The moderating role of local embeddedness on the performance of foreign and domestic firms in emerging markets

• This paper examines the impact of local embeddedness on performance for domestic and foreign firms in emerging markets.
• We use the degree of localization of sourcing and sales to measure the degree of embeddedness in the host country market.
• We find that both dimensions are subject to a reversed U-shaped function.
• We also find that foreign firms involved in local sales lose part of their ability to exploit their ownership advantages.

This paper examines the impact of the firm’s degree of local embeddedness on its performance in emerging markets using the World Bank’s Enterprise Survey Manufacturing Sector Module data on 15,715 firms covering 78 emerging markets. We use the degree of localization of sourcing and sales to measure the degree of embeddedness in the host country market. We argue that since embeddedness brings the firm into closer interaction with local firms and institutions, the costs of embeddedness should be lower for local firms than for MNE subsidiaries, since local firms can be assumed to be better able to decipher local institutions. We find that both dimensions are subject to a reversed U-shaped function. That is, by extending the degree of local sales and local sourcing up to a certain percentage, a firm can realize positive performance growth by becoming more embedded into the emerging market, but beyond this point, the performance impact is negative. We also find that foreign firms involved in local sales seem to lose part of their ability to exploit their ownership advantages as compared to foreign firms that export their production.