shareholder valuation of foreign investment and expansion

Strategic Management JournalStrat. Mgmt. J., 27: 1123–1140 (2006)

Published online in Wiley InterScience (www.interscience.wiley.com) DOI: 10.1002/smj.561

Received 14 March 2003; Final revision received 20 April 2006

SHAREHOLDER VALUATION OF FOREIGNINVESTMENT AND EXPANSION

HEATHER BERRY*The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania, U.S.A.

This study analyzes when different foreign investment location choices are value creating for firmsat different stages of international expansion. I argue that because direct investment in developingcountries is riskier than in advanced countries, shareholders may not value a firm’s investment indeveloping countries until that firm has experience from previous international investments andcapabilities to better manage and hedge the higher levels of risk and uncertainty. Using a panel of191 U.S. manufacturing firms and their foreign investments over a 20-year period (1981–2000),the empirical results show that firm investments in advanced and developing countries are valueddifferently by shareholders, depending on the firm’s prior international expansion, the firm’scapabilities and experiences, and the knowledge intensity of the firm’s industry. These resultshighlight the importance of considering firm location decisions, prior experiences, and resourceswhen analyzing. Copyright 2006 John Wiley & Sons, Ltd.

INTRODUCTION

A number of studies have examined whether afirm’s multinational operations are value creat-ing or value destroying for firms. Studies thatfocus on the positive aspects for firm perfor-mance argue that firms have opportunities to gaingreater returns from their intangible assets andmarket power, from spreading risk, from sub-sidizing poorly performing operations and fromseeking less expensive inputs abroad (Doukas andTravlos, 1988; Ramaswamy, 1992; Sullivan, 1994;Morck and Yeung, 1991; Bodnar, Tang, and Wein-trop, 1999; Berry and Sakakibara, 2006). Studiesthat focus on the negative aspects have arguedthat increased coordination and management costs,

Keywords: performance; foreign direct investment; loca-tion∗ Correspondence to: Heather Berry, The Wharton School, Uni-versity of Pennsylvania, 2022 Steinberg Hall–Dietrich Hall,Philadelphia, PA 19104-6370, U.S.A.E-mail: [email protected]

increased cultural and institutional diversity, andthe complexity that results from differing govern-ment regulations and currency fluctuations createsubstantial barriers for firms attempting to bene-fit from international operations (Sundaram andBlack, 1992; Geringer, Beamish, and de Costa,1989; Hitt, Hoskisson, and Kim, 1997). Despitemany empirical analyses on this topic, there is noconsensus about whether (or when) a firm’s multi-national operations create value for firms (for pos-itive results, see Errunza and Senbet, 1981, 1984;Doukas and Travlos, 1988; Morck and Yeung,1991; Bodnar et al., 1999; Berry and Sakakibara,forthcoming; for negative results, see Click andHarrison, 1999; Dennis, Dennis, and Yost, 2002;Haar, 1989; Kumar, 1984; for no relationship,see Brewer, 1981; and for nonlinear results, seeGeringer et al., 1989; Daniels and Bracker, 1989;Sullivan, 1994).

Though numerous, existing studies on this issuehave not yet considered how firm foreign locationchoices, experiences, and capabilities gained from

Copyright 2006 John Wiley & Sons, Ltd.

1124 H. Berry

prior foreign expansion may interact to influencethe performance effects from a firm’s multina-tional operations expansions. These are impor-tant considerations, given that there are signif-icant differences across advanced and develop-ing country locations in terms of institutional,financial, political, economic, and social issuesthat are likely to influence shareholder valuationof such investments. Further, there are impor-tant firm differences associated with various lev-els of multinational operations that provide firmswith distinct capabilities and options to invest inthese different locations. In this paper, I focus onthe higher level of risk associated with develop-ing country locations and the prior experiencesof firms to manage and benefit from operationsin these riskier environments to examine whenshareholders value heterogeneous firms’ invest-ments in advanced and developing country loca-tions.

I analyze these issues using a panel of 191U.S. manufacturing firms and their foreign invest-ments over a 20-year period (1981–2000). Inthe empirical analysis, I show that advanced anddeveloping country investments are valued dif-ferently depending on the experiences and capa-bilities firms have gained from prior investmentsabroad. Further, I find differences in shareholdervaluation of firm foreign investment choices forfirms in high vs. low knowledge-intensive indus-tries. For firms in high knowledge-intensive indus-tries, shareholders value early expansion by firmsinto advanced countries. At higher levels of inter-national involvement, however, further expansioninto advanced countries is not significantly val-ued by shareholders. In contrast, shareholders onlyvalue developing country location investment byfirms in high knowledge-intensive industries afterthese firms have a high level of multinationaloperations in place. Taken together, these resultssuggest that U.S. manufacturing firms in highknowledge-intensive industries need to gain man-agerial capabilities and experiences in advancedcountry locations before shareholders value theirdeveloping country location investments. For firmsin low knowledge-intensive industries, the resultsare quite different. For these firms, sharehold-ers value initial expansion into developing coun-try locations. At higher levels of internationalexpansion, however, shareholders do not valueincreased investment in either advanced or devel-oping country locations. These results suggest that

shareholders may value early access to cheaperinputs for firms in low knowledge-intensive indus-tries, despite the lower institutional protections andhigher risk that exist within these developing coun-try locations.

Why are these results important? The majorityof studies examining the performance effects froma firm’s foreign investments use very aggregatemeasures of foreign investment, without consider-ing how and why firm characteristics, experiences,and location choices are likely to influence share-holder valuation of firm foreign investment andexpansion. In this study, I include firm capabil-ities, choices, and experiences in the analysis. Ishow that different paths to international expan-sion are valued by shareholders for different typesof firms—that advanced and developing countryinvestments are valued differently depending onthe experiences and capabilities firms have gainedfrom prior investments abroad. These results high-light the importance of considering firm locationdecisions, prior experiences and resources whenanalyzing shareholder valuation of the foreigninvestment choices of firms at different stages ofinternational expansion.

THEORY

The study of strategic management is concernedwith the choices and actions of managers. Thevarious decisions managers make regarding whichproducts to produce and sell, what capabilities andresources to develop, when and where to invest(among many other issues), all impact the perfor-mance of firms. Not all firms will benefit from sim-ilar expansion strategies—rather, different expan-sion strategies will be more or less beneficial fora firm, depending on its capabilities and resourcesor its prior experiences, for example. In essence,heterogeneous firms will benefit from differentgrowth strategies. In this paper, I focus on growthstrategies that are available to firms investing inforeign markets through foreign direct investment(FDI).1

1 It should be noted that exports are not considered part ofthis definition in this paper. While exporting is certainly oneexpansion strategy available to firms, the focus of this paper ison the effects from investment involving control over operationsin foreign countries. In fact, Caves (1996) defines a multinationalfirm as one that has established two or more country businessenterprises in which it exercises some minimum level of control.

Copyright 2006 John Wiley & Sons, Ltd. Strat. Mgmt. J., 27: 1123–1140 (2006)DOI: 10.1002/smj

Foreign Investment and Expansion 1125

Location choice

Almost all studies that have examined the perfor-mance effects from a firm’s foreign investmentshave used aggregate measures to examine a firm’smultinationality—including measures such as for-eign to total sales ratios, a firm’s total number offoreign subsidiaries, or the total number of for-eign nations in which firms have subsidiaries (seeErrunza and Senbet, 1981, 1984; Geringer et al.,1989; Geringer, Tallman, and Olsen, 2000; Morckand Yeung, 1991; Sullivan, 1994; Hitt et al., 1997;Christophe, 1997; and Doukas, Pantzalis, and Kim,1999, for example).2 In general, these proxies havebeen regressed against a measure of firm per-formance to make conclusions about the overalleffects from a firm’s multinationality. The problemwith these aggregate measures, however, is thatone has no ability to analyze how separate loca-tions may impact a firm’s performance—and howfirms with distinct resources and experiences maybe differentially affected by the costs and benefitsassociated with various country environments.

