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Cross-border mergers and domestic-firm wages: Integrating “spillover effects” and “bargaining effects”

Journal of International Business Studies volume 45, pages 450–470 (2014)Cite this article

Abstract

Two literatures exist concerning cross-border merger activity’s impact on domestic wages: one focusing on positive spillover effects; the other focusing on negative bargaining effects. Motivated by scarce theoretical scholarship spanning these literatures, we nest both mechanisms in a single conceptual framework. Considering the separate phenomena of inward and outward cross-border merger activity, our theoretical model generates three formal propositions: cross-border mergers can lead to wage increases via positive spillover effects; and negative bargaining effects are relatively more dominant when union market power is high, and when merging firms exhibit relatedness. Employing US firm-level panel data on wages combined with industry-level data on unionization and merger activity (covering 1989–2001), we find support for our propositions as inward and outward cross-border merger activity generate positive spillovers to wages, but are more likely to generate firm-level wage decreases when unionization rates are high and when cross-border merger activity is characterized as horizontal. Accordingly, future research on how cross-border mergers affect domestic wages should be mindful that both spillover and bargaining effects are at play, and that the degree of union market power and the relatedness of cross-border merger activity are critical in determining which effect dominates.

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Notes

  1. Works formalizing the spillover mechanism include: Wang and Blomström (1992), Fosfuri, Motta, and Rønde (2001), Glass and Saggi (2002), Grünfeld (2006), Lin and Saggi (2007), and Markusen and Trofimenko (2009).

  2. The model is largely influenced by Lommerud et al. (2006), although in contrast to that model we focus on how spillover and bargaining effects impact domestic-outsider firm wages.

  3. Other cross-border combinations of firms exist that lead to similar results. Lommerud et al. (2006) allow for two cross-border M&As and find results consistent with ours, as a second cross-border M&A in the absence of spillovers leads to even greater downward pressures on wages, but they do not model externality-based spillovers.

  4. We treat spillovers – measured by μ – as exogenous, but the externality-based spillover effects process is modeled in Fosfuri et al. (2001) and Glass and Saggi (2002). In particular, they model the interaction in the labor market between the workers and the firm after technology has been transferred via a cross-border merger.

  5. While the mechanism we focus on for negative bargaining effects to domestic-outsider firms is valid, it is not necessarily the only mechanism behind our empirical findings. In particular, a “threat effect” may also be present, as the establishment of production sites in foreign countries by domestic-insider firms may provide enhanced bargaining power for domestic-outsider firms, as they can more credibly threaten to move production abroad after these concrete actions have been taken by industry competitors (Mezetti & Dinopoulos, 1991). Yet we should underscore that such a mechanism resides outside our modeling approach.

  6. This follows straightforward from our assumptions that a>c and 0<b<1.

  7. Such a downward pressure on wages will not be present in a corresponding model with a competitive labor market with a horizontal supply curve (a constant reservation wage). Furthermore, Lommerud et al. (2005) model bargaining effects via a monopoly union setting wages (like we do here) and also via a situation where domestic-industry wages are set through bargaining. Most importantly, they find identical qualitative results when considering the impact of cross-border mergers on wages under both approaches.

  8. Any uncontrolled-for demand effects from cross-border merger activity that reside outside the error term will be captured by the inward-share and outward-share variables, thus reducing the size of the coefficient estimates for these variables meant to capture positive spillover effects.

  9. The average unionization rates for each of our 36 two-digit SIC industries are: Metal Mining 31%; Coal Mining 30%; Oil & Gas Extraction 3%; Food & Kindred Products 20%; Textile Mill Products 5%; Lumber & Wood Products 7%; Furniture & Fixtures 8%; Paper & Allied Products 31%; Printing/Publishing 8%; Chemicals 10%; Petroleum Refining 24%; Rubber Products 16%; Stone, Clay, Glass & Concrete 19%; Primary Metal 32%; Fabricated Metal 15%; Industrial & Commercial Machinery 11%; Electronic & Electrical Equipment 9%; Measuring & Analyzing Instruments 5%; Misc. Manufacturing 7%; Local & Highway Transit 35%; Motor Freight & Warehouse 20%; Water Transport 24%; Air Transport 38%; Pipelines 19%; Transport Services 7%; Communications 23%; Electric Gas & Sanitary Services 31%; Depository Institutions 1%; Non-depository Credit Institutions 1%; Hotels 10%; Personal Services 3%; Business Services 3%; Auto Repair & Parking 3%; Health Services 10%; Educational Services 35%; Social Services 7%. Accordingly, the average unionization rate for the 36 industries ranges from 1 to 38% (and the annual measures range from 0.34 to 41.0%), thus indicating plenty of variation in this measure.

  10. Data do not extend beyond 2001 due to the switch from SIC to North American Industry Classification System classification. An attempt to bridge these industry classifications found the correspondence tables to be quite imperfect at this level of analysis.

