Why Do Companies Decide to Invest Overseas and to Go Multinational - Literature review Example

Why do companies decide to invest overseas and to go “multinational?” Overview Dickens (2007) demonstrates in his writing that the ability, or at any rate the willingness, of many countries to absorb direct dollar investments may reach its limits much sooner than most people think, this analysis suggests. Fortunately, for companies that see their future in terms of continued overseas expansion, there is a viable alternative to the direct-investment route. Coherent Analysis Jepson (2002) explains the unprecedented flow of foreign direct investments during the last two decades has made spectacular contributions to the economic restoration of Europe and to the industrialization of many of the developing countries. Spectacular, too, have been the returns realized by the international corporations that undertook the investments. However, if we examine the conditions a host country must satisfy if it is to continue attracting foreign investments, quite distinct limits to a country's ability to keep its doors open to the foreign investor become apparent. A few basic facts will make the point. (McLaughlin Mitchell 2006). Barry (2002) defines that the most fundamental fact is this: A country's capacity to absorb foreign direct capital inflows is ultimately limited by its ability to service that capital, in terms of current account debits (e.g., dividends) and eventual repatriation of principal. In turn, a country's ability to service the stock of foreign-owned capital is tied to its ability to generate sufficiently large payments surpluses on other current account items. (Relying on a positive balance in the capital accounts is just putting off the day of reckoning.) These relationships are obviously more easily stated in the aggregate than conclusively sorted out in detail. The "current account" of a country's balance of payments has many components, and "foreign-exchange availabilities" come from many sources. And there are the well-known leads and lags in the balance of payments effects of foreign direct investment: Primary capital inflows are followed, before giving rise to dividend outflows, by initially high rates of earnings re-injection (which, of course, raise the host country's future liabilities proportionately). The Other Side of the Coin These arguments seem perfectly true for most foreign direct investments looked at individually. Barry (2002) goes further and says that the total effects of rapidly rising inflows of direct capital from abroad are causing concern too many host countries—not entirely without reason. In an indirect but thoroughly convincing way, the U.S. foreign-investor community itself has supported this contention. Congressional hearings on the Administration's program to curb the outflow of private long-term capital saw witness after witness assert that foreign direct investment, far from burdening the U.S. balance of payments, in fact strengthened it. No failing Returns Dickens (2007) argues that not all this would be particularly alarming if there were any reason to expect the growth rate or profitability of individual foreign investments to decline as the host country's total exposure to direct foreign investment approaches its ceiling. However, there is absolutely no necessary, or even probable, connection between the two. If there were, individual foreign investors would by themselves cut back their commitments, and the ultimate external limits would have no practical significance for the individual firm. Jensen (2006) says that in reality, however, these limits do have significance: They tend to motivate host governments to take restrictive actions at precisely the point when existing foreign investments are producing their largest yields and available market opportunities are calling for continued expansion. For this is the point at which profit remissions begin to rise, burdening the host country's balance of payments, it is also the point at which aroused local competitors are likely to enlist their government's support in trying to cut in on the foreign investor's success. Skirting the burden of Ownership Howitt (2001) suggests the fundamental requirement that any alternative to the traditional concept of direct investment must meet if it is to escape the objections, and the restrictions, it is just mentioned: Such an alternative must not involve control through ownership by the foreign firm, with its indefinite foreign-exchange liabilities and political costs. As Barba et al (2004) explained that it is no oversimplification to affirm that any company that succeeds in so planning and structuring a foreign commitment of its resources as to obviate the need for ownership has thereby neutralized the essence of the economic and political constraints discussed above. At the same time, as we shall see, such a company will have put itself in a position to seize potentially vast profit opportunities in areas where conventional direct investments are clearly unworkable: the industries of the Eastern Bloc and the public sector of developing countries. Howitt (2001) explained that the listing of the latter's securities on local exchanges is intended to facilitate such investment. The attractiveness of this approach, from the local standpoint, would appear somewhat doubtful. However, for the market price and per-share