Wharton's Zeke Hernandez discusses the dual entry strategy companies expanding abroad can deploy if they are targeting their own expatriates.

When a company wants to expand internationally, one of the strategies it deploys is to open branches in a country populated by people of its own ethnic group. For example, Chinese banks have opened branches in various Chinatowns in the U.S., counting on the shared culture to attract customers.

Wharton management professor Exequiel (Zeke) Hernandez studied this phenomenon in the banking industry in his paper, “When Do Ethnic Communities Affect Foreign Location Choice? Dual Entry Strategies of Korean Banks in China,” which was co-authored with Yong Li, a professor at the University at Buffalo School of Management, and Sunhwan Gwon, who earned his Ph.D. at the University at Buffalo School of Management. Hernandez spoke to Knowledge at Wharton about his findings.

An edited transcript of the conversation follows.

Knowledge at Wharton: How did you get this idea to study ethnic communities and banks? It seems like a fairly unusual topic.

Zeke Hernandez: It goes back to my early years in grad school. I started my Ph.D. very interested in the globalization of companies. And what I had in my head as a young and bright-eyed grad student was this visual of a map of the world with dots scattered across the map representing the locations of companies. And what I wanted to explain was why they chose these locations to expand abroad.

One day I was lying in bed, stressed about an upcoming statistics exam, and the map popped up in my head. And for a reason that’s hard for me to explain, another map overlaid onto the original map, one that had dots representing the movements of people or immigrants around the world. And there was a moment of inspiration or insight where I thought, ‘there has to be some relationship between these two maps — the movements of firms and the movements of immigrants around the world.’ That was the beginning … [and it led] to a stream of research on this topic. This paper is a follow-up to previous research.

The topic might seem unusual, but the phenomenon of firms expanding into foreign markets [to follow immigrants] is actually quite common. We see it all the time with, fast food chains entering the U.S. market to serve Asian or Central American customers. We also see it with tech companies moving from Silicon Valley to Asia or vice versa to tap into engineering talent of a certain nationality … or things like that. So it’s actually fairly common.

“Firms are more likely to move into a foreign location the greater the number of co-national immigrants living in that location.”

One of my co-authors on this paper, Yong Li, and I had separately done research showing that foreign companies are more likely to invest and survive in the U.S. in cities or states that had a greater size of immigrants from their country of origin. We decided to join forces and ask a different question for this paper.

Knowledge at Wharton: Tell me about your research. What did you set out to study?

Hernandez: What this paper does is build on an empirical finding that I just mentioned. … We’d shown that firms are more likely to move into a foreign location the greater the number of co-national immigrants living in that location. So to use another interesting example, a South African company is more likely to invest in Colorado than Arkansas because Colorado has the second largest population of South African immigrants in the U.S. And this is after we account for the economic attractiveness of Colorado and Arkansas for that company.

What we wanted to add was some nuance into this previous finding because on average it’s true, and it’s been shown in lots of different countries, that a firm, say from country X, tends to locate in a place with immigrants from country X. But there’s actually a lot of variation around that average. So not all companies will find it desirable to locate where immigrants from their home country live. We even became aware of some cases in which companies deliberately avoided locating where immigrants live because they didn’t want to be associated with catering to a ‘niche-y’ ethnic group of customers or workers. Instead they actually wanted to serve the broader market.

So in some ways we asked the opposite question of what our prior research had asked before, ‘When do firms not co-locate with immigrants of their same nationality?’ And we felt that this could be important and interesting to help us understand the real fundamental mechanism by which immigrant populations attract firms from their home countries.

Knowledge at Wharton: You also mention in your paper something called the dual entry strategy. This is something, I gather, that foreign companies employ when they enter another market. Tell us about that.

Hernandez: The argument goes something like this — the population of people of a certain ethnicity or nationality is quite small. So if you’re going to rely on that population as a platform for foreign expansion to move into, say, a new country or a new market, city or state, that can be fairly limiting because it’s going to prevent you from serving the much larger or broader market in the foreign location.

