. Hypothesis 3b is supported if '4 is positive and statistically significant while '2 continues being negative and statistically significant. 3. Results Table 2 presents the summary statistics and correlation matrix. High levels of correlation among the variables are as expected, since many of the characteristics of a country (such as GDP and population) tend to correlate. This high level of correlation is also found in other studies (Uhlenbruck et al., 2006). Table 3 presents the results of analyzing the influence of corruption on FDI. Model 3a shows the analysis with only the control variables. To compare with previous studies, Model 3b shows the analysis introducing the measure of level of corruption in the host country. The coefficient of the level of corruption in the host country is negative and statistically significant at the 0.01 level. This supports Hypothesis 1a and is in line with previous analyses. Corruption does reduce FDI in the country because it increases the costs and uncertainty of operations. Model 3c presents the results of introducing the interaction between host country corruption and host country transition economy. This product captures the additional influence of corruption in transition economies on FDI, beyond the general influence of corruption on FDI. The coefficient of this product is positive and statistically significant, while the coefficient of host corruption is still negative and statistically significant. These results support Hypotheses 1a and 1b. In other words, corruption in transition economies has a smaller negative influence on FDI than corruption in other countries. The costs and uncertainty that corruption creates may be partially balanced out by potential gains in terms of solving limitations of poorly developed institutional characteristics of transition economies. Table 4 presents the results of the analysis of the influence of pervasive and arbitrary corruption on FDI. Model 4a presents the results of the analysis with only the control variables. Model 4b provides the results of the analysis with the measures of pervasive and arbitrary corruption. The coefficients of pervasive corruption and of arbitrary corruption are
Table 3 Results of the analyses of the impact of host country corruption on FDI inflows Dependent variable: Ln of bilateral FDI inflows Model 3a Host country corruption Host country transition economy Host country corruption Ln host country GDP Ln host country population Host country GNI per capita Host country FDI limitations Host country inflation Host country oil producer Host country transition economy Ln home country GDP Home country corruption Ln distance Landlocked Island Common border Common language Colonial link Intercept Chi2 N Log likelihood 0.2342 (0.9039) 0.1355 (0.0957) 0.0008 (0.0106) 0.2826 (0.0587) 0.0007 (0.0029) 0.2084 + (0.1177) 0.2026 + (0.1063) 0.5375 (0.0646) 0.2262 (0.1575) 0.2972 (0.0467) 0.0215 (0.0959) 0.0550 (0.1446) 0.2542 + (0.1434) 0.5365 (0.1151) 0.0896 (0.2288) 12.3918 (1.9830) 903.23 1178 1776.5887 Model 3b 0.0629 (0.0294) 0.2638 (0.0939) 0.1369 (0.0955) 0.0006 (0.0128) 0.2521 (0.0603) 0.0001 (0.0029) 0.1691 (0.1189) 0.2134 (0.1062) 0.5356 (0.0639) 0.2245 (0.1591) 0.2993 (0.0466) 0.0625 (0.0976) 0.0420 (0.1444) 0.2444 + (0.1432) 0.5412 (0.1149) 0.0915 (0.2284) 12.6631 (1.9795) 916.75 1178 1756.2930 Model 3c 0.4142 (0.0702) 0.0908 (0. 0293) 0.1757 + (0.0937) 0.2468 (0.0960) 0.0003 (0.0126) 0.5078 (0.0736) 0.0017 (0.0029) 0.0606 (0.1187) 2.1932 (0.4211) 0.5449 (0.0630) 0.2137 (0.1568) 0.3129 (0.0460) 0.0102 (0.0968) 0.1310 (0.1431) 0.2559 + (0.1412) 0.4927 (0.1136) 0.0754 (0.2251) 11.6871 (1.9557) 951.06 1178 1739.1371

Dummy variable controls for the country of origin are included in the analysis but not reported. Significance levels: +p b 0.1, p b 0.05, p b 0.01, p b 0.001.

