Determinants of Capital Budgeting Strategies: An Econometric Analysis of U.S. Multinational Subsidiaries
Hasan, Iftekhar, Shao, Lawrence Peter, Shao, Alan T., Multinational Business Review
Given the increased trend toward integrated global markets, the financial strategies used by foreign managers have become increasingly important areas of concern for multinational enterprises. This exploratory study evaluated the capital budgeting strategies of 159 foreign subsidiaries of U.S.-based multinational enterprises. A logit regression model was used to test the likelihood that foreign subsidiaries would adopt sophisticated capital budgeting strategies given various firm-specific and company-specific factors. The results of this study indicated that ownership arrangement, financial leverage, and asset size were key factors related to the adoption of sophisticated capital budgeting strategies.
Determining which firm-specific and environmental factors affect a firm's capital budgeting practices is a difficult task in any domestic market - this task is even more difficult in the international arena. In particular, there are various foreign issues associated with the political, economic and financial environments that can upset even the best laid plans. Thus, a clear understanding of a company's internal and external environments is necessary if it is going to be successful abroad.
When multinational enterprises (MNEs) open offices in foreign markets, there are many options regarding how to manage their foreign subsidiaries. On one end of the continuum, they may choose to operate with a heavy hand. That is, they instruct their subsidiaries how and what to do and when to do it. At the other end of the continuum, they may allow their foreign subsidiaries to make their own decisions. In this case, it would be left up to the subsidiaries to design their own strategies and carry them out. The rationale behind this strategy is that since the subsidiaries are located in local markets, they should be equipped to handle the tasks. Today, many companies are utilizing a compromise between these two extremes by setting strategic goals at the home office and then allowing local managers to achieve the goals by implementing their own specific techniques.
To determine how well foreign subsidiaries are performing, it is necessary to examine which financial decision models are being used by subsidiary managers. Unlike domestic capital budgeting analysis, there are more factors to consider when doing international analyses. Foreign influences that can affect the capital budgeting decision include complex cash flow estimates, foreign exchange rate changes, lack of standard accounting systems, financial risks and political uncertainties. The purpose of this study is to examine several additional factors that may affect the capital budgeting practices utilized by foreign subsidiaries of U.S.-based MNEs. The findings based on responses generated from 159 foreign subsidiaries of U.S.-based MNEs operating in 43 countries.1
The findings of this study show that ownership status and financial leverage are important factors which are related to the sophistication of capital budgeting techniques utilized by foreign subsidiaries. The analysis also shows that firm age and asset size are directly related to the source used to determine discount rates. Finally, the results indicate that publicly traded subsidiaries and asset size are positively associated with sophisticated risk-assessment strategies.
This paper is composed of five parts. The first part briefly gives both a theoretical and practical overview of international capital budgeting analysis. The second part discusses the data collection techniques and the questionnaire design used in this study. The third part focuses on the logit regression model used in our analyses. The fourth section provides some important findings of our research. The last section offers some conclusions from this study.
Theoretical Issues on International Capital Budgeting Analysis
Due to the complex environmental concerns abroad, capital budgeting analysis is more difficult for foreign projects than it is for local projects. …