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International corporate governance spillovers: Evidence from cross-border mergers and acquisitions

Previous research has shown that the corporate governance practices of firms are constrained by the legal standards of their country of incorporation. This column explores how an active international market for corporate control can substitute for weak institutions in a host country. Using firm-level data from 22 countries, it shows how cross-border M&A activity improves the governance of non-target firms in the same industry, via peer pressure. These findings provide evidence for corporate governance improvements as a novel positive spillover from FDI.

In recent years, firms worldwide have adopted more shareholder-friendly corporate governance practices. What are the main drivers behind the convergence of corporate governance around the world? Gilson (2001) identifies three possible modes:

  • Functional convergence, when firms respond to market pressure, namely, demands by investors;
  • Formal convergence, when such change comes about from new laws that forces the adoption of best governance practices; and
  • Contractual convergence, when firms commit themselves to better governance regimes, for example by cross-listing in the US (Doidge et al. 2004).1

In a recent study, we provide evidence of the economic significance of functional convergence via peer pressure from cross-border M&As (Albuquerque et al. 2015). This functional convergence is an important complement to formal governance changes – which occur infrequently and sometimes are not fully implemented (Khanna et al. 2006) – and to contractual convergence through cross-listings, which have declined in the last decade (Doidge et al. 2013).

According to our study, cross-border M&As produce corporate governance spillovers on non-target firms that operate in the same country and industry as the target firm. One example of a cross-border M&A with governance spillovers is the 2007 acquisition of the truck manufacturer Nissan Diesel (a Japanese firm) by Volvo AB (a Swedish firm). Volvo previously held a 19% stake in Nissan and achieved full control after the acquisition. The Volvo/Nissan Diesel cross-border deal (as well as the Renault/Nissan Motors alliance in the same industry) has been credited as a catalyst for corporate governance changes in the Japanese auto industry (The Economist 2007). In our sample, Nissan’s local peers’ average corporate governance index improved from 2006 to 2008.

Our study uses firm-level data on corporate governance from 22 developed countries, excluding the US, over the period 2004-2008. Following Aggarwal et al. (2011), we measure corporate governance using an index that captures the percentage of 41 attributes on which the firm meets the minimum acceptable requirements (in terms of board, audit, anti-takeover provisions, and compensation and ownership) as defined by a leading proxy advisor firm, RiskMetrics/Institutional Shareholder Services (ISS). Our main explanatory variable is the entry of foreign firms into an industry through cross-border M&As. We measure the value of all cross-border M&As in the target firm’s industry (at the two-digit SIC level) as a fraction of the industry’s market capitalisation in each country and year. While Aggarwal et al. (2011) study own-firm governance changes following cross-border portfolio investment flows, we study the spillover effects of foreign direct investment (FDI). Because foreign investors assume control of the target firm, they are more likely to enact governance changes in the target firm than foreign portfolio investors, and these changes have spillovers to the local economy.

Figure 1. Cross-border M&A and governance improvements

On average, increases in cross-border M&A account for 15% of the annual increase in governance, mostly in the compensation and ownership component. 

When the acquirer comes from a country with better investor protection, the estimated effects are almost three times larger.

Note: The top panel shows the estimated increase in a given governance index associated with a one standard deviation increase in cross-border M&A activity, as a percentage of the index's annual average change. The bottom chart shows the estimated increase in a given governance index associated with a one standard deviation increase in cross-border M&A activity originating in countries with better investor protection that the recipient country, as a percentage of the index's annual average change. Solid bars mean the estimated effect is significant at least at the 10% level.

We find that cross-border M&As produce significant positive governance spillovers within the target firm’s industry (Figure 1). The governance spillovers seem to affect mainly internal governance mechanisms (i.e. board structure and executive compensation) rather than external governance mechanisms (i.e. audit and anti-takeover provisions). The effect is most pronounced when the acquirer firm comes from a country with a better legal environment than the target firm’s country and when the target firm faces tougher product market competition. Interestingly, the effect of cross-border M&As on governance alone persists even after including these interaction terms, indicating the presence of other spillover channels from FDI.

The effect is also economically significant – a one-standard deviation change in cross-border M&A from a country with stronger investor protection and into a perfectly competitive industry results in a 5% improvement in the governance index, which corresponds roughly to satisfying an additional two out of the 41 governance provisions. We show that these effects remain significant after controlling for covariates such as firm size, growth opportunities, leverage, tangibility, and ownership structure. Furthermore, the results are unchanged after the inclusion of firm fixed-effects, suggesting that time-invariant unobserved firm characteristics cannot explain our findings.

To validate our approach further, we use instrumental variables estimators to address omitted variables and reverse causality issues. For this effect, we use domestic M&A activity in the US – unlikely to be directly correlated with governance changes elsewhere – as a source of exogenous variation in cross-border M&A activity in a given industry and country. We also use import penetration and the US Treasury bill rate as instruments. The instrumental variable estimates suggest a causal effect from cross-border M&A to non-target firm corporate governance improvements.

