The effect of domestic uncertainty on the real options value of international investments

Abstract

Scholars have noted that international investments have the potential to provide firms with real options value under uncertainty. To assess this issue, prior studies have tended to focus primarily on exchange rate volatility. Although multinational firms face other types of uncertainty as well, including those stemming from their domestic operating environment, the role of such uncertainty for firms' flexibility needs has not been previously considered. In this study we compare the influence of both domestic economic uncertainty and exchange rate uncertainty on the real option value of international investments of Korean firms over 16 years of varying uncertainty. We find evidence that an international investment network characterized by greater breadth and lower depth is associated with higher firm value under domestic economic uncertainty. Exchange rate uncertainty, however, was not found to play a role in firms' need for flexibility. The results suggest that firms are able to hedge exchange rate uncertainty by using mechanisms such as forward contracts or derivatives, thus potentially reducing the impact of this type of uncertainty on their operations. Journal of International Business Studies (2009) 40, 405–420. doi:10.1057/jibs.2008.79

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