Value of Multinationality: Internalization, Managerial Selfinterest, Compensation

Transcription

1 Journal of Business Finance & Accounting, 29(1) & (2), January/March 2002, X Value of Multinationality: Internalization, Managerial Selfinterest, and Managerial Compensation Kenneth K. Yung* 1. INTRODUCTION The liberalization of restrictions to international capital flows and the trend toward an integrated world economy have dramatically increased foreign direct investments (FDI) by multinational corporations (MNCs) in the last three decades. The total value of global FDI was estimated at US$105 billion in By 1997 it had climbed to above US$4 trillion (source: United Nations). The vast amount of resources involved has captured the attention of academic researchers on multinational corporations. One major issue studied is the value of multinationality. 1 Existing studies have shown that there is in general a positive relationship between firm value and foreign investment activity (see e.g., Fatemi, 1984; Errunza and Senbet, 1981; and Doukas and Travlos, 1988). However, the source of the value of multinationality is inconclusive. 2 Among the proponents of the internalization theory of multinational enterprise, Morck and Yeung (1991) provide evidence and show that the value of multinationality is basically due to a MNC's ability in internalizing foreign markets for its * The author is Associate Professor of Finance at Old Dominion University, Norfolk, VA, USA. (Paper received March 2000, accepted January 2001) Address for correspondence: Kenneth Yung, Professor of Finance, Old Dominion University, College of Business and Public Administration, Norfolk, VA 23529, USA. kyung@odu.edu ß Blackwell Publishers Ltd. 2002, 108 Cowley Road, Oxford OX4 1JF, UK and 350 Main Street, Malden, MA 02148, USA. 55

2 56 YUNG intangible assets. That is, a MNC can enhance its firm value because of its ability to capture foreign markets by transferring the firm's proprietary intangible assets to foreign subsidiaries. A MNC gains a return on its intangible assets by using them to produce goods in the foreign markets. 3 Hence, according to Morck and Yeung (1991) and supporters of the internalization theory, multinationality itself does not have any value. Multinationality is valuable only when a MNC possesses R&D or advertising-related intangible assets. However, Buckley (1993) argues that internalization theory has traditionally neglected the decision-making role of management, and the principal-agent relationships within the firm. While foreign direct investment is, on average, a value-increasing activity, agency theory suggests that multinationality can also be value-decreasing. According to agency theory, the value of a firm is lowered if an investment is undertaken to promote managerial self-interest. In this regard, foreign investments can decrease the value of a MNC because the personal interest of the manager is frequently in conflict with that of the shareholders. There is ample evidence in the literature that corporate decisions are sometimes motivated by the self-interest of a manager. Amihud and Lev (1981) suggest that corporate international diversification may be intended for the diversification of management's personal portfolio rather than maximizing shareholders' wealth. Jensen (1986) and Stulz (1990) show that managerial discretion in using a firm's resources may result in the misallocation of the firm's free cash flow for promoting personal interest of the manager and cause the `overinvestment' problem. Without providing any empirical analysis, Morck and Yeung (1991) also suggest that a divergence of interests between managers and shareholders may reduce firm value in some multinational firms despite they argue that the negative effect of managerial self-interest is more than compensated for by the advantages of multinationality in exploiting intangible information-based assets. Recently, Gomes and Ramaswamy (1999) also report evidence that the relationship between multinationality and firm value is not linear and monotonic. They show that the value of multinationality can be negative beyond a certain optimum level. Given that multinationality can be value decreasing in some situations and that the role of firm management is neglected by

