Entry and Survival in Foreign Markets from Emerging Countries ...

Università Commerciale Luigi Bocconi

KITeS Knowledge, Internationalization and Technology Studies

Working Paper n. 18/2009 Marco S. Giarratana and Salvatore Torrisi

Entry and Survival in the US Software Market: International Linkages, Technology Competences and Firm Experience

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Entry and Survival in the US Software Market

Entry and Survival in the US Software Market: International Linkages, Technology Competences and Firm Experience Marco S. Giarratana Associate Professor of Management Universidad Carlos III de Madrid, calle Madrid 126 Getafe (Madrid), email: [email protected] Salvatore Torrisi Professor of Management Department of Management, University of Bologna, Via Capo di Lucca 34 40126 Bologna and KITES-CESPRI Bocconi University, Via G. Roentgen, 1 - 20136 Milano e-mail: [email protected]

Abstract This paper examines entry and survival in the US software market of a sample of firms based in India, Ireland and Israel. Our investigation focuses on pre-entry technological capabilities, international linkages and home based experience as determinants of the firm entry decision and post-entry survival. Our novel measure of foreign activity is the registration of software trademarks in the US. Trademark renewals and new trademark applications trace firm survival. Our analysis shows that international linkages have a positive relationship with entry and survival. Firm technological capabilities and age are not associated with entry. Instead, technological capabilities affect the likelihood of survival. JEL classification: F23; O32, O34, L86 Keywords: Internationalization, Linkages, Patents, Trademarks, Software Acknowledgements Teymour Haider has assisted in data collection and elaborations. We thank Davide Castellani and Antonello Zanfei who provided us access to Who Own’s Whom data. We also thank Alfonso Gambardella, Brownyn Hall, Reinhilde Veugelers and seminar participants at the 2nd Econ-Change workshop (London) for useful comments. Participants to the Innovation in Services Conference at the University of Manchester, and the Strategic Management Society, in San Juan, Puerto Rico have provided useful comments to earlier drafts of the paper. Finally, the financial support of the EC-DGXII and the Italian Ministry of University Research (MIUR) is acknowledged. The usual disclaimers apply.

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Introduction The strategic management literature increasingly recognizes the hurdles faced by firms when entering into a foreign market. A major obstacle to entry and survival abroad arises from a lack of legitimacy and the difficulty of establishing brand recognition. This liability of foreignness (Hymer, 1976) leads firms to try an incremental foreign involvement that typically starts with exportation and alliances with domestic firms (Kogut & Zander, 1993; Lu & Xu, 2006). Moreover, firms will probably begin entering foreign markets with limited psychical distance. Bilateral ties between home and host countries due to geographical proximity, cultural and linguistic ties or immigration flows reduce psychical distance and the cost of entry into a foreign market (Kogut & Singh, 1988; Rangan, 2000). The uncertainties associated with the lack of familiarity and communication barriers with the host market have also important implications for survival (Westhead et al., 2001). If entering foreign markets is not easy, surviving is even more difficult especially in the presence of intense competition and novel types of customers. Not surprisingly, foreign firms tend to have higher exit rates compared with domestic ones (Zaheer & Mosakowski, 1997). With few exceptions, the international management literature does not clarify what are the differences between factors that explain entry and factors that account for survival in foreign markets (Caves, 1996; Rangan & Drummond, 2003). In particular, these differences are unknown when small, young firms are concerned rather than large, established multinationals. Moreover, only few works deal with the internationalization of service firms (Coviello & Munro, 1997; Contractor et al., 2003; Hitt et al., 2006; Di Gregorio et al., 2008b) or the commercialization strategies of software products (Easingwood et al., 2006), while they extensively deal with manufacturing industries (e.g., Yeniyurt et al., 2007). This is at odds with the rising importance of services in GDP for both developed and developing countries.

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This paper tries to fill this gap in the literature by examining the drivers of firm entry and survival in the US software market for a sample of firms from Ireland, Israel and India. As explained more thoroughly in the next section, software is a knowledge-intensive sector that shares several key characteristics with professional services like R&D and consulting. The set of firms analyzed in this paper is an ideal sample since it allows singling out the determinants of foreign entry and survival of firms from emerging economies where software and information technology represent a recent and pivotal driver of growth. In this context, we explore the importance of international linkages, technological capabilities and firm experience as determinants of entry and survival. Our results imply that international linkages foster firm entry and survival, while technological capabilities only affect firm survival. Firm experience does not produce any consistent results. Taken this for granted, the article provides three major contributions. First, this is one of the few articles with direct evidence on the drivers of internationalization in a business service sector. Interesting exceptions are the work of Di Gregorio et al. (2008b), who analyze the determinants of offshore outsourcing of services of small and medium enterprises, and Hitt et al. (2006) who study the importance of skills and relational capital in the internationalization of business service firms. We expand this line of research looking at the determinants of foreign market penetration. Second, compared to earlier works we provide a test of the simultaneous effect of international linkages, technological capabilities and experience in firm’s foreign activities. Focusing on a single sector and a single host market enables a finer grained exploration of our research hypotheses. The extant literature analyzes the interplay between firms’ technological activities and internationalization strategies (e.g., Cantwell, 1989; Kogut & Chang, 1991). However, studies centered on the foreign activity of service firms usually resort on quite imprecise measures of technological capabilities such as the adoption of information

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technology (Zaheer & Mosakowsi, 1997). Up to date, the evidence of factors affecting entry and survival of business services firms is indeed particularly scattered (Coviello & Munro, 1997; O’Farrell et al. 1998; Khota et al. 2001). Our study contributes to advancing the knowledge of these factors. Third, a substantial body of the literature focuses primarily on entry decision of established multinational corporations, that are endowed with considerable resources and international experience while few studies focus on new ventures or small and medium enterprises (McDougall et al., 1994). Consequently, as Westhead et al. (2001: 334) notice, “there remains considerable debate surrounding the factors encouraging new and small ventures to export their goods or services abroad”. Our work aims to contribute also to this matter. Finally, this study also contributes to the international entrepreneurship literature by using a novel measure of entry and survival in foreign markets that is firm’s trademarks registered at the US Patent and Trademark Office (USPTO). Earlier studies have relied on trademarks as a measure of intellectual property or new product introduction to the market (Schmoch, 2003; Fosfuri & Giarratana 2007). To our knowledge, this is the first attempt at using trademarks as an indicator of foreign activity. The paper is structured as follows. First, the theoretical background on entry and survival in foreign markets is presented. We then develop our research hypotheses. Next, data are described and the results of empirical analysis are presented. Finally, a discussion of the main findings and managerial implications closes the paper.