22

A. Cuervo-Cazurra / Journal of International Management 14 (2008) 1227

Table 4 Results of the analyses of the impact of host country pervasive and arbitrary corruption on FDI inflows Dependent variable: Ln of bilateral FDI inflows Model 4a Host country pervasive corruption Host country transition economy Host country arbitrary corruption Host country transition economy Host country pervasive corruption Host country arbitrary corruption Ln host country GDP Ln host country population Host country GDP per capita Host FDI limitations Host country inflation Host country oil producer Host country transition economy Ln home country GDP Home country corruption Ln distance Landlocked Island Common border Common language Colonial link Intercept Chi2 N Log likelihood 0.0073 (0.0929) 0.5615 (0.0933) 0.0531 (0.0119) 0.1040 + (0.0563) 0.0126 (0.0026) 0.1953 (0.1232) 0.1801 + (0.1026) 0.3157 (0.0978) 0.1637 (0.1267) 0.3314 (0.0505) 0.0500 (0.0953) 1.2282 + (0.6325) 0.2171 (0.1397) 0.4146 (0.1260) 0.1096 (0.2467) 6.9478 (3.2402) 747.89 766 963.8100 Model 4b 0.1285 (0.0420) 0.6350 (0.0928) 0.2058 (0.0946) 0.7662 (0.0946) 0.0389 (0.0125) 0.1107 (0.0555) 0.0132 (0.0026) 0.2094 + (0.1193) 0.4672 (0.1393) 0.3040 (0.0947) 0.1696 (0.1366) 0.3977 (0.0501) 0.0924 (0.0933) 1.3763 (0.6125) 0.0872 (0.1368) 0.4206 (0.1222) 0.2549 (0.2403) 1.7470 (3.2184) 797.97 766 938.7737 Model 4c 0.6809 (0.2827) 1.0437 (0.2463) 0.1503 (0.0424) 0.8400 (0.1069) 0.2293 (0.0953) 0.8131 (0.0957) 0.0450 (0.0125) 0.1794 (0.0609) 0.0132 (0.0026) 0.2934 (0.1211) 0.5773 (0.1458) 0.3280 (0.0938) 0.1608 (0.1350) 0.4391 (0.0507) 0.2677 (0.1011) 1.3456 (0.6053) 0.0714 (0.1352) 0.4067 (0.1207) 0.2700 (0.2374) 1.4009 (3.1848) 816.78 766 929.3684

Dummy variable controls for the country of origin are included in the analysis but not reported. Significance levels: +p b 0.1, p b 0.05, p b 0.01, p b 0.001.

negative and statistically significant, as expected. These results support Hypotheses 2a and 2b. Pervasive corruption, which results in an increase in the costs of operating abroad, leads to a reduction in FDI. For its part, arbitrary corruption, which results in an increase in the uncertainty of operating abroad, also discourages FDI. Model 4c presents the results after adding the interactions between the indicator of host country transition economy and the indicators of pervasive corruption and arbitrary corruption. The coefficients of pervasive corruption and arbitrary corruption are still negative and statistically significant, supporting Hypotheses 2a and 2b, respectively. Additionally, the coefficient of the product of pervasive corruption and host country transition economy is negative and statistically significant. In contrast, the coefficient of the product of arbitrary corruption and host country transition economy is positive and statistically significant. These results support Hypotheses 3a and 3b. In other words, both pervasive and arbitrary corruption discourage FDI because they create additional costs and uncertainty for investors. However, in transition economies, pervasive and arbitrary corruption have different influences. Pervasive corruption becomes a known, unofficial cost of operating that foreign investors dislike, since they already have to deal with the additional costs that arise from the lack of a well established institutional framework (Meyer, 2001a). These known costs may increase the costs of operation to the point where it is not profitable to enter the country. As a result, investors are further discouraged by pervasive corruption in transition economies beyond the general negative influence that pervasive corruption has on FDI. Arbitrary corruption, in contrast, results in lower deterrence to foreign investors in transition economies. Operating in a transition economy is more uncertain than operating in developed countries because the institutions and rules are not well developed, applied, or both (Bevan et al., 2004). An investor that has decided to enter a transition economy must be prepared to deal with the uncertainty created by poorly developed institutions. It may as well be ready to deal with the additional uncertainty created by arbitrary corruption, thus not being discouraged by it. The nature of these results is illustrated in Figs. 1 and 2. The figures should be interpreted with caution, however. They illustrate the relationship of corruption and FDI, but do not take into account the influence of the controls. Fig. 1 illustrates the relationship between corruption and FDI. I computed the numbers in the figure using the coefficients of corruption and of the product of corruption and the indicator of transition economies from Model 3c, multiplying each

