How do borders differ? An institutional view on the effects of international and subnational borders.

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How do borders differ? An institutional

view on the effects of international and

subnational borders.

Frank Schutte

Student number: S2375087

Abstract

The aim of this study is to provide insight into the consequences of crossing into different institutions on both an international and subnational level. This research analyses internationalization using institutional theory and emphasizes the relevance of subnational regions for firm performance. A total

of 910 mergers & acquisitions from China, Hongkong, Macau and Taiwan were used in order to explore the consequences of crossing into different border types. Both formal and informal institutions

were found to significantly influence firm performance, with formal institutions positively affecting firm performance on a subnational level and informal institutions negatively affecting firm performance on an international level. The findings emphasize the importance of institutional borders

and pave the way for future research to distinguish in more detail why institutions impact firm performance.

Keywords: Internationalization, subnational borders, institutional theory, firm performance

Msc. Strategic Innovation Management Thesis supervisor: dr. K.J. (Killian) McCarthy

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Introduction

Borders are everywhere. Most of the academic literature related to borders has however been

predominantly focussed on one specific type of border, that being international borders. This concept of internationalization is already thoroughly explored in existing literature and is one of the most researched topics in International Management (Werner, 2002). Even though a multitude of effects stemming from the crossing of an international border have already been identified by researchers, no consensus has been reached whether internationalization ultimately positively or negatively effects firm performance (Contractor, 2007). The impact of internationalizing seems to be decreasing however, as a result of globalization breaking down the barriers that are international borders (Chen, 2004).

In part due to the predicted diminishing effects of international borders, we will attempt to provide more insight into a different set of borders. The abundance of attention for the crossing of an international border did not ignite interest in borders on a more local level, namely subnational borders. Subnational borders, referring to borders within a country, have only recently received more attention from literature in order to explore the consequences they can have on firm performance. This lack of previous interest in subnational borders is surprising, since scholars have long hinted at the importance of the subnational region. In 1994, Porter already emphasized the importance of subnational regions by expressing that “the relevant economic region is smaller than the

nation”(Porter, 1994, p.38). Supporting this claim, Meyer and Nguyen (2005) argue that subnational institutions have a similar effect regionally as national institutions do on a national scale. This study will attempt to shed more light on the influence of subnational regions on firm performance.

Despite the aforementioned extensive academic coverage of the relationship between

internationalization and performance, Marano et al. (2016) found that the institutional view is one perspective which has been largely neglected in extant literature regarding internationalization. By applying the institutional view on both an international as well as the subnational level, this study will have a two-pronged approach. Not only will we respond to the call of Marano et al. (2016) by

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level, providing evidence that institutions do significantly effect firm decision making. This research builds upon that idea and attempts to explore how institutions effect firm performance on a

subnational level. Moreover, since data is gathered on international as well as subnational borders in the same dataset, this study allows for a comparison between the different types of borders and their effect on firm performance.

As indicated, this article will mainly revolve around the institutional view. The institutional view itself distinguishes between two different types of institutions, formal and informal institutions. Formal institutions are defined as “written or formally accepted rules and regulations which have been implemented to make up the economic and legal set-up of a given country” (Tonoyan et al., 2010, p. 805), whereas informal institutions refer to “traditions, customs, ideologies, and templates that have never been consciously designed but are still in everyone’s best interest to keep” (Tonoyan et al., 2010, p. 805). For this study we use administrative regions as the operational variable for formal institutions, while using cultural regions in order to distinguish between informal institutions. The aim of this study is to provide more insight into how informal and formal institutions affect firm performance on both an international as well as a subnational level. The managerial implications from this study might prove particularly helpful for firms which are close to an international border with the same cultural group. Firms which are located in a country where there is a clear cultural divide

between subnational regions might benefit more from internationalizing into a different country with the same cultural group instead of expanding domestically into another cultural region. For example, this could be the case for a firm in Belgium located in the Dutch speaking half of Belgium, Flanders. Rather than expanding operations into Wallonia, the French speaking part, it might prove more beneficial to start operations in the Netherlands due to the similarities in language.

In order to provide context, an overview of the existing literature on the subjects of international borders, subnational borders and institutions will be presented. Afterwards, extant literature will be used to develop hypotheses. In this study, the institutional impact on firm performance will be measured. Differences in firm performance will be measured through an event study (Brown & Warner, 1985), in which the ‘normal’ stock price is compared with the stock price directly after an acquisition. In the method and results section, we provide elaboration how a total of 910 mergers and acquisitions from China, Hongkong, Macau and Taiwan were used to attempt and find support for our hypotheses. These 910 observations are composed of 54 companies moving into a different country, while the remaining 856 observations are companies who expanded domestically. Finally, the contributions of this paper for both academics as well as managers will be outlined and several limitations and avenues for further research will be proposed.