Background Our analysis focuses on the software sector, which comprises a variety of activities ranging from packaged software to customized applications and IT services. Firms located in India mostly focus on IT services, e.g., business process outsourcing (BPO) or IT-enabled services like sales and customer support services. Instead, firms based in Ireland and Israel focus more 4


on software products for specific customers (like chip design software and telecommunication software). However, even firms specialized in packaged software in general draw a significant share of their revenues from services like customer support, maintenance, training, internet and multimedia services, and facility management (Arora et al., 2004). Software is also viewed as a service sector by the US Software and Information Industry Association (http://www.siia.net). Like other business services, software has become more standardized and this is one reason for the growth of export and offshore outsourcing (Erramilli and Rao, 1990; Arora et al., 2004; Di Gregorio et al, 2008b). However, the software sector maintains some key features typical of business services like immateriality, a high customization of output, and intense client-supplier interactions (Cloninger, 2004; Di Gregorio et al., 2008b). Another important characteristic of the software sector is a sustained high entry rate of new firms and relatively limited market concentration. For instance, the top ten largest software producers account for less than 30% of the world market of software (OECD, 2002). The US industry in particular is characterized by a high entry rate of new start-ups attracted by the technological and market opportunities offered by the Internet and networked and distributed computing (Rubin, Johnson, and Iventosch, 2002). A rough measure of intense innovation-based competition in this sector is given by the number of software patents granted by the USPTO that rose from 1,080 (1.7% of total patents) in 1983 to 25,973 (15.7%) in 2001. Similarly, the number of software trademarks registered at the USPTO passed from 223 in 1983 (0.5% of total trademarks) to 15,607 in 2002 (11%) (Bessen and Hunt, 2003; www.uspto.gov, 2003). The characteristics illustrated thus far - high entry rates and intense innovation-based competition, are typical of Schumpeterian sectors (Schmalensee, 2000). In this context, software firms with home offices in India, Ireland and Israel are an ideal testbed for several reasons. First, the software industry in these regions has taken off in recent

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years and represents an important driver of growth (Arora et al., 2004; De Fontenay and Carmel, 2004; The Economist, 2003a, 2003b and 2003c; Business Week, 2001). Indeed, software is a very fast growing industry in the sample countries and much of the growth is accounted for by exports, which represent about 75% of Indian’s total sales and about 84% of Irish sales (NASSCOM; 2002, and NSD, 2002). The Israeli software industry exhibits similar figures, with exports amounting to 73% of total sales (IASH, 2002). Second, because of the limited size of their domestic software market, the access to foreign markets represents a necessity for the domestic firms of these regions. Not surprisingly, foreign sales are the largest source of revenues for several software firms located in these countries and the US represent the largest foreign market. In the case of India and Israel, for example, several software firms have been set up with the purpose to exploit the opportunities of international markets and some of these firms have established their front-end activities (e.g., marketing) in the US immediately after their foundation. Third, historical linkages with the communities of expatriates and the abundance of English-speaking software engineers have reduced the cost of access to foreign markets like the US and gave the firms examined in this paper a significant competitive advantage compared to competitors from other emerging regions. However, while entry in leading markets like the US may be relatively easy for firms located in countries with cultural, linguistic and immigration ties, survival is not because of intense competition and escalation of R&D and marketing costs. As a consequence of intense Schumpeterian competition and the great sophistication of US customers, many software firms from emerging regions like India that have entered the market during the 1990s are now struggling to survive by ‘moving up the value chain’.

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Hypotheses Entry and post-entry performance in foreign markets Entry in foreign markets entails additional uncertainty and costs to the liability of newness that, in general, must be faced by new start-ups or established firms that enter a new market (Bhidé, 2000; Klepper & Simons, 2000). To operate in foreign markets a firm must possess distinctive ownership advantages that compensate for the natural disadvantage of competing with domestic firms (Hymer, 1976; Caves, 1996; Buckley & Casson, 1998). A substantial part of the additional costs arising from the ‘liability of foreignness’ is associated with the need to gain legitimacy and establish brand recognition and reputation abroad. According to the behavioral theory of internationalization, firms experiment a step-by-step foreign involvement and try different modes of entry into foreign markets to moderate the liability of foreignness (Kogut & Zander, 1993). An interesting implication of this theory is that foreign markets can be ranked according to their ‘psychical’ distance (Johanson & Vahlne, 1977; Kogut & Singh, 1988). Firms will probably start their internationalization process from foreign markets with limited psychical distance by relying on exports or intermediate modes of entry like joint ventures and licensing to minimize their commitment and reduce the risk of the foreign venture. This view is in line with Aharoni (1966) who noticed that the acquisition of competences needed to operate in international markets is an incremental and costly process. In this respect, bilateral ties between countries (geographic and immigration ties, linguistic and cultural linkages) reduce the cost of entering a foreign market (Veugelers, 1991; Caves, 1996; Rangan, 2000; Rangan & Drummond, 2003). Like entry, post-entry performance in foreign markets is constrained by the lack of familiarity with the local environment (business practices, language, law and institutions) and the

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communication costs with local customers. For example, employing data on currency trading rooms, Zaheer & Mosakowski (1997) show that foreign firms have higher exit rates than domestic ones. Souder and Song (1998) have also showed that introduction of new products in unfamiliar markets reveals a higher failure rate. Despite the similarities, entry and post-entry performance are likely to be driven by different factors (Geroski, 1995). Firms that survive longer have to accumulate a consistent and unique array of complementary resources and capabilities in order to foster a sustainable growth (Teece, 1986). Some of the resources and capabilities to survive can be easily developed while others require more efforts and longer accumulation times. This is one reason why we expect to find differences in the drivers of entry and survival. Moreover, firms may learn that their capabilities are unfit for the target market only after entry and this could also lead to different patterns of entry and survival. In line with this argument, Westhead et al. (2001) find that the most significant explanatory variables for the export decision are different from those affecting the exporting performance. Other empirical works have also found that the long-term success of foreign expansions depends to a substantial extent on the strategic choices after entry (Fershtman, 1996).