Say you’re a Korean bank and you’re only serving ethnic Koreans [living in China] as a customer base, maybe you limit your ability to serve the larger Chinese population in the host market. Or if you only hire workers from among your co-ethnic network, you can’t always access the broader pool of labor and talent that’s non-ethnic. So the question is then why would a firm take the risk of limiting their growth in a foreign location by catering to a small ethnic population?

Our argument is that firms take that risk when the institutional environment of the target location is weak and it presents risks that only the ethnic population can mitigate. Otherwise if the institutional environment is strong, then you don’t need to rely on the ethnic population as much and you don’t run that risk of being stuck in a niche.

Say I’m a bank and I’m considering moving into a foreign market in China, a province that has very weak laws, weak courts, weak property rights. That makes lending very risky, right? I don’t have credit rating agencies or other ways to ascertain the reliability of a potential borrower or a potential employee.

“For firms it offers a rule of thumb to determine when it’s actually valuable to rely on an immigrant population as a platform for foreign expansion.”

In a situation like that it turns out that an ethnic community can be really valuable. We know from other research in sociology and political science and even economics that ethnic communities or groups of immigrants essentially create these markets that are powered by trust to facilitate business transactions. Why? Because we have bonds based on common nationality. … You have a reputation in this community, and if you act in bad faith, that is going to be harmed.… This is just what we call social enforcement.

When is social enforcement valuable? It’s valuable if I don’t have another means of enforcing business practices. So if the legal or local institutional environment is weak then firms from country X will really benefit a lot from tapping into this social fabric and doing business within the ethnic communities. But this is limiting because the social mechanisms that produce trust really only work within the boundaries of the ethnic social group.

In contrast, if the legal or institutional environment is strong, then as a firm from country X, I will probably want to rely more on those formal mechanisms that allow me then to do transactions with the entire population rather than with just a niche within that population.

This leads to what we call the dual entry strategy. If I’m a firm and I’m considering expansion into a location that has an ethnic population, I’m going to do it if that location has a weak institutional environment — weak courts, weak laws, weak property rights — but I will not or I will be at least much less swayed by the ethnic population in places where institutional environments are strong. That’s the dual entry strategy.

Knowledge at Wharton: Your paper in particular looked at the ethnic Korean population in China and Korean banks entering the country. First of all, I didn’t even know there were that many Koreans in China. Can you set the context for us a little bit there?

Hernandez: I’m glad you asked that because actually this is one of my favorite aspects of this paper — the data and the context are very, very cool. … I have two co-authors on this paper … and it turns out that one of them is Chinese and the other one is Korean. So I learned a lot from them. One of the things I learned is that China actually does have a really large population of ethnic Koreans. And their history is, I think, both inherently interesting and really important for our empirical research design.

“We can explore how the post-1992 expansion of Korean banks into China is affected by the presence of these ethnic Koreans.”

These ethnic Koreans moved to China in the early 1900s to escape Japanese colonial rule. And at their peak they actually reached a population of nearly two million. In 1949, the Communist party takes power in China and the South Korean government does not recognize that government as fully legitimate. They actually recognize the Taiwanese government as well. That led to a longstanding diplomatic stand-off. From 1949 until 1992 all investment, all migration, all travel completely ceases between South Korea and China.

What we have here is a population of ethnic Koreans, over a million of them, that between 1949 and 1992 are essentially stuck in China. They can’t go back to the motherland. And so what they do is they assimilate into China, but they are very careful about maintaining a separate Korean identity and language and even schools and neighborhoods. They are well received by the Chinese, but they’re distinct enough that they’re, even to this day, recognized as one of the 50-plus officially recognized minorities in China. They actually have a specific name, the Chaoxian, if I’m pronouncing that correctly.

