THE VALUE OF SWITCHING AND GROWTH OPTIONS
IN FOREIGN DIRECT INVESTMENT
DISSERTATION
Presented in Partial Fulfillment of the Requirements for
the Degree of Doctor of Philosophy
in the Graduate School of The Ohio State University
By
Sangcheol Song, M.S.
*****
The Ohio State University
2008
Dissertation Committee: Approved by
Professor Mona Makhija, Advisor ______
Professor Jay Barney Advisor
Professor Benjamin Campbell Business Administration Graduate Program ABSTRACT
According to real options theory, foreign direct investments can be structured in ways that allow firms flexibility under environmental uncertainty. Through the options built into these investments, multinational companies can capture upside opportunities and contain downside risks stemming from the environment. Prior empirical studies on real options investments, however, have shown mixed or inconclusive results about the real options value of foreign direct investment. In this dissertation we argue that this may be due to the fact that these studies do not fully take into account the different types of environmental uncertainty faced by firms, the potentially contradictory interplay among different types of options embedded in an investment, and/or managerial costs of creating and managing real options. The purpose of this dissertation is to address these
problems in the multinational flexibility literature.
In the main essay, ‘Growth and Switching Options in Foreign Direct Investments,’
we examine in greater depth the two important perspectives of real options associated
with foreign direct investments, growth and switching. We show that the ability to derive
growth and switching options depends on the way in which foreign direct investments
are configured across countries. Furthermore, these configurations of foreign direct
investments are argued to have different theoretical implications for firm value under
different types of host country uncertainty. Using panel data of Korean foreign direct
II
investment during the period 1991-2004, a period encompassing varying conditions of
uncertainty in host countries, we find that, consistent with our expectations, firms with
switching options (gained through highly dispersed operations and higher levels of ownership across countries) were associated with higher value in periods of higher
exchange rate uncertainty than those without such options. As predicted, we also find
that firms with growth options (gained through concentrated presence of subsidiaries in
specific countries and lower levels of ownership) were associated with higher value in
conditions of host market uncertainty than firms without such option.
Additionally, we found that greater cultural distance between host and home
countries within the international network reduces the value of switching options, most
likely due to the additional transactions costs associated with it. On the other hand,
higher ownership levels lessen this negative impact of cultural distance. The findings
associated with ownership and cultural distance within the firm’s international network
point to the relevance of managerial control and coordination within the realm of real
options. Finally, we found evidence supporting the notion that firms make future investment choices based on their expected needs for real options. When firms desire switching options, we find that they add to their breadth by establishing a new subsidiary
in new countries. When the need for growth options is greater, they add a new subsidiary
in countries in which they already have investments.
III
Dedicated to my parents, my sister and two brothers, and nieces and nephews
IV
ACKNOWLEDGMENTS
My special thanks are reserved for Professor Mona Makhija. Her kind endurance
and warm-hearted encouragement have enabled me to run to the finish line of my
doctoral program. Professors Jay Barney, Jay Anand, Seung-hyun Lee, and Banjamin
Campbell, Mikelle Calhoun have guided me through my coursework and dissertation
work. Their ardent love for teaching and research has stimulated my academic journey to
more interesting and new questions in my field.
Having arrived at this juncture in my life, I would also like to share my delight and thanks with my lovely parents, sister, two brothers, four nieces and two nephews at Korea.
Their inherent love for me and unhesitant support of my academic pursuits in the United
States empowered me in every moment I experienced of disappointment and depression.
The support and prayers of Pastor Sung-jin Hong and the Handul church family will be forever cherished in my mind. God and Jesus Christ raised me up more than I could do myself in every step of the Ph.D. program.
Financial and administrative support from The Ohio State University and the Fisher
College of Business is also greatly appreciated.
V
VITA
February 6, 1972 Born- Buan, Korea
1992 – 1996 B.A., Yonsei University, Seoul, Korea
1996 – 1998 MBA, Yonsei University, Seoul, Korea
1998 – 2001 Teaching officer, Korean Third Military Academy, Korea
2001 – 2004 Korea Development Bank, Seoul, Korea
2004 – 2008 Graduate Research/Teaching Assistant, The Ohio State University
PUBLICATIONS
1. Song, S., Makhija, M., and Lee, S., 2008. Growth and Switching Options in Foreign Direct Investments, Academy of Management 2008 Annual Conference Best Paper Proceedings, Anneheim, USA (Also nominated as one of four finalists for the Samsung Distinguished Paper).
2. Song, S. 2007. Two Contradictory Effects of Prior Experience on Early Exits of Partially-owned Firms,” Hayes Research Forum Proceedings, The Ohio State University, 2007. Volume 7.
3. Song. S. 1999. The Effect of Resource Types and Ownership Share Levels on Ownership Change: The Bargaining Power Perspective (in Korean), Korean Academy of International Business, Korea (Awarded as Best Master’s Thesis)
FIELDS OF STUDY
Major Field: Business Administration (International Business)
VI
TABLE OF CONTENTS
Page
Abstract……….……………………………………………………………………...…..ⅱ
Dedication……..……………………………………………………………………...… ⅳ
Acknowledgments…….…………………………………………………….……………ⅴ
Vita………………………………………………………….……………………………ⅵ
Table of Contents……….……………….....……………………………………………ⅶ
List of Tables ……………..……………………………………………………………..ⅸ
List of Figures…………………………………………………………………………....ⅹ
Chapters:
1. Purpose of this Dissertation…………………………………………………………….1
2. Review of the Literature on Real Options and Foreign Direct Investments …………...6
2.1 Introduction…………………………………………………………………………6
2.2 Key Components of Real Options Theory………………………………………….8
2.3 Management and Implementation of Real Options………………………….……27
3. Need for Future Research……………………………………………………………..43
3.1 Motive for the Research...... 43
3.2 Theoretical Underpinnings...... 48 VII
4. Conceptual Model and Hypotheses...... 56
4.1 Conceptual Model...... 56
4.2 Hypotheses...... 57
5. Research Methodology...... 69
5.1 Data...... 69
5.2 Dependent variables...... 70
5.3 Independent variables...... 71
5.4 Control variables...... 76
5.5 Analytical procedures...... 80
6. Research Findings and Discussion...... 83
6.1 Research Findings...... 83
6.2 Discussion of Findings...... 93
7. Conclusions and Implications...... 105
7.1 Conclusions...... 105
7.2 Implications...... 108
References
VIII
LIST OF TABLES
Table Page
2.1 Uncertainty Types in Real Option Literature………………….....……...……...……36
2.2 Investment Types in Real Options Literature………...………………………..…….38
2.3 Delayability and the Boundary of Real Options Theory………...……………..……39
2.4 Timing and value of Exercising Real Options………………………………...... …40
2.5 Options Types in Real Option Literature………………………………………….....41
2.6 Performance Measures in Real Options Literature…………….…………...……..…42
3.1 Two Option Relating to FDI……...……...………………………………………..…55
6.1 Descriptive Statistics and Correlation Matrix.………….…………………...….…....98
6.2 Selection Model 1……………………………………………………………...... 99
6.3 Selection Model 2……………………………………………………………….….100
6.4 Results for Hypothesis Tests……………………………………...……………...…101
6.5 Effects of Cultural Distance……………....…………….……………………….….103
6.6 Firm’s Behavioral Choice: Increase in Breadth and Depth…….……………...... 104
IX
LIST OF FIGURES
4.1 Conceptual Model…………………………………………………………...... …....68
X
CHAPTER 1
PURPOSE OF THIS DISSERTATION:
THE REAL OPTIONS VALUE OF FOREIGN DIRECT INVESTMENTS
Real options theory suggests that under conditions of high uncertainty, firms can
use various types of strategic investments to “keep their options open” (Bowman and
Hurry, 1998; Dixit, 1989; Dixit and Pindyck, 1994; Kogut, 1991; McDonald and Siegel,
1986). Real options can enable a firm to monitor the business situation in a particular
market or industry at relatively low cost. The upside potential of option-like investments
can be very high, whereas the cost of developing and managing the investment, including
the cost of canceling it should it turn out to have limited value, is assumed to be quite
low. Based on these arguments, real options logic has become an important theoretical
tool in analyzing the value of an investment under high uncertainty.
Scholars have noted that foreign direct investments are also a type of investment
potentially associated with real options that provide firms with flexibility under
uncertainty (Campa, 1993; Kogut, 1991; Rangan, 1998; Tong and Reuer, 2007). In this
regard, a priori investments allow firms preferential access to future opportunities and
reduction of downside risks in specific countries by allowing them to adapt their investments specifically in line with the evolving environment, or sequence their 1
investment over time as they gain knowledge about the local environment. The issue of
uncertainty is particularly important in the international context, in that multinational
firms are exposed to considerable uncertainty stemming from different sources, such as
exchange rate volatility, unanticipated fluctuations in consumer demand or economic
conditions, political risk or unexpected policy changes that substantially affect firm
profits, or other unforeseen transformations in the country’s institutional environment.
When faced with high uncertainty, then, firms can structure foreign direct investments “to
keep their options open” (Cuypers and Martin, 2006; Kogut, 1991; Tong and Reuer,
2007).
A real options perspective has been applied to foreign direct investment in several
areas of research, including timing of foreign entry (Campa, 1994; Rivoli and Salario,
1996), mode of foreign entry (Cupyers and Martin, 2006; Folta, 1998; Tong, Reuer, and
Peng, 2007), value of multinationality or international joint ventures (Chi, 2000; Chi and
McGuire, 2000; Reuer and Leiblein, 2000; Tong, Reuer, and Tong, 2007; Tong and
Reuer, 2007), as well as the timing, conditions, and value of foreign exit (Folta and
Miller, 2002; Kogut, 1991; Kumar, 2005). Although the literature on multinational flexibility has shed considerable light on why and how firms invest and structure their foreign operations, much of the findings in this regard are mixed and divergent. For example, while some researchers have shown that multinationality generates additional value through the increased flexibility it affords (E.g. Allen and Pantzalis, 1996; Kogut, 2
1991; Lee and Makhija, 2008; Tang and Tikoo, 1999), other researchers do not find that international investments yield real options benefits because of multinational complexity and non-trivial costs of management (Reuer and Leiblein, 2000). While some have shown that dispersed operations across national borders have a linear and positive relationship to firm value (Allen and Pantzalis, 1996; Huchmerier and Cohen, 1996; Tang and Tikoo,
1999), others have shown a negative relationship to firm value and performance (Lee and
Makhija, 2008). Still others have found a non-linear relationship to real options value, as in the case of Tong and Reuer (2007), who uncovered an inverted U-shaped relationship
between multinationality and downside risk reduction. The diversity of these findings
points to the need for a more fine-grained investigation of the real options perspective in
relation to foreign direct investments.
In uncovering the reason for these divergent findings, we find that several
assumptions made in the current literature are problematic. First, some researchers (E.g.
Allen and Pantzalis, 1996; Tang and Tikoo, 1999; Tong and Reuer, 2007) have only
assumed that the international context is associated with high levels of uncertainty, and
do not actually measure it in any fashion. These studies therefore assume that foreign
direct investments are always associated with real options value under any conditions.
These assumptions are of concern, however. Since uncertainty is the most important
component of real options logic, without which the value of flexibility to the firm is
3
highly diminished, we argue that it should be incorporated explicitly and investigated
carefully. In this regard, it should be recognized that different forms of uncertainty may be faced the multinational firm, influencing in specific ways the nature of strategies it uses, the structures adopted, and performance achieved.
A second concern is that, although the theoretical literature clearly indicates that
foreign direct investments can potentially provide multiple types of options to the firm,
most of the empirical studies to date assume and study only one option type at a time.
The problem with this assumption is that different options may co-exist within the firm’s
portfolio of international investments. These different options, which may include options
to defer, invest, or switch, may be valuable at different times or only under specific
conditions. That is, some investments in the portfolio may yield one type of option while
others another type of option, and in this sense, lead to contradictory effects within the
portfolio which may cancel out the positive and/or significant effects of any given option.
It is important, therefore, to examine and take into account the interplays between
different options within a firm’s investment portfolio.
An additional assumption commonly seen in the extant literature is that firms are
able to control and coordinate their foreign operations as necessary. That is, it is assumed that once option-like investments are in place, multinational flexibility will be achieved automatically. It may be not, however, easy to gain control and coordination over far- flung foreign subsidiaries due to multinational complexity and organizational constraints. 4
Firms may be unable to use the options embedded in these subsidiaries in a timely
or efficient manner due to organizational factors that impede their control of these
investments. We argue, for this reason, that it is also important to take into consideration
the issues that influence the issues surrounding the management of real options
investments.
Finally, the literature has tended to assume that the costs of creating and managing real options are quite low. This, in fact, is an important assumption, since low costs of a
priori investments are a primary source of value associated with real options investments.
What if, however, the costs are not so low under some circumstances? What if the costs
of creating and managing real options are positively correlated with the values of the
investments? How would this affect managerial decision making? The problem is that
little effort has been devoted thus far in the literature to examining the relationship
between costs of real options investments and the value generated from them. We argue
that these managerial costs may lead to very different decisions on foreign entry and exit
from those argued in the current literature.
The goal of this dissertation is to address the problems discussed above that are
associated with the extant literature that has applied a real options lens to foreign direct
investments. To begin, we review the prior literature on real options theory in the next
chapter, in order to establish the main assumptions of this literature in greater depth and
to examine the need for future work in this regard. 5
CHAPTER 2
A REVIEW OF THE LITERATURE ON REAL OPTIONS
AND FOREIGN DIRECT INVESTMENTS
2.1 Introduction
Real options theory has become an important theoretical tool in understanding the strategies of a firm facing high uncertainty. This theory suggests that under conditions of high uncertainty, firms can use various types of strategic investments to “keep their options open” (Bowman and Hurry, 1998; Dixit, 1989; Dixit and Pindyck, 1994; Kogut,
1991; McDonald and Siegel, 1986). Multinational firms in particular are exposed to many significant forms of uncertainty, including unanticipated fluctuation in the relative value of currencies, unexpected changes in demand for their products, and institutional disruption (Allen and Pantzalis, 1996; Campa, 1993; Cuyper and Martin, 2006; Kogut and Chang, 1996; Makhija, 1993; Miller, 1998; Tong and Reuer, 2007). To help them deal with such uncertainty, their foreign direct investments may embody real options in that they preserve future decision rights for the firm (Kogut, 1991; McGrath and Nerkar,
2004; Tong and Reuer, 2007). 6
That is, they may contain significant upside potential due to the firm’s preferential access to future growth opportunities embedded in the foreign environments in which they operate. They may also reduce downside risks by allowing the firm to switch production or sales across countries in response to macroeconomic changes in any given country (Kogut, 1991; Kogut and Kulatilaka, 1994; Allen and Pantzalis, 1996; Tang and
Tikoo, 1999; Tong and Reuer, 2007; Tong, Reuer, and Peng, 2007). In this way, foreign direct investments have the ability to provide the firm with valuable flexibility under uncertainty.
The purpose of this chapter is to review the extant literature on real options theory
with a special focus on the real options associated with foreign direct investment. We
begin analyzing key components of real options theory in order to understand how real option logic works. We will show how real options theory contributes significantly to our understanding of how firms can invest in specific ways in order to address the uncertainty they face, and the particular role of foreign direct investments in this regard.
In this respect, we conduct a thorough examination of the theoretical and empirical literature in relation to foreign direct investment. In doing so, we identify areas for future research in the literature.
7
2.2 Key Components of Real Options Theory
2.2.1. The Issue of Uncertainty
Uncertainty can be characterized as situations where firms cannot anticipate future developments due to randomness or arbitrariness of events in the environment, resulting
in an inability to assess in advance the value of an investment. Real option theorists have
focused on such exogenous uncertainty as the key driver of the value real options
investments. More specifically, exogenous uncertainty refers to the volatility of the
economic returns caused by unpredictability of the external environment (Chi, 2000;
Dixit and Pindyck, 1994; Folta, 1998). Importantly, the creation and resolution of this
volatility is unaffected by the actions of the firm (Roberts and Weitzman, 1981; Chi and
Seth, 2001). For example, uncertainty associated with currency exchange rates is
exogenous to the firm since these rates are determined in atomistic markets (Campa,
1994).
Uncertainty of this sort is also abnormal, which means that there must be recognizable variance in the uncertainty before and after a critical point (such as an event
or shock). The economic crisis that took place in Asian countries in 1997 is an example
of this sort (Chung and Beamish, 2004; 2005; Lee and Makhija, forthcoming). The
unpredictability of a firm’s external environment may be due to movements in
8
macroeconomic factors that are determined in a complex system involving uncountable
forces within the markets as well as the behaviors of sovereign governments. Uncertainty
over the economic value of an exchange, including that relating to price, markets, and
technology, is the issue of concern to firms investing in real options (Copeland and
Kennan, 1998; Folta, 1998; Kogut, 1991; Kulatilaka and Wang, 1996; Kumar, 2005;
Roemer, 2004; Sanchez, 2003; Vassalo, Anand, and Folta, 2004).
Note that, while exogenous uncertainty is a key element in the real options argument, endogenous uncertainty is not an important issue in this regard. According to this perspective, endogenous uncertainty is resolved (at least in part) by the actions of the firm (e.g. by engaging in more learning) over time (Chi and Seth, 2001; Cuypers and
Martin, 2006; Folta, 1998; Roberts and Weitzman, 1981). In making the point that real options logic does not hold for endogenous uncertainty, Cuypers and Martin (2006) noted since only investing will reveal the relevant information under uncertainty so that it can
be resolved endogenously, there exists an incentive to invest and commit resources rather
than to wait (Roberts and Weitzman, 1981; Smit and Trigeorgis, 2004). Regarding the
relationship between uncertainty, learning, and the boundary of real options, it is argued
that as a consequence of the open-ended nature of this learning process, the discrete
nature of real options investment is eroded, which creates serious organizational challenges in preserving the flexibility that made the real options investment attractive
(Adner and Levinthal, 2004a; Cuypers and Martin, 2006). 9
Considering the importance of uncertainty as the key driver of real options value, it
is necessary to identify and measure uncertainty under appropriate contexts. In this regard, it is also important to precisely capture unexpected changes in the main sources of uncertainty. A number of different methods have been used for this purpose in the real options literature. For example, Kogut (1991) captured unexpected change in the product market, measured as the difference between actual and forecasted shipment growth rates.
Consistent with this, Hauser (2004) criticized the traditional standard deviation method of
computing volatility since it does not capture ‘unexpected volatility.’ Instead, he took
into account expectations of future exchange rates to get an appropriate exchange rate
risk measure which captures the unexpected deviations of the current spot exchange rate
from its expected value, using a second order autoregressive equation with a time trend
for each country derived from monthly data of real exchange rates taken from
Datastream.1 Folta and O’Brien (2004), and Folta, Johnson, and O’Brien (2005) pointed
out that other measures fail to account for the potential trends in data and also for
possible heteroskedasticity. In their own research they use the conditional variance
generated from generalized autoregressive conditional heteroskedasticity (GARCH)
1 Hauser (2004) used a second order autoregressive equation with a time trend for each country j from monthly data, exrjt = a + b · trendj + c · exrjt−1 + d · exrjt−2 +_jt (2.1) where exrjt−x is the nominal exchange rate in country j at time (month) t−x (x = 0, 1, 2), _jt is the error term of this regression equation and a, b, c, d are coefficients to be estimated. The standard deviation of the monthly residuals is calculated for each year and each country. In order to account for the level of the exchange rate, the standard deviation is normalized by the mean exchange rate. As we will show in our methods chapter, this is the method we adopt as well. 10
models, which they argue captures the uncertainty (i.e., that which is not predictable regarding a trend) that might exist for each period in the time series. Table 1 summarizes several types of uncertainty currently examined in the real options literature.
It is also important to consider not only individual sources of uncertainty but potential correlations among multiple sources of uncertainty. Kogut and Kulatilaka
(1994) also points out the impacts of possible correlations of uncertainty on overall volatility and real options value. This issue comes into play due to the typical approach of real options scholars to only consider a single source of uncertainty in their analyses.
Doing so suggests the assumption that potential correlations among different sources of uncertainty faced by the firm are not significant, and therefore, do not need to be taken into account. It is worthwhile, however, to revisit this assumption of little correlation of the sources of uncertainty. For instance, during the Asian economic crisis in 1997, at least ten countries in the East Asian region of the world had significant unexpected plunges in the value of their currencies at approximately the same time. Analysts have suggested that some, albeit not all, of the causes underlying this downturn in currency value were similar. This case clearly shows that a relatively large region of the world, encompassing multiple countries, can have highly correlated uncertainty. Since South
Korea (hereafter, Korea) was one of these countries, it is possible that Korean firms may have tried to address this uncertainty using investments in other countries, including
11
those in other Asian countries. However, since other crisis-stricken countries (e.g.
Malaysia, Philippine, Thailand, and Indonesia) experienced currency change in the same direction as the Korean currency, Korean firms would be unable to generate significant flexibility from their investments located in these countries as compared to those located in other non-crisis countries.
