Abstract
This paper presents new evidence on US multinational firms and shows that the decision to diversify internationally is endogenous, and depends on firm, industry, and home-country characteristics. US multinational firms are a self-selected sample, and firms that are more likely to diversify internationally have lower firm values. Contrary to the global diversification discount literature, multinational firms are valued at a premium after controlling for the endogeneity of the global diversification (foreign direct investment-FDI) decision. These results parallel the industrial diversification literature and underline the importance of controlling for endogeneity when examining the impact of international diversification on firm value.
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Notes
The average multinational firm in my sample earns about 41% of its sales revenues from international sources.
Doms and Jensen (1998) find that foreign-owned plants in the US have higher productivity (11–13% higher) than domestic plants.
According to Graham et al. (2002), benchmarks for valuing conglomerate firms should be carefully chosen, and the interpretation of conglomerate valuations that rely on comparisons with stand alone firms should be done cautiously.
The advantage of the international benchmark is that it allows comparisons between an MNE and the sum of its parts. See the Methodology section for a more detailed description of the international benchmark.
Dastidar and Weiner (2007) find a similar negative self-selection impact on firm performance for multinational conglomerates.
Bodnar et al. (2003) show that the Denis et al. (2002) results can be replicated by including small firms in the sample and changing the measurement of the control variables. They suggest that the inclusion of small firms could be a problem, because they are less likely to be multinational and more likely to affect the valuation of the benchmark firm. This could increase the difference between the multinational firm and its imputed value, resulting in a globalization discount.
Denis et al. (2002) suggest the use of firm fixed effects to try to control for endogeneity. Firm fixed effects controls for unobserved firm-level heterogeneity, whereas the Heckman two-stage procedure explicitly captures the impact of firm-specific characteristics as well as industry and macroeconomic influences on the firm's decision to diversify.
After 1998, rule no. 14 of FASB was replaced by rule no. 131, where segments do not necessarily reflect industrial or geographic segments.
A finer classification would reduce the number of firms in a particular industry, making it difficult to calculate imputed values.
If the company reports more than 10 segments, the additional segment data are summarized and added to segment 10. While this may be somewhat arbitrary on the part of Worldscope, the data provided by firms are also somewhat inconsistent because there are no rules defining the scope of each segment – that is, firms report data by country or by region.
Though the multinational is defined in terms of segment “sales”, these segment sales represent international operations. According to Worldscope, geographic segment sales represent production facilities or subsidiaries of companies abroad. It also includes export sales when they cannot be subtracted out. This is a small fraction of the total data, according to Worldscope. Regardless of whether the segments represent greenfield investments, acquisitions, or export sales operations, the theoretical advantages or disadvantages of international diversification still apply. For example, the multinational firm can benefit from a lower cost of capital, exploitation of proprietary assets, and economies of scale. Hence these advantages or disadvantages arising from multinational expansion should be reflected in firm value.
Based on the list of developed and emerging markets provided by the International Finance Corporation (IFC). Two countries are dropped owing to lack of data.
If segment sales do not add up to total sales of the firm it creates an artificial difference between the actual and the imputed value of the firm.
Accounting data on Datastream and Worldscope are primarily consolidated data. However, the segment data are not consolidated. Consequently, the sum of the segment sales data can be greater than the firm's total sales. To address this issue, firms where the sum of segment sales are greater than total segment sales have been excluded from the sample. Since the results do not change materially, all the tables are based on the entire sample including consolidated and non-consolidated accounting data.
The word “common” refers to the adjustments that Datastream makes to the accounting data to account for differences in treatment across countries. I cannot comment on how accurate these adjustments are, but I do acknowledge that there are accounting differences across countries, and using Datastream's adjusted accounting numbers is an attempt to address this problem.
Leverage is the ratio of total debt to total assets. Leverage ratios in this paper are comparable to those of Rajan and Zingales (1995).
Dastidar and Weiner (2007) examine the interaction between industrial and geographic diversification for multinational conglomerates. The paper compares multinationals and multinational conglomerates to a local benchmark using a different methodology, which does not ignore geographic diversification.
This ratio is used since segment-level assets and EBIT data are limited for non-US firms. Further, alternative ratios yield similar results in Berger and Ofek (1995) and Bodnar et al. (1997).
