Value Creation in Foreign Direct Investments (1)

Article excerpt


* This study examines stock market reactions i.e. wealth creation in foreign manufacturing investments. In addition to empirically examining the wealth effects of investing firms, the study examines the impact of several investing firms and investment related factors on the wealth effects. The data of the study is based on 79 foreign investments made by Finnish firms between 1985 and 1996.

Key Results

* On average, foreign direct investments have significant value creating effects for investing firm shareholders, i.e., value creation of foreign direct investments generally proves to be a fact. However, none of the specific features of the investment, such as type, form or target country of the investment, showed any divergent value creation effects.


Strategic investments have attracted the attention of scholars in a number of business disciplines, especially in the areas of strategic management, international business, finance and industrial economics. Previous research investigating mergers and acquisitions in the USA and in many Western European countries, including Finland, has mainly focused on domestic acquisitions. However, because of the great growth in the foreign direct investment flows an increasing amount of attention has also been directed to international or cross-border acquisitions and greenfield investments.

This study investigates stock price reactions to the announcements of the foreign direct manufacturing investments of Finnish firms. Thus, the primary purpose of the study is to find out if FDIs increase shareholders' wealth. Previous findings in the area have been ambiguous. The results in some studies indicate that there have been more positive wealth gains associated with foreign acquisitions than in domestic ones, but the results in other studies indicate that foreign acquisitions have not created value for acquiring firm shareholders.

In addition to investigating whether FDIs in general increase shareholders' wealth, we also investigate a series of refined hypotheses: how different investing firm and investment related features influence incrementally to the value creation. Although the main interest has been in value creation in general, most of the studies have included some additional features related to the investing firm and investment in order to have a better understanding of the value creation effects. However, several studies have included only very few additional features. Thus this study will include additional information about value creation in various FDI situations.

The structure of the paper is as follows: first a literature review is made and the hypotheses for the empirical part are constructed; in the next section the methodology of the study is discussed and the main features related to the sample are reviewed. After that the results of the study are discussed, and finally a summary and key conclusions are presented.

Literature Review

General Aspects Related to Value Creation in FDIs

There are several theories and motives for the existence of foreign direct investments (FDI). According to the so-called internalization theory FDIs occur when a firm can increase its value by internalizing markets for certain of its intangible assets, e.g. 1) technological know-how, 2) marketing ability and related consumer goodwill, and/or 3) effective and dedicated management (see e.g. Buckley/Casson 1976 and Morck/Yeung 1991, 1992). According to the internalization theory such intangible assets have some of the characteristics of public goods in that their value increases in direct proportion to the scale of the firm's market. Since they are also based largely on proprietary information, they cannot be exchanged at arm's length for a variety of reasons arising from the economics of information as well as from the economics of public goods. To realize the potential additional value of employing these intangible assets abroad, a firm must internalize the market for them. This can be accomplished by engaging in FDI. A value-maximizing firm does this if the expected gains from applying its intangibles abroad exceed the expected cost of running a foreign subsidiary. The theory thus implies that when firms possessing significant assets expand abroad, shareholders' wealth increases owing to the increased scale over which such intangible assets are applied. (see Morck/Yeung 1992).

There are also other theories and motives for FDIs (see e.g. Hood/Young 1979 or Cantwell 1990). These are based e.g. on the availability of new markets, access to scarce specialized resources, opportunities to achieve production efficiencies, the possibility of overcoming trade barriers and improving a firm's competitive position (see e.g. Root 1987). Potential benefits include also reduced market risk and the possibility of stabilizing the overall returns on investments because economic conditions and major political climates tend to be uncorrelated across different international market areas (Caves 1982). All these theories suggest that a firm's value increases when the company makes an FDI (see e.g. Morck/Yeung 1992).

Previous empirical evidence related to value creation in FDIs has, however, been mixed. Results by Doukas and Travlos (1988), Morck and Yeung (1992), Markides and Ittner (1994), and Shelton (1996) for instance, indicated that international acquisitions created value for acquiring US firms and results by Kang (1993), Cakici, Hessel and Tandon (1996) and Eun, Kolodny and Scheraga (1996) indicated positive wealth creation also in acquisitions made by mainly OECD based firms in the USA. Positive wealth creation has also been found in several studies focusing on international joint ventures established by US firms in various foreign countries (see e.g. Chen/Hu/Shien 1991, Hu/Chen/Shien 1992, Merchant 1995, and Arnott/Rasheed 1997). In their comparative study of domestic and foreign acquisitions Harris and Ravenscraft (1991) found that US target firms in foreign acquisitions had significantly higher wealth gains than US target firms in domestic acquisitions. However, e.g. Datta and Puia (1995) did not find any value creation in foreign acquisitions taken by US firms. Merchant (1995) made similar finding in his study of US-foreign joint venture projects. Similar findings were also reported by Jonsson (1995), who investigated foreign acquisitions made by Swedish firms, and by Lonroth (1995) who focused on foreign acquisitions made by Danish firms.

