Does geopolitical risk matter for corporate investment decisions? Evidence from cross-border acquisitions

Abstract

Heightened geopolitical risk has become the new normal. We study the effects of geopolitical risks on cross-border acquisition activity. Using military alliance to proxy for the degree of geopolitical risks, we find that the formation of military alliance between two countries is associated with greater cross-border acquisition flows. Using the recent North Atlantic Treaty Organization enlargements as identification strategy, we find stronger effects of military alliance, especially with defense pacts. One important channel is that military alliance can substitute for target countries’ institutional quality and minimize extreme geopolitical threats faced by acquirers. We find that countries with poor governance and weaker legal enforcement benefit more from military alliance, especially by receiving inbound acquisitions from major military powers. These findings highlight the role of military alliance in the global market for corporate control by reducing geopolitical risks.