In studies that have considered foreign loca-tion choices (for recent examples, see Belderbosand Sleuwaegen, 1996; Dunning, 1998; Pantza-lis, 2001), the location choices that are avail-able to firms have been categorized into advancedand developing countries. Advanced countries gen-erally include the United States, Canada, West-ern Europe, Japan, Australia, and New Zealand,and the developing countries generally include allother countries in the world (Eastern Europeancountries, Central and South American countries,African countries, and Asian countries (besidesJapan) and Mexico). While the distinction betweenthese groupings can be based simply on levels ofeconomic development, there are other importantdifferences between these locational groupings.For example, there are differences in the typesof institutions, levels of political risk, intellectualproperty protection, judicial remedies in place andother political, social, and financial factors thatmay play an important role in determining howshareholders value investments across these loca-tions.

Extant literature in economics, finance, and strat-egy suggests various well-known reasons for firms

2 The one study that has considered how shareholders valuedifferent foreign location investment choices (Pantzalis, 2001)will be discussed in more detail below.

to invest in each of these categories of coun-tries—on a fairly general level, advanced countrylocations are argued to provide firms with access toconsumers with higher incomes and higher educa-tion levels, to locations with less risk (financial andpolitical, for example), to locations where knowl-edge can be acquired or learned, and to moreinstitutional protections for investments. Develop-ing countries are argued to provide firms withhigher returns (and higher associated levels ofrisk), lower costs and more abundant sources forinputs (including land, labor, and capital), and,in the specific cases of developing countries likeChina and India, access to areas of the world withthe largest (and fastest-growing) populations.

The one performance study that has analyzedthese two location categories (Pantzalis, 2001) hasused internalization theory reasoning and focusedon the influence of transaction costs across thesetwo location groupings. The internalization theoryis concerned with identifying situations in whichthe markets for intermediate products are likelyto be internalized, and in which firms will ownand control value-adding activities outside theirnational boundaries. The presence of strong intan-gible assets and a firm’s desire to keep theseassets proprietary render alternatives to foreigndirect investment (such as licensing or franchising)too expensive because of the costs of monitor-ing the contracts (and the potential of giving otherfirms the ability to appropriate returns from firm-specific know-how). Because of market imper-fections associated with the international transac-tion of firm-specific intangible assets (especiallyknowledge-based assets), it is a firm’s possessionof intangible assets that is considered to be a cen-tral determinant of foreign direct investment in theinternalization theory. Pantzalis argues that arm’s-length transaction costs for proprietary know-howwill be higher in developing countries than inadvanced countries (because market failure is morelikely in developing country locations). An impor-tant implication from this reasoning (and findingfrom this study) is that higher market valuation willresult from foreign direct investments in develop-ing country locations than from advanced coun-try locations (because of the associated highertransaction costs). While a focus on higher trans-action costs seems appropriate, these results aresurprising for two reasons. First, while prior stud-ies have not tended to break down the foreigninvestment variable into advanced and developing


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country components, Pantzalis’ study would sug-gest that previous positive valuation findings aredriven by developing country investment. This ishard to imagine, given that the majority of MNCinvestment occurs in advanced country locations.(According to many years of World InvestmentReports from the United Nations Commission onTrade and Development (UNCTAD), a large per-centage of annual foreign direct investment by allfirms goes to advanced country locations—with 70percent going to advanced countries in the last yearreported in the most recent edition of the report(2003).) Second, if it is only developing countrylocation investment that is valued by investors, itseems that U.S. firms in particular would changetheir strategy and try to increase their market valueby investing much more than they currently do indeveloping country locations.

Similar to studies that use internalization theorylogic, I include firm intangible assets in the anal-ysis below.3 However, I also include other firmresources and industry characteristics to examinehow different firm capabilities and experiencesmay moderate the levels of risk found in theselocations. In addition to the associated transactioncosts needed to monitor a contractual relationshipin advanced and developing country locations, animportant difference between these firm invest-ment location choices for shareholders may bethe overall levels of uncertainty and risk involvedwith the foreign direct investment for the investingfirm. Higher risks from developing countries resultfrom a number of differences across advanced anddeveloping countries (including different institu-tional settings that may not provide adequate legalprotection (especially for property rights)), higherlevels of exchange rate risk, different types of gov-ernment regulations, different levels of politicaland financial risk, and less developed infrastructureand essential inputs (such as power and telecom)).All of these differences are likely to impact thesuccess of firms—especially for firms that havenot previously been exposed to managing opera-tions under such conditions. Thus, both the envi-ronment a firm faces in a developing country andits own prior experiences and resources are likely

3 As will be discussed further below, I also included interac-tion terms between a firm’s intangible assets and its foreigninvestments (following the studies by Morck and Yeung, 1991;Christophe, 1997; Pantzalis, 2001); however, none of these wassignificant.

to have important influences on how successful dif-ferent firms will be when they attempt to manageoperations in foreign markets.

Shareholder valuation of developing countryinvestment

Finance studies show that MNCs are better ableto hedge the increased risk from their develop-ing country operations across many geographicareas and to reduce foreign exchange exposure(Agmon and Lessard, 1977; Adler and Dumas,1983; Fatemi, 1984; Doukas and Travlos, 1988).Further, management studies have shown thatthrough operating in foreign markets MNCs learnto deal with the political risk, regulatory changes,financial crises and other issues that affect thevalue of operations in various types of environ-ments (Barkema, Bell, and Pennings, 1996; Deliosand Henisz, 2000). While the empirical evidenceon whether developing country location investmentwill provide MNCs with higher market values isinconclusive, these studies suggest that sharehold-ers may value developing country investment byMNCs that have gained experience from prior for-eign investments and that have developed capabil-ities to manage the higher level of risk and uncer-tainty associated with developing country loca-tions. Management studies have also suggestedthat firms with more extensive multinational oper-ations may have a number of options and benefits(see Kogut, 1985, for example) that can be used tooffset some of the risk found in developing coun-try locations—for example, a firm with a moreextensive network may be able to leverage its sizeand influence in a region to bargain with develop-ing country governments to reduce political risk;it may be able to hedge risk from one market withinvestments in other less risky markets; it mayhave learned from experiences with similar issuesor problems in other countries; it may change pro-duction amounts depending on local situations (ina number of different markets) or it may subsidizeoperations with profits from more profitable oper-ations until a foreign subsidiary is able to operateon its own financially.

Because direct investment in developing coun-tries is riskier than in advanced countries, it issuggested here that shareholders may not pos-itively value a firm’s investment in developing



countries until that firm has a certain level of multi-national operations in place that allows it to effec-tively manage and hedge the higher risk (includingfinancial, operational, and political risk) and toapply learning from investments in other interna-tional markets. While clearly building on financearguments that developing country investments aremore risky, this is not meant to suggest that financereasons provide the only rationale for firms toinvest in developing countries, or the only rea-son for shareholders to value developing countryinvestment. Rather, the fact that higher risk existsin one type of location may mean that economicand international strategic management reasons forthe investment may be more effectively realizedafter a firm has learned from its previous networkexpansions and can better manage the increasedrisk found in developing country markets.