In summary, at a theoretical level it is possible that FDIs provide benefits to the firm. Whether they do so in practice and represent value creation is an open empirical question that our study aims to answer. However, our expectation is that making an FDI has a positive value creation effect.

Relationships Between Various FDI Specific Features and Value Creation

An additional aspect related to FDIs is whether it is the investment itself or also other variables -- variables related to the investing firm, investment and home country of the investment -- which affect the value creation. Do shareholders rely on the management of the investing firm to make the right decisions related to the home country and other features of the investment or does the value creation vary depending on the specific features related to the FDI? Based on previous domestic and foreign investment studies, the following variables have been assumed to influence the value generated by an investment (see e.g. Doukas/Travlos 1988, Markides/Ittner 1994, and Markides/Oyon 1998): the nature of the investing firm, nature of the investment, and nature of the target country of the investment. The results in some studies (e.g. Morck/Yeung 1991, 1992, Eun et al. 1996) have given support to value creation really being dependent also on the specific features related to the investing firm, investment, and target country whereas e.g. Cakici et al. (1996) found that the specific features did not significantly influence the value creation.

Nature of the Investing Firm

Previous results e.g. Morck and Yeung (1991, 1992) give support to the view that shareholders value multinationality, especially in cases of R&D and advertising intensive firms. (2) However, what's the influence of prior international experience of the investing firm on the value creation is not so clear. The first foreign investment is apparently a greater strategic move than in new investments where the firm already has several prior FDIs. Therefore it could be expected that the wealth creation would also be greater in cases of no or limited prior FDI experience than in cases of extensive prior FDI experience. However, if the firm is making its first FDI, the management may lack the knowledge of how to make the investment in an "optimal way" and how to manage it. In cases where the investing firm already has several prior FDIs, the probability is that the management has better knowledge of how to make the investment and how to manage the foreign unit. Thus the influence of prior international experience on value creation is not so clear.

In addition to prior international experience, target (host) country experience may also affect the value creation. If the investing firm does not have any prior FDI in the target country, the investment usually means a greater strategic move than in an investment where the investing firm already has a unit in the target country. However, how to operate in the target country market is learned as a by-product of doing business there. Therefore it could be expected that the risks in making and managing the FDI are greater in cases of no prior investments in the target country than in cases where the investing firm already has target country specific experience. Thus, just as in the case of international experience, so the impact of target country experience on the value creation is not so clear.

Fatemi (1984) and Hu et al. (1992) have found a negative relationship between international experience and value creation, whereas both Markides and Ittner(1994) and Markides and Oyon (1998) found that international experience had a positive impact on value creation. Fatemi and Furtado (1988), Merchant (1995) and Eun et al. (1996) could not find any statistically significant relationship between international experience and value creation. In the studies made in Nordic countries Jonsson (1995) found positive abnormal return in cases of frequent acquirers but Lonroth (1996) found just the opposite, i.e. abnormal positive return in cases of infrequent acquirers. Whether the acquisitions were made in the domestic and/or foreign market is not clearly stated in these studies. The relationship between target country experience and wealth creation has been analyzed to a much more limited extent than the relationship between international experience and value creation. Fatemi and Furtado (1988) found support for a negative relationship between target country experience and value creation whereas Cakici et al. (1996) did not find any statisitically significant relationship.

Thus, the empirical results seem to be somewhat mixed. However, based on the above for international experience a positive relationship and for target country experience a negative relationship with value creation is expected.

Nature of the Investment

Apparently the most commonly analyzed variable related to (domestic and) foreign acquisitions is the relatedness of investment. Relatedness is typically associated with operating synergies in the form of scale and scope e.g. in R&D, marketing, and production, resulting in a firm being able to secure a cost advantage over its global competitors. Related investments are expected to be associated with higher benefits and lower integration costs than unrelated types of investments because the investing firm is already familiar with the product(s) and their procurement, production and marketing, which makes it is easier to reach synergy effects and to gain market power advantages. An unrelated investment means product diversification for the investing company and the possibilities of gaining synergy effects are mainly related to management and financial synergies (see e.g. Kitching 1973).

The wealth creation effect of relatedness has been extensively studied in the case of domestic acquisitions. Singh and Montgomery (1987), Shelton (1988), and Morck, Shleifer and Vishny (1990) found support for the relatedness hypothesis, but Lubatkin (1987) and Sheth (1990) did not find any association between relatedness and value creation. In the context of foreign acquisitions, the results by Doukas and Travlos (1988), Datta and Puia (1995) and Shelton (1996) did not indicate any significant relationship between the type of investment and value creation in the short run, but in the long term Datta and Puia (1995) reported clearly more positive wealth effects in related types of investments. Also results by Fatemi and Furtado (1988), Markides and Ittner (1994) and Markides and Oyon (1998) indicated support for a positive relationship. Thus an expectation of a positive relationship between relatedness of the investment and value creation effects is posited.

