Chinese companies in the United States are generally adaptive to their host country’s legal and regulatory institutions. However, the adaptation varies in accordance with the companies’ ownership structure and the institutional distance between the two countries across different subject matter areas.
The practice of Chinese foreign direct investment in the United States has generated intense debate. Some welcome it for the immediate benefits such as job creation. Others view Chinese investments, especially those controlled by the Chinese government, as a critical threat. The debates have so far missed an important question: how do Chinese companies investing in the United States react to the host country’s laws?
The book begins by presenting an analytical framework for exploring the reactions of Chinese firms to various U.S. laws and regulations. The framework comprises two parts. The first part examines the institutional distance between China and the United States in a particular subject matter area. The concept of institutional distance is not new and, when applied, it generally refers to the differences in norms, laws, and institutional structure between two countries. For the purposes of this book, I adopt a more nuanced definition; i.e., formal law differences and differences in law enforcement in a specific subject matter area (e.g., contracts or antitrust). The first part of the book also consists of comparative law as well as a comparative politics analysis that may lead to two diverging conclusions. If the institutional distance is deemed to be insignificant, adaptation to U.S. rules will not be an issue for Chinese companies. The companies that continue to act in their “old” manner will not cause any disruption of the host country’s law. However, if the institutional distance is large, one needs to move to the second part of the analytical framework, which branches out into two variables: the desire to adapt and the ability to adapt to the host country’s laws and regulations in the subject matter area. Both of the aforementioned variables are broad and vague. In this book, a Chinese firm’s desire to adapt is assessed by looking at its investment motives and the managers’ perception of relevant U.S. institutions. Everything else being equal, long-term investment in the United States driven by commercial considerations and managers’ positive view of U.S. institutions translate into a stronger inclination to adapt. Meanwhile, a Chinese company’s ability to adapt is associated with, on the one hand, how corporate decision-making power is allocated between the Chinese headquarters and the U.S. affiliates and, on the other hand, the reliance on local professionals. With all else being equal, localized decision-making and the use of local professional services enhance the adaptive capacity of the Chinese company.
Having laid out the analytical framework, the book proceeds to investigate the institutional distance and the adaptive inclination and capacity of the Chinese company in general. In doing so, the book heavily relies on interviews with Chinese managers in the U.S. affiliates and a comprehensive set of survey data over three years, collected annually by the China General Chamber of Commerce, which is by far the most prominent business association of Chinese companies in the United States. First, a broad-stroke comparative study concludes that the institutional distance between China and the United States, while varying substantially across different subject matter areas, remains very large overall. In line with the argument, the survey data show that the vast majority of Chinese managers consider their compliance cost in the U.S. to exceed that incurred while doing business in China. Second, according to the interviews and the data, Chinese companies hold very positive views about various U.S. institutions enabling free market capitalism. Meanwhile, the vast majority of Chinese companies invest in the United States out of commercial considerations such as to exploit the market or to enhance brand recognition. In addition, most of the Chinese companies plan to operate in the United States for a long time. All these indicators portray a general inclination to adapt to U.S. institutions. Third, the empirical evidence on the ability to adapt tells a more complicated story. With regard to decision-making power allocation, the data suggest that for many Chinese companies the headquarters in China retain control over major decisions concerning their U.S. operations. At the same time, however, Chinese managers heavily rely on local service providers. Mixed evidence indicates that Chinese companies may be less efficient in adapting to U.S. rules if it requires constant decision-making by local managers.
Does the ownership structure make a difference? In other words, do state-owned Chinese investors differ from other companies on the three dimensions of the analytical framework? Tests of the survey data do not return robust evidence for a general variation in the institutional distance as a result of ownership structure; however, ownership structure does make a difference in certain subject matter areas. Also, analysis of the data does not show any ownership-associated variation in the perception of U.S. institutions. In other words, if some managers view the United States less positively, it is due to idiosyncratic variables such as age and place of education and not due to the ownership structure of the company.
It is found that there is a correlation between the ownership structure of the Chinese company and investors’ investment motives. Therefore, state-owned investors are more likely to respond to the investment policies of the Chinese government. In addition, state-owned firms are less likely to re-invest U.S. profits locally, suggesting a lack of long-term commitment to the U.S. market. The combined evidence indicates a preliminary association between state ownership and a hesitation to adapt to U.S. institutions.
