In today’s global world, there have increasing trends of international geographic diversification which can be define as a business expansion across the borders of global regions into different geographic location with many subsidiaries in a large numbers of countries- Multinational Corporations (MNCs).
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MNCs have taken on an increasing role and become the key component in the world economy as a whole and in globalization of market. International business scholars have argued that international diversification is vital because it is based on exploiting imperfections and foreign market opportunities through internalization (Rugman, 1979, 1981).
Today global was become more challenges; as a result, many multinational companies (MNCs) seek to expand their business in the international geographic region through aggressively establishing subsidiaries and direct foreign investment to increase the return and lower the risk as well as enhance the value of shareholders’ equity
By looking at the past and more recent survey, it seems that the number of MNCs that are bases in Malaysia have increased significantly over the year (Bala & UNCTAD, 1999; Annuar et al., 1996 and Heenan & Keegan, 1979). Bala (1999) points out as of 1997; half of the firm that is listed on KLSE is MNCs. This mean over the year to year, Malaysia has increased on the international diversification. Many MNCs from developing countries such as Malaysia also build up their operation in oversea. For example, the company in Malaysia that operates abroad is PETRONAS and IOI.
Have MNCs or international diversification really bring benefits to the business. As shown by David and Qian (1997), firms anticipate positive returns on the foreign investments or else they will not involve in the activities. Therefore if the previous performance of Malaysia MNCs on investments overseas is good, it will encourage more of such investments.
However, MNCs is also exposure to some international risk that firm must pay more attention. Those risks are exchange rate movement exposure foreign economy exposure and political risk exposure.
This study focuses on Multinational Corporations (MNCs) in Malaysia that listed in the KLSE. In previously discussion, some of the researchers found that international geographic diversification by MNCs will bring benefits to company. However, sometime MNCs may contribute less and no significant effect through international geographic diversification.
Firm seeks to invest in foreign country due to many factors. Isn’t international geographic diversification will bring benefits to the firm? If foreign investment no brings any advantages to the firm, no points to firm diversify in outside country. This study will focuses on the impact of diversify in other geographic region.
Furthermore, a lot of researchers are most likely to look at outside country perspective compare to look at Malaysia perspective on MNCs. In Malaysia, more researchers are seldom focuses on analyze the impact of Malaysia MNCs to the risk and return performance. That is a reason for this study to analyze the influence of MNC in Malaysia risk and return performance.
This study is to determine the impact of international diversification on Malaysia’s risk and return performance.
2.1 Define of MNC
Multinational Corporations (MNCs) is a corporation that has operation and production of fixed assets or other facilities in at least one overseas country and makes its major management decisions in a global context. Sometimes it also called as “transnational corporation” (Vernon, 1971).
According to the Eun & Resnick (2004), multinational corporation (MNC) is a business firm incorporated in one country that has sales operations and production in several other countries those in abroad countries. This mean a firm obtains the raw materials from one geographic market from other, after that, produces the goods with capital equipment in third country, and finally sell the finished product in other international markets.
Furthermore, according to Dunning (1993), a multinational corporation is “an enterprise that engages in activities such as foreign direct investment (FDI) and owns or controls value adding in more than one country”.
2.2 The Advantage and disadvantage of MNC
There have some advantages of MNCs. An increasing of the geographic scope of operation may enhance a firm’s ability to coordinate or share its international geographic activities (Kimet al. 1989, Qian 1997). It enables a firm to realize about the economies of scale and scope (Caves, 1996). For example, firm can get cheaper labor in certain countries compared with their parent company and used technology to reduce costs. It helps it to diminish fluctuations in profit by spreading its investment risks over other different countries (Kim, Hwang, & Burgers, 1993). It helps reduce costs and increase revenues by enhance a firm’s market power over its distributors, suppliers and customers (Kogut, 1985).
Although these are the major exploitation benefits of MNCs, the initial impetus to a firm’s internationalization comes from the opportunity to exploit market imperfections in the cross-border use of its intangible assets (Caves, 1971). A firm can gain above-normal returns by exploiting its firm-specific assets, especially intangible ones, in international markets (Buckley, 1988). Recently, scholars have drawn attention to the exploration benefits of internationalization using an organizational learning perspective. This perspective emphasizes that a firm’s subsidiaries in disparate host countries can help to enhance its knowledge base, capabilities, and competitiveness through experiential learning (Barkema and Vermeulen, 1998; Delios and Henisz, 2000; Zahra, Ireland and Hitt, 2000).
