Risk, Returns, and Multinational Production

Abstract

This paper starts by unveiling a strong empirical regularity: multinational corporations exhibit higher stock market returns and earning yields than nonmultinational firms. Within non-multinationals, exporters exhibit higher earning 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. Selling abroad is a source of risk exposure to firms: following a negative shock, they are reluctant to exit the foreign market because they would forgo the sunk cost that they paid to enter. Multinational firms are the most exposed due to the higher costs they have to pay to invest. The calibrated model is able to match both aggregate US export and foreign direct investment data, and the observed cross-sectional differences in earning yields and returns.

Global Engagement and Returns Volatility

“…This result suggests a ranking of firms’ volatility based on the margin used to reach foreign customers similar to that established by Helpman, Melitz and Yeaple () for the first moment of firm‐level productivity. This is also consistent with Fillat and Garetto (), who find that US multinational firms are riskier than exporters and that these in turn are riskier than domestic firms.…”

“…Several points are noteworthy; to start with, globally engaged firms are not only more volatile than their domestic counterparts, but also exhibit higher stock returns. Firms conducting horizontal FDI exhibit annualized excess stock returns that are 3.1 percentage points higher than their domestically oriented counterparts, while exporters’ returns are one percentage point higher than those of domestic firms, the same ranking found by Fillat and Garetto () among publicly listed US firms. The same pattern arises when we consider returns on assets.…”

“…On the one hand, if the costs of establishing a subsidiary abroad are to a large extent irreversible, then the resulting hysteresis implies that firms serving foreign markets using horizontal FDI will be more volatile than those choosing to rely on exports, following an argument analogous to that of Riaño () discussed above. Fillat and Garetto () provide evidence in support of this mechanism. They establish that US multinational firms are riskier in the sense that the level of their stock returns exhibits a higher covariance with aggregate consumption growth than that of exporters, which are in turn, riskier than domestic firms.…”

On returns differentials

“…However, after making assumptions on the magnitude of the mispricing that might be attributed to USDIA vs. FDIUS firms, CT estimates that 15 Other literature suggests that foreign investments also include compensation for sunk costs specific to investing in a foreign country. For example, in the models of Helpman et al (2004) and Fillat and Garetto (2010) FDI investments are subject to sunk costs beyond those encountered domestically. Fillat and Garetto (2010) estimate that compensation for these sunk costs adds 25% to MNE yields relative to the yields of domestic-only exporters.…”

“…For example, in the models of Helpman et al (2004) and Fillat and Garetto (2010) FDI investments are subject to sunk costs beyond those encountered domestically. Fillat and Garetto (2010) estimate that compensation for these sunk costs adds 25% to MNE yields relative to the yields of domestic-only exporters. CT estimates that this accounts for 1.2-1.5 percentage points of the USDIA yield.…”