Skip to main content
SpringerLink
Log in

Valuation effects of global diversification

  • Article
  • Published:
Journal of International Business Studies Aims and scope Submit manuscript

Abstract

This paper examines the effect of global diversification on firm value using a data set of US firms from 1994 to 2002. We document that global diversification enhances firm value. Specifically, we find that Tobin's q, our proxy for firm value, increases with foreign sales (measured as a fraction of the firm's total sales), even after we control for well-known determinants of firm value. In contrast, we find no such evidence for industrial diversification. We find evidence of both financial and real effects driving such a value enhancement from global diversification. Furthermore, we find that the valuation benefits from global diversification are higher if the firm diversifies into countries with creditor rights that are stronger than those of the United States. Our results are also robust to controlling for the firm's endogenous choice to diversify across countries or across industries. Our study is anchored by the theories of both the financial and real dimensions of global diversification, and our results support both theories. Overall, our results provide a unifying view that global diversification benefits are driven by both the real and financial dimensions.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

Notes

  1. Another synonym for corporate international diversification is geographic diversification. However, since “geographic” could imply both domestic and international dimensions, we do not use that term, to avoid possible ambiguity.

  2. Errunza and Senbet (1981, 1984) use the term “degree of international operations”, which we treat as being synonymous with the degree of multinationality.

  3. These four measures are: (a) foreign sales percentage; (b) number of foreign, that is, non-US subsidiaries; (c) entropy measure of firm's geographical diversification; and (d) absolute foreign sales, measured in dollars.

  4. In a related paper, Delios and Beamish (1999) claim that the observed positive relationship between geographic scope and performance is spurious, because it is the possession of proprietary assets that is the foundation of superior performance, not expansion into international markets per se. They test this hypothesis with data on the corporate performance of 399 Japanese manufacturing firms, and demonstrate that geographic scope was positively associated with firm profitability, even when the competing effect of proprietary assets on firm performance was considered.

  5. For example, Doukas and Kan (2006) examine foreign direct investments and find that global diversification has a positive impact on bondholders’ wealth but a negative influence on shareholder value. In a related study, Fauver, Houston, and Naranjo (2004) find that international diversification has no effect on firm value for UK or German multinational firms, whereas it results in a diversification discount for US multinational firms.

  6. See also Jiraporn, Kim, Davidson, and Singh (2006) and Nam, Tang, Thornton, and Wynne (2006) for evidence of the influence of shareholder rights and managerial compensation on firm value.

  7. See the Empirical Results section for segment reporting rule changes that occurred during the sample period.

  8. To ensure comparability of our results with other studies, e.g., Bodnar et al. (1998), we impose this restriction to prevent potential distortions from small firms.

  9. The purpose of this restriction is to ensure that all firm sales have been allocated to individual business and global segments. See Denis et al. (2002), who use the same restriction.

  10. A simple example illustrates the difference between these two structures. If firm X reports three segments annually during each year in the sample period, a dataset based on the firm-year approach has one observation each year, whereas a dataset based on the firm-year country approach has three observations each year.

  11. In addition, when we use a firm-year structure, it requires us to correct only for clustering effects by firm, which we do in all our tables. This approach helps us avoid the econometric issues relating to simultaneously correcting for clustering effects by the firm and country had we chosen a firm-year-country structure for our dataset. See Petersen (2008) for an explanation of the size of resultant bias from not correcting for such simultaneous clustering.

  12. We thank two anonymous referees for these insights, which have helped us sharpen the corporate governance hypothesis.

  13. Companies are not required to report under the accounting rules that relate to segment reporting whether their foreign sales are through a foreign subsidiary or not. Additionally, we inquired and verified with Standard & Poors’ that there is no data item in the Compustat database that allows us to capture this distinction in foreign sales. As a result, we are unable to distinguish between these two forms of foreign sales in our empirical analysis.

  14. Morck and Yeung (1991) scale R&D expenditures and advertising expenditures by the level of tangible assets, rather than by total sales as we do. Since we employ R&D expenditures and advertising expenditures scaled by total sales as control variables (following more recent papers, such as Denis et al., 2002), we decided to interact these variables (rather than create new ones scaled by the level of tangible assets) with our measure of multinationality.

  15. Since our sample consists of US firms, we measure this variable relative to that of the United States. We thank an anonymous referee for the suggestion. See the Appendix for how this variable is constructed.