Another characteristic of the investment that may affect its valuation effects is the size of the investment. Smaller investments may be easier to manage andtherefore less risky than big ones where e.g. the integration of the foreign unit to the parent can be a very troublesome operation. On the other hand there is empirical evidence that small acquisitions have often caused rather more problems than big ones. Sometimes also the commitment of the management of the investing firm to a small investment may cause problems (see e.g. Business International 1988). Small acquisitions may also be expected to have a distinctly smaller impact on value creation than big ones. Empirical results from domestic acquisitions have indicated that the size of the target firm relative to the acquiring firm has been found to be positively correlated with the returns to acquirers (e.g. Jarrell/Poulsen 1989) and according to the results by Kitching (1973), Markides and Ittner (1994) and Shelton (1996) this was the case also in foreign acquisitions. Thus it is expected that the larger the relative size of the investment, the larger the return to the investing firm.

One key strategic decision in FDIs is also the ownership arrangement. In wholly-owned units the great advantage is that the investing firm does not have to share the decision making and profits from the operation, but it demands more financial and management resources than a joint venture. A joint venture/partial equity stake acquisition means shared decision making and shared profits, but it does not demand as much financial and management resources as a wholly-owned unit/full acquisition. A joint venture/partial acquisition allows the investing firm a "getting to know the partner" period and may potentially be associated with lower integration costs than wholly-owned units/full acquisitions (e.g. Kitching 1973). The latter alternative may also be a less expensive way for oligopolistic firms to prevent their competitors from acquiring the target (Caves 1982). Although the empirical results in several studies have indicated support for positive value creation in joint ventures (see e.g. Chen et al. 1991, Hu et al. 1992, Markides/Ittner 1994, Merchant 1995), the instability rate in joint ventures has been rather high (see e.g. Gomes-Casseres 1985, Harrigan 1988, and Kogut 1988). Furthermore, based on the internationalization theory a higher value creation may be expected in wholly-owned foreign units than in jointly owned ones. Exceptions may be cases where there are regulatory constraints related to ownership (as there have been e.g. in China, India, and Russia). Thus it is expected that the value creation is higher in wholly-owned investments/full acquisitions than in joint ventures/partial acquisitions.

Nature of the Home Country of Investment

Besides relatedness, the literature on FDIs and acquisitions has emphasized the importance of cultural distance in influencing investment performance (e.g. Datta 1991, Jemison/Sitkin 1986). Culture can be viewed as the collective programming of the mind that distinguishes the members of one group or category of people from another (Hofstede 1980). Studies indicate that organizational cultures are to a great extent influenced by national cultures (e.g. Terpstra/David 1991). Consequently, one can expect that the greater the cultural distance between two countries the more difference is likely to be seen in organizational characteristics and practices (Kogut/Singh 1988). Similarity between the national cultures may facilitate greater trust and organizational stability through shared norms and values. Therefore, one might expect easier integration and greater value creation when the cultural distance between the home country of the investing firm and the target country of the investment is small. Markides and Ittner (1994) did not find empirical support for their assumption that the value creation in foreign acquisitions made by US firms was greater in English speaking countries than others, but the results by Datta and Puia (1995) indicated clear empirical support for the positive relationship between short/low cultural distance and value creation. Thus also in this study a negative relationship between cultural distance and value creation is expected.

A summary of the sample features and results in various previous studies is presented in Table 1 (see next page). As can be seen from the table, the relationship between value creation and several of the variables included in this study has been analyzed to only a very limited extent so far although they all are strategic decisions when a company makes an FDI and therefore could be expected to influence the value creation. Furthermore, previous empirical results have been more or less mixed. Thus additional empirical evidence is needed to analyze the relationships between various firm, investment, and target country specific factors and stock market reactions.

Methodology, Variable Operationalization and Sample Selection

Methodology of the Study

Empirical analyses are conducted by using so-called event study methodology. Event study methodology has been developed to measure the effect of an unanticipated event on stock prices. As pointed out by McWilliams and Siegel (1997), often inadequate attention is paid to theoretical and research design issues in management research using event study approach. This criticism and proposals are taken carefully into account in the study. (3)

An event period of 11 trading days around the announcement day is used to investigate stock prices reactions to the FDI announcements. An estimation period of 250 trading days is used to estimate the market model parameters from the following time-series regression:

(1) [] = [[alpha].sub.i] + [[beta].sub.i] [] + [[epsilon]],

where [] is the return on the stock of firm i on day t, [] is the market return on day t, [[alpha].sub.i] is the market model alpha, [[beta].sub.i] is the market model beta, and [[epsilon]] is the (white noise) error term such that E([[epsilon]]) = 0, Var([[epsilon]]) = [[sigma].sup.2.sub.[epsilon]i] and Cov([[epsilon]], [[epsilon]]) = 0 for all s [??] t.

