FDI, export, and capital structure: an agency theory perspective.

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RESEARCH ARTICLE

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FDI, export, and capital structure: an agency theory perspective.

Abstract:

* This study investigates the impact of foreign direct investment (FDI) and export on capital structure for firms in emerging economies. The hypotheses are developed based on an agency theory perspective and are tested using a sample of 566 Taiwanese firms. We find that the behavior of multinational corporations (MNCs) with a high debt ratio is in line with agency theory predictions.

* Our findings show that: (1) MNCs in emerging economies, defined as those firms with at least one foreign subsidiary or some extent of FDI, have a higher level of debt than non-MNCs, which contrasts with the findings for MNCs based in developed countries; and (2) export intensity leads to a lower debt ratio, which has not received much attention in previous studies. We propose several factors related to the context of emerging economies to explain these contradictory findings.

* We also explore the interaction effect of the extent of FDI and export intensity on the capital structure of MNCs, and find that the impact is negative, which implies that both monitoring costs and agency costs rise dramatically for creditors when firms' international operations become overly complicated.

Keywords: Foreign direct investment (FDI) * Export * Agency theory * Internationalization * Capital structure * Emerging economies

Introduction

Multinational corporations (MNCs) benefit from geographical diversification through economies of scale and scope (Hitt et al. 1997). Firms that are located in relatively small home markets (i.e., emerging economies) may be forced to internationalize at an early stage to gain additional benefits from scale economies as compared to internationally diversified firms based in larger home markets (Glaum and Oesterle 2007; Hennart 2007). In addition, MNCs have monopolistic advantages related to research and development capabilities that enable them to outperform local firms in host countries (Kim and Lyn 1986); these advantages are reflected in the value of their future growth options.

Firms that engage in internationalization activities, whether they are located in developed countries or emerging economies, (1) exhibit higher demands for funding as compared to firms that restrict themselves to their domestic markets. The long-term financing problem encountered by MNC managers in developing or emerging economies is more complicated, since it encompasses multiple capital markets, capital control (e.g., foreign exchange repatriation), political risk, poor corporate governance and tax burden considerations. The paramount issue concerns how to obtain the long-term financing to pay for the international investment (export and FDI) by bringing in additional owners or by borrowing the required funds. This issue, a major concern for MNC managers, is related to the capital structure of firms: the specific mixture of long-term debt and equity the firm uses to finance its operations. Managers must consider both the percentage of financing that should be borrowed and the least expensive sources of funds for the firm. As the expenses associated with raising long-term financing are often considerable, the various possibilities must be carefully evaluated. If capital structure is not taken into account, several negative situations can arise including a higher cost of capital and a greater risk of financial distress, both of which may threaten firms' profitability and even their survival. Therefore, it is necessary to explore the impact of FDI and export on firm financing behaviors and in terms of their capital structure (Harris and Raviv 1991).

Jensen and Meckling (1976) proposed the agency theory to explain variations across firms in terms of corporate financing decisions. The agency theory attempts to model the relationship that exists when one party, the "principal", delegates its duties to another party, the "agent". Con...

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