Internationalization, diversification strategy and ownership structure: Implications for French MNE performance

International Business Review Vol. 5, No. 4, pp. 367-376, 1996

Pergamon

S0969--5931 (96)00018-2

Copyright © 1996 Elsevier Science Ltd Printed in Great Britain. All rights reserved 0969-5931/96 $15.00 + 0.00

Internationalization, Diversification Strategy and Ownership Structure: Implications for French MNE Performance Ahmed Riahi-Belkaoui Department of Accounting, College of Business Administration, University of Illinois at Chicago, 601 South Morgan Street, Chicago IL 60607-7123, USA

Abstract - - This study examines potential explanations for corporate economic performance of 31 French multinational enterprises (MNEs). The results suggest that the corporate economic performance varies contingent on the direct and interaction effects of the degree of internationalization and the type of diversification strategy, and on the direct effect of ownership structure. Copyright © 1996 Elsevier Science Ltd

Key words - - Internationalization, Diversification Strategy, Ownership Structure, Corporate Performance.

Introduction A search for the variables associated with the observed differences in performance among multinational enterprises (MNEs) is an important international research topic. Empirical evidence on the issue leads to results supporting the importance of diversification strategy and internationalization for MNE performance (Geringer et al., 1985; Kim et al., 1989). This impact of ownership structure or concentration of stockholdings on this relationship has not been examined. One school of thought argues that the distribution of ownership has important implications for corporate efficiency and strategic development (Galbraith, 1967; Marris, 1964; Pfeffer and Salancik, 1978; Williamson, 1964; Belkaoui and Pavlik, 1991). This study suggests that the economic relationships between MNE corporate performance on one hand and diversification strategy and internationalization on the other hand are best examined in the context of ownership differences between firms, and develops and tests a model that describes the influence of internationalization, diversification strategy and ownership structure on MNE corporate performance in France. Theoretical Framework Geringer et al. (1989) examined the effects of diversification strategy and internationalization on the MNE performance of the 100 largest MNEs from the USA and Europe. Diversification strategy and degree of 367

French MNE Performance

368

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internationalization, two fundamental elements of any MNE's strategy, involve two aspects: range and relatedness of products, and relative emphasis on foreign versus domestic operations. Both diversification (measured by Rumelt's (1974) classification scheme) and degree of internationalization (measured by the ratio of a company's foreign subsidiaries' sales to its total worldwide sales) were found to be significantly related to MNE 1977-1981 performance (measured by the ratio of net annual profit-to-sales). Kim et al. (1989) e x a m i n e d the same r e l a t i o n s h i p s for 62 US multinationals. The results were that the corporate profit performance impact of related and unrelated diversification varies, contingent upon the extent of a firm's international market diversification. To measure both the product and the international market dimensions of diversification, they relied on a measure used by Kim that extends the Jacquemin-Berry (1979) entropy measure of diversification into the global context. Performance was measured by profit growth and stability adapted from the statistic proposed by Hunter and Coggin. This study expands on previous research along the following four lines. First, the effects of ownership structure or concentration of stockholdings are added to examine the relationship in the context of ownership differences between firms. Second, to control for country effect, the sample was limited to French MNEs. Third, dual strategy diversifiers were included in the analysis. Fourth, both direct and interaction effects of diversification structure and internationalization were examined. The model (illustrated in Fig. 1), indicates that the ownership structure as expressed by stock concentration, diversification strategy as expressed by both related and unrelated diversification, and internationalization influence corporate profit performance of French firms. The model assumes an interaction between diversification and internationalization.

I

I

I

OWNERSHIP STRUCTURE

I

I

i-->1 I i

| I

I

I [

i I_ >1 I'1

DIVERSIFICATION STRATEGY

•i _ _ I

I

i

I

iI

m ~..>I

I'

'1

Research Model

RELATED DIVERSIFICATION

UNRELATED DIVERSIFICATION

I'

I a

I i

I--I

I I I

I I I

i--I i !

i

I

I

I

.

