In this section, we develop our formal test whether institutional competitive advantage affects the location decisions of multinational banks. Our competitive advantage hypothesis can be stated as:
Hypothesis: Banks will enter countries with an institutional development that, compared
to their competitors, gives them an advantage to operate in.
To determine whether indeed competitive advantage due to familiarity with the institutional environment can explain location decisions, we need to construct a variable that takes the quality of institutions of the host and source country, but also that of competitor banks into account. We therefore first develop such a formal measure of institutional competitive advantage. We then describe our dependent variable, the measure of foreign bank entry. We perform our tests applying a first-difference model which we will elaborate on in this section. Furthermore, there are a number of other variables that may affect locations decisions of foreign banks which we introduce.
Measure of institutional competitive advantage We want to test whether banks that are more familiar, compared to their competitors, with working in a country due to similarities in institutions will tend to invest more. To capture this notion of institutional competitive advantage, we divide the absolute difference between the institutional quality of the source country and that of the target host country by the average absolute difference between the institutional quality of each competitor source country and that of the host country (where we use the simple average for our benchmark model and a weighted average in one of our robustness tests). In other words, we define institutional competitive advantage for a bank from source country j with regard to host country i at time t as:
InstCompAdvijt = (|| InstSourcejt − InstHostit ||) /
⎜ ⎜ ⎝ ∑ = j 1 k
|| InstSourcejt − InstHostit || / N