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internationally suffered a hit on performance from doing so. After applying the institutional view, we found that firms which cross into different informal institutions when internationalizing experienced more negative consequences in terms of firm performance compared to firms who decided not cross such a border, therefore hinting at the idea that informal institutions negatively affect firm

performance. Lastly, on a subnational level, we found a positive effect for firms which cross into a different formal institutions, indicating that crossing a border does not inherently have to hurt the performance of a firm but can actually positively impact the performance of a firm. The findings emphasize the importance of institutional borders and pave the way for future research to distinguish in more detail why institutions impact firm performance.

Literature review

Internationalization

Using the definition of Welch and Luostarinen (1988, p. 36), internationalization is defined as: “the process of increasing involvement in international operations”. This can refer to a company not yet operating abroad starting new operations in another country, but it can also refer to international companies increasing their participation in countries besides their home country where they are already active.

As mentioned, despite the significant amount of attention to internationalization in extant literature, no consensus has been reached whether internationalization ultimately positively affects firm

performance (Bausch & Krist, 2007). The benefits of internationalization are however plentiful. By entering or expanding into another market, firms are not as vulnerable to changes in one market, diversifying their assets (Capar & Kotabe, 2003) and subsequently reducing the risk they are exposed to (Kim et al., 1993). Moreover, crossing into another country allows a firm to gain access to cheap labour (Contractor, 2007), make larger use of economies of scope (Grant et al., 1988) and discover new market opportunities (Bühner, 1987; Kogut, 1985). These new market opportunities do not solely constitute opportunities in the market where the country is internationalizing into, but can also refer to the firm profiting from knowledge being imported back to the firms home country. Domestic

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complexity for management (Hitt et. all, 1997), leading to poor decision making and subpar performance (Katrishen & Scordis, 1998). In addition to this, the limited absorptive capacity can hinder the firm in fully learning all there is to learn about its new environment (Cohen & Levinthal, 2000).

As described above, the crossing of an international border can provide several hurdles for a firm to overcome in order to operate successfully in another country. Even though the impact of international borders has decreased in impact through globalization, borders still pose as barriers for firms to cross (Beugelsdijk & Mudambi, 2013). Besides the described international borders, there is another set of borders which literature indicates can influence firm performance. On a more local scale compared to international borders we find subnational borders, dividing a country. The concept of borders itself can be defined as “places where transaction costs increase in a discontinuous matter" (Beugelsdijk & Mudambi, 2013, p. 24). Following this definition from Beugelsdijk and Mudambi (2013) regarding borders, we expect to find discontinuities on both an international as well as a subnational level. In the next section several consequences of subnational differences will be outlined.

Subnational borders

Despite the abundance of interest in international borders, the topic of subnational borders has not been investigated to the same extent. This is surprising, since clues can be found highlighting the relevance of these subnational regions for firms. Indicating the importance of subnational regions, Beugelsdijk and Mudambi (2013, p.416) emphasize that by solely focussing on the international level and not paying attention to subnational information, an analysis can be ‘not incorrect, but severely incomplete’, with the subnational location adding crucial information to characteristics of the country. Furthermore, analysing the subnational region is essential for understanding the connection between multinational enterprises (MNE’s) and its spatial environment (Beugelsdijk et al., 2010).Therefore, it is important to gain insight what effect crossing a subnational border will have on a firm.

Existing literature supports the notion that differences between subnational regions can have an impact on firms. As a consequence of differences between regions, foreign affiliate performance can differ significantly between regions in a country (Chan et al., 2010). This is partly caused by the

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In the case of foreign subsidiaries, a factor influencing how well a firm integrates into its local environment is the level of attractiveness of a region for foreign direct investment. In instances where foreign subsidiaries are favoured by subnational regions through the implementation of policies, this can positively affect the ease with which a firm integrates in the region (Park et al., 2006).

Subsequently, this also results in a higher amount of foreign direct investment flowing into the region (Park et al., 2006). As a final indicator, the attractiveness of the subnational region is affected by R&D intensity in a region. A higher R&D intensity allows firms to diversify their knowledge or catch up to the latest knowledge in their field (Chung & Alcácer, 2002).

In order to investigate the exact consequences of crossing a border, this study will make use of institutional theory. Using institutional theory, the concept of borders is further divided into two different types of institutions, informal and formal institution.

Institutional theory

Dubbed by North (1990, p.3) as “the rules of the game”, institutional theory “considers processes by which structures, including schemas, rules, norms, and routines, become established as authoritative guidelines for social behavior” (Scott, 2005, p. 2). As argued by Peng et al. (2008), the institutional view provides, together with the industry - and resource-based views, a foundation on which to build international business strategy. The goal of this article will be to determine the consequences when firms cross between different institutional regions, both on a subnational as well as on an international level.

