We integrate institutional theory and the resource-based view of capability to examine the interplay of institutional environments and firm-specific capabilities on value-creating synergy by emerging market firms (EMFs). We argue that EMFs expand into countries with better-developed institutions as a means to overcome poor institutions at home. EMFs that develop strong absorptive capacity and knowledge transfer capability are better able to benefit from a portfolio of complementary sources of knowledge across multiple markets. We analyze data on a sample of manufacturing firms’ international expansion to demonstrate that expansion into a host country with a better-developed institutional environment promotes innovation success. This effect was found to be stronger for firms with strong absorptive capacity and well-developed knowledge transfer capability.

This study examined the impact on a firm’s product innovation success when it expands internationally into a host country with political, economic and cultural institutions different from those it is accustomed to at home. Data on 917 Chinese manufacturing firms’ international activities were analyzed to demonstrate that expansion to countries with political institutions better developed than those of a firm’s home country promotes innovation success, as does expansion to countries characterized by greater individualism than the home country. A more advanced economy in the host country strengthens these relationships. This study was designed to contribute to the extant literature in three areas. First, it was designed to enrich the theory explaining how the institutional environment affects firm performance in an emerging economy. Most previous studies have examined the relationship between the institutional environment and the probability of organizational survival or financial performance (e.g., Xu & Shenkar, 2002; Gaur & Lu, 2007), but this study instead examined the institutional environment and product innovation. Product innovation is, after all, a primary way in which many firms compete and grow (Eisenhardt & Tabrizi, 1995; Wu, 2012). Second, previous research has not clearly identified how different components of the institutional environment individually relate to product innovation success, nor have previous studies sufficiently explored their interactions. This study was designed to fill that gap by integrating the literature on new institutional economics, product innovation and the international expansion of emerging market firms. It sought to derive and test propositions explaining how political institutions and cultural norms relate to product innovation success, and to what extent the relationships depend on economic development. Then, this study extended previous research on the institutional environment to an emerging market context. Evidence clarifying the relationships between different components of the institutional environment and the innovation performance of emerging market firms would be relevant for designing effective and efficient international expansion strategies for emerging market firms. These findings therefore enrich our understanding of the impact of the institutional environment by showing its multifaceted influence on product innovation. Previous research has highlighted the important role of institutional differences between the home and foreign countries in strategic decision making and performance (e.g., Kostova & Zaheer, 1999; Xu & Shenkar, 2002). This study has extended that by clearly demonstrating the importance of differences in political institutions and individualism with respect to innovation performance. This is consistent with the idea that expanding to foreign countries with better-developed political institutions helps a firm avoid the institutional void and political hazards at home and gain access to better-functioning institutions in the host country, which can promote successful product innovation. Individualism in a host country drives a firm to experiment with new technologies and develop new products to satisfy diverse customer needs.