In addition to correlations within a given type of uncertainty, such as exchange rate uncertainty, correlations among different types of uncertainty should also be taken into consideration. For example, Goldberg and Kolstad (1995) take the correlation between export demand and exchange rate shocks into consideration, saying that if non- negative correlation exists between export demand and exchange rate shocks, the multinational company should optimally locate some productive capacity. This is due to the fact that producing abroad helps to insulate the firm from currency related uncertainty. Indeed, we would expect that the capacity share located abroad increases as exchange rate volatility rises and becomes more correlated with export demand shocks.
As can be seen from our discussion above, the practice of using country as a boundary condition in operational flexibility may in fact overvalue actual flexibility.
Interestingly, however, past studies have tended to rely on country context as the boundary condition in their analyses (e.g. Pantzalis, Simkins, and Laux, 2001; Allen and
Pantzalis, 1996; Tang and Tikoo, 1999). As we suggest in our examples, using country as a boundary condition may not provide assurance that different countries are not 12
correlated in terms of a given source of uncertainty. For example, the relationship
between two countries in the European Union (EU), such as Germany and France, is not
likely to be the same as that of India and France. We would expect EU membership to
influence the correlation seen between some types of uncertainty among member
countries. Thus, we suggest that including a regional dummy for regions with high
correlation in the level of uncertainty would be important for taking into account possible correlation of this kind.
2.2.2. The Issue of Irreversibility
Irreversibility of investments indicated the situation that the salvage value is
substantially less than its purchase price, which in turn reduces the likelihood of returning
to the initial state. For this reason, even though reversal is possible, in most cases the reversal undertaken will be only partial and very costly (Dixit and Pindyck, 1994; Folta and O’Brien, 2004; Wang, 2002).
Wang (2002) pointed out three causes for the irreversibility of an investment.
First, the ‘lemon effect’ is a cause for irreversibility since it indicates that there is
inherent discrepancy between the seller’s price and the buyer’s price of the asset. As
lower price of assets drives out higher price of assets, firms cannot receive the original
price of prior set-in assets when they want to sell them. Second, in case that an 13
investment was specifically built in for a purpose, the selling price of the specific assets would be lower than their original price since they cannot used for other purposes. Third, governmental and environment regulations on investments put constraints on their usage,
and thus, prior established investments in some specific contexts cannot be returned to its
original price in times of their shrinkage or withdrawal.
This irreversibility of an investment implies that there is value in a firm waiting
and seeing until uncertainty is resolved as information arrives over time. It also implies
that firms can start with small-scaled investments, using the initial investments as a
platform to follow-on investments. Real option value inherent in small-scaled investment
is associated with irreversible characteristics (Folta, 1998). The two different value components can be captured in different ways. Specifically, the passive NPV component
requires a large investment in order to capture as much as flow as possible, while the
dynamic option component can be captured with a smaller investment (Cuypers and
Martin, 2007). When capital is substantially sunk, the firm faces additional opportunity
costs due to the loss of flexibility that results from locked and thus difficult to reverse
actions (Kumar, 2005; Miller and Folta, 2002). The effect of irreversibility on the option
to defer becomes more relevant as uncertainty increases (Folta and O’Brien, 2004).
The real option value associated with small-scaled investment is therefore derived
from the irreversible characteristics of investment (Folta, 1998). Since small-scaled
investment reduces the sunk costs, the irreversibility of the investment is also minimized. 14
The extent to which investments are small scaled is often used as dependent or
independent variables in the real option literature. In this vein, due to their ability to
minimize firm outlays, minority investments and/or joint ventures are thought to help
firms retain flexibility under high exogenous uncertainty (e.g., high technological
uncertainty in pharmaceutical industry) as compared to majority investments and/or acquisitions (Cuypers and Martin, 2006; Kogut, 1991; Folta, 1998; Folta and Leiblein,
1994; Tong, Reuer, and Peng, 2007). Furthermore, Cuypers and Martin (2006) find that only exogenous uncertainty (such as that stemming from economic conditions, local institutions, and exchange rate fluctuations) is associated with real options value. They encourage firms to make investments with smaller stakes in joint ventures. They do not
find that endogenous uncertainty (stemming from cultural distance, capability uncertainty,
or scope uncertainty) influences real options value of investments. Table 2.2 summarizes
several types of small-scaled investments in the extant literature.
Although providing us with important insights relating to the issue of irreversibility and real options value, past research has not explored a number of related questions. For example, although small-sized investment helps to reduce the problems of irreversibility, it is possible that it has other side effects relating to the valuation and exercise of real options. One such effect may be higher competition due to low entry barriers associated with smaller investments. Another concern relates to the issue of governance with respect to small-sized investments. What, for example, is the difference between an investment 15
that has been minimized due to a smaller ownership stake versus one limited in terms of overall investment level? The two may have trade-offs with respect to governance and performance. For example, the ability to control the investment may be compromised due to the existence of partner firms, in contrast to one solely owned by the firm. On the other hand, the two may provide different kinds of options for the firm. Since sharing equity with another set of firms allows for a larger overall investment, there may be greater ability to penetrate the market rapidly or overcome uncertainty using partners’ resources and capabilities.
Finally, although there is agreement among researchers regarding the benefits of small-scaled investments for real options value, an issue that has remained untouched in the current literature is how small an option-like investment should be. It may be the case that even large-sized investments could generate real options value, if specific options are embedded in aspects of its structure (Lee and Barney, 2000). This issue should be explored as well.
16
2.2.3. The Issue of Delayability
We had noted earlier that the real options value of an investment is enhanced by
the ability to “wait and see” until uncertainty associated with the initial investment is
reduced (Adner and Levinthal, 2004; Bowman and Hurry, 1993; Dixit and Pindyck,
1995; Folta, 1998; Folta and Miller, 2002; Kester, 1984; Kogut, 1991; Kogut and
Kulatilaka, 2001; Kumar, 2005; McGrath, 1997; Reuer and Leiblein, 2000; Tong, Reuer,
and Peng, 2007).
Considering that real options are all about the flexibility that a firm can enjoy under
conditions of uncertainty, the further into the future a firm can delay its decisions, the more flexibility it retains. Real options allow management the strategic flexibility to defer
undertaking the investment and to make additional choices until after uncertainty is
resolved. The choice can be either to invest when market conditions turn favorable or to
back out altogether if market conditions are adverse. Importantly, then, real options
theory allows for incremental commitment to strategies through sequential investment
processes that facilitate consecutive decisions of waiting, increasing, acquiring, or
divesting (Bowman and Hurry, 1993; Folta, 1998; Folta and Miller, 2002; Kogut, 1991;
Kogut and Kulatilaka, 2001; Kumar, 2005; McGrath, 1997; Roemer, 2004; Rivoli and
Salorio, 1996).
17
The notion of delayability also helps us to understand the boundary conditions of
real options theory. Even though waiting and seeing until uncertainty associated with
initial investments is resolved carries real options value, the question remains as to how long any given option can be held by the firm. The concern over the issue of
abandonment was ignited by Adner and Levinthal (2004a), who argued that while well-
structured abandonment is a crucial condition for flexibility generated from real options investment. They warned of ‘option traps’ that hinder the abandonment of opportunities,
from, for example, psychological biases regarding sunk costs and escalating commitment.
Adner and Levinthal (2004a) also argued that it is necessary to distinguish between
investments ‘having real options’ and ‘being real options’ investments, since real options
are not implementation issue but a theoretic point for retaining flexibility coming from well-structured abandonment. On the other hand, McGrath, Ferrier, and Mendelow
(2004) criticized Adner and Levinthal’s (2004) argument for its restricted boundaries for real option reasoning. Instead, they argued for a more extended view of flexibility,
allowing for flexible adjustment with path-dependent strategic choice and changes.
Zahrkoonhi (2004) agrees with McGrath, Ferrier, and Mendelow’s argument that Adner
and Levinthal’s restricted approach to real options reduces the value of lens to strategic
decision making. Table 2.3 includes the summary of main arguments relating to the
boundary of real options and delayability of investments.
18
To address the concerns of these authors, it is important to examine the timing of
decisions relating to real options investments. This includes issues relating to when firms
will exercise real options associated with their investment, the manner of doing so, and
how their exercise decision will affect its value. Real option theorists have drawn upon
traditional options arguments to determine the appropriate conditions of uncertainty for
exercising options and assess the value-enhancing effects of buyout or divestment in their
investments. For instance, exogenous uncertainty reduce the value of exercise and thus
retard exercise (Folta and Miller, 2002; Kumar, 2005; Reuer, 2000; Tong and Reuer,
2000), endogenous uncertainty. Empirical studies in recent years on IJVs using a real
options framework have examined a variety of variables in this regard, including technological uncertainty, initial investment levels, number of partners, and the number
of options, as well as preemption by competitors (Folta and Miller, 2002; Miller and
Folta, 2002; Kumar, 2005; Trigeorgis, 2002).
Table 2.4 shows the extant literature dealing with the conditions and value of
acquiring and/or divesting real options investment.
19
2.2.4. The Issue of Flexibility
In addition to the options to defer, which help to understand the timing and abandonment decisions, there are other types of options of importance to the firm, including the option to grow or increase investment. In order to accomplish this, firms make foothold investments in a new market for the possibility of expansion in the future
(Chang, 1995; Kogut, 1983). After the initial foothold investment, they can expand their investments (e.g., buying out their IJV partners) if demand turns out to be stronger than expected (Kogut, 1991). Since the initial investment serves to keep the option open for possible greater commitment in the future, it is called a ‘platform investment,’ carrying growth options for sequential entry (Kogut and Chang, 1996). An example in this regard is when a firm begins with a joint venture and acquires its partner when it gains sufficient expertise in managing alone in a novel environment (Folta and Miller, 2002; Kogut, 1984,
1991; Kumar, 2005). For example, Kogut (1991) proposed that when a firm initiates an alliance or an equity joint venture, it obtains an option to expand in response to future technological and market developments while retaining the option to defer complete commitment. He found that unexpected growth in the product market does increase the likelihood of joint venture acquisitions, supporting the interpretations of joint ventures as an option to expand. Similarly, Folta and Miller (2002) showed that managers acquire
20
additional equity stakes from their biotechnology partner when the subfield of the partner
has larger growth potential.
While the option to grow focuses on growth potential in the market, the option to
switch reflects a change in the firm’s current strategies. When a firm faces an
unpredictable environment, it has difficulty in adapting its strategy to the new
circumstances, which negatively affects its operations and performance (Rivoli and
Salorio, 1996). Under these circumstances, firms need to be able to reallocate resources
quickly and smoothly in response to abrupt changes. The external uncertainty faced by
firms may be due to fundamental shifts in the level of demand or the relative costs of inputs. These abrupt changes in factor and product markets require firms to hastily adjust or even radically reconfigure their value chains in response to new opportunities for, or threats to, profitable production (Kogut, 1991, 1994). For instance, a broader network of countries would enable firms to arbitrage markets by shifting factors of production across borders and by transferring resources within their network of affiliates located in one or
more foreign countries (Allen and Pantzalis, 1996; Cater, Pantzalis, and Simkins, 2003;
Tang and Tikoo, 1999).
In addition to individual options, recent literature has also begun to focus on a
portfolio of options. Firms usually undertake multiple projects, and for this reason, we
may view firms’ strategic decisions as bundles of resource-investment alternatives or real
options (Bowman and Hurry, 1993; Zingales, 2000). This implies that a key aspect of 21
firm strategy involves the optimization of their option portfolio (Bowman and Hurry,
1993; Luehrman, 1998; McGrath, 1999; Tong and Reuer, 2006). Option value at the portfolio level is a function of the value of individual options in the portfolio, reflecting important inter-firm difference. Some options may be uniquely available to a firm but not to others, presenting proprietary opportunities that differ across firms (Kester, 1984;
Trigeorgis, 1996). The value of a portfolio of options can differ from that of individual options, due to the potentially super-additive or sub-additive properties of the portfolio in comparison to the value of an individual option, determined by the characteristics or correlations of underlying assets, uncertainty types, and organizational constraints
(Vassalo, Anand, and Folta, 2004; Anand, Oriani, and Vassola, 2007).
Based on the interactions among different types of options within a portfolio of investments, Folta and O’Brien (2004) compared the relative magnitude of growth and deferral options. They found that entry into a new industry is influenced by the relative value of these two options, moderated by uncertainty level, growth potential, irreversible investments, and preemptive advantages. The level of uncertainty shows a U-shaped relationship to the entry rate, with a threshold at then 94th percentile. Growth potential and preemptive advantages enhance the value of growth options and thus shorten entry timing, whereas irreversibility retards the timing of entry as uncertainty increases.
Table 2.5 incorporates relevant studies examining the impact of several types of options on firms’ behaviors and performance. 22
2.2.5 Upside Gains, Downside Risks
In order to capture the additional value of a real option to traditional net present value, researches have used multiple measures of firm value and performance. First,
Tobin’s q is used as a standardized measure of the value ascribed to a firm by investors.
Its denominator (book value of total assets) represents the investment input in the firm, and its numerator (market value of common stock+ book value of preferred stock + book value of debt) captures the value created by the firm with these inputs (Lee, Makhija, and
Baik, 2008). While alternative measures such as return on equity (ROE) are expected to differ across firms depending on the risk of the firm, Tobin’s q is a “forward looking” measure that adjusts for risk and is therefore a particularly appropriate measure for assessing real options value. Since the market value of the firm depends on the growth potential of the firm, as well as the efficiency of management to actualize it, Tobin’s q as a performance measure is more appropriate than other short-run measures such as ROE or ROA (Lee, Makhija, and Baik, 2008). It is important to note, however, that using this measure also has some limitations (Tong and Reuer, 2006). In prior empirical analyses in economics and finance, Tobin’s q has been used to capture a number of diverse theoretical constructs, such as monopoly power, management quality, shareholder value and intangible resources (Tong and Reuer, 2006). A way to overcome some of the
23
criticisms against Tobin’s q, that it reflects the confounding values generated by multiple firm activities and thus not appropriate for measuring future growth potential (Tong and
Reuer, 2006), is to eliminate the observations with more than 20% changes in book value to control for any M&A activities (Bulan, 2005). As a proxy for Tobin’s q, stock ratio is also used for reflecting forward-looking value of the firms, measured by market value over book value of common stock (Folta and O’Brien, 2004; Tong and Li, 2007, working paper).
In order to separate out pure growth options value embedded in an investment,
Tong and Reuer (2006, 2008) used variance composition analysis with their Stern and
Stewart dataset. They faithfully followed Meyer’s (1977) original notion of growth options which is distinct from net present value. As predicted, they found that the growth option value of international joint ventures was associated with characteristics such as smaller ownership, location in developing countries, and non-core product markets.
In addition to the individual firm’s value, the relative value of individual firms to other firms has also used to measure the additional value generated by real options investment. For example, in order to measure the value of multinational flexibility, Allen and Pantzalis (1996) and Thomas and Eden (2004) assessed the firm’s excess market value (EMV), the ratio of market value plus the book value of debt minus total assets, all divided by total net sales. They extracted the EMV of each individual firm from the
24
averaged EMV of all the domestic firms in the same industry. This measure is used to
reflect the value of multinational flexibility of multinational firms.
The value of operative flexibility has also been assessed by relating economic
exposure, such as exchange rate exposure, with the scope of host countries scattered in
multiple countries. Sensitivity of the firm’s cash flow to positive and negative fluctuation
in exchange rates can be influenced by its response to such change using its international
investments in an asymmetric manner (Cater, Pantzalis, and Simkin, 2003; Huchmeier
and Cohen, 1996; Miller and Reuer, 1998b; Panzalis, Simkins, and Laux, 2001). The firm
shifts its value chain activities across countries in such a way that reduces its overall
economic exposure (Kogut and Kulatilaka, 1994; Miller and Reuer, 1998b).
Besides these measures of the upside potential of real options investments, researchers have also used measures of downside risk to test the ability of certain types of investments with embedded options to reduce the firm’s downside losses. In contrast to traditional variance-based measures of risk that incorporate the entire distribution of firm performance, measures of downside risk solely captures organizational outcomes below some target value (Reuer and Leiblein, 2000; Tong and Reuer, 2007). Miller and Reuer
(1996) provided three rationales for moving from variance-based measures of risk to such
a downside conceptualization of risk; First, downside risk explicitly incorporates the
notion of reference (i.e. target or aspiration) levels. Second, a downside risk model of equity returns explains stock returns better than the capital asset pricing model. 25
And third, empirical research in the management field documents that decision makers
tend to consider risk in terms of negative outcomes or hazard rather than as variance in
outcomes of a real option.
Reuer and Leiblein (2000) used three measures of downside risk which is
operationalized by ROA, ROE, and financial beta in order to investigate whether firms are able to take advantage of multinationality and international joint ventures to reduce their downside losses. However, they found that neither investment type carried the effect of downside risk reduction. They attributed their lack of findings in this regard to multinational complexity and costly coordination over foreign subsidiaries. Using the same measures, Tong and Reuer (2007) examined the relationship between multinationality and downside risk, moderated by ownership level at the FDI portfolio level and cultural distance between host and home countries. They found that multinationality has a U-shaped relationship to downside risk. They argue that these results indicate that downside risk initially falls as firms enter more foreign countries, and later rises due to high coordination costs of highly dispersed operation across country borders.
Table 2.6 shows the different measures of real options value for different types of
options used in the literature.
26
2.3 Management and Implementation of Real Options
Although researchers have supported option-based logic in the literature, there has
been limited application of commonly-accepted heuristics to date. Formal valuation
methods with actual measures of option value-enhancing attributes have not been developed. This is because it is not easy to recognize, separate, and measure the real options value of specific attributes of investments in real assets. Additionally, it is important to consider the fundamental differences between financial options and real
options. Flexibility suggested by real options logic cannot hold if fundamental
assumptions are violated in the real world. Even in the case that flexibility can hold, other
managerial issues should be incorporated into real decision making processes. These gaps also reflect the problems of establishing the theoretic boundaries of real options theory.
2.3.1. Firms’ Heterogeneous Resources and Capabilities
By using variance composition analyses, Tong and Reuer (2006, 2008) found that
firm effects explain of the variance of their growth options value more than industry or
country effects. Their results imply that it is the heterogeneity in firms’ proprietary
options and the differences in how firms manage them that matter the most in explaining the variance in the value that firms can actually capture from growth options. 27
Because of the heterogeneity in the capabilities of firms, different firms facing the same opportunity are likely to display different investment patterns in relation to option creation or exercise (Cupyers and Martins, 2007). We argue that learning capabilities lead
to firms’ heterogeneity of realizing real options value under uncertainty. Learning
capabilities of the firm enable it to perceive and respond to opportunities in an uncertain
future (referred to as shadow options in Bowman and Hurry, 1993). Firms with greater
experience in dealing with uncertainty are likely to have greater capability in exercising
real options. Holding and being able to strike this real option depends fundamentally on
the competences and learning activity of the firm (Burger and Helmchen, 2004).
In such contexts, firms’ ‘absorptive capacity,’ or ability to recognize the value of
new information, assimilate it, and apply it to commercial ends (Cohen and Levinthal,
1990), is relevant. In the context of real options terms, this notion is expressed as “the ability to perceive and respond to exogenous uncertainty and opportunities.” This ability is embedded in exploitation and exploration activities in the process of developing organizational knowledge (March, 1991), in relation to with the two dimensions of FDI breadth and depth (Wijk, Bosch, and Volberda, 2001) in accordance with the stability and turbulence of the environment (Starbuck, 1992). It may be interesting to assess the relationship between the two dimensions of learning and the two learning activities (i.e. breadth with exploration vs. depth with exploitation) under different conditions of uncertainty. It is expected, for example, that broader bases of knowledge will be more 28
relevant in turbulent environments and have a more positive impact on firm value. We
would further expect that firms involved in option-like investments with broader bases of
knowledge are more likely to adjust to turbulent environments and thus generate greater
real option value. Managers cannot gather all possible information from their
environment due to limited attention and information processing capacities (Cupyers and
Martin, 2007). As a result, investors are unable to make complete or fully accurate
representations of their complex environments on which their actions are based. For this reason, it is expected that decision-makers’ subjective perceptions of uncertainty, and therefore their valuation of options, is dependent of their experiences from prior investment. Similar to the argument made by Argyres and Liebeskind (1998), incorporating the learning associated with prior investments into real option theory is one
way to fill in this gap in the theoretical literature.
A possible way to test this issue is by looking at prior investments of Korean firms in their domestic and foreign markets before the 1998 economic crisis. This crisis was considered to be virtually unanticipated by managers and analysts alike (Lee and Makhija,
2008), providing an appropriate setting for examining the real option value of these firms’ investments. We can test the impact of firms’ prior experiences with real options
investments on the value of these investments during the period of the crisis. Prior
experience with uncertainty will help firms to derive greater real options value from their
international investments. 29
2.3.2 Explicit and Implicit Learning
While the value of having flexibility has now been widely studied in real options
literature, the learning involved in keeping and managing these investments has not
received much attention. However, as we argued earlier, learning is a crucial part of real
option investment in that it can potentially increase the value of the flexibility. Extant
literature, however, currently sees learning as a nonessential part of managing flexibility.