International alliances. Uncertainty about reliability, trust and quality of products or services is an important source of transaction costs for firms that are new to a foreign market. Reputation reduces this type of uncertainty and inter-firm international linkages are a critical reputation-building mechanism, especially for firms from emerging regions (Rangan, 2000). Moreover, international linkages may yield significant learning gains to entrants. Through international linkages, a firm can leverage its internal assets to draw on a broader set of external resources and learning opportunities (Teece, 1986; Kotha et al., 2001).

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Beyond bilateral ties between countries, which reduce the psychical distance and the cost of entry, collaborative linkages with foreign firms (such as distributors or resellers) may favor the entry into a foreign market and help establishing an international brand name. A rich body of the business literature explores the role of inter-firm alliances for firm competitive advantage and international growth (Vyas et al., 1995; Rangan, 2000; Hagedoorn & Duysters, 2002). Some studies point out that relationships with international partners are more important than market or cultural distance in determining the success in entering new foreign markets (Johanson & Mattsson, 1988). As noted by Rangan (2000: 208): “Firms embedded in wellelaborated cross-border networks exhibit relatively speedier and more vigorous responses to international economic opportunities”. We expect that the effects of networking on entry and survival in a foreign market are particularly important for the following reasons. The frequent interactions with foreign partners increase the awareness of foreign market opportunities and help managers learning foreign customers’ needs. The experience accumulated by negotiating and contracting with foreign partners may also affect the firm’s ability to market its products and services abroad which in turn increases the likelihood of survival and growth in the international markets. To understand more deeply the importance of inter-firm linkages previous studies have drawn on the concept of relational capital, defined as the benefits embedded in a firm’s network of relationships with other parties like customers and suppliers (Dyer and Singh, 1998). Relational capital is composed of three basic elements: trust, information transfer and joint problem solving (Uzzi, 1997). International business studies have found that relational capital is an asset that firms can exploit to enter and grow in international markets (Hitt et al., 2006). More precisely, repeated exchanges with foreign partners foster a firm’s absorptive capacity and result in greater relational capital. Hitt et al. (2006) found that business service companies

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leverage on their experience accumulated by interacting with a specific partner to acquire new customers and expand their international activities. These scholars reason that relationships with foreign customers provide business service firms with two valuable sources of competitive advantage: the knowledge of foreign markets and legitimacy. In theory, the potential benefits of relational capital for software firms should not be different from those found by Hitt et al (2006). For instance, collaborative ties with foreign firms have been an important source of reputation for Irish software firms. A case in point is Iona Technology. In 1993 Sun Microsystems bought 25 per cent of Iona for $600,000 and two Sun’s executives entered Iona’s Board of Directors. Sun also became an important customer of Iona’s integration technology and sold its stake for $60m at the Iona’s initial public offering (IPO) in 1997. According to Iona’s founder and CEO, the alliance with Sun had a huge importance not for the money but for Iona’s credibility in the international market (Arora et al., 2004). This example supports the idea that international linkages are an important antecedent of entry in foreign markets because they reduce the liability of foreignness and provide useful information about foreign markets. From this theoretical perspective, an increasing number of international linkages signal the firm investment in relational capital and in the capability to enter and grow international. In the case of software, the importance of international linkages is documented by Coviello & Munro (1997) who notice that small, resource-constrained software firms rely on network relationships for market selection. Moreover, Easingwood et al. (2007) have found that in the global software industry alliances are used by firms that succeed in entering new markets and reaching new customers with novel products. Needless to say, relational capital is a costly asset to build and the potential benefits mentioned before could not materialize if a firm fails to translate the knowledge acquired by interacting with partners into an effective entry and competitive strategy. Thus, our first set of hypotheses reads:

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Hypothesis 1a: The greater the number of international collaborative linkages, the higher the likelihood of a firm’s entry in a foreign Schumpeterian market. Hypothesis 1b: The greater the number of international collaborative linkages, the higher the likelihood of a firm’s survival in a foreign Schumpeterian market.

Experience in the home market. Firm’s experience in the home market is one of the most important factors that could reduce the liability of foreignness. Firms that are more experienced in home markets acquire the marketing and technological abilities to potentially replicate their business models in other environments. Therefore, the technical and marketing knowledge arising from experience can play the function of a platform from which firms can start off experimenting with new markets (Kim and Kogut, 1996). As the economics and management literature suggests, experience fosters survival in new markets (Singh et al., 1986; Hannan & Freeman, 1989). Established firms can rely on their earlier experience with the sector of origin to compete successfully in new industries (Klepper & Simons, 2000). Accordingly, the international management literature stresses that experience is an important determinant of success of foreign operations. For instance, Zaheer & Mosakoswi (1997) find that likelihood of exit for foreign firms diminishes over time with experience and tends to approach that of domestic firms. Other scholars have also noted that organizational learning is influenced by age and experience (Sinkula, 1994; Yeniyurt et al. 2007). This means that firms with stronger experience could adapt more quickly to new competitive environments and respond better to the liability of newness. In sum, firms benefit from the increasing returns generated by their experience acquired by interacting with domestic customers, suppliers and competitors. However, recent studies on international entrepreneurship suggest that the role of experience can be different from what hypothesized

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by stage theories of internationalization, especially in the case of firms based in small, emerging economies. For example, Di Gregorio et al (2008) refer to the “accelerated internationalization of sales” to indicate a pattern of internationalization adopted by firms that start exporting at an early stage of their life to respond to foreign market opportunities. These scholars illustrate this internationalization mode with the case of a young Czech firm specialized in water treatment technology and note that “international sales and competitiveness on the global scale has been the main goal [of this firm]…since its inception” (p. 193). As we mentioned before, this pattern of internationalization is common to several software firms examined in this paper. Therefore, the role of experience accumulated in the home market for these firms overall should be limited because many of them have started international activities in the early stages of their life. However, there are differences across software firms in their experience at the time of entry into the US market and we are interested to know whether these differences affect the likelihood of entry and survival. These arguments lead to the following hypotheses:

Hypothesis 2a: The greater the experience of a firm in the home market, the higher the likelihood of a firm’s entry in a foreign Schumpeterian market. Hypothesis 2b: The greater the experience of a firm in the home market, the higher the likelihood of a firm’s survival in a foreign Schumpeterian market.

