Journal of Management & Muamalah Jurnal Pengurusan & Muamalah eISSN 2180–1681 EDITORIAL BOARD/SIDANG EDITOR Chief Editor/Ketua Editor WAN NOR HAZWANI WAN RAMLI Managing Editor/Editor Pengurusan MAWAR MURNI YUNUS EDITORS/EDITOR MAWAR MURNI YUNUS NURNADDIA NORDIN NORZALINA ZAINUDIN NUR SURIANA AWALUDIN WAN SHAHDILA SHAH SHAHAR EDITORIAL ADVISORY BOARD/SIDANG PENASIHAT EDITORIAL PROF. DATO’ DR. AB. HALIM TAMURI DR. MOHAMAD SYUKRI ABDUL RAHMAN DR. NOR HAKIMAH HAJI MOHD NOR DR. MAWAR MURNI YUNUS MDM. NORAZLINA RIPAIN Special thanks to all involved in the publication of this journal. Sidang Editor merakamkan ucapan jutaan terima kasih kepada semua yang terlibat dalam menjayakan penerbitan jurnal ini. Views expressed in this journal are not necessarily reflect views of the editor or publisher. Authors are fully responsible towards their articles. Artikel yang diterbitkan tidak semestinya mewakili pandangan editor atau penerbit. Para penulis bertanggungjawab sepenuhnya terhadap artikel dan tulisannya. Copyright Kolej Universiti Islam Antarabangsa Selangor, 2015 Hak Cipta Kolej Universiti Islam Antarabangsa Selangor, 2015
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6 Personal Data Protection Act 2010: Taking the First Steps towards
Compliance
(Akta Perlindungan Data Peribadi 2010: Mengambil Langkah
Awal ke arah Pematuhan)
Farah Mohd Shahwahid & Surianom Miskam
64 – 75
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IMPACT OF ORGANISATIONAL FACTORS ON BUDGETARY SLACK
(Kesan Faktor Organisasi ke atas Regangan Belanjawan)
Noor Raudhiah Abu Bakar
Kolej Universiti Islam Antarabangsa Selangor
Rozita Amiruddin
Sofiah Md Auzair
Universiti Kebangsaan Malaysia
ABSTRACT
This study examines the impact of organisational factors on budgetary slack among managers
in Malaysia. The organisational factors as identified in prior research are budget participation,
budget emphasis, information asymmetry and power distance. Specifically, this paper focuses
on the influence of these factors either individually or interactively on the occurrence of the
budgetary slack. Data are collected using questionnaire from 83 managers randomly selected
from companies listed in Bursa Saham excluding finance, warrant and loan sector. Factor
analysis results show that there are two dimensions of power distance i.e. supervisor style and
management style. Individual relationships were tested using multiple regression and
interaction relationships used moderated regression. Multiple regression results indicate a
negative and significant relationship between management style and budgetary slack.
Moderated regression results show a significant positive relationship between two way
interaction of budget participation and budget emphasis with budgetary slack, and three way
interaction of budget participation, budget emphasis and information asymmetry with
budgetary slack. As a whole, the results imply that high power distance (management style)
decreases the budgetary slack, while high interaction of budget participation, budget
emphasis, and information asymmetry increases the budgetary slack. These results indicate
that management should choose the right combination of budget participation, budget
emphasis, and information asymmetry, and management style to control budgetary slack. The
findings of this study could assist management of companies to understand the important
factors that influence budgetary slack, which in turn may lead to effective management.
Keywords: Power distance; budgetary slack; budget participation; budget emphasis;
information asymmetry
ABSTRAK
Kajian ini mengkaji kesan faktor organisasi ke atas regangan belanjawan di kalangan
pengurus di Malaysia. Faktor organisasi seperti yang telah dikenalpasti dari kajian lepas
adalah penyertaan belanjawan, penekanan belanjawan, asimetri maklumat dan jarak kuasa.
Khususnya, kajian ini fokus kepada pengaruh faktor-faktor ini secara individu atau secara
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interaksi ke atas kehadiran regangan belanjawan. Kutipan data adalah menggunakan borang
soal-selidik dari 83 pengurus yang dilpilih secara rawak dari syarikat yang disenarai di
Bursa Malaysia tidak termasuk kewangan, waran dan sektor pinjaman. Hasil dari analisis
faktor menunjukkan terdapat dua dimensi jarak kuasa iaitu gaya pengurus dan gaya
pengurusan. Hubungan individu diuji menggunakan regrasi berganda dan hubungan
interaksi pula diuji dengan menggunakan regrasi moderat. Hasil analisis regrasi berganda
menunjukkan hubungan negative yang signifikan antara gaya pengurusan dan regangan
belanjawan. Hasil analisa regrasi moderat menunjukkan hubungan positif yang signifikan
antara interaksi penyertaan belanjawan dan penekanan belanjawan dengan regangan
belanjawan dan antara interaksi penyertaan belanjawan, penekanan belanjawan dan asimetri
maklumat dengan regangan belanjawan. Secara keseluruhan, kajian menunjukkan semakin
tinggi jarak kuasa (gaya pengurusan) mengurangkan regangan belanjawan, sementara
semakin tinggi interaksi penyertaan belanjawan, penekanan belanjawan dan asimetri
maklumat meningkatkan regangan belanjawan. Hasil kajian ini menunjukkan pengurusan
perlu memilih kombinasi penyertaan belanjawan, penekanan belanjawan, asimetri maklumat
dan gaya pengurusan untuk mengawal regangan belanjawan. Hasil kajian ini juga dapat
membantu pengurusan syarikat dalam memahami faktor penting yang mempengaruhi
regangan belanjawan dan seterusnya ke arah pengurusan yang efektif.
Kata kunci: Regangan belanjawan; penyertaan belanjawan; penekanan belanjawan;
asimetri maklumat; jarak kuasa
INTRODUCTION
Even though the notion of budgetary slack had been discussed since 1953 by Aygris, the issue
of budgetary slack is still of researchers’ interest and being debated in the literature (e.g.
Church, 2012; Yang et al., 2009; Maiga & Jacobs, 2008). Lau and Eggleton (2003) indicate
that there are still major unresolved issues of budgetary slack, one of which is the issue on the
factors influencing budgetary slack. Previous studies had identify three main factors affecting
budgetary slack i.e. budget participation, budget emphasis and information asymmetry. The
conflicting results on the direction of the relationship between these three factors and
budgetary slack contribute to these unresolved issues.
