Internationalization and Firm Risk: An Upstream-Downstream Hypothesis
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Risk:
An
Upstreamr-Downstream Hypothesis ChuckC. Y. Kwok* UNIVERSITY OF SOUTH CAROLINA
David M. Reeb** AMERICAN UNIVERSITY
Corporateinternational diversification theory posits that multinational corporations (MNCs) should have lower risk and higherfinancial leverage than purely domestic corporations (DCs). We suggest an alternative upstream-downstreamhy-
M
uch of the early literature on the
multinational corporation (MNC) posits a diversification benefit for MNCs, leading to lower levels of risk and to subsequently higher levels of debt. Initial research by scholars such as Hughes, Logue, and Sweeny (1975) finds evidence consistent with the diversification benefit. However, more recent research by Bartov, Bodnar and Kaul (1996) and Reeb, Kwok and Baek (1998) finds that firm risk is positively related to internationalization. Similarly, research on leverage finds that US MNCs have significantly lower levels of debt in their capital structure relative to domestic cor-
pothesis according to which the overall effect of internationalization on the risk and leverage of MNCs is expected to vary with home and targetmarket conditions. The empirical results are consistent with the suggested hypothesis. porations (DCs) (e.g. Lee and Kwok, 1988). An implication of this body of research is that firm risk is increasing in corporate internationalization. Owing to data availability, the research on the financial aspects of firm internationalization has focused primarily on US based firms. We explore how internationalization affects risk and leverage for firms based in emerging markets and in other developed markets.1 Specifically, we argue that when firms from more stable economies make international investments, it tends to increase their risk and leads to a reduction in debt usage. By contrast, when firms from less
*Chuck Kwok is Professor of International Business at the University of South Carolina. He was Vice President-Administration of the Academy of International Business in 1995-96. * *David
Reeb is an Assistant Professor in the Kogod School of Business at American University. His research focuses on the financial aspects of international business.
We would like to thank Andy Chui, three anonymous reviewers, and the participants at the Academy of International Business 1998 Annual Conference in Vienna Austria for their valuable input. Chuck Kwok gratefully acknowledges the support of the Center for International Business Education and Research (CIBER) at the University of South Carolina. JOURNAL OF INTERNATIONALBUSINESS STUDIES,
31, 4
(FOURTH QUARTER
2000): 611-629
611
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AND FIRMRISK INTERNATIONALIZATION
stable economies make international investments, it decreases their risk and allows for greater debt utilization. In other words, we predict that the relative business risk among countries influences the risk impacts of foreign direct investments. Th
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