On the Origins of the Multinational Premium 
Direct investment in foreign markets may expose a firm to additional risks that are different from those it faces in the domestic market, or it may serve as a vehicle for diversification, acting as a hedge against a firm’s country-specific risks. This paper examines the risk premia of firms that expand their operations into foreign markets, considering both mergers and acquisitions (M&A) and greenfield foreign direct investments (FDI). After establishing the existence of a sizeable risk premium associated with FDI and M&A activity, the authors investigate its origins, looking specifically at whether firms that become multinational acquirers grow riskier as they expand abroad, or if other factors explain firms’ risk premia and foreign expansion.
Key Findings
- Firms with foreign affiliates have systematically higher returns compared with firms that operate only in their domestic market, which is consistent with the findings of previous studies.
- Firms that make foreign acquisitions have systematically higher returns compared with non-acquirers, which is a novel finding.
- A firm's expected stock returns decline when it first engages in M&A activity and as it continues to do so.
- Before they enter foreign markers, firms that will become multinationals have higher stock returns compared with non-multinational firms.
- Future multinational acquirers experience higher risk premia compared, at a given point in time, with similar firms that remain domestic for the study's entire sample period.
- A substantial amount of variation in risk premia across firms is explained by the fact that the firms have different CEOs. In addition, a firm's CEO affects the likelihood that the firm will engage in foreign acquisitions.
Implications
The paper’s empirical analysis shows that management—that is, the CEO—matters for firms’ engagement in foreign direct investment (FDI) and mergers and acquisitions. Therefore, the role of management is important in understanding observations that can seem puzzling, namely that (1) firms’ expected returns decline after foreign acquisitions and as they deepen their acquisition activity, and (2) future multinational acquirers experience higher risk premia compared with similar firms that remain domestic. To better understand the relationship between the CEO, FDI, acquisition activity, and stock returns, the authors develop a model that highlights how managerial decisions play a fundamental role in the origins and dynamics of multinational enterprises and acquirers’ risk premia.
Abstract
How do foreign direct investment (FDI) dynamics relate to the risk premium of a firm? To answer this question, we compare the stock returns of US firms with different FDI and mergers and acquisitions (M&A) exposure to study the evolution of stock returns as firms expand into foreign markets. We document three empirical regularities. First, there are cross-sectional risk premia associated with both multinational activity and mergers and acquisitions. Second, firm-level stock returns decline when a firm undertakes M&A activity and with merger deepening. Third, future multinational acquirers already have higher stock returns compared with domestic non-acquirers prior to entering foreign markets, indicating that cross-sectional returns differentials are driven by selection based on common unobserved firm characteristics. We find that CEOs play a role in explaining the relationship between firms’ risk premia and foreign expansion. To rationalize these facts, we develop a dynamic model in which management attitudes shape the relationship between firm characteristics, selection into FDI, and risk premia.