A. Cuervo-Cazurra / Journal of International Management 14 (2008) 1227

23

Fig. 1. Level of corruption and FDI.

by the levels of corruption, which can take values from 1 to 10. In general terms, as the level of corruption in the country increases, the amount of FDI in the country diminishes. In contrast, in transition economies, the negative influence of corruption on FDI is compensated by an incremental positive influence. This positive relationship does not mean that corruption in transition economies is good, however. The analysis of the relationship between type of corruption and FDI reveals that this positive influence is not uniform. Fig. 2 illustrates the relationship between pervasive and arbitrary corruption and FDI. As in Fig. 1, I computed the numbers in the figure using the coefficients of pervasive and arbitrary corruption and the coefficients of the products of transition economies with pervasive corruption and with arbitrary corruption that appear in Model 4c, multiplying each by the level of arbitrary and pervasive corruption, which can take values from 1 to 6. The figure illustrates that as arbitrary and pervasive corruption increase, the level of FDI in the country decreases. However, in transition economies, the negative influence of pervasive corruption on FDI is further accentuated, while the negative influence of arbitrary corruption on FDI is reduced by an incremental positive influence. Hence, corruption does not encourage FDI in transition economies. Whereas arbitrary corruption appears to facilitate FDI, pervasive corruption acts as a large barrier to FDI. Although illustrative, these figures should be interpreted with caution, especially with respect to

Fig. 2. Level of arbitrary and pervasive corruption and FDI.

24

A. Cuervo-Cazurra / Journal of International Management 14 (2008) 1227

arbitrary corruption. In transition economies, pervasive corruption can take values close to 6, but arbitrary corruption does not take values above 4; the impact of arbitrary corruption on FDI is more limited than the effect of pervasive corruption. Additionally, as I indicated before, the figures do not take into account other influences on FDI. I run additional tests to check the robustness of these results.5 First, I checked whether the results are driven by investments in the oil rich nations of Russia, Azerbaijan and Kazakhstan, but did not find evidence for this. These three countries attract large amounts of FDI to exploit their natural resources, while they are viewed as having high levels of arbitrary corruption. I checked whether investments in these countries show a different attitude towards pervasive and arbitrary corruption than investments in other countries by introducing two additional variables in the model, one that is the product of the indicator of Russia, Azerbaijan and Kazakhstan and the measure of pervasive corruption, and another that is the product of the indicator of Russia, Azerbaijan and Kazakhstan and the measure of arbitrary corruption. The coefficients of these products are negative and positive, respectively, but not statistically significant. At the same time, the coefficient of the product of the indicator of transition economies and pervasive corruption is negative, the coefficient of the product of the indicator of arbitrary corruption is positive, the coefficient of pervasive corruption is negative, and the coefficient of arbitrary corruption is negative, all of them at statistically significant levels below 5%. Investments in Russia, Azerbaijan and Kazakhstan do not show a different attitude towards pervasive and arbitrary corruption. Second, I checked whether outliers in the corruption data drive the findings, but did not find evidence for the existence of outliers with high leverage. The indicators of pervasive and arbitrary corruption do not have countries with extremely high or low levels that would bias the results. However, as I indicated before, the indicator of pervasive corruption does come close to its maximum of 6, while the indicator or arbitrary corruption does not go beyond 4. The findings, although statistically significant, should be interpreted with care. Third, I analyzed whether correlation among independent variables is driving the results, that is, whether the findings exist because of multicollinearity, but I found no sign of this. I ran additional analyses excluding variables to check for changes in the significance of the coefficients (Greene, 2000). The analyses that exclude arbitrary corruption, that exclude pervasive corruption, and that exclude transition economies continue to generate statistically significant coefficients with the same sign for the variables that are not excluded. Fourth, I analyzed whether round-tripping of FDI may affect the results identified; although there may be some round-tripping in the data, it is not likely to bias the results. Round-tripping refers to domestic investors in transition economies moving funds abroad, then investing back into their country of origin to take advantage of policies that benefit foreign investors. In the case of transition economies in Europe, Cyprus tends to be a particularly important source of round-tripping. However, the analyses already include a control for the home country that would address the particularities of Cyprus or any other country as a source of FDI. Additionally, although Cyprus is a source of relatively large levels of FDI going into Bulgaria and Russia, the main sources of FDI going into transition economies are developed countries (USA, Germany, France, etc.). In sum, while not dismissing the possibility that there may exist round-tripping of FDI, it does not appear to be sufficiently prevalent to bias the results. Fifth, I studied whether the results are restricted to the year I study, but the analyses using other years yield similar results. The results of the analyses with data for 1998 and 2000 are similar in sign, size and significance to the ones reported for 1999. I can conclude that in transition economies in the late 1990s, corruption has a smaller negative influence on FDI, pervasive corruption has a larger negative influence on FDI, and arbitrary corruption has a smaller negative influence on FDI. These relationships may have changed now that some of the transition economies have joined or are about to join the European Union, which is imposing improvements in the countries' institutions. This can be explored in future studies; I do not have more recent data to test it. 4. Conclusions In this paper, I studied the influence of corruption on FDI, paying particular attention to this influence in transition economies. Existing literature has provided arguments for both a negative impact of corruption on FDI and also for a positive one. Empirical studies have found mostly a negative impact, but a few studies do not find such a negative influence. I presented one solution to this theoretical conflict by arguing that the impact of corruption on FDI depends