Building on this reasoning, firms can be catego-rized as having different levels of multinationality,based on how extensive their operations are in for-eign countries. One way to approach this issue isto categorize firms as having low, medium, or highlevels of multinational operations. Firms with lowlevels of multinational operations have few foreignsubsidiaries (and have less ability to manage orhedge risk, and fewer learning experiences fromprevious foreign investments), while firms withhigh levels of multinational operations have muchmore extensive operations abroad (and thus muchgreater ability to manage and hedge risk and applylearning from other foreign investments). Firmswith medium levels of multinational operations liesomewhere in between in terms of their abilitiesto manage risk and apply learning from other mar-kets. In terms of these levels of multinationality, itshould be those firms with medium or high levelsof multinational operations that have the informa-tion externalities and hedging opportunities thatKogut refers to when he writes about multination-ality providing valuable options to firms.

An additional issue that is likely to influenceshareholder valuation of a firm’s location choiceis the knowledge intensity of the firm’s industry.Braunerhjelm and Oxelheim (2000) characterizecompetition in industries with high R&D expen-ditures as resting on product differentiation, whilecompetition in low R&D-intensive industries restslargely on country-specific resources—where fac-tors of production exhibit relatively low mobilityacross industries and products tend to be fairly

homogeneous. High knowledge-intensive indus-tries are characterized by relatively large outlayson R&D with the knowledge coming from thisR&D transferable across many different locations.Low knowledge-intensive industries are character-ized by competitive advantage that rests more oncountry-specific factors, with foreign investment inthese industries often associated with the exploita-tion of raw materials and cheap labor. More prac-tically, looking at data on flows of FDI, one cansee large differences between the paths of inter-national expansion in these two types of indus-tries. The United Nations Commission on Tradeand Development (UNCTAD) yearly data on worldFDI flows show that high R&D-intensive indus-tries tend to dominate FDI flows, with much moreinvestment occurring in advanced country loca-tions than developing country locations. The dif-ferent types of competition in these industries,the different role of technology, and the differ-ent role that country endowments play (in termsof cheap labor and raw materials) all suggest thatdifferent firm foreign location investment strate-gies are likely to be valued by shareholders forfirms in high vs. low knowledge-intensive indus-tries. More specifically, shareholders may valuedeveloping country investments earlier for firmsin low knowledge-intensive industries, given theimportance of accessing cheaper factors of produc-tion and the less prominent role of technologicalexpertise for firms in these industries. These argu-ments lead to the first two hypotheses, which focuson shareholder valuation of investments in devel-oping countries:

Hypothesis 1: Shareholders value FDI in devel-oping countries for firms in high knowledge-intensive industries with medium and high levelsof multinational operations.

Hypothesis 2: Shareholders value FDI in devel-oping countries for firms in low knowledge-intensive industries with low, medium and highlevels of multinational operations.

Shareholder valuation of advanced countryinvestment

While shareholders may want firms to have pre-vious international investments in place to bet-ter manage and hedge investments in develop-ing countries, this may not be the case for


1128 H. Berry

advanced country investment. Advanced coun-try investments provide firms with more protec-tions in the form of institutions, judicial systems,and intellectual property enforcement—basically,less risk to manage than developing countryinvestment. Further, advanced country invest-ments offer advanced country firms more sim-ilar market conditions (similar GDP, levels ofeducation, population characteristics) than devel-oping country locations. This type of environ-ment provides a relatively safer market for firminvestment—especially for firms that have notpreviously ventured abroad and do not have thecapabilities to manage higher levels of risk. Inaddition, there are not likely to be the samedifferences discussed above for low and highR&D-intensive industries, as advanced countriesoffer less risk for firms in both types of indus-tries. These arguments lead to the third hypoth-esis, which focuses on shareholder valuation ofadvanced country FDI:

Hypothesis 3: Shareholders value FDI inadvanced countries for firms (in low andhigh knowledge-intensive industries) with low,medium and high levels of multinationaloperations.

As noted in the introduction, there is some ques-tion as to whether all levels of a firm’s multina-tionality will provide firms with benefits becauseof the complex organizational structure that canresult from an extensive network of operations. Tosuccessfully manage a large number of businessunits across different countries requires immensecoordination efforts and effective decision-makingprocesses regarding resource allocation (Hitt et al.,1997). In addition, with more extensive invest-ment abroad in many different foreign countries,various government regulations, trade laws, andcurrency fluctuations will add significant complex-ity to firms (Sundaram and Black, 1992). Empiri-cally, Geringer et al. (1989) found that the rela-tionship between multinationality and firm per-formance is positive for low and mid-levels ofinternational involvement, but negative for firmswith foreign sales representing more than 80 per-cent of total sales. Because this threshold seemsquite high (and also because I do not have for-eign sales data for the U.S. firms in my sampleto break down the data in this way), I have notincluded this reasoning in the hypotheses offered

above. Rather, I note that these arguments ques-tion whether shareholders will value investmentsin both advanced and developing country locationsfor firms with very high levels of multinationaloperations.

DATA

All publicly traded manufacturing firms that arelisted in the Compustat Database from 1977 to2000 and provide information on their R&Dexpenditures are included in the sample (thisresults in a sample size of 191 firms).4 This sampleis an unbalanced panel because some firms inthe sample were acquired in the second half ofthe 1990s. All financial figures are real annualfigures deflated to the base year 1977 using U.S.Department of Commerce, Bureau of EconomicAnalysis GDP deflators.

Firm performance

A firm’s Tobin’s q value is used to measure firmperformance. Tobin’s q is defined as the ratio ofthe market value of the firm to the replacement costof its tangible assets. Tobin’s q is widely used as anindicator of intangible value in economics researchand in the international strategic managementliterature (Dowell, Hart, and Yeung, 2000). Theattractiveness of q is that, first, it provides anestimate of the firm’s intangible assets and, second,no risk adjustment or normalization is required tocompare q across firms (Lang and Stulz, 1994).Chung and Pruitt’s (1994) approximation for q hasbeen used.5

Technological know-how

Following other studies, a firm’s R&D expendi-tures are used as a proxy for technical know-how.

4 U.S. firms were included in the sample as long as they reporteddata in at least three-quarters of the years, or at least 18 of the24 years in this study. If a U.S. firm did not report R&D dataduring 4 consecutive years (where I would be unable to create astock variable), I did not include it in the sample. This yieldeda sample size of 191 firms.5 NBER q ratios (which were calculated following themore complex and involved Lindenberg and Ross, 1981,approximation) are readily available through NBER for U.S.firms up to 1991. I compared Chung and Pruitt’s method tothe NBER q’s (using Lindenberg and Ross’s method) for theU.S. firms in the sample for the years 1981–91 and found a0.95 correlation between the two variables.



Because the effect of R&D expenditures can per-sist over time, an R&D stock measure (whichincludes both accumulated and current periodexpenditures) is used to proxy for a firm’s techni-cal know-how. Following Griliches and Mairesse(1984), a depreciation rate of 15 percent is appliedto the previous year’s expenditures going back4 years. I tested both a current year and 1-yearlag for the RDStock variable in the analysis below(as investment decisions occur prior to the actualinvestment). The results are the same whether I usethe current or lagged R&D stock variable. Becauseof this, I only report the current year RDStockresults below.