Daily abnormal returns, A[], are obtained by matching the parameters estimated from Equation (1) with the daily returns from an event period as follows:

(2) A[] = [] - ([[alpha].sub.i] + [[beta].sub.i] []),

where [[alpha].sub.i] and [[beta].sub.i] are the market model parameters estimated in Equation (1), [] is the return on the stock of firm i on day t, and [] is the market return on day t.

Diffusion in daily stock prices may cause problems in a small and infrequently traded stock market. The problem of diffusion arises because in infrequently traded stock markets, such as the HeSE, daily returns are not independently and identically distributed over time (see, for instance, Theobald and Price 1984 for the theoretical investigation of implications of diffusion in the context of stock market seasonalities). Thus, the results based on individual days may be biased because of the diffusion, and the conclusions should therefore be based on abnormal returns cumulated over longer time intervals. Cumulative abnormal returns are calculated for different windows in the event period:

(3) CA[] = t[summation over (s=1)] A[].

Two different kinds of test statistics are applied for testing the statistical significance of abnormal and cumulative abnormal returns for these portfolios. The first one is Patell's (1976) "standardized-residual method". It is based on the standardized abnormal returns determined for each event day by dividing each stock's abnormal return by the standard deviation estimated from the time-series of its abnormal returns. Data from the estimation period is used to estimate the time-series standard deviation of each stock as follows:

(4) S(A[R.sub.i]) = [square root of [[summation].sup.-11.sub.t=-250] (A[] - [bar]A[R.sub.i]).sup.2/239]

The test statistic for each event day is calculated by dividing the sum of standardised abnormal returns of stocks in the portfolio of this day by the square root of the number of stocks in the portfolio. The second test statistic is the "standardised cross-sectional" test proposed by Boehmer et al. (1991). The event period abnormal returns are first standardised by the estimation period standard deviations. The test statistic is obtained by dividing the average standardised abnormal return by its contemporaneous cross-sectional standard deviation. This test statistic has the advantage of taking into account the event-induced increase in the cross-sectional variances of abnormal returns. Moreover, it can be used to control for the cross-sectional variance increase caused by the autocorrelation in cumulative abnormal returns when the uniform return procedure is applied to approximate missing prices due to thin trading (see Kallunki 1995).

Variable Operationalization

Variables Related to the Nature of the Investing Firm

International Experience of the Investing Firm (Intexp)

In the measurement of international experience the share of foreign sales from total sales, the length of experience in foreign manufacturing operations in years, the number of countries in which the firm has established subsidiaries and the number of FDIs made by the firm have been used. In this study international experience was proxied by the number of foreign manufacturing investments made by the firm prior to making the reviewed FDI because sales experience does not necessarily give similar type of experience needed in FDIs. The data for the variable was received from the FDI register of Finnish firms established by one of the authors. A positive sign is expected for Intexp.

Target Country Experience (Tcexp)

Target country specific experience has usually been proxied by the number of years elapsed between the establishment of the affiliate and the establishment of the parent's first manufacturing unit in the target country (see e.g. Harris/Ravenscraft 1991, Eun et al. 1996). An alternative possibility is to use a dummy variable. The latter alternative was chosen in this study. Thus, the target country experience variable takes the value zero if the investing firm has no prior manufacturing unit and value one if the investing firm already had manufacturing operations in the target country. The data for the variable was received from the FDI register of Finnish firms established by one of the authors. The Tcexp is expected to be negatively signed.

Variables Related to the Nature of the Investment

Relatedness (Related)

Relatedness has usually been operationalized as a dummy variable which takes the value one if the products manufactured in the foreign unit were also produced by the investing firm, and zero otherwise (see e.g. Harris/Ravenscraft 1991, Datta/Puia 1995, Eun et al. 1996, Shelton 1996). This operationalization was also used in this study. The sign for Related is expected to be positive.

Size of the Investment (Relsize)

The size of the investment can be measured using absolute size or relative size. In this study relative size of the investment is used as e.g. in the study by Cakici et al. 1996. In cases of acquisitions the size was counted based on the total sales of the target firm in the year preceding the investment in relation to the total sales of the investing firm in the year preceding the investment. In greenfield investments the size was counted based on the announced total value of investment in relation to the total sales of the investing firm in the year preceding the investment. The sign for Relsize is expected to be positive.

Ownership Arrangement (Ownership)

Ownership arrangement has in several studies been operationalized as a dummy variable which takes the value one if the investment was a wholly-owned unit/full acquisition (ownership 95-100%), and zero if the investment was a joint venture/partial acquisition (ownership 10-94%) (see e.g. Hennart/Park 1993). This operationalization was also used in this study. The sign for Ownership is expected to be positive.

