Capital Structure with Risky Foreign Investment

Transcription

1 Capital Structure with Risky Foreign Investment March 2006 Washington DC Emerging Markets Conference Mihir Desai C. Fritz Foley James R. Hines Jr. Harvard & NBER Harvard & NBER Michigan & NBER Motivation (1) Exposure to political risk is a central consideration in financing investments in emerging markets. With a greater reliance on foreign operations, multinational firms are increasingly facing exposures associated with political risk How are greater political risks manifest in returns? How do these risks influence financing choices? 2 1

2 Motivation (2) An empirical investigation of multinational firms can offer evidence on the effects of business risks on capital structure more broadly These effects of risk on financing choices have proven elusive to identify despite practitioner views Differences among multinational firms in exposures to country risk can help identify effects of business risk on capital structure. 3 Preview of Results A simple model of MNC financial decision-making yields distinct predictions for subsidiary and domestic capital structure Greater political risk is associated with greater return volatility and more negative outcomes for MNC affiliates Leverage of local affiliates is higher in politically riskier countries Risk-mitigation efforts extend to operational decisions including shared ownership and the export/fdi decision Domestic leverage decreases as foreign political risk rises as does firmwide leverage 4 2

3 Relation to the literature Capital structure and business risks Harris and Raviv (1991), Opler, Pinkowitz and Stulz (1999), Graham and Harvey (2001) Emerging markets finance - return experiences and role of politics (Bekeart & Harvey) - property rights vs contractual institutions (Acemoglu & Johnson) FDI motivations and local market conditions - Horizontal vs Vertical FDI (Helpman (1984), Helpman, Melitz & Yeaple (2004) - Intrafirm transactions in response to local market imperfections (Desai, Foley & Hines; Desai, Foley & Forbes ) 5 MNC financial decision-making and political risk In a simple model of costly external finance and differential pricing of risk by local lenders, firms will employ higher debt ratios for investments in risky countries. This increase in leverage at the subsidiary level may be offset by reduced leverage at parent level given increased overall risk exposure. Overall leverage should decline but there is significant shifting to local lenders. 6 3

4 Data BEA USDIA Survey Results Data cover period Most extensive data in benchmark years (1982, 1989, 1994, 1999) Data from different countries reported following GAAP FIRE industries excluded Affiliate Specific Volatility Use affiliates reporting in all years between two benchmark years Compute standard deviation of profits over those samples and share of negative outcomes Affiliate Leverage Analyze ratio of current liabilities and LTD to assets Consider effects of treating cash as negative debt 7 Data Political Risk is average of monthly index of political risk presented in International Country Risk Guide Shares of firm activity in politically risky environments Compute share of total firm sales, employment, net PPE in countries with above median levels of political risk Domestic or Firmwide Leverage Analyze ratio of current liabilities and LTD to assets Consider effects of treating cash as negative debt and removing trade credit 8 4

5 Does political risk influence volatility of earnings? T2 * Going from Canada to Mexico increases STDEV of returns by 12.8% of mean value and increases likelihood of negative returns by 21.6% 9 Does political risk change subsidiary capital structure? T3 * Significant effects on affiliate leverage that are robust to viewing cash as negative debt 10 5

6 Does political risk change other operational decisions? T4, T5 * Risk mitigating efforts extend to a greater willingness to share ownership and serve foreign customers through exports rather than local production 11 Does political risk change domestic capital structure? T6 * A one STDEV change in foreign risk exposures reduces domestic leverage by 3.8% of mean value Effects are robust to cash and trade account considerations 12 6

7 Does political risk change firm-wide capital structure? T7 * And these effects are large enough to overturn affiliate effects so firm-wide leverage is reduced 13 Implications/Conclusions There appear to be significant effects of risk exposures on financing choices. Specifically, there is considerable risk shifting to local lenders and reduced overall leverage within the multinational group. These patterns, that appear in the foreign risks of U.S. multinational firms, are suggestive of: * effects on local firms * reactions to risk that may appear in other contexts. 14 7