Past findings have already provided evidence that institutions can have an impact on firms in a variety of ways. Institutional differences within a country have been found to influence corporate strategy (Schlevogt, 2001), entry strategies (Meyer & Nguyen, 2005) as well foreign direct investment inflow (Zhou et al., 2002). The heterogeneity in institutional development also influences intellectual property rights enforcement, international openness and the quality of academic talent in universities and research institutes (Kafouros et al., 2015).

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can co-exist in one administrative region. As will be elaborated upon in the upcoming sections, the different types of institutions can both have an impact on the operating of firms.

Formal institutions

As mentioned, formal institutions constitute “written or formally accepted rules and regulations which have been implemented to make up the economic and legal set-up of a given country”(Tonoyan et al., 2010, p. 805). On an international level formal institutions refer to international borders, while on a subnational level formal institutions make up the different provinces within a country. Even though the policies within a country are mostly developed on a national level, the implementation is executed on a local level (Meyer & Nguyen, 2005). The enforcement of formal institutions is executed by third parties, such as a court or another enforcement agency (Dyer & Singh, 1998; Pejovich, 1999).

Evidence points to the direct relevance of these institutions for the economic performance in a region. Legal institutions, for instance, have been found to be responsible for between country variations in financial development (La Porta et al., 1997).

The extant institutional literature on formal institutions has predominantly focused on the effect of formal institutions when firms internationalize (Beugelsdijk & Mudambi, 2013). Formal institutions can be used to stimulate internationalization in the form of the provision of government support for firms looking to internationalize. This home country government support enhances the organizational capability of firms, facilitating easier entrance into foreign markets (Lu et al., 2014). The same effect can be found for host country institutions, where the quality of formal institutions within the country and the amount of foreign direct investment into the country seem to be directly related (Pournarakis & Varsakelis, 2004). Local governments also have the ability to alter institutions to create favorable conditions for foreign firms in order to positively affect the ease with which a firm internationalizes into their region (Lu et al., 2014). Furthermore, research suggests that stronger formal institutions result in an increase of venture capital investment (Li & Zahra, 2012).

However, stronger formal institutions in the home country do not always positively impact internationalization performance for a firm. A conflicting perspective argues that weaker formal institutions in the home country of the firm can actually be beneficial for a firm when crossing into a different region. The reasoning being that weaker formal institutions push the firm to adopt more agile competencies. For instance, the quality of business regulations in home countries has been identified as having a negative impact on the internationalization - performance relationship, with higher quality of business regulations being detrimental for firm performance (Marano et al., 2016). The explanation for finding is that a lower quality of business regulations forces firms to acquire coping mechanisms with regards to uncertainty. These coping mechanisms can then be utilized in foreign markets,

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countries (Holburn & Zelner, 2010; Marano et al., 2016), with higher uncertainty in political environments stimulating flexibility within a firm that can be utilized in different markets.

Informal institutions

The counterpart of formal institutions are informal institutions. To reiterate, informal institutions refer to “traditions, customs, ideologies, and templates that have never been consciously designed but are still in everyone’s best interest to keep” (Tonoyan et al., 2010, p. 805). Informal institutions are generally not codified and are enforced outside of the official channels (Estrin & Prevezer, 2010). Examples of the enforcement of informal rules can include expulsion from the community or a loss of reputation (Pejovich, 1999). Illustrating the importance of informal institutions, Estrin and Prevezer (2010, p.43) claim that if informal institutions are not accounted for “one risks ignoring many of the real incentives and constraints that underlie the functioning of firms in emerging economies”. Several of the arguments presented later on will be built around the idea that institutions can be seen as a consequence of culture (Hofstede, 2001).

Previous findings have found evidence that within-country ethnic diversity, one aspect of informal institutions, can negatively influence long-term economic development of a country (Robinson, 2014). Furthermore, corruption networks based upon informal institutions, such as the mafia, can result in negative societal effects (Dauner et al., 2012). A firm dependent variable which determines the impact of regional institutions is how well a firm is integrated into the subnational network (Mcevily and Zaheer, 1999). This connectedness within the local network is an important source of variation in the acquisition of competitive capabilities for firms (Mcevily and Zaheer, 1999; Andersson et al., 2001). In other words, when firms are more closely related to the informal institutions which are present in a subnational region, this will positively affect the firm’s ability to acquire capabilities from external sources.

