International diversification and performance: The mediating role of implementation

ARTICLE IN PRESS International Business Review 17 (2008) 600–615

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International diversification and performance: The mediating role of implementation David M. Brock , Tal Yaffe Guilford Glazer School of Business and Management, Ben-Gurion University, Beer-Sheva, Israel

a r t i c l e i n f o

abstract

Article history: Received 24 July 2007 Received in revised form 16 January 2008, 21 March 2008 Accepted 9 July 2008

In this paper, we investigate the role of implementation in the effectiveness of international diversification strategies. Our approach contains several advances intended to contribute to the internationalization–performance research stream. First, we separate international diversification into two components: a growth component by which the firm moves into selected overseas markets; and an implementation component by which the firm tailors its offerings and managerial practices to international contexts. Whereas most recent research has investigated the internationalization/growth issues, we pay attention to implementation. Our theory presents the implementation variables mediating the effect of internationalization on performance. We also broaden the scope of enquiry by using a more dynamic measure of firm performance. Our theory building and testing first address these general issues and then focus on the use of a key implementation variable, namely the use of partner leverage, in globalizing law firms. & 2008 Elsevier Ltd. All rights reserved.

Keywords: International diversification Implementation Law Leverage Performance

1. Introduction Recent research has sounded several warnings on the downside of internationalization, showing the non-linear and often negative relationship between international diversification and various measures of profitability (e.g., Chakrabarti, Singh, & Mahmood, 2007; Contractor, 2007; Fang, Wade, Delios, & Beamish, 2007; Gary, 2005; Goerzen & Beamish, 2003; Hitt, Bierman, Uhlenbruck, & Shimizu, 2006a; Hitt, Tihanyi, Miller, & Connelly, 2006b; Lu & Beamish, 2004). However, most studies have tried to explain these effects in terms of exogenous factors that are not directly controllable by management—like economies of scale, economies of scope, costs of foreign entry, and learning effects/costs. In this paper, we follow those few studies that break from this trend—for example, Gary’s (2005) study of diversification strategy implementation and Hitt et al. (2006a) showing the importance of various human resources in law-firm internationalization—by investigating other implementation factors that are endogenous to the management of internationalizing firms. The specific contributions of this paper include the separation of internationalization strategies into growth and implementation vectors; studying the mediating roles of strategy implementation between internationalization strategies and firm performance; and generally exploring the process underlying the relationship between internationalization and performance. Also, our method also goes several steps further than prior studies, controlling for several context and strategy variables, and using multiple measures of firm performance. In the next section, we explore the extant literature on the topics of international diversification in general and the law-firm context in specific.

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E-mail addresses: [email protected] (D.M. Brock), [email protected] (T. Yaffe). 0969-5931/$ - see front matter & 2008 Elsevier Ltd. All rights reserved. doi:10.1016/j.ibusrev.2008.07.003

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2. International diversification International diversification is a growth strategy whereby the firm seeks market opportunities offshore (Capar & Kotabe, 2003). Contractor, Kundu, and Hsu (2003) and Sarkar, Cavusgil, and Aulakh (1999) use the term ‘‘international expansion’’, while Ruigrok and Wagner (2003) and Hitt et al. (2006a) talk about ‘‘internationalization’’ to describe similar concepts. This is usually a spatial or market diversification, not necessarily in the product domain—in other words, firms tend to use the same set of service offerings and diversify into new markets (Løwendahl, 2000). While firms generally expand internationally with a view to improving their long-run financial performance, research on diversification in general (e.g., Campa & Kedia, 2002; Graham, Lemmon, & Wolf, 2002; Palich, Cardinal, & Miller, 2000) and international diversification in particular (e.g., Goerzen & Beamish, 2003; Kotabe, Srinivasan, & Aulakh, 2002; Lu & Beamish, 2004; Ruigrok & Wagner, 2003) has questioned the efficacies of these strategies. Even when economies of scope and efficiencies can be exploited by expanding into additional national markets, these benefits are generally more likely to be present in manufacturing and other capital-intensive industries than they are in services (Capar & Kotabe, 2003). In fact, some recent studies point to an S-shaped return–multinationality curve implying an initial U-shaped effect followed by decreasing returns for highly internationalized firms expanding into peripheral markets, areas of large cultural distance, and incurring high coordination costs in highly dispersed markets (Contractor, 2007; Contractor et al., 2003; Lu & Beamish, 2004). Ruigrok and Wagner (2003) conclude that the internationalization–performance relationship may T be U-shaped for German firms and -shaped for US firms, as the former tend to diversify early into unrelated markets (which hurt returns) while Americans opt for relatively related markets early-on (which help returns) and later move further away from home. Amid some variations, there seems to be a weight of evidence that initial internationalization often results in negative returns until some future stage in which firms learn to manage their internationalization better. Our article builds on this literature, and points to some areas in which learning needs to occur in order to successfully implement international diversification strategies. Our theoretical framework follows the work of Hitt, Hoskisson, and Kim (1997) that shows how returns to internationalization are a function of the ability of the firm to structure its overseas operations to reduce transaction costs and expedite information processing; and over time to learn to attract and retain the relatively rare resources (like knowledge and experience) that the firm needs in order to compete effectively in overseas markets. The following paragraphs proceed to assemble this framework, primarily through an integration of concepts from the resource-based view, and learning theory. 2.1. Resources and learning The firm’s ability to succeed in internationalization requires the overall capability to achieve both revenue and cost benefits (Hitt et al., 1997), and this entails a set of dynamic capabilities (Eisenhardt & Martin, 2000) that includes the ability to structure foreign business units effectively, hiring and retaining suitably qualified staff; and learning from new sources of information about clients, competition, costs, and technologies. Blomstermo, Eriksson, Lindstrand and Sharma (2004) use the term ‘‘experiential knowledge’’ to include a wide range or accumulated knowledge concerning the firm’s international operations in various markets, and the capability to exploit this knowledge in an ongoing and effective way. Hadley and Wilson (2003) similarly discuss ‘‘experiential knowledge’’ as a key capability for the internationalizing firm. Experiential knowledge reflects the firm’s ability to tap into its know-how with respect to making smart choices in the process of internationalizing. For example, an experienced firm is more likely to select suitable locations, suppliers, partners and information systems in foreign locations (Fang et al., 2007). The resource-based view of the firm would see this experiential knowledge as a rare, inimitable, and valuable resource that would lead to competitive advantages for the internationalizing firm—a set of capabilities summarized by Maister (2005) as ‘‘a track record of being superb.’’ In sum, resource and learning considerations help us conceive of the dynamic capabilities that a firm would need for successful globalization. We will show below how the firm’s ability to accumulate and exploit these capabilities. But first some background on the context of this study. 2.2. The context of global law firms Given the rising importance of knowledge-intensive services in the contemporary economy, the industry/sector backdrop for the study is the emerging field of global law firms. We use the global moniker referring to the very largest (e.g., top 100) law firms in the world all of whom are internationalized to some extent: although a few of them have offices in only one country, even these have significant overseas clients. The vast majority of law firms are tiny, comprising perhaps a single professional or a small partnership; and their work is also mainly local, be it transferring a home from one family to another or representing a client in a local court. Global law firms, on the other hand, tend to focus more on investment banking, major litigation usually involving a multinational and/or governmental organization, and transactional law (e.g., contracts, patents) for similar large organizations (Brock, Yaffe, & Dembovsky, 2006; Pinnington & Morris, 2003). These firms are highly competitive, profit oriented, and place substantial emphasis on the annual ratings of firms based on various profitability and growth measures1 (Cannon, 1997; Carlson, 2004; Denny, 2003, 2004; Flood, 1999). 1

We expand on this point in Section 4, where the performance measures are justified and explained.