Why does all this history matter for us? It actually is empirically very convenient for our purposes because after 1992, South Korean firms, attracted by the size of the Chinese market, start expanding back into China, including banks, which are the firms we studied. … We can explore how the post-1992 expansion of Korean banks into China is affected by the presence of these ethnic Koreans. And the nice thing about this is that where these ethnic Koreans live is clearly not driven by the movement of banks. So that is a natural experiment that allows us to make casual claims and not just correlational claims.

Knowledge at Wharton: What did you find and what are some of the practical implications of your research?

Hernandez: In a nutshell what we found is support for this idea of a dual entry strategy. We assessed the entries of South Korean banks, province by province, and we found that the presence of these ethnic Koreans strongly influenced their location in a province, but only if that province had a weak and unstable institutional environment. If the province had strong and stable institutions, then these Chaoxian or ethnic Koreans did not have a significant influence on the location choice of the banks.

In terms of practical implications, I think for firms it offers a rule of thumb to determine when it’s actually valuable to rely on an immigrant population as a platform for foreign expansion, and the factor or the pivot that would tell you that it is worthwhile taking that risk of catering to a niche population, either as customers or employees or anything else. When the institutional environment is weak, they can serve as this community of social enforcement as I mentioned earlier. If the institutional environment is strong, then perhaps … the benefits will be less.

Knowledge at Wharton: What sets your work apart from prior academic work in this area?

Hernandez: The most distinctive aspect is just introducing the importance of institutions as an explanation for this relationship between immigration and foreign investment. All the research so far had not considered context enough. We looked at the context of the receiving location in terms of its institutions. There’s certainly other aspects of the context that matter, [which we didn’t study]. But perhaps that adds a little more realism — immigrants are really valuable for firms but they’re not a panacea. They’re not this magic bullet that is desirable in all cases.

Knowledge at Wharton: How are you going to follow-up this research? What’s your next step?

Hernandez: I hope to have some other dream that gives me a flash of inspiration!

But more seriously, this is a subset of a much bigger research agenda. Today we live in a time when [the value and impact of] immigration is being questioned rather significantly. Is it valuable for the economy? Do immigrants contribute? Do immigrants take away jobs? Do immigrants facilitate investment or not?

At the risk of perhaps being a little too grand, let me just set this in context. Much of what’s studied about immigration these days is what I call the labor effects of immigration, which has to do with immigrants affecting jobs and wages. It turns out that there’s a lot of research on this, decades and decades. The National Academies of Sciences, [Engineering, and Medicine] recently wrote a very large report that anyone interested in this topic should read. The conclusion was that in terms of wages and jobs, immigrants either have negligible effects or they might have a very small negative effect on a very small sliver of the population. We’re debating a lot about an issue that turns out to be not that consequential.

“You have a reputation in this community, and if you act in bad faith, that is going to be harmed.”

The problem with a lot of the research that’s come before is that an economy doesn’t just grow based on labor. Basic economic models tell us that an economy is a function of labor, but also capital and innovation or knowledge. Those are the three things that power growth in an economy. What my research, this particular paper for example, shows is that there’s a relationship between immigration and capital. Immigrants actually attract capital from foreign markets, which then helps the economy grow. That’s not something that you hear a lot about in the public debate.

Then there’s other research, some by me [but a lot by others too], which shows that immigration actually has a huge effect on innovation and knowledge. We know for example that immigrants tend to start firms that produce innovative products at a much higher rate than natives. We know, for example, that immigrants increase the stock of patents in a country significantly, and immigrants produce a lot of other kinds of innovations.

So I would say that my follow-up to this research is to hit on those two other aspects — on the capital and innovation aspects of the economy, [which are less spoken of in our public debate].

A third piece of this is that we also need to know more about how firms respond to immigration. That’s another thing that’s missing from our public debate, is that firms are the ones who end up hiring immigrants or natives. Firms are the ones who produce the bulk of innovation. And firms are the ones who make most of the capital investments. So how this triad of immigrants, the economy, and firms mutually affect one another is super important. There’s so much to do that I would say my follow-up to this research is to try to make a dent in this really big area that is not just important but politically sensitive these days.