Global diversification discount and its discontents: A bit of self‐selection makes a world of difference

Abstract

Research summary: The documented discount on globally diversified firms is often cited, but a correlation is not per se evidence that global diversification destroys firm value. Firms choose to globally diversify based on their firm attributes, some of which may be unobservable. Given these exogenous firm attributes, the decision to diversify globally is endogenous and self‐selected. Our study offers a replication of an earlier study. Using the same specifications save for the Heckman selection instrument, our results contradict past research that did not address endogeneity. We posit that the global premium should reflect the value of multinational operating flexibility. We use the 2008–2009 financial crisis as creating exogenous variation to permit a test for the positive change in firm valuation due to global diversification. During the 2008–2009 financial crisis, the premium associated with global diversification became larger and more significant than before the 2008–2009 financial crisis. The churn of subsidiaries entering and exiting countries increased during the crisis, pointing to the value of an operating flexibility to restructure the geography of the multinational network. In all, the results contradict past findings and provide evidence that operating flexibility is more valued during times of high volatility, thus generating the diversification premium. Managerial summary: There are thousands of multinational corporations that have been international for decades and some even longer. They undoubtedly learned that there is money to be made in international markets. Yet, the recent academic literature has found that foreign diversification destroys firm economic value. Our article uses a statistical technique that corrects for an obvious problem. Some firms invest overseas because they are facing troubles, for example, they are experiencing slowing growth and are exiting bad home markets. Once we correct for this “selection bias,” we find that global diversification, at worst, has no negative effect on value. However, during the financial crisis, the value of multinational companies increased. This finding is consistent with the option theory of multinational investment whereby operating in multiple countries permits firms to shift their activities among countries. Overall, our results indicate that there is a reason for why firms globalize: It is profitable. Copyright © 2016 John Wiley & Sons, Ltd.

Multinational investment and the value of growth options: Alignment of incremental strategy to environmental uncertainty

“…In particular, foreign entries often focus on the more certain direct returns by exploiting existing firm‐specific assets in host countries and current market opportunities. In addition, assuming larger equity shares and greater control over affiliates facilitates system‐wide coordination that is critical to switching option value and operating flexibility (Belderbos et al, ; Belderbos & Zou, ; Chang et al, ; Tong & Reuer, ). In all, the finding implies an important qualification to the relationship between multinational investment and the value of growth options: While alignment in terms of pursuing incremental investment strategies in high‐uncertainty environments can create substantial growth option value contributing to firms' market valuation, firms face a tradeoff between the pursuit of growth option value and other objectives of multinational investment, such that growth option considerations may not necessarily be the predominant feature of investment.…”

“…Fifth, prior research suggests that greenfield ventures and acquisitions may confer different option values (e.g., Brouthers & Dikova, ; Smit & Kil, ), so we include the variable Acquisition Ratio , measured as the percentage of entries through acquisition in a firm's foreign affiliates. Finally, we control for the value of switching options available from the firm's network of multinational operations (Chang, Kogut, & Yang, ; Fisch & Zschoche, ; Kogut & Kulatilaka, ; Tong & Reuer, ) by including the variable Switching Flexibility , calculated as one minus the correlation in labor cost across all host countries (e.g., Belderbos, Tong, & Wu, ).…”

Portfolio configuration and foreign entry decisions: A juxtaposition of real options and risk diversification theories

“…Although valuation of these compound options is difficult because of the complexity involved in managing calls and puts (Margrabe, 1978), significant evidence exists that firms and managers follow a real options “logic” in their strategic decision making (Kogut & Kulatilaka, 1994; McGrath & Nerkar, 2004), rather than estimating option values per se (Trigeorgis & Reuer, 2017). For instance, research has shown that multinational firms indeed shift their sourcing of inputs across locations in response to exchange rate movements (Belderbos & Zou, 2007; Rangan, 1998), and that operational flexibility enhances firm values (e.g., Chang, Kogut, & Yang, 2016; Sakhartov & Folta, 2014). Research using survey data and self‐disclosed information has also reported that managers are aware of, and take into account, real options under uncertainty in multinational investment (e.g., Driouchi & Bennett, 2011).…”

Does going global or staying local improve the long‐term survival and performance of IPOs?

“…Operational flexibility permits firms that are global to allocate investments optimally across domestic and international operations (i.e., it provides growth and switching options) in response to changes in factor and product markets, exchange rates, and regulatory barriers (Chang, Kogut, & Yang, ; Kogut & Kulatilaka, ; Tong & Reuer, ). As Tong and Reuer (, p. 216) state, “a distinctive advantage of an MNC relative to a purely domestic company lies in the operational flexibility that global operation affords.” Financial flexibility permits firms that are global to gain access to financing from foreign sources such as banks and debt markets that may not be available to firms that stay local (Jang, ).…”