Strategic Management Journal Strat. Mgmt. J., 24: 1187–1208 (2003) Published online in Wiley InterScience (www.interscience.wiley.com). DOI: 10.1002/smj.347 LIABILITY OF FOREIGNNESS IN GLOBAL COMPETITION? FINANCIAL SERVICE AFFILIATES IN THE CITY OF LONDON LILACH NACHUM* Baruch College, City University of New York, New York, U.S.A. This study was inspired by the observation that foreign financial service firms operating in the City of London do not suffer the liability of foreignness to the extent suggested by theory. To examine the reasons for this departure from theory, the study advances a theoretical framework that distinguishes between three types of advantages that together account for the competitive performance of MNEs relative to that of indigenous firms. Empirical analyses of a sample of 296 foreign financial service firms in the City of London show that in this particular context major sources of competitive performance are the firm-specific advantages and the advantages of multinationality, where British firms may not necessarily possess an advantage over foreign firms. An examination of the validity of the findings, in order to assess the extent to which this situation is unique to the City of London or rather signifies a more general trend that requires theoretical modifications and extensions, is emphasized as a major task for future research. Copyright  2003 John Wiley & Sons, Ltd. There is great potential to enliven current theory and to develop new insights if theorists search for and work with inconsistencies, contradictions, and tensions in their theories, and in the relationships between them. (Poole and Van de Ven, 1989: 575) INTRODUCTION The theories of international business and manage- ment provide two, somewhat related, reasons for expecting that firms based in a locationally advan- tageous home country would outperform their for- eign counterparts in their national markets. First, foreign firms face additional costs, arising from Key words: financial services; City of London; liability of foreignness; global competition *Correspondence to: Lilach Nachum, Baruch College, City Uni- versity of New York, One Bernard Baruch Way, Box B12-240, New York, NY 10010-5585, U.S.A. their unfamiliarity with and lack of roots in a foreign environment (Kindleberger, 1969; Hymer, 1960/1976), what Zaheer (1995) named the ‘lia- bility of foreignness’ (hereafter LOF). A number of studies established the existence and persistence of the LOF in various industrial and geographical contexts (Zaheer, 1995; Zaheer and Mosakowski, 1997; Miller and Parkhe, 2002; Shukla and van Inwegen, 1995; Mezias, 2002). These studies have illustrated the advantages gained by indigenous firms due to their easier access to local information and knowledge, and have shown the higher trans- action and information costs incurred by foreign firms. They have also documented the implications of these asymmetries for the relative performance of foreign and indigenous firms competing in the same environment. The second reason for expecting national firms to be more competitive within their home coun- try is proposed by the theory of the origin of the MNE competitive advantages. This theory Copyright  2003 John Wiley & Sons, Ltd. Received 10 March 2002 Final revision received 10 April 2003