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9 Interaction between formal and informal institutions

Distinct differences exist between the two types of institutions and the exact importance of each institution is context dependent. While formal institutions can be changed over the course of a night, informal institutions are less adaptable and require a longer period of time to change (Helmke & Levitsky, 2004). In the past, most of the research has predominantly focused on formal institutions - in the form of administrative areas - as opposed to informal institutions, partly because of the ease with which data can be collected about formal institutions (Beugelsdijk & Mudambi, 2013). Firms can encounter the same challenge when trying to analyze the relevant institutions in a region. Information about formal institutions can be easily collected and analyzed by firms because it is predominantly codified, while this is significantly harder to do for the tacit knowledge making up informal institutions (Meyer & Nguyen, 2005). Due to increasing interconnectedness and complexity in the world, firms are more frequently crossing institutional borders, resulting in an increased relevance to analyze the effects of changing informal institutions. Some economists now even go as far as

describing informal institutions as more important than formal institutions (Dauner et al., 2012). However, to truly understand the interaction between the two different types of institutions, it is important to see the two institutions as complementary, rather than separate entities (Bratton, 2007). Williamson (2009) examined the fit between the two different institutions and indicated the

importance of formal institutions which are imbedded into informal institutions in order to achieve higher economic development. Similar to the relation between the national and subnational level, analyzing the formal institutions in a region would not be sufficient if informal institutions are not taken into account (Helmke & Levitsky, 2004; Estrin & Prevezer, 2010). While formal institutions dictate which rules have to be obeyed, informal institutions create or strengthen the incentives whether to comply with those rules (Helmke & Levitsky, 2004). Previous literature has found evidence that the two different institutions grow in importance depending on the presence or absence of its counterpart. Sheng et al. (2011) found that business and political ties grow in importance with regards to their effect on firm performance when the government is unable to adequately provide legal enforcement. In other words, informal institutions take a more dominant role in the absence of formal institutions and vice versa. Furthermore, the impact of institutions differs strongly due to the highly localized

processes that develop them (Makino et al., 2004) and there is reason to believe that identifying and transferring institutions between regions is very hard to achieve (Williamson, 2009). Due to this difficulty in achieving institutional change, firms should be aware what institutional environment they are entering when expanding, since the environment is difficult to change.

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Hypotheses building

As indicated before, extant literature on internationalization has not found a conclusive answer whether internationalizing is actually beneficial for a firm. Following Marano et al. (2016), we argue that these inconsistencies are partly due to the neglection of a firms’ home country formal and

informal institutions when analyzing the consequences of internationalization. In the upcoming section we will apply the institutional view on both an international as well as a subnational level in order to build our hypotheses.

Internationalization

Crossing into a different country inherently brings uncertainty for a firm, due to the difficulty that firms have in assessing the risk of operating in a host country (Voss et al., 2010). Building on this, the expectation is that firms who internationalize will mostly focus on the beneficial institutions in place, while being unable to correctly identify the risks that crossing the border will bring (Meyer & Nguyen, 2005). This can lead to an overestimation of the attractiveness of the market compared to the real situation, leading to the making of decisions which are ultimately not in the best interest for the firm. In addition to this, countries have the ability to erect barriers in order to prevent firms from investing outside the country. The domestic environment in China, for instance, is perceived as being a barrier to outbound investment, creating an additional barrier for firms trying to internationalize (Voss et al., 2010). Moreover, firms do not always internationalize after they have saturated their domestic market (Boisot & Meyer, 2008). In the case of unfavorable domestic conditions, firms can actually be forced to internationalize in order to escape their domestic market (Bell et al., 2003). In this scenario, firms trying to pursuit profits will be forced to internationalize in a reactive manner, rather than from proactively executing a strategy. Since the firm is not internationalizing on its own terms, we expect this will negatively affect firm performance. Combining the effects of these arguments, it is therefore expected:

Hypothesis 1: The crossing of an international border negatively impacts the performance of a firm. Further dissecting the effects of internationalization, a distinction will be made between the two types of institutions when internationalizing. First, we will outline the expected effects when a firm crosses into a country which has different informal institutions.

Firms crossing into a region with different informal institutions inevitably forces their employees from the recently entered region to work together with employees from the cultural region where the firm is based. According to the cultural fit model (Cartwright & Cooper, 1993), the degree of cultural

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process. The proposed logic is that acquired firms develop a new, third culture together with their new owner. However, this can cause friction due to the new owner striving to maintain its own culture, resulting in integration problems. Removing this friction would require the investment of firm

resources in order to facilitate the integration, negatively affecting firm performance. This effect is not dependent on the development of the formal institutions in a region. Even when an economy has developed sufficiently to mostly rely on formal rules, informal institutions still play an important influence for economic performance (Raiser, 1997). Therefore, we expect this effect to be present in all cases when a firm crosses into a different informal institution, even in countries with strongly developed formal institutions.