In studies examining the intangible assets offirms, it is also common to include the market-ing ability of firms (Morck and Yeung, 1991,1992; Pugel, Kragas, and Kimura, 1996; Kogut andChang, 1991; Belderbos and Sleuwaegen, 1996).However, because of the problem of a severelyreduced sample size if I limit my sample to thosefirms reporting their advertising expenditures,6 Ido not use a marketing ability variable in theanalysis reported below. It should be noted, how-ever, that I also ran the analyses using a variablethat combined the stock of R&D and the stockof advertising together, and the results were thesame.

Foreign investment (NewAdvancedFDI andNewDevelopingFDI)

Finding an adequate measure for a firm’s multina-tionality, especially a measure that is consistentlyavailable for 20 years, is challenging. The mostcommon measures in prior empirical studies areforeign to total sales ratio, the number of foreignsubsidiaries, and the number of foreign nations.The problem with the variable that has been usedmost often (foreign sales to total sales) is that afirm’s foreign sales include both export and for-eign operation sales, making it difficult to separatethe performance impact from a firm’s multinationaloperations.

Information regarding foreign operations that isfairly consistently reported over time can be found

6 If I limit my U.S. sample to include those firms that report theiradvertising expenditures for at least half of the time period underconsideration, my sample is cut down to 47 firms. I am unable toexamine differences across the levels of multinationality reportedbelow (because of a lack of firms in some of my categories) ifI limit my sample to these firms.

in directories that list a firm’s foreign subsidiariesand the location of these subsidiaries. Unfortu-nately, however, the data are very inconsistent inthe reporting of performance or financial informa-tion (like value of assets or sales, or number ofemployees) that might provide more insight intothis issue. What is fairly consistently reported isthe name and location (the country) of the foreignsubsidiaries. In this study, a firm’s foreign invest-ment is defined as a firm’s number of advancedcountry foreign subsidiaries (NewAdvancedFDI)and a firm’s number of developing country for-eign subsidiaries (NewDevelopingFDI) for eachyear from 1981 to 2000. I consulted each vol-ume of the Directory of Corporate Affiliates forthe years 1981 through 2000 to determine newforeign subsidiaries for each of the firms in thesample for each year. I started with 1981 becausethe data are more consistent starting in this year(due to the publication of a separate directorythat focuses specifically on the foreign affiliatesof U.S. MNCs). I coded each of these foreignsubsidiaries as coming from advanced or develop-ing countries. Following other studies, advancedcountries include the United States, Canada, West-ern European countries, Japan, Australia, and NewZealand. All other countries are classified as devel-oping countries (including Mexico and most Asiancountries (not Japan), Central and South Amer-ican countries, Eastern European countries, ex-Soviet bloc countries, Russia and African coun-tries). Domestic firms that are not multinationalsand thus have no subsidiaries abroad are includedin the sample; a portion of these firms becamemultinationals during the 20-year time period ofthis study. As will be discussed further in the spec-ifications section below, I focus on new investmentby the firms in the sample across these two locationcategories in the empirical analysis.

Control variables

Debt is included to proxy for any variation in firmvalues because of differences in capital structure.The dollar real exchange rate (RER) is used tocontrol for exchange rate effects.7 Firm growth is

7 The models that are reported below include annual exchangerate variables. I also ran the models using year dummy variablesand the results are the same. I do not report these year dummyvariable results below as I am unable to run the models withboth the exchange rate and year dummy variables.


1130 H. Berry

captured by the change in sales over the previous2 years.

Table 1 describes each of the variables and givesinformation on data sources. Table 2 provides sum-mary statistics of the main variables for the lowand high knowledge-intensive industry samples.Included in this table is summary information onboth the overall levels of foreign direct invest-ment and new foreign subsidiary investment bythe firms in the sample. As can be seen in Table 2,the mean firm with a low level of multinationaloperations opened a new subsidiary in advancedcountry locations approximately every 6–8 years(across low and high knowledge-intensive indus-tries) and a new subsidiary in developing countrylocations approximately every 10–13 years. Themean firm with a high level of multinational oper-ations opened approximately one new subsidiarya year in advanced country locations and a bit

more than one new subsidiary every other yearin developing country locations. The total num-ber of foreign subsidiaries ranges from 0 to 206in advanced country locations and 0 to 202 indeveloping country locations. It should be notedthat for both the levels and the new yearly invest-ment statistics, however, the standard deviationsare quite large. Table 3 provides the means andstandard deviations for the first differences of thevariables used in the analyses in Tables 5 and 6,while Table 4 provides the product moment cor-relations between the first differences of the vari-ables used in the two samples. Firms in each ofthe low, medium, and high levels of multinationaloperations invest in both advanced and developingcountries. Also, not too surprisingly, firms withhigher levels of multinational networks have moreinvestment in R&D, higher sales, and more foreignsubsidiaries.

Table 1. Operationalization and sources of variables

Variable Operationalization Source

Q A firm’s Tobin’s Q is the ratio of its market value to thereplacement cost of its tangible assets. All variablesare inflation adjusted using GDP deflators.

Compustat

RDStocka The stock of a firm’s R&D is its technical know-how.R&DStock is the total value of 100% of a firm’scurrent year expenditures on R&D, plus R&Dspending from the 4 previous years depreciated at a15% rate. Yearly firm-level financial data are inflationadjusted using GDP deflators.

Compustat

Debta The market value of a firm’s short and long term debtAll values are inflation adjusted using GDP deflators.

Compustat

NewAdvancedFDI The number of new foreign subsidiaries in advancedcountries (see text for a list of these countries) byeach firm in each year.

Directory of CorporateAffiliates

NewDevelopingFDI The number of new foreign subsidiaries in developingcountries by each firm in each year (see text for list).

Directory of CorporateAffiliates

RER Dollar real exchange rate International FinancialStatistics, InternationalMonetary Fund

FirmGrowtha The 2-year change in sales for each firm CompustatMultinationality levels Multinationality levels correspond to the quartile

differences in the sample of high and lowR&D-intensive industries. A low level ofmultinationality for firms in high (low) R&D-intensiveindustries is defined as a firm with subsidiaries in 1–3(1–2) foreign countries, medium level is 4–15 (3–5)foreign countries, high level is 16 or more (6 or more)foreign countries. See the description of the data inthe text for more discussion of the cut-offs for thesubsamples).

a These variables are scaled by the replacement cost of tangible assets (from Compustat data) to control for firm size. (Inflationadjusted values of this variable are used.)



Table 2. Descriptive statistics

Variable Mean S.D. Min. Max.

A. Firms in high knowledge-intensive industries (126 firms) (including chemical,electric equipment, industrial machinery, transportation, and precision instruments)

Q 1.30 0.87 −0.06 5.85RDStock (M$) 80.94 188.7 0.0015 1892.94Debt (M$) 230.46 581.13 0 4376.2AdvancedFDI 10.2 19.82 0 206

NewAdvancedFDI—low levela 0.12 0.63 0 8NewAdvancedFDI—medium levela 0.41 1.36 0 12NewAdvancedFDI—high levela 1.10 2.9 0 17

DevelopingFDI 7.3 16.38 0 202NewDevelopingFDI—Low Levela 0.07 0.43 0 6NewDevelopingFDI—medium levela 0.25 0.87 0 8NewDevelopingFDI—high levela 0.64 2.2 0 19

Sales (M$) 1503.57 2881.5 2881 41326.4

B. Firms in low knowledge-intensive industries (65 firms) (including textiles, food,paper and paper products, rubber products, fabricated metals, and misc.)