General notion expressed using budgetary slack as a tool to manipulate the budget in
which the presence of budgetary slack causes the budget target easy to achieve. Cyert and
March (1963) has included a slack as a key component of the manager trying maximized.
They say that when the organization achieves its goals, organizational resources will fill
individual goals. This is consistent with agency theory which states that managers as agents
are act according to its own goals and budgetary slack is one action that allows them to be
rewarded easily. Presence in the form of budgetary slack so stated as undesirable and
unethical (Douglas & Wier 2000) and it should be limited (Dunk 1995; Fisher et al., 2000;
Fisher et al. 2002a; Nouri 1994; Young 1985). In addition, budgetary slack increased
inefficiencies in resource allocation, affect the operating performance (Leibenstein 1966;
Williamson 1964) and affect the reliability of the information (Nouri 1994; Govindarajan
1986). These are the negative effects due to the presence of budgetary slack.
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Despite the common perception, there is also empirical evidence that says otherwise
that is budgetary slack led to a positive effect (Elmassri & Harris, 2011). Budget slack is used
to motivate employees, enable the work to achieve the goals of management and manage
budget risk (Davila & Wouters 2004; Elmassri & Harris, 2011). It encourages innovation and
creativity of employees, absorb stress, resolve conflicts and motivate employees to stay in the
company (Bourgeois 1981; Cyert & March 1963). This shows that budgetary slack increase
the performance of employees and organizations if appropriate circumstances.
Indirectly, this implies that the practice of budgetary slack considered leads to the
undesirable situation and have potential positive impact on the organization. Onsi (1973)
states budget slack is undesirable depending on the factors that affect it. Knowing the factors
will control the behavior of budgetary slack. Previous studies have found that three major
factors affecting the budget is budgetary slack participation (Lukka 1988; Merchant 1985,
Young 1985), the emphasis of the budget (Dunk 1995; Hopwood 1972; Merchant 1985; Otley
1978) and information asymmetry (Fisher et al. 2002p; Fisher et al. 2002b; Lambert 2001).
High degree of participation in the budget process is claimed to provide an opportunity
for employees to create slack in the budget. The higher the degree of participation in the
budget process, the higher the propensity of budgetary slack (Lukka, 1988; Young, 1985). On
the other hand, Merchant (1985) and Lal et al. (1996) found that budget participation is
negatively associated with budgetary slack or budget slack is reduced as staff felt appreciated
when they are allowed to participate in budget process. With regard to the effects of budget
emphasis, Leavins et al. (1995) and Linn et al. (2001) results contradict those of Van der
Stede (2000) whereby they found that budget emphasis was negatively associated with budget
slack. With regard to the effects of information asymmetry on slack, contrary to Jaworski and
Young (1992), Chow et al. (1988) found that information asymmetry is positively associated
with budget slack.
The three main factors determining budgetary slack; budget participation, budget
emphasis and information asymmetry shown to be related to budgetary slack, but decisions
about the relationship turned out to be consistent. Indirectly, this gives room for future
researchers to continue to study the budgetary slack. In addition, this study identified
inconsistency as determining factors not directly affect budgetary slack. There are other
factors that influence the interaction with budgetary slack. Dunk (1993) studied the
relationship between budgetary participation and budgetary slack in the presence of budget
emphasis and information asymmetry. He expects the interaction positive organisational
factors to the budget slack, but failed to establish a relationship. Lau and Eggleton (2003)
continue efforts Dunk (1993) with the same make and successful studies provide empirical
evidence that there is a negative relationship between budget participation, budget emphasis
and information asymmetry budgetary slack.
In Malaysia, studies on budgetary slack still in initial stage. Mohamad Adnan and
Sulaiman (2006, 2007) studies on the effect of religion, organisational and cultural on
budgetary slack among Malaysian organisation. Review by Nik Nazli et al. (2003), a tendency
to do budgetary slack is high for companies in Malaysia compare to companies in the United
Kingdom (UK) and New Zealand. High power distance in Malaysia than in the UK and New
Zealand identified as an explanation of the practice of budgetary slack. Fear of failure and the
need for good image for, corresponding to the characteristics of high society, high
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dependency employees to the superior namely power distance (Hofstede 1991) may be invited
to practice high budgetary slack.
Power distance is one of the nation's cultural dimensions presented by Hofstede (1980).
Ueno and Wu (1993) study on cultural differences and budgetary slack. However, their study
only on two cultural dimensions of individualism / group (individualism / collectivism) and
avoidance of uncertainty (uncertainty avoidance) and the results state that only the cultural
dimension of individualism / group only positively related with budgetary slack. A study by
Lau and Eggleton (2004), however, took individualism / group and power distance (power
distance) as proxy for the country's culture and examine its relationship with the budgetary
slack. However, their study is not able to prove an individual relationship between culture and
budgets slack but found a negative relationship interaction between the culture of the country,
budget emphasis and information asymmetry budgetary slack.
This study is choose four organisationals of budgetary slack budget participation,
budget emphasis, information asymmetry and power distance. Budget participation, budget
emphasis and information asymmetry selected because previous studies found that these three
factors is the main factor leading to budgetary slack. But the previous research on these three
factors has never been consistent. This gives the opportunity to study confirm. Another factor
which is chosen because of the power distance dimension of this culture that make the
difference between Malaysia and other countries as noted in the study by Nik Nazli et al.
(2003).
The study will not only examine the relationship between the organisationals directly
above the budgetary slack, but the interaction between the organisationals of budgetary slack
is also tested. This study continue the efforts of Dunk (1993) and Lau and Eggleton (2003,
2004) who studied the interaction the determining factors of budgetary slack.
The remainder of the paper is structured as follows. The next section discusses the
literature review and development of research hypothesis. This is followed by sections that
discuss method and present results. Before concluding remarks are made, the limitation and
avenue of further research are presented.
LITERATURE REVIEW AND HYPOTHESES DEVELOPMENT
Budgetary slack is defined as intentional underestimation of revenues and productive
capabilities and/or overestimation of costs and resources required to complete a budgeted task
(Dunk & Nouri 1998). Budgetary slack is usually associated with dysfunctional behaviours;
achievement of budget target without much effort, unethical behaviour, ineffective resource
allocation and unreliable information.
However, there are empirical evidences that proved the opposite effect. Budgetary
slacks do motivate employees and lead to achievement of organisation’s goal (Davila &
Wouters 2004). It also encourages employees’ innovation and creativity, absorbed tension and
resolved conflicting goals (Bourgeois 1981; Cyert and March 1963). In addition, Yang et al.
