Chapter 9ReliabilityWhat is ReliabilityReliability is.docx

Chapter 9
Reliability
What is Reliability?
Reliability is concerned with questions of consistency
Other terms for reliability are:
Repeatability
Reproducibility
Stability
Consistency
Predictability
Agreement
Homogeneity
Measurement
Measurement is the assignment of number to object or events
according to certain rules (Carmines and Zeller, 1979)
Measurement
Measurement is important in quantitative research because:
Quantification allows for powerful statistical analysis
Numbers are often more clearly communicated
Objectivity is increased
Efficiency may be increased
Levels of Measurement
Nominal: a label but nothing more
Categorical: identifies group membership

Ordinal: indicates an order
Interval: also in order but an estimation of distance between the
scores
Ratio: order, defined distance, and a zero point
Measurement Error
The sources of error causing unreliability may be one or more
of the following:
Measurement is inaccurate or inconsistent
Raters or testers are inaccurate or inconsistent
Measurement Error
The sources of error causing unreliability may be one or more
of the following:
Phenomenon being measured varies from one measurement time
to the next
The situation is confounding the measurement
Classic Measurement EquationX =t
+eObservedTrueRandomScoreScoreError
Consistency
In order to maintain consistency of measurement there needs to
be:
Interrater reliability
Intrarater reliability
Intercoder reliability

Cohen’s Kappa
A way to calculate the percent of agreement between the two
coders
K = fo – fc K = kappa
N – fc fo = frequency of agreement
fc = frequency expected by chance
N = number evaluated
Test-Retest Reliability
A type of reliability that is evaluated by administering the same
test to the same people or taking the same measurement on the
same people after a specified period of time
The results of the two testing times are then compared
statistically
Factors affecting the test-retest reliability:
Assumes stability in the phenomenon being measured
May be affected by reactivity
Practice effect may also affect reliability

Ways to calculate test-retest reliability include:
Pearson product moment correlation
Intraclass correlations (ICCs)
Homogeneity
Cronbach’s alpha can be used to test the homogeneity of items
within a measure
It indicates the extent to which all of the items on the test are
“behaving” similarly
Homogeneity
Alpha of 0.70 is acceptable for new measures
Alpha of at least 0.80 is expected for established measures
Higher alphas (at least 0.90 or higher) are desirable for use in
clinical evaluation
Reliability of Physical Measures
Systematic error: a consistent error
Random error: inconsistent, unpredictable errors
Random errors can cancel each other out unless the researcher
know how to detect them by using the technical error of
measurement (TEM)

√ ∑ d2 d = the difference between scores of paired examiners
__________
2 N N = number of pairs of scores
Technical Error of Measurement (TEM)
Improving Reliability
Thoroughly trained raters
Periodic monitoring of raters
Retest and calibrate instruments
Add appropriate items and delete those that lower the alpha
coefficient to increase homogeneity
Improving Reliability
Standardize the conditions under which testing is done and
minimize any distractions
Make instructions clear, standardized
Eiteman, D., Stonehill, M., & Moffett, M. (2016). Multinational
business finance. Boston, MA: Prentice-Hall.
Read Chapters 3
This is a major resource, however, I think the assignment can be
accomplished without it. I can’t seem to be able to download
the book.
52 Academy of Management Perspedives August

S Y P O S I U
Political Markets and Regulatory Uncertainty:
Insights and Implications for Integrated Strategy
by Allison F. Kingsley, Richard G. Vanden Bergh, and Jean-
Philippe Bonardi
Executive Overview
Managers can craft effective integrated strategy by properly
assessing regulatory uncertainty. Leveraging the
existing political markets literature, we predict regulatory
uncertainty from the novel interaction of
demand- and supply-side rivairies across a range of political
markets. We argue for cwo primary drivers of
regulatory uncertainty: ideology-motivated interests opposed to
the firm and a lack of competition for
power among political actors supplying public policy. We align
three previously disparate dimensions of
nonmarket strategy—profile level, coalition breadth, and pivotal
target—to levels of tegulatory uncer-
tainty. Through this framework we demonstrate how and when
firms employ different nonmarket strategies.
To illustrate variation in nonmarket strategy across levels of
regulatory uncertainty, we analyze several
market entry decisions of foreign firms operating in the global
telecommunications sector.
F
irms know that entering a new industry or
geographic market involves market risk. Com-
mitting to that investment may also suhject
flrms to a critical nonmarket risk: regulatory un-
certainty. Firms entering new markets are often
required to gain approval from a regulator, and
once approved the firm's investments are typically

suhject to ongoing scrutiny hy a regulator over
issues such as product safety, pricing, rate of re-
turn, competition, and access to distrihution
channels. The uncertainty associated with
changes in regulation or public policy can reduce
the firm's profitability or block the firm from
meeting other performance objectives.
This applies, of course, to developed countries
but also to emerging economies. Consider for in-
stance the case of the German wholesaler Metro
Cash and Carry when it enteced India in 2003
(Khanna, Palepu, Knoop, & Lane, 2009). Al-
though Metro's distribution processes could be of
value in India, where getting fresh fruits and veg-
etables was often challenging for local restaurants
and hotels, the firm struggled to obtain regulatory
approval. Several years after obtaining initial reg-
ulatory approval to enter the market, shelves in
Metro's large stores were still half-empty because
of local governments' interpretation of the Agri-
cultural Produce Marketing Committee Act. This
act, in effect, prevented the company from sourc-
ing from farmers directly. Metro also faced much
stronger local opposition, particularly from local
retailers, than it had expected. Overall, regulatory
uncertainty was the major reason a multinational
like Metro struggled in India.
In a similar spirit, more than 300 multinational
executives from diverse firms, industries, and host
* Allison F. Kingsley (altison[email protected]) is Assistant
Professor of Management at the University of Vermont School
of Business

Administration.
Richard G. Vanden Bergh ([email protected]) is Associate
Professor of Management at the University of Vermont School
of
Business Administration.
Jean-Philippe Bonardi ([email protected]) is Professor at the
Faculty of Business and Economics of the University of
Lausanne.
Copyright of the Academy of Manogement, all rights reserved.
lontents may not be copied, emoiled, posted to a listserv, or
otherwise tronsmitted without the copyright holder's express
written permission.
Users may print, downlood, or email articles for individuol use
only. http://dx.doi.org/10.5465/amp.2012.0042
2012 Kingsley, Vanden Bergh, and Banardi 53
countries were asked in July 2011 to assess the
salience of political risks in their emerging market
investments (World Bank, 2011). Among the re-
spondents, 54% rated adverse regulatory change as
a political risk of most concem, a significantly
more pressing concem than either risk of expro-
priation (34%) or risk of war (31%). About one in
five executives regarded war (23%) and expropri-
ation (18%) risk as having "no impact" on their
risk perception; fewer than 1 in 25 regarded reg-
ulatory uncertainty as such (3%). Indeed, 35% of
multinational companies have experienced finan-
cial losses in the past three years due to adverse
regulatory changes. In the past 12 months alone,
43% of surveyed multinationals withdrew existing
or canceled planned investments due to unfavor-

able changes in regulation. To manage ongoing
investments with regulatory uncertainty, execu-
tives closely monitor the risk (27%) but also find
that the most effective strategy relies on engaging
with local public entities (10%), local enterprises
(14%), or key political leaders (25%). Nonmarket
strategies matter to executives. When firms fail to
align nonmarket strategies to the regulatory un-
certainty they face, struggles like those experi-
enced by Metro Cash and Carry in India occur.
Understandably, both market and regulatory un-
certainty will vary from one industry or geographic
region to the next but are not exclusive to any one
industry or region. Thus firms need to develop an
understanding of the key factors affecting both types
of uncertainty, and from this understanding craft an
integrated strategy (Baron, 1995a, 1995b) that min-
imizes the costs associated with the regulatory un-
certainty while complementing the firm's market
investments. Crafting strategy to manage market
uncertainty is important and highly developed in the
business field. In this paper we focus our analysis on
designing nonmarket strategies to manage regulatory
uncertainty and discuss ways for firms to integrate
this with their market strategy. Our empirical con-
text centers on firms' market entry strategies, al-
though our analysis can be applied across multiple
market strategies.
We propose a practical and novel framework
for managers to predict the level of regulatory
uncertainty. The framework we develop builds
from what are referred to as "political markets," a
term first coined by Nobel laureates in economics

