Risk perceptions and risk management approaches of Chinese overseas investors: An empirical investigation

Highlights

• We investigate how Chinese firms perceive and tackle risks associated with their overseas investments.

• Our survey data consist of 289 responses from firms located in 15 different provinces in China.

• Risk exposure of Chinese firms varies according to: ownership structure, investment motives, and the host country institutional quality.

• Our findings provide preliminary insights about the “Chinese way” of managing risks in the international markets.

Abstract

This paper presents empirical evidence on how Chinese firms perceive and tackle risks associated with their overseas investments. Using a first-hand survey dataset of Chinese firms who invest abroad, we depict variations in (1) the levels of different types of perceived risk, and (2) the risk management approaches taken by these firms. These variations are assessed with respect to three prominent factors: firm ownership structure, investment motives, and the host country institutional quality. Our evidence uncovers a significant degree and pattern of heterogeneity in the strategic behaviour of Chinese investors in risky environments.

Introduction

Investing overseas is a risky business. This is particularly the case for investors from a transitional economy such as China which may be less familiar with overseas markets than their counterparts from industrialised economies. This paper attempts to investigate the perceptions of overseas investment risks by Chinese firms and the influencing factors behind the perceived risks. Specifically, this paper strives to provide answers to the following research question: What are the different types of risk faced by Chinese firms in overseas markets, and how do these perceived risks, and management approaches to risk, differ across firm ownership, destination institutional quality and investment motives?

In addressing this question, the concept of risk perception follows the common definition in the literature of risk management and other disciplines, i.e. judgments made by individuals or organisations when they are asked to characterise and evaluate hazardous activities and factors (Slovic, 1987). Our focus on (subjective) risk reception as opposed to (objective) actual risks enables us to explore the heterogeneity in firms’ evaluations of their overseas investment even when they are facing similar political and economic environment, thus shedding light on the underlying firm-level decision-making process.

The practical prominence of this question is evident in China’s ever-growing interest in expanding its economic influence on a global scale. In particular, commencing from its Tenth Five-Year Plan (2001–2005), a legacy of Soviet-style national development agenda, China’s “Go Global” policy emphasised a strengthening of the country’s position in overseas direct investments (ODI), and was highlighted in its recent global-reaching economic ambition - mostly notably the “Belt and Road” Initiative.¹ With a strong supporting hand from the government, not too surprisingly, China’s non-financial ODI has increased exponentially from US$6.9 billion in 2001 (Davies, 2013) to a staggering US$118.02 billion in 2016 (MOFCOM, 2016), placing the country at the head of the world foreign investment rankings (refer to, United Nations Conference on Trade and Development, 2016, p. 6). Researchers and economic analysts also forecast that China will become the world’s largest economy after 2020 (Batten and Szilagyi, 2016).

Chinese firms have of course been subjected to a range of research on their ODI activities (Liu et al., 2008; Lu et al., 2014; Ramasamy et al., 2012; Liu et al., 2014). However, this paper develops a combined-factor risk perspective on the specific confluence of the role, interaction and influence of three key factors which underpin the market risk perceptions of overseas investors.

This study is facilitated via access to a survey dataset on Chinese firms. Significantly, the paper looks at the conjunction of risk factors (i.e. pertaining to ownership, institutional quality and investment motives) and the implications of this. It complements the extant literature in a range of ways. First, this study builds a link between ODI and risk management from the perspective of the investing firms’ perception about destination markets. Despite the fact that ODI is subject to various ongoing types of risks in different markets, risk management in the process of internationalisation (particularly for Chinese ODI), is relatively underdeveloped in current international business literature. The existing body of literature, nevertheless, suggests that, in the context of ODI, political turmoil in the target region reduces the likelihood of internationalisation, and also the acquisition of political knowledge about the target market reduces uncertainty (Hilmersson et al., 2015). Liesch et al. (2011), recognising that risk factors can vary for differing firms in different markets, advocate further empirical insight into this issue as part of a move towards the adoption by the international business literature of a more holistic approach towards risk identification and management. The present study responds to this call. This approach is particularly pertinent, and indeed imperative, in the aftermath and ongoing consequences of the 2008 global financial crisis. Risk management has received increasing attention from academics and policy makers, with a heightened focus on particular categories of risk faced in the internationalisation process including: economic and political risks; cultural differences; and, changes in customer need. (Hilmersson et al., 2015). This prescience of these risk factors was responded by regulatory changes in some developed countries, The UK Corporate Governance Code of 2014, for example, requires that: “directors should confirm in the annual report that they have carried out a robust assessment of the principal risks facing the company, including those that would threaten its business model, future performance, solvency or liquidity” (Financial Reporting Council, 2014). Consequently, risk reporting in the annual reports of listed firms around the world has increased significantly and firms now disclose information about the different types of risks, changes in their risk exposure, and how risks are managed or mitigated.

