Financial Resource Flows in Multinational Enterprises: The Role of External Capital Markets
Aulakh, Preet S., Mudambi, Ram, Management International Review
* This paper integrates insights from internalization theory and recent advancements related to internal capital markets to understand the efficiency of markets and hierarchies in explaining financial flows in multinational enterprises (MNEs). In particular, we examine how the efficiency of external capital markets in MNE home countries impact the financial flows between the MNE and its subsidiaries.
* Using data from the UK subsidiaries of 222 MNEs across 32 countries, and after controlling for subsidiary characteristics, industry and country factors, we test two hypotheses relating external capital market efficiency indicators and to net financial flows from the UK.
* We find evidence that external capital markets affect the use of internal capital markets within MNEs. In particular, the lower the per capita stock market liquidity in the MNE home market, the higher the net financial flows from the UK subsidiary to the firm's headquarters (HQ). Further, the lower the debt-finance availability in the MNE home market, the higher the net financial flows from the UK subsidiary to the firm HQ.
* These two external capital market efficiency indicators significantly enhance the explanatory power of the HQ-subsidiary financial flows equation beyond that explained by factors related to subsidiary's independence, arbitrage opportunities, and risk-return factors associated with home and host markets.
In The Future of Multinational Enterprise, Buckley and Casson (1976) depart from the orthodox theory of production by repudiating the neo-classical assumption of perfect competition. They note that the multinational enterprise (MNE) operates in a world of imperfect competition and therefore has the ability to organize itself to generate competitive advantage and exercise some degree of control over price. The MNE does so by carrying out many activities apart from the routine production of goods and services: "... particularly important are marketing, R&D, the training of labor, the building of the management team, the procurement of finance and the management of financial assets, etc" (p. 33) (italics added).
Buckley and Casson note that firms make strategic organizational choices between the use of external markets and internalization based on efficiency and that internalization over national boundaries creates MNEs. Their analysis primarily focuses on the marketing and R&D functions. While they point out that the failure of short and long-term futures markets is a key factor underlying the formation of MNEs, they do not go on to analyze the finance function directly. There is a growing recognition of the need to incorporate finance-specific factors in understanding firms' international investment decisions (Oxelhei/Randoy/Stonehill 2001). As suggested by Liebeskind (2000, p. 59), "the theory of the firm today remains centered on the firm's role in administering exchanges of real goods and services; the financial transactions of the firm are not considered determinants of a firm's boundaries.... It is just as important to compare the efficiency of markets and hierarchies in administering transactions of capital as it is to compare their efficiency in administering non-capital transactions." Our objective in this paper is to elaborate on this particular aspect of Buckley and Casson's analysis using the modern developments in the study of the resource flows within multi-divisional (Lamont 1997) and exporting firms (Campa/Shaver 2002).
There is a recent body of literature suggesting that the primary function of the headquarters of a multi-divisional firm is to run the internal capital market, which effectively re-distributes resources within the firm (Shin/Stulz 1996, Lamont 1997, Stein 1997). The running of this internal capital market involves channeling resources within the firm. It creates both winners and losers--some units receive broader mandates and responsibilities while others are slimmed down or closed altogether. …