earnings of the parent company's stock reflect neither the lower price-earnings ratio likely to prevail in local capital markets nor, more importantly, the profitability of the local subsidiary. The Regional Holding Company Dickens (2007) presents more imaginative approach is being tried or considered by some U.S. firms with extensive direct investments in Europe. This approach calls for consolidating all European operations into a new parent company, based in Europe that owns and controls all subsidiaries in the area. The new holding company then sells its shares on European exchanges. On the other hand Jensen (2006) suggests that this plan has important advantages from the standpoint of local interests. Participation is much more direct than in the approach described earlier, and local capital invested in the holding company is more likely to stay "at home." However, two problem areas remain. To the extent that the initiator of the holding company retains majority control (some U.S. firms considering this plan have been reported to be intent on retaining absolute control), national criticism of foreign ownership will persist. Moreover, Cantwell (2000) suggests that the problem of reaching agreement with local shareholders on the "reasonableness" of management and license fees paid to the original parent can prove to be a thorny one indeed. A third approach to the ownership issue is the following. At the time the investment is made, the foreign corporation agrees to sell, within a specified number of years, all or part of its interests to local parties. This approach has been advocated especially in connection with investments in the developing countries. The difficulties of this plan are readily apparent. Entrepreneurship without Capital An alternative to the traditional form of direct investment that overcomes these limitations is known as the "management contract." This device, by which a corporation manages an enterprise in which it has no ownership interests, in effect separates the capital-risk bearing from the managerial and technical elements of entrepreneurship. Ietto-Gillies (2005) say that the management contract makes available to host countries the benefits accompanying foreign direct investment without raising the issue of foreign ownership of local industry. Similarly, the management contract limits the host country's liabilities from the import of foreign resources to the period during which these are deemed essential to the local economy. According to Cantwell (2000) that the standpoint of the foreign corporation, the management contract eliminates the risk of property seizure by host governments, since no title to property is obtained by the foreign firm. For this reason, the arrangement is particularly suitable to associations between foreign private and local public enterprises. It thus permits the application of foreign corporate skills to situations where conventional direct investment is impractical or impossible. Control without Ownership Ietto-Gillies (2005) put light on the statement that as many international corporations have found out in operating joint ventures, most of these purposes can be attained without control by majority ownership of the local enterprise. The ability to make all major technical decisions will often suffice to render production processes, or output generally, dependent on the equipment, component parts, or other goods supplied by the parent organization. Dickens (2007) says if the objective is to secure a source of supply, possession of unique distribution channels or outlets can give the international corporation an adequate measure of monopolistic control over the venture in question. In other words, functional control over an enterprise does not necessarily require ownership. It can be achieved as effectively through dependence of that enterprise on the services supplied by the other firm. However, there is still an important distinction between control by ownership and control by management. Cantwell (2000) differentiate the distinction is a legal one. It relates to the temporal dimension of control. Ownership gives the investor definite property rights in the receiving enterprise. Second-Best Management Now let us turn to the second question, that of the scope and quality of the managerial and technical resources a foreign firm would be likely to supply under a management contract. According to Barba et al (2004), the conventional view on this issue, proper development and administration of a project require that the managing company have a financial stake in it. At first blush, this view seems to make a lot of sense. A company will assign its best managerial and technical talent wherever a part of the corporate substance is at stake; where no such interests are involved, the residue of lesser capabilities will be deployed. Similarly, it seems easier to make a decision to pull out when nothing but a recall of company personnel is required than in situations where abandonment of a project involves writing off substantial financial assets. However, Cohen (2007) says that the sensible viewpoint appears to be, analysis of foreign-investment decision-making leads to an opposite conclusion. So far as the first question is concerned, one of the more comprehensive surveys of foreign-investment practice has revealed that companies are prone to "regard their foreign earnings much as a