Subsidiary divestment: the role of multinational flexibility.

VerfasserSong, Sangcheol
PostenRESEARCH ARTICLE

Abstract We take the multinational flexibility perspective and examine the conditions under which multinational corporations' (MNCs') foreign manufacturing subsidiaries in labor-intensive industries are not divested from their host country markets under the influence of their host country's rising labor costs. We examine in this paper the effects of intra-firm product shifts within the same MNC network on foreign subsidiary divestment. We utilize a panel of data of Korean MNCs' foreign subsidiaries in labor intensive industries and employ a Cox proportional hazard rate model as an event history analysis methodology on STATA 10. We find that intrafirm product shifts within the same MNC network reduce the probability of subsidiaries exposed to rising labor costs in their host countries being divested earlier. We also find that greater cross-country labor cost differentials and more country options in the same MNC network are helpful in facilitating intra-firm product shifts and lowering divestiture rates of the subsidiaries. Contrastingly, we find from control variables that weaker performing, smaller, and stand-alone subsidiaries, in riskier countries, facing currency appreciation, and increasing labor costs are more likely to divest. We conclude from our findings that MNCs are able to enhance multinational flexibility by using intra-firm trade connections among affiliated firms in flexible responses to cross-border cost and value differentials.

Keywords Multinational corporations * Foreign subsidiaries * Multinational flexibility * Labor cost * Intra-firm product shifts * Subsidiary divestment

1 Introduction

Foreign subsidiaries of multinational corporations (MNCs) often face fluctuations in macro-economic factors in their host tcountries. For example, changes in local currency, demand, or institutions affect their production costs and price competitiveness, and by extension, their performance and longevity (Belderbos and Zou 2009; Chung et al. 2010; Chung and Beamish 2006; Fisch and Zschoche 2011). In addition to the traditional causes for divestment, foreign subsidiaries' exposure to hostile economic conditions can lead to early exits. The exits are conducted as part of their parent MNCs' restructuring of internationally dispersed operations (Benito 2005; Haynes et al. 2003; Mata and Portugal 2000; Meinshausen and Schiereck 2012).

However, even when foreign subsidiaries are exposed to unfriendly economic conditions in their host countries, they are not necessarily targets for their parent MNCs' global restructuring via divestment. In fact, holding onto troubled subsidiaries can also be a strategic choice for MNCs. When a troubled subsidiary is operationally linked to other subsidiaries, it can adjust its production volume through its international network. The flexible adjustment reduces the need for divestment. Some foreign subsidiaries can also offer alternative production options for other subsidiaries. The switching role is more obvious at times when the operations of other subsidiaries involve heightened production costs. Based on these facts, in this paper, we examine how MNCs' foreign subsidiaries that are troubled by adverse economic conditions can be maintained instead of being divested.

Given the aforementioned issues, it is clear that structuring international investments and coordinating foreign subsidiaries is important for International Business (IB) managers. The multinational flexibility literature provides a convincing argument for the flexible structuring and coordination. It suggests that when an MNC faces cross-country costs or revenue differentials, its ability to relocate value chain activities or transfer resources among subsidiaries offers significant benefits (Belderbos and Zou 2009; Chung et al. 2010; Huchzermeier and Cohen 1996; Kogut and Kulatilaka 1994; Lee and Makhija 2009a, b). MNCs that have more switching options throughout their entire networks are more capable of taking advantage of their multinational flexibility (Huchzermeier and Cohen 1996; Lee and Makhija 2009a, b; Pantzalis et al. 2001). This capability reduces foreign subsidiary divestment even when subsidiaries face unfriendly macro-economic conditions (Chung et al. 2010; Fisch and Zschoche 2012).

Our survey suggests that, in spite of its insightful explanation of MNC foreign subsidiary divestments, the multinational flexibility literature faces two primary problems. First, while most prior research has examined the value of multinational flexibility (e.g., Allen and Pantzalis 1996; Reuer and Leiblein 2000; Tang and Tikoo 1999; Tong and Reuer 2007), studies on individual firms' behavioral choices from this perspective are still lacking. (1) As exiting a market is typically the last resort for a firm, it is necessary to pay more attention to how firms attempt to change their strategies and keep their subsidiaries viable. Only a small number of studies have examined how foreign subsidiaries flexibly adjust their businesses to changing environmental conditions in host countries prior to making divestment decisions. Second, the divestments of foreign subsidiaries relate to their positions within their international networks and their linkages with other subsidiaries at the portfolio level (Belderbos and Zou 2009; Chung et al. 2010). Therefore, subsidiary divestment decisions are not only affected by subsidiary-level factors but by network-level factors. However, prior literature on subsidiary divestment has mainly focused on the independent business situations of individual subsidiaries, rather than their positions within networks.