Furthermore, when a firm crosses into different informal institutions when internationalizing, this inherently means that formal institutions are crossed in the form of the international border. These formal institutions are rooted heavily in national culture (Hillman & Hitt, 1999), with the national culture providing a foundation on which the formal institutions are based (Holmes Jr. et al., 2013; Raiser, 1997). This indicates that the development of formal institutions are ingrained to the informal institutions which are present. Therefore, when a firm crosses into different informal institutions when internationalizing, the formal institutions in that country are likely to differ significantly from the formal institutions which the firm was used to. As a result, this means that not only does the firm have to adapt to the cultural changes in the new country, the firm also has to adapt to the different buildup of the formal institutions. Therefore, it is expected:

Hypothesis 2: The crossing of an international border while crossing into different informal institutions negatively impacts the performance of a firm.

Next, we will look at crossing into a different country without changing informal institutions. Even though the informal institutions might stay unchanged when crossing an international border, the exact importance given to the institutions in different countries changes when a formal institutions is

crossed. This difference in importance of the informal and formal institutions between different countries can pose a challenge for MNE’s, since they have to decide whether to adapt their global strategy to the variation in institutions between their home- and host country or implement their global strategy without adaptations to the institutions present (Wright et al., 2005). This creates a trade-off where they can choose to either maintain global consistency with regards to their strategy, or adapt to local demands (Kostova & Zaheer, 1999). According to Wright et al. (2005), it might be worthwhile for MNE’s to develop a separate approach for markets in which there is an increased importance given to informal institutions. However, we expect that such an adaptation would require the investment of resources that will hurt the overall performance of a firm. Thus:

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12 Subnational borders

Zooming in, existing literature will be used in order to determine what the expected effects are of informal and formal institutions on a subnational level.

Due to the ambiguity of laws developed on the national level, local authorities have flexibility with regards to the interpretation of national laws (Meyer & Nguyen, 2005). Extant research has

demonstrated that by creating preferential policies, subnational regions can influence their

attractiveness for foreign direct investment (Zhou et al., 2001; Chung & Alcácar, 2002). According to Meyer and Nguyen (2005), this is due to businesses being more inclined to locate themselves where they can expect the least interference in their operations from the government. By exercising less control through the regulatory institutions, local governments can increase their appeal for inward foreign direct investment (Holmes Jr. et al., 2013). This can be applied more specifically as well, through the creation of incentives for certain industries, allowing subnational regions to target specific industries (He, 2003). This allows firms to select subnational regions that offer the most attractive environment for them, providing an opportunity to make better use of their firm specific advantages (Ma et al., 2013). As a result of these effects, the expectation is that firms choose to settle in regions which have policies that will beneficially impact their performance. Therefore:

Hypothesis 4: The crossing into different formal institutions without crossing into different informal institutions on a subnational level positively affects the performance of a firm.

As indicated, firms can have difficulty recognizing the differences between informal institutions (Meyer & Nguyen, 2005). Therefore, the underlying assumption for this study is that firms are

generally unable to identify the differences between these informal institutions. This can lead to a firm crossing into different informal institutions without themselves being aware of having done so. When the firm is not aware that a border has been crossed into different informal institutions, this can cause friction. As indicated before, firm performance is dependent on a high level of integration to the subnational region it operates (Ma et al.,2013). The lack of knowledge about a subnational regions informal institutions would hurt a firm’s ability to successfully integrate into the subnational region and therefore negatively affect firm performance.

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Hypothesis 5: The crossing into different informal institutions without crossing into different formal institutions on a subnational level negatively impacts the performance of a firm.

Methods

Sample

We used the Thomson Reuters SDC Platinum database to build a sample of Chinese mergers and acquisitions. We refine it to include all deals announced between Jan, 1990 and June, 2015, by stock listed / public acquirers, for 100% of the target, and with a transaction value above US$ 10 million. We only include deals that do not involve a repurchase of own shares, recapitalization, or a spin-off to existing shareholders, and we only include deals that involve Chinese acquirers and Chinese targets, which we identify to include firms from Mainland China, Hong Kong, Macau and Taiwan. Doing so lead to the creation of a sample of 1,805 mergers and acquisitions.

Motivation for country selection

The decision to select China as a nation of choice was mainly based on the distinct subnational regions present in the country. Where subnational regions in developed countries tend to converge with poorer regions displaying higher growth (Barro & Sala-i-Martin, 1992), emerging economies, such as China , see the gap between its subnational regions gap widen (Williamson, 1965; Ma et al., 2013). This can partly be explained by the incentives of governments of developed countries to spread equality by promoting less developed regions (Porter, 1996). Even though China has started to invest more in its poorly developed regions, a large divide still exists between its subnational regions (Taube & Ögütçü, 2002, Ma et al., 2013). We expect that this high variance among institutions between China’s regions (Boisot & Meyer, 2008) facilitates a greater insight into the exact consequences of crossing into a different institution.

