Effects of internationalization on ownership structure: evidence from Latin American firms.
| Autor | Sheng, Hsia Hua |
Introduction
According to the report of the Economic Commission for Latin America and the Caribbean (ECLAC, 2011), there has been an intense internationalization movement of Latin American companies during the last five years (ECLAC, 2011). The same situation has been reported in countries such as Thailand and China; similar to Latin American countries, these Asian countries are considered emerging countries or late movers (Bhaumik, Driffield, & Pal, 2010; Lien, Piesse, Strange, & Filatotchev, 2005).
Studies based on agency theory provide evidence of ownership structure as a determinant of outward foreign direct investment (FDI). Lien, Piesse, Strange and Filatotchev (2005) find that the corporate governance characteristics of Taiwanese firms, such as different forms of ownership structure and the composition of the board of directors, affect their FDI strategies. Bhaumik, Driffield and Pal (2010) conclude that family firms and firms with concentrated ownerships are less likely to invest overseas than other types of firms.
Although the main strands of agency literature provide evidence that ownership structure affects internationalization, little research has examined how internationalization decisions affect ownership structure or whether both may be mutual determinants. Would this situation constitute another case of endogeneity in finance as described by Coles, Lemmon and Meschke (2012)?
This paper extends the agency literature on ownership structure by investigating the effects of the degree of internationalization and main entry modes on ownership structure. In particular, using a sample of listed companies from Argentina, Brazil and Chile, we seek to assess how ownership structure is affected by (a) ownership concentration and (b) different forms of shareholders presences, including financial institutions, professional/business groups, families/individuals, investment funds and governments (La Porta, Lopez-de-Silanes, & Shleifer, 1999; Leal, Silva, & Valadares, 2002).
Thus, this paper investigates the unexplored relationship between internationalization and ownership and the simultaneity between them in Latin American multinationals. The following questions regarding internationalization and ownership structure will be investigated: (a) Do more internationalized companies tend to have a more or less concentrated ownership structure? (b) Do international market entry modes determine the level of ownership concentration? (c) Is there a relationship between internationalization and the presence of specific ownership? (d) Finally, is there a simultaneous relationship between internationalization and ownership structure?
Literature
The agency theory proposed by Jensen and Meckling (1976) argues that managers have a propensity to pursue their own interests at the expense of shareholders because of information asymmetry and differences between the interests of business owners and managers. This opportunistic behavior causes managers to make suboptimal decisions and waste resources and thus reduces the value of companies. Shareholders who pursue the maximization of corporate value tend to increase control to reduce such conflicts of interest. Accordingly, agency costs relating to ownership structure are created.
This nature of agency conflict arises when a company expands abroad. Multinational enterprises (MNEs) tend to have higher agency costs than domestic firms as a result of the greater difficulty of monitoring the behavior and actions of managers who are outside of the country (Wright, Madura, & Wiant, 2002). In addition, shareholders of multinational companies are more susceptible to communication and information failures, which in turn increases the cost of monitoring by shareholders (Burgman, 1996).
Agency conflict between MNEs and their international operations
Agency costs for MNEs exceed those of purely domestic companies. The complexity of international operations activities compared with domestic operations, including auditing and preparing multiple financial statements for each country with different cultures, languages and regulations makes monitoring activities more difficult for multinational companies than for domestic firms (Wright et al., 2002).
Another conflict that cannot exist in a purely domestic company is the headquarters-subsidiary conflict, which also increases multinational firms' agency costs (Wright et al., 2002). The parent-subsidiary relationship is essentially a principal-agent structure that gives rise to conflicts resulting from the mismatch between the objectives of headquarter managers and those of branch managers. They argue that although headquarter managers may act in line with the objective of maximizing shareholder wealth, foreign subsidiary managers may not do so.
This conflict between MNEs and their operations in other countries has been recognized in the literature on equity and non-equity entry-mode decisions. Based on agency theory and transaction cost analysis, Fladmoe-Lindquist and Jacque (1995) explain a service firm's international organizational choice between equity-based control and franchising. Other more common theories explain entry modes from the perspective of transaction cost theory (TCA), the resource-based view, institutional theory and Dunning's eclectic framework (Brouthers & Hennart, 2007).
Greater concentrated ownership in parent MNEs could cause the MNEs to become more attuned to shareholders' interests, who can better control and monitor a company's international operations and pressure managers to improve performance. A high level of ownership concentration may also reduce the information asymmetry between the principal and the agent because owners can request management information in a more rapid and centralized manner. Furthermore, with higher levels of ownership concentration, shareholders can prevent the opportunistic behavior of managers, who tend to become more committed to maximizing firm value (Dharwadkar, George, & Brandes, 2000).
Hypothesis 1: The higher the degree of internationalization is, the higher the ownership concentration is.
Agency conflict within the parent MNE
Internationalization is a means of diversifying markets, which is an interesting strategy for managers (Aggarwal & Samwick, 2003), as a company can reduce its risks by investing in unrelated activities and economically-integrated countries (Annavarjula & Beldona, 2000; Hennart, 2007).
In addition, international diversification also creates new opportunities for investments. However, this cash-flow outlet will cause an agency problem when managers have control of free cash flows, as this cash-withholding power can provide a favorable condition for a manager to act opportunistically against firm value maximization (Denis, Denis, & Sarin, 1997; Jandik & Makhija, 2005).
As a consequence, when a company's managers choose internationalization, minority shareholders may sell their shares back to the company, thereby affecting ownership concentration. Because of the small proportion of capital that they have invested in the company, minority shareholders may prefer to use capital markets to diversify their investment portfolio rather than diversifying through internationalization as a result of potential conflict issues between managers and shareholders. The difficulty in monitoring managers' decisions also favors selling. Because of geographic and market regulation distances, the costs to monitor and obtain information from such international operations or to implement robust control and incentive programs for executives are considerably higher.
This issue becomes more critical when a company uses the equity entry mode to enter a foreign market, as joint ventures, acquisitions and new investments (equity entry modes) require the use of a company's free cash flow. Accordingly, a company's management may be able to enter a foreign market only if it returns a large proportion of its current net earnings to shareholders through a buyback of shares, which in turn affects ownership concentration. A portion of shareholders might also be more willing to sell their shares back to the company rather than accept higher dividends because equity participation in an international operation involves a degree of risk that some shareholders are not willing to undertake.
Hypothesis 2: Companies that choose to internationalize via equity entry modes tend to have higher levels of ownership concentration.
Simultaneity between internationalization and ownership concentration
As noted previously, agency theory has been used to explain how the concentration and type of ownership structure affect companies' degrees of internationalization. Lien et al. (2005) study corporate governance factors in firms' decisions to accept FDI. Extending this discussion and considering ownership concentration and structure as key responses to the weak institutions of the emerging market, Bhaumik et al. (2010) find that firms with concentrated ownership are less likely to invest overseas than firms with lower levels of ownership concentration.
Oesterle, Richta and Fisch (2013) consider beyond the linear approach by arguing that the effect of ownership concentration on the expected degree of a company's internationalization follows a cubic function in a U shape. This pattern was introduced and confirmed in a study that involved 1990-2006 data from the 102 largest German manufacturing companies.
The main argument is that shareholders tend to be risk neutral and...
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