Variables Related to the Nature of the Home Country

Cultural Distance (Cultdis)

Cultural distance was computed in the manner suggested by Kogut and Singh (1988), Erramilli (1991) and Hennart and Park (1993), using a composite index based on differences between Finland and the target country of the investment along the four cultural dimensions (power distance, uncertainty avoidance, individuality, and masculinity and feminity) identified by Hofstede (1980). Data on the index of the various cultural dimensions for each target country of the sample FDIs and Finland were obtained from Hofstede (1980). The respective measurement has been used in most studies after Kogut and Singh (1988) developed their composite index, e.g. in Datta/Puia 1995. The expected sign for Cultdis is negative.

Sample Selection

Until the mid-1980s the amount and value of FDIs by Finnish firms was very modest. However, from the mid-1980s until the early 1990s Finland, as also the other Nordic countries, was characterized by rapid internationalization of manufacturing operations. During 1988-90 outward FDI flows exceeded the corresponding flows during the previous 20 years. In 1991-93 there was a clear slowdown in the amount and value of FDIs as also in several other Western European countries. In 1994 there was again a growth trend both in the amount and value of FDIs which, however, stopped in 1995, but turned to growth again in 1996. In Finland, as well as in other Nordic countries, the majority of the amount and value of FDIs has been made by the 30 largest manufacturing companies.

The basic sample of this study consists of all manufacturing FDIs made by listed Finnish firms during the time period from 1985 to 1996. In total 192 FDIs made in 1985-96 by 26 various listed firms could be identified (not all of these firms had been listed already in 1985). However, to be included in the sample the investment had to fulfill the following conditions: a) the date of the investment announcement could be identified in the leading business magazine (Kauppalehti), b) the acquiring firm's stock price returns were available from the Helsinki Stock Exchange, c) related to the size of the investment, the turnover of the acquisition target firm had to be at least FIM 50 million (about USD 10 million) or the size of the investment in greenfield investments had to exceed FIM 50 million, d) the share acquired or agreed in greenfield investments had to be at least 25 percent, and e) the major confounding announcements (i.e. earning, dividends, share repurchases) could be identified. In only 79 FDIs made by 19 firms were all the conditions presented above fulfilled (the sample size was reduced mainly because of the last condition presented above). The sample size can be regarded as sufficient when compared to the sample size used in previous studies (see, for instance, Jonsson 1995, who has 30 observations in his sample, and Shelton 1996, who investigated 55 acquisitions. Lonroth 1995, and Lin/Madura/Picou 1994 included 92 foreign acquisitions in their sample).

On average, the same firm had three investments in the sample. In all cases the investing firms had experience of FDIs, in most cases the firms had made at least 10 foreign manufacturing investments before the reviewed FDI. In one-third of cases the investing firms did not have previous manufacturing experience from the target country, whereas in two-thirds of cases the investing firm had at least one, in some cases already several previous units in the target country. The investments were made in 19 different countries, mainly in OECD countries. Measured with cultural distance, the distance to the closest target country was 0.24 (the Netherlands) and to the most distant target country 3.29 (China). Most of the investments were related type of investments, only six were unrelated i.e. represent product diversi-fications. The mean relative size was 7.4 per cent, but the variation was great, from 0.17 per cent to 30.0 per cent (in c. half of the cases less than four per cent). About one-third of the cases were partial acquisitions or joint venture greenfield investments and two-thirds wholly-owned investments. Related to target country experience, type of investment and ownership arrangement the distribution of the reviewed cases coincides rather closely with the distribution in all FDIs made by Finnish firms (see e.g. Larimo 1993 and Larimo 1997).

Daily stock returns for the sample of Helsinki Stock Exchange (HeSE) firms are calculated as logarithmic closing price index differences. For days when no trading took place, returns are approximated with so-called uniform returns. Days when the preliminary information concerning the firms' FDI were given to the HeSE are used as announcement days. These are also the days when the information was published in major business newspapers in Finland. To be selected for analysis a stock had to have the required time-series of returns both in the estimation and the event periods and at least 11 price observations in the event period.

Stock Market Response to the Announcements of Foreign Direct Investments

Figure 1 depicts the cumulative abnormal stock returns for the event period. A relatively clear increase in abnormal returns after the foreign direct investment announcement day is observed. Price reaction seems to occur during the first trading week after the announcement day (days from -1 to 5).


Daily abnormal returns around the announcement day are reported in Table 2. The results indicate that there are no significantly positive abnormal returns on any of the days before the announcement day. However, significant abnormal returns are observed on days 1 and 4, suggesting that the announcement of foreign direct investment creates a positive price reaction in the stock market. In other words, investors take these announcements as positive signs concerning the future profitability of firms.

