Conducting R&D in countries with weak intellectual property rights protection

Multinational enterprises (MNEs) are increasingly conducting research and development (R&D) in countries such as China and India, where intellectual property rights (IPR) protection is still far from adequate. This paper examines this seemingly puzzling situation. I argue that weak IPR leads to low returns to innovation and underutilization of innovative talents; MNEs that possess alternative mechanisms for protecting their intellectual properties will therefore find it attractive to conduct R&D at those locations. A theoretical framework is developed to capture the interaction between firm strategy and the institutional environment. The empirical analysis on a sample of 1,567 U.S.-headquartered innovating firms finds results consistent with the hypotheses that (i) technologies developed in countries with weak IPR protection are used more internally, and (ii) technologies developed by firms with R&D in weak IPR countries show stronger internal linkages. The results suggest that firms may use internal organizations to substitute for inadequate external institutions. By doing so, they are able to take advantage of the arbitrage opportunities presented by the institutional gap across countries.