  11. Unreported empirical tests suggest that the lack of robustness for inward-based bargaining effects may be due to low value-added firms where inward-based bargaining effects (and spillover effects) appear to be minimal.

  12. In results available upon request, we engage in a theoretical exercise akin to that of Pagel and Wey (2013) where we show our theoretical propositions concerning negative bargaining effects to be robust when we layer-on additional firm heterogeneity in the form of low-cost and high-cost firms.

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Acknowledgements

We wish to thank ESMT-Berlin for institutional support, Claudia Baldermann for research assistance, and Sørgard thanks the Norwegian Research Council for financial support through the project “improving competition policy” on SNF. We greatly appreciate comments and suggestions by our editor (Ram Mudambi), Ragnhild Balsvik, Tomaso Duso, anonymous referees, and during presentations at the 2010 EARIE in Istanbul, University of Stavanger in March 2011, 2011 IIOC in Boston, 2012 AIB in DC, and the 2012 JIBS special issue conference on the “Multinational in Geographic Space”.

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Authors and Affiliations

  1. University of Illinois at Urbana-Champaign, Champaign, USA

    Joseph A Clougherty

  2. CEPR, London, UK

    Joseph A Clougherty

  3. WU Vienna University of Economics and Business, Vienna, Austria

    Klaus Gugler

  4. Norwegian School of Economics, Bergen, Norway

    Lars Sørgard

  5. DIW, Berlin, Germany

    Florian W Szücs

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  1. Joseph A Clougherty
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  2. Klaus Gugler
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Accepted by Ram Mudambi, Area Editor, 24 December 2013. This paper has been with the authors for four revisions.

APPENDIX

APPENDIX

Equations (1), (2) and (3) in the main text, respectively, show the inverse-linear demand, unions’ utility and firms’ profit functions. Since unions set wages in Stage 1 and firms set quantities in Stage 2, we start by solving the last stage of the game (i.e., via backwards induction). Given that one unit of labor is needed to produce one unit of output (q i =n i ), we can find the chosen amount of labor (and thus output) at Stage 2. Given the labor demand, we can derive the optimal wages chosen at Stage 1. In the absence of a cross-border M&A, the firms’ first order condition from the profit function can be used to find labor quantities. We set ∂π i /∂n i =0 for i=1.4, and solve simultaneously with respect to demand for all four firms, for example, Firm 1 – which is located in Country A – has the following labor demand:

Given the optimal value of n i (where i=1.4) at Stage 2, we can solve the union’s maximization problem by setting ∂U A /∂w A =∂U B /∂w B =0, and solving with respect to w A and w B . Then we find the domestic wage.

We compare this scenario with a situation where cross-border M&A activity takes place. In particular, we have Firm 1 merge with Firm 4; hence, the domestic-outsider is denoted with Subscript 2. As explained in the text, we allow for spillovers to all firms following a cross-border merger. While the union’s maximization problem remains the same, the merged entity faces the following maximization:

The post-merger profit functions for the domestic-outsider and foreign-outsider firms are as follows:

At Stage 2 we solve four first-order conditions simultaneously, ∂π 14 /∂n 1 =∂π 14 /∂n 4 =∂π 2 /∂n 2 =∂π 3 /∂n 3 =0, with respect to n 1 , n 2 , n 3 , and n 4 .

Given labor demand at Stage 2, the unions in Country A and B set firm wages simultaneously. Setting ∂U A /∂w 1 =∂U A /∂w 2 =∂U B /∂w 3 =∂U B /∂w 4 =0, we can solve with respect to w 1 , w 2 , w 3 , and w 4 . If we negate spillover effects (i.e., set μ i =0), we can find post-merger wages in the absence of spillovers. The wage in the domestic-insider firm is the following:

Equation (7) in the main text reports the wage in the domestic-outsider firm. It can be verified that wages in both the insider and outsider firms drop post-merger; furthermore, the post-merger wage is lower in the domestic-insider than in the domestic-outsider firm. Since our principal interest involves the domestic-outsider firm’s wage, we report the wage in Country A for Firm 2 in the presence of spillovers (μ i >0):

where

The impact of spillovers on domestic-outsider wages (which is always positive per Eq. (6)) follows:

Finally, we consider how merger relatedness affects the wage reduction following a cross-border M&A. From Eq. (9) we have the following:

This is always positive and implies that an increase in b leads to a larger post-merger wage reduction.

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Clougherty, J., Gugler, K., Sørgard, L. et al. Cross-border mergers and domestic-firm wages: Integrating “spillover effects” and “bargaining effects”. J Int Bus Stud 45, 450–470 (2014). https://doi.org/10.1057/jibs.2014.2

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Keywords

  • multinational corporations (MNCs) and enterprises (MNEs)
  • foreign direct investment
  • bargaining
  • econometrics
  • spillovers
  • wages