I thank the editors for suggesting these analyses.

A. Cuervo-Cazurra / Journal of International Management 14 (2008) 1227

25

on the characteristics of the economic system of the host country. I proposed that corruption has a negative impact on FDI in developed economies because it increases the uncertainty and cost of operating in the country, but that this negative impact may be compensated in transition economies because corruption enables the bypassing of inadequate regulation and institutions. Additionally, I argued that separating corruption into two types, pervasive and arbitrary, may provide further insights into the relationship between corruption and FDI. I argued that each type will have a negative influence on FDI, but in transition economies pervasive corruption will have an additional negative impact because of the creation of additional costs of operating in the country, while arbitrary corruption will have less of a negative influence because investors will not be sensitive to the additional uncertainty that arbitrary corruption creates, since the investors have already decided to enter countries characterized by high uncertainty. The empirical analysis reveals that corruption, pervasive corruption, and arbitrary corruption have a negative influence on FDI. However, when I explore how these relationships differ in transition economies, I find that corruption results in less of a negative influence on FDI in transition economies. This finding is further refined when I separate corruption into different subtypes and find that pervasive corruption has a larger negative influence on FDI in transition economies, while arbitrary corruption has a lower negative influence on FDI there. These findings point to the importance of exploring in more detail the different types of corruption and also analyzing how corruption may vary in its influence on FDI depending on the host country. The empirical findings are subject to some limitations that emerge from the nature of the data. These limitations can be addressed in future research. First, I have implicitly assumed a degree of homogeneity within investors from the same country. Future research can analyze firm-level data to study differences among investors from the same country. Second, I have assumed a degree of homogeneity in the industries of operation. Future research can explore how the characteristics of the industry will affect the impact of corruption on FDI. Third, I have made a distinction between pervasive and arbitrary corruption and used recently developed measures. Future research can explore how other types of corruption influence FDI. Fourth, I have used the data available on FDI inflows at the UNCTAD and OECD. Future research can explore how the results hold for other samples of countries, for example one that includes China, a country with high levels of corruption that has received large FDI inflows. The paper contributes to two streams of research: a thematic stream focusing on the impact of corruption on FDI, and a theoretical stream that analyzes the influence of the institutional environment on the behavior of MNEs. With respect to the first line of inquiry, the paper provides a better understanding of the relationship between corruption and FDI by highlighting how differences among host countries affect this relationship. It presents a solution to the theoretical discussion of whether corruption has a positive or negative impact on FDI by arguing that the influence depends on specific characteristics of the host country. Additionally, the paper separates the costs and uncertainty of corruption by distinguishing between pervasive and arbitrary corruption, and discusses how their influence on the amount invested in the country differs according to the characteristics of the host country. It was found that the type of corruption matters for FDI. Future studies will need to take into account how the characteristics of the host country affect the impact of corruption and its types on FDI. The paper also contributes to a research stream focusing on the impact of the institutional environment on the behavior of MNEs. Studies of institutions have highlighted how good institutions help countries better develop and attract more foreign investment (Bevan et al., 2004; Delios and Henisz, 2000). This paper goes deep into the lack of properly developed institutions that corruption represents and highlights how these limit FDI coming into a country. Additionally, this paper illustrates the need to separate among types of corruption, since they represent different aspects of corruption and have different influences on FDI. Additionally, the paper highlights how, by analyzing transition economies, we can gain new knowledge and refine or even create theories (Meyer, 2001b). The paper illustrates how the accepted idea that corruption has a negative influence on FDI must be refined when studying transition economies, where this negative influence is altered. The strong institutions that exist in developed countries are not necessarily present elsewhere, resulting in different investor behavior. The paper helps managers better understand how to deal with corruption abroad. It explains how the challenges of operating in transition economies influence the overall difficulties of dealing with corruption abroad. It highlights to managers that corruption creates additional costs and uncertainty in a foreign operation and thus limits the incentive to invest. However, it also explains why, when investors have to choose between a known higher cost and an unknown higher uncertainty, avoiding additional costs is likely to be preferred to avoiding additional uncertainty. It is easier to deal with an unknown evil arbitrary corruption rather than a known one pervasive corruption.