In addition, each host country has its own unique resource endowments and location specific advantages, which might not be available in the home country. Such host country specific advantages can motivate a firm to establish subsidiaries there to explore these advantages and augment its competitiveness in both its home and host markets (Kogut & Chang, 1991). Finally, Technology transfer can in turn generate significant positive externalities with wider implications for development (Graham , 1996).In Malaysia, for example, Motorola Malaysia transferred the technology required to produce a particular type of printed circuit board to a Malaysian firm, which then developed the capacity to produce these circuit boards on its own (Moran, 1999).
Nevertheless, these have some disadvantages of MNCs. When making a foreign investment, a firm’s managers contend with many challenges related to a new operation, such as purchasing and installing facilities, staffing, and establishing internal management systems and external business networks. These challenges can put a new subsidiary in a disadvantageous position, as compared to an established firm in the target market, and can decrease its competitiveness. These liabilities, however, tend to decrease as a firm’s subsidiaries build and improve reputations and legitimacy in the host country in which they operate (Barkema, Bell, & Pennings, 1996).
Challenges can be experienced by any new subsidiary, but there are difficulties specific to new subsidiaries established in foreign countries. A foreign subsidiary has a liability of foreignness (Hymer, 1976) that can lead to it having higher costs because it cannot conduct business activities as effectively as a local firm. Being foreign means mistakes in various business decisions are more likely (Barkema & Vermeulen, 1998; Vermeulen & Barkema, 2002).
Hoskisson and Turk (1990) argued that internal capital markets have governance and control limits. Markides (1992, 1995) reported value creation from corporate refocusing for firms in the 1980-88 periods. Bergh and Lawless (1998) found in a panel of 164 Fortune 500 firms that there were limits in the efficiency of hierarchical governance and that environmental uncertainty heightened its costs. Many of the costs associated with product diversification such as coordination difficulties, information asymmetry, and incentive misalignment between headquarters and divisional managers in multidivisional firms can be also manifest in multinational enterprises between headquarters and subsidiary managers (Denis et al., 2002; Harris, Kriebel, & Raviv, 1982).
As the number of internal transactions increases with the number of foreign subsidiaries established by a firm, governance costs can rise rapidly to a point at which the governance costs exceed any internalization benefits (Hitt et al., 1997; Tallman & Li, 1996). The governance costs and coordination costs associated with increasing multinationality are compounded if these increases take place by a firm’s expanding the number of host countries in which it operates.
2.3 Background of Malaysia MNCs
According to Madura (2000), there have three form of foreign investment which are acquisitions of existing companies in foreign countries, a joint venture with companies in foreign countries and opening up a company’s subsidiary in foreign countries. Companies that conduct any of above form of investment are known as MNCs.
Bala (1999) conducted a survey of foreign investments conducted by firms listed at KLSE in orger to identify MNCs originating from Malaysia. From 436 listed firm (as at October 1997), he discovers that 207 firms are actively involved in foreign investment activities and they can be considers as MNCs. In the survey, it was also discovered that 17 companies have more than 20 ongoing foreign investment projects in various countries. Top of the list is Sime Darby with 110 ongoing foreign investment activities spanning in 19 countries (Bala, 1999). As a result, we known Malaysia has highly engages in foreign investment.
Above table show the companies in Malaysia that have diversify in foreign country in year 2008. The higher the diversification the lower the risk is. For example, Tanjong PLC has higher diversification which is 2.3667 and has a lower risk which is 1.691 for standard deviation ROA and 1.762 for standard deviation ROE. In contrast, Ireka Corp Bhd has lower diversification which is 0.6931 will has a relative higher risk in which 10.411 for standard deviation ROA and 33.472 for standard deviation ROE.
Above table show the companies in Malaysia that have diversify in foreign country in year 2009. The higher the diversification the lower the risk is. For example, Insas Bhd has higher diversification which is 1.3778 and has a lower risk which is 2.009 for standard deviation ROA and 2.990 for standard deviation ROE. In contrast, Selangor Dredging Bhd has lower diversification which is 0.5004 will has a relative higher risk in which 3.835 for standard deviation ROA and 8.024 for standard deviation ROE as compare with Insas Bhd.
2.4 Evidence of Effect on International Diversification on Firm Performance
As shown in many studies, the results towards international diversification were uncertainty. Some studies showed benefits of a business by diversification and sometime, some researchers showed that was no benefit on international diversification .
