Legal Systems, Information Asymmetry, and Firm Boundaries: Cross-Border Choices to Diversify through Mergers, Joint Ventures, or Strategic Alliances

Abstract

We examine how the organizational structure for diversification decisions involving firms from different countries is affected by the institutional context of the target country. Our theoretical analysis suggests that as legal systems improve and information asymmetry is reduced, a transition from relational, firm-like arrangements to arms-length, market-like arrangements takes place. If institutions continue to improve, eventually a threshold is crossed after which arms-length deals edge out internal firm contracting. We provide an empirical test of the model using the sample of international strategic alliances, joint ventures and cross-border mergers involving US firms. Our empirical findings support the predictions of the theory. In addition, we document that US companies entering organizational structures predicted by our model are associated with greater abnormal returns around deal announcements.