Investors Rate Multinationals

Foreign assets harm stock prices

In recent years, as globalization has swept the world economy with the seeming inevitability of an avalanche moving down a mountain, Corporate America has led the way--pouring $273 billion into foreign-direct investment in 1998 and 1999 alone. Although the expansion of international production has sparked considerable controversy, many U.S. companies seem confident that it is a sure path to profitable growth.

But is it? In an intriguing study, Reid W. Click of George Washington University and Paul Harrison of Brandeis University find that there is a skeptic in the wings--one deemed to be a peerless judge of corporate strategy. That skeptic is the investment community.

Tracking all publicly held U.S. nonfinancial corporations from 1984 to 1997, the authors looked at how Wall Street values multinational companies compared to domestic companies with no foreign production facilities. Their measure was the market value of a company relative to the replacement cost of its assets (called "Tobin's q" because Nobel economist James Tobin first used it).

The results were striking. Controlling for such factors as company size, industry, and debt load, the two economists found that the equity value of multinationals relative to assets was 9% to 17% lower than similar domestic companies. The multinational "discount" remained even when companies with similar earnings were compared, indicating that the culprit was the large amount of assets involved in overseas investment. In fact, the study showed that the greater the foreign share of a company's assets, the larger the market penalty.

That's not all. The authors report that companies that expanded the foreign share of their output over time fared progressively worse in the market, while those cutting back such operations did better. And the market penalty for multinationals vs. domestic companies remained even after adjustments for exchange-rate shifts and volatility.

Significantly, it was the decision to invest directly in foreign assets rather than to do business abroad that hurt companies' stock performance. Unlike multinationals, exporters did better in the market than similar nonexporting domestic companies, the study shows.

In sum, U.S. companies that choose to expand production overseas appear to be engaged in what economists term "value destruction"--that is, deploying investment dollars abroad that in Wall Street's judgment would be worth more at home. The question is why?

Click and Harrison have some ideas. Noting that many domestic conglomerates also suffer value discounts in the market, they theorize that the same problems facing them--a lack of focus and a tendency to use profits from thriving divisions to subsidize lagging ones--may also plague multinationals.

Their data also reveal that the greater the share of a company owned by top management, the less likely it is to be a multinational and the smaller the relative size of its foreign assets. And that, they say, suggests that "managers without stakes in their companies are prone to build multinational empires to the detriment of shareholders."

Thus, while many multinationals thrive, says Click, many clearly don't, and on average, they underperform. The moral of the story, he adds, is that "globalization is far from a sure ticket to profitability. Companies that go that route need to do so with a lot of care."

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