In addition, Kim et al. (1989) argue that the firm has more subsidiaries in outside country, its opportunities to leverage strategic resources is greater while simultaneously diversifying market risks, thus raising its performance. As a result, many firms seek to get this benefits by diversify in overseas.
One of the studies found that horizontal S-curve between geographic diversification and firms performance (Lu and Beamish, 2004). This mean which at first showed an increasing internationalization and the performance is decline, followed by a positive relationship between increasing firm performance and geographic diversification, and after that declined at very high levels of multinationality. This relationship in turn was moderated by intangible asset advantages that accrued with expansion of the geographic scope of a firm. Firms achieved higher returns to geographic expansion by strong technology or advertising asset advantages.
However, there are also some arguments showed the result is negative effects and no relationship of firms’ international geographic diversification negative relationship. Denis, Denis & Yost (2002) and Geringer, Tallman, & Olsen (2000) found a negative relationship between geographic diversification and firms’ performance. It mean that diversification on overseas doesn’t result in high return or lower risk to the firms. Furthermore, some studies (Hitt et al., 1997; Gomes and Ramaswamy, 1999; Capar and Kotabe, 2003) found an inverted-U relationship between the extent of geographic spread and performance. Kumar (1984) and Yoshihara (1985) found that there is no significant relationship between diversification and firms’ performance. Many researchers have different result on whether MNCs gain benefits to the firms’ performance.
3.1 Data Collection
The data of MNCs is collect from the Kuala Lumpur Stock Exchange (KLSE) and obtain by using the source like internet. From the KLSE, we have chosen 27 companies’ annual report in which fourteen MNCs in year 2008 and thirteen MNCs in year 2009 that all is listed at KLSE. After find the annual report of each company, we calculate the subsidiaries of each company that incorporated in foreign country that outside Malaysia. Furthermore, we also calculate the ROA and ROE in year 2008 and 2009 for each company toward annual reports. We use Microsoft Excel to calculate our data such as ROA, ROE, and Standard Deviation.
3.2 Measurement of International Diversification
During last decades, the measurements of the firm diversification seem to have significantly increased. Entropy is one of the methods which have remained use for over two decades (Sankaran P. Raghunathan, 1995). Recently, the entropy measure has been found to enjoy more validity than the other measures of firms’ diversification (Hoskisson, Hitt, Johnson & Moesel, 1993).
International diversification is calculated as the entropy of each firm’s relative to the country or region holdings:
D= Siloge (1/S)
Where D is diversification, Si is the ratio of a firm’s holdings (number of subsidiaries) in the country or region i to the total number of foreign subsidiaries.
According to the market imperfection and transaction costs theories, the ability of a firm to earn profits upon its intangible assets and to minimize its costs of managing is affected by differences and similarities between the countries in which it was operated (Vachani, 1991). The relevant geographic units have close similarities in fluctuation of demand; external restriction and pattern of general economic conditions.
Five geographic region are use to measure international diversification. These market areas are Asia, America, Europe, Asian and other ocean. These five international regions provide with the basic for geographic specification. Each of the firm is assigned a value in term of both the number of its subsidiaries in each region and the number of geographic regions in which it is involved.
3.3 Measurement of Performance
Many researchers prefer accounting variables as performance measures such as return on equity (ROE) and return on assets (ROA), along with their variability as measures of risk (Anil M. Pandya and Narendar V. Rao, 1998).
Return on total asset (ROA). This is the most frequently used performance measure in previous studies of diversification (Pandya and Rao, 1998). ROA is defined as the ratio of net income (income available to common stockholders) to the book value of total assets it is expressed as:
Return on Equity (ROE). This is the ratio of net income (income available to common stockholders) to stockholders equity. It is a measure of company performance from the viewpoint of shareholders. It is essential in the calculation of the ROE to use the profit for ordinary shareholders, which is the profit after tax and after interest charges (Weetman, 2003). It is expressed as:
3.4 Measurement of Profit and Risk
In addition to these financial measures, the risk profile of the different diversification groups was also compared. This was achieved by computing the variability and risk per unit of return of the financial ratios. Variability could be measured by the standard deviation while risk per unit of return measured by the coefficient of variation (CV; Pandya and Rao, 1998). The CV is the ratio of the standard deviation to the arithmetic mean. It is expressed as (Frankfort-Nachmias and Nachmias, 1992):
Where SD is standard deviation and is arithmetic mean.