Technological capabilities. Earlier studies (e.g., Kogut & Chang, 1991; Kogut & Zander, 1993) demonstrate the importance of technological competences as a driver of internationalization. The resource-based view suggests that capabilities accumulated before and during internationalization can play an important role in reducing the liability of

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*foreignness and affecting the post-entry performance outcomes of foreign firms (Bowen & Wiersema, 2005). The reason why technological capabilities are important is twofold. As Cohen and Levinthal (1990) have pointed out, innovative activities serve two functions: developing new products and accumulating absorptive capacity. Cohen & Levinthal (1990) have defined absorptive capacity as the “ability to recognize the value of new information, assimilate it, and apply it to commercial ends” (p. 128.). Technological capabilities favor the firm ability to screen the technological environment and reduce the cost of information acquisition (Katila & Ahuja, 2002). These capabilities may also play a significant role in fostering entry and survival in new sectors (Klepper & Simons, 2000). From this perspective, technological assets and capabilities are important to entry in a foreign market, especially if a Schumpeterian one, because they help firms quickly recognizing new business opportunities, introducing new products or services that satisfy foreign customers, and preparing ad-hoc business models. Indeed, technological competences may allow a firm to enjoy first mover advantages in foreign markets over domestic competitors, thus lowering the liability of foreignness. Technological capabilities are also important to survive. According to the traditional international business theory, technological competences accumulated in the home country provide firms with an ownership advantage that increases the likelihood of survival of foreign operations (Caves, 1996; Buckley & Casson 1988; Kotha et al. 2001; Cantwell, 1989). This is because technologically endowed firms are more prepared to face the uncertainty about the needs of foreign customers and can respond more quickly to customer requirements and feedbacks (Gaba et al., 2002). Especially in Schumpeterian sectors, the speed and the quality of response to heterogeneous customer tastes across different markets and over different periods are important sources of competitive advantage (Garud & Kumaraswamy, 1993).

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Clearly, in R&D-intensive sectors like security or telecommunication software only firms endowed with strong technological capabilities can understand correctly technical problems and find satisfactory solutions. Mastering new technologies, however, is also important for firms operating in less R&Dintensive sectors like IT or financial services. For example, Zaheer & Mosakoswi (1997) find that the adoption of electronic dealing systems reduces the likelihood of exit of trading rooms operating abroad. To sum up, technological capabilities are important for survival because they allow firms operating abroad: (a) to continue developing new products and services over time; (b) to recognize, assimilate and exploit the positive feedbacks arising from internationalization. This amounts to say that technological capabilities help firms to learn from the internationalization process by absorbing new knowledge generated in the host market. This type of learning in turn translates into enhanced technological capabilities and reinforced competitive advantage (Dunning and Narula, 1995; Frost, 2001; Zanfei, 2000). This perspective on learning from internationalization provides further insights on the mechanisms through which technological capabilities affect the international performance of the firm. Although technological capabilities are potentially important for both entry and survival, one may argue that these capabilities are especially relevant for survival. Indeed, previous studies in industrial organization suggest that firm entry is relatively easy - even in sectors with high entry barriers, while survival is not (Acs and Audretsch, 1989; Geroski, 1995). However, entry into Schumpeterian foreign markets may be difficult also for firms based in countries with strong cultural ties with the host country. These arguments lead to the following hypotheses:

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Hypothesis 3a: The greater the technological capabilities of a firm, the higher the likelihood of a firm’s entry in a foreign Schumpeterian market. Hypothesis 3b: The greater the technological capabilities of a firm, the higher the likelihood of a firm’s survival in a foreign Schumpeterian market. .

Data and Methodology Sample and Data Sources Our analysis draws on various data sources. First, we collect information from the National Software Directorate (NSD), a division of Enterprise Ireland, the National Association of Indian software firms (NASSCOM) and the Israeli Association of Software Houses (IASH). Supplementary data are drawn from Dun and Bradstreet’s Who Owns Whom Linkages (2001 edition), and companies web sites. From these datasets we selected all firms operating in the software and IT software industry with a headquarter in the three countries (core sector SIC 737). The total sample of potential entrants in the US market accounts for 875 firms, 84 of which from India, 230 from Ireland and 561 from Israel. This is a representative sample of the population on several grounds – size (large and SMEs are included), corporate structure (individual firms and firms that belong to a group), age, specialization (packaged software and services) and location (firms located in software clusters and elsewhere). Over 71 per cent of the sample firms have been founded during the 1990s while 23 per cent have been established during the 1980s. The median age of the firm at the end of the sample period is 9 years while the median lag between firm foundation and firm entry in the US market is 5 years.

Dependent Variables

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We use US Patent and Trademark Office (USPTO) software trademarks for the period 19832002 as a measure of activity in the US market. No sample firm registers any trademark before 1983. We do not have significant left censoring problems because software trademarks in general were unusual before the 1980s. We downloaded trademarks information according to the following search criteria: the owner should be a company resident in India, Ireland or Israel, and the “Good and Services” description field should contain the word “software” or “data processing”. With trademarks, we constructed our dependent variables: (i)

Entry. The decision to entry the USPTO with a trademark is captured by a dummy variable which takes value one if a software trademark application is filed by the firm and zero otherwise; we take the date of the first trademark application filed at the USPTO as a proxy for a firm’s entry into the US software market with a branded product/service;

(ii)

Exit. Exit from the USPTO trademark dataset occurs when all software trademarks registered by a firm are cancelled by the USPTO or abandoned by the firm.This variable is used as a proxy for the exit from the US software market with a branded product/service.