Q 1.07 0.70 −0.14 3.62RDStock (M$) 23.41 64.3 0.0033 501.23Debt (M$) 190.23 496.32 0 6863.49AdvancedFDI 5.4 8.3 0 56

NewAdvancedFDI—low levela 0.18 0.66 0 6NewAdvancedFDI—medium levela 0.35 1.18 0 10NewAdvancedFDI—high levela 0.93 2.8 0 18

DevelopingFDI 4.6 9.2 0 52NewDevelopingFDI—low levela 0.11 0.67 0 10NewDevelopingFDI—medium levela 0.17 0.74 0 8NewDevelopingFDI—high levela 0.69 2.4 0 15

Sales (M$) 1228.4 3772.5 1.07 38558.2

a For the FDI variables, NewAdvancedFDI and NewDevelopingFDI (at the low, medium, and high levels ofmultinationality) refer to the yearly change in new foreign investment by firms. These variables are used in theanalysis reported in Tables 5 and 6.

SPECIFICATIONS

The model used in this paper builds on theapproach used in other studies of market valu-ation. The financial market-based approach hasstrong theoretical and empirical foundations inthe efficient-markets literature (Ross, 1983; Fama,1970). In a well-functioning capital market, thefinancial market value of a firm provides the bestavailable unbiased estimate of the value of a com-pany’s assets (including both tangible and intangi-ble assets). A basic assumption of the model usedin this paper is that there is financial market effi-ciency and that the market value of a firm (V ) isthe sum of the value of its net tangible assets (T )and its net intangible assets (I ). Thus:

V = T + I (1)

For publicly traded firms, V is defined as themarket value of its outstanding common sharesplus estimates of the market value of its debt.The tangible assets variable is an estimate of thereplacement value of the firm’s tangible assets,while the intangible assets variable is an estimateof the replacement value of a firm’s intangibleassets. Following Morck and Yeung (1991), tocontrol for firm size the intangible variables arescaled by the replacement cost of tangible assets.

V

T= T

T+ I

T(2)

This causes the left-hand side of the equation tobecome Tobin’s Q,8 and the right-hand side to be

8 By focusing on a firm’s Tobin’s Q ratio rather than on its stockreturn or on an accounting measure of performance, no riskadjustment or normalization is required to make comparisonsacross firms (Lang and Stulz, 1994).


1132 H. Berry

Table 3. Univariate sample statistics for low, medium and high levels of multinational operationsa

Full sample(with domestic)

Low level ofmultinational

operations

Medium levelof multinational

operations

High level ofmultinational

operations

A. Firms in high knowledge-intensive industriesMean �Q 0.04 0.009 0.04 0.07(S.D.) (0.56) (0.37) (0.32) (0.39)Mean �RDStock/Assets 0.004 0.002 0.004 0.003(S.D.) (0.48) (0.62) (0.025) (0.55)Mean �Debt/Assets 0.12 0.37 0.06 0.38(S.D.) (7.07) (9.27) (0.07) (7.91)Mean �FirmGrowth/Assets 0.71 0.79 0.69 0.64(S.D.) (37.69) (41.35) (36.42) (28.28)Mean 0.51 0.12 0.41 1.11NewAdvancedFDI (1.94) (0.63) (1.36) (2.9)Mean 0.29 0.07 0.21 0.64NewDevelopingFDI (1.42) (0.43) (0.87) (2.26)

B. Firms in low knowledge-intensive industriesMean �Q 0.008 0.005 0.01 0.02(S.D.) (0.32) (0.31) (0.35) (0.31)Mean �RDStock/Assets 0.008 0.002 0.006 0.001(S.D.) (0.11) (0.023) (0.13) (0.15)Mean �Debt/Assets 0.01 0.01 0.01 0.03(S.D.) (0.44) (0.23) (0.30) (0.85)Mean �FirmGrowth/Assets 0.56 0.51 0.46 0.57(S.D.) (21.25) (6.73) (5.78) (10.82)Mean 0.34 0.18 0.35 0.93NewAdvancedFDI (1.46) (0.66) (1.18) (2.85)Mean 0.21 0.10 0.17 0.69NewDevelopingFDI (1.19) (0.67) (0.74) (2.45)

a Firms can and do change categories over the 20 year time period of this study. Therefore, it is difficult to classify the number offirms in each of the categories. What can be classified is the number of observations. For this information, see Tables 5 and 6.

Table 4. Product moment correlations of variables used in analysis

1. 2. 3. 4. 5. 6.

A. Firms in high knowledge-intensive industries1. �RDStock/Assets 12. �Debt/Assets 0.01 13. NewAdvancedFDI 0.02 −0.001 14. NewDevelopingFDI 0.07 0.002 0.38 15. �RER 0.01 0.001 0.02 −0.013 16. �FirmGrowth/Assets 0.349 0.009 0.015 0.03 0.101 1

B. Firm in low knowledge-intensive industries1. �RDStock/Assets 12. �Debt/Assets 0.07 13. NewAdvancedFDI 0.29 −0.03 14. NewDevelopingFDI 0.005 0.17 0.31 15. �RER 0.005 0.009 0.05 0.02 16. �FirmGrowth/Assets 0.204 −0.014 −0.11 0.041 0.078 1



Table 5. Shareholder valuation of advanced and developing country foreign direct investment: firms in high knowl-edge-intensive industries

Dependent variable: �QCross-sectional time series FGLS regression

Multinational network level Model 1All firms

Model 2Low levela

Model 3Medium levela

Model 4High levela

�RDStock/Assets 0.001 0.004 0.008 0.007(0.11) (0.18) (1.45) (0.48)

�Debt/Assets −0.32 −0.72∗∗∗ −0.92∗∗∗ −0.001(−1.49) (−3.69) (−5.31) (−0.37)

NewAdvancedFDI −0.07∗∗∗ 0.02∗∗ −0.05 −0.08∗∗

(−2.58) (2.48) (−1.11) (−2.05)NewDevelopingFDI 0.04∗∗ 0.02 0.02 0.05∗

(2.01) (0.95) (0.79) (1.86)�RER 0.027∗∗∗ 0.01 0.02∗∗ 0.02∗∗∗

(5.05) (1.25) (2.03) (3.09)�FirmGrowth/Assets 0.08∗∗∗ 0.02∗∗ 0.01 0.09∗∗∗

(6.23) (2.52) (1.41) (5.22)Constant 0.01 0.01 0.03 0.01

(1.53) (1.18) (1.13) (1.25)Log-likelihood −396.42 −87.56 −131.23 −130.22Wald χ 2 (6 d.f.) 65.06∗∗∗ 41.93∗∗∗ 30.34∗∗∗ 37.41∗∗∗

n 1881 552 683 646

(t-statistics) Heteroscedasticity-consistent standard errors used. All models include an ar(1) term.a A low level of multinational operations for firms in high R&D-intensive industries is defined as a firm with subsidiaries in 1–3foreign countries, medium level is 4–15 foreign countries, high level is 16 or more foreign countries. See text for further discussion.∗ p < 0.10; ∗∗ p < 0.05; ∗∗∗ p < 0.01

function of a firm’s intangible assets. Including thecontrols, the model becomes the following:

Qit = αi + β1RDStockit

Assetsit

+ β2Debtit

Assetsit

+ β3 NewAdvancedFDIit

+ β4 NewDevelopingFDIit

+ β5RER + β6FirmGrowthit−i(t−2)