The fact that it takes a few trading days for the stock market to fully absorb the information involved in FDI announcements may be because of the diffusion in stock prices described in the previous section. To investigate this issue, cumulative abnormal returns around the announcement day are next calculated. The results reported in Table 3 indicate that the observed increase in stock price during the first trading days after the FDI announcement is clearly significant in terms of cumulative abnormal returns. This confirms the conclusion that the FDI announcement is taken as positive news by investors. Hence, these results clearly support the hypothesis that the markets react on average positively to the FDI announcements.

Table 4 summarizes the results concerning the refined prediction powers of the effects of the various specific features discussed in Section 2 on the CAR. The analysis is worked out by regressing CAR on these factors. We have also reported the sample correlations between the variables in the appendix. A statistically significant regression coefficient would indicate that the manner investors value investments would depend on the approach (e.g. relatedness or ownership) or the background factors how the firms carry out otherwise similar investments. Particularly this would imply that certain approaches to investments would systematically outperform others, and hence indicate that management in certain cases would choose systematically a sub-optimal investment approach.

The estimation results in Table 4 show that none of the regression coefficients estimates are statistically significant. Even the joint F-test is well below any standard significance thresholds with p-value equal to 0.711. Hence, no empirical evidence can be found that would indicate that the special features affect differently the market's reaction to investments. (4) This finding suggests that markets trust the firms' management abilities to carry out investments in an optimal manner, and the only force that creates value here is the investment per se. Earlier Cakici et al. (1996) found also similar results that the specific features of the FDI did not significantly influence the value creation in foreign acquisitions of US firms made in 1983-92.

Also the mutual correlations (reported in the appendix) between CAR and the explanatory are insignificant. Thus confirm further the above results. Furthermore, as a diagnostic check, correlations between the explanatory variables remain also pretty low, indicating that there should be no collinearity problems in the estimation.

Summary and Conclusions

This paper has investigated shareholders' wealth creation in foreign manufacturing investments. In addition, the effects of specific features of these investments on shareholders' wealth are investigated. These features include international and target country experience, relatedness (related versus unrelated) of investments, relative size of the FDI, ownership arrangement, and cultural distance.

The results based on 79 FDIs made by 19 Finnish firms in 1985-96 suggest that, on average, foreign direct investments have significant value creating effects for investing firm shareholders. Results in earlier studies regarding the special features of investments, target country, etc. effect on firm performance and hence on shareholders' wealth are mixed. Our results did not show empirical evidence for the existence of any separate effects of these special features of investments on shareholders' wealth. The results coincide with earlier results by Cakici, Hessel, and Tandon (1996), who also found that the specific features of the FDI did not significantly influence shareholder wealth gains in the foreign acquisitions of US target firms. These results indicate that there seems to be no specific kind of FDI strategy that outperforms another (e.g. that a wholly-owned unit creates more shareholder wealth than a joint venture). Thus, in sum, the results suggest that the belief in the value creation effect of FDIs is a fact, but the belief in the extra effect of specific features of the investment on firm performance and consequently on shareholders' value creation is more an illusion. This supports the idea that markets are efficient to the extent that there is no systematic way of making an FDI (e.g. by using wholly-owned subsidiaries and/or investing only in culturally close countries) that would outperform another strategy (e.g joint ventures and/or investments in culturally more distant countries).

The finding that the announcement of investment decision clearly had a positive effect on share prices merits further study. The study did not include e.g. the R&D and advertising intensity of the firm or business field, competition in the field, competition between various bidder firms, form of payment and/or impact of exchange rates on stock market reactions. In a further study all these aspects could also be included. Other topics for future research are e.g. whether the investing firm is capable of fulfilling the shareholders' positive expectations, whether profitability improves as a consequence of an FDI and how the synergy effects and wealth creation are distributed between stockholders of target and acquiring firms.


Correlation Coefficients of the CAR and FDI Factors

CAR          Intexp       Tcexp        Related

CAR           1
Intexp        0.011        1
Tcexp        -0.082        0.035        1
Related       0.121       -0.162       -0.104
Relsize      -0.069       -0.282 *      0.325
Ownership    -0.129       -0.022        0.111
Cultdis       0.143        0.068       -0.145

CAR          Relsize      Ownership    Cultdis

Related       1
Relsize      -0.107        1
Ownership     0.097        0.230 *      1
Cultdis      -0.047       -0.227 *     -0.306 *

* = significant at the 5% level. Sample size n = 79. In terms of the
test statistic t = r x [square root of n-2]/[[square root of r.sup.2]]
statistically significant correlations at the 5 percent level are those
with absolute value above 0.22.
Table 1. Summary of the Sample Features and Results in Various Studies

Study              Sample Features

                   Origin           Target          Number
                   of               country(ies)    of
                   investors        of              investments

Doukas and         USA              OECD and        301
Travlos (1988)                      non-OECD

Harris and         mainly           USA             159
Ravens-Scraft      OECD

Chen, Hue, and     USA              China            88
Shien (1991)

