Value Creation in Foreign Direct Investments (1)

Abstract * This study examines stock market reactions i.e. wealth creation in foreign manufacturing investments. In addition to empirically examining the wealth effects of investing firms, the study examines the impact of several investing firms and investment related factors on the wealth effects. The data of the study is based on 79 foreign investments made by Finnish firms between 1985 and 1996. Key Results * On average, foreign direct investments have significant value creating effects for investing firm shareholders, i.e., value creation of foreign direct investments generally proves to be a fact. However, none of the specific features of the investment, such as type, form or target country of the investment, showed any divergent value creation effects. Introduction Strategic investments have attracted the attention of scholars in a number of business disciplines, especially in the areas of strategic management, international business, finance and industrial economics. Previous research investigating mergers and acquisitions in the USA and in many Western European countries, including Finland, has mainly focused on domestic acquisitions. However, because of the great growth in the foreign direct investment flows an increasing amount of attention has also been directed to international or cross-border acquisitions and greenfield investments. This study investigates stock price reactions to the announcements of the foreign direct manufacturing investments of Finnish firms. Thus, the primary purpose of the study is to find out if FDIs increase shareholders' wealth. Previous findings in the area have been ambiguous. The results in some studies indicate that there have been more positive wealth gains associated with foreign acquisitions than in domestic ones, but the results in other studies indicate that foreign acquisitions have not created value for acquiring firm shareholders. In addition to investigating whether FDIs in general increase shareholders' wealth, we also investigate a series of refined hypotheses: how different investing firm and investment related features influence incrementally to the value creation. Although the main interest has been in value creation in general, most of the studies have included some additional features related to the investing firm and investment in order to have a better understanding of the value creation effects. However, several studies have included only very few additional features. Thus this study will include additional information about value creation in various FDI situations. The structure of the paper is as follows: first a literature review is made and the hypotheses for the empirical part are constructed; in the next section the methodology of the study is discussed and the main features related to the sample are reviewed. After that the results of the study are discussed, and finally a summary and key conclusions are presented. Literature Review General Aspects Related to Value Creation in FDIs There are several theories and motives for the existence of foreign direct investments (FDI). According to the so-called internalization theory FDIs occur when a firm can increase its value by internalizing markets for certain of its intangible assets, e.g. 1) technological know-how, 2) marketing ability and related consumer goodwill, and/or 3) effective and dedicated management (see e.g. Buckley/Casson 1976 and Morck/Yeung 1991, 1992). According to the internalization theory such intangible assets have some of the characteristics of public goods in that their value increases in direct proportion to the scale of the firm's market. Since they are also based largely on proprietary information, they cannot be exchanged at arm's length for a variety of reasons arising from the economics of information as well as from the economics of public goods. To realize the potential additional value of employing these intangible assets abroad, a firm must internalize the market for them. …