(2009) find the relationship between budget slack and innovation performance to be an
inverse, U-shaped curve which means too little budget slack is as bad for innovation
performance as too much budget slack. However, Onsi (1973) stated that dysfunctional
behaviour of budgetary slack depends on the factors contributing to it and by knowing these
factors, control could be done to reduce the dysfunctional behaviour of budget slack.
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Previous research that linked culture with budgetary slack is Ueno and Sekaran
(1992). The study identifies the role of culture in budgetary control practices in the U.S. and
Japan. These studies assumes that two-dimensional culture which are individualism and
uncertainty avoidance is able to explain and understand any differences that may exist in the
practice of budgetary control for two countries, Japan and the United States. The results show
that the culture of individualism is higher in the U.S. than in Japan where there is greater use
of communication and coordination. This creates more traction in the budget and there is
greater effect on short-term performance assessment than in Japanese companies.
Results of the survey by Ueno and Sekaran (1992) show that the country's culture
plays an important role in the practice of budgetary control in general, and particularly in
budgetary slack. This gives more room for future research taking into account the culture of
the country as one of the main factors. This will also give more exposure to managers
involved in international business to understand so that they can prepare themselves when
they have to operate in different countries. Accordingly, the study by Nik Nazli et al. (2003),
using a sample of Malaysian companies, found that budget participation is high and the
propensity to create budgetary slack is very high compared with the companies in the United
Kingdom and New Zealand. High power distance in Malaysia than in the UK and New
Zealand is identified as an explanation of the practice of stretching the budget. Fear of failure
and the need for good image corresponds with power-distance society of employees
dependent on their superior (Hofstede 1991) contributed to increase budgetary slack.
Based on the discussion above, the expected power distance is one of the main
organisationals of budgetary slack in Malaysia and expected environmental range of this
power has a positive relation with budgetary slack. This study is also expected to provide
additional empirical evidence for the literature on budgetary slack.
Beside power distance, previous research had identified the organisational factors of
budgetary slack, of which, the main factors are budget participation, budget emphasis and
information asymmetry. These three organisational factors receive much conflicting results on
the direction of their relationship with budgetary slack.
The research on budgetary slack’s organisational factors could be traced back to Onsi
(1973). Onsi (1973) provides opportunities to subsequent research to explore more on these
organisational factors. Using experimental method, Young (1985) found that budget
participation is positively associated with budgetary slack, contradicting with Onsi (1985).
Merchant’s (1985) result on budget participation on the other hand, is consistent with Onsi
(1973). However, his result on budget emphasis is negatively associated with budgetary slack
as opposed to Onsi. This demonstrates there are conflicting results on the direction of the
relationship between organisational factors and budgetary slack. Research in 1980’s focus on
the relationship between organisational factors and budgetary slack individually.
Interaction effects of organisational factors started to be incorporated in the next
decade. Proposed by Dunk (1990) as an explanation for inconsistent results of individual
relationship of organisational factors to budgetary slack, his research examined three way
interactions between budget participation, information asymmetry and budget emphasis on
budgetary slack. However, the results are different from the hypothesized positive
relationship, which further widens the controversy on the direction of relationship between
organisational factors and budgetary slack. The effect of two way interactions of
organisational factors (information asymmetry and budget emphasis) was also discussed by
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Dunk and Perera (1997). Although the interaction effects of organisational factors were
introduced, most of the research in this decade still examined the relationship between
organisational factors and budgetary slack individually. Inconsistent results on organisational
factors of budget participation and budget emphasis are exhibited in the research by Leavins
et al (1995) and Lal et al (1996).
In the following decade, new organisational factors such as business strategy and
business achievement (Van der Stede 2000) and reputation and ethic (Douglas 2002) are
introduced. The focus of the research in this decade is more towards three way interaction of
organisational factors, for example (1) interaction effects of budget participation, budget
emphasis and asymmetry information on budgetary slack (Lau & Eggleton 2003) (2)
uncertainty, budget participation and control system (Kren 2003) and (3) budget emphasis,
asymmetry information and culture (Lau & Eggleton 2004). Beside this, individual
relationship between organisational factor and budgetary slack were also examined for
example, budget emphasis (Van der Stede 2000; Linn et al., 2001), asymmetry information
(Douglas & Wier 2000; Fisher et al., 2002a; Fisher et al., 2002b) and budget participation
(Linn et al., 2001).
Research in Malaysia on budgetary slack is still in early stage. The newest studies in
Malaysia is Mohamad Adnan and Sulaiman (2007; 2006) and Nik Nazli et al. (2003).
Mohamad Adnan and Sulaiman (2007; 2006) studies on factors influencing budgetary slack in
Malaysia. The factors include organisational, religious and culture. Nik Nazli et al. which
examined implementation of budget at general. Their study shows budgetary slack in
Malaysia is higher than in New Zealand and USA. Though the reasons for this difference are
not clear, it is possible that cultural factors may account for the difference (Nik Nazli et al.,
2003). Malaysia ranks very high on Power Distance (Hofstede, 1991). According to Hofstede
(1991) in large Power Distance societies, employees tend to be dependent on their superiors
and bosses have the ultimate authority. Thus, the fear of failure and need to ‘look good’ on the
part of employees are paramount. As such, participative budgeting may lead to a higher
propensity to create budget (Nik Nazli, 2000).
The above discussions indicate power distance, budget participation, budget emphasis
and asymmetry information are the main factors contributing to budgetary slack due to
inconsistent results of the direction of the relationship. The effects of interactions between
organisational factors are emphasized in the research as one possible explanation to these
inconsistent results. Thus, it offers an avenue for further research on organisational factors of
budgetary slack within the perspective of interactive effects.
Hypothesis Development
Over the years slack has been viewed as an agency, organizational behaviour and ethical issue
(Hobson et al., 2011; Ozer & Yilmaz, 2011). The premise of agency theory is that agents are
self-interested, risk averse, rational actors who always attempt to exert less effort and project
high capabilities and skill than they actually have. Given compensation or reward as
depending on budget attainment, managers (i.e. agents) will build a slack in the budget as to
ensure the budget targets are achieved. (Lowe & Shaw 1968; Schiff & Lewin 1968, 1970;
Waller 1988)
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Participation in budget gives opportunity for employee to do slack (Young 1985).
