10.5465/AMBPP.2017.86 EXPLORATIVE OR EXPLOITATIVE? HOW LOCAL FIRMS RESPOND TO FDI PRESENCE BY INNOVATION ADAPTATION RENFEI GAO University of Melbourne 198 Berkeley Street, Parkville, Victoria, 3010, Australia ANDRE SAMMARTINO University of Melbourne INTRODUCTION It is well-established in the literature on FDI impacts on local firms that foreign entries can influence local firms through both positive spill-over and negative competition (or crowding- out) effects (Spencer, 2008). These effects are especially prominent in emerging market contexts (Chang & Xu, 2008; Zhang, Li, Li, & Zhou, 2010; Zhang, Li, & Li, 2014). However, most existing research looks simply at the relationship between FDI presence and local performance, and implicitly treats local firms as passive receivers (Chang & Xu, 2008). Consequently, the interaction process between foreign and local firms – specifically the local firms’ strategic responses to FDI presence – largely remains a “black-box” (Dau, Ayyagari, & Spencer, 2015; Liu, Lu, Filatotchev, Buck, & Wright, 2010). In light of this gap, our study treats the coexisting spill-over and competition effects as environmental changes brought by foreign entries, and examines the local firms’ strategic adaptations thereto. In particular, we explore how local firms adapt their explorative and exploitative innovation in response to both spill-over and competition mechanisms derived from FDI presence. Applying March’s (1991) original conceptualization to the innovation context, we define explorative innovation as researching and pursuing new technologies, such as inventing new products and processes; while exploitative innovation refers to refining and improving existing technologies for better practices and functions, such as releasing new product shapes and structures. This delineation is consistent with several prior studies (e.g., He & Wong, 2004; Zhou & Wu, 2010). From the standpoint of local firms, we articulate how decision-makers of local firms adapt their attention distributions between explorative and exploitative innovation, building on the attention-based view (ABV) (Ocasio, 1997). The ABV explains firm behaviours based on how decision-makers channel and distribute their attention to different issues, which in turn, depends on the environments they are in (Ocasio, 1997). In this sense, this perspective can provide a solid and relevant underpinning for linking two environmental changes led by FDI presence with local firms’ strategies of explorative and exploitative innovation. We propose that each effect of FDI presence has distinct implications for local firms’ explorative and exploitative innovation. Through the spill-over effect, local firms increase exploitative innovation while decreasing explorative innovation. This is because more technological possibilities may arise from foreign entries, and these, in turn, provide more learning or imitation opportunities for local firms to exploit (Zhang et al., 2010; 2014), while substituting their own explorative efforts. In contrast, through the crowding-out effect, the intensified competitive pressures led by foreign entries (Chang & Xu, 2008; Spencer, 2008) can push local firms to increase explorative innovation so as to differentiate themselves from foreign rivals, and decrease exploitative innovation which could amplify homogeneous competition in