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3. Strategies and performance of the global law firm The aim of international diversification may be to exploit emerging market opportunities (Chakrabarti et al., 2007), to follow existing clients (Spar, 1997), or perhaps as a defensive foil against possible invasion of their home turf by foreign competitors (Porter, 1980). However, there are likely to be limits to the firm’s ability to diversify into foreign markets: Hymer (1976) introduced the concept of ‘‘foreignness as a liability,’’ assuming that operating abroad exposes the internationalizing firm to inefficiencies such as higher coordination costs, inexperience with the local market, and lack of familiarity with local culture and employment practices. The internationalizing firm must constantly cope with the inefficiencies involved with entering remote markets, unfamiliar legal systems, and foreign cultures. Leverage/partner. While some firms may experience positive learning effects as they expand, our survey of research has thus far not found these benefits to be consistently significant. In fact, as mentioned earlier, recent research (e.g., Contractor et al., 2003; Fang et al., 2007; Palich et al., 2000) has pointed to various zones of increasing and decreasing returns to international diversification. The above survey of relevant literature indicates mixed aggregate relationships between this strategy and performance—with ups and downs based on learning effects, country of origin, economies of scale, and other exogenous effects. As such we do not propose any simple or aggregate hypotheses linking international diversification and performance. Our approach is to separate the effects of internationalization into two parts (or effects), namely growth and implementation: The first effect is a growth vector for which the firm needs a similar set of capabilities—like working capital, people, and marketing—needed for domestic growth. The second effect is more central to this paper, requiring capabilities specific to expanding into foreign markets, such as market selection, structuring of reporting relationships, cultural integration, and political/legal integration. We will discuss these two categories of capabilities and how they might relate to firm performance in the following sections. 3.1. Internationalization and growth As is generally the case in strategic management, growth strategies reflect an orientation to increasing size, top-line revenues, and market presence (Buzzell & Gale, 1987). Growth represents the common business objective of gaining market position—in the context of internationalizing service firms this generally means increased offices overseas. The consequences of international diversification are in some ways analogous to those of the abovementioned growth strategy: to the extent that growth is a necessary condition for internationalization, the international firm will pursue growth in revenues (at least as a by-product of its international expansion) (Goerzen & Beamish, 2003). When knowledge intensive service firms internationalize, they generally are able to take advantage of new business opportunities with very little added investment in infrastructure. It seems that the general expansion model followed by successful firms is initially to build a network of domestic offices from which to launch international expansion (Brock et al., 2006). Also, they may follow existing, lucrative clients abroad (Spar, 1997). International growth thus builds (at least initially) off existing resources—offices, reputation, information systems, people, and experiential knowledge. In this way they begin to achieve what Hitt et al. (1997, p. 789) refer to as ‘‘the learning needed to prepare for managing international diversification.’’ The entry strategy generally includes acquiring offices in foreign locations where there is growing demand for their services. Organizational changes are slight, using what Perlmutter (1969) would call an ‘‘ethnocentric’’ approach whereby management control, leadership, and information systems come from the home country. The internationalizing firm thus is likely to experience growth in its assets and revenues. Also, this growth effect of internationalization is likely to be profitable due to the fact that the firm can take advantage of extant business opportunities with minimal risk, need for reorganization, and major expenditure. Thus, we summarize the above arguments with the growth variables mediating the effect of internationalization on profitability: H1a. Internationalization will have a positive direct effect on firm growth; H1b. Firm growth will have a positive direct effect on firm revenue growth; H1c. Revenue growth will have a positive direct effect on firm profitability growth; or, in sum, H1. Internationalization will have a positive indirect effect on profitability growth, through its effect on size and consequently on the revenue growth. The direct effects are also labeled in Fig. 1. 3.2. Internationalization and implementation We now consider aspects of internationalization where the firm needs to face the realities of structuring its operations across diverse and often distant markets. Key resources in knowledge-intensive industries like law are human resources (Hitt et al., 2006a). A key capability in these contexts is managing the trade-off between allocating professionals of different costs and capabilities in a way that satisfies clients in an effective way. Leverage—or the ratio of junior to senior

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Firm Growth

H1a

H1b +

603

Revenue Growth

dg

dr

+

% Lawyers abroad

H1c

+

+

_ H2a H2b Leverage Growth

+ dl

Profitability Growth dp

Fig. 1. Initial hypothesized model.

