FDI, Export, and Capital Structure

As in previous research (Kwok and Reeb 2000), the definition for “emerging markets” in this study follows that found in the International Monetary Fund’s 1999 Capital Market Report. The criterion for emerging markets is indicated on page 1 of the report.

In this study, we used FDI and export stock data rather than flow data to support our arguments.

The composite measure includes four facets of multinational corporations: geographic diversification, foreign sales/assets, exports, and the number of foreign subsidiaries.

A challenge to home country financial institutions is: how can they monitor the activities of the foreign subsidiaries of home country firms in foreign countries? We argue that a bank in a foreign country where a Taiwanese firm has a subsidiary can monitor activities with regard to subsidiary operations better than a bank at home. If an MNC uses its technological and operational links to grasp the operations of subsidiaries in different countries, then a bank in the country where the MNC is headquartered should be able to access this information and use it to evaluate the risk of the MNC. However, as we argued in the paper, poor corporate governance in emerging economies, such as Taiwan, enables some firms to manipulate their transactions with external or internal clients. The case of Procomp Information Ltd. is an example. In 2004, the CEO of the firm was prosecuted for swindling investors of US$ 217.22 million by manipulating the intra-firm transactions with the firm’s foreign subsidiaries. We also interviewed a banker and were told that, because most Taiwanese banks do not have subsidiaries in foreign countries, these banks are not able to get full information pertaining to firms with international operations. However, in recent years, some governments in emerging economies have tried to enhance the quality of corporate governance. For example, the Taiwan Stock Exchange Corporation (TSEC) and the GreTai Securities Market (GTSM), published the “Corporate Governance Best-Practice Principles for TSEC/GTSM Listed Companies” in 2002. The principles have been revised in 2003, 2005, 2006, 2008, 2009, and 2010, respectively. We thank a reviewer for bringing up this important issue.

As pointed out by a reviewer, a further hypothesis for the higher level of debt is the tax shield provided by debt. Interest is an effective way to minimize local tax payments and withhold taxes upon repatriation. Why do MNCs from developing countries and developed countries have different debt ratios? When MNC home countries have signed tax treaties with host countries, MNCs seem less likely to retain higher debt to enjoy the tax shield. We argue that developing countries usually have signed tax treaties with a limited number of countries. Therefore, MNCs from developing countries are motivated to enjoy the tax shield by increasing the use of debt. For example, from 1981 to 2009, Taiwan had signed tax treaties with only 16 countries/areas (e.g., Singapore, Australia, the UK, etc.) and shipping/air transportation tax treaty agreements with 14 countries/areas (e.g., Canada, the EU, the US, Japan, etc.). It is clear that Taiwan has yet to sign tax treaties with the major countries/areas hosting Taiwan MNCs, such as China, the US, Hong Kong, Central and South America. Taking into account the tax burden, Taiwan MNCs have a strong incentive to retain a higher level of debt to enjoy this tax shield benefit.

We agree that foreign banks with operations in Taiwan can usually convey information to their parent banks to support the financing of the subsidiaries of Taiwan companies as pointed out by a reviewer. However, based on statistics from the Banking Bureau, Financial Supervisory Commission, Executive Yuan, R.O.C. (http://www.banking.gov.tw/Layout/main_ch/FscSearch_BankMain.aspx?path=1614&Type=R), as of April, 2010, 31 and 7 of the world’s 500 largest banks have established branch offices and representative offices in Taiwan, respectively. This means that, even if some foreign banks are able to assess the risk of Taiwanese MNCs more accurately, because most Taiwanese MNCs choose local banks as their main banks, these MNCs can provide less accurate information about their operations in foreign countries if they want to. We thank the reviewer for reminding us to discuss this issue.

We thank a reviewer for urging us to deal with this issue explicitly.

We hired two assistants to assist us in collecting data. The first assistant printed out the export sales and FDI information from corporate annual reports and coded the data, while the second assistant checked the data accuracy to avoid coding errors, as suggested by Hyland and Diltz (2002).

According to Lu and Beamish (2004), who used a sample of Japanese-based MNCs, the average number of overseas subsidiaries and the average number of host countries were 8.45 (ranging from 1 to 601) and 3.96 (ranging from 1 to 61). This indicates that the extent of FDI for Taiwanese firms is less than that of Japanese firms.

Market value of debt would be preferable since it is a more accurate measure of debt. However, to use market value, information regarding the maturity of the debts and the interest rates is required, which was not always available. Moreover, Bowman (1980) reported a large cross-sectional correlation between the market value and the book value of debt.

They used bi-dimensional constructs to classify MNCs—a firm was classified as multinational (MNC) when it had at least one foreign subsidiary and a foreign sales to total sales ratio of 10% or higher.

As pointed out by one reviewer, exports and FDI are as often seen as complements: a majority of exports take place among MNC affiliates. Based on statistics from the Ministry of Economic Affairs (paid website: https://2k3dmz2.moea.gov.tw/gwweb/), overseas production as a percentage of total exports is very high (e.g., 49.41% for the Information and Communication industry in 2003). Because many firms apply the model of “processing export orders in Taiwan-manufacturing in China-exporting from China,” exports and FDI complement each other for Taiwan MNCs.

Some emerging markets such as China, Hong Kong, and Singapore have started to employ the IFRS. Other emerging markets such as Taiwan and South Korea have gradually revised their GAAP standards to achieve high quality, understandable and enforceable global accounting standards (IFRS), in addition to scheduling the application of IFRS by 2013 and 2011, respectively. As such, the application of IFRS regulations will provide a strong motive for MNCs to load up on debt, which should lead to the gradual occurrence of the expected potential effect of IFRS in terms of MNC capital structure. We thank a reviewer for reminding us of the impact of IFRS.

The cross-tabulation results are the same if we replace the mean by the medium.