The FDI-induced corporate governance spillovers produce real effects. We find firm-level evidence that cross-border M&A activity in an industry is associated with higher market valuation of non-target firms. This finding is consistent with the industry-level evidence in Bris et al. (2008). We also find important effects on the investment rate of non-target firms in the same industry following cross-border M&As. Non-target firms appear to react to cross-border deals in their industry by reducing their investment rate. In line with our hypotheses, the positive valuation and negative investment effects are more pronounced when the acquirer comes from a country with better investor protection than the that of the target, and when the industry is more competitive.

We develop a simple model to help our understanding of the mechanism of a general spillover phenomenon that acts through the product market. When corporate governance is low, managers may derive private benefits and engage in ‘empire building’ via overinvestment and overproduction (Shleifer and Wolfenzon 2002, Albuquerque and Wang 2008). If a firm is the target of a cross-border M&A and the acquirer firm imposes a higher level of governance, then that firm engages in less overinvestment and this releases demand for its competitors. In an industry where there is imperfect competition, the reduction in overinvestment by the target firm increases economic rents to its competitors.  This makes formal incentive pay a more attractive form of compensation and private benefits a less attractive form of compensation. The M&A therefore acts as a coordinating device for all other firms to also improve governance, reduce overinvestment, and reduces private benefits. 

The positive spillover to the governance of the target’s local rival firms following a cross-border M&A by a high-governance acquirer firm should be more pronounced in more competitive industries. This is because of decreasing marginal returns of governance in curtailing private benefits. Consider an industry with high product market competition, where economic rents are small and relatively more of total compensation to managers is in the form of private benefits. In this industry, the optimal level of governance is low. After an M&A that improves governance at the target firm, the governance improvements at non-target firms are especially productive in curtailing private benefits, since these firms are starting from a low level of governance. 

Concluding remarks

Our work sheds light on the mechanisms through which FDI can generate positive spillovers. FDI can be a source of valuable technology transfer and expertise transfer because it promotes linkages with host country firms, which can generate improvements in productivity. Since firm-level productivity gains are often conducive to higher economic growth and larger tax revenues in the future, many governments have actively sought to attract FDI with investment-friendly policies, including tax breaks and subsidies (UNCTAD 2015). However, the evidence on positive productivity spillovers associated with FDI is mixed and the mechanisms that facilitate those spillovers are not well understood.2  In our study, we propose a new mechanism – corporate governance improvements – through which FDI can have positive spillovers on firm profitability and productivity.


Aggarwal, R, I Erel, M Ferreira and P Matos (2011) “Does governance travel around the world? Evidence from institutional investors”, Journal of Financial Economics, 100: 154-181.

Aitken, B and A Harrison (1999) “Do domestic firms benefit from direct foreign investment? Evidence from Venezuela”, American Economic Review, 89: 605-618.

Albuquerque, R, L Brandao-Marques, M A Ferreira and P Matos (2015) “International corporate governance spillovers: Evidence from cross-border mergers and acquisitions”, CEPR Discussion Paper No. 10917.

Albuquerque, R and N Wang (2008) “Agency conflicts, investment, and asset pricing”, Journal of Finance, 63: 1-40.

Bris, A, N Brisley and C Cabolis (2008) “Adopting better corporate governance: Evidence from cross-border mergers”, Journal of Corporate Finance, 14: 224-240.

Doidge, C, G A Karolyi and R Stulz (2004) “Why are foreign firms listed in the US worth more?”, Journal of Financial Economics, 71: 205-238.

Doidge, C, G A Karolyi and R Stulz (2007) “Why do countries matter so much for corporate governance?”, Journal of Financial Economics, 86: 1-39.

Doidge, C, G A Karolyi and R Stulz (2013) “The US left behind? Financial globalisation and the rise of IPOs outside the US”, Journal of Financial Economics, 110: 546-573.

Gilson, R (2001) “Globalizing corporate governance: Convergence of form or function”, American Journal of Comparative Law, 49: 329-357.

Haddad, M and A Harrison (1993) “Are there positive spillovers from direct foreign investment? Evidence from panel data for Morocco”, Journal of Development Economics, 42(1): 51-74.

Haskel, J, S Pereira and M Slaughter (2007) “Does inward foreign direct investment boost the productivity of domestic firms?”, Review of Economics and Statistics, 89: 482-496.

Keller, W and S Yeaple (2009) “Multinational enterprises, international trade, and productivity growth: Firm-level evidence from the US”, Review of Economics and Statistics, 91: 821-831.

Khanna, T, J Kogan and K Palepu (2006) “Globalisation and similarities in corporate governance: A cross-country analysis”, Review of Economics and Statistics, 88: 69-90.

Morck, R, D Wolfenzon and B Yeung (2005) “Corporate governance, economic entrenchment, and growth”, Journal of Economic Literature, 43(3): 655-720.

Shleifer, A, and D Wolfenzon (2002) “Investor protection and equity markets”, Journal of Financial Economics, 66: 3-27.

The Economist (2007) “Message in a bottle of sauce – Japan’s corporate governance is changing, but it’s risky to rush things”, 29 November.

UNCTAD (2015) World Investment Report, United Nations Conference on Trade and Development, United Nations, New York.  


1 It is known that improvements in corporate governance can lead to profitability and productivity gains at the firm level by limiting self-dealing and rent extraction by corporate insiders (Morck et al. 2005).

2 See, for example, Haddad and Harrison (1993), Aitken and Harrison (1999), Haskel et al (2007), and Keller and Yeaple (2009).

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