I-=>I

[ I i

I

|

INTERNATIONALIZATION I - - > 1 I I

I STOCK CONCENTRATION

I i

II

F i g u r e 1.

I

INTERNATIONAL SALES / TOTAL SALES

! I -I II |--i

I I

CORPORATE

PROFIT

I PERFORMANCE

369 Stock Concentration and Performance The separation of ownership and control in the large corporation causes owners' motivations to differ from those of managers (Gordon, 1940; Mason, 1958; Williamson, 1964; Monsen and Downs, 1965). The assumption is that the shareholders, as value maximizers, view managers as being responsible for the maximization of efficiency. Shareholders need to be able to both coordinate action and demand information that will allow them to overcome any information asymmetries (Berle and Means, 1932), and influence management's decisions and responsibility towards value maximization and strategies that are in the best interest of stockholders. One solution for shareholders is to increase their share of stock ownership. Accordingly, higher ranges of stock ownership will be positively related to performance.

Hypothesis 1: There will be a positive relationship between performance of French MNEs and higher ranges of stock concentration. Diversification and Performance The strategic management literature differentiates two different types of diversification strategies: related and unrelated. Related diversifiers diversify predominantly within their industries while unrelated diversifiers diversify predominantly across industries (e.g. Rumelt, 1974). Empirical results on the M-Form hypothesis differentiated between the impact of related and unrelated diversification on performance with mixed results (Hoskisson, 1987; Belkaoui and Pavlik, 1991; Hill and Snell, 1989). Lower economic returns (Christensen and Montgomery, 1981; Rumelt, 1974, 1982) and lower risk (Amit and Livnat, 1989; Bettis and Mahajan, 1985) were found, however, to be associated more with unrelated diversification than related diversification (Bettis, 1981; Christensen and Montgomery, 1981; Rumelt, 1974, 1982; Belkaoui, 1992). Because of the mixed results in previous studies, both forms of diversification are expected to be significantly associated with the performance of French firms.

Hypothesis 2: There will be a positive relationship between, on one hand, performance of French MNEs and, on the other, related and unrelated diversification. Internationalization and Performance Various studies support a positive relationship between the degree of internationalization and performance (Rugman, 1986; Bergsten et al., 1978; Porter, 1988; Buhner, 1987; Geringer et al., 1989). Various explanations are given to include the arguments that internationalization (a) yields competitive advantages by permitting a firm to exploit the benefits of performing more activities internally (Rugman, 1979); (b) allows the firm to capitalize on proprietary parent firm skills, highly developed but under-utilized (Dubin, 1980); (c) allows a firm to exploit inter-relationships between different

French MNE Performance

370 International Business Review 5,4

segments, geographical areas, or related industries (Porter, 1985); and (d) creates e c o n o m i e s of scope, scale and experience (Porter, 1985). The evidence to date includes either U S - b a s e d M N E s or a mix of US and European MNEs. To control for possible country effects, the hypothesis in this study is limited to the French context. Therefore:

Hypothesis 3: There will be a positive relationship between performance of French MNEs and degree of internationalization of the firms' operations.

Ownership Structure, Diversification Strategy, Internationalization and Performance The three hypotheses state that performance is associated with ownership structure as expressed by the degree of stock concentration, diversification as e x p r e s s e d by b o t h r e l a t e d and u n r e l a t e d d i v e r s i f i c a t i o n , and i n t e r n a t i o n a l i z a t i o n , as well as with the i n t e r a c t i o n e f f e c t s o f internationalization and diversification strategy. The interaction effects are motivated by the thesis that both internationalization and diversification act in concert for an improvement of performance of French MNEs. For most multinational firms, diversification is only possible or is greatly facilitated by entering international markets. The combined effect of internationalization and diversification increases performance. The model follows: PERFi = al + (a2*INTi) + (a3*RTDi) + (a4*UTDi) + (a5*STCi) + (a6*INTi*RTDi) + (a7*INTi*UTDi) + u, where PERFi = performance of the French MNE, INTi = internationalization, RTDi = related diversification, UTDi = unrelated diversification, STCi = stock concentration, a = regression coefficient and u = residual.