Among the 875 firms in our sample, 791 have entered the USPTO trademark dataset, 255 of which exited by 2002 and 536 survived. Therefore, we have 84 firms who have not entered the USPTO trademark dataset during the sample period. Among firms that exited the dataset, we checked for firms that have filed a new trademark application after exit and we did not find any such case. Generally, our measure of foreign activity is new in the international management literature and the reader may wonder whether trademarks are a good proxy for firm entry and survival abroad. Trademarks are important to protect the firm brand from imitation. Brand names

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reduce search costs for buyers who cannot observe ex-ante the quality of the product or service and therefore serve the function of identifying the provider of a good by making a name visible in the marketplace (Schmoch, 2003). Marks are also used in the service sector as a differentiation strategy (Semadeni, 2006). As said before, this suggests that the date of the first trademark registered by a foreign firm in the USPTO signals the first step of its entry process with a branded product or service. Exit from the trademark dataset indicates that a firm ceases to use its brand name in the US market. Since the maintenance of trademarks is costly, a firm will exit the USPTO trademark database when the benefits from its US operations are not worth the costs. It is should be noted that trademarks imply direct monetary and indirect administrative costs - the owner must file a trademark application for each class of goods/services, pay application fees and renewal fees, file a statement of use, demonstrate that it uses the mark in commerce and file requests for time extension. At regular intervals, the owner has to demonstrate that it has used the mark in commerce for five consecutive years and pay extension fees. Maintenance costs include attorney fees. Although registration and maintenance costs account usually for only a share of total marketing costs it is difficult to believe that a firm will continue to bear such costs if it is not active in the market. It is worth to note that a trademark can be abandoned, cancelled or expire if not renewed after a fixed period. It is also worth to notice that abandonment (voluntary abandonment of the trademark by the firm before the expiration time) is the most common event for a software trademark. In the whole USPTO dataset, 77 % of software trademarks classified as ‘dead’ have been abandoned and 22 % have been cancelled because the USPTO has found that the firm did not meet all criteria required to maintain the trademark alive, while only 1% have expired. In our sample, the percentage of abandonment is 89% and there are no expired trademarks. Among the abandoned trademarks, 48.3% lasts less than one year, and

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27.3% less than two years. These data suggest that the date of death of the last trademark is a good proxy for a firm’s exit from the USPTO dataset. Obviously, trademarks cannot tell the degree of success of the firm neither they can reveal the quality of the products or services offered. In principle, both high-tech software products like a firewall and low-tech services such as business process operations or call centers can be protected with a trademark. These limitations notwithstanding, trademarks are probably the best measure of foreign activity when: a) no reliable data on foreign sales are available; b) alternative indicators fail to provide more accurate proxies for entry and survival. For example, earlier works in international management rely mostly on self-reports where the firm categorize itself as a first mover, an early follower etc. These measures of entry timing have severe shortcomings and recent studies have suggested the adoption of the actual time of entry (Gaba et al., 2002).

Key independent Variables Our explanatory variables of theoretical interests are firm age, technological capabilities, and international linkages before entry into the USPTO trademark database – i.e., before the registration of the first trademark in the US. Firm age. Firm age is a proxy for experience. Following a standard practice in the industrial organization literature, age was calculated as the difference between the year of the database and the year of foundation of the firm (Klepper & Simons, 2000). Technological Capabilities. We measure technological capabilities with the firm’s stock of patents before entry. We collect information on patents granted by the USPTO for the period 1976-2002. Earlier data are not available from the USPTO on-line database. The front page of a patent reports the assignee and inventor(s) names and address. For the purposes here, we focus on patents whose assignee is resident in one of our sample countries - India, Ireland or

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Israel. It is worth noting that even if patents have their limits as a proxy for innovation and technological capabilities, several scholars use them as a proxy for technological knowledge (i.e. Yayavaram & Ahuja, 2008; Silverman 1999; Di Gregorio et al., 2008b). Empirical studies on innovation have found a strong positive association between other indicators of innovation (R&D expenditures) and patents (e.g., Cohen and Klepper, 1992). Linkages. International linkages include equity (joint-ventures and minority stakes) and nonequity strategic alliances, such as joint R&D, commercial contractual agreements and outsourcing agreements with foreign partners. These linkages are drawn from the Gale Group’s InfotrackWeb database (Business and Company Resource Centre and Expanded Academic ASAP) over the period 1980-2002. The InfotrackWeb database reports articles in English from various press sources. It is worth noting that in our dataset equity alliances (joint ventures and minority stakes) accounts for a very small share of the total sample (only 5 joint ventures). This is in line with earlier works that have noticed a small number of international equity alliances relative to non-equity agreements in the software industry (Hagedoorn & Narula, 1996). These alliances involve with foreign partners in general, not only US ones; however 78% of partners are US-based. Additionally, international linkages in our sample include alliances aiming at different purposes – from joint R&D to commercial agreements. This implies that the variable Linkages captures the learning effect of international alliances in general rather than that of technological alliances in particular.

Control Variables Group dummy. We control for the firm ownership structure. We code a dummy variable that equals to 1 if the firm is part of a group and zero otherwise. Data are obtained from Dun and Bradstreet’s Who Owns Whom Linkages. Since firm revenues and employees are available for a limited set of firms in the sample, this dummy can also be viewed as a proxy for size and

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liquidity constrains. To control for the endogeneity of this dummy with respect to international linkages we check for all M&As that may have affected the status of our firms. Entry cohort dummies. To measure potential first mover advantages we rely on the time of firm entry in the USPTO database with a trademark application. This is a classical control used in survival studies (Klepper & Simons, 2000) which may capture unobservable characteristics that vary across different waves of entrants. To this aim, we created two dummy variables that capture the first and the second 15% of all entrants respectively. We choose 15% because 30% of the sample firms entered in the first half of the sample period. We have also experimented with different time windows for early entrants and obtained similar results. Country-level controls. To account for structural differences across the three countries we rely on three variables. First, we code three country dummies. Second, drawing on Hofstede’s (1980) estimates of national culture, we calculate the Kogut and Singh’s (1988) Cultural Distance Index (Cultural Distance). This index is obtained as follows:

{

}

CulturalDis tan cej = ∑ (I ij − I iUS ) / Vi / 4 4

i =1

2

Where Iij is the value taken by the ith cultural dimension (i.e., power distance, uncertainty avoidance, masculinity/femininity, and individualism) of the jth country (i.e., India, Ireland, and Israel). Vi is the variance of the ith cultural dimension across all 60 Hofstede’s countries. Cultural distance measures the cultural distance of the jth country from the US. This variable is used in our regressions to account for the effect of exogenous, bilateral ties between countries. Although our proxy for cultural distance is based on indicators dating back to the 1980’s, we have no reasons to believe that the rate of cultural change occurred afterwards has been substantially different across the sample countries. Third, we control for the average monthly wages in dollars at 1990 prices (Wage). We introduce this variable to capture the

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effect of differences in labor costs across the sample countries. Wage data was obtained from the LABORSTA database (http://laborsta.ilo.org). Cluster dummy. Finally, we generate a dummy for location in geographical clusters (Dummy Cluster), because several Irish, Israeli and Indian software industries are concentrated in a limited number of counties and metropolitan areas. For example 21% of Indian firms are located in Bangalore, 72% of Irish firm in Dublin and 19.5% of Israeli firms in Tel Aviv. These areas are characterized by a population density above the country average and the location of important academic institutions. The cluster variable is used to control for unobserved heterogeneity due to agglomeration economies. The dummy cluster takes the value 1 if the firm is located in a software cluster, zero otherwise.