James Buchanan and Gordon TuUock (1962) and
later applied to the study of firms' nonmarket
activities (Bonardi, Hillman, & Keim, 2005). Ac-
cording to the framework, political markets con-
sist of demanders of public policy such as firms,
consumers, and special-interest groups. Demand-
ers have a stake in regulatory policy. For example,
a firm's stake reflects the incremental effect a
regulation will have on profitability, while a con-
sumer's stake reflects the effect a regulation will
have on the value-to-price ratio of the product.
Political markets also consist of suppliers of public
policy such as legislators and the executive, regu-
lators, and courts. Similar to demanders, suppliers
also have interests in regulatory outcomes. Sup-
plier interests, in contrast to firms', are assumed to
reflect their own ideology and/or the interests of
their constituents (Kalt & Zupan, 1984).
Demanders and suppliers interact with each
other by exchanging information, votes, and/or
other valuable resources. Erom this exchange be-
tween demanders and suppliers a regulatory policy
emerges; predicting the level of regulatory uncer-
tainty, however, remains elusive. Whereas the po-
litical market approach has already been used to
study firms' ability to influence policy-making, we
propose that a similar approach can be used to
predict regulatory uncertainty and how firms can
manage the regulatory uncertainty through the
design of an integrated strategy.
In jointly analyzing political markets and regula-
tory uncertainty, we make several meaningful con-
tributions. We provide a flexible framework that
applies to the range of nonmarket settings by trans-

lating the political markets framework developed in
more mature and formal institutional settings (e.g.,
the United States and Westem Europe) to the
emerging-market and developing-country context.
Specifically, we analyze the supply-side interaction
among multiple political actors, including autocratic
sovereigns. We also develop new insights into the
key characteristics of demand-side interest groups.
Eurthermore, we explore how the characteristics of
both the demand- and supply-side actors interact
with each other to affect the degree of regulatory
uncertainty a firm faces.
We offer an innovative perspective on the
54 Academy af Management Perspetiives August
three dimensions of firms' nonmarket strategies,
effectively synthesizing several previously dispa-
rate nonmarket choices. In addition, we integrate
this nonmarket analysis with one of a firm's most
critical market strategies: market entry. In show-
ing how firms can assess regulatory uncertainty in
the context of entering new markets, we contrib-
ute to several literatures on market, nonmarket,
and integrated strategy. In addition, our insights
on nonmarket strategies offer managers clear, ex-
ecutable strategies with direct overall performance
implications for firms.
The paper is organized as follows. Overall we
propose a simple two-by-two framework in two parts.
In the "Political Markets and Regulatory Uncer-
tainty" section, we develop the first part of the

framework, which derives predictions about regula-
tory uncertainty. In the 'TSIonmarket Strategies" sec-
tion, we propose the second part of the framework,
which develops strategic implications for firms to
manage regulatory uncertainty in the context of
their expected and/or existing market investments.
To create an integrated strategy, we suggest the
dimensions of a nonmarket strategy that fit well with
the characteristics of the political market, that is,
activities and tactics in which market decisions such
as market entries are aligned with nonmarket ones
such as campaign contributions, lobbying, or coali-
tion building (Baron, 1995a; de Figueiredo &. Ed-
wards, 2007; Hillman & Hitt, 1999). In the "Discus-
sion" section, we provide various examples from
firms' market entry choices in the global telecom-
munications sector that involve different nonmarket
strategies; we argue that the observed integrated
strategy fits well with our framework. Finally, in the
"Gonclusions" section, we discuss our contribution
and the critical open questions that need to be
addressed to develop a deeper understanding of reg-
ulatory uncertainty and the implications for firms as
they develop their integrated strategy.
Political Markets and Regulatory Uncertainty
P
olitical markets are different from economic
markets (Boddewyn &. Brewer, 1994; Bonardi
et a l , 2005; Bonardi, 2011; Buchanan & TuU-
ock, 1962; Hillman & Keim, 1995; Weingast &
Marshall, 1988). This is why managers pursue
market strategies to improve the firm's economic

performance and nonmarket strategies to improve
the firm's political performance. For the best over-
all firm performance, managers integrate market
and nonmarket strategies (Bach &. Allen, 2010;
Baron, 1995a, 1995b). In this section of the paper,
we focus mainly on the nonmarket environment
of business, specifically the political market for
regulation, and we analyze a key nonmarket issue
confronting managers: regulatory uncertainty.
The magnitude of regulatory uncertainty is
critical to the performance of firms in many in-
dustries, including oil, natural gas, electric utili-
ties, airlines, pharmaceuticals, and telecommuni-
cations. Research has shown that heavily
regulated (e.g., banking, telecommunications, nu-
clear power) and government-dependent (e.g., de-
fense) industries necessarily spend the most cor-
porate resources managing regulatory uncertainty
(Baron, 1995a; Goates, 2011; Grier, Munger, &.
Roberts, 1994; Stigler, 1971). However, the re-
cent growth of social and environmental interest
groups has spread regulatory uncertainty to indus-
tries not traditionally considered highly regulated
(Holbum & Vanden Bergh, 2008; King & Lenox,
2000). Such uncertainty is difficult for business
(Ryan, Swanson, &. Buchholz, 1987), and execut-
ing nonmarket strategies is increasingly seen as
"the cost of doing business" (Kwak, 2012). That
cost derives in part from regulators' leaming
curve—their need to learn how to regulate new
business models and/or technologies—and from
the political games taking place among the various
players involved in the regulatory process, such as
firms, regulators, politicians, consumers, and in-
terest groups (Holbum & Vanden Bergh, 2004,

2008). Whereas authors in the international busi-
ness literature typically have focused on the bar-
gaining power of multinational firms vis-à-vis lo-
cal govemments (Blumentritt & Rehbein, 2008;
Lecraw, 1984; Luo & Zhao, in press), we consider
here the interactions among a much larger poten-
tial set of institutional players.
Managers will find it useful to view regulation
in the context of a political market where there
are demanders of regulation and suppliers of regu-
lation. See Figure 1 for an illustration. As expli-
cated in the introduction of this paper, demanders
are the regulated firm, other firms, consumer
Figure 1
Political Markets, Regulatory Uncertainty, and Integrated
Strategy
Rivalry faced by the
focal firm on the
DEMAND SIDE of the
political market
(interest groups,
activists, other firms)
Political Market Conditions
REGULATORY
UNCERTAINTY
Rivalry among public

players on the SUPPLY
SIDE of the political
market (regulators,
politicians, courts)
Focal Firm's
Integrated Strategy
groups, and other activist interests or stakeholders
(Arrow, 1951; Black, 1958; Buchanan & TuUock,
1962); suppliers are the regulator, the executive,
legislators, political parties, and courts (Downs,
1957; Riker, 1962; Stigler, 1971). Demanders and
suppliers transact by trading regulatory policies for
resources such as votes, finances, or information
(de Eigueiredo & Edwards, 2007; Hillman & Hitt,
1999). Eirms can be strategic with political market
transactions to maximize firm performance.
Indeed, the political market matters for firms.
Scholars have shown that the nature of demand-
ers can influencé the regulatory process. Eor ex-
ample, in the electric utility sector regulators tend
to reduce the allowed rates charged to consumers
when a competing interest group advocates for
consumers within the political market (Bonardi,
Holbum, & Vanden Bergh, 2006). Researchers
have also shown that the nature of suppliers
shapes regulatory outcomes. In the political econ-
omy literature, for example, scholars have shown
that elected regulators tend to have a negative
effect on tiie profitability of firms (Besley &.
Coate, 2003). There are thus factors in the polit-
ical market that tend to bias regulation in predict-
able directions. However, there are also factors
that create greater uncertainty for firms subject to

regulation over their market investments.
To predict the relative magnitude of regulatory
uncertainty, managers must understand their spe-
cific political market context, notably the nature
of demand-side rivalry and the nature of supply-
side rivalry. Drawing from the political markets
literature we focus on two drivers of regulatory
uncertainty: political motivation/level of ideology
(on the demand side) and level of competition for
power among political decision makers (on the
supply side). Eurthermore, we argue that this reg-
ulatory uncertainty makes political markets less
attractive for business investment.
Nature off Demand-Side Rivalry
The political markets literature identifies demanders
of regulation as firms in the industry, consumer
groups affected by regulatory policy, and other activ-
ist interest groups with a stake in the policy outcome
(Bonardi et al., 2005; Hardin, 1982; Moe, 1980;
Olsen, 1965). Demanders can originate locally or
intemationally. In developing-country contexts, ex-
ternal or foreign interests tend to assume a larger
role, capitalizing on foreign firms' vulnerabilities
and/or vocalizing local groups' interests. We exam-
ine regulatory uncertainty from the perspective of
regulated firms, whereby the focal firm is opposed by
either another firm or an interest group representing
stakeholders or affected interests. The firm's rival on
the demand side is characterized by its motivation
for regulatory change, either ideology or efficiency
motivations.

Ideology-motivated interests generate the most
regulatory uncertainty. Demanders with ideologi-
cal agendas are difficult to manage (Bonardi et al.,
2006; Bonardi & Keim, 2005) and tend to lever-
age public pressure effectively through tactics such
as mailings, campaigns, boycotts, reports, and/or
advocacy advertising (Baron, 2010; Holbum &
56 Academy oí Management Perspectives August
Vanden Bergh, 2004). Nonmarket issues that
have an ideological underpinning also tend to be
uniquely partisan and widely salient, which corre-
lates with more unattractive political markets
(Bonardi et a l , 2006; Bonardi & Keim, 2005).
Intensified rivalry among competing demanders
makes markets even more unattractive. Research
finds that rivalry increases with election issues,
concentrated costs or benefits, and attempts to
change existing regulation (Bonardi et al., 2005;
Bonardi et al., 2006; Bonardi & Keim, 2005; Hill-
man &. Hitt, 1999; Lowi, 1964; Wilson, 1980), all
of which arguably accompany ideological opposi-
tion. In addition, the coalition of voter interests
tied to ideology-motivated opponents likely holds
more strongly felt preferences with greater indi-
vidual stakes, and thus they make more durable
opponents than efficiency-motivated interests
(Stigler, 1971; Weingast & Marshall, 1988).
Efficiency-motivated interests, by contrast, tend
to be associated with narrower issues that are not
defined along partisan lines but rather reflect bot-
tom-line concerns. With efficiency-motivated ri-

