MNEs’ R&D governance decisions are shaped by the host institutional environment, which entails constraining institutions and enabling institutions. The former restricts economic activities, and the latter orients MNEs toward certain possibilities over others. Prior internalization studies emphasize constraining institutions. They argue that because market failure increases transaction costs, MNEs pursue R&D internalization. This paper conceptualizes R&D tax incentives as the proxy for enabling institutions that actively and purposely guide MNEs’ R&D governance decisions toward R&D outsourcing. We hypothesize that R&D tax incentives direct MNEs to pursue R&D outsourcing by reducing the costs of R&D contracts, acting as information signals of legitimacy that facilitate MNEs’ access to local resources, and addressing market failure to compensate MNEs’ return on R&D. Specifically, the relationship is enhanced as the influence of the constraining institutions decreases. Thus, we hypothesize that the relationship is strengthened when 1) the host country’s intellectual property regulatory institution is stronger than that of the MNE’s home country, 2) a bilateral investment treaty exists between MNEs’ home and host countries, and 3) the MNE has prior outsourcing experience in the host country. We find empirical support for all our hypotheses using the Business Research Microdata of Statistics Canada.