Some researchers argue that real option value is only associated with exogenous
uncertainty and its exercise is only influenced by the arrival of external information. They
argue that open-ended and path-dependent learning activities make real options logic
indistinguishable from other theories (Adner and Levinthal, 2004) and also undermines
the discretionary nature of real options (Adner and Levinthal, 2004; Cupyers and Martin,
2006). In contrast, other researchers have suggested the importance of endogenous
discovery through learning within the real options framework. They have noted the
ability for flexible adjustment through path-dependent learning activities within firms
(McGrath, Ferrier, and Mendenlow, 2004), and also, the appropriate timing of learning compared with the cost of learning and quality of information (Martzoukous and
Trigeorgis, 2001; Murto, 2004).
Although the option to defer or learn is an important type of flexibility, the role of
learning within the real option framework is still unclear. Is learning in this context the
30
same as just waiting and seeing until information associated with initial investment and
exogenous uncertainty becomes evident or is it the active gathering of information
starting from the initial investment? What kinds of learning activities are actually taking
place in real option investments? How do these learning activities affect the value and
exercise of real options? Are real options solely exogenous to learning or are they
influenced endogenously in that their exercise is influenced by prior learning? Also
relevant is whether these influences on learning provide an explanation for why firms
would want to learn even under uncertainty, since real options theories argue it is
sometimes irrelevant or beyond the scope of real option fundamentals? Based on these
questions, three key issues can be summarized as follows: 1) understanding the reasons
and conditions under which firms would want to learn, since the real options literature
suggests that learning does not matter due to unpredictability of the environment, 2)
identifying the conditions that make it possible to learn at low cost under high uncertainty,
and 3) determining the timing of learning under which decision-makers would want to exercise the uncertainty-reducing learning option, even in the existence of a trade-off between cost of learning and quality of information.
Regarding the first issue, it can be argued that real options are at least partly
endogenous to learning. Prior learning about the market and partners facilitates decisions about whether to exercise the option or not. This idea is in line with Chi and McGuire’s
(1996) efforts to valuate joint ventures among partners based on asymmetric learning 31
about the partner and demand conditions. Relevantly, we expect that what is learned in
time 1 influences specific decisions at time 2. A relevant research topic, therefore, is to investigate the impact of the actual learning in alliances and subsequent decisions such as buyouts and sell-offs. In competitive situations, learning is likely to secure, at the very least, first mover advantages by knowing what partners know. This view of the active role of learning contrasts with the traditional argument within the real options framework that learning means passive waiting and learning. Instead, firms gather information, accumulate capabilities, and take actions flexibly as external information arrives.
Nevertheless, it is expected that costs of learning are non-trivial under high
uncertainty. As noted earlier, it will be interesting to identify the conditions under which
it would be possible to learn at low cost under high uncertainty. In this vein, governance
modes can affect the relative opportunity cost of learning. For example, alliances have
been conceptualized as a mode for learning at lower cost (Makhija and Ganesh, 1997;
Hamel, 1991). However, the opportunity costs associated with alliances are likely to
differ under different contexts. Alliances in highly concentrated industries (e.g. alliance
with one among two partners) will create higher opportunity costs than those in less
concentrated ones (e.g., one among ten partners). Additionally, alliances in mature
industries will create higher opportunity costs than alliances in growing industries.
The third issue is about the different views on explicit and implicit role of learning
within the real option framework. It is also about the firms’ role in this regard. Do firms 32
just passively wait and see for information arriving from outside? Would they not do anything about learning? The standard theory of real options focuses on investment projects, whose values are subject to a given exogenous stochastic process (Murto, 2004).
In other words, by waiting and observing the development of the exogenous process, the firm under consideration continuously updates the present value of the project. This process of continuously resolving uncertainty induces a value to waiting, which makes the firm more reluctant to carry out the investment than would be the case under certainty.
But little has been written about managers´ ability to intervene in order to change strategy or acquire information (Martzoukous and Trigeorgis, 2001). Since (optional) learning actions intended to improve estimates actually reduce uncertainty, whereas option values are in general increasing functions of uncertainty, why would the decision-maker want to exercise the uncertainty-reducing learning options?.
When considering the optimal timing for learning, the firm faces a trade-off situation. By postponing the learning activity, the firm postpones the cost of learning as well, but on the other hand, increases the probability that learning will reveal information that would have been more beneficial if received earlier (Murto, 2004). The firm must balance these two counteracting effects in determining the optimal timing of learning.
Martzoukous and Trigeorgis (2001) attempt to find the appropriate timing of learning.
In the presence of costly learning, there exists an upper and lower critical boundary within which it is optimal to exercise the (optional) learning action. Outside this range, it 33
is not optimal to pay a cost to learn. The investment is already either too good to worry
about possibly lower realized cash flows, or too bad to invest a considerable amount in
order to learn more.
2.3.3 Cost of Creating and Managing Real Options
What if the assumption that the cost of creating and managing real options is quite low is not the case? In other words, what if the cost of creating and managing real options is positively correlated with the value in the investment? For example, while the point that high exogenous uncertainty can give firms positive real options value is based on explicit assumptions, the assumption that it is not costly to manage a real option investment is not stated explicitly. This would suggest that the very attribute of an investment that drives the value of a real option also drives the cost of creating and managing the investment. In principle, this could mean that the most valuable real
options will also be the most costly to create and manage. Exchanges occurring in very
uncertain settings may have significant option value, but if the cost of creating and
managing these options through strategic alliances is high enough, they will not be pursued, even if they could create value for a firm.
It will be interesting to examine the relationship between the potential value a real
option creates and the cost of creating and managing the real option. For this purpose,
after four main attributes of an exchange that have the effect of increasing option value 34
in the Black and Scholes formula are identified, the effect of these attributes on the costs
of creating and managing real options can be discussed. When the value of flexibility
may be positively correlated with the cost of managing flexibility by these attributes, this
study identifies potential circumstances where the value of flexibility is less than the cost
of creating and managing flexibility and where received theory suggests a firm may have
a real option that other theories suggest it does not. Different propositions on entry and
exit will be made subsequently. A possible application would be that real options logic
says that a firm with low exercise price, longer maturity, but high uncertainty prefers to
choose alliance, while transaction cost logic says that a firm with low exercise price,
longer maturity, high uncertainty about behavioral actions of exchange partners prefer to
choose vertical integration.
Although the point that there are costs to creating and managing real options is not new, showing that the same factors that increase the value of flexibility also increase the
cost of creating and managing flexibility is new. When flexibility is valuable and when
the cost of creating/managing flexibility is low, then a real option exists. By contrast, (a)
when flexibility is not valuable or (b) when flexibility is valuable but the cost or
creating/managing flexibility is high, then no real option exists. This can add an answer
to the question of Adner and Levinthal (2004), "what is/isn't real option?."
35
Uncertainty Dependent Measure type Variable Market Demand Kogut JV First difference b/w actual and forecast shipment growth rates (1991) buyouts
Campa Standard deviation of the monthly change in the logarithm of FDI entry (1993) demand for a period of time Folta&O’Brien Time-varying estimates of demand uncertainty for 51 broad (2004) industries generated from GARCH model, which captures the Folta,Johnson, FDI entry uncertainty that is not predictable about any trend that might &O’Brien exist for each period in the time series. (2005) Acquisition Kumar (2005) Volatility of shipments Divestment Standard deviation of market demand over rolling samples of Goldberg& twelve quarters of data, prior to and inclusive of each period t, FDI entry Kolstad (1995) normalized by the mean level of demand within the interval. Output Price Campa Standard deviation of the monthly change in the logarithm of FDI entry (1993) price for a period of time Exchange Rate Campa Standard deviation of the monthly change in the logarithm of FDI entry (1993) the exchange rate for a time Standard deviation of exchange rates over rolling samples of Goldberg& twelve quarters of data, prior to and inclusive of each period t, FDI entry Kolstad (1995) normalized by the mean level of rates within the interval. Yearly standard deviation of unexpected exchange rate FDI timing Hauser movements(monthly residuals) in a country, divided through Entry mode (2004) the mean of the exchange rate level in that year FDI type Cuypers& Parallel market premium=|average annual official rate-average IJV Martin (2006) annual parallel rate|/ average annual official rate ownership
Table 2.1. Uncertainty types in Real Option literature (Continued)
36
Table 2.1: Continued
Technology Entry mode: Folta (1998) 26-week standard deviation of the log of weekly returns Minority Folta & Miller for each biotechnology sub-field index alliance, (2002) Acquisition Extent to which participants took technology Information Sutcliffe&Zaheer into account in making their decision was measured with (1998) five items, averaged to create a variable score Santoro&McGill Systematic differences in volatility among three sub-fields (2005) Exogenous Shock Chung&Beamish Divestment Economic crisis in five Asian countries (2004;2005) of IJVs Grewal&Tansuhaj Asian economic crisis in Thailand Performance (2000) Lee & Makhija Real options Korean economic crisis (2008) value Institution Cuypers&Martin IJV Location in Special economic zone or open coastal cities (2006) ownership Reuer(2002) Explicit Property right Reuer&Tong option to Political (2005) acquire in JV Country risk A composite risk variable, the Euromoney country risk IJV Cuypers&Martin index on which has been transformed such that values ownership (2006) between zero and 100 indicate an absolutely save environment and mostly uncertainty one respectively FDI timing/ Hauser(2004) Entry modes A dummy variable that distinguishes between entries into /FDI type Erramili lower-risk and high-risk countries. High risk countries &D’Souza(1995) based on the classification system developed by Goodnow and Hansz (1972). FDI entries
37
Investment type/ Contents of Research Research Minority Investment Governance choice under technological, competitive uncertainty, Folta (1998) growth opportunity, or learning Alliance Vassalo,Anand, &Folta Super vs. sub-additive value of alliance divestment (2004) JV as strategic options to expand in case of receiving favorable Kogut(1991) market responses Choice between non-equity and equity JV is made by real option Folta&Leiblein (1994) logic with volatility, duration, interest rates. Acquisition is chosen by high competition Smaller share in JVs is positively related to market, partner-related, Chi&McGuire (1996) legal uncertainty. Minority investment and JVs are preferred to acquisition under Folta (1998) exogenous technological uncertainty and competitive uncertainty. Chi (2000) Develop model for assessing options to acquire or divest in JVs Reuer&Leiblein (2000) Downside risk effects (ROA, ROE, CARR) of IJV investment Folta&Miller (2002) Timing of acquisition/additional increase) in biotechnology JVs Reuer (2002) Explicit option to acquire JV equity is influenced by property right, Reuer&Tong (2005) political, diversification-related uncertainty Kumar (2005) Timing of acquisition/divestment of IJV and option value Smaller stakes in IJVs are chosen under exogenous uncertainty such Cuypers&Martin (2006) as institutional, exchange rate, and country risk. Growth options value of IJVs: 1) number of JVs; 2) # of minority Tong,Reuer,&Peng JVs; 3) # of non-core JVs; 4) # of JVs in developing vs. developed (2006) countries
Table 2.2 Investment Types in Real Option literature
38
Research Main argument Bowman & Hurry ▪ Systemic, deliberate and oriented toward maximizing economic returns (1983) ▪ No specific guidance to the lengths of real option investment
▪ Flexibility generated from well-structured maturity ▪ Psychological biases regarding sunk costs and escalating commitment hinder the abandonment of opportunities ▪ Abandonment is not implementation issue, but a theoretical point for Adner & Levinthal retaining flexibility (2004a,b) ▪ Real option theory needs a specific condition for its boundary, and so having real options and being real options should be distinguished. ▪ Unstructured and adaptive innovation journey runs contrary to the disciplined project abandonment procedures implicit in a real options approach
▪ Abandonment is an implementation issue and real options argument is McGrath, Ferrier, not confined to well-structured abandonment. & Mendelow (2004) ▪ Extended view of flexibility: Flexible adjustment with path-dependent strategic choice and changes
Zahrkoonki ▪ Not open-ended nature but other factors lead to escalating commitment (2004) ▪ Flexible adjustment is more suitable for real options logic
▪ Appropriate timing by the ability to perceive and respond to uncertainty Barnett and opportunities (2005) ▪ Necessary means for deescalating commitment
Table 2.3 Delayability and Boundary of Real Option Theory
39
Research Dependent Variables Independent variables JV as strategic options to expand in case of Kogut JV buyouts receiving unexpected and favorable signals (1991) of product market responses
Chi&McGuire Real option value in JVs is influenced by Real options Value in JVs (1996) Market, partner, legal Uncertainty The acquisition/divestiture price is Chi Option to acquire/divest specified ex ante in the initial contract or (2000) negotiated ex post
More value of underlying asset and more Timing of acquisition number of parties is positively associated Folta&Miller (2002) (additional increase) with option exercise. Uncertainty is in biotechnology JVs negatively related.
Timing of exercise in influenced by, current dividends, exercise price, residual Miller&Folta (2002) Timing of exercise resource value, discount rate, call option value, compound vs. simple option
The value of acquiring and divesting a Kumar Timing of exercise venture is influenced by the degree of (2005) (IJV acquire/divest) technological and demand uncertainty (negative), and degree of rivalry Explicit option to acquire JV equity under Reuer the influence of property rights-related, Uncertainty+JV buyout (2002) diversification-related uncertainty, not by cultural uncertainty. Alliance divestment is influenced by Industry uncertainty, technological Vassolo,Anand, Abandonment of distance b/w the focal alliances and the &Folta collaborative ventures parent’s portfolio of other alliances, and (2004) technologicial distance b/w the firm and the focal alliance
Table 2.4 Timing and Value of Exercise Real Options 40
Research Option type Dependent Variables Kogut (1991) Option to grow JV as explicit option to acquire Chi (2000) Option to grow Learning and valuing Joint ventures Explicit option to acquire JV equity Reuer (2002) Option to grow under property rights, diversification, cultural uncertainty Buyout of partner stakes in Folta & Miller (2002) Option to grow biotechnology JVs IJV ownership under exogenous and Cupyers & Martin (2006) Option to grow endogenous uncertainty Tong,Reuer,&Peng Option to grow Growth options value of IJVs (2007) FDI entry under demand, exchange Campa (1993) Option to defer vs. grow rate uncertainty Belderbos & Zou (2007) Option to defer vs. grow Subsidiary increase Industrial entry rates by the relative Folta & O’Brien value of two options influenced by Option to defer vs. grow (2004) growth potential, irreversibility, preemption. The impact of exchange rate Kogut&Kulatilaka(1994) uncertainty and switch across Options to switch Buchmeier&Cohen(1996) countries.
Allen&Pantzalis (1996) Value of multinational flexibility Switching options Tang & Tikoo (1999) by FDI breadth and depth Reuer &Leiblein (2000) Downside risk reduction effect of Option to switch Tong & Reuer (2007) multinationality and IJVs
Relative value by Correlations of Anand,Oriani,&Vassalo Option to grow vs. switch underlying assets, uncertainty types, (2007) exercise constraints
Table 2.5 Options Types in Real Option Literature
41
Measure/ Description of Measure Option Relevant Research Tobin Q
market value of common stock+book value of Allen & Pantzalis(1996) Growth/ preferred stock+book value of debt) / (book value Berk,Green,&Naik(1999) Switch of total assets)
Excessive Market value (market value of common stock + book value of Allen & Pantzalis (1996) Switch debt – total assets) / total net sales Thomas & Eden (2004) Stock ratio
Market value / book value of common stock Growth Folta & O’Brien (2004)
Abnormal return Growth Kumar(2005) Abnormal cumulative return Switch Tang & Tikoo (1999) Downside risk Below-target performance Kogut & Kulatilaka(1994a) Growth Miller & Reuer (1996) ▪ ROA, ROE, Switch Reuer & Leiblein(2000) ▪ Beta Tong & Reuer (2007) Economic Exposure Cater,Pantzalis, & Simkin Sensitivity of the firm’s cash flow to changes in (2003) Switch exchange rate Panzalis,simkins, & Laux (2001) Growth Options Value ▪ Difference b/w a firm’s market value and the capitalized value of its current earnings stream, Kester (1984) discounted at a fixed rate Growth Tong, Reur, & Peng(2007) ▪ Market value subtracting capital invested and Reuer & Tong (2007) present value of current level economic value added (EVA), scaled by market value
Table 2.6 Performance Measures in Real Option Literature 42
CHAPTER 3
NEED FOR FURTHER RESEARCH
3.1 Motive for the Research
Under conditions of high uncertainty, it is difficult for firms to determine appropriate courses of action that lead to high performance (Chi, 2000; Cupyers and
Martin, 2006; Folta, 1998). For this reason, they invest in real assets in a manner that allows them to ‘keep their options open’ (Bowman and Hurry, 1993; Dixit and Pindyck,
1994). Multinational firms in particular are exposed to many significant forms of uncertainty, including unanticipated fluctuation in the relative value of currencies, unexpected changes in demand, and institutional disruption (Allen and Pantzalis, 1996;
Campa, 1993; Cuyper and Martin, 2006; Kogut and Chang, 1996; Makhija, 1993; Miller,
1998; Tong and Reuer, 2007). Their foreign direct investments may, however, embody real options to the extent that they preserve future decision rights for the firm (Kogut,
1991; McGrath and Nerkar, 2004; Tong and Reuer, 2007). Such investments may retain significant upside potential due to the firm’s preferential access to future growth opportunities embedded in the foreign environments in which they operate.
They may also limit downside risks by allowing the firm to switch production or sales across countries in response to macroeconomic changes in any given country (Kogut,
43
1991; Kogut and Kulatilaka, 1994; Allen and Pantzalis, 1996; Tang and Tikoo, 1999;
Tong and Reuer, 2007; Tong, Reuer, and Peng, 2007).
To date, the literature on multinational flexibility has shed considerable light on
why and how firms invest and structure their operations in the international context, yet
the evidence presented on the real options value of foreign direct investments remains
mixed. For example, some researchers have shown that multinationality generates
additional value through the increased flexibility it affords (E.g. Allen and Pantzalis,
1996; Cupyers and Martin, 2006; Kogut, 1991; Lee and Makhija, 2008; Tang and Tikoo,
1999). Other researchers, however, have not found that international investments yield
real options benefits, ascribing this finding to multinational complexity and non-trivial
costs of management (Reuer and Leiblein, 2000). Still others have found a non-linear
relationship between multinationality and the reduction of downside risks (Tong and
Reuer, 2007). The diversity of these findings points to the need for a more fine-grained investigation of the real options perspective of foreign direct investments (FDI).
We believe that there are three main reasons why prior investigations of the real
options value of international investments have exhibited divergent findings. First stems
from the fact that real options take on greater value under higher uncertainty, rendering
the external conditions under which international investments are examined very
important.
44
However, much of the empirical literature does not adequately control for or assess
such attributes of the environment associated with these investments (e.g. Allen and
Pantzalis, 1996; Tang and Tikoo, 1999; Tong and Reuer, 2007). Since the nature of
uncertainty influences the strategic needs of firms, the interactions between specific
conditions of uncertainty and the ability of strategic investments to resolve them is a
critical determinant of their value to the firm. Second, while prior studies have considered the geographic configuration (i.e. breadth and depth) of international investments, they have not taken into account other important issues, such as control and governance of
these investments, which affect firms’ ability to manage the real options associated with
them.
Finally, researchers have not fully considered the potential conflicts among
competing options within a portfolio of real options investments. A firm’s portfolio of
FDI can contain more than one type of options (Bowman and Hurry, 1993; Lehrman,
1998; Trigeorgis, 1993, 1995). It is possible for this portfolio to contain multiple options
that differ markedly from each other, and which provide value under different conditions
of uncertainty. In this case, the attributes of an investment that drive the value of one type
of option may also drive the cost of another type of option. Thus, the findings of a study
that focuses on only one type of option in a portfolio of investments that contain more
than one option may not be sufficiently informative.
45
The purpose of this research is to address these concerns. We begin by considering two types of options of interest to multinational firms: growth and switching. Growth options are yielded by international investments providing a foothold or initial platform in a host country by which the firm can identify and exploit future growth opportunities through further incremental investment in that country (Chang and Kogut, 1996; Kogut,
1991; Sharp, 1981; Tong, Reuer, and Peng, 2007). Switching options are gained through international investments that allow the firm flexibility in transferring value-adding activities from one location to another in response to unanticipated fluctuation in any of its host countries (Allen and Pantzalis, 1996; Buchmeier and Cohen, 1996; Tang and
Tikoo, 1999; Tong and Reuer, 2007). Although growth and switching options are both derived from a firm’s international investments, there are fundamental ways in which they differ.
As seen above, each offers different potential courses of action to the firm, likely to be valuable only under specific conditions of uncertainty. That is, growth options are likely to be valuable under certain circumstances, while switching options provide value under others. In addition, the contrasting nature of the two types of options requires correspondingly different ways of structuring the firm’s international investments.
Interestingly, though, growth and switching options associated with FDI have not been empirically differentiated to date in the literature. The problem lies in the fact that the two types of options can coexist in a firm’s portfolio of FDI, and in empirical analyses, may 46
have the effect of masking the other’s effects. It is important, therefore, to identify and
decompose the contribution of each option type to the value of the firm.