vals, the regulated firm is better able to identify
rivals and has more substitute actions available to
trade, which, in tum, lowers transaction costs of
negotiation relative to ideology-motivated rivals
(Coase, 1960). Thus, from the regulated firm's
perspective, the political market is more attractive
(Bonardi et al., 2006) when there is less intense
rivalry among demanders (Bonardi et al., 2005;
Bonardi et al., 2006; Bonardi & Keim, 2005) and
less saliency in the eyes of suppliers. All else being
equal, if demand-side rivalry exists, regulatory pol-
icy outcomes are more predictable and regulatory
uncertainty lower when the rival is an efficiency-
motivated interest.
Nature of Supply-Side Rivalry
Suppliers of regulation are the regulator, execu-
tive, legislators, political parties, courts, and other
institutional decision makers. Previous work has
tended to concentrate analysis on select roles. Eor
instance, much of the literature on foreign invest-
ment and bargaining power focuses on only one
aggregate supplier: the host government (Brewer,
1992; Dunning, 1993). In the nonmarket strategy
literature, Bonardi et al. (2005) focused on two
types of suppliers, bureaucrats and elected officials;
Holbum and Vanden Bergh (2004) and Bonardi
et al. (2006) focused on regulatory agencies, rep-
resentatives and senators, and executives; and
Spiller and Gely (1990) and Spiller and Vanden
Bergh (2003) focused on courts. Eollowing this
work, we focus on how the regulator supplies
regulatory policy jointly with politicians.

Competition among political actors creates a
more attractive political market for firms (Anso-
labehere, de Eigueiredo, &. Snyder, 2003; Baron,
2001; Bonardi et al., 2006). Eundamentally this is
because competitive elections increase rivalry
(Bonardi et al., 2006), which makes politicians
more willing to trade policy favors (Baron, 2001)
and more responsive to satisfying constituent in-
terests (Keim & Zeithaml, 1986). As Stigler
(1971, p. 13) noted, "If entry into politics is ef-
fectively controlled, we should expect one-party
dominance to lead that party to solicit requests for
protective legislation but to exact a higher price
for the legislation." Thus competition among
elected politicians creates opportunities for corpo-
rate political strategies to work (Hillman &. Keim,
1995; Keim &. Zeithaml, 1986), including in a
regulatory setting. We note, however, that in de-
veloped countries such political actors are typi-
cally elected, whereas in developing countries
elections may be less potent or even nonexistent.
There are fewer actors, potentially only one piv-
otal decision maker, less delegation of power from
the executive, and thus signiflcantly less compe-
tition. We incorporate this important distinction
explicitly in our framework.
Competition may be defined beyond rivalry
for power. When competition among political
actors is driven also by heterogeneous prefer-
ences (Bonardi et a l , 2006; Vanden Bergh &.
Holburn, 2007) instead of or in addition to
checks and balances, the logic holds: More com-
petition creates a more attractive (and oppor-
tunistic) political market, which corresponds
with less regulatory uncertainty.

The political markets literature uses several
empirical measures to capture this idea of compe-
tition among political actors. In Bonardi et al.
(2006), the degree of supply-side rivalry is opera-
tionalized as the margin of winning votes for the
executive (governor or president) or the legislator
(or party). Rivalry is considered intense if there is
a greater than 5% difference between votes. In.
Holbum and Vanden Bergh (2012), legislative
competitiveness is also measured by the degree of
partisan control of the legislature. Rivalry is most
intense when political parties hold equal shares of
the legislative seats. In addition, a country's gov-
emance environment has been measured by the
political constraint index (POLCON) compiled
by Henisz (2000) and tested successfully against
intematiorial infrastructure data (2002) and
across a wide range of developed and developing
countries. POLCON measures the feasibility of
policy change based on a simple spatial model of
veto players, party alignment, and preferences
across branches of government.^ The index ranges
from 0 to 1, with higher scores indicating more
political constraints. The more political con-
straints there are, the less feasible policy change
but the more potential leverage or pivot points. In
political markets with no delegation of power
from the executive (e.g., autocratic regimes),
there are no constraints against the executive. In
all measures of political competition, the funda-

mental idea remains the same: Competition
makes political markets more attractive and less
uncertain for the regulated firm.
Predicting Regulatory Policy Uncertainty
I ntegrating these insights on the nature of de-mand-side rivalry
and the nature of supply-siderivalry, we can predict regulatory
uncertainty.
Figure 2 suinmarizes these insights in the first part
of our simple two-by-two framework.^
Figure 2
Predicting Regulatory Uncertainty
' POLCON I measures the feasibility of policy change, that is,
the
extent to which a change in the preferences of any one political
actor may
lead to a changé in govemment policy. The index is composed
from the
following information: the number of independent branches of
govemment
with veto power over policy change, counting the executive and
the
presence of an effective lower and upper house in the
legislature (mote
branches leading to more constraint); the extent of party
alignment across
branches of govemment, measured as the extent to which the
same party
or coalition of parties controls each branch (decreasing the level
of con-
straint); and the extent of preference heterogeneity within each
legislative
branch, measured as legislative fractionalization in the relevant

house
(increasing constraint for aligned executives, decreasing it for
opposed
executives).
We recognize that differences among political markets are more
aptly
represented as continua of competition and ideology.
I
Ideology-
Motivated
Opponent(s) I
Efficiency-
Motivated
Opponent(s)
Highly Uncerlairi
"NC/E"
Uncertain
uncertain
"C/l"
"C/E"
Least Uncertain
No Competition Competition

Among Among
Political Actors Political Actors
NATURE OF SUPPLY-SIDE RIVALRY
Using the insights on regulatory uncertainty
from Figure 2, we can also make predictions about
market entry and implications for investment. If
the regulated firm is opposed by an efficiency-
motivated interest and there is significant compe-
tition among political actors (Cell C/E), there is
less uncertainty. We predict that the regulated
firm will enter the new market, potentially as a
leader (Bonardi et a l , 2005). In hybrid situations
(Cell C/I and Cell NC/E), there is moderate reg-
ulatory uncertainty, which constrains the firm's
entry decision. If the regulated firm is playing a
political game with an ideology-motivated oppo-
nent in the context of no or little competition
among political actors (Cell NC/I), the regulatory
outcome is highly uncertain. This uncertainty im-
pedes investment, akin to a postpone strategy
(Bonardi et al., 2005). The regulated firm is likely
to not enter a new market (or further invest in an
existing market) if it cannot foresee the value of
its investment over time or anticipate opportuni-
ties to influence the political market. Generally
this results in a net loss for society but may be the
best outcome for the individual firm. Accordingly,
when considering entry into a new market and
when regulatory uncertainty exists, firms have two
stark choices: if uncertainty is too great, delay
investment, or develop and implement a nonmar-
ket strategy that sufficiently mitigates the negative
effects of the uncertainty. We now focus our at-
tention on the latter.

SB Academy af Management Perspedives August
Nonmarket Strategies
D
ifferent types of regulatory uncertainty require
different strategies (Bonardi &. Keim, 2005).
As uncertainty increases so too does the cost
of implementing a nonmarket strategy. We iden-
tify three dimensions previously treated dispa-
rately in the literature to guide how a regulated
firm should allocate incremental resources to mit-
igate uncertainty. The strategies differ in terms of
profile level, coalition breadth, and pivotal tar-
get—and, ultimately, cost. Variation in firm strat-
egies is driven by changes in the nature of both
demand-side and supply-side rivalries, and we ar-
gue that the demand side explains more of the
variation. Eigure 3 summarizes these strategic im-
plications for firms.
Profile Level
Corporate political strategies can be divided into
low- and high-proflle strategies. Low-profile strat-
egies occur without public involvement, whereas
high-profile strategies engage the public. High-
profile strategies are significantly more costly be-
cause the firm needs to invest more in publicity
and runs a greater risk of suffering reputational
damage.

Using the taxonomy of political strategies iden-
tifled in Hillman and Hitt (1999) and further
discussed in Hillman (2003) and Bonardi and
Keim (2005), low-profile strategies include but
are not limited to information strategies such as
lobbying, commissioning research projects and re-
porting research results, and supplying position
papers or technical reports; financial incentive
strategies such as honoraria for speaking and paid
travel; and constituency-building strategies such
as political education programs. High-profile strat-
egies can include information strategies such as
testifying as an expert witness; financial-incentive
strategies such as contributions to politicians and
political parties and personal service (hiring peo-
ple with political experience or having a firm
member run for office); and constituency-building
strategies such as grassroots mobilization (of em-
ployees, suppliers, and customers), advocacy ad-
vertising, public relations, and press conferences.
We can find numerous examples of high-profile
strategies in the literature. They include engaging
in public corporate social responsibility programs
to signal information to consumers and potential
coalition partners (Siegel &. Vitaliano, 2007) as
well as other demanders and suppliers, attending
to political ties and personal relations between the
multinational corporation (MNC) and its host
government (evaluated at length in bargaining
power and political connection theories); strate-
gically increasing political connections between
the firm and high-level govemment officials (Blu-
mentritt, 2003; Blumentritt & Rehbein, 2008;
Dieleman & Boddewyn, 2012; Faccio, 2006; Law-

rence, 2010; Luo &. Peng, 1999); and preemptive
self-regulation (Bonardi &. Keim, 2005; Maxwell,
Lyon, & Hackett, 2000),
Firms tailor the profile of their strategy based
on the nature of opposing demand. For example, if
the firm is opposed by an ideology-motivated in-
terest, it will deploy high-profile political strate-
gies that actively engage the public as well as
political actors. In cases of extreme regulatory
uncertainty (Cell NC/I), the firm will also need
low-profile strategies thai go behind the scenes to
provide information and financial incentives to
key decision makers. With efficiency-motivated
opponents, and thus less uncertainty, the firm
need pursue only low-profile strategies.
Coalition Breadth
Much work on market strategy centers on the
question of corporate scope, whether a firm should
integrate vertically and expand horizontally (Por-
ter, 1985). For nonmarket strategy, the question of
coalition scope can be equally important in deter-
mining performance. Managers must evaluate
whether to build "horizontal" coalitions among
interest groups and stakeholders outside of the
flrm's "vertical" chain o: production where more
natural coalition partners often reside (Baron,
1995b; Porter, 1985). This vertical rent chain
includes factor inputs (employees, suppliers and
their employees, capital, communities), the value
chain (inbound logistics, operations, outbound lo-
gistics, marketing and saies, service, support activ-
ities, alliances), channels of distribution (whole-
salers, distributors, retailers), and customers