professionals—is a key organizational and strategy implementation variable in professional service firms (Maister, 1997). Generally, the concept of leverage may be conceived of as the ratio of fixed to variable assets (operating leverage) or debt to equity capital (financial leverage). In the context of large law firms, all of whom use some form of partnership structure, we consider leverage to be a ratio of total lawyers to partners. Collins (2007) defines leverage as the use of ‘‘the use of nonequity fee earners’’ like junior lawyers and legal assistants to boost the income of equity partners. A large leverage ratio (for example, around four or five) may indicate that the firm has very competent and independent junior lawyers; and, if sustainable, will contribute to partner profitability. On the other hand, high leverage may result in disenchantment of behalf of lawyers with their chances of promotion (to partner) and perception of behalf of clients that their work is being done by less qualified staff (Sherer & Lee, 2002). Options, specifics, and variations about how this ratio may be operationalized will be discussed later. The population of global law firms represents relatively successful organizations that already have learned the dynamic capability of balancing the demands of client needs and lawyer abilities—at least to some extent. We can thus assume that the range of leverage strategies represent optional positions that reflect some strategic reality of the firm (Maister, 1997). Profitability in these firms surely demands some capability to manage the nexus between partners and other professionals. For example, because firms are trying to maximize profitability, we can expect that firms will try to maximize leverage at some acceptable level of service quality. Generally, leverage will thus be positively associated with profitability; and leverage growth will be positively associated with profitability growth. It is ever clearer from the behavior of these firms that they are paying increasing attention to maximizing their leverage ratios (Carlson, 2004; Collins, 2007). For example, the tactic of ‘‘de-equitizing’’ partners is now increasingly used not only to decrease the number of equity partners and thus arithmetically improve profitability2 ratios, but also as a demotion for less productive partners (Denny, 2003). The class of non-equity partners was fairly uncommon until recently. However, there is more to this tactic than simple arithmetic: a substantial amount of managerial and systems capability is required for an effective interface between partners, associates, assistants and clients. For example, clients who engage these elite firms for important (and lucrative) cases or contracts should not get the impression that their work is being done by junior staff or that they are not getting the attention of a senior partner. Further, the complexities related to internationalization are likely to increase the difficulties in managing the leverage ratio. For example, it is harder for lawyers of various levels, legal assistants, and clients to communicate if they are dispersed across several offices, languages, and time zones. These problems multiply as a result of increasingly distant offices and partners as the firm becomes increasingly global. Most global law firms are North American, and thus decentralization does not come naturally to them (Young & Tavares, 2004). Moreover, according to basic contingency theory (Lawrence & Lorsch, 1967), complex environments are best implemented with decentralized structure—however, the myriad integrating mechanisms needed to ensure seamless top-quality professional services in these contexts pose managerial and organizational challenges. As argued earlier, experiential knowledge, the key capability for the internationalizing professional firm, is a vital resource to allow integration of the interface among clients and the set of firm representatives involved with client service. However, this knowledge is often location, language, or service-specific, making global strategies tricky to implement. Thus, Brock et al. (2006, p. 487) describe such integrating mechanisms as

2 The most common profitability ratio currently in use among global law firms is ‘‘profits per equity partner,’’ or PEP—to be discussed later in the measurement section.

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Table 1 Some descriptive statistics and correlations Mean

S.D.

1. Origin 2. PPP 2001 ($’000) 0.15 0.36 3. Firm size 814.69 451.3 4. Growth in lawyers 750.08 465.51 5. % Lawyers abroad 0.17 0.18 6. Offices in no. of countries 14.05 17.57 7. Leverage change 6.43 6.45 8. Non-Eq partners 0.17 0.21 9. % Growth in revenues 67.82 69.25 10. PEP 2003 17.43 16.76 11. PEP Growth (0103) 877.55 375.99 9.94 16.87

1

2

3

4

5

6

7

8

9

10

0.14 0.44 0 0.54 0.48 0.1 0.03 0.13 0.02 0.43

0.02 0.04 0.16 0.15 0.16 0.35 0.34 0.93 0.29

0.04 0.60 0.68 0 0.30 0.03 0.04 0.18

0.06 0.05 0.54 0.27 0.71 0.06 0.08

0.92 0.13 0.12 0.04 0.08 0.24

0.11 0.07 0.61 0.02 0.42 0.40 0.08 0.07 0.17 0.2 0.21 0.35 0.31 0.42 0.04

 po0.05.  po0.01.  po0.001.

‘‘speed-dating for lawyers’’ to build up client-relevant organizational knowledge. Further, the sensitive negotiations involving status changes between equity and non-equity partnership are more likely to be complicated when involving culturally diverse partners operating in dissimilar legal systems. One can imagine the array of difficulties confronting a senior partner who needs to meet with a partner from a different country and explain in a language that is not a common mother-tongue why the firm has decided to demote the partner to non-equity status. Thus, the more international the firm, the more difficult it will be successfully to implement leverage strategies; and this may explain firms’ lack of effectiveness in internationalization diversification. We summarize the above arguments with the implementation variables mediating the effect of internationalization on profitability: H2a. Internationalization will have a negative direct effect on leverage; H2b. Leverage will have a positive direct effect on profitability growth; or, in sum, H2. Internationalization will have negative indirect effect on profitability growth, through its negative effect on the leverage growth. In the following sections, we describe our method, data sources, and analyses.

4. Method There are two parts to our method: first, theory testing via regression analysis in which we focus on the hypotheses. Then we use empirical modeling to understand better some of the dynamics and to dig deeper into some of the intervening effects between internationalization strategies and performance.

4.1. The data We collected data on the world’s largest law firms from The American Lawyer (www.law.com) and Legal Business 100 tables (www.legalbusiness.co.uk). These tables list the top 100 law firms by revenue, profits per equity partner, and several other measures. We collected comparable data for the 2001 and 2003 years thus giving our study a 2-year time horizon. However, due to some missing data, entry/departure from the list over the 2001 to 2003 periods and an outlier,3 we were able to work with data from only 89 firms that remained on the lists throughout. Of these, 76 are US firms (or global firms originating from the US) and 13 British. A small number of Australian, Canadian, and Continental European firms that have appeared in the second half of these top-100 rankings were among those eliminated for missing data. A correlation matrix and other descriptive statistics appear in Table 1. 3 Our statistical software constantly indicated that the firm Wachtell, Lipton, Rosen and Katz is an outlier, and we subsequently eliminated their data from our analyses. This firm has been the topic of several case studies and also scholarly analysis (e.g., Starbuck, 1993) confirming their status as a truly exceptional organization. For example, their profitability has averaged around $3 million per partner, 5.5 standard deviations above the mean for these top-100 firms.

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4.2. Dependent (performance) variables Because no one performance measure can hope to capture all aspects of the performance of an organization, one of the contributions of this paper is that we use three dependent variables, two of which are profitability measures and one growth measure. Further, unlike listed corporations where measures like return on assets earning per share are more likely to resonate with shareholders, the law literature we surveyed (Carlson, 2004; Chen, 2007; Collins, 2007; Denny, 2003, 2004; Flood, 1999; Løwendahl, 1997; Sherer & Lee, 2002) pointed us to profitability and growth measures commonly used in these contexts. The two profitability measures are profits per equity partner (PEP) for the year 2003; and growth in PEP between the 2001 and 2003 years. These are justifiable by assuming that the prime objective of these super-large law firms is the maximization of partner profits. PEP maximization has an additional benefit as various agencies like Amlaw and Legal Business rank law firms according to variables like PEP and revenues; and these measures thus become a signal of status and quality in the industry, which in turn can lead to business opportunities. In the same way as rankings of business schools become an end unto themselves in the absence of more objective measures of education quality, so do PEP and other measures used in legal industry rankings assume primary significance as strategic aims of global law firms. The third item that we used as a dependent variable was growth in revenue, or percentage increase in gross revenue (2001–2003), an important indicator of the firm’s ability to compete successfully in the increasingly deregulated and cutthroat industry of legal business services. Positive growth is also essential for these elite firms to maintain good stature in annual rankings such as Amlaw and Legal Business. The cardinal importance of growth in both PEP and revenues is clear in the way the legal press report on firms’ results—for example, a recent report on the 2006 American Lawyer 100 states ‘‘Compared to 2005, average revenue per lawyer went up 7.3 percent y, and average gross revenue shot up 11.4 percent y [and] head count also grew by 3.9 percent’’ (Chen, 2007). 4.3. Control (context) variables In investigating these issues, we also want to control for various contextual variables that may account for unique variance in firms’ outcomes. The three areas of context of concern are origin, size, and baseline profitability. There have historically been two dominant distinct domains for global law firms, namely London and New York. London firms have been more global yet less profitable than their American counterparts (Flood, 1999). We thus want to control for country of origin. Firm size, via its association with market power, is generally considered to be related to profitability (Buzzell & Gale, 1987). Larger firms may also have more difficulty sustaining growth rates. Number of workers (lawyers, in our case) is a particularly apt surrogate for firm size in knowledge intensive industries. Baseline firm size was measured by the natural logarithm of the total number of lawyers in the firm in 2001. Log transformation makes the results easer to interpret, and also make the distribution of data closer to normality (Contractor et al., 2003). Finally, we want to control for baseline profitability due to the fact that prior years’ profitability is expected to be a close predictor of future profits. Because non-equity partnerships were relatively rare in 2001, we use here a profitability measure more common at that time—namely profits divided by total partners, a measure akin to return on assets. More details on how variables were operationalized are as follows:

