Performance of foreign subsidiaries: Does psychic distance matter?

Psychic distance paradox emerged from studies that found a positive effect of psychic distance on subsidiary performance. Recently, it was argued that international experience influences the relationship between psychic distance and performance. We propose that the effect of market-specific knowledge, rather than general international experience, should be examined because it negates the effect of psychic distance. We study 208 foreign direct investments made by west-European MNEs in the CEE (Central and Eastern European) region between 1996 and 2002 and find that positive relationship between psychic distance and subsidiary performance is observed only in the absence of market-specific knowledge. Psychic distance has no effect on subsidiary performance when the MNEs have CEE investment experience or have established the subsidiary with a local partner.