In the context of Chinese ODI, overseas investment risks also prompt new risk management mechanisms to safeguard overseas investment. At the macro-level, the Chinese government attempts to reduce potential risks associated with ODI through signing “mutual protection agreements” with other countries. At the micro-level, the China’s People’s Insurance Company provides personal accident insurance subsidies for overseas working expatriates (Luo et al., 2010, p.76). Furthermore, to facilitate ODI, the Chinese government regularly collects data on the problems that investors face in the overseas market and these are published in the “Obstacles Report Rules on Investment in Different Countries” (Luo et al., 2010). Together, these efforts work to provide a platform for potential Chinese investors in assessing their overseas investment destinations and making investment decisions according to their own risk preferences. Nevertheless, thus far, thorough empirical assessments of the risk exposure of Chinese ODI are scarce, with an exception being Buckley et al. (2007) and Han et al. (2018) who provide some valuable insights. They state that Chinese ODI is strongly associated with countries exhibiting higher political risk, and that much of the ODI in politically risky countries is partly driven by the close political ties between China and the host countries. Therefore, our exploration of the specific risks associated with Chinese investments as well as the influencing channels would build on and therefore significantly enrich this line of research.

Second, this paper looks explicitly at firm ownership and its effects on a firm’s self-reported investment motives in the context of ODI risk perception, offering the first evidence on the conditionality of ODI risk perceptions and risk management approaches in respect of firm ownership background and ODI motives. This novel angle is pertinent given the observation that, hitherto, a significant amount of Chinese overseas investment has been, and is being developed, through government investment initiatives, namely: the China “Belt and Road” strategy (see Fig. 1), overseas mergers and acquisitions (M&A), foreign contract projects – including projects initiated through built-operate-transfer (BOT), built-own-operate projects (BOO), and public-private partnerships (PPP) (MOFCOM, 2016). The existing empirical research on Chinese ODI has established some general evidence on: the determinants and motivations of ODI (Buckley et al., 2007; Zhang and Daly, 2011); the choice of ODI locations (Ramasamy et al., 2012); ODI in emerging markets (Chen et al., 2015); ODI in developed countries (Chen and Tang, 2014); ODI by Chinese public firms (Hu and Cui, 2014); Chinese multinationals (Deng, 2004); and, private enterprises (Huang and Renyong, 2014). Our investigation focuses on the role of ownership structure and investment motives in relation to risk and points to the importance of stakeholders (in particular government background) and ODI drives for understanding ODI behaviour originating from a transitional economy.

Third, our focus on destination market institutional quality (and its interacted effect with firm ownership) aligns closely with the notion of institutional environment in the academic literature. Within the international business commentary, in particular, the degrees and extremes of this issue have been signalled through, for example, the notion of institutional voids, namely the: “absence of specialized intermediaries, regulatory systems, and contract-enforcing mechanisms in emerging markets” (Khanna et al. 2005, p. 4,). Institutional voids occur in an extensive range of varieties and contexts depending on the given national context under examination (Mair et al., 2012; Zhou et al., 2016). In the case of Chinese overseas investment, as firms go abroad, their business models with “Chinese characteristics” (that are uncommon for western firms) are often faced with unprecedented challenges in dynamic institutional environments (Fang, 1999; Gammeltoft et al., 2012), raising a host of challenges for conventional business models. Owing to the paucity of disaggregated data, the literature nevertheless offers a more holistic approach in understanding the relationship between country-level socio-economic factors and the pattern of Chinese ODI without offering much information about how the institutional environment interacts with firm-level characteristics. An investigation of how Chinese firms of different backgrounds perceive and respond to the risk factors in other markets would therefore fill this gap with evidence from a micro-level.

Finally, the design of our study allows identification of perceived market risks for individual firms. Prior research on Chinese ODI utilises both country-level macroeconomic indicators (Buckley et al., 2007) and firm-level data (Ramasamy et al., 2012; Chen and Tang, 2014; Hu and Cui, 2014; Huang and Renyong, 2014; Chen et al., 2015) to explore the patterns and determinants of ODI. Discussing the prescient issues in the emerging market research, Kearney (2012) provides a succinct overview of the risks involved in the internationalisation process, which includes: complexity in contracts’ enforcements; protection of patents; governances and compliance costs; higher degree of uncertainty relating to foreign exchange movements; taxation policies, and political challenges in the overseas destinations. While these studies have extensively investigated how the local and overseas institutional environments determine and facilitate the flow of Chinese ODI, it is nevertheless not clear how risk factors play a role. However, the international business literature has employed risk indices to measure country-level risk. For instance, Brown et al. (2015) introduce the Robinson Country Risk Index (RCRI), a tool which incorporates four broad dimensions—Governance, Economics, Operations, and Society (GEOS). These risk-related indices provide a very generic overview about the risk profile of a country, and hence the potential risks associated with different countries are not further decomposed into sub-categories. This makes it difficult for ODI-seeking firms to understand what specific type of risk would be more pertinent to their investment should they decide to enter the international market. From a behavioural economics point of view, firms make investment decisions based on their own subjective perception of risks formed through the utilisation of both public and private information. This facilitates using “perception” instead of employing a homogenous measure of country-level risk, and enables the study to capture not only the heterogeneity in individual perception, but also to uncover the relationship between the macro-level politico-economic environment and the firm-level risk perception at the actual level where investment decisions are made. Thus, our analysis of firm heterogeneity in ownership and investment motives reveals a fuller picture and finer details of the links which are often masked in more aggregate level studies.

The rest of our paper is organised as follows. In Section 2, key hypotheses are developed as benchmark guidance for our empirical examination. Section 3 describes the survey data and the estimation strategy employed in this research. In Section 4, we analyse our findings drawn from our sample of surveyed Chinese ODI firms. Section 5 concludes the paper and offers some interpretation of the results in a broader context.