Firm Internationalization and Systematic Risk : A multidimensional approach Robert JOLIET Gestion financière (Ulg) March 2003

2 Introduction Barriers to international trade are falling and corporations are increasingly “international”. (Large) multinational corporations (MNCs) derive most of their earnings from their international sales and activities.

3 Does Corporate International Diversification really matter ? Market Completion Theory (MCT) Hugues et al. (1975), Agmon & Lessard (1977), Errunza & Senbet (1984), etc. « costless international corporate intermediation through foreign direct investment restores perfect market type results by undoing barriers to international capital flows faced by investors ».

4 Does Corporate International Diversification really matter ? (2) The proliferation in recent years of new foreign investment vehicles such as country funds casts doubt on the potential empirical validity of the MCT. JACQUILLAT & SOLNIK (1978), SENSCHACK & BEEDLES (1980), DADA & WILLIAMS (1993): “(…) The evidence seems to support strongly the behavior guide to investors that positioning in U.S. multinational firms doesn’t provide all the benefits available from direct investment in foreign securities” (Senschack & Beedles, p.56).

5 Does Corporate International Diversification really matter ? (3) Question somewhat unresolved, resulting from a wrong specification of an internationalization index; from the dodging of other elements such as industry factors.

6 The multidimensionality of internationalization Dichotomy of home vs. foreign (FSR, FAR, etc.). Geographical variation of corporate internationalization (number of countries or regions a company is active in). Striking differences between countries (geographical and cultural distance). = PSYCHIC DISPERSION of international operations.

7 The psychic distance concept The psychic distance can be defined as the perceived distance between the home country and a foreign country, resulting from the differences in terms of cultural, business and political differences, i.e. differences in language, political and legal system, trade practice, industry structure, etc.

8 Incremental internationalization process JOHANSON & VAHLNE (1977) : firms are assumed to successively enter markets at an increasing « cultural distance » from the home country, as measured by differences in language, values, political systems, trade practices, etc.

9 A new internationalization index

10 The model The return of a purely domestic firm is given by : Investors can be expected to value the earnings at a national risk-adjusted discount rate. NB : the return on the firm is proportionnal to both its world beta and its domestic beta, since the domestic market factor is sensitive to the world market factor.

11 The model (2) As for an internationalized firm, the distributable earnings are derived from n countries. If we regard the internationalized firm as a portfolio of international activities, the return on this portfolio is : where wij is the relative importance of country j in the economic activity of the firm i.

12 The model (3) To see the potential diversification effects, we have to broken down the return on the index of country j a bit further : The return on the index of country j has to be a function of the psychic distance with the home country D and, on the other side, a function of the degree of world cointegration.

13 The model (4) Hence, with

14 Empirical Results : the sample

15 Empirical Results : a comparative study Estimation of the different factor exposures (on the period) : INT vs FSR

16 Empirical results : Global Sample Analysis

17 Empirical results : Cross-Country Analysis

18 Empirical results : Cross-Industry Analysis

19 Conclusions Firms belonging to the same homogeneous industry will generally reduce their domestic and international exposures by taking into account psychically distant markets. International exposures do not seem influenced by the degree of internationalization for firms belonging to heterogeneous industries such as consumer discretionary. International exposure tends to INCREASE concerning the industrial industry where the degree of product or service differenciation and the entry barriers are weak.