To begin, we present a model that takes into account the geographical organization
of the firm’s FDI, distinguishing between its breadth across countries and depth within
countries, and the level of ownership in these investments. We argue, consistent with
others (Kogut, 1991; Tang and Tikoo, 1999), that these dimensions are the source of the
firm’s ability to derive switching and growth options, respectively. In order to disentangle
the effects of the growth and switching options potentially embedded in a firm’s
international investments, we next identify conditions of uncertainty in which the value
of switching options theoretically exceeds the value of growth options, and vice versa. In
particular, we consider two types of international environmental uncertainty faced by the
multinational firm, exchange rate volatility and domestic market uncertainty associated
with host countries. We test the effects of different FDI structures on firm value under these differing conditions of environmental uncertainty using a sample of 1,334 observations from 176 publicly-traded manufacturing firms listed on the Korean Stock
Exchange during 1991-2004. Employing a two-staged model and panel data methodology, we find that switching options are associated with more value than growth options under high exchange rate volatility, while growth options are associated with greater value under high host country market uncertainty. We further find that ownership level and
47
cultural distance play an important role in allowing firms to derive real options value
from their international investments.
By examining multiple options embedded in firms’ international investments, this
study has the potential to provide a number of contributions to the literature. One, it helps
to provide more insight into the portfolio properties of FDI, adding to the body of work
on international investments that focuses primarily on international diversification. Two,
it adds to the literature on multinational flexibility by empirically differentiating between
two types of options drawn from international investments. Three, it compares two
important sources of environmental uncertainty rather than just focusing on exchange rate
uncertainty, which is the typical focus of studies on multinational flexibility. Finally, by
showing that options can conflict within a firm’s portfolio of investments, this study can
help explain the varied results seen in the real options literature regarding the value of real options.
3.2 Theoretical Underpinnings
3.2.1 FDI as a portfolio of real options
Firms’ strategic decisions can be viewed as bundles of real options (Bowman and
Hurry, 1993), in which investments are undertaken to maximize firm value under
unknown future conditions. Thus, a key aspect of firm strategy is the optimization of the
48
firm’s option portfolio (Luehrman, 1998; McGrath, 1999; Tong and Reuer, 2006). The
value of the option portfolio is a function of the value of individual options within the
portfolio, which varies across firms. Some options may only be available to a given firm
but not to others, presenting proprietary opportunities that differ across firms (Kester,
1984; Trigeorgis, 1996). The value of a portfolio of options differs from that of individual
options, and can be super-additive or sub-additive to individual options depending on
characteristics and correlations of underlying assets, uncertainty types, and organizational
constraints (Vassalo, Anand, and Folta, 2004; Anand, Oriani, and Vassalo, 2007).
Real options theory considers FDI to confer real options since it can preserve significant upside potential by providing the firm with preferential access to future
growth opportunities embedded in the environmental uncertainty of foreign countries.
FDI can also detain downside risk by allowing the firm to divest at low cost or shift
production across countries when adverse changes in macro-environmental factors occur
in any given country (Kogut, 1991; Kogut and Kulatilaka, 1994; Allen and Pantzalis,
1996; Tang and Tikoo, 1999; Tong and Reuer, 2007). Since FDI takes the form of several
investments in multiple countries, it can also be considered to be a portfolio of real
options. Since, as noted earlier, different options within a portfolio can sometimes be
conflicting, it is worthwhile to separate out the effect of each option. The extant literature
deals with the difference between options to defer and options to invest. This distinction
between these two options types stems from the timing of investment, relating to when 49
firms postpone or actually make the investment. In an environment of uncertainty, when investments are typically irreversible, a real options investment can be economically
more valuable than the typical “invest or don’t invest” decision (Campa, 1993; Folta and
Miller, 2004; Hendrick, 2008). While this view of options relates to the timing of FDI,
another set of two options is derived from the manner in which FDI is structured. We
discuss these below.
3.2.2 Two Options Associated With Foreign Direct Investments
The real options literature has discussed two different kinds of flexibilities afforded by a firm’s international investments: 1) switching flexibility, and 2) growth flexibility
(Bowman and Hurry, 1993; Kogut and Kulatilaka, 1994). Kogut and Kulatilaka (1994) have observed that switching flexibility is derived from ‘across-country options,’ with which firms can shift production and sales from one country to another in line with unanticipated changes in the macroeconomic conditions of these countries. They further noted that growth flexibility is associated with ‘within-country options,’ with which firms can establish a platform from which they can gather information and learn about the market, or test drive a given strategy (Kogut and Kulatilaka, 1994). This platform investment can subsequently serve as the basis for future expansion in the country. While growth options provide the firm with flexibility to decide whether to continue or expand in a given direction in an incremental manner, switching options allow the firm flexibility 50
to change its country-specific strategies (Bowman and Hurry, 1993). Below we discuss
both types of flexibility in more detail.
Growth Options
An initial investment made by the firm may also allow additional incremental
investments in the future, undertaken as conditions unfold (Sharp, 1981). Typically, small
initial investments allow the firm to develop knowledge of emerging economic
conditions in the host country before any further investments. In this way, the firm is able
to adapt its strategy to the unique conditions of the country and avoid making strategic
errors in the future. The ability of growth options to allow the firm time to adapt to a
country’s conditions and make correspondingly appropriate decisions for operating in that country make such investments appropriate for expanding within a given country
(Kogut and Kulatilaka, 1994). When a firm wishes to invest in countries that are believed to hold great economic potential but characterized by unknown environmental conditions, it is valuable for the firm to expand its investment in stages, as greater understanding of this foreign environment develops, including the workings of the economy, customer preferences, as well as deeper relationships with government officials, workers and other local entities (Chang and Kogut, 1996; Kogut and Kulatilaka, 1994). One example can be seen in the case of Czech privatization. Although privatization was expected to occur along certain broad guidelines for a long time, the exact manner in which these policies 51
would be executed remained uncertain. Laws and regulation remained underdeveloped,
resulting in tremendous ambiguity as to the direction of the emerging economy. Thus,
managers of foreign firms entering the Czech economy in 1990, ahead of mass
privatization, could sequence investments in a manner that enabled them to respond
effectively as the uncertainty of new policy development and specific nature of market
competition was resolved.
Foothold investments in a new foreign market allow for the possibility of expansion in the future (Chang, 1995; Kogut, 1983). It is only once the initial foothold investment is in place that foreign direct investors can expand their operations in that country with relative ease if demand turns out to be stronger than expected. Since the initial direct investment made in this country serves to hold the option open for greater future commitment in this location, it carries growth options for sequential entry (Kogut and Chang, 1996). By the same token, a foothold investment can be terminated at relatively low cost in case the market does not turn out to be as advantageous as originally envisioned. An example of such an option is an international joint venture in which a firm begins with reduced investment. Once the firm has gained sufficient expertise in the novel environment, it can choose to acquire its partner’s share (Folta and
Miller, 2002; Hurry 1993; Kogut, 1984, 1991; Kumar, 2005). Evidence of this type of option is also seen in the case of Gerber in Hungary, which invested a relatively small amount to acquire a state-owned enterprise in the early 1990s. While the set of 52
opportunities were not at all clear at the time of investment, they would eventually
include using this platform for exporting to the vast markets of the European Union,
moving further towards international diversification, expanding its product mix, and
selling the plant profitably to another firm in the future. Managers would then be able to
choose among the most profitable of these for the company.
Switching Options
We noted above that for firms newly investing in uncertain host country
environments, investments with growth options allow them to expand in stages as
uncertainty continues to be resolved. However, another type of uncertainty stems from
significant and fundamental shifts in the relative levels of demand or costs of inputs
across countries, perhaps making continued operations in a given country untenable and
those in another more attractive. When a firm’s operating environment is characterized
by this type of unpredictability, difficulty in adapting its strategy to the new
circumstances can likewise have a detrimental effect on its performance (Rivoli and
Salorio, 1996). Coping with such volatility requires operational flexibility that provides the firm with the ability to reallocate resources quickly and smoothly in response to change. In particular, such abrupt changes in factor and product market require firms to
quickly reconfigure their value chains across national contexts (Kogut, 1991).
53
A bundle of investments located in multiple countries can in fact serve as switching
options (Kogut and Kulatilaka, 1994), allowing firms to change their strategies in line
with environmental fluctuations across countries rather than those only within countries.
These types of options enable firms to arbitrage markets by shifting factors of production
across borders and by transferring resources within their network of affiliates that
includes production, marketing/sales, research and financial units located in one or more
foreign countries (Allen and Pantzalis, 1996; Cater, Pantzalis, and Simkins, 2003; Tang
and Tikoo, 1999). Firms gain operational flexibility through across-country shifts in its value chain activities when operating or market conditions in one country becomes much less advantageous. For example, firms may be able to vary the locations in which to declare profits, depending on differential taxation and permissible transfer pricing policies in the countries in which they operate (Kogut and Kulatilaka, 1994). Consistent with this, when a firm’s foreign direct investments is characterized by greater breadth, reflecting more dispersion across countries, they will tend to be associated with switching options. Matsushida and Hitachi were able to quickly expand export-oriented manufacturing operations in Malaysia in order to take advantage of local currency devaluation. Table 3.1 summarizes the main differences between two option perspectives.
54
Growth options Switching options
▪Within-country option ▪Across-country options Definition (Kogut&Kulatilaka, 1994) (Kogut&Kulatilaka, 1994) ▪Incremental options (Sharp,1981) ▪Flexibility option (Sharp,1981) Country-specific uncertainty such as Across-country uncertainty such as
Uncertainty economy, demand, institution exchange rate uncertainty (Huchmeier (Cuypers&Martin,2006; Kogut,1991) &Cohen,1996;Kogut&Kulatilaka,1994)
▪ Preferential access to future opportunities existing in foreign countries
Upside ▪ Censoring external environments and adapting to local environments
potential Growth flexibility: Exploiting Operative flexibility: Exploiting cost Unexpected growth on a local base differentials on a global base
▪Small-sized platform investment ▪Limit switching costs by not Limited (minority investment, alliance, IJVs) divesting but just switching product downside (Cupyers&Martin,2006;Kogut,1991; mix or volume (Kogut&Kulatilaka, risk Tong,Reuer,&Peng,2007) 1994,Huchmeier&Cohen,1996)
▪ Coordination costs due to Costs of ▪Non-trivial management costs due to Multinational complexity, cultural creating and complexity, coordination of IJVs difference, incentive misalignment managing (Reuer&Leiblein,2000) (Tong&Reuer, 2007)
Table 3.1 Two Options Relating to FDI
55
CHAPTER 4
CONCEPTUAL MODEL AND HYPOTHESES
4.1 Conceptual Model
In the previous section, we noted that multinational firms are able to derive two important types of options, growth and switching, from their portfolio of international investments. The manner in which multinational companies structure their foreign direct investments affects their ability to respond flexibly to unanticipated fluctuations in macroeconomic factors in host countries. This in turn determines the value of these investments and the firms’ long-term performance. In this section, we first consider the flexibility needs of multinational firms under different conditions of uncertainty faced by them. We then show how different structuring of foreign direct investments can address
these needs. In line with our arguments, we develop and present several testable
hypotheses. The conceptual model from which these hypotheses are derived are shown in
Figure 4.1.
56
4.2 Hypotheses
4.2.1 Exchange Rate Uncertainty
Exchange rate volatility is commonly considered to be the greatest source of uncertainty faced by multinational firms (Goldberg and Kolstad, 1995; Hauser, 2004;
Huchzermeier and Cohen, 1996; Kogut and Kulatilaka, 1994; Pantzalis, Simkins, and
Laux, 2001). Fluctuations in the value of currencies are largely unpredictable and out of the control of any given firm, yet can adversely affect costs and revenues of its foreign business. The ability of multinational firms to respond to such uncertainty in their value chain activities greatly influences their long-term performance.
Firms facing high exchange rate volatility can respond to such uncertainty by increasing their exposure in environments that are more favorable for their costs and revenues, and decreasing their exposure to the environments that are more detrimental in this regard. Such an asymmetrical response to exchange rate volatility is possible when firms operate in multiple countries, providing them with the ability to shift their sales or productions across countries (Cater, Pantzalis, and Simkins, 2003; Camps, 1994;
Huchzermeier and Cohen, 1996; Pantzalis, Simkins, and Laux, 2001). Firms with significant exposure to foreign exchange rate movements can manage their investments in such a way as to take advantage of currency movements that increase firm value while 57
reducing exposure to exchange rate movements detrimental to firm value.
Firms with international investments that are dispersed across a large number of countries are likely to have greater flexibility in this regard than those that are less dispersed, since they will be able to choose among more environmental options when reconfiguring their operations. Firms with investments that are concentrated in only a few locations would not have nearly as many options, however. Thus, we present the following hypothesis:
Hypothesis 1a: Under higher exchange rate uncertainty, FDI breadth will be positively associated with the value of multinationality.
From a switching options perspective, firms with dispersed operations can take advantage of exchange rate uncertainty by shifting value chain activities such as production and/or sales from one plant to another in more than two different countries. It is assumed, then, that firms can flexibly shift production from one subsidiary to other subsidiaries as needed. However, it is important to consider that such flexibility does not arise automatically from dispersed operations (Kogut and Kulatilaka, 1994; Tong and
Reuer, 2007). A multinational firm that establishes subsidiaries in many different countries can be overloaded by information processing and overwhelmed by the complexity of coordinating different operations (Tang and Tikoo, 1999; Tong and Reuer,
58
2007). This entails non-trivial agency and transaction costs, thereby reducing the operational flexibility benefits that the MNC had hoped to gain from diversifying internationally (Allen and Pantzalis, 1996; Doukas and Pantzalis, 2003; Roth, Schwiger, and Morrison, 1991; Tang and Tikoo,1999).
The shifts in value-chain activities across countries can only occur when the
subsidiaries are viewed as a coherent set of related investments, rather than simply as
individual investments. This in turn requires coordination and control of these
subsidiaries by firm headquarters (Kogut, 1985). Switching such activities requires coordinated effort on the part of both the headquarters and its foreign subsidiaries. If subsidiaries are relatively independent or are focused on only localized strategies, their value in terms of switching flexibililty will be limited. By the same token, if foreign subsidiaries are characterized by significant proportions of shared ownership with other firms, it will be difficult for headquarters to exercise the necessary control over them allowing them to make appropriately rapid decisions. Instead, they would have to take into account objectives of the partner firms, which may conflict with the firm’s switching needs. The time it would take to come to consensus with partners would reduce the value of the option. This would be particularly true in the case of shared ownership of investments with local firms, whose interests are likely to be embedded in the domestic environment. Thus, a portfolio of FDI that is characterized by significant local ownership
59
is likely to have adverse effects on the conformity of value chains across foreign subsidiaries and on the alignment of incentives.
This in turn constrains the benefits of operational flexibility by reducing the opportunities for switching or increasing the costs of doing so (Tong and Reuer, 2007). These problems are significantly reduced, however, when the firm possesses controlling stakes in their foreign subsidiaries, which allows them to more easily shift production or sales across countries as necessary.
Hypothesis 1b: Under higher exchange rate uncertainty, higher ownership in FDI breadth will be positively associated with the value of multinationality.
4.2.2 Market Uncertainty within the Host Country
Domestic market uncertainty in a given country may make it difficult for the multinational firm to determine an appropriate long-term structure for its investment there. To address this problem, the firm should invest only minimally in order to stake out an initial position there, and wait until conditions become clear before taking further action. In this respect, the foreign direct investment serves as a foothold investment, allowing the firm to take advantage of opportunities that emerge later. These opportunities can be due to greater understanding of how the market works, enhanced
60
clarity on the specific preferences of the consumers there, or the resolution of an
economic crisis.
In all these cases, the firm has taken advantage of potential growth embedded in
the host market, but only because the initial investment made this potential apparent. An
already existing subsidiary within a given country enables the firm to test the
environment of that country, serving as an on-the-ground sensor of evolving conditions.
Based on such country-specific investments that allow the development of in-country
relationships, market knowledge, or brand image, firms gain a window into the workings of the market. They are in a position, therefore, to preemptively capture future growth
opportunities that emerge under uncertainty, but which are unapparent to firms without
such investments (Kulatilaka and Perotti, 1998).
Since an initial investment of the kind discussed above provides a platform for
subsequent investments (Kogut and Chang, 1996), it will be associated with higher value
in markets that have high market uncertainty. This type of investment allows the firm to
adapt its investment strategy to unfolding circumstance in a given country, including
increasing ownership or investing further within the country. We argue, therefore, that
firms with greater depth of investments in a given market are in a position to understand
and take advantage of newly emerging opportunities, and grow or rescind their
investments accordingly at lower cost.
61
Note that for firms facing host country uncertainty, switching needs are low. Thus, the possession of switching options through a broadly dispersed set of investments is not likely to be associated with value to the firm, as they provides little benefit to it.
The rather formidable costs of maintaining and coordinating such a network will be detrimental to the strategic goals of the firm. Instead, a firm operating in comparatively fewer countries, with limited investments in any given country, will be able to keep monitoring costs lower while benefiting from a less dispersed network. In light of this, we offer the following hypothesis:
Hypothesis 2a: Under higher market uncertainty in the host country, high depth of FDI will be positively associated with the value of multinationality
From the growth options perspective, it is important that each subsidiary limit its downside risk while maximizing upside potential by starting with smaller scaled investments. Thus, growth options are obtained when a firm has a foothold in a domestic market, but not a full investment. The foothold investment opens the door for the possibility of subsequent expansion. Consistent with this, a minority share of ownership in an investment allows the firm to enter the market at reduced risk due to its lower outlay, but also benefits the firm by leaving open the option of acquiring more or all ownership when uncertainty gets resolved (Kogut, 1991). The international joint venture literature,has also noted that reducing risk is one of the most important reasons for 62
sharing ownership with partners (Root, 1988). During times of uncertainty, MNCs can
buffer the negative impacts of abrupt environmental change by sharing risk with their
joint venture partners (Anderson and Gatignon, 1986). This lower risk enables MNCs to
better tolerate joint venture subsidiaries during times of uncertainty (Contractor and
Lorange, 1988; Harrigan, 1985). Thus, joint ventures can be viewed as a “hedging
vehicle” against environmental risks (Shan, 1991: 559). Starting with smaller ownership,
firms can limit any associated downside risk and instead preserve upside potential as the
environment changes (Kester, 1984). Utilizing similar reasoning in this regard, Chi and
McGuire (1996) find empirical support for the notion that an investor who aims to capture dynamic real options under high uncertainty will invest in a smaller share in joint ventures. Indeed, Cuypers and Martin (2006) have argued that real options logic holds well for minority ownership, while it does not hold for majority ownership. In all, the level of ownership levels proxies for the level of irreversibility in the investment. In light of these arguments, we present the following hypothesis:
Hypothesis 2b: Under higher host market uncertainty, higher ownership level will reduce the positive relationship between FDI depth and the value of multinationality.
63
4.2.3 Exchange Rate Uncertainty and Market Uncertainty in the Host Country
In the discussion above we considered the role of two forms of uncertainty,
exchange rate volatility and market uncertainty, for determining the real options value of
international investments. Specifically, we noted that exchange rate volatility boosts
switching needs, and thus, firms will be able to utilize their dispersed operations across
foreign countries as options to shift value chain activities as needed. In contrast, host market uncertainty enhances the need for growth in current markets, and firms can therefore utilize established subsidiaries within current host countries as growth options.
Multinational firms are sometimes exposed to more than one salient form of
uncertainty, such as both exchange rate volatility and host market uncertainty. As we
noted earlier, however, these two forms of uncertainty require differing types of options.
In this case, we argue that firms possessing both high FDI depth and high FDI breadth
together will be comparatively better off than firms with any other kind of FDI
configuration. This is because high depth can provide growth options for addressing host
country uncertainties while high breadth may elicit more switching options for addressing cross-country variations such as those reflected in exchange rate fluctuations. Thus, despite the likelihood that an FDI configuration consisting of both greater breadth and
depth will be associated with higher costs of operation (Allen and Pantzalis, 1996; Tang
64
and Tikoo 1999; Lee and Makhija, 2008), such a configuration provides the requisite diversity of options required by firms in the most complex of environments.
Hypothesis 3: Under both higher exchange rate uncertainty and higher market uncertainty, FDI with high breadth and high depth will be positively associated with the value of multinationality.
4.2.4. The impact of Cultural Distance
The difficulties of managing a highly dispersed set of international investments are amplified when the cultural contexts of the countries in which the firm is operating differ significantly (Gomes and Ramaswamy, 1999). If a multinational firm operates in a number of such countries, misalignment of coordination among subsidiaries and headquarters becomes a greater risk, along with increased complexity of monitoring subsidiary managers (Tang and Tikoo, 1999). Higher transaction costs are also a factor since firms have to be involved in a variety of internal transactions among managers located in different foreign subsidiaries and external transactions with government agencies, suppliers, and customers in those countries (Tang and Tikoo, 1999). The burdens associated with multiple transactions among geographically diverse units subsequently increase transaction and governance costs (Allen and Pantzalis, 1996;
Gomes and Ramaswamy, 1999: Tong and Reuer, 2007), high information costs (Hitt et 65
al., 1990), and leads to organizational inefficiencies (Lu and Beamish, 2004). These costs increase the uncertainty of future earning and thus undermine the total value of a firm’s operative flexibility (Doukas and Pantzalis, 2003; Roth, Schwiger, and Morrison, 1991;
Tong and Reuer, 2007). Thus, we argue that, all else being equal:
Hypothesis 4a: Under higher cultural distance, high breadth of FDI will be negatively associated with the value of multinationality.