Lowe and Shaw (1968) stated that employee do budgetary slack to protect their own interest
and this action is economic rational behaviour. This is also supported by Lukka (1988) which
argued that a high degree of participation gives subordinate managers the opportunity to
contribute directly to the creation of slack and vice versa. This leads to hypothesis as follows:
H1: Budget participation is positively associated with budgetary slack Emphasis on meeting budget target as a criterion for evaluation of subordinates’ performance
(high budget emphasis) may be associated with high job-related tension (Hopwood, 1972). In
situation of high budget emphasis, employee will find a way to protect themselves from risk
of not achieving the budget target (Lukka 1988). Budgetary slack is one of the solutions for
this situation. Onsi (1973) reported a positive relationship between employees’ need to create
slack and emphasis on budget. Camman (1976) results are also consistent with Onsi (1973)
showing that when managers used budget emphasis, the responses of their employees are
defensive. These findings suggest as Merchant (1985) proposed that the budgetary slack is
positively related to budget emphasis. This leads to second hypothesis as follows:
H2: Budget emphasis is positively associated with budgetary slack
High information asymmetry will give opportunity for employee to do a slack without being
detected by the managers. In this situation, the ability of managers to detect slack is low.
Merchant (1985) concluded that the ability of superiors to detect slack may also influence
their employee to create slack. This leads to the third hypothesis as follows:
H3: Information asymmetry is positively associated with budgetary slack
According to Williams and Seaman (2001), high power distance reduces trust on individual.
Low trust will increase control on employees. Employees will have conflict of interest and try
to get good performance evaluation and try to protect themselves by doing budgetary slack.
According to Hofstede (1991) in high power distance society, employees fear of failure and
need to look good to their manager. This leads to fourth hypothesis as follows:
H4: Power Distance is positively associated with budgetary slack Budget participation give opportunities to employee do budgetary slack. Consequently,
subordinate managers may react favourable to budgetary slack or tend to increase the creation
of slack when there is a high job related tension due to high budget emphasis. The creation of
budget slack also increased when there is high budget emphasis coupled with opportunity to
participate in budget. This leads to the fifth hypothesis as follows:
H5: Interaction between budget participation and budget emphasis is
positively associated with budgetary slack
Dunk (1993) shows that participation alone does not affect budgetary slack and Dunk (1993)
suggests there may be other factors associated with participation will lead to budgetary slack.
Budget participation gives opportunity to employee to do slack and the opportunity become
wider with information asymmetry. Budget emphasis gives reason why employee do budget
slack. Thus, the above discussion suggests that high participation with high budget emphasis
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and high asymmetry information is likely to give rise to high budgetary slack. This leads to
the sixth hypothesis as follows:
H6: The interaction between budgetary participation, budget emphasis and
information asymmetry is positively associated with budgetary slack.
Budget participation and information asymmetry give opportunity to employees to do
budgetary slack while budget emphasis and power distance gives reason why employees do a
budgetary slack. Thus, the above discussion suggests that high participation with high budget
emphasis, high asymmetry information and high power distance is likely to give rise to high
budgetary slack. This leads to the seventh hypothesis as follows:
H7: The interaction between budgetary participation, budget emphasis,
information asymmetry and power distance is positively associated with
budgetary slack.
METHOD
Sample Selection
A total of 150 companies were randomly selected from companies listed in Bursa Malaysia on
15 November 20051. Listed companies in Bursa Malaysia is chosen as sampling frame
because of their big size, they employ more workers and have high paid up capital.
Therefore, it is expected that the companies use formal budget and control to guide
operations. From these 150 companies, 450 managers were chosen as sample respondent.
Each company is given three questionnaires together with a cover letter and self-addressed
envelope for the questionnaire to be returned directly to the researchers. First reminder letters
were sent one week after sending the questionnaires followed by second reminder letter two
weeks later. Telephone calls also were used to solicit higher response.
From a total of 450 questionnaires sent to managers, 83 questionnaires were returned, which
yielded a response rate of 18.44 per cent. All questionnaires returned are valid to analyse.
Variables Measurements
A five point likert scale is used to measure all items of the research variables. These items are
anchored by (1) low usage and (5) high usage.
Budgetary Slack
This study uses measurement suggested by Van der Stede (2000), which measures budgetary
slack with five items: (1) succeed in submitting budgets that are easily attainable, (2) budget
targets induce high productivity in the department,(3)budget targets require costs to be
managed carefully in the department, (4) budget targets have not caused employees to be
1 The sampling framework excludes companies from financial, warrant and loan sector. High possibility that this
sector does not practice budgetary slack since this sector is under Banking and Financial Institution Act
(BAVIA)
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particularly concerned with improving efficiency in the department, (5) whether the budget is
very easy to attain, attainable with reasonable effort, attainable with considerable effort,
practically unattainable or impossible to attain. From factor analysis, first and second items
are excluded because factor loading is less than 0.5.
Budget Participation
Budgetary participation is the means by which subordinate managers influence plans and their
means of implementation, thereby sharing in the decision making process with their superiors
on matters that affect their areas of responsibility (Milani, 1975). This study adopts Milani’s
measurement of budget participation on (1) the importance of employees involvement in
setting the budget, (2) the kind of reasoning provided to employees by their superior when the
budget is revised, (3) the frequency of discussion related to budget initiated by superior with
the employees, (4) the influence that employees have on final budget, (5) the importance of
employees contribution to the budget, and (6) the frequency of discussion with employees
related to budget is initiated by superior when budgets are being set. From factor analysis, all
the items are valid.
Budget Emphasis
It refers to tight budget control (Anthony & Govindarajan, 1994) and accordingly when
budget control is tight, performance is measured predominantly on the basis of attaining
budget goals (Van der Stede, 2000). Although most studies adopt the measurement developed
by Hopwood (1972), this study utilizes Van de Stede (2000) since the latter’s measurement is
more specific with regard to the high emphasis of the subordinates to achieve budget target
and consistent with the given definition. Budget is emphasised because of the following: (1)
it is reminder by superiors of the need to meet budget targets, (2) superiors judge performance
predominantly on the basis of attaining budget goals, (3) Control over the department by
superiors is principally through monitoring how well the budget is on target, (4) superiors
achieving the budget is an accurate reflection of whether the employees are succeeding in
their work, (5) not achieving the budget has a strong impact on employees performance as
rated by the superiors, (6) Employees promotion prospects depend on their ability to meet the
budget, and (7) In the eyes of the superiors, not achieving the budget reflects poor
performance. From factor analysis, all the items are valid.