3 VALUE OF MULTINATIONALITY 57 the internalization theory, the objective of this study is to examine how managerial behavior would affect the value of multinationality. Specifically, we want to examine the impact of managerial self-interest on the value of multinationality. In addition, since agency theory also suggests that a divergence of interests between shareholders and managers can be aligned by effective managerial compensation, we want to examine also whether CEO compensation can effectively promote valueincreasing multinationality and mitigate the agency costs of managerial self-interest. Our results show that the internalization theory is valid for multinational corporations in general. That is, multinationality is valuable in the presence of intangible assets. When we separate the high-q (Tobin's Q > 1) MNCs from the low-q (Tobin's Q < 1) MNCs, it is found that the value of multinationality of high-q firms is due to the presence of intangible assets and enhanced by efficient spending of the firm's free cash flow, and promoted by effective managerial incentives. For low-q firms, multinationality is value-decreasing. For low-q firms, the benefit of foreign direct investments is overwhelmed by the concern of managerial self-interest. For them, investors associate spending free cash flows on multinationality with overinvestments. In addition, managerial compensation is ineffective in promoting valuable foreign investments and mitigating the agency problem of managerial self-interest. The rest of the paper is organized as follows. Section 2 discusses the value of multinationality. Section 3 presents the methodology and provides information on the data. Section 4 presents results, and Section 5 concludes the paper. 2. VALUE OF MULTINATIONALITY (i) Value-Maximization Arguments In general, multinationality is considered a firm-value enhancing activity because of the following reasons: (1) internalization of foreign markets; (2) corporate risk diversification in the imperfect world capital markets, and (3) lower production costs and/or tax advantage.

4 58 YUNG Based on the internalization theory, Morck and Yeung (1991) argue that multinationality itself does not have any significant value. They suggest that the value of multinational operation is due to the internalization of foreign markets for the firm's proprietary intangible assets. It is argued that a firm's value (as measured by Tobin's Q) increases with the degree of multinationality. This positive relationship is dependent on the firm's spending on intangibles (R&D and advertising). That is, investors value multinationality only when the firm spends money on intangible assets. Morck and Yeung further conclude that the positive relationship between firm value and multinationality indicates foreign investments is consistent with valuemaximization, and inconsistent with the managerial self-interest hypothesis which would have shown a negative relationship between firm value and multinationality. Similarly, they also present evidence that the value of multinationality is not related to corporate risk diversification or production cost/tax advantage. Another frequently cited benefit of multinationality is the improvement of investor's risk-return opportunities. Given the institutional constraints on international capital flows, information asymmetries, or other reasons, investors may be prevented from optimally diversifying their portfolios internationally in a direct manner. Multinational corporations give shareholders international diversification opportunities via their direct investments abroad. Evidence on this benefit has been abundant (see e.g., Solnik, 1974; Agmon and Lessard, 1977; and Fatemi, 1984; among others). (ii) Managerial Self-Interest The arguments of internalization, corporate risk diversification, and production cost/taxation advantage are consistent with the firm value-maximization hypothesis. However, agency theory suggests that foreign direct investments can be value-decreasing if the investments are undertaken to promote managerial selfinterest. There is ample evidence in the literature that corporate decisions are sometimes motivated by the self-interest of a manager. Amihud and Lev (1981) suggest that corporate international diversification may be intended for the diversi-

5 VALUE OF MULTINATIONALITY 59 fication of management's personal portfolio rather than maximizing shareholders' wealth. Jensen (1986) suggests that some managers would rather expand firm size for personal interest rather than returning the free cash flow of the firm to shareholders in the form of higher dividend payments. Shleifer and Vishny (1989) postulate that some investment decisions are simply undertaken to increase a firm's dependence on its incumbent management. Stulz (1990) also shows that given managerial discretion in using a firm's resources, firms with high free cash flows tend to suffer from the `overinvestment' problem. Even Morck and Yeung (1991) agree that managerial self-interest may reduce firm value in some multinational firms despite they argue that the negative effect is more than compensated for by the advantages of multinationality. While agency theory postulates that managerial self-interest can decrease firm value, the theory also suggests that a divergence of interests between shareholders and managers can be aligned by effective managerial compensation. Agency theory predicts a positive relationship between a manager's compensation and his firm's performance. 4 Jensen and Murphy (1990) find a marginally significant positive relationship between CEO compensation and firm performance in many industries. Carroll and Ciscel (1982) and Joskow et al. (1993) observed the same phenomenon among regulated firms. Recently, Hermalin and Wallace (1997) find a strong positive relationship between executive pay and firm performance that is 2.8 times larger than that found using previous methods. 3. DATA AND METHODOLOGY (i) Data Firms with significant foreign direct investments are usually multinational corporations. As a result, the sample for this study includes the major US-based multinational corporations listed in the CIFAR Global Company Handbook published in The handbook publishes the names of multinational firms by country. The sample is then cross-examined with the various issues of the World Directory of Multinational Enterprises, the Moody's Directory of

