Stock Market Recognition of Multinationality: An Empirical Study of U.S. Markets

Article excerpt

To the extent that business cycles tend to behave independently across different countries and that there exist imperfections in international markets for products, capital, and other factors, foreign operations by firms should provide their stockholders risk-return opportunities superior to those available to the stockholders of purely domestic firms. In this paper, we examine the empirical evidence with regard to these advantages of investing in multinational firms as a method of diversifying internationally, investigating the issue of investor recognition of the advantages enjoyed by a multinational firm.

This issue is important not only for investors but also for corporate management, for example, when formulating corporate strategy (see, for example, Hisey and Caves [13]). It is hypothesized that, consistent with the capital asset pricing model, international diversification of real assets by firms is rewarded in their domestic capital markets by a reduction in their systematic risk (beta) and by an increase in their price/earnings ratios. Further, it is hypothesized that the strength of these relationships is related to the degree of international involvement.


An early application of portfolio theory in an international context was by Grubel [11]. He demonstrated that for the individual portfolio investor, risk reduction is facilitated by holding a diversified portfolio of international securities. These results have been subsequently confirmed and extended by Levy and Sarnat [17], Grubel and Fadner [12], Solnik [25], Agmon and Lessard [4], and Solnik and Noetzlin [26]. These empirical studies have confirmed benefits from international diversification at the shareholder level in the form of risk-adjusted returns that are superior to those achievable in a single national market.

However, there are many restrictions that may prevent investors from achieving an efficient, internationally diversified portfolio. Among the barriers to investments in individual foreign markets are higher information processiong and transactions costs in the form, for example, of a general lack of information about foreign securities, the peculiar nature of trading and brokerage arrangements in the foreign capital market, lack of liquidyt, foreign exchange and other controls on the movement of capital, and the fear of expropriation and other political risks. To avoid these limitations of international portfolio diversification, it has been suggested that investors could achieve the advantages of international diversification by investing in domestically traded multinational firms.

A large number of researchers (Severn [23], Hughes, Logue, and Sweeney [14], Rugman [22], Agmon and Lessard [4], Miller and Pras [21], Aggarwal [1,2], Mikhail and Shawky [20], Barone [5], Kumar [16], Yoshihara [28], Grant [10], Aggarwal and Soenen [3], Daniels and Bracher [8], and Brewer [6] have provided empirical evidence of a positive relationship between international involvement and firm performance. These studies reported that multinational firms tend to be more profitable) measured as return on assets, return on sales, return on equity, and the price-earnings ratio) and/or showed lower risk (in terms of diversification of the unsystematic component of risk, beta coefficients, probability of insolvency, and equity variability) than domestically-based firms.

However, some authors )Severn [23], Rugman [22], Barone [5], and Aggarwal and Soenen [3]) have indicated that benefits of international diversification via the multinational firm seem to be deteriorating over time and will eventually fade away as the integration of economies proceeds.

A smaller number of researchers (Jacquillat and Solnik [15], Brewer [6, 7], Mathur and Hanagan [18], Fatemi [9], Shaked [24], and Michel and Shaked [19]) have provided empirical evidence that when both risk and return were considered, the risk-adjusted returns of multinational firms do not (always) outperform those provided by purely domestic firms. …