Information Asymmetry
Information asymmetry arises when subordinates (agents) are in possession of information
that affects the decision process between subordinates and superiors (principals). The research
used revised instrument of Jaworski and McInnis (1988) suggested by Ramaswami et. al
(1997). Respondents are asked on the information possessed by them compared to their
principal with regards (1) Employees know more about how to accomplish the work they
normally encounter, (2) Employees are intimately familiar with the day-to-day decisions
related to their work, (3) Employees have developed a better working knowledge of their job,
(4) Employees can assess their performance more adequately after completing the activities,
(5) Employees can specify the most important variables to monitor in their work, (6)
Employees can specify the performance objectives to cover the range of activities they
perform. From factor analysis, all the items are valid.
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Power Distance
Hofstede (1980) defined power distance as the difference between the extent to which the
superior can determine the behaviour of the subordinate and the extent to which the
subordinate can determine the behaviour of the superior. Measurement of power distance uses
three questions used by Hofstede (1980) and two additional questions. The three questions
from Hofstede are: (1) Employees are frequently afraid to express disagreement with their
superior, (2) employees perceive that their superior decision making style is more autocratic
than persuasive, (3) employees prefer autocratic style of decision making from their superior
than the persuasive way. Two additional questions are: (4) employee expects to be consulted
than to be told by the superior, (5) employee’s company hierarchy is seen to be more
exploitive than reflecting natural differences. From factor analysis, the items are divided into
two dimensions. First dimension is manager style which is represented by items (1) and (2).
Second dimension is management style which includes items (4) and (5). Item no (3) is
excluded.
The Cronbach Alphas of the variables under study are (1) budgetary slack 0.74 (2) budget
participation 0.89 (3) budget emphasis 0.95 and (4) information asymmetry 0.92. (5) power
distance (manager style) 0.69 and management style 0.59.
FINDINGS AND DISCUSSIONS
Respondent Profile
Nearly all the respondents are subordinate managers, with mean age of below forty years.
They have been holding their current position on average less than five years, and most of
them (83.1 %) are interested to continue working in the same company in the next five years.
More than half of the respondents have at least diplomas.
Summary descriptive statistics for independent and dependent variables are presented in Table
1.
Table 1: Descriptive statistics of independent and dependent variables
Variables Min Max Mean Median Std dev
budgetary slack
budget participation
budget emphasis
information asymmetry
1.00
1.33
1.00
2.00
5.00
4.50
4.71
4.83
2.65
3.07
2.90
3.60
2.67
3.00
3.00
3.67
0.83
0.79
0.87
0.65
Power Distance-
Manager Style
1.00 5.00 2.60 2.50 0.86
Power Distance-
Management Style
1.00 5.00 2.70 2.50 0.77
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Hypotheses Testing
The results of testing hypotheses 1 to 4 are presented in Table 2. The finding suggests that
hypotheses 1 to 3 are rejected. Budget participation, budget emphasis and information
asymmetry do not have a significant relationship individually with budgetary slack.
Hypothesis 4 expects positive relationship between power distance and budgetary slack.
Result from factor analysis, shows power distance is divided into two dimensions; manager
style and management style. There is no significant relationship for manager style but for
management style, the result shows negative relationship and significant. This result is
opposite of the hypothesis stated before.
Table 2: Multiple Regression for testing Hypotheses 1-4
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OVERVIEW OF THE ROLE OF FINANCIAL DEVELOPMENT AS A FORM OF
ABSORPTIVE CAPACITY IN THE FDI-GROWTH NEXUS
(Tinjauan Peranan Pembangunan Kewangan sebagai Pemangkin dalam Hubungan Pelaburan
Langsung Asing dan Pertumbuhan Ekonomi)
Nor Hakimah Haji Mohd Nor
Kolej Universiti Islam Antarabangsa Selangor
ABSTRACT
This study provides extensive review of the literature that encompasses two broad underlying
frameworks namely the FDI-growth nexus and the financial development-growth nexus. The
discussion is extended to the literature on the FDI-financial development-growth nexus where
the role of financial development is shown to be crucial in the FDI-growth link. The importance
of absorptive capacity has been recognized by past studies to enhance the relationship of FDI and
economic growth that so far empirically resulted in mixed findings. In serving the absorptive
capacity, higher level of financial development is identified as one of the significant channels
that would fulfill the purpose.
Keywords: Foreign direct investment; financial development; economic growth
ABSTRAK
Kajian ini meninjau peranan kualiti pembangunan kewangan sebagai pemangkin kepada
pelaburan langsung asing (FDI) dalam menggalakkan pertumbuhan ekonomi melalui sorotan
literatur. Tinjauan merangkumi dua kajian besar yang melibatkanhubunganFDI-pertumbuhan
ekonomi danhubungan pembangunan kewangan-pertumbuhan ekonomi. Perbincangan
dilanjutkan kepada pengembangan literaturhubunganFDI-pertumbuhan ekonomi di mana
peranan pembangunan kewangan dibuktikan sebagai pemacu penting dalam pertalian FDI dan
pertumbuhan ekonomi. Keupayaan menyerap telah diiktiraf oleh kajian lepas dalam membantu
meningkatkan kesan hubungan FDI dan pertumbuhan ekonomi, di mana setakat ini hasil kajian
hubungan tersebut tanpa pemangkin secara empirikal mendapati kesan yang bercampur.
Kesimpulannya, sebagai memenuhi fungsi keupayaan menyerap, tahap pembangunan kewangan
yang lebih tinggi dikenal pasti sebagai salah satu saluran penting yang akan memenuhi tujuan
tersebut.
Kata kunci: Pelaburan langsung asing; pembangunan kewangan; pertumbuhan ekonomi
INTRODUCTION
Since the last two decades, many countries have been taking earnest initiatives to promote their
economies as the destination for foreign direct investment. The flow of FDI increased sharply in
the developed and emerging economies that had designated FDI as a major vehicle for economic
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development (UNCTAD, 2010). FDI has been a capital formation of choice and identified as one
of the most important factors that contribute towards economic expansion through its benefits
and externalities. Alfaro et al. (2004, 2009) highlight several benefits of FDI that could promote
economic growth, for examples, knowledge spillover of technology transfers, introduction of
new processes to domestic market, learning-by-observing, training of labor force and managerial
skills.
