Does corruption distance affect cross‐border acquisitions? Different tales from developed and emerging markets

• Published date: 01 March 2022
• Author: Chinmoy Ghosh,P. C. Narayan,R. Shyaam Prasadh,Muthuveerappan Thenmozhi
• Date: 01 March 2022
• DOI: http://doi.org/10.1111/eufm.12350

DOI: 10.1111/eufm.12350

ORIGINAL ARTICLE

Does corruption distance affect cross‐border

acquisitions? Different tales from developed

and emerging markets

Chinmoy Ghosh

1

|P. C. Narayan

2

|R. Shyaam Prasadh

3

|

Muthuveerappan Thenmozhi

3

1

Department of Finance, School of

Business, University of Connecticut,

Connecticut, USA

2

Department of Finance & Accounting,

IIM Bangalore, Bangalore, Karnataka,

India

3

Department of Management Studies,

IIT Madras, Chennai, Tamil Nadu, India

Correspondence

Chinmoy Ghosh, Department of Finance,

School of Business, University of

Connecticut, CT 06268, USA.

Email: chinmoy.ghosh@business.

uconn.edu

Abstract

Using a large sample of cross‐border deals, we find an

inverted U‐shaped relationship between corruption

distance and cross‐border acquisition (CBA) volume.

CBAs involving higher corruption distance show ne-

gative post‐acquisition performance. However, multi-

national enterprises (MNEs) with larger equity stakes

deliver superior gains. We find that the ownership

strategy varies with levels of corruption distance.

MNEs mitigate adverse selection and moral hazard

problems by acquiring targets from a related industry

and targets with a foothold. We demonstrate that CBA

activity and ownership strategy vary between devel-

oped and emerging economies and both ‘level’and

‘direction’of corruption distance are important in its

effect on CBAs.

KEYWORDS

corruption distance, cross‐border acquisitions, emerging

markets, ownership structure, post‐acquisition performance

JEL CLASSIFICATION

G34, D73, F23, L25

Eur Financ Manag. 2022;28:345–402. wileyonlinelibrary.com/journal/eufm © 2021 John Wiley & Sons Ltd.

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We thank Professor John Doukas, the Editor, an anonymous referee, Sjoerd Beugelsdijk, Yakov Amihud, Harminder

Singh, May Hu, Hao Liang and Chamu Sundaramurthy and the seminar participants at IFMA 2016, Indonesia, India

Finance Conference, 2019 and the CRISIL doctoral symposium, 2019, India, for their insightful comments. All

remaining errors are ours.

1|INTRODUCTION

Cross‐border acquisitions (CBAs) are an important strategic initiative for multinational en-

terprises (MNEs) to expand business, leverage capabilities and expertise and diversify into

markets abroad. In 2016, global CBAs reached the third‐highest deal value of $2.4 trillion since

2007, with 17,639 deals and an aggregate volume of $3.2 trillion. As such, there is considerable

interest in the flow and motivation of CBAs and their long‐run performance. Cross‐country

differences in the regulatory, normative and cognitive aspects of the acquirer and target firms

have been identified as important factors in the CBA decisions of MNEs (Ahern et al., 2015;

Aleksanyan et al., 2021; Chikhouni et al., 2017; Dow et al., 2016; Malhotra & Gaur, 2014;

Maung et al., 2020; Prasadh & Thenmozhi, 2019). In this study, we examine how corruption

distance influences MNEs' internationalization decisions. Corruption distance is the difference

in the ‘corruption perception index’(Godinez & Liu, 2015), which is an index published by

Transparency International, between the acquirer and the target countries. We specifically

focus on the relation between corruption distance and three critical aspects of CBAs: the

volume of transactions, the long‐run post‐acquisition performance and equity ownership in the

target firm. We also examine how strategic choices moderate these outcomes.

In contrast to extant studies that focus on specific characteristics of CBAs, our objective is to

analyze how corruption distance influences MNEs' entry mode strategies and the associated

long‐run synergy gains. There is a lack of consensus regarding the relation between corruption

and the critical dimensions of CBAs. Prior studies demonstrate that a higher level of corruption

in the target country leads to less foreign direct investment (FDI) (Habib & Zurawicki, 2002;

Lambsdorff, 2003; Wei, 2000b), particularly from countries with strict laws against corruption

(Cuervo‐Cazurra, 2008). This evidence is consistent with the adverse effect of high transaction

costs caused by corruption (including bribes) and indirect costs associated with operating under

information asymmetry in a corrupt country. Previously, it has been argued that to successfully

consummate CBAs, MNEs need information about target firms' operating environment and

strategic initiatives. If the cost of acquiring information in the target countries increases with

corruption (Portes & Rey, 2005), the volume and synergistic gains realized in the inter-

nationalization activity may be disrupted. However, an alternative school of thought known as

the ‘grease the wheels’hypothesis (Huntington, 1968) asserts that corruption can act as a

lubricant for transactions, particularly in emerging economies where institutional voids allow

acquirers to exploit corruption as a strategic tool to bypass complex regulations and win gov-

ernment contracts (Cheung et al., 2012). Consistent with this view, Cuervo‐Cazurra (2006)

notes that MNEs from high‐corruption economies adapt to the practices in high‐corruption

target countries by taking advantage of the new environment using their ‘skill to corrupt’.