26

A. Cuervo-Cazurra / Journal of International Management 14 (2008) 1227

Appendix A. Host countries analyzed

Host countries with availability of FDI data and the corruption indicator from Transparency International

Host country transition economies with availability of FDI data and the corruption indicator from Transparency International Host countries with availability of FDI data and pervasive corruption and arbitrary corruption indicators from World Business Environment Survey, World Bank

Host country transition economies with availability of FDI data and pervasive corruption and arbitrary corruption indicators from World Business Environment Survey, World Bank

Argentina, Armenia, Australia, Austria, Azerbaijan, Belgium, Bolivia, Brazil, Bulgaria, Cameroon, Canada, Chile, Colombia, Costa Rica, Czech Republic, Denmark, Ecuador, El Salvador, Estonia, Finland, France, Germany, Guatemala, Honduras, Hungary, Iceland, Italy, Jamaica, Japan, Kazakhstan, Korea, Kyrgyzstan, Lithuania, Macedonia, Malawi, Mauritius, Mexico, Mongolia, Morocco, Mozambique, Netherlands, New Zealand, Nicaragua, Norway, Paraguay, Peru, Poland, Portugal, Russia, Slovakia, Slovenia, Spain, Sweden, Switzerland, Tanzania, Tunisia, Turkey, Uganda, UK, Uruguay, USA, Uzbekistan, Venezuela, Zimbabwe Armenia, Azerbaijan, Bulgaria, Czech Republic, Estonia, Hungary, Kazakhstan, Kyrgyzstan, Lithuania, Macedonia, Mongolia, Poland, Russia, Slovakia, Slovenia, Uzbekistan Argentina, Armenia, Azerbaijan, Belize, Bolivia, Brazil, Bulgaria, Cameroon, Canada, Chile, Colombia, Costa Rica, Czech Republic, Dominican Republic, Ecuador, El Salvador, Estonia, Ethiopia, France, Germany, Guatemala, Haiti, Honduras, Hungary, Italy, Kazakhstan, Kyrgyzstan, Lithuania, Malawi, Mexico, Nicaragua, Panama, Peru, Poland, Portugal, Russia, Slovakia, Slovenia, Spain, Tanzania, Trinidad and Tobago, Tunisia, Turkey, Uganda, UK, Uruguay, USA, Uzbekistan, Venezuela, Zimbabwe Armenia, Azerbaijan, Bulgaria, Czech Republic, Estonia, Hungary, Kazakhstan, Kyrgyzstan, Lithuania, Poland, Russia, Slovakia, Slovenia, Uzbekistan