While there is an extensive body of literature that investigates the relation between FDI
and economic growth, the empirical findings are ambiguous and inconclusive. On the one hand,
there are studies that find a positive relationship between FDI and economic growth (see, for
examples de Mello 1999; Yao & Wei 2007; Elsadig 2012). On the other hand, some studies have
shown that FDI is negatively related to economic growth (see, for examples Konings 2001; Elia
et al. 2009; Doytch & Uctum 2011). There are also studies that find no significant effects of FDI
on economic growth (Beugelsdijk et al. 2008; Temiz & Gokmen 2013; Yalta 2013; among
others).
Drawing on the ambiguous and inconclusive results of the FDI-growth relationship, the
literature has identified absorptive capacity of the host country as the key explanatory variable
for the varied conclusions. Specifically, absorptive capacity is described as a pre-requisite that
enables a host country to successfully incorporate the benefits and positive impacts of FDI
spillovers (Alfaro et al. 2009, Hermes & Lensink 2003).1 According to Crespo and Fontoura
(2007), absorptive capacities of domestic firms and regions are important preconditions for
realizing the benefits of FDI inflows. Since different countries have different levels of
development and local conditions, the impact of FDI in each country would be different. It is
expected that maximum benefits of FDI spillovers could be reaped through higher levels of
absorptive capacity. As stated in Alfaro et al. (2009), the success of domestic firms is determined
to a certain extent, by the local characteristics and the inherent weaknesses of domestic firms
might reduce their ability to absorb new technologies brought about by their foreign
counterparts. Consequently, this would hold back technological innovation and limit its impact
on the overall economy.
The literature of FDI-growth nexus has been extended with the introduction of financial
development as one form of absorptive capacity. Financial development of a country has been
recognized as one form of absorptive capacity since it has the potential to spur economic growth
by resolving various financial market imperfections which in turn allows the benefits of FDI to
be materialized. Levine (2005) provides detailed discussion on the following five major
functions of a financial system: producing information and allocating capital; monitoring firms
and implementing corporate governance; ameliorating risk; pooling of savings; and easing
exchange, all of which contribute to promoting economic growth.
Furthermore, in the realm of the FDI-growth literature, recent empirical studies that
investigate the role of financial development in FDI-growth nexus have collectively indicated
that finance is vital for the growth effects of FDI (see, for examples Hermes & Lensink 2003;
Lee & Chang 2009; Azman-Saini et al. 2010; Choong 2012). Hermes and Lensink (2003) find
that the development of banks and stock market are important preconditions for FDI spillovers to
be positively realized. Lee and Chang (2009) and Azman-Saini et al. (2010) also find that the
impact of FDI spillovers on economic growth requires a well-functioning financial market. The
findings of Azman-Saini et al. (2010) based on 91 countries over the period from 1975 to 2005
1 Cohen and Levinthal describe an absorptive capacity as “…an ability to recognize the value of new information,
assimilate it, and apply it to commercial ends” (1990: 128). In addition, Falvey et al. (2007) highlighted that a
country with higher absorptive capacity gained more from trade-related knowledge spillovers. In the study, trade is
measured by the average ratio of imports plus exports to GDP that capture the other benefits of openness.
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show that FDI’s impact on growth is positive only when financial development exceeds a
threshold level. Similarly, in a recent study, Choong (2012) also find that a well-developed
domestic financial market is a precondition for FDI to affect economic growth positively.
Taken together, prior studies have shown that financial development plays an important
role in the FDI-growth nexus and that it serves as one form of absorptive capacity of the host
country. Higher level of financial development suggests that the well-functioning financial
sectors are efficient in mobilizing and allocating capital to its most productive use. Thus,
countries with greater financial development will have better absorptive capacity, that would
enable them to realize more benefits from the FDI spillovers. As highlighted by Lai et al. (2009),
sufficient absorptive capacity is the foundation for FDI technology spillovers. Thus, it is
concluded that the role of financial development is shown to be crucial to enable a country to
make the most of the positive growth effects of FDI.
LITERATURE REVIEW
Foreign direct investment or abbreviated as FDI hereafter, serves as a primary form of
international capital transfer that has prospered tremendously in the past decades in both
developed and developing countries, to acquire cross-border expenditures and to expand the
corporate control of productive assets (Froot 1993). The first years of the 80s saw FDI becoming
the most crucial medium of integrating the world economy through its offerings of international
lending and borrowing. In recent years, FDI inflows have undergone a fast-paced development
and this leads to noteworthy economic success. As established from UNCTAD (2010), the FDI
inflows’ rapid increase is evident through the anticipation that the world inflows would escalate
to more than $1.2 trillion in 2010, further climb up to $1.3–1.5 trillion in 2011, and peak at $1.6–
2 trillion in 2012. The report which also ranks top economies based on the 2009 magnitude of
FDI flows, shows that the United States stays prominent as the world’s leading recipient of FDI,
besides its competitors namely China, France, Hong Kong and the United Kingdom.
The perception of the FDI as the very crucial component of capital flows in the global
economy and a dependable source of external financing is explained by the fact that it is more
stable than other types of investment. According to Chuhan et al. (1996) who study the behavior
of four major components of international capital flow in 15 developing and industrial countries
for the period of 1985-1994, direct investment is discovered as less volatile, owing to its less
drastic responses to disturbances in other capital inflows and in other countries.2 Besides,
through their adoption of the quarterly net flows and a univariate analysis in the study, it has
confirmed that direct investment is far from being ‘hot money’ or the term which denotes the
short term investment which is possibly speculative and which leads to market instability. In
addition, by incorporating FDI in the components of capital flows, it gives equal position to the
compositions of the loans and equity in international capital flows for the country. Lipsey (1999)
also shows that FDI suggests relatively higher stability than other types of international financial
flows. In the study, Lipsey (1999) places in comparison the differences among the types of
2 Four major components of international capital flows that are studied by Chuhan et al. (1996) are direct investment
(DI), short-term investment (STI), portfolio investment (PI) as well as other long-term investment (LTI). As
elaborated by Chuhan et al. (1996), DI contains some capital investment, retained earnings and intra-company debt,
STI captures changes in assets’ investment with one year maturity period, PI includes additional corporate equities
and bonds and LTI contains additional public and private sector debt securities, trade credit, loans, deposits and
other long-term assets. The source of data is Balance of Payments Statistics Yearbook of International Monetary
Fund.
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investments based on their direction of flows or volatility which measurement is by the standard
deviations.
