Foreign direct investment and shareholders’ wealth: Evidence from the newly industrialized countries (NICS)
Ueng, C Joe
This study investigates the wealth effect of foreign direct investment (FDI) by U.S. multinationals in four Asian newly industrialized countries (NICs)- South Korea, Taiwan, Singapore, and Hong Kong. In addition, it examines wealth effects of two different types of FDI: wholly-owned subsidiary (FDI) and international joint venture (IJV).
Results show that shareholders of U.S. MNCs benefit from the FDI in four Asian NICs. Stock prices of U.S. MNCs increase significantly surrounding the announcement dates of FDI. Both types of FDIwholly-owned subsidiary and international joint venture- in NICs by U.S. MNCs are wealthincreasing activities for their shareholders.
INTRODUCTION A great deal of research has documented the positive wealth effect from overseas expansion (Lessard 1973; and Logue 1982). The wealth effects of those activities depend on the type of expansion and the destination countries. Exporting and licensing could result in different effects than foreign direct investment ( FDI)either through wholly owned subsidiary (WOS) or international joint venture (IJV). The destination countries in which multinationals (MNCs) operate could also have an impact on the shareholders’ returns. The main purpose of this paper is to investigate the stock valuation effects of FDI into the four Asian Newly Industrialized Countries (NIC)South Korea, Taiwan, Singapore, and Hong Kong -on U.S. MNCs ‘ shareholders. Additionally, wealth effects from two different types of FDI-wholly owned subsidiary (WOS) investment and international joint venture (IJV)are compared based on the abnormal returns accrued to firms engaged in these activities. To do so, we examine the market reactions to the announcements of FDI. The results show that overall investors react favorably to FDI in NICs. The abnormal returns surrounding the announcement dates of FDI are significantly positive. When looking at the type of FDI, both WOS and IJV deliver positive stock price reactions around the announcement dates of the FDI by US MNCs in NICs. We do not find a significant difference between two types of FDI in terms of wealth effects. This paper is organized as following. Section 2 presents the prior literature related to the wealth effects of FDI activities on the shareholders wealth. Section 3 presents the data collection and event study methodology. Section 4 provides the empirical results. Finally, Section 5 concludes the study.
LITERATURE REVIEW Numerous studies have reported that international expansion is beneficial to shareholders of firms engaged in such activities. A recent paper by Morck and Yeung (1991) maintains that internationalization creates incremental wealth for multinationals engaged in those activities. The wealth created from such activities derives from a variety of sources. For example, international diversification could result in decline in the firm’s overall risk (Solnik 1974). Therefore, it subsequently increases the firm’s value. Lummer and McConnell (1990) document that internationalization through an IJV generates positive wealth for the shareholders of MNCs engaged in such activities. In their recent paper, Mathur and Waheed (1991) document that investors are indifferent to the degree of industrialization of the host countries when firms expand overseas. Lee and Wyatt (1990) report that the overall markets’ reactions to IJV are negative and that only joint ventures with lesser developed countries have nonnegative effects on the firm’s value. The implication of these studies is that the economic development of the countries where U.S. MNCs invest may have the impact on the FDI success. This study attempts to examine the wealth effects of FDI on the shareholders’ wealth. It differs from previous works in that it focuses on four Asian emerging markets. It attempts to provide further evidence on the US MNCs FDI wealth effects by examining four Asian NICs: South Korea, Taiwan, Singapore, and Hong Kong. Furthermore, this study examines whether the difference of wealth effect between two types of FDI- WOS and IJV is different. DATA COLLECTION AND METHODOLOGY The sample analyzed in this study consists of U.S. manufacturing firms engaged in four Asian NICs over the period from 1980 through 1994. Data was collected from the Wall Street Journal Index. Firms that announced investments in four Asian NICs were included in the study. To be included in the sample, the following criteria were further utilized: 1. Firms must be traded on the NYSE or AMEX at the time of the announcement date.
