Academic journal article Management International Review

The Impact of Cultural Distance on Bilateral Arm's Length Exports: An International Business Perspective

Academic journal article Management International Review

The Impact of Cultural Distance on Bilateral Arm's Length Exports: An International Business Perspective

Article excerpt

Abstract:

* Prior studies have argued and regularly found that cultural distance is negatively related to bilateral export flows, which are the sum of arm's length and intra-firm exports. However, these macro-level studies overlook the firm-level insights that arm's length exports are a substitute for arm's length affiliate sales, and that firms' choices between these substitutes are influenced by cultural distance.

* Moreover, intra-firm exports are a complement to arm's length affiliate sales and hence likely to respond in the same way to cultural distance as such sales. The inclusion of intra-firm exports in export flows has thus obscured the effect of cultural distance on aggregate arm's length exports.

* We overcome these conceptual and methodological deficiencies by examining how cultural distance influences aggregate arm's length exports, while simultaneously considering its impact on aggregate arm's length affiliate sales. Drawing on several strands of firm-level international business (IB) research, we argue that while arm's length affiliate sales are likely to decline with cultural distance, this is not necessarily the case with arm's length exports, which may in fact increase with cultural distance.

* Analyzing a panel dataset of US foreign affiliate sales and US exports to unaffiliated parties, we find that cultural distance negatively affects arm's length affiliate sales but positively affects arm's length exports. Our study thus shows that the explicit consideration of firm-level entry mode choices helps us better understand and explain macro-level IB activity.

Keywords: Cultural distance * Arm's length exports * Arm's length affiliate sales * Entry mode choice * Liability of foreignness * Benefits of foreignness

Introduction

The hundredfold increase in world merchandise exports since the early 1950s (WTO 2005) has prompted both international business (IB) scholars and international economists to explore the determinants of bilateral merchandise exports and bilateral merchandise trade, the sum of bilateral exports and imports (e.g., Clougherty and Grajek 2008; Dow and Karunaratna 2006; Frankel and Rose 2002). Using gravity models, these scholars have found that bilateral export and trade volumes increase with the economic size and development level of the trading nations, and decrease with formal trade barriers and geographic distance. Beckerman (1956) was the first to suggest that bilateral exports may not only decrease with geographic but also with cultural or psychic distance, as trading partners from culturally more distant countries are generally less familiar with one another. Many subsequent studies have empirically tested this prediction by relating bilateral export or trade flows to various proxies for cultural differences, such as the Hofstede-based Kogut and Singh index (Dow and Karunaratna 2006), bilateral trust levels (Guiso et al. 2009) and differences in dominant religions and languages (Anderson and Marcouiller 2002; Dow and Karunaratna 2006; Frankel and Rose 2002; Srivastava and Green 1986).

However, all these macro-level studies of the impact of cultural distance on bilateral exports do not take into account two key firm-level insights. First, exports to unaffiliated customers (henceforth arm's length exports), comprising the bulk of exports, are a substitute for foreign affiliate sales to such customers (Buckley and Casson 1981; Root 1998; Brainard 1997; Hennart and Park 1994). (1) Second, firms' choices between these substitute types of arm's length sales are influenced by the cultural distance to the target market (Anderson and Gatignon 1986; Hill et al. 1990). Firms select the optimal mode of serving unaffiliated foreign customers by considering how the costs and benefits associated with each mode vary with cultural distance (Albaum et al. 2005; Root 1998).

These firm-level theoretical insights imply that prior studies of the relationship between cultural distance and bilateral trade flows have used the wrong dependent variable. …

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