(consumers, locked-in customers) (Baron, 1995b).
2012 Kingsley, Vanden Bergh, and Bonardi 59
Figure 3
Nonmarket Strategies
Ci
lu
g
Q
<
m
a
u.
O
lU
oc
Ideology-
Motivated
Opponent(s)
Efficiency-
Motivated
Opponent(s)
Profile: Low & High

Coalition: Horizontal & Vertical
Pivots': Regulator, Executive,
Legislators, Party Leaders
"NC/E"
Profile: Low
Coalition: Vertical
Pivots': Regulator, Party Leaders
iProfile: High
|Coa//i/on; Horizontal
iP/Vofs; Regulator, Executive,
¡Legislators
"C/I"
"C/E"
Profile: Low
Coalition: Vertical
Pivots: Regulator, Executive,
Legislators
No Competition Among
Political Actors

Competition Among
Political Actors
*ln extremely uncompetitive
contexts (e.g., strong
autocracy). Pivots: Executive $$
Horizontal coalitions can include any interest
group that wants the same regulatory policy out-
come the focal firm seeks.
Our framework helps firms determine the
breadth of their nonmarket coalition based on the
nature of opposing demand. With ideology-moti-
vated opponents, regulated firms must find allies
and advocates outside of their conventional coali-
tion of business-related groups with aligned inter-
ests. This makes horizontal coalitions more costly
to implement. With efficiency-motivated oppo-
nents, firms pursue less costly vertical coalitions.
Situations with the highest uncertainty (Gell
NG/I) require both horizontal and vertical
coalitions.
Pivotal Target
Based on the political markets' structured models,
demanders will invest incremental resources in
influencing pivotal institutions or actors (Grose-
close, 1996; Groseclose & Snyder, 1996; Holbum
& Vanden Bergh, 2004; Krehbiel, 1998, 1999;
Snyder, 1991).^ The target of the regulated firm's

•* Because we combine executives and legislatures into one
category of
"political actors," our framework can be translated from
presidential to
parliamentary systems or corporatist and pluralist systems as
explicated in
Hillman and Keim (1995) and Hillman (2003). Specifically,
there is an
elective affinity between our model and the predictions in the
literature on
presidential versus parliamentary systems. Presidential systems
that are
nonmarket strategy will depend on the relative
policy preferences and formal structure of the dif-
ferent institutions (de Figueiredo & de Figueiredo,
2002; Hillman & Hitt, 1999; Holbum & Vanden
Bergh, 2008; Vanden Bergh &. Holbum, 2007).
Following the logic of Holbum and Vanden Bergh
(2008) and Vanden Bergh and Holbum (2007),
the pivotal political institution or actor is the one
that represents, in essence, the swing vote.
In a competitive political environment, the
focal firm will tend to allocate greater resources to
pivotal legislators/executives to counteract pres-
sure brought by opposing ideology-motivated op-
ponents. In a less competitive environment, ap-
pointed party leaders are pivotal, as they organize
the politicians' preferences and constrain rivalry.
Targeting party leaders is, however, more expen-
sive than targeting legislators and the executive,
as parties have ongoing costs of operation and
costs of maintaining an organization and compet-
ing in elections (Stigler, 1971). Again, the most
uncertain or least attractive political market (Gell

NG/I) requires regulated firms to allocate signifi-
cant resources to comprehensively target multiple
political actors (Vanden Bergh &. Holbum, 2007)
explicitly political, more confrontational, and legislator focused
will group
in Cell C/I, generally, whereas parliamentary systems will
group in Cell
NC/E due to their executive focus, long-term cost-benefit
analysis, and
more cooperative sensibility.
60 Academy of Management Perspectives August
(see Eigure 4, which outlines the costs of nonmar-
ket strategies). While costly, jointly targeting the
regulator, executive, legislators, and party leaders
can serve as insurance or a majority protection
strategy (Croseclose, 1996; Croseclose & Snyder,
1996). In extreme situations lacking competition
(e.g., strong autocracies), the swing vote is the
executive, and all resources must be directed to
the single pivotal actor.
In sum, the most expensive nonmarket strate-
gies are associated with the most uncertain polit-
ical markets. Yet without a nonmarket strategy
tailored to the level of regulatory uncertainty, a
firm will not (or cannot successfully) invest in a
new market.
Discussion
le illustrate our nonmarket framework by an-
'alyzing several foreign entry decisions by

firms operating in the global telecommuni-
cations sector. Our goal is to highlight variation in
nonmarket strategy given different political land-
scapes. We discuss general strategies used by for-
eign investors and specifically address the market
entry strategies of firms domiciled in the United
States, Malaysia, Italy, and Luxembourg that in-
vested in the host markets of India, Thailand,
Russia, and the more risky emerging markets. At
the end of the section, we discuss where we need
to develop a better understanding of regulatory
uncertainty, and we provide managers with key
takeaways.
Foreign Entrants to Emerging-Market
Telecommunications Markets
In global contexts, firms are keen to manage reg-
ulatory uncertainty. Arguably, assessing the na-
ture of demand-side rivalry and the nature of
supply-side rivalry is most critical when entering
new geographic markets, where success depends
on navigating the new political landscape and
where exit strategies are typically more compli-
cated. To illustrate how our political markets and
regulatory uncertainty framework applies to firms
entering foreign markets, we focus on select cases
from the telecom sector. In doing so, we keep
variation associated with industry type constant,
effectively isolating the effect of political markets.
The telecom sector also makes for a strong test of
the proposed framework: Civen domestic con-
sumption and government oversight of pricing
and sector regulation, telecom markets are in-

tensely political affairs. The sector also exempli-
fies the tensions of entering foreign markets, as
telecom investments are characterized by high
capital intensity, significant asset specificity, and
economies of scale and scope (Williamson, 1985).
Our time period also covers the first decade of
internationalization, which has been determined
through previous research (Holburn &. Zelner,
2010) to be a critical and broadly applicable em-
pirical framework.
When a telecom firm evaluates new geographic
markets, it aims to predict the level of regulatory
uncertainty it will face over the life cycle of its
investment. Such uncertainty arises because the
regulator can terminate exclusive rights, license
new competitors, set new rate structures, change
license terms, or intervene in consumer disputes
or interconnection arrangements between service
providers. To predict the magnitude of the uncer-
tainty, the telecom firm anticipates the motiva-
tions of its primary opponents and assesses the
competitiveness of poli deal actors. Ideology-mo-
tivated opponents are often labor unions fighting
against job losses, nationalists opposed to foreign
ownership of strategic state assets, or local and
intemational development groups concerned with
universal service requirements. Efficiency-moti-
vated opponents tend to be consumers advocating
for better service or local and intemational pro-
liberalization groups opposed to anticompetitive
practices like monopolies or supportive of opening
the sector to foreign ownership. Because telecom
regulation is jointly supplied by the regulator and
other political actors (e.g., executive, legislators),
telecom firms can benefit from competition

among them. Where regulatory uncertainty ex-
ists—due to an ideology-motivated opponent
and/or lack of competitiveness of political ac-
tors—telecom firms can implement a nonmarket
strategy to mitigate the uncertainty or delay in-
vestment in the country if uncertainty is too great.
We use information from a subset of telecom
entry decisions that took place in 103 emerging
markets throughout the 1990s, the first decade of
Figure 4
The Cost off Nonmarket Strategies
E
Ut
o
à
<
UJ
o
3
Ideology-
Motivated

Opponent(s)
Efficiency-
Motivated
Opponent(s)
Profile: Low & High $S
Coalition: Horizontal & Vertical SS
Pivots': Regulator, Executive,
Legislators, Party Leaders SSS
"NC/I"
"NC/E"
Profile: Low $
Coalition: Vertical $
Pivots': Regulator, Party Leaders $ $
; No Competition Among
i Poiiticat Actors
Iproff/e; High $$
lcoa//f/on,- Horizontal $$
IP/Vois,- Regulator, Executive,
¡Legislators $ $

j "C/i"
"C/E"
Profile: Low $
Coalition: Vertical $
Pivots: Regulator, Executive,
Legislators $$
Competition Among
Poiiticai Actors
i NATURE OF SUPPLY-SiDE RIVALRY
1 *ln extremely uncompetitive |
1 contexts (e,g,, strong |
; autocracy). Pivots: Executive $$ ;
internationalization in the telecom sector. Ana-
lyzing cases during this time frame provides spe-
cific insight into how firms integrate market and
nonmarket strategy under extreme information
constraints and in the process of new market
openings. In the 1990s, 65 of the 103 countries
experienced positive entry decisions by foreign
firms into the country's telecom sector. In the
other 38 countries, either the sector did not open
to new entrants (e.g., China) or telecom firms
chose to postpone investing (e.g., Colombia in
1992, Pakistan in 1996, Slovakia in 1999).
Eoreign investors strategically assessed their en-
try options, specifically how well integrated strat-
egies might work and thus which ones to employ.