Methodology To estimate the effect of our covariates on entry decision we run a logit regression while the hazard of exit is estimated by a proportional hazard model. Using a logit model we estimated the probability that a firm enters the US market with a trademark as a function of firm’s and other characteristics: prob(entry)= exβ /(1+ exβ), where the vector of covariates x includes firms characteristics before entry and controls. To estimate the probability of exit from the US market we used a Cox proportional hazard model. This is a semiparametric model which does not specify the functional form for time dependence while the functional form for the covariates is fully specified (Kiefer, 1988; Klepper and Simons, 2000). The dependent variable of our duration model is the probability of exit from the US market in year t conditional on being in the market at time t. Hazard rates are the rates at which spells are completed at duration t, given that they have lasted until t. Formally, the hazard rate is

21


λ(t) = f(t)/S(t), where f(t) is the number of firms who completed their spell (exited the market) at time t while S(t)=Pr(Τ ≥ t) is the set of firms still at risk at time t (Greene, 1997). In a Cox model λ(t)= λ0(t)⋅ exp(β’ Xit) where λ0(t) is the baseline hazard rate corresponding to the hazard function for the mean individual in the sample. λ0(t) varies over time to allow the hazard of entry to take on its best-fitting value each year. The parameters βs measure the effect of covariates on the hazard rate and are assumed to have a multiplicative effect on the baseline hazard. The Cox specification is a partial likelihood estimator which allows a linear interpretation of results (Kiefer, 1988). In the hazard model, time dummies are estimated accordingly to the baseline model. Usually, time dummies estimates are not reported in regression tables (see, for example, Sorenson 2001).

Results Analysis Table 1 reports the descriptive statistics and a correlation matrix for the variables used in our analysis. The descriptive statistics show that there is a high variability in the number of international linkages, patents, and trademarks across the sample firms. Only 5 per cent of the sample firms have established international linkages, with limited differences across countries. Instead, a substantial part of variability in patents and trademarks is accounted for by the differences between Israel and the other two countries. About 20 per cent of Israeli firms in our sample own USPTO patents against 2 per cent of Irish firms and 1 per cent of Indian firms. The share of Israeli firms with a trademark registered with the USPTO (97 per cent) is also significantly larger than that of Indian and Irish firms – 65 and 86 per cent respectively. These differences between Israeli firms and other firms in our sample reflect the specialization of Israeli firms in software products.

22


[Table 1 about here]

Table 2 reports the estimates of logit regressions. Models 1, the baseline model, includes the controls only, then other models add progressively our variables of theoretical interests. In the last Model, we report the results of the same model but only for the Irish and Indian sub-sample for robustness reasons (Model 3). Indeed, the last model is motivated by the differences between Israel and the other two countries in terms of sample firms, patents and trademarks. These differences may raise the question whether our results are entirely driven by an Israeli effect. Results overall are robust across all specifications above. As Table 2 shows, only international linkages have a positive and significant impact on the probability to enter in the US market. On the other hand, prior patents and firm age do not produce any significant effect on the entry decision of the firm.


Before relating these findings to our hypotheses, let us move to the survival estimation. We estimate different specifications of a Cox proportional hazard model to examine the drivers of the hazard of exit. The results are reported in Table 3. Like in the previous estimations, the first Model includes only the controls while subsequent Models progressively add our variables of theoretical interest. The findings overall are similar and consistent across different models. The survival analysis supports the evidence that both patents and international linkages have a negative and

23


significant effect on the hazard of exit from the US trademark dataset. Contrary to expectations, the age of the firm, our proxy for experience, does not explain firm survival. The interpretation of controls is straightforward. Being part of a group (a proxy for firm size) reduces the hazard of exit. This result shows that the internal network of subsidiaries of the same group offers resources and competitive advantages beyond those arising from technological capabilities. The time of entry proxied by the two cohort dummies does not appear to affect the hazard of exit. The coefficient estimates of the first movers and later entrants in the US trademark dataset (first cohort and second cohort respectively) are insignificant at the conventional levels although their signs are negative. These two last results are in line with previous studies showing that in the software industry first mover advantages and experience are weak predictors of survival (Gandal, 2001). The insignificant effect of the cultural distance index maybe due to the high cultural proximity of these countries to the US. Finally, the significant coefficient of the dummy for location in clusters indicates the importance of the network of localized business relationships for foreign performance. We should notice that the coefficients of most variables of theoretical interests, including patents and international linkages, remain significant and with the expected sign when Israeli firms are excluded from the sample (Model 3). In unreported regressions, the estimations on the sub-sample of Israeli firms confirm these results, with a 5% significance level for patents and a 10% for alliances.