 Country of origin (UK ¼ 1, US ¼ 0);  Log of number of lawyers for 2001 year (baseline firm size); and,  Profits per partner (PPP) in 2001 year (baseline profitability). 4.4. International diversification In law firms, the number of lawyers is often used as a surrogate for investment in a specific location. Common measures of internationalization relate the proportion of the firm’s assets or sales in the abroad versus in the home country. An alternative way to consider degree of internationalization is the number of different countries in which the firm has offices. We thus used the following two measures of internationalization:

 Percentage lawyers abroad in the 2003 year; and  Number of countries in which the firms had offices in 2003. 4.5. Growth Again we use number of lawyers as a surrogate for the assets of the firm.

 Percentage growth in number of lawyers between 2001 and 2003.

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Table 2 Predictors of internationalization strategy % Lawyers abroad

Origin PPP 01 ($) No. of lawyers 01

b

t

0.32 0.10 0.45

3.6 1.3 5.1

Offices in no. of countries F (d.f.)

24.3 (3,85)

2

Adj. R

b

t

0.32 0.10 0.61

3.6 1.3 7.0

0.44

F (d.f.)

Adj. R2

30.1 (3,85)

0.50

 po0.01.  po0.001.

4.6. Leverage As discussed above, measures of leverage we are indications of the extent to which the firm is using professionals who are non-equity fee earners versus those who are equity partners (Collins, 2007) versus those who are equity partners. Also, given the importance of growth in these contexts (Chen, 2007), we also use a dynamic measure that captures change in leverage.

 Number of non-equity partners in 2003.  Leverage change (% change in lawyer-to-equity-partner-ratio between 2001 and 2003). 5. Analyses and findings Given the paucity of data on large professional service firms in general and global law firms in particular, we began with some analyses to explore the organizations in question and their context. Hierarchical regression was used to explore the three dependent variables and basic hypotheses. Then, because our general hypotheses involve complex effects, we use structural equation modeling (SEM) for more in-depth analyses of the internationalization–profitability issue. The 89 mega-law firms present some interesting descriptive statistics—see Table 1 (the two internationalization variables are presented in bold for ease of identification). For example, 2001 mean profits per partner were $814,690; average size was 750 lawyers; and PEP grew almost 10% over the 2001–2003 period. There are also strong correlations between the size variables (number of lawyers) and internationalization (lawyers abroad, offices in different countries), showing that the bigger the firm the more likely it is to have a large international network of offices and lawyers. This indicates that the expected growth trajectory for these already-large firms is a global strategy. The correlations between the indicators of international diversification (% lawyers abroad, offices in no. of countries) and the performance measures are far from unequivocal. Correlation coefficients with both revenue growth and 2003 profitability were not significant, while profitability growth was correlated negatively (0.24 and 0.21; both po0.05) to the two internationalization measures. This indicates that internationalization hurt profitability growth over the 2-year period of the study. To continue with this exploration, we investigate the effects of various contextual variables on these internationalization–performance relationships. 5.1. Contextual variables We began by using regression to explore the context of internationalization. The three contextual variables (country of origin, baseline profitability, and firm size) were used as independent variables, and internationalization as the dependent variable. As we have two measures of internationalization (% lawyers abroad, offices in number of countries), we performed separate regressions, but found that either internationalization measure gave more or less the same results.4 The two regression summaries are shown in Table 2. Both the firm size in 2001 (b ¼ 0.45, po0.001) and the country of origin (b ¼ 0.32, po0.001) seem to have significant and considerable contribution to the explained variance in internationalization (adjusted R2 ¼ 0.44), as indicated by the percentage of lawyers abroad. The firm profitability in 2001 (PPP) was not strongly related to either measure of international diversification. Remembering the coding of the origin variable (0 ¼ US, 1 ¼ UK), this pattern is consistent with the reputation that UK firms are larger and tend to have higher international diversification. Results for the second indicator of internationalization suggest the same pattern, with somewhat more salient effect on internationalization of firm size (b ¼ 0.61, po0.001) compared to its nationality (b ¼ 0.32, po0.001), and higher percent of explained variance in this strategy (adjusted R2 ¼ 0.50). This confirms the strong correlation between size and internationalization mentioned 4

The two measures are highly correlated, as indicated by the correlation coefficient of 0.92 in Table 1.

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Table 3 Effects of strategy on firm performance % Growth in GR (2001–2003)

b Step 1: Controls Origin PPP 01($) Firm size (01) Step 2: Strategy Origin PPP 01($) Firm size (01) Growth in lawyers % Lawyers abroad Leverage change

T

DF (d.f.) 3.9 (3,85)

0.1 0.85 0.36 5.2 0.02 0.13 0.16 1.3 0.36 5.2 0.06 0.69 0.75 9.3 0.01 0.16 0.05 0.64

Profitability (PEP 2003) 2

Adj. R

2

DR

0.09

40.4 (3,82) 0.62

DF (d.f.) Adj. R

t

b

0.15 0.95 0 0.52 0.16 0.96 0.02 0.03 0.04 0.09

Profitability change 2

226.9 0.885 3.8 26.1 0.09 1.5 3.6  25.9 0.43 0.75 0.79 2.0

2

DR

t

b

DF (d.f.)

