Informal institutions—society’s unwritten codes of conduct—influence all aspects of international business, but they have received surprisingly little attention in the literature to date. Helping to fill this gap, HKUST’s Jiatao Li and co-researchers build a novel typology and framework for examining neglected aspects of informal institutions, as well as the relationships between formal and informal institutions and how they influence international strategy. Thanks to their study, multinational enterprises (MNEs) and policy makers now know much more about the advantages and pitfalls of adapting to local norms in overseas markets.

When a multinational enterprise (MNE) enters a new market, it has an important strategic decision to make: whether and how to adjust its operations to conform to local norms. For example, can and should Disneyland Paris impose expectations of “American”-style customer service on French employees? As the authors note, MNEs must balance the benefits and costs involved in adapting home country practices to local needs. This process is complicated by the existence of both formal institutions (such as written laws) and informal institutions (such as customs and traditions) in the new market, along with the varying effectiveness of those institutions and differences between the institutional environments of the home and host markets.

Against this complex institutional backdrop, the authors develop three hypotheses regarding the pressure on MNEs to adapt to local practices. The first relates to institutional effectiveness. Enterprises are under less pressure to adapt when the host country’s formal institutions are more effective, but they face greater pressure to adapt when the host has a better informal institutional environment. The second hypothesis concerns institutional convergence; that is, the convergence between formal and informal institutions in the host market decreases the pressure on MNEs to adapt. Third, the researchers hypothesize that institutional distance—both formal and informal—between the home and host markets increases the pressure on MNEs to adapt.

To test their model, the authors first examine the direct effects of formal and informal institutional effectiveness, convergence, and distance on MNEs’ local adaptation. Second, they develop an eight-way typology illustrating the role that informal institutions take in a market depending on the interactions between these three institutional factors. Third, the researchers further extend their arguments to develop a conceptual framework of market and MNE institutional diversity and dynamism. This framework captures the formal and informal institutional relationships within and between the home market and the host market, the parent firm and the foreign subsidiary.

Their innovative theorizing not only consolidates, synthesizes, and extends previous research but also offer meaningful implications for practitioners and policy makers. “MNEs entering foreign markets will be well served,” say the researchers, “by paying greater attention not only to the formal institutional environment but also to the informal institutional environment.” They should consider “providing training on local norms from host-market experts, hiring a combination of home- and host-market managers, and pursuing joint ventures or other forms of strategic alliances that allow them to tap into local knowledge.” Meanwhile, when policymakers want to encourage foreign MNEs to enter their markets, they should provide them with “informal institutional training” to facilitate the entry process.