man does his winnings at a racetrack, in that they are much more willing to utilize them than fresh dollar capital for additional foreign investment." (Mansfield 2007) If the venture is incurring losses, then financing will almost certainly be in the form of additional investment by the parent organization. The point is that conventional direct investment constitutes an indissoluble compound of continual financial and "intangible" (managerial and technical) commitments. (Contributions to Political Economy 2002) In order to maintain its initial stake in the project, the resource-supplying corporation continually has to make decisions about further investments that are inevitably required. If this is so, the value of a financial interest from the standpoint of strengthening management's determination to stick with a project even when "the going gets rough" appears doubtful. Instead, as Barba et al (2004) argues it would seem that the dimmer management's view of the emergency, the more strongly wills it is tempted to apply the "sunk-cost" rationale to the investment, and the less attractive the alternative of further capital injections will become. Contractor's Incentives Let us now examine the matter of the relative quality of managerial and technical resources likely to be supplied under a management-contract relationship. Cohen (2007) raises the question comes down to this: Are the benefits that the resource-supplying firm gains from a management contract smaller than the benefits associated with a conventional direct investment? Alternatively, more precisely, are these benefits sufficiently smaller to have an adverse effect on the company's incentive to operate the project at least as efficiently as it would if it had an ownership interest in the venture. Research on the management-contract experience of major international corporations indicates that the incentives this arrangement provides are at least as powerful as the incentives perceived in conventional direct investments. Cohen (2007) suggests that there are two reasons for this. In the first place, just as the expected gains from a direct investment typically go beyond the direct financial payout of the foreign venture, so the benefits from a management contract transcend direct returns in the form of fees. Mansfield (2007a) goes without saying that, in practical application, the management-contract concept requires considerable sophistication in the planning of foreign operations and the greatest skill and imagination in negotiations with the local owners of the enterprise. It is equally clear that this concept does not represent a panacea relevant to all projects traditionally undertaken through direct investment. Nevertheless, the growing diversity of projects successfully operated by management contracts suggests that the applicability of the device is far wider than commonly assumed. Evolution, Not Revolution According to many analysts such as McLaughlin (2006) and Mansfield (2007), the most significant development in private business during the first half of this century was the divorce of management from ownership through the rise of the professional manager. Today most large corporations are administered by executives who have little or no significant ownership interests in the companies they run. Armony and Armony (2005) provide the new concept supplements, but do not supplant the traditional economic function of the corporation. Within the total activities of a given firm, the relative importance of the new "management- selling" function vs. the traditional capital-mobilizing and capital-allocating functions will depend on the firm's stage of development and on the maturity of its natural markets. Mansfield (2007a) argues that this is because the more developed the firm, the larger and more diversified its inventory of managerial and technical resources is likely to be. Similarly, the more the firm's natural markets mature, the greater is the incentive for alternative applications of its resources. Reference Armony A & V Armony (2005). Indictments, myths, and citizen mobilization in Argentina: a discourse analysis. Latin American Politics & Society 47: 4, 27–54. Barba Navaretti, G. and A.J. Venables (2004), Multinational Firms in the World Economy. Princeton: Princeton University Press, ch. 2. Barry, P (2002). Beginning theory: an introduction to literary and cultural theory. Manchester University Press, Manchester. Cantwell, J. (2000), “A survey of theories of international production”, in: Pitelis, C. and R. Sugden (eds). The Nature of the Transnational Firm, 2nd edition. London: Routledge, ch. 2. Carrere R (2006). Greenwash. Critical analysis of FSC certification of industrial tree monocultures in Uruguay. World Rainforest Movement, Montevideo. Cohen,S. (2007), Multinational Corporations and Foreign Direct Investment, chapter 6 (Why companies invest overseas). Contributions to Political Economy (2002), vol 21. This is a special issue on the contribution of Stephen Hymer to the study of multinational companies, esp. articles by Pitelis, Kindleberger, Graham, Sudgen and Wilson, Nolan et al., and Ietto-Gillies Dickens, P. (2007). The Global Shift. Mapping the Changing Contours of the World Economy, 5th edition. London: Sage Publications, ch 4. Dunning, J.H. (1993) (ed). The Theory of Transnational Corporations. 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