Assetsit

+ εit (3)

where Qit is a firm’s Tobin’s Q ratio; RDStockit

is a firm’s stock of technical know-how; Debtitis a firm’s debt; AdvancedCountryFDIit is thenumber of a firm’s foreign subsidiaries in advancedcountries; DevelopingCountryFDIit is the numberof a firm’s foreign subsidiaries in developing coun-tries; RER is the real exchange rate for the dollar;FirmGrowthit−i(t−2) is the 2-year change in salesfor each firm; and Assetsit is a firm’s total tan-gible assets. αi represents intangibles related toother factors; this could represent such intangi-ble assets as efficient use of human resources orother firm-specific intangible assets not includedin the model (like marketing know-how). Finally,

εit is an error term. Equation 3 indicates that afirm’s value to shareholders as measured by itsTobin’s Q is a function of its intangible assetsand foreign investments, with controls for lever-age (debt), exchange rate fluctuations and firmgrowth, as discussed above. All scaled variablesin Equation 3 have been transformed by adding aconstant and taking the natural log of this sum.Using the log transformation does not change thestatistical significance of the variables of interest; itdoes, however, result in a better fit of the models.9

Panel data from 191 U.S. manufacturing firmsand their foreign investments over the 1981–2000time period are used to test the predictions. Hsiao(1986) and Baltagi (1995) have noted that pooling

9 As indicated above, following internalization theory predictionsand previous study findings that firms with strong intangibleassets will have higher market valuations associated with theirmultinationality (see Morck and Yeung, 1991, and Pantzalis,2001, for example), I also ran all models including interactionterms for a firm’s foreign investments (NewAdvanceFDI andNewDevelopingFDI) and its intangible asset of R&DStock.When using the first difference of my independent variables,however, these interaction terms were never significant. Thisdifference with prior studies will be discussed more below inthe discussion section.


1134 H. Berry

Table 6. Shareholder valuation of advanced and developing country foreign direct investment: firms in low knowl-edge-intensive industries

Dependent variable: �QCross-sectional time series FGLS regression

Multinational network level Model 1All firms

Model 2Low levela

Model 3Medium levela

Model 4High levela

�RDStock/Assets 0.03 −0.04 0.02 0.02(0.53) (−0.78) (1.50) (0.82)

�Debt/Assets −0.48∗∗ −0.69∗∗∗ −0.52∗ −0.37∗

(−2.13) (−3.41) (−1.88) (−1.85)NewAdvancedFDI 0.02 0.03∗ 0.02 0.01

(0.73) (1.72) (0.66) (0.02)NewDevelopingFDI 0.03 0.08∗ 0.05 0.03

(1.44) (1.83) (1.48) (0.28)�RER 0.004 0.004 0.006 −0.001

(1.52) (0.98) (1.31) (−1.27)�FirmGrowth/Assets 0.47∗∗∗ 0.38∗∗∗ 0.21 0.32∗∗∗

(3.61) (3.60) (0.42) (3.31)Constant 0.08 0.08∗ 0.02 0.03∗

(1.42) (1.69) (1.53) (1.71)Log-likelihood −116.18 −26.76 −16.98 −78.07Wald χ 2 (6 d.f.) 24.91∗∗∗ 12.43∗∗∗ 16.63∗∗∗ 25.09∗∗∗

n 985 261 336 389

(t-statistics) Heteroscedasticity-consistent standard errors used. All models include an ar(1) term.a A low level of multinational operations for firms in low R&D-intensive industries is defined as a firm with subsidiaries in 1–2foreign countries, medium level is 3–5 foreign countries, high level is 6 or more foreign countries. See text for further discussion.∗ p < 0.10; ∗∗ p < 0.05; ∗∗∗ p < 0.01

data across time can result in serially correlatederror terms. In fact, the combination of time-seriesand cross-section variables adds a dimension ofdifficulty to the problem of model specificationbecause the error term may be correlated overtime and over cross-sectional units. This serialcorrelation problem can introduce substantial biasinto the efficiency of the estimators. More practi-cally, I also have very high correlations across myadvanced and developing country FDI variableswhen I use the level of the multinationality vari-ables (this problem is most pronounced for firmsat a more advanced stage of multinational expan-sion (Model 4 in Table 5). To control for serialcorrelation problems, I used the first differencesof all variables and included a first-order autore-gressive term in each of the models. For the FDIvariables, I focused on new subsidiaries (in theprior year) for each firm. In so doing, I am captur-ing new investment by firms at the different levelsof multinationality included in the analysis.10 I amalso controlling for firm fixed effects by using the

10 While FDI divestments are also likely to have an impacton firm performance, they are not considered in this analysis.

change of the variables included in the analysis.Finally, I used feasible generalized least squares(FGLS) to test the hypotheses.

As argued above, some industries are moreknowledge-intensive than others. To examinewhether industry differences influence howshareholders value a firm’s foreign investments,I divided the sample in a number of ways.First, the larger and more internationally integratedindustries (and those subsamples that could berun separately) were run separately (includingsubsamples of firms in the chemical, electricequipment, industrial machinery and precisioninstrument industries). Though the FDI coefficientsvaried slightly in how statistically significant theywere (p < 0.05 vs. p < 0.10, for example), theresults were very similar for each of these 2-digit SIC code industries. As these firms tendto be more knowledge-intensive, I grouped themtogether in what I call the high knowledge-intensive industry grouping (I also included firmsin the R&D-intensive transportation equipment

Rather, this analysis is focused on firm growth strategies throughforeign direct investment.



industry (though I was unable to run this industryseparately because of insufficient observations)).These industries correspond well with what theOECD calls ‘high R&D intensive industries.’11

The industries that are left make up a group calledthe low R&D-intensive firms (and include firmsin the textiles, food, paper and paper products,rubber products and fabricated metals industries.) Iam unable to run each of the industries separatelybecause of the smaller numbers of firms and lowerlevels of foreign investment.

Finally, to analyze differences across variouslevels of a firm’s multinationality, the sample wasdivided into subsamples based on quartile differ-ences for the total number of nations in which afirm has subsidiaries. I used the number of nationsto construct this variable to capture the hedgingopportunities available to a firm across differentcountries. I used a 1-year lag in the informationon the number of nations to capture the networkthat was fully available to the firm. (It is likely thatit take times before foreign subsidiaries are inte-grated into a firm’s multinational network to pro-vide arbitrage or learning experiences.) By usingthe number of nations in which a firm has sub-sidiaries, the multinationality effects for a firmthat has five subsidiaries in Canada are classifieddifferently from a firm that has two subsidiariesin Canada, one subsidiary in Mexico, and twosubsidiaries in the United Kingdom—though theyboth have five foreign subsidiaries in total. About25 percent of the observations are for firms withno foreign operations (domestic-only firms). Thesefirms are included in each of the other three sub-samples to provide a base case for analysis. Icalculated the quartile differences for the high andlow knowledge-intensive industry firms separately.For high (low) knowledge-intensive industries, alow level of multinational operations is assigned tothe second quartile observations—firms with sub-sidiaries in one to three (one to two) foreign coun-tries; a medium level of multinational operations isassigned to the third quartile observations—firmswith subsidiaries in four to fifteen (three to five)foreign countries; and a high level of multinationaloperations is assigned to the fourth quartile obser-vations—firms with subsidiaries in sixteen (six) ormore foreign countries.

11 Based on OECD data, these industries tend to have higherthan 5 percent of R&D spending as a percentage of sales ratios(http//:www.oecd.org).