0.41 3.8 0.24 2.5 0.01 0.11 0.887

0.01 0.4 0.19 0.05 0.12 0.09 0.36

3.6 2.1 0.42 1.1

Adj. R2 DR2

9.1 (3,85) 0.21

3.6 (3,82)

0.28

0.09

0.67 3.1

 po0.05.  po0.01.  po0.001.

above (when surveying the initial descriptive statistics in Table 1) and also reinforces the nationality issue—namely that the UK firms are significantly more internationally diversified than the Americans. The first point indicates that larger firms are more international, which is barely surprising. The point on nationality is less a function of strategy than one of history and geography, given London’s long-standing reputation as an international trading hub and its relative proximity to a variety of foreign shores. However, the non-finding—i.e., the lack of correlation5 once again between profitability and both measures of internationalization—reminds us of the ambiguous state of the internationalization-performance literature discussed above. 5.2. Performance A main research issue is to explore the internationalization–performance relationship. We used hierarchical regression analyses to examine the effects of internationalization6 on the three measures of firm performance. In the first steps, the control variables (firm origin, size and baseline profitability) were entered. These three variables are used because they indicate relevant aspects of the firms’ context that correlate with aspects of performance (see Table 1). These were followed by the three strategic variables: international diversification, growth (in number of lawyers) and leverage (change in the lawyers-to-partner ratio). In order to avoid multicolinearity, we excluded pairs of highly correlated variables (e.g., PEP and PEP growth; and ‘‘% lawyers abroad’’ and ‘‘offices in number of countries’’) in the same equation. The VIF (variance inflation factor) and the tolerance indicators in all the regression analyses reported were rather low, indicating that multicollinearity is not a problem. Specifically, the VIF values range between 1.0 and 1.9, and the tolerance values range between 0.59 and 0.98. As can be seen in Table 3, the control variables explained significant aspects of all three performance measures: 88.5% of the variance in the partner profitability, 21% of profitability change, and 9% of revenue growth. This indicates that significant aspects of a firm’s performance are relatively fixed in the short term. Baseline profitability (PPP 2001) is a strong predictor of 2003 PEP (b ¼ 0.95, po0.001), but had negative effects on the other two performance measures: growth in revenue (b ¼ 0.36, po0.001), and profitability change (b ¼ 0.24, po0.01). The country of origin results (b ¼ 0.41, po0.001) suggests the US firms had faster profitability growth rates. After controlling for the firm origin, starting profitability, and size, the three strategy variables (internationalization, growth, leverage) contributed 52% to the explained variance in revenue growth and 9% to the explained variance in profitability change. However, because this combined effect of the three controllable aspects of strategy may well hide some individual subtleties, we continued to explore each aspect separately. Growth is a significant predictor of growth in revenue (b ¼ 0.75, po0.001), but did not significantly affect firm profitability and profitability change. This finding gives partial support for Hypothesis 1b, although more in-depth treatment of the hypothesis tests will be presented in the following section. As foreshadowed in Hypothesis 2b, leverage change7 is a significant predictor of the two profitability measures (b ¼ 0.09, po0.05 for PEP; and b ¼ 0.36, po0.001 for PEP change), although it did not affect the revenue growth. This evident power of leverage is an important finding relative to the strategic context of all partnership-governed 5

We also examined nonlinear (cubic, quadratic/squared) models, none of which yielded any significant effect on our dependent variables. Give that our two measures of internationalization (‘‘% lawyers abroad’’ and ‘‘offices in number of countries’’) are highly correlated, we show only the former in these analyses (see Table 3). Very similar outcomes were obtained when using the ‘‘offices in number of countries’’ measure. 7 As indicated by changes over the 2-year period in the lawyer-to-equity partner ratio. 6

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professional organizations, and we will return to further analyses of some of the strategic implications in the following section. However, the lack of statistical effect of internationalization (% lawyers abroad) is perplexing—perhaps a reflection of the to-and-fro u-shaped versus n-shaped versus s-shaped diversification debates outlined earlier. We will also pursue this issue via further analyses in the following section. Our analysis thus far has aimed at an understanding of the main aggregate relationships among our strategic, context and effectives variables. However, in order to explore more fully the processes involved—including direct and indirect relationships among the strategic variables and performance—the final section of our analyses switch to using SEM.

6. Testing potential complex effects of internationalization In addition to the relatively static analysis presented above, we want to explore some more dynamic relationships between the strategic and performance variables in our model. We further wanted to extend our understanding of the internationalization–performance relationship. For these purposes we used SEM, a statistical method that extends general linear model procedures. SEM enables researchers to examine a set of regression equations simultaneously, in order to gain a better understanding of the relationships within a set of theoretical variables. Although SEM is generally a priori methodology and requires thinking in terms of models, many applications of SEM are a blend of exploratory and confirmatory analyses (Kline, 1998). SEM analysis enables us to explore more complex effects of strategic behavior and performance. Specifically, while regression analysis introduces the direct effect of a strategy (like international diversification) on each of the firm’s outcomes, it does not readily show potential indirect (mediated) effects. SEM, on the other hand, allows us to observe effects that operate in opposite directions, and thus might offset each other. For example, it may well be—as hypothesized in H1 and H2—that one aspect of internationalization causes increased profit growth and another aspect causes decreases. So while prior analyses show no statistical relationship between internationalization and profitability, SEM may reveal some subtleties of how the internationalization impacts on the firm. Jo¨reskog (1993) identified three approaches in SEM: strictly confirmatory, alternatives models, and model generation. In the strictly confirmatory mode, the researcher postulate a single model based on theory, collects the appropriate data and then tests the fit of the hypothesized model to the sample data; and based on this test, the researcher either rejects or except the model. In the alternatives models approach, the researcher proposes several alternative theoretical models, and examines which of them better represent the sample data. Finally, in the model generation approach, the rejection of a theory-based model on the basis of its poor fit to the data, lead researchers to proceed in an exploratory fashion to modify and re-estimate the model. The primary focus in this most common approach is to locate the source of misfit in the model and to determine a substantively meaningful model that describes the data better (Byrne, 2001, p. 8). On the basis of the above theory and hypotheses we postulated a structural causal model that is focuses on two paths through which aspects of firms’ international diversification (in terms of percentage lawyers abroad) might affect the firm’s growth and profitability growth (see Fig. 1). We choose to examine these two dependent variables for reasons of relevance—i.e., importance to managers of global law firms—and statistical convenience—the PEP variable creates multicollinearity problems due to its correlation with other key variables in the model. A basic assumption in this initial model is that firm’s profitability growth is a function of two mediating factors, namely, the growth in firm’s revenue and the growth in the leverage (lawyer per equity partner ratio). Thus, internationalization might indirectly affect firm’s profitability in either or both of these paths. Further, growth in a firm’s size is expected to enhance both mediating factors—revenue and leverage growth—as the firms hires more lawyers than partners to cope with the growth (H1b and H1c). The model includes both the positive and the negative effects of international diversification on profitability growth. The positive effect is from the fact that the international diversification seems to result in increases in the firm’s size (in terms of number of lawyers). This increased size should lead to increased revenue, which should (other things equal) increase the firm’s profits (H1). The negative effect is hypothesized to be a result of an actual difficulty to manage leverage. As argued above, these difficulties tend to increase as a result of spatial differentiation of offices and partners as the firm becomes increasingly global. Also, more global firms are likely to find that the diverse legal and cultural systems in which they operate add complexity to these non-equity partner appointments, making them more difficult to implement. For these reasons increased international diversification could hinder leverage growth, which in turn, decrease profitability growth (H2). We applied SEM analysis using AMOS 4.0 program (Arbuckle & Wothke, 1999) to estimate the goodness of fit of the hypothesized model. However, several fit indexes indicated that the model does not fit the data adequately: the chi-square index was significant (w2 ¼ 26.2, d.f. ¼ 4, po0.001). The normed fit index (NFI) and the Tucker–Lewis index (TLI) values were below the acceptable level of 0.90 (NFI ¼ 0.82, TLI ¼ 0.59) suggested by Bentler and Bonet (1980, p. 600), while the root mean square of approximation (RMSEA) was 0.25, which is above the reasonable level of 0.08 suggested by Browne and Cudeck (1993). To explore further our model adequacy, we examined both the estimated path coefficients and the modification index (MI). All the path coefficients yield significant level, except for the hypothesized effect of international strategy on the growth in number of lawyers. However, since path coefficients are quite meaningless in a model with poor fit to data, we followed the advice of Jo¨reskog (1993) and Byrne (2001, p. 8) first to examine MI to locate the source of misfit in the model and finally to determine a substantively meaningful model that describes the data better, balancing parsimony and fit. This