  16. We consider multinational firms and global firms synonymously.

  17. We thank an anonymous referee for drawing our attention to this econometric issue.

  18. For brevity, we refer to “foreign sales, measured as a fraction of total sales” simply as foreign sales.

  19. Given that the average Tobin's q is 1.877 (see Table 2), and the coefficient of foreign sales in Model 1 of Table 3 is 0.236, this implies an elasticity of 0.13 (=0.236/1.877). That is, a 1% increase in foreign sales results in a 0.13% corresponding increase in Tobin's q, which is the same as 0.01 × 0.236/1.877.

  20. Given that the average Tobin's q is 1.877 and the average level of foreign sales is 0.14 (see Table 2), and the coefficient of the interactive variable based on R&D expenditures in Model 4 of Table 3 is 0.806, this implies an elasticity of 0.06 (=0.14 × 0.806/1.877). That is, a 1% increase in advertisement expenditure results in a 0.06% corresponding increase in Tobin's q purely from the interaction term, which is the same as 0.01 × 0.14 × 0.806/1.877. A similar calculation based on the coefficient of the advertisement expenditures interactive variable in Model 4 shows an elasticity of 0.06 (=0.14 × 0.855/1.877). That is, a 1% increase in advertisement expenditure results in a 0.06% corresponding increase in Tobin's q purely from the interaction term, which is the same as 0.01 × 0.14 × 0.855/1.877.

  21. A calculation similar to that in Note 20, based on data from Table 1 and Table 5 (column 1) of Morck and Yeung's (1991) study, yields an increase in q of 0.14% for a 1% increase in R&D spending, and a 0.24% increase in q for a 1% increase in advertising expenditures from the interaction terms. We need to be cautious in drawing conclusions any stronger than that our estimates are in the same ballpark as theirs, since the regression specifications are not exactly identical.

  22. See Huefner et al. (2005), Module D, for an excellent discussion of the accounting standards underlying segment reporting.

  23. One possible explanation for the higher firm valuation is that these firms were able to borrow on better terms in those countries than in the United States. We thank an anonymous referee for this insight.

  24. Our evidence differs from that of Fauver et al. (2003), possibly because their study uses data from a different time period (1991–1995). In the spirit of the Fauver et al. (2003) study, we examined several country-level proxies based on the level of economic and financial development, such as a weighted GDP per capita (the weights being the sales in that country as a fraction of total sales), trade openness (i.e., the ratio of imports to GDP), accounting standards, corruption, and efficiency of the judicial system. The only variable from this set that when interacted with our measure of multinationality was statistically significantly related to firm value was the weighted GDP per capita. Results that include the weighted GDP per capita are available from the authors upon request.

  25. We also used antidirector rights of La Porta et al. (1997), which has subsequently been revised by Spamann (2008), as well as the more recent anti-self-dealing index of Djankov et al. (2008) interacted with our measure of multinationality in lieu of the interactive creditor rights variable in Table 6. However, none of these variables were significant at the usual 5% level.

References

  • Berger, P. G., & Ofek, E. 1995. Diversification's effect on firm value. Journal of Financial Economics, 37 (1): 39–65.

    Article  Google Scholar 

  • Bodnar, G. M., Tang, C., & Weintrop, J. 1998. Both sides of corporate diversification: The value impacts of geographic and industrial diversification. Working Paper, University of Pennsylvania.

  • Campa, J. M., & Kedia, S. 2002. Explaining the diversification discount. Journal of Finance, 57 (4): 1731–1762.

    Article  Google Scholar 

  • Caves, R. E. 1971. International corporations: The industrial economics of foreign investment. Economica, 38 (149): 1–27.

    Article  Google Scholar 

  • Caves, R. E. 1982. Multinational enterprise and economic analysis. Cambridge: Cambridge University Press.

    Google Scholar 

  • Delios, A., & Beamish, P. W. 1999. Geographic scope, product diversification and the corporate performance of Japanese firms. Strategic Management Journal, 20 (8): 711–727.

    Article  Google Scholar 

  • Denis, D. J., Denis, D. K., & Yost, K. 2002. Global diversification, industrial diversification, and firm value. Journal of Finance, 57 (5): 1951–1979.

    Article  Google Scholar 

  • Djankov, S., La Porta, R., Lopez-de-Silanes, F., & Shleifer, A. 2008. The law and economics of self-dealing. Journal of Financial Economics, 88 (3): 430–465.