6 60 YUNG Corporate Affiliation and the Moody's Industrial Manual. Analyses are performed for years 1992, 1994, and 1996 in order to test for the robustness of the results. Year-end financial data are obtained from the Standard and Poor's Compustat database. CEO compensation information is obtained from Fortune magazine's annual survey of chief executive compensation and supplemented by similar surveys of Forbes magazine. Information regarding foreign assets is obtained from the Disclosure Worldscope database. After eliminating all those with missing data, 207 US MNCs remain in the sample. The sample size is comparable to the 287 of Jorion (1990) and the 213 of Chow, Lee and Solt (1997). (ii) Methodology Following Morck and Yeung (1991), we start with a base model which suggests that the value (Tobin's Q) of a multinational firm is affected by the firm's degree of foreign direct involvement and investments in intangible assets, among others. Q ˆ 0 1 MN 2 R&D 3 ADV 4 DEBT 5 SIZE i INDUSTRY I "; 1 where: Q ˆ Tobin's Q ratio as measured by the Chung and Pruitt (1994) equation; 5 MN ˆ degree of multinational involvement. We use 2 proxies to measure this variable, namely: (1) number of subsidiaries abroad; and (2) ratio of foreign assets to total assets; R&D ˆ research and development spending per dollar of tangible assets; ADV ˆ advertising spending per dollar of tangible assets; DEBT ˆ book leverage as measured by dividing the book value of debt by total assets. It is included as a control variable for variation in firm values due to differences in capital structure; SIZE ˆ firm size as measured by the log of total assets. Firm size is a control variable for any possible scale effects;

7 VALUE OF MULTINATIONALITY 61 INDUSTRY ˆ a 2-digit SIC dummy variable to control for industry effects. In the base model, the variable MN will have a significant positive coefficient if multinationality is beneficial. The benefits could be corporate risk reduction, internalization of foreign markets, or lower production costs. R&D, ADV and DEBT are expected to have significant positive coefficients regarding their impacts on the Q-value. The internalization theory predicts that the positive coefficient 1 in equation (1) should be larger for firms with higher R&D and ADV spending. On the other hand, agency theory suggests that managerial self-interest will have a negative impact on the value of multinationality. In addition, agency theory also predicts that effective managerial compensation will promote valueenhancing foreign direct investments and mitigate the agency cost of managerial self-interest. Hence, we postulate that the value of multinationality ( 1 *MN) is a function of the firm's R&D and ADV expenditures and at the same time affected by managerial self-interest and the CEO compensation. The following equation expresses this argument: 1 ˆ 0 1 R&D 2 ADV 3 FCF 4 COMP; 2 where: FCF ˆ free cash flow of the firm as computed by the Lehn and Poulsen (1989) equation. Similar to Lang, Stulz and Walking (1991), the free cash flow is normalized by total assets since the same dollar cash flow has different implications for firms of different sizes. We follow existing literature in using FCF as a proxy for measuring managerial self-interest; 6 COMP ˆ CEO compensation package (salary, bonus, and long-term incentives) reported in Fortune or Forbes annual surveys. Following Sloan (1993), it is expressed as the change in the log of the compensation value in order to examine the incentive effect. 7 Substituting equation (2) into equation (1) yields a new regression model containing cross products of the variable MN

8 62 YUNG with R&D spending, advertising expenditure, free cash flow, and CEO compensation: Q ˆ 0 0 MN 1 MN*R&D 2 MN*ADV 3 MN*FCF 4 MN*COMP 2 R&D 3 ADV 4 DEBT 5 SIZE i INDUSTRY I ": 3 Equations (1) and (3) 8 are employed for performing our analyses using 1992 data. As mentioned earlier, in order to test for the robustness of our results, we also use years 1994 and 1996 for similar tests. In addition, we separate our sample into subcategories, namely, those with a Tobin's Q higher than 1 and those with a Q lower than 1. We believe such a delineation will yield better insights since it is well documented that firms with a Tobin's Q larger (smaller) than 1 is in generally a good (bad) firm. 4. RESULTS Table 1 reports the selected descriptive statistics of our sample based on the 1992 data. As a whole, the sampled multinational corporations have a mean Tobin's Q value of 1.37, indicating that they are, on average, relatively well managed operations. However, the large range of the Q ratios suggests that some MNCs (those with a Q value less than 1) are quite inefficiently managed relative to others. A leverage ratio of 0.35 is in line with the average of the manufacturing firms in the US. A close examination of the 207 MNCs in our sample shows that more than 70 percent of them are involved in manufacturing businesses. The R&D spending, on average, is about three percent of tangible assets. The advertising expenditure is about two percent of tangible assets. These numbers are comparable to the average figures reported in Morck and Yeung (1991). The average size of the free cash flow is 18 percent of total assets, with a minimum of one percent and a maximum of 29 percent. We follow existing studies in using free cash flow as a proxy for managerial self-interest (e.g., Jensen, 1986; and Stulz, 1991). A positive relationship between a firm's investment decision and free cash flow suggests that the action may be motivated by