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Increase in Lawyers

0.71∗∗

609

R2=0.50∗∗ Revenue Growth dr

% Lawyers abroad

-0.65∗∗

0.55∗∗

0.72∗∗

-0.17∗∗ R2=0.38∗∗

R2=0.33∗∗ Leverage Growth

0.40∗∗ dl

Profitability Growth dp

Chi-square=4.082, df=4, p<.395, chi-square/df=1.021 CFI=.999, NFI=.972, TLI=.998, RMSEA=.015 ∗ p<.05, ∗∗ p<.01 Fig. 2. Summative structural equation model; w2 ¼ 4.082, d.f. ¼ 4, po.395, w2/d.f. ¼ 1.021; CFI ¼ .999, NFI ¼ .972, TLI ¼ .998, RMSEA ¼ .015; *po.05, **po.01.

index (MI ¼ 8.5) suggests that the missing link in our model is a path of direct negative effect of the firm’s increases in size on profitability growth. This effect may indicate that some inefficiency in the management of fast growing firms results in revenue growth but leads to decreased profitability. Another explanation would be that there is a lagged effect of revenue growth—so that in this 2-year period some costs of growth (e.g., hiring additional lawyers and opening new offices) are borne before revenue growth follows. After adding this direct path the model fit the data very well. Fig. 2 presents the summative model with the standardized path estimates and the fit indexes values. We further used the Bootstrap method (Efron, 1979) to examine the significance of the direct, indirect and total effects of the variables in our model. This resampling method enables researchers to create multiple independent sub-samples from an original database, which technically operates as a sampling distribution. However, this is an empirical, rather than theoretical sampling distribution, and thus free from restricting assumptions (i.e., multivariate normality) inherent in classic inferential statistics. This method also enables significant tests for parameters such as indirect effect and squared multiple correlation, that cannot be applied in the usual (maximum likelihood or general least square) estimations methods (Arbuckle & Wothke, 1999). The standardized effects yielded by the bootstrap analysis are shown in Table 4. These analyses further support our hypotheses about the direct effects of revenue growth and leverage growth on firm’s profitability growth (H1c and H2b). However, the hypotheses regarding the effects of internationalization strategy on growth and profitability are only partially supported. Specifically, results support the hypothesized positive indirect effects of the increase in lawyers on the firm’s profitability growth (H1b and H1c). However, a non-hypothesized negative direct effect of this variable (illustrated as the diagonal in Fig. 2) offset the indirect positive effects, resulting in a non-significant total effect. Concerning internationalization, results support the hypothesized negative indirect effect on the firm’s profitability growth, through its effect on the leverage growth (H2). However, in contrast to our initial hypothesis (H1), this strategy did not lead to increase in number of lawyers, and thus did not have a positive indirect effect on profitability growth. In sum, the conclusion of this analysis is that it is the increase in lawyers, rather than internationalization, which results in positive and negative effects that offset each other, resulting in no net significant effect on profitability growth. In contrast, international diversification exerts a significant (albeit small) negative effect on firm profitability growth. Note that these SEM results are consistent with the regression results regarding the direct effects. However, SEM analysis adds to our understanding of the more complex indirect effects that are not reflected in the regression analysis. To validate the relevance of our results, we examine the above model along with several available context variables that might affect strategic choices, firm’s outcomes, or both. In this analysis we particularly wanted to verify two things. First, that strategy—i.e. extent of internationalization, growth and leverage—does indeed account for additional variance in firms’ outcomes above and beyond the variance explained by firms characteristics; and also that these effects are not a results of a third (contextual) variable which affect both strategy and firms’ profitability, thus yielding spurious relationships.

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Table 4 Bootstrap results: standardized direct, indirect and total effects Independent

Dependent International strategy

International. Strategy Direct Indirecta Total effect Increase in lawyers Direct Indirecta Total effect

Increase in lawyers

Leverage growth

Revenue growth

Profitability growth

0.17 (0.05)**

0.07 (0.03)**

0.17 (0.05)**

0.07 (0.03)**

0.55 (0.09)**

0.71 (0.09)**

0.65 (0.21)** 0.73 (0.18)**

0.55 (0.09)**

0.72 (0.09)**

0.08 (0.09)

Leverage growth Direct effect

0.40 (0.09)**

Revenue growth Direct effect

0.72 (0.14)**

R2

0.33**

0.50**

0.38**

(a) Bootstrap estimates are the means of parameter estimates from 2000 independent samples drawn from the original sample. Bootstrap standard errors introduce in parentheses. (b) Two-tailed significance—bias corrected; *po0.05, **po0.01. a Indirect effects are approximately the multiplication of the indirect path from IV to DV. For example, the indirect effect of increase in lawyers on profitability is equal to 0.71  0.72+0.55  0.40 ¼ 0.73.