We noted earlier that high exchange rate uncertainty compels firms towards switching value chain activities across countries. The ability to utilize switching options requires greater control and coordination over dispersed foreign subsidiaries. Thus, higher ownership levels in the firm’s portfolio of investments, which facilitates such control, enable the firm to realize greater operative flexibility. When firms operate in culturally distant countries, the coordination needs increase further. In this case, higher ownership levels in the firm’s FDI will help the firm to overcome some of the problems of cultural distance and more effectively coordinate and control their foreign subsidiaries.
Thus, we argue:
Hypothesis 4b: Under greater cultural distance, higher ownership will reduce the negative relationship between FDI breadth and the value of multinationality.
66
4.2.5 A Firm’s Decision to Add a New Subsidiary
So far we have considered the real options value associated with different
configurations of international investments under two forms of uncertainty associated
with the international context. We therefore expect that subsequent investment decisions
made by the firm will be consistent with its need to maximize options under specific
forms of uncertainty. In particular, the decision to add to their FDI portfolio should
reflect its need and desire for switching or growth options.
Thus far, we have argued that switching and growth options are each associated with higher value under particular environmental conditions. In accordance with switching options logic, firms benefit from greater breadth of investments under conditions of exchange rate uncertainty. We therefore expect that firms facing such uncertainty will tend to add investments in new countries to their investment portfolio. In line with growth options logic, firms benefit from greater depth of investments under conditions of host country uncertainty. Thus, we expect that they will add new investments to an existing host country or increase ownership in existing subsidiaries in response to such uncertainty. Consequently, we offer the following hypotheses:
Hypothesis 5a: Under higher exchange rate uncertainty, a new subsidiary will be added in a new host country. Hypothesis 5b: Under higher host market uncertainty, a new subsidiary will be added in an existing host country. 67
Host Country Strategic Value of FDI Environment Needs Configurations
• Exchange Rate • Need of switching • Geographic Uncertainty across countries -Breadth -Depth
• Host Market • Need of growth • Ownership Uncertainty within countries -Minority -Majority
4.1 Conceptual Model
68
CHAPTER 5
RESEARCH METHODOLOGY
5.1 Data
The hypotheses of this study consider the relationship between host country
uncertainty and the real options value of a firm’s FDI. To examine these relationships, we
use a large sample of publicly traded manufacturing firms listed on the Korean Stock
Exchange (KSE) between 1991 and 2004. This sample is particularly appropriate for this
study since Korean firms have been very active in creating a portfolio of FDI, particularly after the Korean government’s boosting of globalization in the early 1990s. During the period under investigation, Korean firms experienced significant variation in the level of uncertainty in host markets. Firm information is collected from the WISEfn
QUANTIWISE database. FDI data are collected from LEXIS/NEXIS, the Korea Listed
Companies Association database, and the Korea Information Service Company database.
69
5.2 Dependent variable
Since the dependent variable in the study is the value of multinationality (VM) , we
examine the stock ratio (SR) of market over book value of common stock, which is a
forward-looking measure appropriate for our purposes (Folta and O’Brien, 2004; Tong
and Li, 2007). To measure the market value of common stock, we multiplied the number
of common stock by the annually-averaged price of the common stock. We expect that
the averaged price better reflects the market value than yearly end price. SR represents
expected future growth opportunities of the firm as well as the ability of the firm to take actions in the future. To separate out the additional values generated from FDI, we refer to Allen and Pantzalis’ (1996) method of calculating the value of multinationality. VMsr is obtained by extracting the SR of each parent firm from the averaged SR of all domestic firms in the same industry at the two-digit KSIC to which the focal firm belongs.
For a robustness check of the different measures of firm value, we also used
excessive market value (EMV), the ratio of market value plus the book value of debt
minus total assets, all divided by total net sales (Allen and Pantzalis, 1996; Thomas and
Eden, 2004). This is a standardized measure of the value ascribed to a firm by investors,
reflecting the market assessment of intangible assets and the firm’s ability to capture the
benefits of these intangibles in its long-run performance as opposed to other short-run
70
measures such as ROE or ROA (Thomas and Eden, 2004). We eliminated observations
with more than 20% changes in book value to control for any other value-enhancing
activities such as M&As (Bulan, 2005). We then obtained the value of multinational
flexibility based on EMV. The two measures do not make any significant difference to the effect of the main explanatory variables.
5.3 Independent variables
Exchange Rate Uncertainty
All independent variables are measured at the portfolio level of the parent firm. In
order to capture exchange rate volatility of host countries, we began by normalizing the
standardized deviation of the monthly residuals by a second order autoregressive
equation. We followed Hauser’s (2004) method to take into account expectations of
future exchange rates to get an appropriate exchange rate risk measure capturing the
unexpected deviations of the current spot exchange rate from its expected value. This was
done using a second order autoregressive equation with a time trend for each country,
based on monthly data of real exchange rates from Economic Research in the United
States Department of Agriculture. The standard deviation of the monthly residuals is
calculated for each year and each country. The monthly residuals are predicted from the
regression equation, exrjt = a + b · trendj + c · exrjt−1 + d · exrjt−2 + _jt, where exrjt−x is
the real exchange rate in country j at time (month) t−x (x = 0, 1, 2), _jt is the error term of 71
this regression equation and a, b, c, d are the coefficients to be estimated. In order to
account for the level of the exchange rate, the standard deviation is normalized by the
mean exchange rate. For comparison purposes, we also use exchange rate volatility,
measured by natural log of the ratio of the firm’s high and low conditional variances at
each year, in a manner consistent with Pantzalis, Simkims, and Laux (2001). Conditional
variables were obtained using a GARCH model, similar to the method used by Folta and
O’Brien (2004). The two measures of exchange rate volatility lead to similar results in
empirical testing.
In taking into account the uncertainty of a host country attributed to a given firm,
an issue of concern was how to take into account the impact of its having more than one
subsidiary in that country, since the uncertainty of that country potentially has greater
impact on the firm. To address this problem, in this analysis we weighted the general
uncertainty level of the host country by the number of subsidiaries it has in that country.
We first averaged the exchange rate volatility of all host countries by summing the yearly
value of exchange rate volatility, weighted by the number of subsidiaries in each host
country in each year.
Considering that a lower correlation between input/output prices due to exchange rate movements increases the probability that a multinational firm can reap advantages
72
from changes in operating policies such as shifting production or input sourcing and also vice versa in case of a higher correlation (Belderbos, 2008; Kogut and Kulatilaka, 1994;
Pantzalis, Simkins, and Laux, 2001), we multiplied the averaged sum by the reversed correlation ratio of the FDI network (1-correlation ratio of exchange rates between a host country and all other host countries).
Market Uncertainty of Host Countries
In order to capture the market uncertainty of host countries in a firm’s portfolio of
FDI, we first computed the percentage change in economic growth for each host country of a parent firm by the absolute value of (actual value of economic performance at time t
- projected value of economic performance at time t-1 / projected value of economic performance at time t-1). The economic performance value of each host country is obtained from Euromoney. Euromoney reveals the economic performance of each country judged by thirty five economists from leading banks, financial and economic institutions. The judges take into account sustained economic growth, monetary stability, current account, budget deficit or surplus, unemployment and structural imbalances.
Countries are scored in comparison with each other and with previous years. Specifically, the world’s fastest growing, best-performing economy in an ideal year would score 100, the worst in a disastrous year 0. We also averaged market uncertainty of all host countries
73
by summing the yearly value of economic growth rate weighted by the number of
subsidiaries in each country in each year.
Geographic Configuration
Consistent with our arguments, the breadth of FDI is measured by the number of
foreign countries in which an MNC has at least one foreign subsidiary, which is
commonly used for reflecting multinationality of firms in the international literature
(Allen and Pantzalis, 1996; Caves and Mehra, 1986; Kogut and Singh, 1988; Tang and
Tikoo, 1999; Tong and Reuer, 2007). We observed a significant positive skewedness in
the pre-transformed count measure, and therefore took log of the sum of (1+the number
of countries), in a manner similar to Reuer and Leiblein (2000).
The depth of FDI is assessed via an entropy measure, based on the concentration
ratio of foreign subsidiaries in a portfolio of FDI of a firm, derived from Carter, Pantzalis, and Simkins (2003). For example, in the case of a firm that has one subsidiary in each of three countries, the depth would be measured as follows: ( + +111 222 ) / 32 =0.333. For
comparison purposes, we also measured depth by Allen and Pantzalis’s (1996) method, calculating the ratio of the number of subsidiaries in the top two countries (in terms of the number of foreign subsidiaries at each country) out of the total number in foreign countries. We detected no significant difference in the main results between the two
74
measures. Our data show a highly negative correlation between these two dimensions of
FDI. Since both reflect important constructs in this study, we orthogonized the two
variables by referring to a STATA command ‘orthog’ in order to retain both of them in
our equation, rather than dropping one of them. We then created four categories of
multinational networks by combining the two dimensions of FDI for capturing the
varying configurations of FDI of each firm, similar to Lee and Makhija (2008): 1) high
breadth and high depth (HBHD); 2) high breadth and low depth (HBLD); 3) low breadth and high depth (LBHD); with 4) low breadth and low depth serving as the reference group. HBHD, HBLD, LBHD, or LBLD respectively accounts for 5%, 25%, 62%, or 8% out of all observations. High and low levels of each of the two dimensions are determined
by comparing the FDI breadth or depth of the focal firm with the mean of each dimension
in the sample. For instance, high breadth means that firms have breadth value higher than
the mean breadth for the sample. As we noted earlier, firms having the lowest level of
FDI (low breadth and low depth, LBLD) are used as the reference group in this empirical test.
Ownership Configuration
In order to assess the potential impact of ownership composition in FDI portfolio
on firm value, ownership is calculated by the ratio of the sum of the subsidiaries with less
than 50% ownership as a fraction of the total number of foreign subsidiaries. 75
Cultural Distance
In order to take into account the possible effect of cultural distance between Korea and all of the host countries of the firm, we incorporated averaged cultural distance by summing the weighted cultural distance of all host countries from the Korean standpoint by the number of subsidiaries in each country in each year. The values of cultural distance are based on Kogut and Singh’s (1988) Index. We expect cultural distance to decrease the value of breadth by increasing the costs of FDI.
A Firm’s Increase in Breadth and Depth
For testing Hypothesis 5, we generated two new variables reflecting the firm’s decision to increase its FDI breadth and depth. The first assesses whether or not firms set up new subsidiaries in new countries, reflecting change in breadth (Newsubnewctry).
The second assesses whether or not firms set up new subsidiaries in current countries, reflecting change in depth (Newsuboldctry).
5.4 Control Variables
To separate out the real options effects of FDI from other effects, we include a number of control variables that also have the potential to influence the value of the firm.
First, we included the previous year’s value of multinationality (VMsr t-1) to control for
76
the incremental change in the firm’s value in the current year due to other benefits of
rather than the real options effect of its past investments.
Firm size reflects the overall resource inventory of the firm, including its slack
resources, which may buffer financial suffering (Tong and Reuer, 2007). Larger firms
typically have more resources to help overcome short-term losses. On the other hand, smaller firms are less encumbered by administrative heritage and overhead, and therefore more flexible in an uncertain environment. To control for firm size effects, we use log of total assets. In addition, we control for the firm’s R&D intensity and advertising intensity
in order to take into account the impact of firm’s intangible assets and capabilities on
their value (Kotabe et al., 2002; Morck and Young, 1991). R&D and advertising
expenditures are each divided by total sales.
To address the possibility that firms are also able to hedge against exchange rate
volatility in a different way from operative hedging associated with dispersed operations
across national borders, we include a control variable that reflects the extent of gains and
losses due to currency translation. When firms engage in financial hedging, we expect
such gains and losses to be minimal (Lee and Makhija, forthcoming). Hedging is
calculated by the gain in current transactions subtracted by the loss in current
transactions, divided by total export sales. We also control for leverage. To separate out
the pure impact of breadth of FDI, we controlled for another index of multinationality,
77
foreign sales to total sales ratio. It also reflects the level of exposures of multinational firms to foreign exchange volatility (Pantzalis, Simkins, and Laux, 2001).
Regarding the impacts of higher leverage, we predict two contradictory effect. First,
considering higher ratio of debt may reflect higher financial difficulty of a firm, it will
negatively affect firm value. Second, while greater debt holdings in the capital-poor
environment of the economic crisis may reflect confidence and certification on the part of
banks and other lenders (Cole and Park, 1983; Saraswathy and Chatterjee, 1984; Makhija,
2003). It is measured by long-term debt divided by fixed assets.
Considering that Korean conglomerates, chaebols, tend to be larger, enjoy preferential treatment by the government, procure cheaper loans (Cole and Park, 1983),
and may afford better the advantages of an international network, we chose to control for
this type of membership as well. Chaebol membership was identified through the Korea
Fair Trade Commission (KFTC) list of the top 30 chaebols. Dummy variables are created
as follows: the top thirty chaebols are coded 1, while non-chaebol firms are coded as 0.
In order to take into account industry attributes that might affect the value of
international investments, we include industry competition and industry capital intensity
as control variables. First, to assess competition in the focal industry, the total number of
firms in the industry at the 2 digit KSIC is incorporated into the analysis. While greater
rivalry may imply a negative effect on firm value, it may also be that firms facing greater
competition display more aggressive and flexible responses during economic crises 78
compared with firms in less threatening environments. By the same token, capital
intensity of the industry may influence the firm’s desire to pursue larger sales volume
and thus influence the tendency to pursue international strategies. It is measured by
average industry fixed capital as a proportion of average industry total assets.
Considering that firms in different industries may also face different competitive environments and therefore have differing need for flexibility, we included an industry dummy variable. One year-lagged values of all independent and control variables are used to assess the impact of these variables on the firm’s value in the subsequent year.
All interaction terms are centered to reduce any potential multicollinearity (Cohen et al.,
2003).
Lastly, we take into consideration the extent to which the firm chooses to invest in
only regions with which they have familiarity. If they choose to invest in only particular
regions of the world, it may favorably affect its understanding of environmental
conditions in countries in that region. Firms’ choice of investment locations can therefore
influence the real options value of its international investment portfolio. To address this
concern, we incorporate a variable, “regional concentration,” measured by he
concentration of foreign countries represented in a firm’s international network across
different geographic regions.2
2 We base our measure on Cater, Simkins, and Pantzalis’ (2003) categorization of nine major geographic regions. The nine different regions are East Asia, Other Asia, European Union, Other 79
Using variance inflation factors (VIF), we checked for the existence of any
multicollinearity among variables. VIF reflects the degree to which the variances of other
coefficients are increased due to the inclusion of each predictor (Hamilton, 2006). The
VIF of each variable and mean VIF of all variables indicate that multicollinearity is not an issue of concern in this paper since they are all less than the recommended cut-offs
(between 4 and 10 for VIF, 1 for mean VIF).
5.5 Analytical Procedures
For analyzing the pooled time series cross-sectional data of this study, we used
‘xtgls’ in STATA 10 to estimate coefficients based on feasible generalized least squares
(FGLS). FGLS is frequently used to remedy possible problems of panel
heteroschedasticity, contemporaneous correlation and serial correlation (Hitt, Gimeno,
and Hoskisson, 1998), since these can violate the traditional ordinary least squares (OLS)
assumptions of constant variance and no autocorrelation of the error term. FGLS
produces residuals which are used to estimate the unit-specific serial correction of the
errors and then used to transform the model into one with serially independent errors. In
this way, errors without contemporaneous correlation and autocorrelation allow for OLS
estimation. The estimators obtained from the FGLS procedure allow us to investigate the
Western Europe, Eastern Europe, NAFTA, Central America and Caribbean, South America, and Africa.
80
time-series component of the analysis while maximizing the degrees of freedom (Lee,
Makhija, and Baik, 2008). The "force corr(psar1)" command in STATA is used to
address the problem that observations are unequally distributed in time and also to take
care of potential autocorrelation since same units are used repeatedly over time. “psar”
stands for panel specific autoregressive regressive model which allows the value of the
parameters to very from one cross-section unit to another.
The Hausman test is conducted to compare between the random effects and fixed effects. The results of the Hausman test did not reject the null hypothesis that the
individual effects are uncorrelated with the other regressors in the model. Therefore, the
random effects model is chosen for analysis. Another supportive reason for the random
effects model is that the results from this model can be generalized to a longer time span
outside the sample period while the results generated from the fixed-effects model cannot
(Li and Greenwood, 2004).
In studying the performance associated with international investments, it is
particularly important to take into account endogeneity problems, since unobserved
variables influence both strategy and performance at the same time (Shaver, 1998; Tong
and Reuer, 2007), creating potential correlation between independent variables and the
main error term. In order to avoid any potential bias and misspecification errors
associated with this endogeneity problem, we used Heckman’s two stage model. In the
first stage of Heckman’s (1979) method, two choice models are introduced, from which 81
two Inverse Mills Ratio terms can be calculated. The first model takes into account the
choice that firms invest in foreign countries or stay at domestic market. Firms’ choice of
foreign countries can affect overall level of uncertainty that they face and thus their
performance. Investments in foreign countries are expected to raise uncertainty level. To
address this issue, we created a dummy variable indicating whether each firm is a
multinational company which has at least one foreign subsidiary. In the second model we
considered whether or not firms establish new subsidiaries on an ongoing fashion. An
increase in international investments reflects the firm’s willingness to engage in
investments as necessary, including in relation to maintaining breadth and depth, which
in turn affects the real option value of these investments. Based on this, we created a
second selection model in which a subsidiary increase is reflected by 1, and no increase is
reflected by 0.
Two Inverse Mills Ratio terms (invmills 1, invmills 2) are generated from the two
“first stage” selection models discussed above. These are then included in the main
“second stage” equation to account for any potential selectivity bias. To address the
potential problem of using the same predictors in both stages of the two staged equations,
we added an additional meaningful variable (sales growth) in the first stage selection
equation that is not included in the second stage equation. For this analysis, we also use one of STATA’s xt family commands, ‘xtprobit.’ which produces more robust results for random effects and population-averaged models. 82
CHAPTER 6
RESEARCH FINDINGS AND DISCUSSION
6.1 Research Findings
6.1.1 Descriptive Analysis
Table 6.1 contains the descriptive statistics and the correlation matrix for all the
variables included in this study. In order to diagnose any multicollinearity problems, we
checked the variance inflation factors (VIF) for all the variables. VIF of each variable is
around 1, indicating that none of the variables significantly affect the increase of other coefficients’ variances and standard errors. The mean VIF is also less than 2, which is substantially lower than the recommended cutoff of 10 or the more conservative cutoff of
4. These results indicate that multicollinearity is not of main concern in this analysis.
6.1.2 Test of Endogeneity
To test for possible endogeneity in FDI selection and performance, we first
conducted an “xtprobit” analysis as a selection model. The model in Table 6.2 shows that
firms which enter foreign countries are different from those that do not. In particular,
firms with larger size, higher R&D intensity, or greater capital intensity tend not to invest
in foreign countries. Similarly, the model in Table 6.3 shows that firms that increase the 83
number of subsidiaries are also different from those that do not. In this case, firm size and environmental conditions of exchange rate uncertainty have positive effects on this increase, while capital intensity has a negative effect. Based on these two selection models, we incorporated the two inverse Mill’s Ratios obtained from the selection models into the second stage model. The statistical insignificance of the inverse mills ratio in all subsequent models indicates to us that no self-selection bias exists in this sample.
6.1.3 Test for Main Hypotheses
Table 6.4 contains the results for the first set of models. To begin, we consider the effect of the control variables on firm value, and find several of them to be relevant in
this regard, as seen in Model 1. The previous year’s firm value shows a strongly positive
relationship to firm value in the current year, as expected, significant at the .001 level.
Firm size also influences firm value positively, significant at the .05 level, supporting the
argument that larger firms are better endowed with resources that allow them to perform
well. High R&D intensity is also found to be associated with higher firm value, significant at .01, supporting the notion that firms’ investments in R&D opens up additional avenues for future growth or creates additional decision rights. At the same time, we find that high industry competition negatively affects firm value, significant at .05. We also found that capital intensity had a positive, albeit weak, influence on the 84
value of the firm, significant at .1. The findings for most of these particular control
variables remain fairly consistent throughout the analysis.
Although we had expected that a firm’s advertising activities would reflect an
international competitive advantage from which it would derive additional value, this
variable was not associated with significance. A firm’s leverage, interestingly, also did
not make a difference to the analysis, nor did we find that financial hedging activities influenced firm value. Interestingly, chaebol membership did not show up to be significant in our analysis. Since chaebols are among the most internationalized of
Korean firms, it is very likely that the other variables reflecting breadth and depth of international investments are able to capture important chaebol effects.