With these issues in mind, we examine whether foreign subsidiaries in networks of affiliated firms are less likely to divest even in unfavorable situations. We begin by addressing rising labor costs in a host country as the primary impetus for the early divestment of a foreign subsidiary. If the labor costs in a host country increase, it becomes more costly to produce goods in the country. This leads to a greater need for MNCs to reduce production by means that include subsidiary divestment. In such circumstances, MNCs can take advantage of their international networks to shift products among subsidiaries in other countries in the form of intra-firm trade. We also regard cross-border labor cost differentials as environmental factors that facilitate global intra-firm trade. Finally, we consider subsidiaries' affiliations to their parent MNCs' broader network to examine the effects of having more country options on foreign subsidiaries' flexibility in making adjustments and their divestment rates.

Using a large sample of Korean foreign direct investments (FDIs) in labor intensive industries, we find that foreign subsidiaries subject to increasing labor costs are less likely to divest when they import products from their affiliates located in other countries via intra-firm purchases. We also find that this impact of intra-firm purchases is greater in cases involving either larger cross-country labor cost differentials or broader FDI networks.

This study contributes to existing literature on foreign subsidiary divestiture by examining why and how foreign subsidiaries are not divested under hostile market conditions. It also adds value to the literature on the multinational operational flexibility perspective by examining specific environmental and organizational contexts in which MNCs' foreign subsidiaries take advantage of their multinational flexibility to cope with hostile economic conditions.

2 Theory and Hypotheses

2.1 Subsidiary Divestment: The Multinational Flexibility Perspective

Corporate divestiture is a matter of ongoing scholarly concern, since it is closely related to the performance of diversified companies (Bauer 2006; Lee and Madhavan 2010; Yan and Zeng 1999). In considering motives for and drivers of divestiture, corporate diversification theory holds that divestiture can be interpreted as a reversal of past diversification (Benito and Welch 1997; Haynes et al. 2003; Madura and Whyte 1990; Madura and Murdock 2012). Portfolio risk diversification in the areas of finance and strategic management requires the careful allocation and management of a firm's assets (Bauer 2006; Chow and Hamilton 1993; Clarke and Gall 1987; Kumar 2005).

In addition to foreign subsidiaries' internal problems including low performance (e.g., Benito 2005; Delios and Beamish 2004; Mitchell et al. 1994; Serapio and Cascio 1996), relational conflicts with partners (e.g., Bauer 2006; Das and Teng 2000; Hennart et al. 1998; Yan and Zeng 1999), unfavorable macro-economic conditions in host countries affect the longevity of foreign subsidiaries (Belderbos and Zou 2009; Fisch and Zschoche 201 l). International business researchers argue that multinational corporations should be able to adjust their portfolios of international investments in response to environmental changes (Benito 1997; Belderbos and Zou 2009; Chung et al. 2010). Unfavorable changes in a host country's macro-economic environment present a particular challenge for subsidiaries, hindering their successful operation within the country (Buckley and Casson 1998; Chung et al. 2010; Huchzermeier and Cohen 1996). For example, changes in production costs that are associated with increases in the prices of production factors, such as labor or raw materials, place huge cost burdens on foreign subsidiaries, The heightened cost pressure negatively affects their profitability and longevity (Belderbos and Zou 2009; Fisch and Zschoche 2011; Kogut and Kulatilaka 1994). Parent MNCs may regard troubled subsidiaries as targets for global restructuring, which can involve terminating the subsidiary's operations (Benito 2005; Fisch and Zschoche 2011; Hennart et al. 1998; Mata and Portugal 2000).

However, the fact that a foreign subsidiary is exposed to hostile economic conditions in its host country does not necessarily mean that it will be divested. A...

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