The Impact of Cultural Distance on Bilateral Arm’s Length Exports

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.