Picking cherries or lemons: A unified theory of cross‐border mergers and acquisitions

• Date: 01 February 2018
• DOI: http://doi.org/10.1111/twec.12500
• Published date: 01 February 2018
• Author: Tuan Anh Luong

INVITED REVIEW

Picking cherries or lemons: A unified theory of

cross-border mergers and acquisitions

Tuan Anh Luong

Faculty of Business and Law the Gateway, De Montfort University, Leicester, UK

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INTRODUCTION

Foreign direct investment (FDI) is an important driver of economic growth, especially in develop-

ing countries. Understanding of the components that enhance or impede FDI flows is important,

and is still evolving. Geography and national characteristics have often been referred to as the

determinants of FDI flows. On the one hand, the trade-off between proximity (i.e. setting up a

plant close to the market) and concentration (i.e. producing everything in one place to take

advantage of the economies of scale) could be used to explain horizontal FDI when firms con-

template having similar businesses abroad. In particular, FDI is more prominent in remote and

large markets (Brainard, 1997; Markusen & Venables, 1998). On the other hand, if we assume

away transport costs and tariffs (which practically rule out the proximity incentive), factor endow -

ment differences lead to vertical FDI when firms contemplate adding additional businesses abroad

(Helpman, 1984). Recently with the development of new theories, and the availability of new

micro data, firm heterogeneity has been widely accepted as another important feature in an inter-

national economic model (Melitz & Redding, 2015). This feature thus opens a whole new dim en-

sion of FDI determinants. For example, not every firm decides to invest abroad. In fact, the

literature suggests that only the most productive firms engage in FDI (Helpman, Melitz, &

Yeaple, 2004).

This article investigates the role of firm heterogeneity in understanding the motives of mergers

and acquisitions (M&A), activities that are considered to be one of the most important components

of FDI (greater detail is offered in the following section). The motives for M&A activities are dif-

ferent and they are all important (Bower, 2001). Mergers can attempt to create market power by

forming monopolies or oligopolies (e.g. Gowrisankaran, 1999; Kamien & Zang, 1990). Mergers

may generate opportunities for diversification and may reduce cost or demand uncertainty (e.g.

Zhou, 2008). Mergers have also been shown to provide market discipline, for example, if they

change inefficient management at the target firm; or to counteract market discipline, for example,

if they allow the management of the firm in the acquiring role to over-expand (Andrade, Mitchell,

& Stafford, 2001). Moreover, when the contractual relationship between two parties is too complex

(to the extent that a contract cannot encompass all possibilities), an integration is preferred to out-

sourcing (Antras, 2003).

DOI: 10.1111/twec.12500

World Econ. 2018;41:653–666. wileyonlinelibrary.com/journal/twec ©2017 John Wiley & Sons Ltd

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