We examine how changes in foreign labor regulations affect U.S. multinationals operating strategies. We show that firms with integrated operations in countries where labor regulations become tighter tend to establish arm s-length relations with local business partners in that nation. The substitution between integrated and arm s-length operations is stronger toward joint ventures than suppliers and weaker in the presence of financial constraints. Our findings are consistent with the idea that, when firms find it harder to terminate their workers in integrated operations, they change to an operating model where it is easier to replace or discontinue business partners instead of employees.
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