9 VALUE OF MULTINATIONALITY 63 Table 1 Descriptive Statistic of Selected Variables of 207 US-MNCs in 1992 Mean Std.Err. Min. Max. Q-value Leverage Size R&D ADV FCF F. Assets # foreign subsid COMP ($mm) Notes: 1. Q-value is the Tobin's Q value measured by the Chung and Pruitt (1994) equation. 2. Leverage is the book leverage. It is measured as the book value of debt divided by total assets. 3. Size is firm size as measured by the log of total assets. 4. R&D is the R&D spending per dollar of tangible assets. 5. ADV is advertising expenditure per dollar of tangible assets. 6. FCF is free cash flow based on the Lehn and Poulsen (1989) equation. It is scaled by total assets. 7. F. assets is the ratio of foreign assets to total assets. 8. # foreign subsid. is the number of foreign subsidiaries owned by a multinational firm. 9. COMP is the total CEO compensation (salary, bonus, and long-term incentives) reported in annual surveys of Fortune or Forbes magazine. managerial self-interest. The average CEO total compensation in 1992 was $1.68 million dollars. This is much larger than the $0.94 million dollars reported in Barber et al. (1996). We think it is due to the larger number of smaller firms in their sample of 1,249 firms. The 207 firms in our sample are primarily large US MNCs. The range of CEO compensation is considerable. The maximum CEO compensation in 1992 was $14.94 million and belonged to the chief executive of General Electric. Regarding their foreign investments, each MNC has 20 foreign subsidiaries on average. Morck and Yeung reported an average of only four. Again, the difference is mainly due to their sample selection. Their sample includes 1,644 firms which probably consists of a larger number of smaller firms also. The average foreign assets to total assets ratio is 0.23, indicating that the sampled firms are quite active in foreign direct investments. In Table 2, we report regression results of the base model on the relationship between a firm's Q-value and the selected independent variables. In this model, the variable multi-

10 64 YUNG Table 2 The Base Model: Relationship Between Q-Value and Multinationality, Among Other Selected Variables Using 1992 Data (Multinationality is measured by the number of foreign subsidiaries) All Firms n ˆ 207 Q > 1 n ˆ 121 Q < 1 n ˆ 86 Intercept (2.81)** (3.08)* (2.39)** MN (3.68)* (4.13)* (1.70)*** R&D (3.16)** (3.22)** (2.95)** ADV (0.88) (1.10) (0.94) Size (0.73) (0.31) (0.55) Leverage (2.09)** (2.05)** (3.05)* Adjusted R-square Notes: * significant at 1%. ** significant at 5%. *** significant at 10%. nationality (MN) is measured by the number of foreign subsidiaries. For the entire sample of 207 MNCs, MN has a significantly positive coefficient at the one percent level. It indicates that multinationality adds value to a firm. This result is consistent with that reported by Morck and Yeung. Note that at this point, we have not yet made any postulation regarding the source of the positive value of multinationality. The answer will be sought in later regression results. And consistent with many existing studies, R&D spending and leverage are significantly positively related to firm value (Q-value). The coefficient for advertising is positive but insignificant. However, this is consistent with the results of Morck and Yeung (1991). On the other hand, firm size has an insignificant coefficient. For those firms with a Q-value higher than one, the regression results in Table 2 are quite similar to those for the entire sample. Multinationality is valuable, and R&D spending and leverage are positively related to the Q-value. For firms with a Q-value lower