Hue, Chen, and     USA              China            42
Shien (1992)

Markides and       USA              mainly          276
Ittner (1994)                       OECD

Jonsson (1995)     Sweden           OECD             30

Datta and Puia     USA              OECD            112

Merchant (1995)    USA              OECD and        502/393

Cakiki, Hessel,    OECD             USA             225
and Tandon

Eun, Kolobny,      OECD             USA             195
and Scheraga

Lonroth (1996)     Denmark          OECD            92

Shelton (1996)     USA              mainly          55

Markides and       USA              OECD            236
Oyon (1998)

Table 1. Summary of the Sample Features and Results in Various Studies

Study              Sample Features                  Results

                   Number           Timing          Value
                   of               of              creation:
                   investing        investments     total
                   firms                            results

Doukas and         202              1975-83         NO
Travlos (1988)

Harris and         NI               1970-87         YES

Chen, Hue, and     56               1979-90         YES
Shien (1991)

Hue, Chen, and     34               1983-89         YES
Shien (1992)

Markides and       NI               1975-88         YES
Ittner (1994)

Jonsson (1995)       8              1981-91         NO

Datta and Puia     NI               1978-90         NO

Merchant (1995)    NI               1986-90         YES

Cakiki, Hessel,    117              1979-90         YES
and Tandon

Eun, Kolobny,      NI               1983-92         YES
and Scheraga

Lonroth (1996)      40              1988-92         YES

Shelton (1996)      55              1984-89         YES

Markides and       NI               1975-88         YES
Oyon (1998)

Table 1. Summary of the Sample Features and Results in Various Studies

Study              Results

                   Cultural         Type of         Ownership
                   distance:        investment:     arrangement:
                   short            related         wholly

Doukas and         NR               NS/ (- a)       NR
Travlos (1988)

Harris and         NR               NS              NR

Chen, Hue, and     NR (c)           NR              NR
Shien (1991)

Hue, Chen, and     NR (c)           NR              NR (d)
Shien (1992)

Markides and       NS               +               NS
Ittner (1994)

Jonsson (1995)     NR (f)           NR (g)          NR

Datta and Puia     NS/+             NS/+ (I)        NR (j)

Merchant (1995)    NS               NS              NR (k)

Cakiki, Hessel,    NR               NR              NR
and Tandon

Eun, Kolobny,      NR               -               NR
and Scheraga

Lonroth (1996)     NR               NR              NR

Shelton (1996)     NR               NS              NR

Markides and       NS               +               NR
Oyon (1998)

Table 1. Summary of the Sample Features and Results in Various Studies

Study              Results

                   International    Target          Size of the
                   experience       country         investment

Doukas and         NS               NS/ (- b)       NR
Travlos (1988)

Harris and         NR               NS              NR

Chen, Hue, and     NS               NS              NS
Shien (1991)

Hue, Chen, and     (- e)            NR              NR
Shien (1992)

Markides and       +                NR              +
Ittner (1994)

Jonsson (1995)     +  (h)           NR              NS

Datta and Puia     -                NR              NR

Merchant (1995)    NS (l)           NR              NR (m)

Cakiki, Hessel,    NS               NR              NS
and Tandon

Eun, Kolobny,      NS               NR              NR (n)
and Scheraga

Lonroth (1996)     NR (o)           NR              NR

Shelton (1996)     +                NR              +

Markides and       +                NR              NR
Oyon (1998)
NS = not statistically significant; NI = no information; NR = not
reviewed in the study.

(a) Non-significant in the sample; positive abnormal results only in
cases of unrelated investments to new countries. (- b) Connected with
target country experience: NS if target country experience; - if not
target country experience. (- c) All investments were made in China.
(- d) All investments were joint ventures. (- e) In the subgroup small
amount of subsidiaries positive signs and mostly significantly
different from zero whereas firms with a large amount of foreign
subsidiaries showed largelly insignificant investors' reaction.
(- f) The impact of actual cultural distance was not reviewed: positive
abnormal results in US acquisitions; and negative in EU acquisitions.
(- g) All investments were horizontal acquisitions. (h) Acquisition
experience in general. However, Swedish engineering firms in the sample
were multinationals. (- i) No abnormal returns in the short period,
positive in the long period. (- j) Did not include partial
acquisitions. (- k) The study focused only on international joint
ventures. (- l) Previous international joint venture experience, not
all FDI experience. (m) Only the relationship between IJV partners'
relative size was analyzed. The variable was statistically
insignificant. (- n) Absolute size of the deal had a significantly
negative effect on the wealth of aqcuiring shareholders. (- o) Value
creation negative in major acquirers subsample and positive in the
other acquirers subsample.
Table 2. Daily Abnormal Stock Returns Around the Foreign Direct
Investment Announcement Day

Window    AR                 Patell's t-stat    (prob.)