Sample To ensure a large sample size with readily available data, the initial sample chosen was the 83 important French companies surveyed in the 1990 French Company Handbook. The information needed was the 1988 rate of return on assets, the 1988 stock concentration measure, and the 1988 related and unrelated diversification measures. The final sample included 31 French MNEs. The reduction of the sample was largely due to the unavailability of some of the data on stock concentration and diversification.

Methods Performance Measures The dependent variable chosen to express the performance of a firm was the rate of return on assets. The rate of return on assets was chosen because of its use in previous research; using it should facilitate comparison among studies. It was computed as the 1988 after-tax profits-to-assets. The use of a single

371 year was motivated by (a) Belkaoui's findings (1991) that significant performance effects arising from related and unrelated diversification strategies in the French context can be investigated in cross-sectional analyses, and (b) the availability of data for 1988. The 1990 French Company Handbook (International Business Development, 1990) was used to obtain the 1988 rate of return data. The French Company Handbook is an annual bluechip guide published by International Business Development with the International Herald Tribune. All information contained in the guide has been compiled from trade, statistical, and company reports, editorial and other reliable sources.

Ownership Structure The data on ownership structure were also collected from the 1990 French Company Handbook (International Business Development, 1990). Stock c o n c e n t r a t i o n was c o m p u t e d as the share of ownership by outside stockholders holding more than 5% of the common stock in 1988. Degree of lnternationalization Due to the unavailability of data, it was not possible to use the preferred ratio: foreign subsidiaries' sales to total MNE sales (Rugman, 1986). The degree of internationalization was first measured by the ratio of a firm's international sales to total MNE sales (Stopford, 1985). Firms were then classified as highly internationalized if their ratio was higher than or equal to 0.44, the mode of the distribution of the ratio in the sample, or low internationalization if their ratio was lower than 0.44. The dichotomization is accomplished to treat internationalization as a class variable in the covariate analysis. Diversification Measures The choice of diversification measure is crucial to the empirical investigation of performance implications of corporate diversification strategy and ownership structure. Given Montgomery's results (1982) on the strengths and weaknesses of the index approaches used by industrial organization researchers and the categorical approach used by strategy researchers, Palepu (1985) relied successfully on the Jacquemin-Berry measure (1979). This entropy measure is used in this study. Given a firm operating in n industry segments the entropy measure of total diversification DT is defined as follows: n

DT=

5~ pi In (1/pi), i=1

where P~ is the share of the ith segment in the total sales of the firm. The related diversification measure, DRJ, is defined as follows: n

DRJ =

y~ p~i In (1/pji), i=j

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372 International Business Review 5,4

where pig is defined as the share of the segment i of group j in the total sales of the group. The total related diversification measure, DR, is a function of DRL It is defined as follows: n

DR=

~_, DRJ P~, j=l

where P is the share of the jth group sales in the total sales of the firm. The unrelated diversification, DU, is computed as follows: n

D U = ~ PJ In (1/Pi). j=l Values of DR and DU are computed from data derived from the 1990 French Company Handbook. Covariate Variables Two covariate variables were used to control for possible intervening effects. Assets, as a measure of size, were used as a covariate. Previous research had considered assets as a control measure for return on assets and variability of return on assets (Hall and Weiss, 1967; Fisher and Hall, 1969). The natural logarithm of 1988 assets served as a measure of size. The logarithmic transformation was used because (a) size is highly skewed and extreme values strongly affect correlations with other variables (Kimberly, 1976), and (b) a logarithmic transformation closely approximates the normality assumption underlying the methods used in this study (Belkaoui and Pavlik, 1991). The age of the company was also used as a covariate. It is used to control for the potential bias toward newly diversified firms into new international market areas (e.g. see Kim et al., 1989, p. 50). Experience in international markets precedes direct involvement in international markets, which justifies the use of the age of the c o m p a n y rather than the number of years in international markets. The age of the company was calculated as 1988 minus the year of the founding of the c o m p a n y as disclosed in 1990 French Company Handbook. This study did not control for industry effects. The large French-related and unrelated diversified firms, all highly diversified, represented 13 major industrial sectors, so industry effects would tend to cancel out. Results Table 1 presents the overall results for the rate of return on assets (hereafter referred to as ROA). The results suggest that the relationships between performance and internationalization, performance and diversification strategy, and b e t w e e n s t r a t e g y - i n t e r n a t i o n a l i z a t i o n interactions and