11 VALUE OF MULTINATIONALITY 65 than one, it is now observed that multinationality (MN) has a negative coefficient significant at the 10 per cent level. In other words, foreign direct investments of low-q firms actually decrease firm value. The documentation of a negative impact on firm value due to multinationality is not very often in the literature. It may be because existing studies have seldomly divided the high-q firms from their low-q counterparts in this line of research. While Morck and Yeung (1991) also report a negative coefficient for multinationality in some of their regressions, their results are not statistically significant and they have not separated the high-q firms from the low-q firms. Doukas (1995) also reports a negative but insignificant two-day announcement effect of the foreign acquisitions of low-q firms. Hence, our finding of a statistically significant (despite at the 10 percent level only) negative impact of foreign activities on firm value is a rather important new observation. We will come back to examine this more closely in later analyses. Similar to the high-q firms, the coefficients for R&D spending and leverage are significantly positive for the low- Q firms. Coefficients for firm size and advertising are insignificant for low-q firms. Table 3 also reports regression results of the base model on the relationship between a firm's Q-value and the selected independent variables. The difference in Table 3 is that the variable multinationality (MN) is now measured as the ratio of foreign assets to total assets. We use this ratio to proxy for multinationality instead of the ratio of foreign sales to total sales in order to mitigate the problem of mixing international trade and investment (see Reeb, Kwok and Baek, 1998). Results in Table 3 are very similar to those reported in Table 2. For the entire sample and the high-q firms, multinationality adds value to the firm; and R&D and leverage are also positively related to firm value. Similar to earlier results, multinationality is valuedecreasing for low-q firms despite it is only marginally significant at the 10 percent level in this case. Advertising expense and firm size are insignificant in all the regressions in Table 3. In Table 4, we report the regression results of equation (3). Here, we examine the impacts of internalization, managerial selfinterest, and managerial compensation on the value of multinationality. In Table 4, multinationality is measured as the number of foreign subsidiaries. First of all, we will explain the

12 66 YUNG Table 3 The Base Model: Relationship Between Q-Value and Multinationality, Among Other Selected Variables Using 1992 Data (Multinationality is measured by the ratio of foreign assets to total assets) All Firms n ˆ 207 Q > 1 n ˆ 121 Q < 1 n ˆ 86 Intercept (2.52)** (2.78)* (2.30)** MN (3.56)* (3.69)* (1.63) R&D (3.26)** (3.37)** (2.91)** ADV (0.93) (1.23) (1.01) Size (0.56) (0.44) (0.71) Leverage (2.23)** (2.21)** (2.35)** Adjusted R-square Notes: * significant at 1%. ** significant at 5%. *** significant at 10%. results for the entire sample. It is found that multinationality (MN) has a positive but insignificant coefficient. Such a change from a statistically significant variable (in Tables 2 and 3) to a statistically insignificant variable is also observed by Morck and Yeung after several independent (interactive) variables are added to the regression equation. The insignificant coefficient for MN means that multinationality itself does not possess value. According to Morck and Yeung, it also implies a negation of the risk-diversification and the lower production cost arguments regarding the value of multinationality. Otherwise, multinationality should have a significant positive coefficient given the benefits of corporate risk reduction and/or the cost advantage due to the firm's foreign operations. Coefficients for R&D, ADV, leverage, and firm size are similar to those obtained in Tables 2 and 3. However, our interest is on the interactive terms, MN*R&D, MN*ADV, MN*FCF, and MN*COMP. These

13 Table 4 The Extended Model: Relationship Between Q-Value and Multinationality, Among Other Interactive Variables Using 1992 Data (Multinationality is measured by the number of foreign subsidiaries) All Firms n ˆ 207 Q > 1 n ˆ 121 Q < 1 n ˆ 86 Intercept (2.45)** (2.67)* (1.97)** MN (1.37) (0.46) (1.95)** R&D (2.32)** (2.88)** (2.01)** ADV (0.62) (0.79) (0.38) Size (0.41) (0.70) (0.75) Leverage (2.15)** (2.07)** (2.33)** MN*R&D (1.93)** (2.41)** (2.01)** MN*ADV (1.36) (0.99) (0.82) MN*FCF (1.23) (2.20)** (2.35)** MN*COMP (0.89) (1.67)*** (1.22) Adjusted R-square Notes: * significant at 1%. ** significant at 5%. *** significant at 10%. VALUE OF MULTINATIONALITY 67 interactive terms help us determine the impacts of internalization and managerial self-interest, and the incentive effect of managerial compensation on multinationality. For the entire sample, the coefficient for MN*R&D is positive and significant. It implies that while multinationality itself does not possess any value, investors consider multinationality a valuable asset when the MNC has intangible assets such as R&D spending. According to the internalization theory, the possession of intangibles allows a multinational firm to internalize foreign