Geographic variables

We identify the geographic location of the target and the acquiring firm using information retrieved from the SDC. Then, we create a number of cross-border indicators. These include:

1. International cross border dummy: Our sample includes a number of borders which are

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2. Institutional cross border dummy: China consists of 34 provincial-level administrative

divisions (see Figure 1), including: 23 provinces, five autonomous regions, four centrally administered municipalities, and two special administrative regions. We create a dummy variable, which we set equal to 1, if a deal crosses such an institutional border.

3. Cultural cross border dummy: We follow Wu (1996), who identifies eight subcultural regions

in China (see Figure 2), based on a climate, topography, geography, and political and economic ideological features. These include: (1) Inner Mongolia Culture Region (R1); (2) Xinjiang Culture Region (R2); (3) Tibetan Culture Region(R3); (4) Central Plains Culture Region (R4); (5) Northeast Culture Region (R5); (6) Yangtze Culture region (R6); (7) Southwest Culture Region (R7); (8)

Southeast Culture Region (R8). We create a dummy variable, which we set equal to 1, if a deal crosses a subcultural regional border.

In 1,671 cases we were able to identify the geographic features of the target and the acquiring firms, and we were able to program the appropriate geographic indicator variables.

Firm performance

We use an event study, and calculate cumulative abnormal return to the acquirer, using a market-adjusted model, to measure expected deal performance (Brown & Warner, 1985).

An event study is a tool used for assessing the way in which an event − such as an acquisition − causes the market to update the firm’s value (Brown & Warner, 1985). It has been used in a variety of

disciplines (Lubatkin & Shrieves, 1986; McWilliams & Siegel, 1997; MacKinley, 1997; Peterson, 1989; Binder, 1998; Kothari & Warner, 2007), including strategic management. In an event study, a pre-event ‘estimation window’ is defined, and historical data is used to forecast the firms ‘normal’ stock price at a future date. This is an expectation of how the firm’s stock should have been priced, had the event not occurred. Comparing this ‘forecast’ with ‘actual’ data on the firm’s stock price, after Figure 1 - Map of China’s provincial-level administrative

regions

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the event, provides an indicator of the firms ‘abnormal’ return. This is the change in the firm’s value, above or below the firm’s expected value, which is attributable to the event. Summing the abnormal returns to an event over a period of time, known as an ‘event window’, leads to an expression as ‘cumulative abnormal return’ (CARs). All estimates are adjusted to the market they are listed on. The cumulative abnormal returns to the acquiring firm are established with the following procedure. Firstly, we make use of a 30 day estimation window, in the period of -60 days to -30 days before the acquisitions themselves on day 0. Then, we estimate cumulative abnormal returns to the acquiring firm in the period of one day before the announcement, to include information leakages (Asquith, 1983), to: one day after (CAR1), and for robustness checking, to five days, or one week after the deal (CAR5). We were able to estimate CARs for 910 mergers and acquisitions in the sample, listed on the Shanghai Stock Exchange (n=208); Shenzhen Stock Exchange (n=382); DAX 30 Stock Exchange (n=2); FTSE World Stock Exchange (n=3), Hang Seng Stock Exchange (n=181), Straits Times Stock Exchange (n=7); S&P Composite Stock Exchange (n=47); Taiwan Stock Exchange (n=79), and TOPIX Stock Exchange (n=1). We retrieved the necessary data from DataStream. In 464 cases, the firm’s stock market identification number was missing, in 9 cases the data was incomplete, and 163 cases there were multiple acquisitions within a three month period, making it difficult to attribute a particular effect to a particular event. We winsorized each of the resultant CARs, between 0.01% and 99.99%, to reduce the effect of possibly spurious outliers.

Control variables

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acquiring firm managers to learn the business of the target firm; (6) Deal attitude – which we identify with a dummy variable set to 1 if the deal is hostile or unsolicited – because it is suggested that hostility impacts performance (Eckbo, 2009); (7) Method of payment – which is the ratio of cash to equity when the deal is financed – because cash-financed deals outperform stock-financed deals (Heron & Lie, 2002).

We collect data on prior performance, market-to-book ratio and relative size from Datastream, and collect data on the deal controls and the targets status from the Thomson Reuters SDC Database. We winsorized all control variables between 0.1% and 99.9%, and use the logs of any variables that fail the Shapiro-Wilk normality test in order to exclude outliers.

Type of data analysis

We estimate the impact of the various borders described above on the performance of the acquisitions in our sample using an Ordinary Least Squares (OLS) regression technique. This is an appropriate measure, since the dependent variable, the CAR, is a non-count, normally distributed variable. The results from this regression will be outlined in the following section.