RESULTS

The empirical results for firms in the high andlow knowledge-intensive samples and the threelevels of multinational operations are reportedin Tables 5 and 6, respectively. In these tables,Model 1 reports the results for the full sam-ple; Model 2 reports the results for firms in thelow level of multinational operations; Model 3reports the results for firms with medium levels ofmultinational operations; and Model 4 reports theresults for firms with high levels of multinationaloperations.

The empirical results reveal differences betweenshareholder valuation of advanced and developingcountry investment choices, depending on a firm’sprior international experience and the knowledgeintensity of the firm’s industry. Hypothesis 1 pre-dicts that shareholders will value firm investmentin developing countries for firms in knowledge-intensive industries with medium and high lev-els of firm multinational operations. The empiricalresults show support for this hypothesis only forfirms with high levels of multinational operations.Model 4 in Table 5 reveals that new developingcountry FDI (NewDevelopingFDI) is positive andsignificant for firms with high levels of multina-tional operations only. (Model 3 in Table 5 revealsthat NewDevelopingFDI is not statistically signif-icantly valued by shareholders for firms with lowor medium levels of multinational operations.)

Hypothesis 2 predicts that shareholders willvalue firm investments in developing countries forfirms in low knowledge-intensive industries at low,medium and high levels of multinational opera-tions. The empirical results provide support for thishypothesis only for firms with low levels of multi-national operations. Model 2 in Table 6 reveals thatNewDevelopingFDI is positively and significantlyvalued only at low levels of multinational opera-tions. (NewDevelopingFDI is not significantly val-ued by shareholders at medium or high levels ofmultinational operations for firms in low knowl-edge intensive industries.)

Hypothesis 3 predicts that shareholders willvalue firm investments in advanced countries atall levels of multinational operations. The empir-ical results show that this hypothesis is supportedonly at early stages of international expansion (forfirms in both high and low knowledge-intensiveindustries). Model 2 in Table 5 reveals that new


1136 H. Berry

advanced country FDI (NewAdvancedFDI) is pos-itively and significantly valued for firms with lowlevels of multinational operations for firms inhigh knowledge-intensive industries. Model 3 inTable 5 shows that new advanced country FDIfor firms with medium levels of multinationaloperations is not significantly valued by share-holders, while Model 4 in Table 5 reveals thatfor firms with high levels of multinational oper-ations NewAdvancedFDI is negative and signifi-cantly valued by shareholders. For low knowledge-intensive industries, the results in Model 2 inTable 6 show that NewAdvancedFDI is positiveand significantly valued only for firms with lowlevels of multinational operations. (Models 3 and4 in Table 6 reveal that NewAdvancedFDI is notsignificant at medium or high levels of multina-tional operations.)

Regarding the other variables included in theanalysis, the change in R&DStock is not signifi-cantly valued by shareholders in any of the mod-els in either Table 5 or 6. Though not reportedbelow, when the levels of the variables wererun, the level of R&DStock was significantly val-ued by shareholders for firms in high knowledge-intensive industries (though the level was not sig-nificantly valued by shareholders for firms in lowknowledge-intensive industries). This suggests thatit may be the accumulated technological know-how that is valued by shareholders for firms inknowledge-intensive industries, not the incremen-tal changes to a firm’s stock of technology.

The control variables are significant in each ofthe models. The change in firm growth is posi-tive and significant in almost every model. Thechange in debt is negative and highly signifi-cant in almost every model. Finally, the exchangerate effects are significant for firms with mediumand high levels of multinational operations inhigh knowledge-intensive industries. Though notreported in any of these tables (Tables 5 and 6),the results hold when the 1980s and 1990s are runseparately, and when year dummies are included(instead of the RER term). Further, the resultshold when the advanced and developing countryFDI variables are entered separately for the highknowledge-intensive industry firms, though thereare some changes in the statistical significanceof the variables. For example, for firms in highknowledge-intensive industries with a low level ofmultinational operations (Model 2 in Table 5), the

advanced country investment variable (NewAd-vancedFDI) is significant at the 0.10 level (insteadof the current 0.05 level) when entered sepa-rately. Also, for firms in high knowledge-intensiveindustries with a high level of multinational oper-ations (Model 4 of Table 5), each of the FDIvariables becomes more significant when enteredseparately. The only FDI variable that loses sig-nificance when entered separately is the advancedcountry FDI variable for firms in low knowledge-intensive industries with a low level of multina-tional operations (Model 2 of Table 6), with aresulting p-value of 0.14. The developed coun-try FDI variable remains significant when enteredseparately in this model. Because of this changefor firms in low knowledge-intensive industries, Ifocus on the developing country FDI results forfirms in these industries in the discussion sectionbelow.

Regarding the economic significance of themultinational operations variables included in themodel, Tables 5 and 6 report the coefficients forthe change in each variable (with each of thesevariables having also been scaled by the firm’s tan-gible assets). For firms with high levels of multi-national operations in high knowledge-intensiveindustries (Model 4, Table 5), the marginal effectof the change in advanced country investmentimplies that a one standard deviation increase inthe number of subsidiaries in advanced countries(2.9 countries) reduces the change in a firm’sTobin’s Q by 8 percent of the value of tangibleassets, while a one standard deviation increase inthe number of subsidiaries in developing coun-tries (2.26 countries) increases the change in afirm’s Tobin’s Q by 5 percent of the value of tan-gible assets. By comparison, Table 5 shows thata one standard deviation increase in developingcountry investment variable has a little more thanhalf the impact on Tobin’s Q as a one stan-dard deviation increase in prior sales—Model 4in Table 6—reveals that a one standard devia-tion increase in the ratio of sales to tangibleassets (28.28%) increases a firm’s Tobin’s Q by9 percent of the value of tangible assets. For firmsin low knowledge-intensive industries, in Model 2of Table 6, the marginal effect of the change inadvanced country investment implies that a onestandard deviation increase in the number of sub-sidiaries in advanced countries (0.66 countries)increases the change in a firm’s Tobin’s Q by3 percent of the value of tangible assets, while a



one standard deviation increase in the number ofsubsidiaries in developing countries (0.67 coun-tries) increases the change in a firm’s Tobin’s Q

by 8 percent of the value of tangible assets. Bycomparison, a one standard deviation increase inthe ratio of debt to tangible assets (23%) decreasesthe change in a firm’s Tobin’s Q by 69 per-cent of the value of tangible assets. Comparingacross the various models for both industry group-ings, debt has the highest relative negative impacton changes in Tobin’s Q, while firm growth hasthe largest relative positive impact on changes inTobin’s Q. Though the foreign investment vari-ables have less relative impact than firm growth,these foreign investments do have a significanteconomic impact. Further, unlike the consistentlynegative impact from increased debt or the consis-tently positive impact from firm growth, the factthat the international investment variables can haveeither negative or positive significant economiceffects makes their impact important to consider.It highlights the influence of the strategic choicesthat firms are making with regard to their foreigninvestments and the fact that the ‘right choices’(in the eyes of shareholders) in terms of foreigninvestment strategies can have a significant posi-tive economic impact on the market valuation of afirm, while the ‘wrong choices’ can have a signif-icant negative economic impact.