Model 2 introduces the major explanatory variables of the analysis. None of the
context variables, pertaining to exchange rate uncertainty, host market uncertainty, and
cultural distance, showed significance, although the signs of the latter two variables are
negative in relation to firm value. We find that only the variable HBLD, reflecting an
international network characterized by high breadth and low depth, was significantly
associated with firm value, registering a negative sign in this regard, highly significant
at .05. This suggests that, in general, a highly dispersed set of international investments
reduces firm value. This finding coincides with the notion that such a network is typically
difficult to manage for a firm, and more so than any other type of international network,
which showed no significance in influencing firm value. This finding is consistent with 85
prior work on internationalization that has shown that increased international investments
can lead to lower performance. However, this prior work did not consider the contexts in
which these investments were made. This leads us to the investigation of our sets of
hypotheses, which specifically take this into consideration.
Hypotheses 1a, and 1b: Exchange Rate Uncertainty
Hypothesis 1a suggests that under high level of exchange rate volatility, a more
dispersed FDI network across countries (HBLD) will lead to higher firm value. As seen
in Model 3, the interaction term between exchange rate uncertainty and HBLD has a
positive coefficient, with a significance level of .05. The findings support the positive
role of switching options under exchange rate volatility for deriving higher firm value.
This suggests that a network characterized by more international locations can help firms to respond to unexpected exchange rate fluctuation in a flexible manner. In other words,
operations dispersed across countries provide firms the options to rearrange their
production or sales across countries without incurring the significant costs of searching
out new locations and establishing completely new subsidiaries. In contrast, operations
concentrated in only a few countries (i.e. LBHD) lead to negative value, significant at .01.
These two contrasting results support our argument that an FDI network encompassing
smaller and more limited sets of countries puts constraints on the capability of the firm to 86
respond to negative exchange rate conditions by changing their locations, while a broader network provides firms with more available courses of actions. Thus, hypothesis 1a is supported.
Hypothesis 1b notes that, under higher exchange rate volatility, higher ownership levels in FDI breadth will enhance the relationship between breadth and firm value. This hypothesis reflects our concern that lower ownership can undermine a firm’s ability to switch value chain activities across countries due to inadequate control over its investments in these countries. In contrast, higher ownership will allow the firm adequate control in this regard. In model 4, we can see that the inclusion of ownership into the interaction term between exchange rate uncertainty and HBLD renders a positive coefficient, significant at 0.05. This indicates that high ownership improves the value of a broad network to the firm. In contrast, the inclusion of ownership into the interaction term between exchange rate uncertainty and LBHD is negative, indicating that high ownership improves the negative effect between higher depth and firm value under such uncertainty. Thus, hypothesis 1b is supported.
87
Hypotheses 2a and 2b: Host Market Uncertainty
In Hypothesis 2a, we had argued that firms with an international network characterized by greater depth in a specific country would be in a position to comprehend
and exploit market uncertainties, leading to higher firm value. The results in Model 5
indicate that, under higher host market uncertainty, more concentration of subsidiaries
within the firm’s portfolio of FDI, seen by the interaction between market uncertainty and
LBHD, is not significantly associated with firm value, although its sign is positive as
expected. We find, however, that the interaction term between market uncertainty and
HBLD is negative and not significant. Even though this hypothesis is not supported, the
negative sign suggests that higher breadth and less depth in FDI reduces the ability to
benefit from host market uncertainties, consistent with the argument we had made in
support of hypothesis 2a.
Hypothesis 2b predicted that the positive relationship between higher depth of
investments and firm value would be mitigated by higher ownership in these investments.
The findings related to this prediction are seen in Model 6. We find that the inclusion of
ownership into the original interaction term between market uncertainty and LBHD is
associated with a negative sign, significant at 0.05. This suggests that higher ownership in a network characterized by greater depth and less breadth reduces firm value under conditions of host market uncertainty, as suggested by Hypothesis 2b. Interestingly, we
88
also find that higher ownership reduces the value of an international network
characterized by higher breadth and low depth under high market uncertainty, seen by the
negative coefficient and significance at 0.1 for the interaction term relating to HBLD. In
all, these findings suggest that firms dealing with host market uncertainties benefit from
having lower levels of ownership in their investments, which allows them to take
advantage of growth opportunities in these markets. In all, these findings support
hypothesis 2b.
Hypotheses 3: Exchange Rate Uncertainty and Host Market Uncertainty
Hypothesis 3 suggests that, under conditions of high exchange rate volatility and
host market uncertainty, firms will derive value from high levels of both breadth and
depth. The rationale for this hypothesis was that such an international network allows
firms to take advantage of multiple options (that is, switching as well as growth options),
important under more complex conditions of uncertainty. The results for this hypothesis
are seen in Model 7. We find that the interaction term between both types of uncertainty
and HBHD has a positive sign, significant at 0.05. This finding indicates that under both
exchange rate volatility and host market uncertainty, a network characterized by high breadth with high depth improves the ability of the firm to derive value. Also relevant here is the finding relating to the interaction term incorporating LBHD, which is negative 89
and significant at 0.05. This suggests that a network characterized mostly by high depth reduces firm value significantly under the most complex conditions of uncertainty. Under more complex conditions of uncertainty, then, having a portfolio of options is more important than just having one. In all, hypothesis 3 is supported.
Hypothesis 4a and 4b: Cultural Distance
Hypothesis 4a considers the additional costs associated with foreign direct investments when cultural distance is high. These costs are expected to reduce the value of an FDI network that is characterized by high breadth, due to the greater coordination and control needs of such a network. In Model 1, we find that under high cultural distance, a network characterized by greater breadth and less depth has a negative sign and is highly significant at 0.05. Thus, as expected, higher cultural distance reduces the value of a highly dispersed FDI network. Although the signs are negative for the other network configurations, they are not significant. In general, we consider these findings to be in support of Hypothesis 4a.
We had argued in relation to Hypothesis 4b that when a firms’ dispersed FDI network is also characterized by higher ownership, the negative effects of high cultural distance will be mitigated. We find that inclusion of ownership into the interaction term for HBHD reduces the negative impact of cultural distance on such a network to firm 90
value, seen in Model 2. We do not expect cultural distance to negatively impact a network characterized by high depth since such a network is designed to better deal with the uniqueness of each given market. Consistent with this, we do not find the interaction terms associated with the other network configurations to be significant. In all, we consider these results to be supportive of H4b.
Hypotheses 5a and 5b: Firm’s Decision to Add up a New Subsidiary
We had noted that, in accordance with the logic associated with switching options, firms would tend to add subsidiaries to their portfolio of FDI into countries in which they do not currently have subsidiaries. Doing so would allow them to have more options for shifting value chain activities when they encounter enhanced exchange rate-related uncertainty. This argument was the basis for Hypothesis 5a. Models 1 and 2 in Table 6.6 reflect the factors underlying the decision to add a new subsidiary in a new country in the firm’s portfolio of international investments. In Model 1, we see that exchange rate uncertainty is positively associated with this decision, highly significant at .001. On the other hand, we find that host market uncertainty is negatively associated with this decision, significant at .05. Thus, when firms experience high exchange rate volatility in the previous year, they tend to subsequently increase their breadth of FDI in the following year. These results strongly support Hypothesis 5a. 91
At the same time, in line with growth options logic, we had argued that firms were
likely to add subsidiaries in current host countries or increase ownership in existing countries under higher host market uncertainty. This notion is reflected in Hypotheses 5b.
Models 3 and 4 contain the results associated with this hypothesis. We find that host market uncertainty has a positive relationship to this decision, highly significant at .01.
On the other hand, we find a negative sign for exchange rate uncertainty, although it is significant. These results support growth options logic with respect to firms’ investment decisions. That is, when firms experience host country uncertainty in the previous year, they tend to subsequently increase their depth of FDI in the following year. These findings support Hypothesis 5b.
When firms experience more complex forms of uncertainty, as seen via the
interaction term between foreign exchange and host market uncertainties, they tend to
increase new subsidiaries in new countries. This finding suggests that, in general, firms
appear to be more sensitive to exchange rate volatility than to host country uncertainty.
92
6.2 Discussion of Findings
The findings generally support our basic premise that firms’ international
investments have the ability to provide them with real options under various forms of
uncertainty associated with international operations. We had argued that the breadth of
the firm’s FDI portfolio provides them with switching options, allowing them to shift
value-adding activities across countries as necessary, and the depth of this portfolio
yields growth options, facilitating systematic expansion within countries. We had further argued that switching options would be valuable under exchange rate uncertainty,
reflecting fluctuations of a host country’s currency relative to that of the home country,
while growth options would provide value in the face of domestic market uncertainties in
their host countries. These basic notions were supported.
It is interesting that past research tends to be skewed towards one options
perspective, associated with one type of uncertainty. For instance, Kogut and Kulatilaka
(1994), Buchmeier and Cohen (1996), and Lee and Makhija (2008) were only concerned
with the impact of exchange rate uncertainty on the switching value of dispersed
operations across national borders. Similarly, Kogut (1991) and Folta and O’Brien (2004)
included only demand uncertainty in their research on growth options value. Since
potential interactions may exist among multiple types of real options and/or among forms
93
of uncertainty, our results suggest that including only one type of options or uncertainty
may result in missing variable errors.
It was important to include uncertainty in our analysis, without which greater FDI
breadth of operations showed a strong negative relationship to firm value. However, not
all forms of uncertainty were relevant in this regard. Only in conjunction with foreign
exchange uncertainty was FDI breadth associated with higher firm value. Host market
uncertainties tended to dissipate the value of such breadth. On the other hand, FDI depth
tended to reduce firm value under foreign exchange uncertainty, indicating that growth options play little role in this context. The findings for FDI depth under market
uncertainty, although suggesting a positive relationship, were not significantly significant,
and therefore, not as supportive of this argument. However, the positive relationship
between FDI and firm value emerged when it was accompanied by lower ownership (a
finding we discuss in more detail below). These findings underscore the importance of
considering options under conditions appropriate for utilizing those options.
In the prior literature, we find that uncertainty is often assumed and not explicitly
taken into account when drawing conclusions regarding the real options value of
investments. For example, Allen and Pantzalis (1996), and Tang and Tikoo (1999) did
not measure uncertainty in their research on the market value of different combinations of
FDI breadth and depth. Likewise, Reuer and Leiblein (2000) and Tong and Reuer (2007)
did not incorporate specific measures of uncertainty in their analysis of the real options 94
value of multinationality and/or international joint ventures. Our own findings show that
incorporating conditions of uncertainty into a real options analysis is important, since
options vary in value under different conditions of uncertainty. Not doing so may lead
overvalued or undervalued multinational flexibility. In this respect, not only did include
specific measure of uncertainty in this study, but we also took into account potential
correlations of this uncertainty among host countries. Since lower correlation increased
the value of the underlying options (Kogut and Kulatilaka, 1994), whereas high
correlation existing within the network reduces real options value (Belderbos, 2008), out
inclusion of correlation ratios of exchange rates can be expected to capture more
precisely the uncertainty embedded in FDI networks, and help reduce overvaluation of multinational flexibility.
Our results indicate that when ownership is taken into account, the results are
strengthened. Higher ownership helps firms to overcome coordination and control
problems associated with FDI breadth, thereby helping these investments to contribute
more greatly to firm value. On the other hand, lower ownership helps the value of FDI
depth to the firm, by reducing outlays and allowing for greater growth potential in the
future. In fact, the results suggest that, under high host market uncertainty, lower
ownership is better for the firm, no matter what kind of FDI portfolio it is. In all, we
conclude that the real options value of FDI investments is strongly affected by ownership.
In the prior literature, however, the role of ownership in influencing switching options 95
value is relatively less examined compared to the linkage of ownership to growth options
value. One exceptional example can be found in Tong and Reuer’s (2007) study. They tried to look at the effect of downside risk reduction through control and coordination associated with higher ownership levels in the FDI portfolio. They found no impact of higher ownership on the reduction of downside risk, however, and offered the possible
explanation that higher ownership may have a countervailing effect. However, they did
not suggest a way to separate out the impact of differing levels of ownership on the
relative value of options. This study helps to resolve this dilemma by showing the
contrasting effects of ownership level on different types of options.
Since FDI breadth and depth have differing implications for the nature of options
afforded to the firm, we considered the situation where firms faced high levels of both
foreign exchange uncertainty and host market uncertainty. We argued that in this case, an
FDI configuration comprised of high breadth and depth would be valuable to the firm.
We found this to be the case. In fact, firms with only high depth in their FDI portfolio
were negatively affected in this situation. Our results underscore the notion that the
appropriate configuration of investments depends on the nature of the uncertainty
encountered by the firm. It implies that firms need to carefully balance the breadth and
depth of their FDI portfolio in this regard. If exchange rate volatility is the dominant
environmental condition, then switching needs prevail with respect to foreign operations.
96
If uncertainty is internal to specific markets, uncertainties associated with growth will be of paramount importance.
We examined the role of cultural distance within the firm’s portfolio of
investments. We had argued that since cultural distance creates significant costs of coordination, it would be a more important consideration for firms with higher breadth than those with higher depth. We found the evidence to be consistent with the argument that cultural distance imposed significant additional costs that reduced the value of breadth to the firm. In this case as well, higher ownership helped to mitigate these adverse effects of cultural distance.
Finally, we examined the firm’s decision to add to its portfolio of investments in
order to assess whether or not the firm made ongoing decisions on the basis of its
flexibility needs. We found evidence that firms facing exchange rate uncertainty
enhanced the breadth of their FDI portfolio, consistent with the desire to gain switching
options. On the other hand, firms facing host market uncertainty tended to enhance the
depth of their FDI portfolio, consistent with the desire to gain growth options.
97
Variables Mean SD 1 2 3 4 5 6 7 1.Vm sr 1.18 3.36 1.00 2.Vm sr t-1 1.09 2.91 0.76* 1.00 3.Sub Increase 0.10 0.30 0.02 0.03 1.00 4.Size 2.16 0.61 0.10* 0.17* 0.21* 1.00 5.R&D Intensity 0.00 0.01 0.04 0.03 0.04 0.05 1.00 6.Adv Intensity 0.01 0.02 -0.06 -0.06 -0.01 0.04 0.03 1.00 7.Leverage 0.12 0.34 -0.01 0.00 -0.01 -0.10* -0.00 -0.01 1.00 8.Competition 3.25 0.79 0.01 0.00 0.02 -0.01 0.08* 0.22* 0.02 9.Capital Intensity 0.61 0.11 0.09 0.06 0.08 0.18* 0.11* -0.05* -0.01 10.Chaebol 0.14 0.35 -0.05 -0.05 0.10* 0.53* -0.04 -0.03 -0.05* 11.Regional 0.23 0.40 0.02 0.01 0.03 -0.12* -0.09* 0.02 0.01 concentration 12. MKTunc 0.18 0.11 0.07 0.06 0.07 0.04 -0.01 0.05 0.02 13.FX unc 0.03 0.04 -0.03 -0.02 0.12* 0.12* -0.04 -0.02 -0.03 14.HBHD 0.11 0.32 -0.02 -0.00 -0.12* -0.10* 0.02 0.05 -0.03 15.HBLD 0.28 0.45 -0.03 -0.06 0.32* 0.37* 0.03 -0.04 -0.01 16.LBHD 0.40 0.49 0.06 0.09 -0.26* -0.26* -0.01 0.04 0.05 17.LBLD 0.21 0.40 -0.03 -0.04 0.06 -0.02 -0.03 -0.05 -0.03 18.Ownership 0.63 0.23 0.01 0.02 0.05 -0.18 -0.10 -0.04 0.01
Variables 8 9 10 11 12 13 14 15 16 17 18 8.Competition 1.00 9.Capital Int 0.44* 1.00 10.Chaebol 0.03 0.04 1.00 11.Regional 0.05 0.08 -0.13* 1.00 concentration 12. MKTunc 0.07 -0.05 -0.01 0.11 1.00 13.FX unc 0.02 -0.01 0.12* -0.04 -0.13* 1.00 14.HBHD -0.02 -0.12* -0.03 0.02 0.18* 0.01 1.00 15.HBLD 0.06 0.12* 0.27* -0.01 0.08 0.18* 0.23* 1.00 16.LBHD -0.04 -0.08 -0.20* 0.03 -0.04 -0.14* -0.19 -0.30* 1.00 17.LBLD 0.00 0.05 -0.03 0.00 -0.05 -0.05 -0.18 -0.22 -0.21 1.00 18.Ownership 0.08 0.00 -0.05 0.10 0.09 -0.01 -0.03 -0.01 0.03 0.00 1.00 *p<.05: A STATA option, ‘sidak sig,’ is used for controlling for ‘multiple comparison fallacy’ in Pearson correlation table, which identifies the handful that are significant at the 0.05 level (Hamilton, 2006)
6.1 Descriptive Statistics and Correlation Matrix
98
Dependent Variable: Independent Variables MNC or not (Domestic firm) Size 0.36 (2.11)** R&D intensity 7.59(2.23)* Advertising intensity -1.46(0.39) Leverage -0.08 (0.46) Comp 0.18 (1.91)† Capital intensity 0.14 (1.72)† Chaebol 1.14 (1.77) Constant 0.12 (2.38)* Chi-square 150.51*** # of observations 5,888 † significant at 0.10; * significant at 0.05; ** significant at 0.01
Table 6.1 Selection Model 1: MNC or not (Domestic Firm)
99
Dependent Variable: Independent Variables Subsidiary increase Sales growth 0.035 (1.75)† VMsr t-1 0.004 (0.17) Size 0.36 (2.11)** R&D intensity 8.59(1.23) Advertising intensity -1.46(0.39) Hedging 0.70(0.88) Leverage -0.08 (0.46) Comp -0.08 (0.91) Capital intensity -0.14 (1.72)† Chaebol -0.14 (0.97) MKTunc 0.005 (0.57) FXunc 3.37(3.17)** Constant -1.44 (2.38)* Chi-square 87.51*** # of observations 1,504 † significant at 0.10; * significant at 0.05; ** significant at 0.01 Numbers in parentheses are Z statistics3 in absolute term.
Table 6.3 Selection Model 2: Subsidiary Increase or not
3 It is difficult to compare different t-statistics with different degree of freedom. So it is necessary to assess the probability of the contrast being greater than zero. We represent this probability as a Z-statistic by ensuring that the area under one tail is standardized (zero mean and standard deviation of one). Normal distribution corresponds to that probability. 100
Model 1 2 3 4 VMsr t-1 1.02(54.24)*** 1.03(53.11)*** 1.03(54.41)*** 1.02(54.11)*** Size 2.15(1.90)* 2.17(1.83)† 2.17(1.80)† 2.20(1.93)† R&D intensity 8.20(2.70)** 9.01(2.05)* 8.43(2.14)* 9.21(2.21)* Advertising Intensity -1.89(0.30) -2.01(1.20) -1.79(1.13) -2.16(1.05) Leverage -0.05(0.20) -0.09(0.32) -0.09(0.32) -0.06(0.34) Hedging -0.20(0.51) -0.15(0.45) -0.14(0.35) -0.11(0.36) Competition -0.27(2.15)* -0.21(1.98)† -0.21(2.03)* -0.21(1.91)† Capital intensity 1.60(1.99)† 1.44(1.40) 1.45(1.51) 1.43(1.48) Chaebol 0.29(0.60) 0.21(1.21) 0.23(1.34) 0.28(1.53) Regional concentration 0.09(1.01) 0.07(0.98) 0.06(1.00) 0.09(1.11) Industry_dum Included Included Included Included FX Uncertainty -2.16(1.54) -1.34(0.19) -2.50(1.43) Market Uncertainty 0.13(1.12) 0.13(1.03) 0.04(1.78) Cultural Distance -0.04(0.50) -0.01(0.34) -0.09(1.56) HBHD -0.43(0.17) -0.70(0.35) -0.45(0.21) HBLD -0.41(2.40)* -0.16(2.22)* -0.51(2.11)* LBHD 0.21(1.43) 0.32(1.42) 0.41(1.15) Ownership 0.28(1.92)† 0.26(1.98)† 0.24(1.91)† Hypothesis 1a, 1b: High Exchange Rate Uncertainty FXunc*HBLD 2.12(2.15)* 2.99(2.34)* FXunc*LBHD -3.87(3.34)** -1.81(2.05)* FXunc*HBLD*Own 3.55(2.59)** FXunc*LBHD*Own -1.01(1.51) Invmills 1 0.13(1.01)† 0.16(1.04) 0.10(1.43) 0.19(1.13) Invmills 2 0.10(0.79) 0.09(0.71) 0.07(0.31) 0.06(0.30) Constant 0.25(1.11) 0.19(1.01) 0.34(1.09) 0.26(0.99) # of obs (# of firms) 1,334(176) 1,334(176) 1,334(176) 1,334(176) Wald χ2 3420.11*** 3529.15*** 3789.65*** 3909.34*** Numbers are GLS regression coefficients. Numbers in parentheses are Z statistics in absolute term. †p<.10, *p<.05, **p<.01, ***p<.001 Variables are centered in interaction terms.
