Resource accumulation and overseas expansion by Japanese multinationals

Journal of Economic Behavior & Organization Vol. 65 (2008) 277–302

Resource accumulation and overseas expansion by Japanese multinationals Heather Berry a,∗ , Mariko Sakakibara b,1 a

Department of Management, The Wharton School, 2022 Steinberg Hall-Dietrich Hall, University of Pennsylvania, Philadelphia, PA 19104-6370, United States b Anderson Graduate School of Management, University of California at Los Angeles, 110 Westwood Plaza, Suite B508, Los Angeles, CA 90095-1481, United States Received 26 February 2003; accepted 19 July 2005 Available online 17 August 2006

Abstract In this paper, we examine the motivation for and outcome from a firm’s multinational expansion strategy by analyzing two issues: first, the relationship between a firm’s intangible assets and its investment abroad, and second, the evolution of the value of multinationality to shareholders as a firm’s level of international activity and foreign experience changes. Overall, our results show that while it is typical for the Japanese firms in our sample to accumulate intangible assets prior to investing in foreign markets, these firms need experience in foreign markets before a return on this investment will be realized. © 2006 Elsevier B.V. All rights reserved. JEL classification: F23; L25 Keywords: Foreign direct investment; Firm performance; Intangible assets

In this paper, we analyze the process of resource accumulation and overseas expansion by multinational enterprises (MNEs) to examine more fully how firms build and sustain competitive advantage in both home and foreign markets over time. An important focus in both the international business and strategy literatures is on the resources and capabilities of firms that are hard to imitate, strategic in nature and likely to afford a firm unique opportunities. Such assets tend to be intangible, particularly various kinds of knowledge and know-how for new products and processes, for developing and carrying out marketing programs, and for managing these economic activities. ∗ 1

Corresponding author. Tel.: +1 215 898 0990; fax: +1 215 898 0401. E-mail addresses: [email protected] (H. Berry), [email protected] (M. Sakakibara). Tel.: +1 310 825 7831; fax: +1 310 825 1581.

0167-2681/$ – see front matter © 2006 Elsevier B.V. All rights reserved. doi:10.1016/j.jebo.2005.07.007

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Below, we build on arguments from both the strategy and international business literatures that focus on the intangible assets of firms to explore two issues: firm motivations for foreign direct investment and the outcome from this investment in terms of firm performance. Regarding firm motivations for foreign direct investment (FDI), we borrow from the strategy and international management literatures to focus on how firms exploit and develop their intangible assets in both home and foreign markets. We contribute to these literatures by specifically testing whether the accumulation of a firm’s intangible assets actually precedes its investment abroad. Further, we focus more extensively on firm motives for FDI by examining whether MNEs may be more than just exploiters of home country knowledge, and whether foreign markets afford firms access to resources, knowledge and competencies outside their home market that can be used throughout their global network of subsidiaries. By focusing on both firm exploitation and development of intangible assets in home and foreign markets, we examine more fully how firms build and sustain competitive advantage over time. Regarding the outcome from this investment, we examine the performance effects from a firm’s foreign operations as a firm’s level of international activity changes. We build on research in the international business literature while we consider how the firm specific resource of learning and experience from prior foreign investments influences the performance effects of a firm’s multinationality. Unlike existing research on this issue, we analyze how performance effects may change as firms increase their activities abroad and gain both experience and learning from managing subsidiaries in foreign markets. By incorporating the heterogeneous resources and experiences of firms into the analysis, we extend our understanding of how and why a firm’s performance effects from its multinationality may differ depending on the firm’s prior experiences and capabilities. Overall, our results from a panel of Japanese manufacturing firms over a 24-year period suggest that while it is typical for Japanese firms to accumulate intangible assets prior to investing in foreign markets, these firms need experience in foreign markets before a return on this investment will be realized. Thus, while exploiting intangible assets provides the dominant motivation for Japanese firms expanding abroad, our performance results reveal that intangible assets are a necessary but not sufficient condition for performance benefits from multinationality. Our results highlight an important firm specific intangible asset that has not been considered among a firm’s resources and capabilities in prior studies that have examined the performance effects from multinationality: namely, a firm’s experience managing operations in foreign markets. By incorporating the view that firm experiences in foreign markets provide both learning opportunities for firms and important signals to shareholders, we show that there may be different performance outcomes from a firm’s overseas activities depending on how much experience and learning a firm has in foreign markets. These results suggest that both managers and shareholders should allow firms to gain foreign experience prior to evaluating whether FDI is contributing to or detracting from overall firm value. 1. Theory and hypotheses In this paper, we view firms as being bundles of resources (including tangible and intangible assets) and routines that are utilized in specific product and geographic markets. Importantly, the strategic intangible assets we focus on in this paper are not likely to be distributed uniformly across firms within an industry. Firms acquire and accumulate strategic assets over time, and the configuration of asset bundles may differ considerably across firms within an industry, depending on a firm’s initial and subsequent strategic choices. Firms with strong strategic advantages may