    Article  Google Scholar 

  • Dos Santos, M. B., Errunza, V. R., & Miller, D. P. 2008. Does corporate international diversification destroy value? Evidence from cross-border mergers and acquisitions. Journal of Banking and Finance, 32 (12): 2716–2724.

    Article  Google Scholar 

  • Doukas, J. A., & Kan, O. B. 2006. Does global diversification destroy firm value? Journal of International Business Studies, 37 (3): 352–371.

    Article  Google Scholar 

  • Doukas, J. A., & Lang, L. H. P. 2003. Foreign direct investment, diversification and firm performance. Journal of International Business Studies, 34 (2): 153–172.

    Article  Google Scholar 

  • Errunza, V. R., & Senbet, L. W. 1981. The effects of international operations on the market value of the firm: Theory and evidence. Journal of Finance, 36 (2): 401–417.

    Article  Google Scholar 

  • Errunza, V. R., & Senbet, L. W. 1984. International corporate diversification, market valuation, and size-adjusted evidence. Journal of Finance, 39 (3): 727–743.

    Google Scholar 

  • Fauver, L., Houston, J., & Naranjo, A. 2003. Capital market development, international integration, legal systems, and the value of corporate diversification: A cross-country analysis. Journal of Financial and Quantitative Analysis, 38 (1): 135–157.

    Article  Google Scholar 

  • Fauver, L., Houston, J. F., & Naranjo, A. 2004. Cross-country evidence on the value of corporate industrial and international diversification. Journal of Corporate Finance, 10 (5): 729–752.

    Article  Google Scholar 

  • Greene, W. H. 2008. Econometric analysis. Upper Saddle River, NJ: Prentice-Hall.

    Google Scholar 

  • Huefner, R. J., Largay, J. A., & Hamlen, S. S. 2005. Advanced financial accounting. Mason, OH: Thomson Custom Publishing.

    Google Scholar 

  • Jensen, M., & Meckling, W. 1976. Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3 (4): 305–360.

    Article  Google Scholar 

  • Jiraporn, P., Kim, Y. S., Davidson, W. N., & Singh, M. 2006. Corporate governance, shareholder rights and firm diversification: An empirical analysis. Journal of Banking and Finance, 30 (3): 947–963.

    Article  Google Scholar 

  • La Porta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. W. 1997. Legal determinants of external finance. Journal of Finance, 52 (3): 1131–1150.

    Article  Google Scholar 

  • Lang, L. H. P., & Stulz, R. M. 1994. Tobin's q, corporate diversification and firm performance. Journal of Political Economy, 102 (6): 1248–1280.

    Article  Google Scholar 

  • Lins, K., & Servaes, H. 1999. International evidence on the value of corporate diversification. Journal of Finance, 54 (6): 2215–2239.

    Article  Google Scholar 

  • Morck, R., & Yeung, B. 1991. Why investors value multinationality. Journal of Business, 64 (2): 165–187.

    Article  Google Scholar 

  • Morck, R., & Yeung, B. 1992. Internalization: An event study test. Journal of International Economics, 33 (1–2): 41–56.

    Article  Google Scholar 

  • Nam, J., Tang, C., Thornton, J. H., & Wynne, K. 2006. The effect of agency costs on the value of single-segment and multi-segment firms. Journal of Corporate Finance, 12 (4): 761–782.

    Article  Google Scholar 

  • Petersen, M. 2008. Estimating standard errors in finance panel data sets: Comparing approaches. Review of Financial Studies, 22 (1): 435–480.

    Article  Google Scholar 

  • Spamann, H. 2008. “Law and finance” revisited. Harvard Law School Discussion Paper 12.

  • White, H. 1980. A heteroskedasticity-consistent covariance matrix estimator and a direct test for heteroskedasticity. Econometrica, 48 (4): 817–838.

    Article  Google Scholar 

Download references

Acknowledgements

We thank the editors (Lorraine Eden and Vihang Errunza), and three anonymous referees for helpful suggestions and comments. We have also benefitted from comments from conference participants at the American Economic Association (AEA) and the Financial Management Association (FMA) annual meetings.

Author information

Authors and Affiliations

  1. Cox School of Business, Southern Methodist University, Dallas, USA

    Amar Gande

  2. Owen Graduate School of Management, Vanderbilt University, Nashville, USA

    Christoph Schenzler

  3. Robert H. Smith School of Business, University of Maryland, USA

    Lemma W Senbet

Authors
  1. Amar Gande
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Christoph Schenzler
    View author publications

    You can also search for this author in PubMed Google Scholar

  3. Lemma W Senbet
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Amar Gande.

Additional information

Accepted by Vihang Errunza, Consulting Editor, 16 July 2009. This paper has been with the authors for three revisions.