In support of the findings obtained by Chuhan et al. (1996) and Lipsey (1999), Bird and
Rajan (2002) whose foundation of research resting on Malaysia’s balance of payment for the
1995-1998 timeframe, it is found empirically that economies which finance their current account
primarily with FDI are seen to be less vulnerable to a financial crisis.3 In favour of a long term
financing, FDI is acknowledged as more stable since it is irreversible in the short term. Although
the application of FDI as the main external financing is still not devoid of risks, its benefit
spillovers which heighten the development of the economy have made FDI superior to other
forms of capital flow. Moreover, Albuquerque (2003) offers empirical evidence that FDI also
carries a risk-sharing advantage over other capital flows. It is caused by the assumptions of the
flawed enforcement of financial contract and the inalienability of FDI that contributes to lower
levels of default premium and sensitivity to changes in the country’s financing constraints. By
taking an example from various international capital flows based on the said assumptions, with
samples of 111 countries for the period of 1975-1997, Albuquerque (2003) also urges
financially constrained countries to borrow relatively more via FDI.
FDI-Growth Nexus
The ultimate objective of FDI as the interjection of capital in economy is to accelerate the
growth rates, where in theory, FDI is expected to bring about a positive effect on the country’s
economic growth. Burgeoning empirical studies that have extensively investigated the FDI-
growth nexus, however have produced results that are contradictory. In spite of the fact that
some of them empirically find that FDI does have a positive contribution to growth (see, for
examples de Mello 1999; Vu & Noy 2009; Elsadig 2012), other empirical studies on the other
hand, have found otherwise, that is negatively related to growth (see, for examples Li & Liu
2005; Elia et al. 2009; Doytch & Uctum 2011). In addition, some other studies also find that the
significant impact of FDI on economic growth is non-existent (Beugelsdijk et al. 2008; Temiz &
Gokmen 2013; Yalta 2013) and that FDI only promotes growth given some conditions only
(Blomstrom et al. 1992; Balasubramanyam et al. 1996).
It is theoretically known that the major contribution of foreign investment to the host
country possibly stems from its various external effects or spillovers. Some studies have
managed to prove that FDI would contribute positively through its spillovers. For example
Blomstrom (1986) whose study sheds light on foreign investment and productive efficiency,
empirically finds that foreign investment’s multiple positive effects have proven to be an
important determinant in the industry’s structural efficiency. In addition, Blomstrom (1986) also
finds that the most important source of spillover efficiency is manifested in the competitive
pressure exerted by foreign firms. This study has shown that the role of FDI in the world
economy is significantly greater where recipient countries can obtain not only the funds for
investment but to the point that they can also enjoy the benefits through efficient technologies
and know-how. OECD (2003) reports that positive spillover effects of FDI can also become
advantageous to the country through the companies’ development and restructuring, the
enhancement of international trade and smart integration into the world economy, as well as an
3 Bird and Rajan (2002) also suggest that a country is better off if the capital flows are formed not entirely with FDI
but also with other forms of capital flows since a country that finances its current account deficits almost entirely by
FDI may remain vulnerable to capital reversals, as evident in Malaysia, which was affected by the crisis in Thailand
due to this condition. However, the relationship of FDI and other capital flows is other empirical issues shall not be
discussed in detail since it is not a focus in this study.
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increase in the competition and human capital development. A more recent study by Anwar and
Nguyen (2011) finds that an indirect effect or the spillover effect of FDI can be generated
through the links formed between domestic and foreign firms. Having said that, the FDI
spillover may lead to technology and knowledge transfer that increases the competition in the
domestic market, and ultimately contributes towards better resource allocation.
Theoretically, technological knowledge is widely recognized as a major FDI spillover
that contributes positively to the economic growth. According to Aghion and Howitt (1998),
under the growth theory, technological knowledge is important as a channel to maintain
economic growth in the long run since capital accumulation is subject to the effects of
diminishing marginal returns which would in time, cause the growth rate to cease. Some other
studies also find that FDI generates externalities in the form of technology transfer and
contributes to economic development (see, for examples Liu 2002, 2008; Sadik & Bolbol 2001;
Chakraborty & Nunnenkamp 2008; among others).
Furthermore, Liu (2002) who examines 29 industries of manufacturing over the period of
1993-1998 in China, suggests that FDI generates externalities in the form of technology transfer.
In the study, Liu (2002) finds that FDI in the manufacturing industry is significantly and
positively related to the productivity as well as the rate of productivity growth of its components
industries. In addition, Liu (2008) that extends the study of Liu (2002) provides more evidence
on FDI and technology spillovers by examining a large panel data of 17,675 manufacturing firms
over the period of 1995-1999. Liu (2008) proposes that FDI spillovers could decrease the short-
term level of productivity but increase the long-term productivity growth rate of local firms. In
the long run, technology spillovers serve as a source of knowledge that can make productivity
growth rate sustainable, as well as functioning as an ultimate engine of economic growth.4
In addition, Sadik and Bolbol (2001) present other evidence where the study finds that
FDI has been found to be an added advantage of generating technological spillovers for the
positive growth in the countries of the Arab world.5 It is also identified that by facilitating the
technology transfer in a global economy, it can hone the technology edge of other countries
involved in the various international endeavours. Similarly, Chakraborty and Nunnenkamp
(2008) who examine the effect of FDI in the Indian post-reform within a panel co-integration
framework, find that FDI stock and output are positively related through cross-sector spillovers
from the service sector to the manufacturing sector.
However, some other studies also find the FDI spillovers can be branched into positive
and negative spillovers, where some studies contend on their impact towards the host countries.
For example although Damijan et al. (2003) find that FDI is an important channel where
technology can be transferred to developing countries, they also find that there is no, or even
negative, horizontal knowledge spillovers from foreign-owned firm to domestic firms. Damijan
et al. (2003) investigate the effects of FDI’s direct technology transfer, FDI spillovers of intra-
industry knowledge, firm’s R&D accumulation and spillovers via trade for local firms’ total
factor productivity growth by examining firm-level data for eight transition countries for the
period 1994 to 1998. A more recent study by Hanousek et al. (2011) points that the forward
4 On the other hand, the negative effect of spillovers that is found in the short-term rate of productivity growth
indicates that technology transfer or externalities does not exist automatically and require costly learning process
(Liu 2008).
5 Sadik and Bolbol (2001) study the FDI’s role and its importance in the economic performance of the Arab
countries over the period of 1980-1999 by using the OLS. It captures the impact of FDI on the Arab’s technological
development and total factor productivity.