2. To avoid the possible contamination effects, no major event other than the expansion announcements took place during the test period. 3. Stock return information from the Center for Research in Security Prices (CRSP) 300 days before the announcement date must be available to those firms. During the time period between 1980 and 1994, a sample of 76 announcements was collected and analyzed in this study. Standard event study type methodology was utilized. The market model below was employed to analyze the stock market reaction to the FDI announcements. During the test period, one day before and one day after the announcement date, the residuals for each company, Iii, were calculated as The parameters were estimated from equation (1) over the period t = -150 days to t = -30 days relative to the announcement date. The estimation period allowed generation of reliable parameters in the market model. The average abnormal return for day t, ARt, was estimated as N is the total number of firms in the sample. Cumulative average abnormal returns, CART, up to date T were calculated as To examine the wealth effect from the FDI announcements, the cumulative abnormal returns (CARs) were calculated. The announcement date was the date the firms first publicly announced the FDI in the Wall Street Journal. Several event windows were utilized to measure the market reaction to the announcements. Hypotheses in This Study Various studies have documented that international diversification benefits shareholders for a variety of reasons. The first hypothesis in this study, therefore, is that mean event abnormal return should be significantly positive. Hypothesis 1: The mean event abnormal return to firms that announce a direct investment in Asian NICs is significantly positive. Accordingly, the mean event abnormal returns to firms that either announced wholly owned operations or joint ventures into Asian NICs are hypothesized significantly positive. Hypothesis 2: The mean event abnormal return to firms that announce wholly owned operations in Asian NICs is significantly positive. Hypothesis 3: The mean event abnormal return to firms that announce joint venture operations in Asian NICs is significantly positive. EMPIRICAL RESULTS The average abnormal returns and cumulative abnormal returns for firms engaged in either IJV or WOS investments are presented. The results indicate that the sample firms experienced significant increases in wealth during the 21-day test period. The gains are significant at 5% level. The cumulative abnormal return (CAR) over the 11-day period is around .93%, significant at 5 % level. The CAR over the 17day period is 1.09%, significant at 5% level. Results indicate that stock markets react favorably to the FDI announcements of international expansion. Results are consistent with hypothesis 1 that US FDI in NICs generate significantly positive returns for shareholders. A full sample of U.S. firms involved in international expansion in NICs is further stratified into two groups to determine whether markets react to the two different types of announcements differently. Table 2 presents the AR and CAR of firms that announced the international expansion through IJV and firms that announced the international expansion through WOS investment. Shown in Table 2, the 59 U.S. firms engaged in IJVs experienced significant positive abnormal returns. This is evidenced by the significant increases in the cumulative abnormal return five days before and nine days after the announcement date. The CAR over the event windows (-10, +1 ) is +1.17%, significant at 1%level. The CARs over the event windows (-5, +5) and (-8, + 8) are .76 % and .89%, both are significant at 10% and 5 % level respectively. Results indicate that IJV by US MNCs with partners from NICs benefits shareholders of U.S. firms. Results are consistent with hypothesis two that IJV by US MNCs with NICs creates wealth for their shareholders. The eighteen firms that engaged in international expansion through wholly owned subsidiary investment experienced significant positive gains. The CAR over the event window (-10, 0) is 1.35%, significant at 10% level. The CARs over the event windows (-5, +5) and (-8, +8) are 1.49% and 1.71% respectively, both are significant at 1% level. Results show that international expansion through the establishment of a WOS in the NICs create positive wealth for shareholders of U.S. MNCs. Results are consistent with hypothesis three that WOS FDI by US MNCs in NICs creates wealth for their shareholders. To compare the wealth valuation effect of these two different types of international expansions, AR and CAR are compared between two groups. Table 3 presents the results. Evidenced in Table 3, the results do not reveal any significant difference in wealth effects. Both types of international expansions in NICs are rewarded with positive stock price returns. When the two groups are compared, no significant difference in wealth effects is revealed.
SUMMARY AND CONCLUSION Previous studies document that in general FDI by U.S. MNCs generates positive wealth to the firm’s value. The impact of the host countries where the U.S. MNCs invest on the returns remains inconclusive. This study attempts to provide further evidence on the wealth effects of FDI in emerging markets. Specifically, this paper tests the wealth effects of FDI by U.S. MNCs in four Asian NICs, namely, South Korea, Taiwan, Singapore, and Hongkong. The results of this study are consistent with our hypotheses. It reports that significant positive stock price reactions are associated with the FDI announcements by U.S. MNCs in NICs. Shareholders benefit from these activities, either in the form of IJV or WOS. The results support the view that U.S. FDI in NICs creates incremental value for shareholders of firms engaged in those activities. It is reasonable to assume that the main reasons for these increases in shareholders’ wealth are directly related to global diversification, growth potential, and increased market share in the future.
This study has benefited from insightful discussions with Andy Cannon, Richard Green and participants at the 1995 fifth Asian Business and Economics Conference at St. John’s University. All remaining errors are ours.
1. In this study, the weighted average market index is used to measure the market return.
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