Additional tests of the survey data on the decision-making of Chinese companies reveals a strong correlation between the ownership structure and the retention of control over U.S. businesses. To be more specific, state-owned Chinese investors tend to retain their influence over their U.S. operations, whereas their privately-owned peers delegate the decision-making power to local managers. With regard to the reliance on local professionals, however, ownership structure does not have any significant effect. State-owned or not, Chinese investors employ U.S. professionals at roughly the same frequency when other variables, such as size and investment duration, are held constant. The empirical evidence suggests that state-owned Chinese investors may be hampered in adapting to U.S. institutions when doing so requires high-level decision-making.
Having empirically analyzed the general adaptation by Chinese firms to U.S. institutions, the book then explores how Chinese companies react to U.S. laws with regard to tax, employment discrimination, and the national security review of foreign investment. These three areas are chosen because of their broad applicability to Chinese companies and their salience in the debates about Chinese outbound foreign investment.
Applying the analytical framework formulated earlier, the book first presents an institutional comparison of the tax systems in China and the United States and finds wide gaps between the two countries in tax law enforcement. Despite divergent tax systems between China and the United States, Chinese managers hold an overall positive view of the U.S. tax system and they rely extensively on local professionals to handle U.S. tax matters. As a result, Chinese owners adopt a rather conservative approach towards tax compliance. In addition, the ownership structure of Chinese companies does not appear to be a determinant factor for the inter-company variation in tax avoidance. However, state-owned Chinese investors are more likely to experience audits or disputes with the IRS, suggesting that major compliance matters are dealt with less efficiently by China-based headquarters.
In the area of employment discrimination, the difference in how China and the United States handle these matters is comparatively insignificant due to the extensive borrowing by Chinese legislators of key legal concepts and principles from the EU and U.S. laws governing workplace equality. Yet, vast gaps remain between the two countries when enforcement is taken into account. Anecdotal reports suggest that, on average, Chinese managers have a positive view of the U.S. institutions. However, a significant minority of Chinese companies use their home-state models of human resource management as references when handling personnel matters in the United States. Similarly, a significant minority of the companies do not take adequate measures to prevent employment discrimination in the United States. Both of these tactics spell trouble in the long run for Chinese firms in the United States. In this area, however, ownership structure does not appear to have any significant impact. As noted, state-owned Chinese investors are distinct in retaining tighter control over major decisions concerning their U.S. operations. The prevention of employment discrimination may not be considered an important matter to justify intervention from the headquarters; hence, ownership structure is insignificant.
National security review looms large in Chinese direct investment in the United States. However, the institutional gap between the two countries in this area is the largest among the three matters examined in this book. This is because in their home country, Chinese companies never have to deal with any national security review issues prior to making an investment. Hence, about half of Chinese managers are ignorant about the U.S. system. In strong contrast to those regulating taxes and employment discrimination, U.S. rules governing national security review of foreign investment are vague. Moreover, the federal agency in charge (CFIUS) enjoys wide discretion that is subject to only superficial judicial review. It is therefore unsurprising that most Chinese managers who have knowledge about the U.S. national security review process express negative opinions about it. While the majority still consult local lawyers, their reaction towards the CFIUS rules appear more opportunistic, in the sense of skipping the filing of a CFIUS notice even when a filing is deemed necessary. In addition, given that the system is biased against state-owned investors, the ownership structure of Chinese companies is robustly and significantly tied to the likelihood of holding a negative view and in the deterministic of the risk of CFIUS intervention.
In summary, the book takes the first step toward empirically exploring an important topic concerning Chinese investment in the United States and other developed countries — how Chinese companies adapt to unfamiliar, complex, and stringent host country legal and regulatory institutions. The findings contribute to multiple ongoing debates including, among others, state capitalism, emerging market FDI, legal compliance by foreign companies, and Chinese outbound investment and its impacts on host states.
This article is a synopsis of The Clash of Capitalisms? Chinese Companies in the United States (Cambridge University Press, 2018).
(Ji Li, Professor of Law and Zhuang Zhou Scholar, Rutgers Law School, The State University of New Jersey.)