Stock Market Reaction to Foreign Direct Investments: Interaction Between Entry Mode and Fdi Attributes

Zusammenfassung

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What is the expected reaction regarding the stock price of companies which carry out Foreign Direct Investments (FDIs)? Results from previous research focusing on specific entry modes are inconclusive. The aim of this paper is to test whether the stock market reaction to FDIs is dependent not only on the entry mode that the investing firm may have chosen, but also on the interaction between the entry mode and the other FDIs' attributes. By focusing on the recent international expansion by means of FDIs of listed Spanish firms, the researchers have found that stock market reaction to FDIs depends upon the interaction between the entry mode and the location of the investment, the identity of the investor and the latter's international experience.

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Stock Market Reaction to Foreign Direct Investments: Interaction Between Entry Mode and Fdi Attributes

Introduction

Does the internationalization of firms by means of FDIs (Foreign Direct Investments) improve the wealth of their shareholders? Empirical results are inconclusive. While some studies find a positive effect (Berry/Sakakibara 2006, Doukas/Travlos 1988, Meschi/Cheng 2002, Morck/Yeung 1992), other studies - such as Christophe's (1997) and Click and Harrison's (2000) - show exactly the opposite. Contractor et al. (2003) summarize the main results of previous research showing these mixed results. However, they also show that the relationship between multinationality and performance is more complex than initially expected and that it varies according to the phase of internationalization of the firm. Lu and Beamish (2004) recent research also supports this view. Specifically, these two papers show a S-shaped relationship between multinationality and performance with a positive slope only for medium levels of internationalization. Nevertheless, Lu and Beamish (2004) conclude that more research is needed to analyze the impact of the interaction between the entry mode chosen and other attributes of the investment on the performance consequences of FDIs.

In a recent paper, Doukas and Kan (2006) analyze the performance consequences of multinationality for both shareholders and bondholders. However, the bulk of previous research has focused on the performance consequences of FDI for firm's shareholders - for example by using event study techniques (Brown/Warner 1985, Mc Williams/Siegel 1997) to quantify the stock market reaction to internationalization decisions. Most of these studies confirm that a positive stock market reaction - in other words, positive abnormal returns1 - to a FDI only takes place when the investing firm enjoys good investment opportunities and has important intangible assets to help it overcome the liability of foreignness (Morck/Yeung 1 992, Chen et al. 2000).

Stock market reaction to two different types of FDIs, acquisitions and greenfield joint ventures (GJVs), has been analyzed in the literature. Both GJVs and acquisitions allow the foreign investor to gain access to specific resources owned by local companies. However, when analyzing stock market reaction to international joint ventures and acquisitions, some factors external to the internationalization itself should be taken into account as potentially influential. We can cite a few, for instance the intangible assets owned by the local company or, in the case of an acquisition, the price the investing firm pays for the acquired company. On the other hand, investing through both greenfield joint ventures and acquisitions implies the need to cope with additional costs which may also influence stock market reaction, such as those associated with dealing with a partner or managing the acquired company - see, for instance, Kogut and Singh (1988). However, GJVs and acquisitions do not account for all possible entry modes. As we shall argue later on, combining two logical distinctions regarding entry mode - ownership structure and the deci- sion to set up a new company or not (greenfield versus acquisition) -, up to five different types of entry mode may be identified. Not all of them have been equally analyzed in the literature on the stock market reaction to FDIs. Consequently, there is a lack of studies which analyze the entire range of entry modes.

Since there are different types of entry modes, and each of them has distinctive features...

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