14 68 YUNG markets for its predominantly proprietary assets. Hence, our results support the internalization theory. The coefficient for MN*ADV is insignificant. It implies investors value R&D expenditure but not advertising spending of multinational firms. A possible reason is that given today's easy access to information, advertising for brand awareness is sometimes not value-enhancing. The coefficient for MN*FCF is positive but insignificant, suggesting that investors are indifferent when a firm spends its free cash flow on multinationality. According to the hypothesis of managerial self-interest, we would have expected a negative coefficient if the multinationality represents overinvestments to promote self-interest of the manager. However, the insignificant coefficient for MN*FCF obtained suggests that some of the investments on multinationality are not overinvestments. This is probably due to the fact that more than half of the sampled MNCs is relatively well managed firms (Q-value > 1). Thus, it is possible that the concern of managerial self-interest has been mitigated. The coefficient for MN*COMP is positive but insignificant, implying that managerial incentive does not effectively promote valueenhancing foreign investments. This is consistent with the results of Jensen and Murphy (1990), among others, that firm value is quite insensitive to managerial compensation. Separating high-q firms from low-q firms provides more interesting and meaningful observations in Table 4. For the high-q firms, the variable MN itself again is insignificant. R&D spending and leverage are again significantly positive whereas firm size and advertising expense remain insignificant. Similar to the overall sample, coefficient for the interactive term, MN*R&D, is significantly positive. That is, investors of high-q firms consider multinationality valuable when intangible assets such as R&D are present. This again lends support to the internalization theory. On the other hand, the coefficient for MN*ADV is insignificant. For high-q firms, the coefficient for MN*FCF is positive and significant at the five percent level. This implies that investors consider the spending of free cash flow on multinationality by high-q firms valuable investments instead of overinvestments. That is, for high-q MNCs, either the managerial self-interest argument does not apply or the concern is totally mitigated. In addition, the coefficient for MN*COMP is also positively

15 VALUE OF MULTINATIONALITY 69 significant, despite only at the 10 percent level. It suggests that for high-q firms, managers can be motivated by effective incentive to pursue value-enhancing foreign investments and further mitigates the potential of managerial self-interest. For low-q firms, results in Table 4 show that coefficient of multinationality (MN) is significantly negative. That is, multinationality is value-decreasing for low-q firms. The cause of this negative impact on firm-value can be explained by examining the various interactive variables. For MN*R&D, the coefficient is significantly positive at the 5 percent level while the coefficient for MN*ADV is insignificant. The results suggest that the internalization theory is also valid for low-q firms. That is, proprietary intangible assets such as R&D will lead to valuable foreign investments. However, the coefficient for MN*FCF is significantly negative at the 5 percent level. This suggests that investors associate the spending of free cash flow on foreign investments by low-q firms with the problem of overinvestments. In other words, investors are concerned about the problem of managerial self-interest among low-q firms. The coefficient for MN*COMP is negative but insignificant. It further indicates that for low-q firms, managerial incentive is ineffective to motivate value-enhancing foreign investments. In sum, the value of multinationality of high-q firms is due to the presence of intangible assets such as R&D (internalization theory) and enhanced by efficient spending of the firm's free cash flow and also promoted by effective managerial incentives. Whereas for low-q firms, multinationality is value-decreasing. For low-q firms, the benefit of internalizing foreign markets is overwhelmed by the concern of managerial self-interest. For them, investors associate spending free cash flows on foreign investments with overinvestments. In addition, managerial compensation is ineffective in promoting valuable foreign investments and mitigating the agency problem of managerial self-interest. Table 5 reports analyses similar to those in Table 4. The difference is that in Table 5, multinationality (MN) is measured by the ratio of foreign assets to total assets. Results are very consistent with those in Table 4. For high-q firms, multinationality is valuable in the presence of intangible assets such as R&D and benefited from the efficient spending of the