Results

Descriptive statistics

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Regression results

In order to analyze the results an Ordinary Least Squares regression was conducted. All the results from the regression can be found in table 2. The findings supported 3 of our 5 hypotheses, while not providing support for 2 hypotheses. Model 1 contains all the control variables with no filter applied, providing an adjusted R-squared of 0.100. Model 2, with the variable international cross border added, provides insight into hypothesis 1. Consistent with the hypothesis, the analysis found a significant negative relationship between internationalization and firm performance, F (16.82) = - 4.123, p < 0.01, meaning that internationalization has a negative impact on firm performance. In model 3 a filter was applied, filtering down the total amount of firms to only those firms which crossed into a different informal institutions. This allowed us to test hypothesis 2, where we expected a negative relationship between crossing an international border into different informal institutions and firm performance. The results supported hypothesis 2, F (9.227) = - 3.084, p <0.01. Thus, the combined crossing of an

international border and cultural border has a significant detrimental effect on firm performance. Hypothesis 3 expected a negative relationship when crossing an international border while remaining in the same informal institutions. Model 4 contains a filter narrowing down the dataset to only firms that did not cross into different informal institutions when internationalizing. The findings supported hypothesis 3, F (10.12) = -1.274, indicating that crossing an international border while remaining in the same informal institutions did not significantly impact firm performance.

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dataset to answer our hypotheses. Firms which crossed into different formal institutions within their country displayed higher firm performance, F (20,12) = 2.935, p < 0.01. Model 6 focused instead on the informal institutions. Crossing into different informal institutions within a country positively affected firm performance F(17.85) = 1.665, p < 0.1.

Narrowing down the sample to only include domestic firms who did not cross cultural borders allowed us to test hypothesis 4 with model 7. Hypothesis 4 hypothesized that in cases where firms cross into different formal institutions but remain in the same informal institutions this will positively impact firm performance. The results confirmed our hypothesis, F (10.92) = 3.140, p < 0.01. Thus, this result confirms that domestically, crossing into different formal institutions positively effect firm

performance when the informal institutions remained constant. Finally, model 8 was generated in order to test hypothesis 5, only taking into account domestic firms which remain in the same provincial region. When looking at firms which crossed informal institutions within this model, the results did not back hypothesis 5, F (7.513) = -0.915. Therefore, we could not find support for the idea that only crossing an informal institution within a country hurts the performance of a firm.

t-statistics in parenthesis, *** p < 0,01, ** p < 0,05, * p < 0,01 Table 2 – Regression results

Robustness check

Additionally, a robustness check was conducted in order to examine the robustness of the variables (see table 3). In the different models of the robustness check, we compared the firm performance from 1 day after the merger or acquisition with the firm performance 5 days afterwards in order to

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This robustness check was performed with the winsorized results (model 1 & 2), the whole dataset (model 3 & 4) and the whole dataset excluding firms which demonstrate no difference in performance (model 5 & 6). The results of these different models check confirmed that the dependent variable, firm performance, does not differ significantly in case the date on which firm performance is measured changes.

Discussion and conclusion

Academic contributions

With this research we attempted to shed light on the influence of institutions on firm performance, both on an international level as well as a subnational level. The results indicate that both formal and informal institutions can significantly affect firm performance, with formal institutions positively affecting firm performance on a subnational level and informal institutions negatively affecting firm performance on an international level. Furthermore, when institutions were not taken into account, a general negative effect was found regarding internationalization.

The results of this study emphasize the importance of institutional theory for internationalization literature, where - despite significant attention by researchers for internationalization itself -

institutional theory was largely overlooked (Marano et al., 2016). The findings provide support for the idea that institutional theory should be considered as yet another influence on the already highly t-statistics in parenthesis, *** p < 0,01, ** p < 0,05, * p < 0,01

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context-dependent internationalization-performance relationship (Bausch & Krist, 2007, Marano et al., 2016).

Due to the use of institutional theory in our research, it was possible to further divide the concept of borders into both formal and informal institutions. While most of the extant literature focused on either formal institutions or informal institutions, our research allowed for a direct comparison between the two institutions within one data set. For both the internationalization (Hypotheses 2 & 3) and

subnational hypotheses (Hypotheses 4 & 5), crossing into different informal institutions proved to be more detrimental for firm performance compared to crossing into different formal institutions. We expect these effects to result from the difficulty firms have in identifying informal institutions (Meyer & Nguyen, 2005) and the costs required to adapt to the different culture in a region. Moving into different informal institutions requires firms to divert precious resources to successfully integrate the new culture into the company. This result is not as prevalent for formal institutions, since they are more easily identified, allowing firms to choose the most attractive formal institutional region to move into.

Likewise, the sample allowed us to analyze the different effects between international and subnational borders on firm performance. The results found a more negative effect for the hypotheses related to international borders in comparison with the same hypotheses related to domestic borders. We expect that the differences in performance between subnational and international borders can be attributed to the larger discontinuities that an international border brings compared to an subnational border. Similarly, we expect that the lack of significance found for hypothesis 3 and 5 originates partly from different border effects cancelling each other out. In hypothesis 3, for instance, even though crossing into different formal institutions would normally positively affect performance, this can be nullified by the negative consequences of crossing an international border. However, as will be elaborated upon in the limitations, future research will have to provide a more definitive answer to explain what exact mechanisms cause these differences.