The results of this SEM analysis are shown in Fig. 3. In general, the inclusion of the context variables did not change the results pattern, and the effects sizes of the strategy variables are almost the same. Context variables however, add to the variance explained in both revenue growth (0.64–0.50 ¼ 14%) and profitability growth (8%). The analysis of the indirect effects in the model (using the Bootstrap method) revealed that all the context variables have significant indirect effects on the profitability growth. However, with the exception of the negative effect of the initial profitability (0.36  0.66 ¼ 0.24), these effects were very small. The interpretation of this effect is that the more profitable the firm at the start of the period, the less the firm achieved revenue growth over the 2 years (either by design or due to lack of opportunity), and thus the lower the resulting profitability growth. The model also shows that the total effects of initial profitability (0.24, po0.01) and country of origin (0.32, po0.01) on profitability growth are more salient then the total effect of the internationalization strategy (0.06, po0.01). However, the effect of leverage growth (0.37, po0.01) is even stronger (and solely direct). Our model also enables us to consider one potential reason for the negative effect of international diversification on firms’ leverage (lawyers per equity partner ratio) growth. Remember that this strategy did not seem to have any effect on number of lawyers in the firm. However, it is probable (as argued above) that more internationalized firms are less willing or able to use the non-equity partner tactic. If this is indeed the case, the negative effect of internationalization strategy on the leverage growth should be actually explained (mediated) by the use of non-equity partners. To examine this possibility, we first add the number of non-equity partners in the firm to our model as an outcome of internationalization strategy and a result of the firm’s leverage growth. Since we did not have a priori hypotheses about its relationship with the other variables in our model, we first looked at these relationships in order to design a parsimony model within which the mediation hypothesis might be evaluated. Specifically, modification index identified three other factors that have meaningful and significant effects on the number of non-equity partner: firm size, initial profitability (PPP 01) and the increase in number of lawyers 2001–2003. After adding these paths, the model presents good fit to the data (w2 ¼ 23.54, d.f. ¼ 19, po0.18; NFI ¼ 0.934; TLI ¼ 0.973; RMSEA ¼ 0.052) and thus serve as a base line model to our model comparison. We then compared three structural models: a direct effect model, a full mediation (indirect effect) model, and a partial mediation model. The direct effect model includes the direct path from internationalization strategy to the leverage growth, omitting the indirect effect through the non-equity partners (practically, restricting the two path, to and from the mediator, to zero). The full mediation model, includes only the hypothesized indirect effect of this strategy on the leverage growth (through the non-equity partners), omitting its direct effect. The above two models are nested in our baseline model that represents the partial mediation model and includes the direct and the indirect effects of the strategy on the leverage growth. While omitting the indirect effect of internationalization on the leverage from this model yielded a

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611

R2=0.64∗∗ Increase in lawyers

Origin Country

0.72**

Revenue Growth

-0.36** 0.13 0.44

dr

0.34∗∗ PPP 01

0.02

R2=.45** % Lawyers abroad

0.45∗∗ Firm Size

-0.58∗∗ 0.66∗∗ -0.32∗∗

0.5∗∗

da

-0.17∗

R2=0.33∗∗ 0.37∗∗

Leverage Growth

R2=0.46∗∗ Profitability Growth

dl

dp

Chi-square=13.086, df=15, p<.596, chi-square:df=.872 CFI=1.000, NFI=.951, TLI=1.015, RMSEA=.000 ∗ p<.05, ∗∗ p<.01 Fig. 3. Model of strategy in context; w2 ¼ 13.086, d.f. ¼ 15, po.596, w2:d.f. ¼ .872; CFI ¼ 1.000, NFI ¼ .951, TLI ¼ 1.015, RMSEA ¼ .000; *po.05, **po.01.

Origin Country 0.13 0.44

0.34 PPP 01 0.45∗∗

0.02

dg

∗∗

Revenue Growth

-0.36∗∗

dr

R2=0.45∗∗ % Lawyers abroad da

Firm Size -0.30∗∗ 0.57∗∗

R2=0.64∗∗

0.72∗∗

Increase in lawyers

0.33∗∗

-0.43∗∗

-0.058∗∗ 0.40∗∗ -0.32∗∗

R2=0.43∗∗ Non-Equity 0.50∗∗ partners

0.65∗∗

R2=0.54∗∗ R2=0.46∗∗ Leverage Profitability ∗∗ 0.37 Growth Growth

dn

dl

dp

Chi-square=23.542, df=19, p<.214, chi-square/df=1.239 CFI=.986, NFI=.934, TLI=.973, RMSEA=.052 ∗ p<.05, ∗∗ p<.01 Fig. 4. Model of strategy in context: the non-equity partner tactic; w2 ¼ 23.542, d.f. ¼ 19, po.214, w2/d.f. ¼ 1.239; CFI ¼ .986, NFI ¼ .934, TLI ¼ .973, RMSEA ¼ .052; *po.05, **po.01.

significant decrease in the model fit to data (Dw2 ¼ 48.4, d.f. ¼ 2, po0.001), the restriction of the direct path between these variables had no such effect (Dw2 ¼ 1.9, d.f. ¼ 1, po0.16). This finding supports the full mediation model and suggests that the frequency of use of the non-equity partner tactic may indeed fully account for the negative effect of internationalization strategy on the leverage growth. This conclusion is further supported by the non-significance of the direct effect along with the significance of the indirect effect of internationalization on leverage growth, elicited by the Bootstrap method. Fig. 4 and Table 5 summarize the results of this analysis.

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Table 5 Bootstrap results: standardized direct, indirect and total effects Non-equity partners Origin Direct Indirect Total effect PPP 01 Direct Indirect Total effect Firm size 01 Direct Indirect

0.15 (0.05) 0.15 (0.05)

International strategy

0.34 (0.12)

0.34 (0.12)

0.32 (0.08)

Increase in lawyers

Leverage growth

0.32 (0.08) 0.03 (0.01)

0.07 (0.03)

0.35 (0.08)

0.15 (0.05)

0.57 (0.14) 0.19 (0.12)

0.45 (0.16)

0.38 (0.16)

0.45 (0.16)

Profitability growth

0.07 (0.03)

0.15 (0.05)

0.32 (0.08)

Revenue growth

0.36 (0.08)

0.36 (0.08)

0.29 (0.06) 0.29 (0.06)

0.19 (0.08)

0.07 (0.03)

0.19 (0.08)

0.07 (0.03)

International strategy Direct 0.43 (0.12) Indirect

0.22 (0.07)

0.08 (0.03)

0.43 (0.12)

0.22 (0.07)

0.08 (0.03)

Increase in lawyers Direct 0.33 (0.09) Indirect

0.40 (0.09) 0.16 (0.05)

0.72 (0.09)

0.58 (0.20) 0.68 (0.17)

0.33 (0.09)

0.56 (0.09)

0.72 (0.09)

0.10 (0.08)

Total effect

Total effect

Total effect

Non-equity partners Direct Indirect

0.50 (0.07) 0.50 (0.07)

0.19 (0.05) 0.19 (0.05)

Total effect Leverage growth Direct effect

0.37 (10)

Revenue growth Direct effect

0.65 (0.15 )

R2

0.43

0.45

0.54

0.64

0.46

(a) Bootstrap estimates are the means of parameter estimates from 2000 independent samples drawn from the original sample. Bootstrap standard errors introduce in parentheses. (b) Two-tailed significance—bias corrected.  po0.05.  po0.01.