Appendix

Appendix

Variable Definitions

Measures of multinationality

  • Foreign sales/sales: Estimated as the sum of non-US segment sales divided by net sales of the firm. Source: Compustat segment files.

  • Global dummy: An indicator variable that takes a value of 1 if the firm reports at least one non-US segment, and zero otherwise. Source: Compustat segment files.

  • Number of global segments: Number of global segments reported by the firm. Source: Compustat segment files.

Measures of Real Effects (Intangibles)

  • Foreign sales/sales × R&D/sales: Created by interacting Foreign sales/sales and R & D/sales variables. See measures of multinationality and firm-specific variables for details of how these individual variables are constructed. Source: Compustat segment and annual files.

  • Foreign sales/sales × Advertising/sales: Created by interacting Foreign sales/sales and Advertising/sales variables. See measures of multinationality and firm-specific variables for details of how these individual variables are constructed. Source: Compustat segment and annual files.

Measures of industrial diversification

  • Nonprimary sales/sales: Estimated as sales minus primary segment sales. The primary segment is the segment where the business segment SIC code equals the primary SIC code in the company segment file. If we do not find a match, the segment with the largest sales becomes the primary segment. Source: Compustat company segment and business segment files.

  • Multi-industry dummy: An indicator variable that takes a value of 1 if the firm reports two or more industry segments, and 0 otherwise. Source: Compustat business segment files.

  • Number of industry segments: Number of industry segments reported by the firm. Source: Compustat business segment files.

Country-level corporate governance variables

  • Foreign sales/sales × Creditor rights dummy: Created by interacting Foreign sales/sales and Creditor rights dummy. The Creditor rights dummy variable measures whether the countries into which the firm has diversified have stronger creditor rights than those of the United States. We construct this variable as follows. For each firm-year, we calculate the weighted average of the creditor rights variable across all countries in which the firm has foreign sales, the weights being sales in that country as a fraction of the firm's total sales during the same year. If this weighted average is larger than 1 (since the creditor rights variable for United States is 1), the Creditor rights dummy variable takes a value of 1, and 0 otherwise. The creditor rights data (scale of 0–4, with a higher value indicating stronger creditor rights) used in constructing the Creditor rights dummy variable is from La Porta et al. (1997).

  • Foreign sales/sales × Common law: Created by interacting Foreign sales/sales and Common law variables. We construct the latter variable as follows. For each firm-year, we calculate the weighted average of the common law variable across all the countries in which the firm has foreign sales, the weights being sales in that country as a fraction of the firm's total sales during the same year. The common law variable is from La Porta et al. (1997) and is defined as 1 if the laws are modeled on English law and 0 otherwise.

Firm-specific variables

  • Ln (capitalization): The natural logarithm of market capitalization of the firm. It is estimated as total assets (item 6) plus market capitalization (stock price at fiscal year end (item 199) times common shares outstanding (item 25) minus common equity (item 60) minus deferred taxes (item 74). Source: Compustat annual files.

  • Liabilities/assets: The ratio of total liabilities (item 181) to total assets (item 6). Source: Compustat annual files.

  • EBIT/sales: The ratio of earnings before interest and taxes and sales. It is estimated as operating income after depreciation (item 178) divided by net sales (item 12). Source: Compustat annual files.

  • Capital expenditure/sales: The ratio of capital expenditures (item 128) and net sales (item 12). Source: Compustat annual files.

  • R&D/sales: The ratio of R&D expenses (item 46) and net sales (item 12). If item 46 was coded by Compustat as not available or insignificant, we assigned a zero value to this variable. Source: Compustat annual files.

  • Advertisement/sales: The ratio of advertising expenses (item 45) and net sales (item 12). If item 45 was coded by Compustat as not available or insignificant, we assigned a zero value to this variable. Source: Compustat annual files.

Rights and permissions

Reprints and permissions

About this article

Cite this article

Gande, A., Schenzler, C. & Senbet, L. Valuation effects of global diversification. J Int Bus Stud 40, 1515–1532 (2009). https://doi.org/10.1057/jibs.2009.59

Download citation

  • Received:

  • Revised:

  • Accepted:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1057/jibs.2009.59

Keywords

Search

Navigation