Financial Aspects of the Multinational Firm: A Synthesis

This article surveys two major streams of research concerning the financial aspects of the multinational firm. Specifying, we review and synthesize the literature on multinational firm capital structure and the wealth effects of firm internationalization. The theoretical and empirical literature in these two areas is developed with a special emphasis on the more recent research. An integrated summary is provided along with suggested avenues for future research. Our understanding of the multinational firm (MNF) has undergone significant changes in the last 20 years due to the increasingly greater availability and dissemination of firm level financial information. Paralleling this increase in data availability has been an increase in the standard of rigor applied to international finance research. Early work by Shapiro (1978), and Agmon and Lessard (1977) set the ground work for future inquiry and helped define the research standards in international finance. Now, two decades later, it seems appropriate to identify and synthesize some of the existing research on the financial aspects of the multinational firm. Our goal in this survey is to integrate the literature, summarize the results, and to identify some areas in which future research has great promise. A major problem in synthesizing the research available on the financial aspects of the multinational firm is in developing or defining the relevant boundaries. We have chosen to focus on two activities we feel are at the core of the responsibilities for the international financial manager. This excludes many areas covered in a typical international finance text such as monetary systems, currency exchange markets, and international banking. These items are only introduced tangentially as they relate to or affect the financial characteristics of the multinational firm. Specifically, this survey covers two topics: 1) multinational firm capital structure, and 2) the wealth effects of internationalization. Multinational Firm Capital Structure Modigliani and Miller (1958), in a pioneering article, modeled the optimal mix of debt and equity financing. Further work in this area has led to the agency cost/tax shield tradeoff model (ATT) which is arguably the most prominent capital structure model (Megginson, 1997). The ATT model is predicated on the idea that firms choose their optimal mix of debt and equity financing by trading off the increasing agency costs of debt and equity with the tax benefits of debt. As firm leverage increases, debt holder risk increases as shareholders and managers maintain control of firm investments. Therefore, debtholders are forced to monitor shareholders and their agents, the managers, as the potential for wealth expropriation increases with increases in debt. IMAGE FORMULA8 As leverage increases, the debt tax shield and the expected bankruptcy costs increase and agency costs decrease. The literature on capital structure in the multinational firm concentrates primarily on whether TS, EB, or AC differ between MNFs and DFs. The analysis in this section is predicated on the framework in Equation (1). Theoretical Development A) TS: The Impact of Differential Taxes on Capital Structure Senbet (1979) derives a capital structure model suggesting that international tax differentials play an important role in the MNF capital structure decision. Using the nomenclature of the model specified in Equation (1), his model suggests that TS will be different for multinational firms relative to domestic firms. Shapiro (1978) posits that MNFs will tend to use greater debt. He argues that if foreign tax rates are lower than domestic tax rates then dividends will lead to increased taxes. Furthermore, Shapiro notes that if aggregate foreign taxes are higher than domestic taxes and a withholding tax exists, dividends will also lead to greater taxes. These tax arguments suggest that the optimal capital structure for the multinational firm, holding all else constant, will involve a greater usage of leverage as the MNF gets a larger tax benefit of debt (i. …