Table 6.4 Results for Hypothesis Tests (Continued)
101
Table 6.4: Continued
Model 5 6 7 VMsr t-1 1.03(54.11)*** 1.02(56.14)*** 1.02(55.16)*** Size 1.79(2.01)* 2.20(1.99)† 1.89(2.05)* R&D intensity 9.12(2.22)* 9.09(2.27)* 9.44(2.30)* Advertising Intensity -2.16(1.01) -2.30(1.35) -2.16(1.01) Leverage -0.07(0.41) -0.05(0.35) -0.07(0.41) Hedging -0.13(0.22) -0.14(0.20) -0.13(0.22) Competition -0.21(1.91)† -0.20(1.96)† -0.23(1.90)† Capital intensity 1.40(1.31) 1.43(1.42) 1.41(1.40) Chaebol 0.25(1.43) 0.27(1.51) 0.23(1.41) Regional concentration 0.10(0.99) 0.09(1.04) 0.08(1.00) Industry_dum Included Included Included Fx Uncertainty -2.21(1.51) -2.35(1.41) -2.23(1.50) Market Uncertainty 0.15(1.31) 0.17(1.20) 0.16(1.15) Cultural Distance -0.15(1.86)† -0.12(1.91)† -0.10(1.90)† HBLD -0.33(2.15)* -0.45(2.05)* -0.39(2.17)* LBHD 0.40(1.21) 0.41(1.30) 0.41(1.25) HBHD -0.39(0.30) -0.37(0.39) -0.41(0.31) Ownership 0.20(1.92)† 0.23(1.93)† 0.18(1.72) Hypothesis 2a, 2b: High Market Uncertainty MKTunc*HBLD -0.10(1.81) -0.06(1.43) MKTunc*LBHD 0.04 (0.80) 0.03(0.70) MKTunc*HBLD*Own -0.14(1.21) MKTunc*LBHD*Own -0.66(2.08)* Hypothesis 3: Both high FX uncertainty and host market uncertainty FXunc*MKTunc*HBLD 0.33(1.41) FXunc*MKTunc*LBHD -0.19(1.90)† FXunc*MKTunc*HBHD 1.10(2.10)* Invmills 1 0.14(1.01) 0.13(1.00) 0.15(0.97) Invmills 2 0.06(0.11) 0.05(0.10) 0.07(0.15) Constant -1.11(1.12) -0.61(0.89) -0.80(1.01) # of obs.(# of firms) 1,334(176) 1,334(176) 1,334(176) Wald χ2 3620.56*** 3890.34*** 3790.12***
102
Model 1 2 3 4 VMsr t-1 1.04(55.219)*** 1.08(55.93)*** 1.08(56.14)*** 1.04(54.20)*** Size 1.49(2.51)** 1.50(2.49)** 1.49(2.44)** 1.42(2.41)** R&D intensity 8.90(2.32)* 9.01(2.19)* 8.99(2.20)* 8.78(2.22)* Advertising Intensity -3.07(0.63) -3.29(0.77) -3.25(0.70) -3.37(0.73) Leverage -0.03(1.43) -0.03(1.33) -0.05(1.25) -0.05(1.13) Hedging -0.09(1.59) -0.06(1.66) -0.05(1.76) -0.05(1.72) Competition -0.39(1.91)† -0.34(1.95)† -0.33(1.80) -0.37(1.91)† Capital intensity 1.64(1.43) 1.60(1.34) 1.62(1.33) 1.61(1.23) Chaebol 0.14(1.44) 0.15(1.45) 0.17(1.36) 0.17(1.30) Regional concentration 0.07(1.01) 0.08(1.04) 0.06(1.02) 0.07(0.99) Industry_dum Included Included Included Included FX Uncertainty -2.20(1.51) -2.29(1.50) -2.21(1.65) -2.18(1.81) Market Uncertainty 0.14(1.78) 0.12(1.23) 0.14(1.90)† 0.13(1.68)† Cultural Distance -0.12(1.91)† -0.16(1.96)† -0.16(1.99)† -0.14(2.02)* HBLD -0.32(2.32)* -0.31(1.94)† -0.67(2.21)* -0.51(1.97)† LBHD 0.41(1.25) 0.45(1.19) 0.40(1.39) 0.44(1.31) HBHD -0.41(0.31) -0.25(0.36) -0.21(0.32) -0.39(0.37) Ownership 0.18(1.93)† 0.18(1.95)† 0.17(1.80) 0.14(1.93)† Hypothesis 4: Cultural Distance
HBLD*CD -2.12(3.04)** -2.09(2.77)** -1.99(2.78)** -2.01(2.25)*
LBHD*CD -0.15(0.36) -0.15(0.46) -0.13(0.80) -0.10(0.73)
Fxunc*HBLD*CD -1.02(1.84) Fxunc*LBHD*CD -0.37(0.31)
MKTunc*HBLD*CD 0.05(0.65) MKTunc*LBHD*CD 0.03(0.17)
HBLD*CD*Own - 1.56(2.05)* LBHD*CD*Own - 0.06(0.55) Invmills 1 0.12(0.77) 0.13(0.62) 0.13(0.59) 0.15(0.81) Invmills 2 0.07(1.79)† 0.08(1.60) 0.05(1.64) 0.05(1.66) Constant -0.16(0.34) -0.15(0.49) -0.16(0.52) -0.18(0.55) # of obs.(# of firms) 1,334 (176) 1,334 (176) 1,334 (176) 1,334 (176) Wald χ2 3609.65*** 3756.43*** 3666.49*** 3709.23***
Table 6.5 Effects of Cultural Distance 103
Dependent Newsubnewctry Newsuboldctry variable Model 1 2 3 4
VMFsr t-1 0.01(0.31) 0.01(0.36) -0.02(0.46) -0.00(0.00) Size 0.58(5.95)*** 0.57(5.90)*** 0.70(4.17)*** 0.70(4.62)*** R&D intensity -11.92(1.35) -11.90(1.34) -3.21(0.31) -3.65(0.38) Advertising intensity -1.83(0.52) -1.85(0.53) -2.53(0.67) -2.38(0.47) Hedging 0.78(1.00) 0.81(1.05) 0.04(0.09) 0.00(0.00) Leverage -0.30(1.11) -0.30(1.11) -0.63(1.01) -0.53(1.06) Competition 0.16(1.88)† 0.16(1.86)† 0.16(1.12) 0.19(1.54) Capital Intenstiy -1.85(2.96)** -1.86(2.98)** -1.77(1.79)† -2.06(2.37)* Chaebol -0.13(0.92) -0.12(0.88) 0.11(0.47) 0.02(0.11) FXunc 4.62(4.10)*** 4.25(3.53)*** -0.39(1.17) -0.51(1.25) MKTuunc -0.02(2.05)* -0.02(2.30)* 0.10(2.61)** 0.07(2.31)* FXunc*MKTunc - 0.57(1.91)† - 0.20(1.16) Constant -1.25(1.42) -1.09(1.92)† -4.18(4.17)*** -2.78(3.26)** # of obs(# of firms) 1,457(185) 1,457(185) 1,457(185) 1,457(185) Wald χ2 77.42*** 78.12*** 58.48*** 87.02*** Numbers are GLS regression coefficients. Numbers in parentheses are Z statistics in absolute term. †p<.10, *p<.05, **p<.01, ***p<.001
Table 6.6 Firm’s Behavioral Choice: Increase in Breadth and Depth
104
CHAPTER 7
CONCLUSIONS AND IMPLICATIONS
7.1 Conclusions
In this paper we investigated the value effects of growth and switching options for
multinational firms under varying kinds of uncertainty. We showed how growth options
were derived from a priori investments in specific countries, while switching options were gained from a priori investments dispersed across countries. We found that growth options contributed to firm value under conditions of host country uncertainty while switching options contributed to firm value under conditions of exchange rate uncertainty.
We further found that when firms experience multiple forms of uncertainty, their value is enhanced by their access to a combination of growth and switching options. Finally, we found evidence supporting the notion that firms make future FDI decisions that enhance their options based on past experiences with uncertainty.
This study contributes to the literature on multinational flexibility in a number of ways. By examining more than one type of option, we could compare and contrast the conditions under which each added value to the firm. Prior studies have tended to consider only one type of option in this regard, without taking into account the possibility that the investments may carry multiple options that differ in their value depending on the 105
circumstances in which the firm finds itself. A second manner in which this study
contributes insights is by separating out the environmental conditions under which one
option is more value than the other option. Prior studies on the real options of
international investments have tended to consider only one environmental condition,
exchange rate uncertainty, or only implicitly assume the existence of uncertainty. We find
evidence that specific types of uncertainty are relevant for specific types of investments,
influencing their contribution to firm value. Finally, our findings have implications for
understanding the nature of an optimal portfolio of FDI from a real options point of view.
We find evidence that the costs of maintaining a broad and deep FDI network are
significant, yet provide value under complex conditions of uncertainty.
This research also initiates an examination of the role of ownership in influencing
the real options value of foreign direct investments. Interestingly, we found that
ownership plays a completely different role for switching options than for growth options.
In the case of switching options, higher ownership helps firms to gain the control they
need over their investments so that they can use them flexibly to shift operations across
national borders. On the other hand, in the case of growth options, lower ownership helps
firms to reduce outlays, and therefore, the irreversibility of these investments. These
findings underscore the very different but pertinent implications of ownership in
investments with real options, reflecting control over the investment versus scale of investment. The omission of this variable leads to very different implications, particularly 106
for growth options. We therefore believe that future work on real options investments should not neglect the role of this factor, which helps to differentiate different types of
options.
Our findings relating to ownership level imply that growth options and switching
options lead to conflicting predictions on this attribute of FDI. Minority ownership may
increase growth options value, since this can serve as a foothold investment. On the other
hand, minority ownership may undermine the potential of the firm to exercise switching
options. Instead, higher ownership ratio in an FDI portfolio will allow the firm to exercise
effective coordination over subsidiaries. Taken together, higher depth and lower
ownership will be associated with greater ability to exercise growth options within
countries, whereas greater breadth and higher ownership will be associated with greater
ability to exercise switching options across countries. These results also suggest that
firms should pay more attention to the designing and structuring ownership of their FDI
at the portfolio level, and to coordinating and managing dispersed operations across
countries. If they are not able to coordinate foreign subsidiaries for their own benefit,
they will not be able to offset the costs of a broader scope of host countries.
107
7.2. Implications
This research suggests a number of new directions for future work on multinational flexibility. We believe that future work should also look more deeply into the actual mechanism where operational flexibility is actualized within international networks.
Examining firm’s behavioral choices including how firms actually shift their value chains across countries would be worthwhile. What types of considerations go into the decision to locate an investment in a given country? Would we expect to see regional commonalities among these investments, allowing for lower transportation costs and greater cultural similarities that reduce switching costs? Which activities are typically shifted more often? How do firms make sure that value chain activities are transferable across national contexts?
In addition to the overall uncertainty in host countries, some specific events of a
host country economy will affect firms’ subsequent behavioral decisions. It would be worthwhile to examine how firms actually respond to a specific crisis in a host country.
For example, multinational companies operating in Latin America (including Mexico,
Brazil, or Argentina) in the middle of 1980 or 1990 were exposed to abnormally high
volatility in exchange rates. We had argued that firms will respond to such shocks by
switching their operations across countries. It would therefore be useful to examine
exactly how these firms relocate value-adding activities among their foreign operations 108
during or after these abnormal shocks. One natural experiment would be to examine whether or not firms follow real options logic by investigating firms’ decision to divest during these economic crises. Additionally, we can try a choice model indicating firms’ behavioral choice of next investment after these special shocks.
Regarding potential endogeneity problems associated with the impact of firms’ entries into specific host countries on their value and performance, prior international experience of each firm can also be taken into account. Thus, in addition to two kinds of two-stage models that are used in this research, we can consider the role of such experience. Firms’ heterogeneous experience in international markets can effect their ability to perceive and respond to current and subsequent uncertainty and thus influence different values and behaviors of MNCs.
Future work also should take into account potential correlations among different types of uncertainty. For example, Goldberg and Kolstad (1995) considered the correlation between export demand and exchange rate shocks, noting that if non-negative correlation exists between export demand and exchange rate shocks, the multinational firm can optimally locate some productive capacity abroad. In this sense, the practice of using a country as a boundary condition for operational flexibility may overvalue actual flexibility. The country as a boundary may not provide assurance that different countries would have no correlation from the source of uncertainty. For example, treating two
109
countries in the European Union (EU) is not the same as treating India and France as two
countries.
Thus, we suggest that utilizing a regional dummy for regions with high correlation
in the level of uncertainty would demonstrate whether country boundary is a pertinent
measure for the unit of operation.
We studied the role of cultural distance within the firm’s international network, suggesting that it was a source of additional costs to the firm due to the need for greater coordination. However, it may also be conceptualized as a source of endogenous uncertainty, affecting the management of the investment. If so, it would be an interesting area for further theory development. It would be interesting to consider how such endogenous uncertainty interacts with exogenous uncertainty in the real options realm.
(McGrath, Ferrier, and Mendelow, 2004; Wang, 2002).
110
LIST OF REFERENCES
Adler, M. and Dumas, B. (1984) “Exposure of currency risk: Definition and measurement’, Financial Management 13: 41-50.
Adner, R. 2007. Resource reallocation processes. Advances in Strategic Management, 24
Adner, R., & Levinthal, D. A. 2004a. What is not a real option: considering boundaries for the application of real options to business strategy, Academy of Management Review, 29: 74-85.
Adner, R., & Levinthal, D. A. 2004b. Real options and real tradeoffs, Academy of Managemen Review, 29: 120-126.
Akerlof, G. A. 1970. The Market for 'Lemons': Quality Uncertainty and the Market Mechanism. Quarterly Journal of Economics 84(3), 488-500.
Allen, L.,& Pantzalis, C. 1996. Valuation of the operating flexibility of multinational corporations, Journal of International Business Studies 27: 633-653.
Anand, A., Oriani, R., & Vassolo, R.S. 2007. Managing a portfolio of strategic real options. Advances in Strategic Management, 24.
Ang, J., & Ma, Y. 2001. The behavior of financial analysts during the Asian financial crisis in Indonesia, Korea, Malaysia, and Thailand, Pacific-Basin Finance Journal 9: 233-263.
Arman, M., & Kulatilaka, N. 1998. Real Options: Managing Strategic Investment in an Uncertain World, Harvard Business School Press: Boston.
Bartlett, C., & Ghoshal, S. 1989. Managing across borders: The transnational solution. Boston, MA: Harvard Business School Press.
Barnett, M. L. 2003. Falling Off the Fence? A Realistic Appraisal of a Real Options Approach to Corporate Strategy. Journal of Management Development.
111
Barney, J. B. 2002. Gaining and sustaining competitive advantage, Prentice hall, 2nd edition: 308-338. Barkema, H.G., Bell,J.H., & Pennings, J.M. 1996. Foreign Entry, Cultural Barriers, and Learning. Strategic Management Journal, 17(2): 151-66.
Barkema, H.G. & Vermeulen. F. 1997. What Differences in the Cultural Backgrounds of Partners are Detrimental for International Joint Ventures? Journal of International Business Studies, 28(4): 845-64.
Belderbos, R., & Zou, J. 2006. Foreign investment, divestment and relocation by Japanese electronics firms in East Asia. Asian Economic Journal, 20: 1-27.
Belderbos, R. 2008. Real Options, Adverse Selection, and Foreign Affiliate Divestment, working paper.
Berger, P. G., Ofek, E., & Swary, I. 1996. Investor Valuation of the Abandonment Option. Journal of Financial Economics, 42(2): 257-287.
Bernardo, A. E., & Chowdhry, B. 2002. Resources, Real Options, and Corporate Strategy. Journal of Financial Economics, 63(2): 211-234.
Black, F., & Scholes, M. 1973. The pricing of options and corporate liabilities, Journal of Political Economy, 81: 637-659.
Boddewyn, J.J. 1979 Foreign divestment: magnitude and factors, Journal of International Business Studies, 10:21-27.
Bodnar, G.,& Gentry, W. 1993. Exchange rate exposure and industry characteristics: Evidence from Canada, Japan, and the USA, Journal of International Money and Finance 12: 29-45.
Bowman, E., & Hurry, D. 1993. Strategy through the option lens: An integrated view of resource investments and the incremental-choice process, Academy of Management Review 18(4): 760-782.
Bowman, E.H., & Moskowitz, G.T. 2001. Real options analysis and strategic decision making. Organization Science, 12: 772-777.
112
Broll, U., & Eckwert, B. 1999. Exchange rate volatility and international trade, Southern Economic Journal 66: 178-185.
Brown, G. 2001. Managing foreign exchange risk with derivatives, Journal of Financial Economics 60: 401-448.
Buckley, P., & Casson, M. 1998. Models of the multinational enterprise, Journal of International Business Studies 29(1): 21-44.
Buckley, A., & Tse, K. (1996). Real Operating Options and Foreign Direct Investment: Synthetic Approach. European Management Journal 14(3), 304-314.
Campa, J. M. 1993. Entry by Foreign Firms in the United States under Exchange-Rate Uncertainty. Review of Economics and Statistics, 75(4): 614-622.
Campa, J. 1994. Multinational investment under uncertainty in the chemical processing industries, Journal of International Business Studies 25(3): 557-578.
Carter, D., Pantzalis, C. & Simkins, B. 2003. Asymmetric exposure to foreign-exchange risk:Financial and real option hedges implemented by U.S. multinational corporations. Proceedings from the 7th Annual International Conference on Real Options: Theory Meets Practice. Washington, D.C.
Caves, R.E. 1996. Multinational enterprise and economic analysis (Second Edition). New York: Cambridge University Press.
Chang, S.J. 1995. International expansion strategy of Japanese firms: Capability building through sequential entry. Academy of Management Journal, 38: 383–407.
Chang S,J., & Hong J. 2000. Economic performance of group-affiliated companies in Korea: Intragroup resource sharing and internal business transactions. Academy of Management Journal 43(3): 429-448.
Chang, S.J., & Rosenzweig, P. 2001. The choice of entry mode in sequential foreign direct Investment. Strategic Management Journal 22: 747-776.
Chi, T. 2000 Option to acquire or divest a joint venture, Strategic Management Journal, 21: 665-687.
113
Chi, T., & McGuire, D. J. 1996. Collaborative ventures and value of learning: Integrating the transaction cost and strategic option perspectives on the choice of market entry modes. Journal of International Business Studies, 27:2:285-307
Chi, T.L., & A. Seth. 2002. Joint Ventures Through a Real Options Lens. In Contractor, F.J. & P. Lorange, editors, Cooperative Strategies and Alliances. Amsterdam, The Netherlands: Elsevier Science.
Choi, J., & Prasa, A. 1995. Exchange risk sensitivity and its determinants: A firm and industry analysis of U.S. multinationals. Financial Management, 24: 77-88.
Chung, K., & Pruitt, S. 1994. A simple approximation of Tobin’s q, Financial Management 23(3): 70-74.
Coff, R.W. & Laverty, K. 2001. Strategy process dilemma in exercise decisions for options on core competencies, paper presented at the Academy of Management Conference, Washington D.C.
Coff, R., & Laverty, K. 2001. Real Options on Knowledge Assets: Panacea or Pandora’s Box. Business Horizons, 2001(Nov-Dec): 73-79.
Coff, R.W., & Laverty, K.J. 2007. Real options meet organization theory: Coping with path dependencies, agency costs, and organizational form. Advances in Strategic Management, 24.
Cohen, W.M., & Levinthal, D.A. 1990: Absorptive capacity: A new perspective on learning and innovation. Administrative Science Quarterly, 35 (1), 128-152. Cole, D., & Park, Y. 1983. Financial Development in the Republic of Korea 1945- 78,Harvard University Press: Cambridge. Copeland, T. E. & Antikarov, V. 2001. Real Options: A Practitioner’s Guide. Norton, New York.
Copeland T. E., & Keenan PT. 1998. Making real options real. The McKinsey Quarterly, 1998(3): 128-141.
Cyert, R. M., & March, J. G. 1963. A Behavioral Theory of the Firm. Englewood Cliffs, NJ: Prentice Hall. 114
Cupyers, I., & Martin, X. 2006. What makes and what does not make a real options? A study of International Joint ventures, Academy of Management, Philadelphia, USA.
Cupyers, I.,& Martin, X. 2007. Joint ventures and real options: An extended perspective, Advances in Strategic Management, Vol. 24.
Das. T. K.,& Teng, B-S. 2000. Instabilities of strategic alliances: An internal tensions perspective, Organizational Science, 11(1): 77-101.
Delios, A., & Beamish, P. 1999. Geographic scope, product diversification, and the corporate performance of Japanese firms, Strategic Management Journal 20: 711-727.
De Meza, D., & van der Ploeg, F. 1987. Production flexibility as a motive for multinationality, Journal ofIndustrial Economics, 35, 343–351.
Dixit, A. 1989. Entry and Exit Decisions under Uncertainty. Journal of Political Economy 97(3), 620-638.