16 70 YUNG Table 5 The Extended Model: Relationship Between Q-Value and Multinationality, Among Other Interactive Variables Using 1992 Data (Multinationality is measured by the ratio of foreign assets to total assets) All Firms n ˆ 207 Q > 1 n ˆ 121 Q < 1 n ˆ 86 Intercept (2.09)** (3.10)* (2.15)** MN (1.13) (0.51) (2.09)** R&D (2.28)** (2.57)** (2.02)** ADV (1.16) (0.80) (0.45) Size (0.62) (0.51) (0.33) Leverage (3.14)* (2.11)** (2.39)** MN*R&D (1.91)** (2.37)** (1.99)** MN*ADV (0.77) (0.94) (1.21) MN*FCF (1.30) (2.40)** (2.61)** MN*COMP (1.09) (1.73)*** (1.35) Adjusted R-square Notes: * significant at 1%. ** significant at 5%. *** significant at 10%. firms' free cash flows and also promoted by the firms' effective managerial incentive programs. For low-q firms, the value of multinationality is overcome by the concern of managerial selfinterest given ineffective managerial incentive. Our results might have been affected by transitory macroeconomic factors such as exchange rates or stock market fluctuations. To test for the robustness of our results, we perform our analyses using 1994 and 1996 data also. Results are reported

17 in Table 6. Since our interest is on the impacts of intangible assets, managerial self-interest, and managerial incentive, Table 6 only summarizes the information of these salient variables. For the 1994 data, the general pattern of the results is very similar and consistent with those reported in Tables 4 and 5. The only Table 6 The Extended Model: Relationship Between Q-Value and Multinationality, Among Other Interactive Variables (Multinationality is measured by the ratio of foreign assets to total assets) Panel A: Using 1994 Data All Firms Q > 1 Q < 1 MN (1.31) (1.47) (3.09)* MN*R&D (2.16)* (2.98)* (2.23)** MN*ADV (1.59) (1.70)*** (1.21) MN*FCF (1.51) (1.99)** (2.97)** MN*COMP (1.09) (1.73)*** (1.02) Panel B: Using 1996 Data All Firms Q > 1 Q < 1 MN (1.15) (1.07) (3.39)** MN*R&D (3.11)** (1.96)** (2.07)** MN*ADV (0.77) (0.28) (0.68) MN*FCF (1.38) (2.07)** (3.56)** MN*COMP (1.05) (1.70)*** (0.41) Notes: * significant at 1%. ** significant at 5%. *** significant at 10%. VALUE OF MULTINATIONALITY 71

18 72 YUNG difference is that for high-q firms the coefficient for MN*ADV is now positive and significant at the 10 percent level. That is, investors consider both R&D and advertising spending by high-q firms value-enhancing for their foreign activities. Results for the 1996 data are also consistent with those reported in Tables 4 and 5. Thus, our results are quite robust and not affected by transitory macroeconomic factors. 5. CONCLUSIONS The internalization theory suggests that the value of multinationality is due to a multinational corporation's ability in internalizing foreign markets for its intangible assets. However, the role of the firm manager has been totally ignored by the theory. Thus, we examine the impact of managerial self-interest on the value of multinationality. Our results support the internalization theory for multinational corporations in general. In addition, it is found that for high-q (Tobin's Q > 1) firms, investors do not associate the spending of free cash flow on multinationality with the problem of overinvestments. For low-q firms (Tobin's Q < 1), it is found that the concern of managerial self-interest overwhelms the benefits of internalization, making multinationality a valuedecreasing event. Since agency theory also suggests that a divergence between the interests of managers and shareholders can be aligned by effective managerial incentive, we also examine the effect of managerial compensation on the value of multinationality. For high-q firms, it is found that the value of multinationality can be enhanced by effective managerial incentives despite the effect is only marginal at the 10 percent level. However, for low-q firms, managerial compensation is ineffective in promoting value-enhancing foreign direct investments. NOTES 1 Throughout the text, multinationality and foreign direct investment have the same connotation. 2 The major hypotheses include: (1) internalization of foreign markets; (2)

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