373 Source

df

MS

F

P

Model Internationalization Related diversification Unrelated diversification Stock concentration Internationalization x related diversification Internationalization x unrelated diversification

8

0.0020

3.70 2.93 6-73 3.30 2.93 0.1951 0.0072

0.0070* 0.1000"** 0.0166" 0.0828*** 0.1000"**

3.14 0.33

0.09*** 0.57

French MNE Performance

Covariates Size (log of assets) Age of the firm Error Total

1.79 8.77

22 30

0.00055 0-00055

MS = mean square. *P < 0.01; ***P < 0.10.

performance are statistically congruent with past research. The type of diversification strategy, the degree of stock concentration and the level of internationalization are systematically related to performance. An interesting result of this study is the significant interaction b e t w e e n unrelated diversification and internationalization. It suggests that both variables act in concert for an improvement of performance of French MNEs. The significant levels of the covariates indicate that size was an important control. A c o m p a r i s o n of the a d j u s t e d ROA means for high and low internationalized firms yielded a significant difference (t = 2.07387) in favor of the highly internationalized firms. ROA was 0-047 for the high group and 0.0333 for the low group. All these results support the three hypotheses. Discussion The central proposition in this study is that the difference in the performance levels of French firms that employ the different strategic approaches of related and unrelated diversification is best examined in the context of differences in the ownership structure or concentration of holdings. Hypothesis 1 was confirmed, suggesting that performance of French firms is better with higher stock concentration; that allows shareholders to align managers to the best interests of shareholders. It confirms Berle and Means' thesis (1932) that the dispersion of shareholders' ownership allows managers holding little equity in the firm to forego value (wealth) maximization and use corporate assets to benefit themselves rather than the shareholders. The high stock concentration in the French case imposed the appropriate discipline on managers' behavior. Hypothesis 1 also confirms the thesis that if managers have small stockholdings, they will work towards value maximization as a result of factors including market discipline (e.g. the managerial labor market

Table 1. Results of the analysis of covariance for the return on assets

374 International Business Review 5,4

(Fama, 1980), and the product market (Hart, 1983)) and the market for corporate control (Jensen and Ruback, 1983). Hypothesis 2 was also confirmed, suggesting that performance of French MNEs is positively related to both related and unrelated diversification. It confirms findings in other contexts and other countries about the impact of diversification strategy on the performance of MNEs. Hypothesis 3 was also confirmed, suggesting that performance of French MNEs is positively related to the degree of internationalization. It adds to similar evidence with US and/or European MNEs. The significant interaction effect between unrelated diversification and internationalization shows that the performance gains in French MNEs arising from internationalization are best accomplished with unrelated diversification. It allows firms to exploit inter-relationships between different segments in different geographical areas, and unrelated industries. Internationalization increases the firm's capacity to exploit different opportunities in different markets and in different countries. This finding in the French context is entirely compatible with Kim et a l . ' s (1989) findings that unrelated diversification can be associated with favorable profit performance when fh-ms are well diversified internationally. Obviously, more research is needed to verify the results of this study in other periods and other contexts. Additional variables that may influence the relationships examined in this study need to be considered. Firms in other European markets could be included in the sample along with dummy variables to control for firm effects. A comprehensive measure of global diversification introduced in Vachani (1991) also needs to be used. It was not used in this study because of the non-availability of data. Finally, performance measures should include both ROA and stock value to assess the potential differential impact.

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Received July 1994 Revised December 1994 and September 1995