Overall, the SEM confirms the several cautionary signals mentioned earlier concerning international diversification. It also confirms the centrality of leverage as a key to profitability in these contexts. In the following section, we continue with further discussions of these results, their implications, and indications for future research. 7. Conclusions Our findings contribute to better understanding of both the contextual and internal managerial correlates of internationalization performance. Our initial analysis found several interesting effects within the context of this study. First, most of the variance in performance is explained by the context variables in our study, namely baseline profitability (profitability continues, but relates negatively to firms and profitability growth), country of origin (Americans more

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profitable than British), and size (relates negatively to profitability and growth). Further, we did not find any significant contribution of international diversification to any measure of firm performance. Finally, these analyses indicated that leverage is a major contributor to profitability and profitability growth; and internationalization is negatively related to leverage. Further analyses extended and clarified the prior findings, and also allowed us to look at more complex (e.g., indirect) effects. They confirmed the importance of baseline profitability: profitable firms tend to remain profitable, but generally are slower growers. This finding seems to support the fact that there is a tradeoff between growth and profitability strategies. The SEM further helped explain some relatively complex implications of growth strategies. Growth is positively associated with both measures of leverage, namely number of non-equity partners and growth in the leverage ratio (over the 2-year period). As firms grow, they seem to use more non-partners as well as non-equity partners to staff they extended operations. This is logical given the natural lags involved with either promoting lawyers to partner or negotiating new fullpartner contracts in a growing firm. There is also a strong direct, negative effect of growth on profitability growth. However, the combined positive indirect effects via leverage and revenue growth outweigh this negative effect. It is within these dual tracks of growth and leverage that the model sheds light on the strategy of international diversification. First, the significant contextual effects are country of origin and size: British and bigger firms are more international. Then, there is a significant negative, direct effect of internationalization on the use of non-equity partners. This is important empirically because it counterbalances the positive effect of the leverage strategy on profitability growth. We also believe that it is an important contribution to internationalization theory because it shows specifically the effect of a strategic tactic on the internationalization-performance non-effect. This last point is an important contribution of this paper. Prior findings (or non-findings) on the internationalizationperformance issue have speculated as to the reason for the difficulties that firms find in foreign market—be they culture, communication, legal or lack of knowledge. Hitt et al. (1997, 2006a) encourage researchers to investigate implementation issues in international diversification. Our finding points to a specific strategy implementation difficulty: use of leverage in general and non-equity partners in specific are keys to profitability in this particular context. Yet the specifics of the internationalized context create difficulties with this tactic. The implication for firms in this dynamic market is quite clear. Just as the field changed from 2001 to 2003, it is likely to continue to change in ensuing years. Alert managers in this context will use these findings to motivate organizational competency-building to allow better strategy implementation in the future. There is little doubt now as to the salience of leverage as related to superior profitability. Getting lawyers and other non-equity partners to produce revenues efficiently relative to the number of equity partners is clearly an important capability for these firms. This is not simply an arithmetic truism, but also takes managerial competencies, information systems, and skillful support staffs to serve clients, win cases, and successfully bid for contracts with minimal involvement of the most senior professionals in the organization. This is the dynamic capability of leverage. However, as explained above, this capability seems to be hurt by international diversification. Part of the problem will disappear in firms that succeed in boosting the legitimacy of the status of nonequity partners. It will help if this rank becomes more institutionalized, employment contracts become refined to expedite them, and reward systems develop to provide appropriate compensation. Further, additional organizational competencies in inter-country information systems, client management systems, and flexible employment contracts will allow the new generation of leaders in these fields to gain additional profitability gains. In every industry there are particular tactics vital to effective strategy implementation. For example, cost control is vital in supermarketing, staff retention in software, and outsourcing in manufacturing. For global law firms, leverage is one of those crucial implementation tactics. The ability of researchers to isolate and understand these key variables is a key to better understanding and implementation of diversification. Other forms of leverage are pervasive in management, for example operating leverage (use of fixed rather than variable production assets) and financial leverage (use of debt rather than equity). All the forms of leverage tend to magnify earnings under favorable business circumstances and magnify losses in bad times. In other words, leverage increases risk. This paper shows a model of interplay between various strategic and context variables that impact on the use of leverage. And the consequent effects of performance measures. Limitations of this study include the relatively small data base and questionable generalizability. Global law firms are more like other large professional service providers—like the large accounting, consulting investment banking, and engineering firms—but quite dissimilar from the vast majority of service firms that are much smaller and less business-like (Cooper, Hinings, Greenwood, & Brown, 1996). The 3-year time horizon is an improvement on the many studies that have been cross-sectional studies, but future work should attempt to locate even more longitudinal data. As suggested by Hitt et al. (1997), future work will separate some of the product/service (or local) aspects of diversification from the international dimensions. Suffice it to say that in this study of relatively homogeneous organizations, these dimensions seem to be all but orthogonal. They are also commonly associated in strategic thinking (e.g., Grant, Jammine, & Thomas, 1988). Other future steps in this project will be to investigate some of the internal and external contingencies to performance in these firms. The use of leverage strategies and de-equitizing of partners seem to be crucial issues for attaining competitive PEP levels. Further, the difficulty in managing the partner-lawyer-client interfaces over geographically dispersed offices is a crucial competency clearly worthy of investigation. Finally, data on mode of international market entry—for example acquisition, Greenfield, or network alliance—will also allow us better to understand the processes by

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which firms cope with various strategic and contextual contingencies and successfully launch themselves beyond their native markets.

Acknowledgments The authors are grateful to Pervez Guari for his guidance along the way, to two IBR reviewers for their constructive advice, to Michael Lubatkin for his helpful comments, and to Mark Dembovsky for his many insights and help with obtaining the data. The paper would not have been written without the support of Ron Yaffe, may his memory be for a blessing. References Arbuckle, J. L., & Wothke, W. (1999). Amos 4.0 user’s guide. Chicago: Small Waters. Bentler, P. M., & Bonet, D. G. (1980). Significant tests and goodness of fit in the analysis of covariance structures. Psychological Bulletin, 88, 588–606. Blomstermo, A., Eriksson, K., Lindstrand, A., & Sharma, D. D. (2004). The perceived usefulness of network experiential knowledge in the internationalizing firm. Journal of International Management, 10(3), 355–373. Brock, D. M., Yaffe, T., & Dembovsky, M. (2006). International diversification strategies and effectiveness: A study of global law firms. 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