Eor instance, of the 597 individual foreign invest-
ments, 39.5% used traditional vertical coalitions
that involved foreign equity partners (49.8% of
investors), intemational banks (29.2% of inves-
tors), or joint ventures with locals or the govem-
ment (14.9% of investors); 19.1% used more
costly horizontal coalition strategies that involved
home govemments through bilateral investment
treaties (30.2% of investors), intemational orga-
nizations and multilateral institutions such as the
World Trade Organization General Agreement
on Trade in Services (11.2% of investors), or the
World Bank's Intemational Centre for the Settle-
ment of Investment Disputes (15.9% of inves-
tors). These findings align with the World Bank's
executive survey data discussed in our introduc-
tion, thus suggesting that these telecom data are a
reasonable candidate to illustrate the general im-
plications of our framework without sacrificing
external validity.
To further assess the applicability of our regu-
latory uncertainty framework and control for the
role of market strategy, we discuss three cases in
relatively similar market contexts: Thailand, Rus-
sia, and India in the mid-1990s (see Eigure 5). In
each of these settings, the competitiveness of po-
litical actors and the nature of opposing demand
vary, thereby illustrating the key dimensions of
our framework. Using the political constraint in-
dex as our proxy for the competitiveness among
political actors (Henisz, 2000), we see that both
Thailand (0.56 out of 1.00) and India (0.57 out of
1.00) demonstrated more political constraints and
thus more competition among politicians. Russia,

by contrast, had a materially lower score of 0.15,
suggesting that its political markets were less at-
tractive. In terms of ideological political opposi-
tion. Thai labor unions campaigned against for-
eign investment in the sector, citing loss of jobs
and depressed wages. Both Russia's and India's
foreign investment opportunities were opposed
predominantly by efficiency-motivated pro-liber-
alization groups who fought against the lack of
transparency and "worst" practices in the licens-
ing and privatization process.
Figure 5
Indicative Empirical Cases
DC
<
E
UJ
M
à
Z
UJ
o
o
UJ

DC
H
Z
Ideology-
Motivated
Opponent(s)
Efficiency-
Motivated
Opponent(s)
Millicom,
Multiple Countries
199O's
" N C / r
"NC/E"
Telecom Italia,
Russia
1995
No Competition
Among
Political Actors
Samart,
Thailand

1997
"C/l"
"C/E"
US West,
India
1995
Competition
Among
Political Actors
India in the mid-1990s (Cell C/E) experienced
significant competition among elected politicians,
with preferences and control shifting often. US
West, an American Baby Bell, entered the Indian
market in 1995 by acquiring five licenses, most
notably a 10-year pilot license to set up India's
first private telephone network for basic phone
services. The company pursued a baseline low-
profile strategy of working with the Indian regu-
lator almost exclusively. This involved informal
bidding for licenses (often ahead of public ten-
ders) in an attempt to manage opposition from
increasingly vocal pro-liberalization groups, in-
cluding key competitors such as NYNEX and Re-
liance (Pyramid Telecom, 1995a). To secure li-
censes and counter the efficiency opponents, US
West also structured a vertical coalition that in-
cluded its proposed equipment suppliers and the
Cellular Operators Association.

In Russia in 1995 (Cell NC/E) politics were
less competitive than in India, increasing uncer-
tainty for foreign telecommunications firms.
Much of the opposition to foreign investment was
from media and business communities who were
opposed to cozy sales lacking in transparency and
efficiency. Investors generally used baseline low-
proflle, vertical-coalition strategies as in India, but
their political targets were the party and not the
regulator, which was weak in the face of regime
transition and liberalization. Indeed, Telecom Ita-
lia found that investing in Russia required exten-
sive and quiet backroom negotiations with party
insiders. In the privatization of Russia's state-
owned local telecommunications firm, Svyazin-
vest, foreign telecom investors such as Telecom
Italia were "careful not to arouse Russian sensibil-
ities by demanding 'control'" and often portrayed
themselves "as a partner in Russia's development,"
all the while negotiating with key political elites
and oligarchs (Pyramid Telecom, 1995b).
In Thailand (Cell C/I), the political environ-
ment was different. Despite ideological opposition
from labor and trade unions that feared job losses
as the sector liberalized and state-owned enter-
prises privatized (Pyramid Telecom, 1995a), Ma-
laysian company Samart entered the Thai cellular
market in 1997. The company strategically joined
forces with the state-owned Thai Telecom. It pur-
sued high-profile targeting of elected politicians in
the Thai government and tried to leverage a hor-
izontal coalition with the WTO, the IMF, and its
home govemment. In the wake of the 1997 Asian

financial crisis, the WTO and IMF had stepped in
to advocate for both government austerity and
liberalization. While not necessarily a natural
partner for a Malaysian operator, the WTO's lib-
eralization deadline and IMF's privatization de-
mand as a condition for financial aid played into
Samart's desire to manage regulatory uncertainty
and enter the Thai market. Samart also rolled out
high-profile advertisements aimed at the Thai
public that advocated for privatization and foreign
ownership. Indeed, many telecommunications
flrms in the Thai market employed high-profile
strategies: One firm put out explicit ads discussing
how its acquisition would not change labor wages;
another aired an advertisement claiming that its
competitor's handset was a health hazard.
One particular firm based in Luxembourg was
especially opportunistic and entrepreneurial in
emerging-market telecom deals. Millicom Inter-
national Cellular was a niche player in global
telecom investing and proved the second most
proliflc dealmaker in the 1990s. It pursued high-
risk opportunities in smaller markets with more
uncertain growth potential. By 1996, Millicom
had amassed 29 cellular licenses in 30 countries
covering 375 million people in Asia, Eastern Eu-
rope, and Africa. Most of Millicom's investments
occurred (and continue to occur) in unattractive
political markets (Standard &. Poor's, 1996).

To manage the regulatory uncertainty that
comes with ideological opponents and the lack of
competition among political actors (Cell NC/I),
Millicom negotiated "lucrative deals behind
closed doors, relying on the ability of its local
managers to navigate Byzantine regional bureau-
cracies and form lucrative partnerships with lead-
ing local business interests" and telephone author-
ities (Pyramid Telecom, 1996, p. 2). During its
issuance of senior subordinate debt, even the
rating agencies noted this nonmarket strategy:
"Millicom's strategy is to develop mobile oper-
ations by finding a local partner with local
knowledge, expertise, and contacts to assist
with legal and regulatory issues, such as obtain-
ing licenses and organizing interconnection
agreements with other market participants"
(Standard & Poor's, 2004, p. 3). This is funda-
mentally a low-profile vertical coalition target-
ing the regulator. But Millicom also actively
advertises its benefits to local consumers. Al-
though Millicom charges high handset and
monthly service charges, its service and cover-
age benefits the consumer base, and Millicom
publicizes this to engender greater support. Mil-
licom also engages local partners and regional
managers to assist with party and politician
relations.
Conclusions
Properly assessing a firm's exposure to regulatoryuncertainty
helps managers craft an appropri-ate integrated strategy. Our
article suggests two
primary drivers of regulatory uncertainty for firms:
ideology-motivated interests opposed to the firm

and a lack of competition for power among polit-
ical actors such as executives and legislators. Be-
cause managers would like to devise the most
economical strategy to manage regulatory uncer-
tainty, we identify three dimensions of nonmarket
strategy—profile level, coalition breadth, and piv-
otal target—to distinguish how a regulated firm
allocates incremental resources beyond a basic
low-profile strategy that engages the regulator and
the firm's vertical coalition. We argue and find
anecdotal evidence that managers use high-profile
strategies and recruit horizontal coalition partners
to manage ideological opponents. Managers also
target their strategy at the pivotal swing voter—
the regulator, the party, the legislators, or the
executive. In cases of extreme uncertainty, man-
agers pursue a multifaceted nonmarket strategy.
While we derive our two-by-two framework
from diverse, established literatures in political
science, economics, and management, this study
raises a number of questions that will need to be
addressed in subsequent work. For example, we are
somewhat agnostic about the relative effect of
changes in demand-side rivalry versus changes in
supply-side rivalry. Our matrix implies that
changes in demand-side rivalry have a greater
effect on the cost of nonmarket strategy, but why
this is remains incompletely understood. In addi-
tion, this piece has been silent about the nature of
the regulator. Previous research has shown that
appointed regulators create more attractive polit-
ical markets for firms, and that knowing the reg-
ulator's preferences relative to elected politicians
and the regulated firm matters (Holbum &

Vanden Bergh, 2008). We plan an extension of
the current framework that conceptualizes the na-
ture of the regulator more precisely and identifies
how a change in the key characteristics of the
regulator changes the level of regulatory uncer-
tainty and firms' nonmarket strategies. We also
aim to test the robustness of the theoretical frame-
work to different empirical settings, including
those with direct performance data.
This paper nonetheless makes important con-
tributions to firms' understanding of integrated
strategy. First, we provide a flexible framework
that applies to a range of nonmarket settings. We
translate the political markets framework devel-
oped in more mature and formal institutional set-
tings to incorporate the emerging-market and de-
veloping-country context. In doing so, we
differentiate ourselves from the traditional U.S./
Eurocentric political markets literature and ad-
vance the theory. Specifically, we analyze the
supply-side interaction among multiple political
actors and decision makers, not just a select group
of (elected) regulators and legislators. Our char-
acterization of the supply side in our framework
can also accommodate extremely uncompetitive
political markets situations, notably an autocratic
sovereign. Further, we unpack the nature of op-
posing demand by providing a new categorization
of interest groups based on motivation.

