International Diversification: A Review and Analysis of the Evidence

The purpose of this paper was to explore the motivation and rationale behind international investment to better explain the conflicting results reported in previous research and to provide some answers to the current debate on international diversification. Monthly return data and annual financial data of 424 NYSE‐listed companies over four 5‐year periods was examined, dividing the sample companies into three groups according to their degree of international diversification. Averages for monthly returns, market‐adjusted returns, total risk, and systematic risk were analyzed. An ongoing debate among students of multinational corporations (MNCs) focuses on whether the intent of corporate international diversification has been to increase stockholders' return or to reduce risk (Siegel et al. 1992; Shalchi and Hosseini 1990; Ndubiuzu 1990; and Theerathom et al. 1992). Based upon the observation of the pattern of holdings, Buckley (1988) argues that firms do not become MNCs to reduce risk. Risk reduction behavior would lead to a strategy of seeking investments in countries with uncorrected return patterns, as with some of the underdeveloped countries. Instead there has been a concentration of foreign direct investments in advanced market economies with high return correlations among each other. Buckley (1988) concludes, therefore, that MNCs are imperfect vehicles for risk diversification. Fatemi (1984) suggests that much of the international diversification made by corporations may have a defensive purpose. Their goal may be, for example, to maintain participation in some export markets or to match the previous move of a competitor, and not necessarily to increase the firm's revenue. The motivation for foreign corporate investments has been attributed to many specific factors, related both to the firm and the country. Included among these factors are: (a) economies of scale associated with large size and the ability to produce in several countries, (b) intangible assets, such as technological expertise or entrepreneurial skills, (c) market power due to the size of markets and previous experience with the domestic market, (d) industry grouping, (e) the availability of additional natural resources, as well as less costly labor and/or capital, (e) advantageous regulatory framework for the firm offered by the host country, and (f) the economic influence of the particular time period involved on firms and countries. The purpose of this paper is to provide additional evidence on whether international diversification has either increased stockholder's return or reduced their risk and to consider the possible influence of several factors. A sample of 424 companies was drawn from the New York Stock Exchange (NYSE), and was divided into three categories, i.e., domestic, intermediate, and multinational. Two return and two risk measures were then calculated for four periods of time (1968–1972, 1973–1977, 1978–1982, and 1983–1987) to examine the relationships between the degrees of international diversification and the measures of risk and return. One of our concerns was to try to address some of the discrepancies among prior research findings.