Abstract
Scholars have noted that international investments have the potential to provide firms with real options value under uncertainty. To assess this issue, prior studies have tended to focus primarily on exchange rate volatility. Although multinational firms face other types of uncertainty as well, including those stemming from their domestic operating environment, the role of such uncertainty for firms' flexibility needs has not been previously considered. In this study we compare the influence of both domestic economic uncertainty and exchange rate uncertainty on the real option value of international investments of Korean firms over 16 years of varying uncertainty. We find evidence that an international investment network characterized by greater breadth and lower depth is associated with higher firm value under domestic economic uncertainty. Exchange rate uncertainty, however, was not found to play a role in firms' need for flexibility. The results suggest that firms are able to hedge exchange rate uncertainty by using mechanisms such as forward contracts or derivatives, thus potentially reducing the impact of this type of uncertainty on their operations.
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Notes
Environmental uncertainties of this kind include locally based competitive forces that are difficult to predict, especially in the short run (Porter, 1980; Scherer, 1980); unanticipated change in technologies that can threaten the firm's market position, especially if it is overly invested in now-obsolete technologies (Sutcliffe & Zaheer, 1998); and unforeseen fluctuations in price structures and demand in one environment but not another (Kogut & Kulatilaka, 1994).
Errunza and Senbet (1981, 1984) also point out the trade-offs between costs and benefits of foreign investments in the context of international corporate diversification, noting that the excess market valuation of multinationality is influenced by supply-side costs (arising from factors such as information gaps, relative inefficiency in foreign capital markets, the risk of expropriation, and host-country restrictions on foreign ownership) relative to the benefits (stemming from a reduction of market imperfections in product, factor and financial markets and differential international taxation).
We would like to thank Jacey Kim at Samil PricewaterhouseCoopers in Korea for suggesting this measure.
We also ran a separate model using a continuous variable to capture the change in number of foreign subsidiaries. The results were not qualitatively different from those obtained using the dummy approach.
AR corr(psar1) specifies that, within panels, there is AR(1) autocorrelation and that the coefficient of the AR(1) process is specific to each panel. AR, which stands for “autoregressive,” is a stochastic process that is described by a weighted sum of its previous values and a white noise error. An AR(1) is a mechanism by which only the immediately previous value (here, the value of the previous year) has a direct effect on the current value.
We conducted additional analyses by dropping sample outliers more than three standard deviations away from the mean of the size variable. Thirty-four observations were dropped because they were much larger than the sample mean. The results were not qualitatively different from the original analyses.
Two methods were used to generate interaction terms to minimize potential multicollinearity. First, we centered the variables by using deviations around the mean following Ito (1997) and Neter, Wasserman, and Kunter (1985). Second, we used a residual centering procedure (Lance, 1988; Zhang, Li, Hitt, & Cui, 2007). This procedure is accomplished by first regressing each interaction term on its own components and then generating the residuals (Jong, Ruyter, & Wetzels, 2005). Since the results are virtually the same, we report only the mean centered results.
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Acknowledgements
We thank Associate Editor Lemma Senbet and three anonymous reviewers for their insightful comments. We also thank Jay Barney, Michael Leiblein, Seongyeon Lim, Anil Makhija, Mike Peng, Jeff Reuer, Oded Shenkar, and Heli Wang for their helpful comments on the previous versions of this paper. This research was supported by a CIBER grant at the Fisher College of Business of The Ohio State University.
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Accepted by Lemma Senbet, Area Editor, 19 February 2008. This paper has been with the authors for one revision.
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Lee, SH., Makhija, M. The effect of domestic uncertainty on the real options value of international investments. J Int Bus Stud 40, 405–420 (2009). https://doi.org/10.1057/jibs.2008.79
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DOI: https://doi.org/10.1057/jibs.2008.79