Full integration would imply that the global investor could choose a median benchmark firm from anywhere in the world operating within the same industry. However, full integration is not assumed. This paper assumes that the median firm from an emerging market region, for example, is different from a median firm in Europe. An analysis of the median multiplier values from each region shows that they do differ from region to region. For example, the median multiplier value for manufacturing firms (SIC: 20–29) is 0.88 for Australasia, 1.17 for Europe, 0.54 for North America, and 0.69 for purely domestic US firms. Overall there are no consistent patterns in the multiplier values across the regions.
Results for the local benchmark are available though not reported. Papers using the local benchmark include Berger and Ofek (1995), Bodnar et al. (1997), Lins and Servaes (1999), and Denis et al. (2002).
Fama and French (2000) suggest that panel data regressions ignore the cross-correlation problem and the bias in the standard errors of the regression slopes caused by the residuals being correlated across the years. They suggest the use of Fama–Macbeth regressions to address this problem. The number of years in my sample is just 9 and hence makes it difficult to apply Fama–Macbeth t-statistics.
Villalonga (2004) and Campa and Kedia (2002) have run exhaustive tests on alternative statistical techniques to capture endogeneity or self-selection in industrial diversification. All the methodologies find similar results. Hence I apply one of the generally accepted techniques to examine the problem of self-selection.
The Hausman test compares the estimates from fixed and random effects to test whether e it is correlated with the regressors. The results of the test suggest that the fixed effects model is preferred, and that there is unobserved firm heterogeneity correlated with e it . To control for this I include firm-level means of the variables in Z it , as suggested by Woolridge (2002).
Including the firm-level means controls for unobserved firm heterogeneity correlated with e it , which is confirmed by the Hausman test. The difference between the fixed and random effects estimators does disappear.
Econometric Analysis by William H. Greene, p. 952.
The difference could be attributed to the different methodologies, samples, and the databases used in the two papers.
They do not combine international sales into regions, which could also account for the differences in the numbers.
All relative measures are the actual value minus a sales-weighted median industry and regional imputed value. Relative size, for example, captures the deviation of the firm's actual size from that of the sales-weighted portfolio of multiplier firms that form the basis for the excess value measure. Since MNEs are likely to be much larger than the local firm, an absolute measure of size would not sufficiently control for this effect. Similar relative control variables are used in Bodnar et al. (1997), Denis et al. (2002) and Fauver et al. (2004).
Correlations between the explanatory variables are low in general.
All the control variables used in the regression analysis are ratios that are considered to be common across countries and hence have maximum comparability across borders, according to Datastream.
One could also include an additional industry control variable, the fraction of sales by MNEs in the industry (Campa & Kedia, 2002), but this is highly correlated with the number of multi-segment firms and is hence not included.
While many of the firm-specific variables are not significant, these results are comparable to the probit results presented in Campa and Kedia (2002). Similar to their paper, industry factors matter more in influencing the diversification decision of the firm.
As an additional test I compare geographically diversified firms and industrially diversified firms (multinationals and multinational conglomerates) against a domestic benchmark. The results confirm the self-selection bias (significant and negative): that is,the underlying characteristics associated with a greater likelihood of international diversification are associated with lower firm value. As mentioned earlier, industry multiplier values do not exhibit consistent patterns across regions, which could indicate the presence of a regional self-selection bias. However, domestic multipliers yield similar results, suggesting that the differences in regional multipliers cancel out on average.
I also run the Heckman two-stage regressions using the domestic benchmark excess value measure and Tobin's Q. The sign and significance of the variables do not change with Tobin's Q. For the domestic benchmark the net effect of the impact of diversification after controlling for self-selection is insignificant.
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Acknowledgements
I thank René Stulz, Andrew Karolyi, Ingrid Werner, Karen Wruck, Rajshree Agarwal, Kathryn Dewenter, Renata Kosova, Don Lessard, the seminar participants at The Ohio State University, George Washington University, and AIB, for their comments and Laura Tuttle for data assistance. I thank the referees for their comments. Any remaining errors are my responsibility.
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Accepted by Lemma Senbet, Area Editor, 15 October 2007. This paper has been with the author for one revision.
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Dastidar, P. International corporate diversification and performance: Does firm self-selection matter?. J Int Bus Stud 40, 71–85 (2009). https://doi.org/10.1057/palgrave.jibs.2008.57
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DOI: https://doi.org/10.1057/palgrave.jibs.2008.57