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spillover effects is negative and significant however the backward spillover effects are found
positive and significant.6 Hanousek et al. (2011) dispute the previous literature findings on direct
and indirect impacts of FDI in the emerging European market by using a survey and meta-
analysis.7 In addition, Hanousek et al. (2011) also find that the impact of productivity spillovers
in cross-sectional studies is greater than in panel studies since unobserved heterogeneity is not
properly addressed, further resulting in biased estimates.
Extensive literature that has explored the impact of FDI on economic growth has
produced incompatible results. Although FDI inflows are discovered as an engine of economic
growth, where their benefits of knowledge and technology spillovers could contribute to the
economic growth of the recipient countries, the empirical findings on the growth effects of FDI
are still inconclusive and remain ambiguous. Conversely, FDI is found to exert positive growth
effects on the recipient countries. For example, De Mello (1999) empirically finds that FDI
inflows positively affect an output growth in all panels, with and without country-specific factors
(i.e. institutions, trade regime, political risk, policy, etc). Yao and Wei (2007) provides empirical
evidence that FDI positively contributes to economic growth where it has been identified as a
powerful driver of economic growth for a newly industrializing economy to keep abreast with
the world’s most advanced country as a mover of production efficiency and a shifter of
production frontier. A more recent study by Ouyang and Fu (2012) discovers a positive effect of
FDI on growth where inter-regional spillovers studied from the coastal FDI is found to be
positively and significantly related to economic growth in inland regions.
On the other hand, other studies find that FDI is negatively related to growth. As Görg
and Greenaway (2004) review most of the previous empirical literature which investigates the
FDI-growth nexus, they discover that a great deal of the work does not find positive spillover
and thus conclude that the effects of FDI on growth are mostly negative. As shown by an earlier
study by Aitken and Harrison (1999), the study empirically finds that FDI has a negative
consequence on the productivity of domestically owned plants.
Elia et al. (2009) finds that the impact of outward FDI is negative to the home country
when foreign affiliates come from high income countries. Doytch and Uctum (2011) that
investigate the effects of manufacturing and service FDI on their own sector growth, the
spillover to other sectors and the overall economy in the host country, find that the impact of
total FDI on the whole growth in the service-based economies is also negative. Furthermore, as
also found by other studies, FDI has no significant effect on economic growth. Herzer et al.
(2008) that examine the link of FDI-growth for 28 developing countries find no existence of
positive unidirectional long-term effect of FDI to GDP in any country. Carkovic and Levine
(2002) who empirically revisits the relationship of FDI and economic growth find that the
exogenous component of FDI does not give any positive impact to economic growth. The other
study by Beugelsdijk et al. (2008) also finds no significant effect in developing countries, either
from horizontal (market seeking) or vertical (efficiency seeking) FDI even if there are
empirically positive and significant growth effects established in developed countries in both
types of FDI.
6 Forward spillover refers to how local firms benefit from intermediate inputs from foreign firms and backward
spillover refers to how foreign firms may profit from the improvement of domestic firms. 7 The sample in the meta-analysis consists of 21 papers, 10 of which are published in academic journals, 6 are
contributions to an edited volume and 5 are working papers.
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FDI-Growth and Absorptive Capacity
Generally, previous literature has recognized the fact that the impact of FDI on economic growth
is ascertained by certain local characteristics of the host countries. More specifically, it refers to
an absorptive capacity that is recognized by past studies as a key explanation for the inconclusive
and ambiguous findings in the FDI-growth nexus. As highlighted by Alfaro et al. (2009),
absorptive capacity is described as a precondition that aids a country to garner the diverse
benefits and positive impacts of FDI spillovers. Thus, the country’s local conditions matter as
they can restrict the extent to which FDI benefits materialize.8
In a study by Cohen and Levinthal, an absorptive capacity is defined as “…an ability of a
firm to recognize the value of new, external information, assimilate it and apply it to commercial
ends” (1990: 128). Cohen and Levintal (1990) also conclude that since absorptive capacity is
intangible, its benefits are indirect and it appears as part of the firm’s innovative capabilities.
Thus, abundant past studies dwelling into FDI spillovers have made a serious effort in
considering the element of absorptive capacity as the main channel towards investigating the
effects of the FDI-growth nexus. Collectively, past studies empirically find that with a
precondition of absorptive capacity determined by multiple factors, it contributes to a positive
relationship of FDI and economic growth (Blomstrom et al. 1992; Borensztein et al. 1998;
Branstetter 2006; Sinani & Meyer 2004).
Furthermore, recent empirical literature has brought forth the assertion that financial
development is a key explanation for the inconclusive and ambiguous findings in the FDI-growth
nexus where financial development is found to serve as a precondition in enabling the positive
growth effects of FDI to be realized. Financial development is recognized as an important
absorptive capacity due to its major functions in the country’s financial system that includes both
banking and stock market sectors. Alfaro et al. (2009) provide evidence that financial markets
act as a channel in facilitating the positive growth effects of FDI to be realized where the study
finds that countries with well-developed financial markets gains significantly from FDI through
total factor productivity improvements.
Financial Development-Growth Nexus
In the finance-growth nexus literature, a large body of research has shown that financial
development exerts positive impact on economic growth. The theoretical foundation of the
relationship between financial development and economic growth has been discussed over the
decades since the earlier works by Schumpeter (1911) and later by McKinnon (1973) and Shaw
(1973). These classical views have recognized financial sector development as a major catalyst
that contributes positively to economic growth. Well-functioning financial sectors have been
shown to enhance economic growth by lowering transaction costs, reducing market frictions and
ensuring that capital flows are steered towards the most productive use possible.
Levine (1997) provides a theoretical review which proves that financial development
plays an important role to the country’s economic growth. Levine (1997) highlights five
functions of financial system i.e. facilitate risk management, allocate resources, exert corporate
control, mobilize savings and ease trading of goods and services which consequently channels
capital accumulation as well as technological innovation to growth. The more efficient the
functions the more developed financial development will be which impliedly ameliorate market
8 Alfaro et al. (2009) mainly find that the improvement in total factor productivity plays an important role in
benefiting from FDI spillovers and capital accumulation in both physical and by contrast, human however does not.
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frictions of information and transaction costs. Levine (2005) further discusses the five major
functions of financial system in detail which provides different implications in every dimension
due to the possible improvements of the functions that consequently enhance economic growth.
Bertocco (2008) theoretically stresses on the positive linkage between financial
development and economic growth by way of re-assessing some crucial elements derived from
Schumpeter’s theoretical framework which includes innovation and credit. Collectively, past
studies have also empirically proven that there exist positive strong and robust relationship
between financial development and economic growth (see, for examples King & Levine