1

The

contradictory predictions implied by the two competing theories call for further examination of

the relation between corruption distance and CBA volume.

2

Closely linked to the increasing CBA volume is the efficacy and success of international

acquisitions, which are usually measured by the long‐run performance of these deals. Mallon

and Fainshmidt (2017) invoke the ‘imprinting theory’to argue that institutional distance

between the acquirer and target countries provides ‘arbitrage opportunities’to MNEs from

1

Wu (2006) argues that MNEs from high‐corruption economies adapt quickly to local corrupt practices when compared

to counterparts that domicile in a low‐corruption economy.

2

Qian and Sandoval‐Hernandez (2016) finding of an asymmetric effect of corruption distance on entry mode choice

reflects the ambiguity in the relationship between corruption distance and CBA volume.

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GHOSH ET AL.

low‐corruption economies, enabling them to transfer their capabilities to target firms in high‐

corruption countries and thereby enhance the long‐run performance of the merged firms.

3

In

contrast, the notion of ‘liabilities of foreignness’suggests that at higher levels of institutional

distance, MNEs face greater information asymmetry costs and pushback from target man-

agement, which erode the potential synergistic gains (Shirodkar & Konara, 2017).

4,5

As such,

the relation between corruption distance and post‐acquisition performance depends on the

trade‐off between the opposing effects of arbitrage advantages versus information costs and

must await empirical analysis.

Given the costs of information asymmetry and foreignness, which deter the efficacy of

CBAs, we next focus on the mechanisms MNEs can employ to mitigate the challenges of

operating in a foreign country. Size of target ownership is a frequently used strategic me-

chanism (Meyer et al., 2009). However, the evidence that ownership strategy reduces the

challenges of operating in a foreign country is mixed. Uhlenbruck et al. (2006) show that MNEs

assume greater control of targets located in high‐corruption countries, whereas Di Guardo et al.

(2016) report a U‐shaped relationship between target country corruption and ownership stakes.

Additionally, recent research has explored how adverse selection and moral hazard problems

associated with different levels of corruption distance moderate this relationship (Malhotra &

Gaur, 2014). Specifically, at a low level of corruption distance, MNEs tend to manage con-

tractual relationships and target integration via high ownership control (Cain et al., 2011). As

corruption distance increases, greater coordination with target management through shared

ownership (partial acquisition) may be more effective to control adverse selection and moral

hazard risk (Malhotra & Gaur, 2014).

6

The integration of the competing theories implies an

inverted U‐shaped relation between corruption distance and ownership stake.

We examine a sample of 357,409 acquisitions from 69 acquirer and 160 target countries over

the period 1980–2019. Our analysis reveals an inverted U‐shaped relation between corruption

distance and CBA volume. As corruption distance increases, MNEs increase their CBA activity

to imprint their capabilities and exploit assets and growth opportunities in the target country.

However, this relationship depends on the country of origin of the merging firms and holds

only for deals involving acquirer–target pairs of firms from developed economies. At higher

levels of corruption distance, increased information asymmetry and costs associated with

corruption increase moral hazard problems, rendering it difficult to manage the acquired entity

post‐acquisition. Consequently, MNEs from developed economies (D‐MNEs) reduce their CBA

3

Gaur and Lu (2007) characterize ‘arbitrage opportunities’as a situation in which firms seek to identify better op-

portunities and certain types of advantages for exploitation in foreign economic systems and foreign environmental

conditions despite being most familiar with their own domestic institutional environment.

4

Shirodkar and Konara (2017) identify ‘arbitrage opportunities’as first‐mover advantages, research and development

advantages and complementary assets.

5

‘Foreignness’refers to the potential sources of competitive disadvantage to MNEs due to the costs associated with

learning the ‘rules of the game’(North, 1990) in new environments when the institutional distance between two

countries increases (Shirodkar & Konara, 2017).

6

Sartor and Beamish (2018) find that when there is pervasive grand corruption in the host country, MNEs prefer joint

ventures, while equity investment is more prevalent in countries with petty corruption. In brief, under conditions of

more pervasive grand corruption, we anticipate that the primary source of uncertainty will be environmental un-

certainty, while behavioural uncertainty will predominate under conditions of heightened petty corruption. As such,

the relationship between petty corruption pervasiveness and equity‐based foreign entry strategy will be grounded in

trust‐based mechanisms due to the fact that petty corruption garners more pronounced behavioural uncertainty in the

host market. Conversely, in the case of grand corruption, learning‐based mechanisms will govern because grand

corruption generates heightened environmental uncertainty.

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