Being Global Adds to Firm Value, Research Shows

Dec. 4, 2009 - PRLog -- Dallas (SMU) – Why might Apple, Coca Cola and Nike offer their shareholders better value? Because they are global firms. New research by Finance Professor Amar Gande of SMU Cox reveals that globally diversified firms are valued more highly by financial markets, and in comparison to firms diversified across business lines or industrially-diversified. These firms reap benefits from their advertising and R&D expenses courtesy of their global presence; they "complete the market" on the financial side, giving investors access to foreign markets. Also, the research helps explain why firms from developing countries like India would want to access developed countries' markets.

The paper “Valuation Effects of Global Diversification” by Amar Gande of SMU Cox and co-authors is forthcoming in Journal of International Business Studies. A summary follows.

Firms With Global Presence Valued Higher

Firms such as Coca-Cola, P&G and Apple understand that being diversified globally adds value to their firm. Other types of firms such as conglomerates diversify industrially, across business lines, and globally, across countries.  Interestingly, firm value increases more through global diversification than from being diversified across business lines, according to new research by Finance Professor Amar Gande and co-authors. His forthcoming paper reveals how global diversification benefits firms and investors alike.

Global diversification adds value to firms in several ways. On the financial dimension, firms get a boost in value from being diversified internationally.  A multinational firm “completes the market” in a financial sense by allowing its shareholders indirect access to a foreign country. Gande explains, “Consider that I am a U.S. investor buying stock in a multinational firm, such as Coca Cola. “Coke” probably has a market presence even in foreign countries where no stock market exists, and in countries that have information barriers or investment restrictions, such as capital controls. Investing via a multinational firm offers its shareholders indirect access to those foreign countries.” Most academic literature neglects the “financial” side and focuses mainly on the “real” side of global diversification.

The other aspect that drives firm value higher for diversified firms stems from the “real” side of a firm. Firms possessing intangible assets such as R&D and advertising can “internalize the market” for those assets. “Apple, with its advertising accomplishments and R&D, will be valued higher because of these intangible assets,” Gande suggests. “A global firm that has a presence in many foreign countries can both leverage and recuperate those costs relatively quickly – similar to the idea of economies of scale. Having these types of intangible assets gives a global firm more opportunities to internalize (or give value to) those assets.” Firms such as Microsoft, Apple and Nike with intangibles can realize increased firm value from global diversification.

The Diversification Choice
Facing the choice to diversify globally or industrially, what strategy should the firm choose? The evidence suggests that a firm is better off from a valuation perspective to diversify internationally rather than across industries. “Conceptually, global diversification is much different than industrial diversification,” states Gande. “If a firm operates only in the US, it will not get the benefit of completing the market for its shareholders.”

Prior research looked at this global-industrial diversification issue in an overly-simplistic viewpoint.  Some observers have claimed that a firm which focused in more than one segment would stray from its core competencies; it would therefore be less valued owing to a lack of focus -- both global and industrial diversification are bad. . There are other papers that state while global diversification could be valuable, the source of those benefits is the real dimension (i.e., intangibles) and not the financial dimension (i.e., of completing the market). Gande and co-authors wanted to sort out the conflicting viewpoints.  Gande says global and industrial diversification are quite different. The drivers of value and benefits come from both real and financial dimensions for the globally-diversified firm, whereas it only comes from the real dimension for an industrially-diversified firm. One takeaway: if you had to pick one, you should probably pick global diversification, says Gande.

Firms reaching the decision tree of expansion arrive there because they have grown to a certain level or size. Gande re-iterates, “If you want to expand, then our paper would say you should go into foreign markets to enhance firm value.” But there is a catch that pertains to emerging markets and corporate governance, particularly with respect to creditor rights. “In countries with a poor investor protection regime,” he adds, “you lose the benefits of global diversification. In fact, the benefits gained from global diversification may be completely eliminated by weak institutions.”

Gande offers, “If the firm has a choice, then diversify abroad; if you have a further choice, then diversify into countries with better governance.” The findings offer support for the pre-financial crisis trend of emerging market firms expanding globally into more developed countries.

The Coca-Colas and P&Gs realize the full benefits of global diversification. “Their investors receive higher returns over time from being aligned with such a multinational,” Gande says. “If a manufacturing company could enter into new markets that investors cannot access, they bring something more to the table in terms of diversification benefits to its investors.  In the 1980s, Gande recalls the ‘old-style, homemade’ diversification strategy of simply owning multinational stocks, before all of today’s global indices were in vogue: “Instead of buying into countries about whom we were unfamiliar, we recognized that these multinationals knew what they were doing…” Food for thought.

About SMU Cox
SMU’s Cox School of Business offers a full range of business education programs, including BBA, full-time MBA, Professional MBA (PMBA), Executive MBA (EMBA), Master of Science in Management (MSM), and Executive Education. The school also offers a number of unique resources and activities for students, ranging from its Business Leadership Center (BLC), Caruth Institute for Entrepreneurship, Maguire Energy Institute, and American Airlines Global Leadership Program (AAGLP) to its Associate Board Executive Mentoring Program and an international alumni network with chapters in more than 20 countries. SMU Cox is ranked among the top business schools nationally and internationally by major publications, including BusinessWeek, The Economist, Financial Times, Forbes, The Wall Street Journal, and U.S. News & World Report.