Second, much of the literature discussed in this
article recognizes the importance of adjusting po-
litical strategy as political uncertainty increases
(e.g., Dieleman & Boddewyn, 2012; Hillman,
2003). Our research complements this literature
by creating a framework that predicts when regu-
latory uncertainty is likely to be greater for a firm.
We accomplish this by focusing on how the key
demand- and supply-side characteristics interact
with each other to create regulatory uncertainty.
How this interaction leads to predictions about
the degree of uncertainty has not been explored in
the nonmarket strategy literature that analyzes
firms operating in different political contexts (e.g.,
Dieleman & Boddewyn, 2012; Hillman, 2003;
Lawrence, 2010; Luo & Peng, 1999).
Third, we empirically pair this novel nonmar-
ket analysis with one of a firm's most critical
market strategies: market entry. In showing how
firms can assess regulatory uncertainty in the con-
text of entering new markets, we contribute to the
literature on integrated strategy and, separately,
offer an innovation to bargaining power theory.
The latter argues that an MNG entering a new
country has stronger bargaining power to the ex-
tent that it has, for instance, technology, jobs, and
political ties (Blumentritt, 2003; Blumentritt &.
Rehbein, 2008; Dieleman &. Boddewyn, 2012;
Lawrence, 2010). We build our framework from a
similar insight that firms negotiate for the supply
of public policy with host govemments, but we
simultaneously focus on the institutional con-
straints to firms' bargaining power and the other
parties in the negotiation network in addition to
the host government. We also provide clarifica-

tion on when and how certain firm resources, such
as political ties, matter and affect firms' market
strategies.
Thus we are able to complement existing in-
sights (e.g., Blumentritt, 2003) by explaining why
and when we see MNGs employing different in-
tegrated strategies as they enter different political
markets. While this insight can be viewed as con-
sistent with existing literature (e.g., Hillman,
2003), we also extend these insights by being able
to explain why different firms, operating within
the same country, employ different integrated
strategies. The key characteristics of demanders
and/or suppliers, within a given political jurisdic-
tion, can vary across firms. Finally, our insights
extend beyond market entry and can be applied
to other market strategies, such as market
consolidation.
Taken together, our nonmarket framework pro-
vides managers with clear insights on regulatory
uncertainty: Uncertainty is higher in political
markets characterized by ideologically motivated
opponents and less competition among suppliers
of policy. From this assessment, we equip manag-
ers with three discrete nonmarket strategy choices
to execute alongside market entry or other market
strategies. Synthesizing profile level, coalition
depth, and pivotal actor, we advance previously
distinct strategy arguments. Thus our insights
from regulatory uncertainty yield meaningful im-
plications for firms' integrated strategy and thus
performance.

Acknowledgments
The authors would like to acknowledge helpful comments
received from the editor and two anonymous reviewers on
earlier versions of this article and from participants at the
2011 Strategic Management Society and 2012 Academy of
Intemational Business annual meetings.
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Appendix 1
World Bonk (2011) Executives Survey
The survey was conducted on behalf of the World Bank's
Multilateral Investment Guarantee Agency by the Econo-
mist Intelligence Unit. It contains the responses of 316
senior executives (146 chief-level) at multinational enter-
prises investing in developing countries. The geographic
distribution of the respondents is Asia 62, North America
87, Europe 135, and the rest of world 32. The survey in-
cludes 186 organizations with revenue over $500 million in
the following industries (number of executives in parenthe-
ses): primary (26), manufacturing (80), services (110), fi-
nance (77), utilities/transportation/storage/communications

(23). Quota sampling was used to ensure that the industry
and geographic composition of the survey sample approxi-
mated the composition of actual foreign direct investment
outflows to developing countries. We used the following
survey questions in this paper.
Question lOo. In your opinion, which types of political risk are
of most concem to your company when investing in emerg-
ing markets? Select up to three. Transfer and convertibility
restrictions, breach of contract, non-honoring of govem-
ment guarantees, expropriation/nationalization, adverse reg-
ulatory changes, war, terrorism, civil disturbance.
Question 11. In your opinion, in the developing countries
where your firm invests presently, how do each of the risks
listed below affect your company? Rate each risk on a scale
of 1-5 where 1 = Very high impact and 5 = No impact.
Transfer and convertibility restrictions, breach of contract,
non-honoring of govemment guarantees, expropriation/na-
tionalization, adverse regulatory changes, war, terrorism,
civil disturbance.
Question 12. In the past 3 years has your company experienced
financial losses due to any of the following risks? Select all
that apply. Transfer and convertibility restrictions, breach of
contract, non-honoring of govemment guarantees, expro-
priation/nationalization, adverse regulatory changes, war,
terrorism, civil disturbance.
Question 13. To your knowledge, have any of the following
risks caused your company to withdraw an existing invest-
ment or cancel planned investments over the past

12 months? Select one answer for each risk (see question
12). Withdraw existing investment, cancel planned invest-
ments, both withdraw and cancel, neither withdraw nor
cancel, don't know.
Question 15. In your opinion, in the countries where your
company invests, what are the most effective tools/mech-
anisms available to your firm for alleviating each of the
following risks? Select one tool for each risk (see question
12). Engage with local public entities, joint venture with
local enterprises, risk analysis/monitor, relationships with
key political leaders, political risk insurance, risk insig-
nificant for projects, no existing tool can alleviate
this risk.
Copyright of Academy of Management Perspectives is the
property of Academy of Management and its content
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listserv without the copyright holder's express
written permission. However, users may print, download, or
email articles for individual use.
J. Account. Public Policy 32 (2013) 1–25
Contents lists available at SciVerse ScienceDirect
J. Account. Public Policy
j o u r n a l h o m e p a g e : w w w . e l s e v i e r . c o m / l o c

a t e / j a c c p u b p o l
Analyst coverage, earnings management and financial
development: An international study
François Degeorge a, Yuan Ding b,⇑ , Thomas Jeanjean c, Hervé
Stolowy d
a Swiss Finance Institute, University of Lugano, Switzerland
b China Europe International Business School (CEIBS),
Shanghai, China
c ESSEC Business School, France
d HEC Paris, France
a b s t r a c t
0278-4254/$ - see front matter � 2012 Elsevier In
http://dx.doi.org/10.1016/j.jaccpubpol.2012. 10.003
⇑ Corresponding author. Address: Department
(CEIBS), 699, Hongfeng Road, Pudong, Shanghai 20
E-mail addresses: [email protected][email protected] (H.
Stolowy).
Using data from 21 countries, this paper analyzes the relation
among analyst coverage, earnings management and financial
development in an international context. We document that the
effectiveness of financial analysts as monitors increases with a
country’s financial development (FD). We find that in high-FD
countries, increased within-firm analyst coverage results in less
earnings management. Such is not the case in low-FD countries.
Our results are economically significant and robust to reverse
cau-
sality checks. Our findings illustrate one mechanism through
which financial development mitigates the cost of monitoring
firms and curbs earnings management.
� 2012 Elsevier Inc. All rights reserved.
1. Introduction

