Diplomatic relations and cross-border investments in the European Union

This study investigates the extent to which diplomatic relations affected merger and acquisition (M&A) activities in the EU during the years 2001-2019. Implementing a gravity model, we find a U-inverted relationship between diplomatic distance and M&A activities: (i) a worsening in diplomatic relations fosters M&As, but beyond a certain level (ii) an increase in diplomatic distance slows down M&A flows. While (ii) is in line with the dominant view found in the political relations literature, (i) suggests that cross-border acquisitions, in line with the internalisation theory, are a way for the investing firm to mitigate weak diplomatic relations' related issues, such as access to host markets' information and technology. These findings are confirmed especially when foreign investors target technology-intensive firms, as well as in the most recent years.