Risk, Returns, and Multinational Production Risk, Returns, and Multinational Production

By José L. Fillat and Stefania Garetto

This paper starts by unveiling a strong empirical regularity: multinational corporations exhibit higher stock market returns and earnings yields than non-multinational firms. Within non-multinationals, exporters exhibit higher earn- ings yields and returns than firms selling only in their domestic market. To explain this pattern, we develop a real option value model where firms are heterogeneous in productivity, and have to decide whether and how to sell in a foreign market where demand is risky. Firms selling abroad are exposed to risk: following a negative shock, they are reluctant to exit the foreign market because they would forgo the sunk cost that they paid to start investing abroad. Multi- national firms are the most exposed due to the higher sunk costs they have to pay to enter. The model, calibrated to match aggregate U.S. export and foreign direct investment data, is able to replicate the observed cross-sectional differences in earnings yields and returns.

This paper was revised in May 2013.