References
Acemoglu, D., Johnson, S., 2005. Unbundling institutions. Journal of Political Economy 113, 949995. Aslund, A., Boone, P., Johnson, S., 1996. How to stabilize: lessons from post-communist countries. Brookings Papers of Economic Activity 1996, 217291. Bardhan, P., 1997. Corruption and development. Journal of Economic Literature 35, 13201346. BBC News, 2000. Bribery the Russian way. BBC News on-line, Sunday, 16 July. http://news.bbc.co.uk/1/hi/programmes/from_our_own_ correspondent/836252.stm. Bevan, A.A., Estrin, S., 2004. The determinants of foreign direct investment into European transition economies. Journal of Comparative Economics 32, 775787. Bevan, A.A., Estrin, S., Meyer, K., 2004. Foreign investment location and institutional development in transition economies. International Business Review 13 (1), 4364. Blanchard, O.J., 1997. The Economics of Post-Communist Transition. Oxford University Press, New York. Boddewyn, J.J., 1988. Political aspects of MNE theory. Journal of International Business Studies 19, 119144. Boddewyn, J.J., Brewer, T.L., 1994. International-business political behavior: new theoretical directions. Academy of Management Review 19, 119143. Brada, J.C., 1996. Privatization is transition or is it? Journal of Economic Perspectives 10, 6786. Brainard, L., 1997. An empirical assessment of the proximity-concentration trade-off between multinational sales and trade. American Economic Review 87, 520544. Brenton, P., Di Mauro, F., Lucke, M., 1999. Economic integration and FDI: an empirical analysis of foreign investment in the EU and in Central and Eastern Europe. Empirica 26, 95121. CIA, 2005. World Factbook. http://www.cia.gov/cia/publications/factbook/. Accessed July 16. Cuervo-Cazurra, A., 2006. Who cares about corruption? Journal of International Business Studies 37, 803822. Cuervo-Cazurra, A., in press. The effectiveness of laws against bribery abroad. Journal of International Business Studies. De Soto, H., 1989. The Other Path. Harper Row, New York. Delios, A., Henisz, W.J., 2000. Japanese firms' investment strategies in emerging economies. Academy of Management Journal 43, 305323. Djankov, S., La Porta, R., Lopez-de-Silanes, F., Shleifer, A., 2002. The regulation of entry. Quarterly Journal of Economics 117, 137. Doh, J.P., Rodriguez, P., Uhlenbruck, K., Collins, J., Eden, L., 2003. Coping with corruption in foreign markets. Academy of Management Executive 17 (3), 114127. Eaton, J., Tamura, A., 1995. Bilateralism and regionalism in Japanese and U.S. trade and direct foreign investment patterns. NBER working paper # 4758. National Bureau of Economic Research, Cambridge, MA. Elliot, K. (Ed.), 1997. Corruption and the Global Economy. Institute for International Economics, Washington, D.C. Encyclopedia Britannica, 2005. http://www.britannica.com/. Accessed September 1.