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The results from this study emphasize the importance of borders for firms. Managers should be aware that the discontinuities which are associated with crossing a border influence firm performance. The focus on subnational borders reaffirms that international borders are not the only relevant level to analyze for firms and that subnational borders are important to consider when expanding a company. The negative consequences of internationalization identified can make companies more aware of the risks associated with internationalizing. This could offer an additional incentive for firms to first try and expand their business as much as possible in a domestic setting, before attempting to

internationalize and suffer the negative consequences of doing so.

Furthermore, this study emphasizes the importance of both informal and formal institutions when expanding into another region. Perhaps the finding most important for managers is the influence of informal institutions. Due to the difficulty that firms have in identifying these borders (Meyer & Nguyen, 2005), firms can overlook and neglect to adapt to informal institutions. The negative firm performance associated with these borders emphasizes why firms should attempt to spend more attention to the identifying and crossing of such a border in order to prevent accidently crossing into a different cultural region.

In addition to this, our research indicates that crossing a border can actually have positive

consequences. To be more specific, it can actually be beneficial for a firm to cross into a different subnational region in a domestic setting if the only border that is crossed is one from a formal institution. By analyzing the formal institutions of different subnational regions, firms can handpick the region with the most beneficial policies in place, resulting in a positive effect on firm performance. Therefore, firms should not consider provincial borders within a country as a barrier if the political environment in the other province is beneficial. Ideally, this would include crossing into a different province without chancing informal institutions to prevent the detrimental effect that a different culture can have on firm performance.

Limitations and future research

Several limitations must be taken into account when interpreting the findings. In this article we did not use the actual differences between institutions when establishing the effect of institutions on

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The decision to collect our data in China was based partly on the large subnational differences which exist between its regions. Therfore, country specific characteristics between countries must be taken into account when generalizing the findings. In other countries which are more homogeneous in culture, such as Finland, Norway and Sweden (Kaasa, Vadi & Varblane, 2014), institutions would likely not have such an significant effect on a subnational level. The findings of this research might therefore prove more relevant for emerging economies , which are characterized by their high diversity in terms of subnational regions (Ma et al., 2013). Furthermore, Chinese firms tend to internationalize relatively early compared to other countries due to the unfavorable domestic environment (Boisot & Meyer, 2008). This can push firms to internationalize while they might not be ready to do so, possibly generating more negative results with regards to the internationalization hypotheses compared to other countries.

Another limitation of this study is related to the data collection. For the purposes of this article an event study was used to assess firm performance. Even though event studies are the most used tool in merger and acquisition literature to assess firm performance (Zollo & Meijer, 2008), it has its

imperfections. Rather than measuring actual firm performance, it measures the expected performance that the market think the firm will have based on previous experiences(Surowiecki, 2004). This might conflict with our posed argument that the general public is relatively unfamiliar with the effect and locations of informal institutions. In order to assess whether the market is vulnerable to unfamiliarity with informal institutions, future research could make use of an estimation window, where the actual firm performance is tracked over a longer period of time. Using an estimation window would however require the implementation of a significant amount of control variables to remove outside interference with the performance, which could prove hard to achieve.

In addition to this, future research may focus on the increasing interconnectedness of the world and its influence on institutions. The effects of globalization will be interesting to analyze in relation with the discontinuities which originate from international borders. Even though some authors claim that the importance of international borders as institutions will remain constant in spite of increasing globalization (Paasi, 2009; Beugelsdijk & Mudambi, 2013), others emphasize that for firms the increasing flow of information between countries facilitates easier internationalization (Ohmae, 1987). As mentioned, we found that international borders create a larger barrier for firms in terms of firm performance compared to subnational borders. In case globalization diminishes the difference between these two types of borders, this could mean that in the future crossing an international border would more closely resemble crossing a subnational border and be less detrimental for firm performance. Further research can provide an answer to the extent of this effect by comparing mergers and acquisitions from twenty years ago with mergers and acquisitions of today.

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better insight into the exact consequences of crossing borders, future research could pay more detailed attention to a selection of companies and attempt to identify what happens when a border is crossed by using a qualitative research approach. Even though our arguments are based on previous literature, such research can provide additional explanations that have not yet been uncovered. For informal institutions in particular, qualitative research into the effect of institutions can provide an explanation to what strengthens or diminishes the negative effects of informal institutions on firms, providing valuable insight for firms themselves what to expect when a border is crossed.

Conclusion

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How do borders differ? An institutional view on the effects of international and subnational borders.