Dixit, A. 1992. Investment and Hysteresis. Journal of Economic Perspectives 6(1), 107 132.
Dixit, A., & Pindyck, R. 1994. Investment Under Uncertainty, Princeton University.Press: Princeton. The Economist. 1997. Lifebelts on. Jul 12: 62-63.
Dixit, A., & Pindyck, R.S. 1995. The options approach to capital investment, Harvard Business Review, 73(3): 105-115.
Dunning, J. 1980. Toward an eclectic theory of international production: Some empirical tests, Journal of International Business Studies 11: 9-31.
Folta, T.B. 1998. Governance and uncertainty: The tradeoff between administrative control and commitment. Strategic Management Journal, 19: 1007-1028.
Folta, T.B.,& Leiblein, M.J. 1994. Technology acquisitions and the choice of governance by established firms: Insights from opinion theory in a multinational logic model, Academy of Management Proceedings, 27-31. 115
Folta, T., Johnson, D., & O’Brian, J. 2001. Uncertainty and the likelihood of entry: An empirical assessment of the moderating role of irreversibility, Working paper, Krannert Graduate School of Management, Purdue University.
Folta, T.,& Miller, K. 2002. Real options in equity partnerships, Strategic Management Journal 23: 77-88.
Folta, T.B., & O’Brien, J.P. 2004. Entry in the presence of dueling options. Strategic Management Journal, 25: 121-138.
Foss, N. 1998. Real options and the theory of the firm’, in R. Sanchez (eds.) Options Theory in Strategic Management, Sage: London.
Gatignon, H., & Anderson, E. 1988. The multinational corporation’s degree of control over foreign subsidiaries: An empirical test of a transaction cost explanation, Journal of Law, Economics, and Organization, 4(2): 305-336.
Geringer, J., Tallman, S., & Olsen, D. 2000. Product and international diversification among the Japanese multinational firms, Strategic Management Journal 21: 51- 80.
Ghoshal, S.,& Bartlett, C. 1990. The multinational corporation as an interorganizational Network, Academy of Management Review 15: 603-625.
Glauche, I. 2001. A classical approach to the Black-and-Scholes formula and its critiques, discretization of the model, working paper at Duke University, April.
Gulati, R., & Singh, H. 1998. The architecture of cooperation: Managing coordination costs and appropriation concerns in strategic alliance, Administrative Science Quarterly, 43(4): 781-814.
Grewal, R.,& Tansuhaj P. 2001. Building organizational capabilities for managing economic crisis: the role of market orientation and strategic flexibility, Journal of Marketing 65: 67-80.
Griffin, J.,& Stulz, R. 2001. International competition and exchange rate shocks: A cross country industry analysis of stock returns, Review of Financial Studies 14: 215- 241. 116
Guillen, M. 2000. Business groups in emerging economies: A resource-based view. Academy of Management Journal, 43: 362-380.
Heckman, J. 1979. Sample selection bias as a specification error, Econometrica, 47: 153- 161. International Financial Statistics. 1986-2006. International Monetary Fund: WashingtonD.C.
Hitt, M., Bierman, L, Uhlenbruck, K., & Shimizu, K. 2006. The importance of resources in the internationalization of professional service firms: The good, the bad, and the ugly. Academy of Management Journal, 49: 1137-1157.
Hitt, M., Hoskisson, R., & Kim, H. 1997. International diversification: Effects on innovation and firm performance in product-diversified firm. Academy of Management Journal, 40, 767-798.
Huchzermeier, A., & Cohen, M. A. 1996. Valuing Operational Flexibility under Exchange Rate Risk.Operations Research 44(1), 100-113.
Inkpen, A.C., & Ross, J. 2001. Why do some strategic alliances persist beyond their useful life? California Management Review, 44(1): 132-148.
International Financial Statistics. 1986-2006. International Monetary Fund: Washington D.C.
Johanson, J. and Vahlne, J. 1977. The internationalization process of the firm: A model of knowledge development and increasing foreign commitments, Journal of International Business Studies 8(1): 23-32.
Janney, J.J., & Dess, G.G. 2004. Can real-options analysis improve decision-making? Promises and pitfalls, Academy of Management Executive, 18(4): 60-75.
Jap, S. D., & Anderson, E. 2003. Safeguarding inter-organizational performance and continuity under ex post opportunism, Management Science, 49(12): 1684-1701.
Kim, W., Hwang, P., & Burgers, W. 1993. Multinationals’ diversification and the risk- return trade-off, Strategic Management Journal 14: 257-286.
117
Kester, W.C. 1981. Growth Options and Investment: A Dynamic Perspective on the Firm's Allocation of Resources. Cambridge, MA.
Kester, C. 1984. Today’s options for tomorrow growth. Harvard Business Review, 62, 153-160.
Kim, D.,& Kogut, B. 1996. Technological platforms and diversification. Organization Science, 7: 283-301.
Kobrin, S. 1991. An Empirical Analysis of the Determinants of Global Integration, Strategic Management Journal 12:17-31.
Kogut, B. 1983. Foreign direct investment as a sequential process, in C. Kindelberger and D. Audretsch (eds.), The Multinational Corporations in the 1980s, MIT Press: Cambridge, MA.
Kogut, B. 1985. Designing global strategies: Profiting from operating flexibility, Sloan Management Review 26: 27-38.
Kogut, B. 1989. The Instability of Joint Ventures: Reciprocity and Competitive Rivalry. Journal of Industrial Economics 38, 183-198.
Kogut, B. 1991. Joint ventures and the option to expand and acquire, Management Science 37: 19-33.
Kogut, B.,& Chang, S. J. 1996. Platform Investments and Volatile Exchange Rates: Direct Investment in the U.S by Japanese Electronic Companies. Review of Economics and Statistics 78(2), 221-231.
Kogut, B.,& Kulatilaka, N. 1994a. Options thinking and platform investments: Investing in opportunity. California Management Review, 36: 52-71.
Kogut, B.,& Kulatilaka, N. 1994b. Operating flexibility, global manufacturing, and the option value of a multinational network. Management Science, 40: 123-139.
Kogut, B., & Kulatilaka, N. 2001. Capabilities as real options. Organization Science, 12: 744-758.
118
Kogut, B., & Kulatilaka, N. 2004. Real options pricing and organizations: The contingent risks of extended theoretical domains. Academy of Management Review, 29: 102-110. Kulatilaka, N., and Perotti, E. C. 1998. Strategic Growth Options. Management Science 44(8), 1021-1031.
Kumar, M. V. S. 2005. The value from acquiring and divesting a joint venture: A real options approach, Strategic Management Journal, 26(4): 321-331.
Kylaheiko, Y., Sandstrom, J., & Virkkunen. V. 2002. Dynamic capability view in terms of real options, International Journal of Production Economics, Nov.1.
Lander, D.M., & Pinches, G. E. 1998. Challenges to the practical implementation of modeling and valuing real options, the Quarterly Review of Economics and Finance, 38: 537-567.
Lang, L.H.P., Stulz, R.M., & Walkling, R.A. 1989. Tobin’s q and the gains from successful tender offers. Journal of Financial Economics, 24: 137-154.
Lee, S-H., & Makhija, M. 2008a. The Effect of Domestic Uncertainty on the Real Optons Value of International Investments, Journal of International Business, Forthcoming.
Lee, S-H., & Makhija, M. 2008b. Is International Flexibility Valuable During An Economic Crisis? Strategic Management Journal, Forthcoming.
Lee, S-H., Makhija M., Paik, Y. 2008. The Value of Real Options Investments Under Abnormal Uncertainty: The Case of The Korean Economic Crisis. Journal of World Business. Forthcoming.
Leiblein, M.J. 2003. The choice of organizational governance form and performance: Predictions form transaction cost, resource-based, and real options theories, Journal of management, 29(6): 937-961.
Leiblein, M.J., & Miller, D.J. 2003. An empirical examination of transaction- and firm- level influences on the vertical boundaries of the firm. Strategic Management Journal, 24: 839-859.
Levitt, B. and March, J.G. 1988: Organizational learning. Annual Review of Sociology, 14, 119
319-340.
Li, Y., James, B., Madhavan, R.,, & Mahoney, J. T. 2007. Real options: Taking stock and looking forward, Advances in Strategic Management, Vol. 24.
Lu, J.,& Beamish, P. 2004. International diversification and firm performance: The S- curve hypothesis, Academy of Management Journal 47: 598-609.
Luehrman, T. A. 1998. Strategy as a portfolio of real options. Harvard Business Review, 76 (5): 89-99
Lukas, E. 2003. Sequential international joint-ventures and the option to choose, working paper at department of economics, University of Paderborn, Germany.
Lyles, M.A., & Salks, J.E. 1996. Knowledge acquisition from foreign partners in international joint ventures: An empirical examination in the hungarian context. Journal of International Business Studies, 27(5): 877-903.
Mahoney, J. T. (2005). The Economic Foundations of Strategy. Thousand Oaks, CA: Sage Publications.
Makhija. M. 1993. Government intervention in the Venezuelan petroleum industry, Journal of International Business Studies 24(3): 531-555.
Makhija. M., Kim, K.,& Williamson, S. 1997. Measuring globalization of industries using a national industry approach: Empirical evidence across five countries and over time, Journal of International Business Studies 28: 679-710.
Makhija. M. 2003. Comparing the resource-based and market-based views of the firm: Empirical evidence from Czech Privatization, Strategic Management Journal 24: 433-451.
March, J.G. 1991: Exploration and exploitation in organizational learning. Organization Science, 2 (1), 71-78.
Mauboussin, M.J. 1999. Get real, research paper at Credit Suisse First Boston Corporation, June: 1-30.
120
McDonald, R. L., & Siegel, D. 1986. The Value of Waiting to Invest. Quarterly Journal of Economics, 101(4): 707-727.
McGrath, R. 1997. A real options logic for initiating technology positioning investments, Academy of Management Review 22(4): 974-996.
McGrath, R. 1999. Falling forward: Real options reasoning and entrepreneurial failure, Academy of Management Review 24(1): 14-30.
McGrath, R.G., Ferrier, W.J., & Mendelow, A. 2004. Real options as engines of choice and heterogeneity. Academy of Management Review, 29: 86-101.
McGrath, R.G., & Nerkar, A. 2004. Real options reasoning and a new look at the R&D investment strategies of pharmaceutical firms. Strategic Management Journal, 25: 1-21.
Mello, A., Parsons, J., & Triantis, A. 1995. An integrated model of multinational flexibility and financial hedging, Journal of International Economics 39: 27-52.
Merton, R. C. 1973. Theory of Rational Option Pricing. Bell Journal of Economics, 4(1): 141-183.
Merton, R. C. 1998. Applications of Option-Pricing Theory: Twenty-Five Years Later. American Economic Review, 88(3): 323-349.
Miller, K.,& Leiblein, M. 1996. Corporate risk-return relations: Returns variability versus downside risk, Academy of Management Journal 39(1): 91-122.
Miller, K.D.,& Reuer, J.J. 1996. Measuring organizational downside risk. Strategic Management Journal, 17: 671-691.
Miller, K.D.,& Reuer, J.J. 1998a. Asymmetric corporate exposures to foreign exchange rate changes. Strategic Management Journal, 19: 1183-1191.
Miller, K.D.,& Reuer, J.J. 1998b. Firm strategy and economic exposure to foreign exchange rate movements. Journal of International Business Studies, 29: 493- 513.
121
Miller, K.D.,& Folta, T. B. 2002. Option value and entry timing, Strategic Management Journal, 23(7): 655-665.
Morck, R.,& Yeung, B. 1991. Why investors value multinationality, Journal of Business, 64: 165-187.
Myers, S. C. 1977. Determinants of Corporate Borrowing. Journal of Financial Economics 5(2), 147-175.
Neter, J., Wasserman, W., & Kunter, M. 1985. Applied Linear Statistical Models: Regression, Analyses of Variance, and experimental Designs, 2nd edition, Homewood, IL.
Pantzalis, Christos, Betty J. Simkins, and Paul Laux, 2001, Operational hedges and the foreign exchange exposure of U.S. multinational corporations, Journal of International Business Studies 32 (No. 4): 793-812.
Peng. M. W., & Luo, Y. 1999. Managerial ties and firm performance in a transition economy: The nature of a micro-macro link, Academy of Management Journal, 43(3): 486-501.
Peng. M. W. 2003. Institutional transitions and strategic choices, Academy of Management Review, 28: 275-296.
Pape, U., & Schmidt-Tank, S. 2004. Valuing joint ventures using real options, ESCP- EAP working paper, 7: 1-27.
Pindyck, R. 1988. Irreversible investment, capacity choice, and the value of the firm, American Economic Review 78(5): 969-985.
Pindyck, R. S. 1991. Irreversibility, Uncertainty, and Investment. Journal of Economic Literature 29(3), 1110-1148.
Ramaswamy, K. 1995. Multinationality, configuration, and performance: A study of MNEs in the US drug and pharmaceutical industry. Journal of International Management, 1: 231–253.
122
Ramaswamy, K., Kroeck, K.G., & Renforth, W. 1996.Measuring the degree of internationalization of a firm: A comment. Journal of International Business Studies, 27: 167–178.
Rangan, S. 1998. Do multinationals operate flexibly? Theory and evidence, Journal of International Business Studies 29(2): 217-237.
Reeb, D.M., Kwok, C.Y.,& Baek, Y.H. (1998) Systematic risk of the multinational corporation. Journal of International Business Studies, 29: 263–279.
Reuer, J. J. 1998. The dynamics and effectiveness of international joint ventures, European Management Journal, 16(2): 160-168.
Reuer, J. J., & Leiblein M. J. 2000. Downside risk implications of multi-nationality and international joint ventures, Academy of Management Journal, 43(2): 203-214.
Reuer, J.J., & Miller, K.D. 1997. Agency costs and the performance implications of international joint venture internalization, Strategic Management Journal, 18(6): 425-438.
Reuer, J. J., & Ragozzino, R. 2006. Agency hazards and alliance portfolio, Strategic Management Journal, 27(1): 27-43.
Reuer, J.J., & Tong, T. W. 2005. Real options in international joint ventures, Journal of Management, 31(3): 403-423.
Reuer, J. J.,& Tong, T.W. 2007. How do Real Options Matter? Empirical Research on Strategic Investments and Firm Performance, Advances in Strategic Management, Vol. 24.
Rivoli, P.,& Salorio, E. 1996. Foreign direct investment and investment under uncertainty, Journal of International Business Studies 27(2): 335-357.
Roberts, K. & M.L. Weitzman. 1981. Funding Criteria for Research, Development, and Exploration Projects. Econometrica, 49(5): 1261-88.
Roemer, E. 2004. Real options and the theory of the firm, working paper at University of Bradford.
123
Rugman, A. International Diversification and the Multinational Enterprise, Lexington Books: Lexington, MA: .
Sanchez, R. 1993. Strategic flexibility, firm organization, and managerial work in dynamic Markets, Advances in Strategic Management 9:251-291.
Sanchez, R. 1993. Strategic flexibility, firm organization, and managerial work in dynamic markets. Advances in Strategic Management, 9:251-291.
Sanchez, R. 1995. Strategic flexibility in product competition, Strategic Management Journal, 16: 135-159.
Sanchez, R. 1997. Preparing for an uncertain future, International Studies of Management and Organization, 27(2): 71-94.
Sanchez, R. 2000. Modular architectures, knowledge assets, and organizational learning: new management processes for product creation, International Journal of Technology Management, 19(6): 610-629.
Santoro, M. D., & McGill, J. P. 2005. The effect of uncertainty and asset co- specialization on governance in biotechnology alliances, Strategic Management Journal, 26(13): 1261-1269.
Sartori, Anne E. 2003. An estimator for some binary-outcome selection.models without exclusion restrictions. Political Analysis, 11:111-138.
Shaver, M. 1998. Accounting for endogeneity when assessing strategy performance: Does entry mode choice affect FDI survival?. Management Science, 44: 571-585.
Seth, A.,& Chi, T. 2005. What does a real options perspective add to the understanding of strategic alliances? In O. Shenkar, and J. J. Reuer (Eds.), Handbook of Strategic Alliances. Thousand Oaks, CA.: Sage Publications.
Seth, A.,& S.-M. Kim. 2000. Valuation of International Joint Ventures: A Real Options Approach. In Contractor, F., editor, Valuation of Intangible Assets in International Operations. Westport, CT: Quorum Books.
Singh, K.,& Yip, G. 2000. Strategic lessons from the Asian crisis. Long Range Planning, 33, 706-729. 124
Song, J. 2002. Firm capabilities and technology ladders: Sequential foreign direct investments of Japanese electronics firms in East Asia. Strategic Management Journal, 23: 191-210.
Smit, H. T. J. 2001. Acquisition strategies as option games, Journal of Applied Corporate Finance, 14(2): 79-89.
Smit, H., & Trigeorgis, L. 2004. Strategic investment: Real options and games. Princeton, NJ:Princeton University Press.
Spremann, K., & Gantenbein, P. 2003. Are real options dead?, working paper at Swiss Institute of Banking and Finance.
Stata 10. 2007. User’s Guide, State Press: College Station, Texas.
Starks, L.,& Wei, K. 2003. Foreign exchange exposure and short-term cash flow sensitivity working paper.
Starbuck, W.H. 1992: Learning by knowledge-intensive firms. The Journal of Management Studies, 29 (6), 713-741.
Staw, B. M., & Ross, J. 1989. Understanding Behavior in Escalation Situations. Science, 246: 216–246.
Steensma, H. K., & Lyles, M. A. 2000. Explaining IJV survival in transitional through social exchange and knowledge-based perspectives, Strategic Management Journal, 21: 831-851.
Sutcliffe, K.,& Zaheer, A. 1998. Uncertainty in the transaction environment: An empirical test, Strategic Management Journal 19: 1-23. Tang, C.,& Tikoo, S. 1999. Operational flexibility and market valuation of earnings, Strategic Management Journal 20: 749-761.
Tong. T. W., & Reuer, J. J. 2006. Firm and industry influences on the value of growth options, Strategic Organization, 4(1): 71–95
Tong. T. W., Reuer, J. J., & Peng, M. W. 2007. International Joint Ventures and the Value of Growth Options, Academy of Management Journal 125
Tong, T,& Reuer, J. 2007. Switching options and coordination costs in multinational firms. Journal of International Business Studies. 38: 215-230
Trigeorgis, Lenos. 1993. Real options and interactions with financial flexibility. Financial Management, 22, 202–224.
Trigeorgis, L. 1996. Real Options: Managerial Flexibility and Strategy in Resource Allocation. Cambridge, Mass.: MIT Press.
Trigeorgis, L. 2002. Real options and investment under uncertainty: What do we know?, working paper at National Bank of Belgium, 22.
Trigeorgis, L. 2005. Making use of real options simple, The Engineering Economics, 50: 25-53.
Vassolo, R.S., Anand, J.,& Folta, T.B. 2004. Non-additivity in portfolios of exploration activities: A real options-based analysis of equity alliances in biotechnology. Strategic Management Journal, 25: 1045-1061.
Van Den Bosch, F.A.J., Volberda, H.W.,& Boer, M. de 1999: Coevolution of firm absorptive capacity and knowledge environment: organizational forms and combinative capabilities. Organization Science, 10 (5), 551-568.
Van Den Bosch, F.A.J.,& Van Wijk, R. 2001: Creation of Managerial Capabilities through Managerial Knowledge Integration: A Competence-Based Perspective. In R. Sanchez (ed), Knowledge Management and Organizational Competence, Oxford: Oxford University Press, 159-176.
Van Wijk, R.A.,& Van Den Bosch, F.A.J. 1998: Knowledge Characteristics of Internal Network-based Forms of Organizing. In S. Havlovic (ed), Academy of Management Best Paper Proceedings, B1–7.
Van Wijk, R.A.,& Van Den Bosch, F.A.J. 2000: The emergence and development of internal networks and their impact on knowledge flows: The case of Rabobank Group. In A.M. Pettigrew and E.M. Fenton (eds), The Innovating Organization, London: Sage, 144-177.
Van Wijk, R., Van Den Bosch, F.A.J.,& Volberda, H.W. 2001: The impact of the depth 126
and breadth of knowledge absorbed on levels of exploration and exploitation. Academy of Management Meeting, BPS Division, Insights into Knowledge Transfer, Washington DC, USA, August 3-8.
Van Wijk, R., Van Den Bosch, F.A.J.,& Volberda, H.W. 2002: Knowledge and Networks. In M.Easterby-Smith and M.A. Lyles (eds), Companion to Organizational Learning and Knowledge, Oxford: Blackwell Publishers.
Wang, G. Y. 2002. Real options: the key to values, presented in Conference on Efficiency and Productivity Growth, July 19-20.
Zaheer, S., & Mosakowski, E. 1997. The dynamics of the liability of foreignness: A global study of survival, Strategic Management Journal, 18(6): 439-463.
Zahra, S.A.,& George, G. 2001: Absorptive capacity: a review, reconceptualization, and extension. Academy of Management Review.
Zardkoohi, A. 2004. Do Real Options Lead to Escalation of Commitment? Academy of Management Review 29(1), 111-119.
127