A. Cuervo-Cazurra / Journal of International Management 14 (2008) 1227

27

Energy Information Administration, 2006. International Energy Annual 2004. http://www.eia.doe.gov/emeu/iea/. Accessed September 20. Frankel, J., Rose, A., 2002. An estimate of the effect of common currencies on trade and income. Quarterly Journal of Economics 117, 437466. Ghemawat, P., 2001. Distance still matters. the hard reality of global expansion. Harvard Business Review 137147 September. Gordon, R.G. (Ed.), 2005. Ethnologue: Languages of the World, Fifteenth edition. SIL International, Dallas, Tex. Online version: http://www. ethnologue.com/. Accessed July 16. Greene, W.H., 2000. Econometric Analysis, 4th ed. Upper Saddle River, NJ: Prentice-Hall. Habib, M., Zurawicki, L., 2002. Corruption and foreign direct investment. Journal of International Business Studies 33, 291307. Henisz, W.J., 2000. The institutional environment for multinational investment. Journal of Law, Economics and Organization 16, 334364. Heritage Foundation, 2005. Index of Economic Freedom. http://www.heritage.org. Accessed December 24. Hines, J.R., 1995. Forbidden payment: foreign bribery and American business after 1977. NBER working paper # 5266. National Bureau of Economic Research, Cambridge, MA. Horstmann, I.J., Markusen, J.R., 1992. Endogenous market structures in international trade (natura facit saltum). Journal of International Economics 32, 109129. Huntington, S.P., 1968. Political Order in Changing Societies. Yale University Press, New Haven, CT. International Monetary Fund, 2005. International Financial Statistics on-line. http://ifs.apdi.net/imf/about.asp. Accessed July 2. Johanson, J., Vahlne, J.E., 1977. The internationalization process of the firm: a model of knowledge development and increasing foreign market commitments. Journal of International Business Studies 8, 2332. Kaufmann, D., 1997. Corruption: the facts. Foreign Policy 107, 114131. Kaufmann, D., Kraay, A., Mastruzzi, M., 2003. Governance matters III: governance indicators 19962002. World Bank Working Paper # 3106. Washington, D.C.: World Bank. Krueger, A.O., 1993. Virtuous and vicious circles in economic development. American Economic Review, Paper and Proceedings 83, 351356. La Porta, R., Lopez-de-Silanes, F., Shleifer, A., Vishny, R.W., 1998. Law and finance. Journal of Political Economy 106, 11131155. Lambsdorff, J.G., 2003. How corruption affects persistent capital flows. Economics of Governance 4, 229243. Leff, N.H., 1989. Economic development through bureaucratic corruption. In: Heidenheimer, A.J., Johnston, M., LeVine, V.T. (Eds.), Political Corruption: A Handbook. Transaction Books, New Brunswick, N.J., pp. 389403. Linneman, H., 1966. An Econometric Study of International Trade Flows. North-Holland, Amsterdam. Lui, F.T., 1985. An equilibrium queuing model of bribery. Journal of Political Economy 93, 760781. Maddala, G.S., 1983. Limited-Dependent and Qualitative Variables in Econometrics. Cambridge University Press, New York. Meyer, K.E., 2001a. Institutions, transaction costs, and entry mode choice in Eastern Europe. Journal of International Business Studies 32, 357367. Meyer, K.E., 2001b. International business research on transition economies. In: Rugman, A.M., Brewer, T.L. (Eds.), The Oxford Handbook of International Business. Oxford University Press, New York. North, D.C., 1990. Institutions, Institutional Change, and Economic Performance. Cambridge University Press, New York. OECD, 2005. Foreign Direct Investment Statistics. http://www.oecd.org/home. Accessed June 2. Peng, M.W., 2000. Business Strategies in Transition Economies. Sage, Thousand Oaks, CA. Rodriguez, P., Uhlenbruck, K., Eden, L., 2005. Government corruption and the entry strategies of multinationals. Academy of Management Review 30, 383396. Rose-Ackerman, S., 1978. Corruption: A Study in Political Economy. Academic Press, New York. Rose-Ackerman, S., 1999. Corruption and Government. Cambridge University Press, Cambridge. Sachs, J.D., 1996. The transition at mid decade. American Economic Review Papers and Proceedings 86, 128133. Shleifer, A., Vishny, R.W., 1993. Corruption. Quarterly Journal of Economics 108, 599617. Smarzynska, B.K., Wei, S.J., 2000. Corruption and composition of foreign direct investment: firm-level evidence. NBER working paper # 7969. National Bureau of Economic Research, Cambridge, MA. Svejnar, J., 2002. Transition economies: performance and challenges. Journal of Economic Perspectives 16, 328. Svensson, J., 2005. Eight questions about corruption. Journal of Economic Perspectives 19, 1942. Tobin, J., 1958. Estimation of relationships for limited dependent variables. Econometrica 26, 2436. Transparency International, 2005. Corruption Perceptions Index. http://www.transparency.org. Accessed July 10. Uhlenbruck, K., Rodriguez, P., Doh, J., Eden, L., 2006. The impact of corruption on entry strategy: evidence from telecommunication projects in emerging economies. Organization Science 17, 402414. UNCTAD, 2005. World investment directory on-line. FDI country profiles. http://www.unctad.org/Templates/Page.asp?intItemID=3198&lang=1. Accessed May 25. Voyer, P.A., Beamish, P.W., 2004. The effect of corruption on Japanese foreign direct investment. Journal of Business Ethics 34, 114. Wei, S.J., 2000a. How taxing is corruption on international investors? The Review of Economic and Statistics 82, 111. Wei, S.J., 2000b. Local corruption and global capital flows. Brookings Papers on Economic Activity 2000, 303354. Wei, S.J., Wu, Y., 2001. Negative alchemy? Corruption, composition of capital flows, and currency crises. NBER working paper # 8187. National Bureau of Economic Research, Cambridge, MA. Wheeler, D., Mody, A., 1992. International investment location decisions: the case of U.S. firms. Journal of International Economics 33, 5776. World Bank, 2005. World Development Indicators. http://www.worldbank.org/data/. Accessed July 6. World Bank, 2006. World Business Environment Survey. http://info.worldbank.org/governance/wbes/. Accessed September 15.