DISCUSSION AND IMPLICATIONS

In this paper, I have examined whether share-holders value the investment location choices offirms differently, depending on a firm’s experiencefrom prior foreign investments and the knowledgeintensity of the firm’s industry. I have argued thatbecause direct investment in developing countriesis riskier than in advanced countries, shareholdersmay not value a firm’s investment in develop-ing countries until that firm has a certain level ofmultinational operations in place that provides thefirm with experience from previous internationalinvestments and capabilities to better manage andhedge the higher levels of risk and uncertainty.By examining these issues, I have focused on dif-ferent investment strategies that are available tofirms to more thoroughly analyze when multina-tional expansion will be value creating for firms.Overall, the empirical results show how different

investment location choices are value creating forfirms at different stages of international expansion.

For firms in high knowledge-intensive industries(firms in the chemical, electrical equipment,industrial machinery, transportation, and precisioninstrument industries), the empirical resultsprovide mixed support for the hypotheses. Theseindustries include the firms that are doing themajority of foreign direct investing. For theseindustries, the results show that shareholdersreward advanced country location investmentby firms with low levels of multinationaloperations. Because these markets are moresimilar to the U.S. market in terms of GDP,education levels, types of governmental systems,and institutional protections, expansion intoadvanced countries provides a relatively safe wayfor U.S. manufacturing firms to venture intothe international marketplace and to create amultinational network. In addition, these marketsprovide more safeguards for firms that needto protect their proprietary knowledge. Unlikewhat was hypothesized, however, the resultsshow that there are limits to the benefits ofadvanced country investments. Perhaps, as priorstudies have suggested, the higher organizationalcosts and increased difficulties of managinga more extensive network of operations mayoutweigh the benefits from additional internationalinvestments in advanced country locations (Hittet al., 1997). However, unlike prior studies, thisstudy shows that even at these same higherlevels of multinational operations, investments indeveloping countries can provide a firm withincreased market valuation. This implies thatthe difficulties of managing a more extensivenetwork of operations may not be driving theadvanced country location results. Rather, astechnology-intensive manufacturing firms continueto develop their multinational network, they mayneed developing country investment to accesscheaper inputs, or larger populations to increasedemand for their products. While advancedcountry investment may provide a relatively safesetting in which to initially create a network ofoperations abroad, to fully develop a multinationalnetwork of operations (and to fully benefit fromthe international environment) requires investmentin developing country locations. Taken together,the results suggest that while advanced countrylocation investments may be rewarded for firmswith low levels of multinational operations, firms


1138 H. Berry

in knowledge-intensive industries need to find abalance between advanced and developing countrylocation investments as they continue to expandabroad to gain competitive advantages and tocreate value for their firm from their multinationaloperations.

For managers of firms in high knowledge-intensive industries, the results reveal thatshareholders value high levels of multinationaloperations when these firms are expandinginto developing country locations—where riskmanagement is essential for success. This suggeststhat these firms need to gain managerialcapabilities from other international investmentsbefore shareholders value their developing countrylocation investments. While there may beeconomic and strategic reasons for firms toinvest in developing country locations (to accesscheaper inputs or rapidly growing populations,for example), shareholders need to see that firmshave developed capabilities and experiences frommanaging operations in other markets beforethey value investment in developing countries.Overall, a foreign expansion strategy that startsby first investing into the relatively safer advancedcountry environments and expands into developingcountries only after capabilities and experienceshave been acquired is rewarded by shareholdersfor firms in knowledge-intensive industries.

The results are quite different for firms in lowknowledge-intensive industries. For these firms,a foreign expansion strategy that includes earlyaccess to cheaper inputs in developing countylocations is rewarded by shareholders. Becausefirms in these industries (textiles, paper and paperproduct, and fabricated metal) are often involvedin foreign investment to access raw materials orcheaper inputs (especially labor costs), sharehold-ers value investment in developing countries forthese firms before they have acquired capabilitiesthrough investment in other foreign markets tomanage the higher risks in these locations. Share-holders may value access to cheaper inputs inthese industries to better serve the home market.In fact, firms in these industries may need cheaperinputs to compete with foreign competition in boththeir home market and other foreign markets. Inaddition, the results show that continued expan-sion into either advanced or developing countrylocations is not valued by shareholders at highlevels of multinational operations for firms in lowknowledge-intensive industries.

For managers of firms in low knowledge-intensive industries, the results suggest sharehold-ers value early access to developing countries,even though these environments are less similarto the home market. Further, given that share-holders do not value further investment in eitherlocation at high levels of multinational operations,shareholders appear to place more emphasis onthe higher organizational costs and increased dif-ficulties of managing a more extensive network ofoperations for firms in low knowledge-intensiveindustries (Hitt et al., 1997). Given the impor-tance of access to cheaper inputs in these indus-tries, shareholders may also be reacting to theeffects of trade laws and/or currency fluctuations(not to mention the differing governmental reg-ulations and protections that exist in the textileindustry).

Prior studies (including Morck and Yeung, 1991;Christophe, 1997; Pantzalis, 2001) have found thata firm’s foreign investments are only valued inthe presence of strong firm intangible assets intechnology (in these studies, significant interactionterms between a firm’s technological know-howand its foreign investments are reported). Wheninteraction effects were introduced in the mod-els reported in the Tables 5 and 6, none of theseeffects was significant. Even so, the findings inthe present study are not inconsistent with theresults from prior studies or internalization theoryreasoning. For high knowledge-intensive indus-tries the lack of significance for the change inthe R&DStock variable (in all models in Table 5)suggests that shareholders value the accumulatedtechnological know-how of firms more than theincremental change in a firm’s technological know-how. This suggests that shareholders may valuea firm’s multinational operations in the presenceof the already known and proven technology ofthe firm, rather than the future expectations ofcontinued technological innovations by the firm.In addition, the approach in this study differsfrom prior studies in two important ways: first,I use the first differences of my variables due tothe highly correlated nature of the FDI variables(which is different from Morck and Yeung, 1991;Christophe, 1997; Pantzalis, 2001) and, second, Ibroke down the FDI variable into advanced coun-try FDI and developing country FDI (which is dif-ferent from Morck and Yeung, 1991; Christophe,1997). At the very least, the results in the presentstudy suggest that further study of how both



the accumulated stock and incremental additionalstock of technological know-how influence theperformance effects from a firm’s foreign invest-ments is clearly needed to better understand thisissue.

By grouping countries into advanced or develop-ing country locations, this study has revealed someinteresting differences between these categories.Other categories of location choices (includingregional groupings or groupings by institutionalcharacteristics) might reveal additional issues ofinterest to academics and managers alike. Further,the results from this study reveal that additionalanalysis of firms with the highest levels of multi-national networks is needed to better understandwhether or when firms may no longer benefit fromincreased international operations in either loca-tion. In addition, these finding are based on a U.S.sample of manufacturing firms. Analyses of othernational firms (including firms from developingcountry markets) are needed to examine whetherthe results are generalizable. Finally, additionalinformation about the specific activities of firms’foreign investments (including information aboutthe size or profitability of the investment) wouldallow researchers to examine how the motives andgoals of a firm’s international investment strategyinfluence the performance effects from a firm’s for-eign investments.

ACKNOWLEDGEMENTS

I would like to thank Mauro Guillen, Vit Henisz,Don Lessard, Bernie Yeung, anonymous referees,Associate Editor Will Mitchell and participants inthe Wharton Applied Economics workshop, theJones Center Brown Bag Series at Wharton and theMichigan International Management Conferencefor helpful comments. I would also like to thankAnthony Passero for research assistance. Financialsupport from the Jones Center at the WhartonSchool, University of Pennsylvania, is gratefullyacknowledged.

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