A large body of research explores the differences between
financial systems worldwide and docu-
ments the positive effects of financial development: It boosts
industry growth, the formation of new
establishments, and capital allocation (Beck and Levine, 2002).
It predicts capital accumulation and
productivity improvements (Levine and Zervos, 1998). It is
especially important for firms that depend
on external financing (Demirgüç-Kunt and Maksimovic, 1998;
Rajan and Zingales, 1998).
While the benefits of financial development appear to be well
established, the detailed mecha-
nisms through which these benefits are brought to bear are still
largely unknown. Levine (1997) lists
c. All rights reserved.
of Finance and Accounting, China Europe International
Business School
1206, China. Tel.: +86 21 2890 5606; fax: +86 21 2890 5620.
(F. Degeorge), [email protected] (Y. Ding), [email protected]
(T. Jeanjean),
mailto:[email protected]
http://www.sciencedirect.com/science/journal/02784254
http://www.elsevier.com/locate/jaccpubpol
2 F. Degeorge et al. / J. Account. Public Policy 32 (2013) 1–25
five basic functions of a financial system: (1) to facilitate risk

sharing; (2) to allocate resources; (3) to
monitor managers; (4) to mobilize savings; and (5) to facilitate
the exchange of goods and services.
Our paper’s contribution is to focus on the monitoring function;
specifically, on financial analysts as
monitors of firms. We find that higher financial development is
associated with a greater effectiveness
of monitoring by financial analysts. Using a sample of 21
countries from 1994 to 2002, we find that in
countries with highly developed financial systems (hereafter
‘‘high-FD countries’’), increased within-
firm coverage results in less earnings management. Such is not
the case in countries with less well-
developed financial systems (hereafter ‘‘low-FD countries’’).
There is evidence, both systematic and anecdotal, that financial
analysts perform an important
monitoring role, at least in the United States. Dyck et al. (2010)
document that, in the US, financial
analysts are among the quickest detectors of fraud. For example,
in the mid-1990s Sunbeam, an appli-
ance manufacturer, engaged in ‘‘bill-and-hold’’ deals with
retailers: The retailers bought Sunbeam
products at large discounts, but the products were then stored by
the manufacturer at third-party
warehouses for later delivery. In effect, Sunbeam was shifting
revenue from the future to the present.
The first warning to shareholders that Sunbeam was engaging in
extensive earnings management
came from a PaineWebber analyst, who noticed unusually large
increases in sales of Sunbeam electric
blankets in the summer and outdoor barbecue grills around
Christmas time (Byrne, 1998).
The Sunbeam example illustrates a broader pattern. Using US

data, Yu (2008) finds that earnings
management tends to be lower in companies followed by more
financial analysts. It is not hard to
see why this might be so. Analysts have plenty of opportunities
to probe a company’s accounts to
see whether they paint a fair picture of the company’s true
health. Provided they perform their duties
with a modicum of diligence, the very fact that they are
watching can in itself be a deterrent to earn-
ings management and other activities that might embarrass
corporate management. All else being
equal, a company followed by financial analysts has less leeway
to manipulate its earnings.
Findings based on US data, however, do not necessarily apply to
countries with lower levels of
financial development. To monitor company managers, analysts
must overcome severe hidden infor-
mation and hidden action problems: Managers might hide
negative information about the company’s
prospects; they might hide some of their actions if they fear
retribution from investors; they might be
unable to reveal positive information about the firm to
investors. We expect these difficulties to be
easier to overcome in more financially developed countries like
the United States. Holding constant
incentives to manage earnings, we discuss possible reasons for
this difference: Greater transparency
may facilitate analyst monitoring in high-FD countries; investor
demand for analyst monitoring
may be greater; firms’ incentives to facilitate analyst
monitoring may be larger; and the quality and
depth of the financial analyst pool may be improved.
We measure the effectiveness of analyst coverage of managers
by the impact of that coverage on

earnings management by companies. We posit that if more
analyst coverage results in less earnings
management, then analysts are useful monitors of managers’
actions; this leads to our first testable
hypothesis. If a country’s level of financial development
enhances analyst monitoring, then the asso-
ciation between analyst coverage and earnings management
should be more negative in more finan-
cially developed countries.
Not everyone shares the view that the presence of financial
analysts reduces earnings manage-
ment. On the contrary, financial analysts in the United States
have been accused of encouraging earn-
ings management by setting company managers targets that are
impossible to meet – except by
manipulating company performance (Levitt, 1998; Fuller and
Jensen, 2002). If the weight of analyst
opinion is greater in more financially developed countries, the
analyst’s target-setting role, and the
associated pressure on companies to meet those targets, may
also be greater (Brown and Higgins,
2001, 2005). According to this view, as one moves from low-FD
to high-FD countries, companies
would become more fixated on trying to meet or beat the analyst
consensus benchmark; this reason-
ing produces our second testable hypothesis: Analyst coverage
leads to more earnings management in
more financially developed countries.
Using a sample of 21 countries from 1994 to 2002 and
controlling both for firm incentives to man-
age earnings (through various firm characteristics like size,
leverage and growth) and for earnings
management variation among countries and industries (through
firm fixed effects), we find support

for our first hypothesis: Financial development is associated
with more effective monitoring
F. Degeorge et al. / J. Account. Public Policy 32 (2013) 1–25 3
effectiveness by analysts. In high-FD countries, increased
within-firm analyst coverage is associated
with less earnings management: as analyst coverage moves from
zero to one analyst (and respectively
from zero to two analysts) earnings management falls by about
5% (respectively, 8%). By contrast, in
low-FD countries analyst coverage is not associated with a
reduction in earnings management. Our
results are robust to corrections for reverse causality. We find
no support for our second hypothesis.
Our paper is at the intersection of two streams of literature. The
first one considers the influence of
analysts on earnings management. Degeorge et al. (1999) and
Burgstahler and Eames (2006) show
that in the US managers tend to manipulate earnings in order to
reach the analysts’ consensus. Both
studies are limited to a sample of firms actually covered by
analysts, and they only consider the role of
analysts when firms are near the consensus. Yu (2008) extends
the scope of these studies by analyzing
US firms both covered and not covered by analysts. He finds
that firms with high analyst coverage
have a lower level of discretionary accruals than firms with low
coverage. His findings, however, can-
not automatically be applied to other countries. We contribute
to this field of literature by showing
that analyst coverage reduces earnings management only in
highly financially developed countries.

Our paper also contributes to the literature that analyzes the
country-level determinants of earn-
ings management. Past literature shows that earnings
management decreases with investor protec-
tion (Leuz et al., 2003; Haw et al., 2004) and that financial
development is positively correlated
with investor protection (see Beck et al., 2003; Beck and
Levine, 2005). We find that private monitor-
ing activity (analyst following) complements country-level
institutional characteristics. In other
words, previous country-level work may actually have
underestimated the costs of poor institutions
(i.e., weak investor protection) by failing to take into account
this complementarity between firm-
level and country-level mechanisms.
The remainder of this paper is organized as follows: Section 2
develops our research hypotheses.
Section 3 discusses our research design. Section 4 presents our
main empirical findings. Section 5 takes
a deeper look at the link between analyst coverage and financial
development and Section 6 concludes.
2. Hypothesis development
In their seminal article, Jensen and Meckling (1976) hint at the
role of financial analysts in promot-
ing good corporate governance:
We would expect monitoring activities to become specialized to
those institutions and individuals
who possess comparative advantages in these activities. One of
the groups who seem to play a large
role in these activities is composed of the security analysts
employed by institutional investors, bro-
kers, and investment advisory services [. . .] To the extent that
security analysts’ activities reduce the

agency costs associated with the separation of ownership and
control they are indeed socially produc-
tive. (Jensen and Meckling, 1976, p. 354).
Analysts have the means to be monitors. Unlike most investors,
they are trained to analyze the
numbers produced by companies and they enjoy privileged
access to company management. Analysts
also have a motive to be monitors. They could look foolish and
see their reputations suffer if their re-
search reports and recommendations were based on manipulated
numbers. Anecdotal evidence, such
as the Sunbeam example given above, suggests that financial
analysts do sometimes perform an
important monitoring role. Dyck et al. (2010) document that in
the United States analysts are among
the quickest monitors of fraud. Yu (2008) finds that US firms
followed by more analysts manage their
earnings less.
Our goal is to assess empirically whether analyst coverage also
functions as a curb on earnings
management in countries that are less financially developed
than the United States. Beck and Levine
(2002) define financial development as ‘‘the degree to which
national financial systems assess firms,
monitor managers, facilitate risk management, and mobilize
savings’’ (p. 160).1 Analysts are more
likely to be effective monitors in curbing earnings management
in high-FD countries than in low-FD
countries for at least four reasons: in high-FD countries:
1 Note that financial development is a concept distinct from
legal origin, investor protection or legal enforcement, see
Section
3.2, Sample and data.

– The supply of information is likely to be better.
– The demand for information by investors is likely higher.
– Followed firms have higher incentives to be monitored.
– Financial analysts are likely to be of higher quality.
First, financial analysts may be better able to perform their
monitoring role when information is
more diffuse. Dyck et al. (2010), for instance, discuss the
importance of Hayek’s ‘‘diffuse information’’
concept in the context of fraud detection. Consider two possible
stylized environments in which an
analyst might operate. In one environment, which we associate
with high-FD countries, analysts have
several sources of information at their disposal to use to check
the plausibility of statements made by
the companies they follow. This diffuseness of information is
partly due to stricter and better-enforced
disclosure requirements and partly to the existence of an active
and competitive financial community
of investors, journalists, and information sources. An analyst
following firm A can obtain data on A’s
activities, projections, strategies, and financial policies, and can
then compare that information with
information about companies B and C, comparable firms in the
same industry, in effect benchmarking
A’s actions and performance.
In the other environment, which we associate with low-FD
countries, disclosure requirements are
minimal and are not enforced. An analyst following firm X has
to rely on voluntary and unverifiable
disclosures by X to make an assessment of the firm’s quality
and prospects. It is hard to compare com-

pany X with companies Y and Z, for information about all three
companies is patchy and unreliable.2
Hope (2003a) finds that across countries, the level of disclosure
about accounting policies is inversely
related to forecast errors and dispersion. This finding suggests
that the work of analysts is facilitated
in high-disclosure environments typical of high-FD countries.3
Second, the incentives for investors to monitor firms may be
greater in high-FD countries. La Porta
et al. (2002) find that firms in countries with more investor
protection enjoy stronger market valua-
tions. Investors may have more to lose from misjudging the
health of a company in such countries.
Accordingly, investor demand for sophisticated analysis and
information is likely to be greater in
high-FD countries, and brokers may dedicate more resources to
meet this demand. This suggests that
‘‘coverage’’ does not have the same meaning in different
countries with different levels of financial
development: Coverage initiation by an analyst is a significant
event for a company operating in a
high-FD country. It is not so for a low-FD country, where
analyst time may be too thinly spread.4
Third, firms have a greater incentive to be properly monitored
by analysts in high-FD countries.
Firms in high-FD countries enjoy greater access to outside
capital than firms in low-FD countries, at
least potentially; that is, provided they succeed in convincing
outside investors to purchase their secu-
rities. We would then expect firms in high-FD countries to do
more to facilitate the work of the finan-
cial analysts monitoring them – by organizing company visits,
being responsive to analysts’ requests

