INTERNATIONAL INVESTMENTS DON'T REDUCE RISK FOR U.S. FIRMS
COLUMBUS, Ohio - Contrary to common business wisdom, a new study found that American companies don't reduce their financial risks when they expand operations outside the United States or when they establish joint ventures with foreign firms.
A study of 332 U.S. manufacturing companies found that those with international joint ventures (IJVs) actually had higher levels of downside risk - a measure of the likelihood that a firm will not meet specified financial performance objectives.
The study also found that multinational companies showed no difference in downside risk when compared to companies with only domestic operations.
These results should be surprising to many business and economic experts who praise the flexibility and performance advantages of joint ventures and international investments, said Michael Leiblein, co-author of the study and assistant professor of management and human resources at Ohio State University's Fisher College of Business.
"This study points to the significant management and coordination costs associated with these international ventures and how these costs may outweigh the benefits," Leiblein said.
Even domestic joint ventures may not be beneficial. After finding the negative results of international joint ventures, the researchers examined whether joint ventures among U.S. companies reduced downside risk. Again, they found these domestic ventures were associated with increased financial risks.
Leiblein conducted the study with Jeffrey Reuer, an assistant professor at the French business school INSEAD. Their results were published in a recent issue of the Academy of Management Journal.
The study focused on manufacturing firms, including automobile, airplane, semiconductor and consumer electronic manufacturers, firms where international flexibility advantages are thought to be greatest. The average firm had foreign subsidiaries in about six countries and sales of $3.3 billion a year. About 28 percent of the firms had purely domestic operations.
The researchers measured downside risk by calculating the probability that firms in the study would meet several types of financial targets, such as achieving the same earnings it did the previous year, meeting the average earnings in the firm's industry, and breaking even.
It is understandable that most business experts would expect firms with international investments to have less downside risk, Leiblein said. "Experts have long assumed that multinational firms and firms with IJVs have diversified their risk and given themselves more flexibility by spreading their resources into several different economies," Leiblein said.
These investments are thought to provide 'real options' that help to reduce risks typically associated with international expansion. Similar to stock options in the financial sector - which give the investor the option of making a future stock purchase or sale depending on market conditions at the time - real options give firms the right, but not the obligation, to take an action in the future, when conditions may be more in line with corporate goals, Leiblein said. "It makes sense that a portfolio of such investments will lower downside risk."
But what many experts - and companies - don't take into account is that overseas operations increase the complexity of the organization and the subsequent administrative costs. For companies with IJVs, there are a host of coordination issues involved with working with a foreign company that can increase costs and reduce benefits.
"Essentially, we found a gap between the promise of risk reduction and the reality that firms seem to have limited capabilities to manage international investments effectively," he said.
The fact that even purely domestic joint ventures failed to reduce downside risk shows the difficulty in effectively implementing inter-company alliances, according to Leiblein.
"Many companies don't seem to take into account the very real costs of joint ventures when they're planning on reaping all the benefits," he said.
The research was funded by INSEAD and Ohio State.