Robustness Checks

24


In our analysis we have not used size as a control since data on size are not available for all the sample firms. To be sure, missing data on size is a shared concern in most of the studies that analyze services (Barnett & Sorenson, 2002). However, other studies on IT services (Gandal, 2001; Fosfuri & Giarratana, 2007) find that firm size (employees) does not significantly affect firm entry and survival. As a robustness check, we perform the same regressions with the number of employees as a covariate for a sub-sample of firms (98 cases) for which we could find data from various sources. This sub-sample clearly over-represents larger firms. In terms of our core variables, the mean of Technological Capabilities is 0.849, for Linkages 0.517 and for Firm Age 15.72. Our main results, available at request, are broadly confirmed when size is entered in the entry and survival equations. Given the novelty of trademarks as a measure of foreign activity in the international management literature, we investigated further the role of trademarks in the context of our study. First, we conducted telephone interviews with an USPTO officer and IPR and marketing managers of four sample firms. These interviews confirm that trademark registration is a procedure that firms have to follow when they start selling in the US. Typical registration and maintenance costs of a software trademark vary in the range of 2,000 to 5,000 dollars. The name of the firm, its main products or services are usually registered. Moreover, in the words of one of our interviewees, trademark registration is one of “the legal steps [you should accomplish] to sell your products in the US […whatever the entry mode..] - either you open your own branch or you trust local resellers”. Moreover, several of our sample firms have been explicitly founded to exploit the opportunities of the US market. Our interviews with firms and the USPTO confirm that, especially for a foreign firm, trademarks represent a sort of entry ticket into the US business environment. These considerations suggest that the first trademark registration date is a good indicator of the time of entry in the US market.

25


Another interviewee clarifies that trademarks represent “an insurance against abuse and future litigation” and a signal of quality in that they “project a professional image of your company”. Our interviewees share the view that trademarks tend to be used to communicate the corporate brand, to acquire market visibility, rather than promoting specific products or services. Second, we also relate our trademark proxy with a more traditional measure of foreign activities like foreign subsidiaries. Indeed, trademarks signal the firm presence in the market with branded products or services. Even if the mode these products or services are delivered to foreign customers depends on factors that are largely beyond the scope of our paper, we examine the association between trademarks and a more structured form of foreign activity. To explore this issue, we rely on the Dun & Bradstreet Million Dollar Database, which contains information about the ownership structure of more than one million US companies. We find that only 94 firms (11.8% of the sample and 17.8% of survivors) among those who have registered software trademarks at the USPTO have at least an US subsidiary in 2002. Additionally, among the 94 firms with an US subsidiary we find only 9 cases, which have an US subsidiary before registering a trademark at the USPTO. These are mainly hardware and telecommunication equipment producers or resellers that enter the US market and diversify to software afterwards. This result is in line with earlier works on international business, which highlight that resource constraints and risk avoidance spur firms to rely almost exclusively on exports and other partially-owned forms of entry rather than foreign direct investments (Agarwal & Ramaswani, 1992). Another explanation for the limited use of foreign direct investment in our case is that many sample firms focus on niche products or business-to-business software that do not necessarily require significant foreign facilities. Earlier studies also show that Israeli software firms prefer contractual relationships with local distributors to local subsidiaries (Savage, 2003). The manager of an Israeli firm interviewed by the authors reports: “we prefer to rely on a

26


strong network of independent, already installed, distributors with whom we exchange agreements on a medium-term basis”. Trademarks then are associated with a relatively low risk entry mode (Agarwal & Ramaswani, 1992).

Discussion and Conclusions This article analyzes how international linkages, technological competences and firm experience affect entry and survival into the US software market from a sample of Indian, Israeli and Irish firms. Our strongest result is about the significant effect of international linkages on firm entry and survival. This reveals that the importance of inter-firm networks goes beyond the strong cultural and linguistic connections between the home and the host country. In line with the predictions of the behavioral theory of internationalization, inter-firm networks are a fundamental ingredient of a step-by-step model of internationalization, providing small entrants with market knowledge and helping them to establish a reputation in the targeted foreign market (Rangan, 2000). Our findings are also consistent with previous studies on the internationalization of professional services, which point out that the relational capital accumulated through interactions with customers is a key determinant of firm international performance (Hitt et al., 2006). The analysis suggests that international linkages help foreign firms to establish a first contact with the US market and to acquire reputation before launching a brand product or service in that market. Indeed, previous studies also show that these links are often used as a means of learning, extracting information and testing markets before entry (Hagedoorn & Duysters, 2002). Firm experience does not show any significant effect, both in terms of entry and survival. This is in line with the fact that most of our sample firms are young when they enter the US market, and sometimes are explicitly founded with the purpose of exploiting the foreign

27


business opportunities. Some of these firms establish their front-end activities (e.g., marketing) in the US immediately after their foundation. The limited size of the domestic market and the relatively low cost of access to the US explain why several firms of these countries enter the US market in the early stages of their life. Previous studies on firms from small domestic markets operating in global industries reach similar results (Coviello & Munro, 1991). Technological competences are insignificant for explaining entry, but they account for a substantial amount of cross-firm variance in survival. This is a novel result which deserves some discussion. The strong demand for ICT and software, particularly during the 1990s, attract different kinds of firms to the US market, including non-innovators that have the opportunity to gain short-term profits by offering relatively low-tech software products. The low entry costs due to the bilateral ties at the country level also reinforce the effect of market opportunities. These conditions explain why most of these firms are not endowed with substantial technological capabilities at the time of entry into the US market. The limited importance of experience and technological capabilities as determinants of entry in the US market is apparently in contrast with the traditional model of incremental, staged internationalization according to which firms go international after a stage of domestic growth and consolidation of their proprietary advantages. Our findings, however, reflect the increasing globalization of software, the limited size of the home country market and the bilateral ties between countries discussed before. These conditions altogether determine an acceleration of the internationalization process and lead firms to skip some stages of this process observed in previous studies. Our analysis provides novel empirical evidence in line with the model of “accelerated internationalization of sales” (Di Gregorio et al. 2008). Unlike entry, survival in the US software market requires significant investments in technology that are needed to face strong market selection forces. This finding is consistent

28


with the resource-based theory of the firm (Bowen and Wiersema, 2005) and previous empirical literature that also points out that new ventures’ ability to survive in foreign markets is positively associated with the stock of tangible and intangible resources like technology and advertising (Bloodgood et al., 1996). The different importance of capabilities for entry and survival also suggests that market conditions change after entry and therefore the strategies and capabilities needed to remain in the market have to change as well (Geroski, 1995: 434). To survive in foreign markets characterized by sophisticated customers and Schumpeterian competition a firm has to develop significant technological capabilities that are important to innovate and improve the quality of services to customers over time. Moreover, to survive and grow a firm has to develop (or attract from outside) complementary resources such as marketing and distribution capabilities (Teece, 1986). Even entrants endowed with strong technological capabilities are deemed to fail if their efforts in attracting complementary capabilities is too late or too little (Bhide, 2000). Strong technological capabilities at the time of entry provide firms with the absorptive capacity that is required to recognize complementary capabilities and learn from international activity. This explanation of the differences between entry and survival draws on the idea that the value of a product or service depends on the contribution of different complementary resources and capabilities. While some of these capabilities can be developed quite rapidly (e.g., the ability to develop a beta version of a software product and the establishment of contacts with local distributors), others may require a longer time (e.g., the development of stable and reliable release of the same application along with high quality customer support). Given these arguments, the article contributes to the international entrepreneurship literature on various grounds. Our evidence suggests that entry is explained by factors partially different from those that account for post-entry survival. Strong ties between countries reduce entry