for clarifications, and giving analysts access to top management
– since these firms stand to lose sub-
stantially due to analyst distrust. By contrast, firms in low-FD
countries have little to gain from favor-
able analyst opinion, since access to outside finance is limited
anyway.
Finally, the pool of financial analysts may be of better quality
in high-FD countries. Financial ana-
lysts there may be better paid and better trained. This could
explain why some financial analysts enjoy
star status in the United States, while no such phenomenon
exists in continental Europe. As a first pass
on this issue, we gathered the number of CFA-certified analysts
in each of our sample countries, using
the online database at www.cfa.institute.com. We scaled it by
the number of listed companies in each
country. The correlation between this ratio and our measure of
financial development is positive and
2 These arguments do not assume, even implicitly, that firms
are covered exclusively by local analysts, i.e., analysts located
in
the same country as the firm. Bae et al. (2008) provide data
suggesting the opposite.
3 For a related study suggesting that the quality of analysts’
work is superior in countries with high-quality financial
reporting
environments, see Barniv et al. (2005).
4 In his account of his career as a financial analyst in the US,
Reingold (in Reingold and Reingold, 2006) states that he took
9 months to write his first report when he started working as a
financial analyst at Morgan Stanley. By contrast, in a similar
book
about his experience as an analyst in France, Tétreau estimates

that a typical French analyst can devote less than 40 h a year of
actual research time to each of the companies he covers
(Tétreau, 2005). France is in the middle range of our measure of
financial
development.
F. Degeorge et al. / J. Account. Public Policy 32 (2013) 1–25 5
statistically significant at the 5% level. If we assume that CFA
certification is a proxy for financial ana-
lyst quality, this result suggests that average analyst quality
tends to be better in high-FD countries.
All of these arguments suggest that analyst coverage may be
more effective in high-FD countries
and lead to our first testable hypothesis:
Hypothesis 1. If a country’s level of financial development
enhances analyst monitoring, then the
association of analyst coverage on earnings management should
be more negative in more financially
developed countries. We call this the FD enhancement
hypothesis.
But the role of financial analysts as corporate monitors has been
questioned lately, especially in the
United States – hardly an example of low financial
development. Financial analysts have been accused
of fostering earnings management by effectively setting
company managers targets that are impossi-
ble to meet – except by manipulating company performance (see
Levitt, 1998; Collingwood, 2001;
Fuller and Jensen, 2002). In Michael Jensen’s words:
‘‘Indeed, ‘‘earnings management’’ has been considered an

integral part of every top manager’s job
for at least the last two decades. But when managers smooth
earnings to meet market projections,
they are not creating value for the firm; they are both lying and
making poor decisions that destroy
value’’ (Jensen, 2005, p. 8).
Systematic evidence supports these claims. Using US data,
Degeorge et al. (1999) document sharp
discontinuities in the forecast error distribution at zero,
suggesting that firms strive to meet or exceed
analysts’ consensus forecasts for quarterly earnings. Graham et
al. (2005) find that top US executives
admit that they pass up positive NPV projects to meet earnings
benchmarks. This suggests that in a
financially developed country such as the US, analyst coverage
might actually increase earnings
management.5
We would expect the same four factors that enhance the quality
of analyst coverage in high-FD
countries (better supply of information, greater demand for
information, higher incentives to be mon-
itored, higher quality of financial analysts) to give greater
weight to analyst opinion in those countries.
High-FD countries might then be associated with a greater role
for analysts in setting targets, and
companies there might engage in more earnings management to
reach the consensus forecast than
they do in low-FD countries.
According to this view, as one moves from low-FD to high-FD
countries, companies would become
more fixated on trying to meet or beat the analyst forecast; this
produces our second testable
hypothesis:

Hypothesis 2. The association between analyst coverage and
earnings management is more positive
in high financially developed countries than in low financially
developed countries. We call this the FD
analyst consensus fixation hypothesis.
Thus, the effect of financial development on the quality of
analyst coverage is a priori ambiguous.
The relation of earnings management and analyst coverage is
jointly determined by the four factors:
managerial incentives of earnings management, managerial
ability of earnings management, incen-
tives of high-quality monitoring by analysts and the ability of
high-quality monitoring by analysts.6
In our previous hypothesis development, while a higher level of
financial development may enhance
analysts’ ability to perform their monitoring tasks, the increased
company fixation on meeting the ana-
lysts’ forecast targets in high-FD countries might create
earnings management incentives that would not
exist in low-FD countries. Ultimately, the question of whether
financial development tends to facilitate
the analysts’ monitoring role or whether it encourages a
dysfunctional game of manipulation to meet
analysts’ earnings targets is an empirical issue.
5 Jumps in the earnings forecast error distribution could be due
both to earnings management and to forecast management
(Brown and Higgins, 2001, 2005), that is, managers attempting
to downplay analysts’ earnings expectations to make them
easier to
beat. Several US-based studies report findings consistent with
both interpretations. Hirst et al. (2008) provide a framework in
which to view management earnings forecasts.

6 We thank an anonymous reviewer for bringing up this point.
3. Research design
3.1. Methodology
We use the following regression to assess the impact of
financial development on the enhancement
of analyst monitoring for firm i in country j in year t:
7 Hop
studies
institut
this iss
valuatio
EM Activityijt ¼ a0 þ a1Analyst Coverageijt þ a2Analyst
Coverageijt � Medium FDj
þ a3 Analyst Coverageijt � High FDj þ a4 Control variablesijt þ
eijt ð1Þ
The dependent variable, EM Activity, is the amount of earnings
management by a company in a
year. Medium FD (resp. High FD) is a dummy variable equal to
one if the company is in a medium-
FD country (resp. high-FD country), and zero otherwise. We
explain the details of the construction
of our variables below and provide the exact definitions of all
variables in Appendix A.
To test the FD enhancement hypothesis, the coefficients of
interest to us are a1, a2, and a3. If finan-
cial development is associated with analyst coverage, then a
given amount of incremental analyst cov-
erage should result in a greater reduction in earnings
management as we move up in the level of

financial development. a1 measures the effect of analyst
coverage on earnings management in low-
FD countries. a1 + a2 measures the impact of analyst coverage
on earnings management in med-
ium-FD countries, while a1 + a3 measures it in high-FD
countries. As we have discussed, two opposite
effects may be at work for a2 and a3:
– According to the FD enhancement hypothesis (Hypothesis 1),
higher financial development may
facilitate the analysts’ monitoring role, so that we should have
a1 + a3 < a1 + a2 < a1 and a1 + a3
should be negative, i.e., analyst coverage reduces earnings
management in high-FD countries.
We form no expectations about the sign of a1 + a2 and a1.
– According to the FD analyst consensus fixation hypothesis
(Hypothesis 2), higher financial develop-
ment may result in companies being more pushed to manage
earnings to meet consensus expec-
tations, so that we should have a1 + a3 > a1 + a2 > a1 and a1 +
a3 should be positive under analyst
consensus fixation hypothesis, i.e., analyst coverage increases
earnings management in high-FD
countries. We form no expectations about the sign of a1 + a2
and a1 under Hypothesis 2.
This formulation clarifies our contribution relative to Yu (2008)
who only uses US data. Yu’s mon-
itoring effect hypothesis, for which he finds empirical support,
predicts that a1 + a3 < 0. His pressure
effect hypothesis, which is rejected by the data, predicts that a1
+ a3 > 0. We focus on assessing
whether financial development is associated with the
effectiveness of analyst monitoring across
countries.

Several factors might simultaneously influence analyst coverage
and earnings management, poten-
tially creating an omitted variable bias. For example, the quality
of a firm’s accounting policy might
impact the decision by analysts to follow it and also determine
the leeway that managers have in
reporting income. Similarly, the ownership structure of the firm
might affect analyst coverage (firms
with small float and trading volume might offer little
inducement to analysts to follow them), as well
as the potential and incentives for earnings management. Firms
with better corporate governance
might manage their earnings less and at the same time attract
more coverage by analysts.7
To take into account this possible bias, we need to control for
heterogeneity across observations.
We, therefore, estimate our model using a panel fixed-effects
regression, using the firm as the panel
unit. This estimation technique reduces the bias generated by a
simple pooled OLS estimation (see
Wooldridge, 2002, p. 421).
e (2003b) finds evidence consistent with disclosures being more
important when analyst following is low. While these
do not directly address the link between firm governance
characteristics and analyst coverage, it is plausible that larger
US
ional stockholdings would encourage financial analysts to
follow a company. Lang et al. (2004) provide indirect evidence
on
ue. They analyze the relationship between the quality of
corporate governance, the extent of analyst coverage, and
n. They find that analysts are less likely to follow firms with
potential incentives to manipulate information.

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