-5        -0.001             -0.234             0.8156
-4        -0.000             -0.368             0.7140
-3         0.002              1.528             0.1305
-2        -0.001             -0.125             0.9005
-1         0.001              1.052             0.2960
 0         0.001              0.120             0.9051
 1         0.004              2.069             0.0417
 2         0.003              1.213             0.2287
 3         0.001              0.409             0.6835
 4         0.004              2.565             0.0122
 5        -0.001             -0.449             0.6543

Window    BMP t-stat         (prob.)

-5        -0.264             0.7926
-4        -0.334             0.7391
-3         1.242             0.2179
-2        -0.103             0.9186
-1         1.110             0.2703
 0         0.105             0.9167
 1         1.884             0.0632
 2         0.968             0.3360
 3         0.323             0.7478
 4         2.311             0.0234
 5        -0.520             0.6048

Abnormal stock returns are calculated by first regressing each
stock's return on the market return using the data from the estimation
period of 240 days. The estimated parameters of the model are then
matched with the return data from the event period, and the difference
between realised returns and the returns predicted by the model is the
abnormal return. The first test statistic is Patell's (1976)
"standardised-residual method". The second test statistic is the
"standardised cross-sectional test" suggested by Boehmer et al. (1991).
Table 3. Cumulative Daily Abnormal Stock Returns Around the Foreign
Direct Investment Announcement Day

Window       AR                 Patell's t-stat    (prob.)

-5,0         0.002              0.805              (0.423)
-1,5         0.014              2.638              (0.010)
 0,5         0.012              2.419              (0.018)
 1,5         0.011              2.597              (0.011)

Window       BMP t-stat         (prob.)

-5,0         0.694              (0.490)
-1,5         2.223              (0.029)
 0,5         1.829              (0.071)
 1,5         1.951              (0.055)

Abnormal stock returns are calculated by first regressing each stock's
return on the market return using the data from the estimation period
of 240 days. The estimated parameters of this model are then matched
with the return data from the event period, and the difference between
realised returns and the returns predicted by the model is the abnormal

Window refers to the time period over which daily abnormal returns are
cumulated. The beginning and the end of the cumulation period is
expressed relative to the announcement day.

The first test statistic is Patell's (1976) "standardised-residual
method". The second test statistic is the "standardised cross-sectional
test" suggested by Boehmer et al. (1991).
Table 4. Effects of Various FDI Features on Stock Prices

             Coeff       std-err     t-val       p-val

Intercept     0.02063    0.03090      0.668      0.5070
Intexp        0.00009    0.00038      0.246      0.8060
Tcexp        -0.00525    0.01359     -0.386      0.7010
Related       0.02707    0.02335      1.160      0.2500
Relsize       0.00013    0.00083      0.152      0.8790
Ownership    -0.00022    0.00026     -0.864      0.3900
Cultdis       0.00866    0.00947      0.915      0.3630

             N           R-Square    F-Stat      p-val F
             79          0.049       0.624       0.711


(1) The authors want to express their sincere thanks to the two anonymous referees for many useful suggestions and constructive comments, which made possible to improve the paper. Sincerest thanks go also to Marianne Luoto and Satu Kiuru for their assistance in the research process. Finally, the authors want to express their gratitude to the Wihuri Foundation and Saastopankki Foundation for their financial support of this study.

(2) Unfortunately data related to R&D and/or advertising spending could not be obtained for all case firms and for all the years they had made FDIs. Therefore these variables had to be dropped out from the study.

(3) The major criticism presented in McWilliams and Siegel (1997) related to event studies concerns too little attention being paid to the following aspects: sample size, outliers, length of the event window and confounding effects.

- The sample size in our study is 79, which is about three times bigger than the average of the smallest subsamples reported in the event study examples in Table 1 of McWilliams and Siegel (1997).

- Outliers are checked utilising DFFITS proposed by Cook (1977). No obvious outliers are present in the data. The results are available from the authors on request. Furthermore the Boehmer et al. (1991) t-statistic is used to eliminate the effects of possible event-induced increase in the cross-sectional variances of abnormal returns.

- In this study relatively short event windows with different lengths are used to avoid confounding effects and leakage of information before the event.

- Confounding effects are very difficult to control fully. We have done this by keeping the event window short.

(4) Note, however, that the signs of international experience (Intexp), target country experience (Tcexp), relatedness (Related) and ownership arrangement (Ownership) are as expected, whereas the signs of size of the investment (Relsize) and Cultural distance (Cultdis) are counter the expectations.


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Juha-Pekka Kallunki, Professor of Accounting, University of Oulu, Oulu, Finland. Jorma Larimo, Professor of International Business, University of Vaasa, Vaasa, Finland. Seppo Pynnonen, Professor of Statistics, University of Vaasa, Vaasa, Finland.

Manuscript received March 1999, revised March 2000, revised July 2000.


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