29


costs and the ‘liability of foreignness’ (Aharoni, 1966; Hymer, 1976; Kogut & Singh, 1988). This explains why many firms with very different levels of capabilities enter the US software market from India, Ireland and Israel. However, despite the limited ‘psychical distance’ due to cultural and historical ties between countries, entrants have to invest in networking and technological capabilities to survive in Schumpeterian markets. Clearly, the scope of factors that explain survival is much wider than that which accounts for entry, given the variety and complexity of resources, strategies and capabilities required to grow in Schumpeterian markets (Geroski, 1995; Klepper & Simons, 2000). These findings may help managers of small-to-medium sized firms identify the key factors needed to elaborate effective international growth strategies. International linkages are a necessary condition to enter and to increase the chance of survival, but strong technological capabilities are also needed to structure a successful and sustainable internationalization strategy. Another contribution of this article is about measurement. We explore the usefulness of a novel measure of foreign activity that is represented by trademarks. Future research on smallto-medium sized, non-publicly traded firms can then benefit from the use of this variable to overcome the lack of data on sales in foreign markets. The contributions of this paper to the literature have to be set in the context of the study’s limitations. We do not know how far the results obtained in our study can be generalized beyond the boundaries of the software industry. However, we believe that our findings can be useful to understand better the patterns of internationalization in knowledge-intensive services from other emerging regions. An implication of our analysis for other developing regions is that policies aiming to promote the development of new knowledge-intensive services should target firms with strong technological capabilities because these are more likely to survive and grow in foreign markets. The experience of the countries analyzed in this work also

30


highlights the consequences of policies that succeed in attracting high-tech foreign direct investments. The presence of multinational corporations like Texas Instrument in India, Sun in Ireland and Intel in Israel most probably is not directly responsible for the development of a domestic software sector. However, their location has contributed to legitimate the domestic firms in the international market and helped them to enter a wider network of alliances. Future studies could also see if the international success is associated with the choice of a particular product niche (Semadeni, 2006). Finally, adding more information on the type of partner (age, size, patents) could help to gain a finer-grained picture of the specific role of alliances as a source of learning and a driver of internationalization. These limits notwithstanding, we believe that our analysis offers a useful approach to understand the association among technological capabilities, international linkages and foreign activity.

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Table 1. Descriptive statistics and correlation matrix Mean

Std. Dev 1

1.Technological

0.549

2

3

4

5

6

7

8

9

10

11

3.372

Capabilities

1

2. Linkages

0.217

1.872

0.0003

1

3. Firm Age

10.72

8.456

0.1623*

0.0094

4. Wages Cost

1155.27

441.27

-0.0583

-0.1265* -0.3788* 1

5. Dummy Cluster

0.436

0.469

-0.0195

0.064

6. Dummy Ireland

0.096

0.274

-0.0863* 0.0035

7. Dummy Israel

0.641

0.468

0.1068*

-0.0809* -0.2060* 0.3828*

8. Dummy India

0.262

0.429

-0.0475

0.1325*

0.1450*

-0.7670* -0.0218

-0.1694* -0.4313* 1

9. Dummy 1st entry 0.153

0.305 0.1672*

0.0248

0.3332*

-0.3790* 0.0521

-0.0378

0.0854*

-0.0867* 1

-0.0089

-0.0332

-0.1097* 0.0115

-0.1050* -0.0685

0.1097*

-0.0802* -0.3422* 1

-0.0347

0.0262

0.0924*

0.053

1

0.0862*

0.0455

0.0760*

-0.0236

cohort 10. Dummy 2nd entry 0.345

1

0.0378

-0.0434

1

0.1321*

0.0731*

0.3702*

1

-0.3261* -0.8161* 1

0.500

cohort 11. Dummy group

12

0.083

0.276

-0.0072

0.1506*

0.0516

-0.1046* 0.0942*

12. Cultural Distance 1.401

0.595

0.0912*

-0.0149

-0.1459* -0.0087

0.0211

-0.3724* -0.9965* 0.8617*

1

Notes: * 5% level of significance.

40


Table 2. Logit models for entry into the USPTO trademark database Variable

Model 1

Model 2

Model 3

Model4

Model 5

Technological Capabilities

-

0.212

0.205

0.047

-0.082

(0.282)

(0279)

(0.380)

(0.526)

3.312**

2.915**

2.915**

1.111**

(1.759)

(1.356)

(1.356)

(0.591)

-0.005

-0.003

-0.003

-0.003

0.008

(0.014)

(0.012)

(0.012)

(0.012)

(0.014)

-1.326**

-1.644**

-0.732**

(0.254)

(0.328)

(0.253)

-

-

-0.972

Linkages

Firm Age

Dummy Ireland

Dummy Israel

Dummy India

Cultural Distance

-

-5.751** -

(2.946)

(0.875)

-

-

-2.777**

-2.814**

(0.393)

(0.341)

-

-

-

-

-

-

0.208

-

(0.193) Dummy Group

0.432**

0.044

0.0456

0.072

0.0325

(0.179)

(0.379)

(0.249)

(0.256)

(0.156)

0.088

0.079

1.9**

1.431**

6.912**

(0.595)

(0.257)

(0.170)

(0.166)

(0.283)

0.414

0.137

-1.507**

-1.140**

-6.504**

(1.048)

(1.759)

0.416

(0.476)

(0.550)

Firms

875

875

875

875

324

Log Likelihood

-208.36

-228.90

-228.57

-228.578

-158.239

Dummy Cluster

Constant

Notes: Standard Errors computed from analytic second derivatives (Newton) in parentheses p