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undertake FDI whereas those firms lacking these advantages may remain home-bound or service foreign markets by other modes. In this paper, we extend the literature that examines a firm’s resources in its intangible assets in two ways. First, we consider the relationship between a firm’s accumulation of technological know-how and marketing ability with its investment abroad to analyze firm motivations for FDI, and second, we examine how the performance effects from multinationality change as a firm gains the firm-specific resource of foreign experience and learning from managing operations abroad. Each of these issues is developed more below. 2. Motivations for FDI Traditional arguments in the international management literature about the motivation for FDI by multinational enterprises have tended to emphasize the possession and exploitation of firm-specific advantages. Similar to Coase (1937), Hymer (1976) explained how the logic of multinational organization is governed by the internalization of international markets. Drawing on Bain (1956), Hymer explained how the profitability and growth of MNEs reflect their possession of monopolistic competitive advantages such as proprietary technology, brand names and other firm-specific assets. Building on Hymer’s concept of firm-specific assets, Dunning (as developed in Dunning, 1980, 1988, 1993) focuses on how patterns of firm foreign investment are determined by three sets of advantages: ownership, location and internalization (OLI) advantages. Within this paradigm, MNCs are viewed to have ownership advantages vis-`a-vis their major rivals, which they utilize in establishing production in sites that are attractive due to their location advantages (Dunning, 1988). Ownership advantages arise both from unique firm specific intangible assets (proprietary assets) and from a firm’s ability to create new technologies or coordinate (through common governance of a network of assets) cross-border activities effectively (Dunning, 1988; Cantwell and Narula, 2001). Both types of ownership advantages lead to firm specific assets that can be exploited abroad by firms through their foreign direct investment. The majority of empirical studies that test what we are calling the exploitation prediction (that a firm’s intangible assets precedes its investment abroad) have analyzed a cross-section of firm data during a single period in time (see, for example, Caves, 1974; Buckley and Casson, 1976; Dunning, 1980; Morck and Yeung, 1991; Kogut and Chang, 1991; Pugel et al., 1996). While previous empirical studies have reported a significant relationship between a firm’s technological know-how and marketing ability and its foreign investment, these studies have been limited in their analysis by including only cross-sectional data. The problem with this static approach is that the idea of precedence is not really tested; to test adequately for this motivation, one needs to consider the process of intangible asset accumulation and the foreign expansion strategy of firms. An exploitation motive does not simply predict an association between a firm’s intangible assets of technological know-how and marketing ability and its foreign direct investment; rather, it predicts a very clear direction for this association: the existence of these assets should precede a firm’s international investment abroad. By looking at only one year in time, previous studies have been unable to conclude whether a firm’s accumulation of technological know-how and marketing ability actually precedes its international expansion. In the present analysis, the relationship between a firm’s lagged intangible assets of technological know-how and marketing ability and its foreign investment is explored to test the predictions regarding the exploitation abroad of assets created in a firm’s home market. Granger’s concept of causality (Granger, 1969) is used to investigate the issue of precedence between a firm’s home market asset accumulation and its investment abroad. If the exploitation prediction holds, the

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intangible assets of technological know-how and marketing ability should Granger cause investment abroad. Hypothesis 1. The accumulation of technological know-how and marketing ability precedes a firm’s foreign direct investment. The exploitation rationale provides one motivation for foreign direct investment. Another motivation for FDI is to develop assets that could be used by an MNE throughout its multinational network of operations. Dunning (1993), in his eclectic paradigm and others (including Bartlett and Ghoshal, 1989; Kogut and Zander, 1993; Cantwell, 1995; Dunning and Nurula, 1995; Kuemmerle, 1997; Madhok, 1997; Patel and Vega, 1999; Le Bas and Sierra, 2002, for example) have gone beyond the exploitation motive and recognized that MNEs may be more than just exploiters of home country knowledge or advantages, that foreign locations may allow firms to acquire competencies throughout their network. Bartlett and Ghoshal have asserted that MNEs operating in a variety of environments are exposed to multiple stimuli that enable them to develop competencies and learning opportunities. Further, Cantwell has analyzed the US patenting activity of the largest US and European companies over a 100-year period and found a significant international dispersion of these firms’ technological activities. Kuemmerle (1997) and Wesson (1993) have argued that feedback may exist from a firm’s subsidiaries to its technical activities in its home market because, as Florida (1997) and Kuemmerle (1997) suggest, foreign investments may represent a strategy to achieve competitive advantage through generating new technological capabilities and assets. In particular, foreign subsidiaries may gain access to local technological knowledge or may create knowledge themselves that can be transferred back to the parent company (Kogut and Chang, 1991). To test whether firms may be more than just exploiters of home country knowledge and whether a firm’s multinational network of operations allows a firm to access knowledge and competencies in foreign markets to be used in their home market, both directions between FDI and the intangible assets of technological know-how and marketing ability are explored in tests of Granger causality. If there is feedback and if firms are tapping into foreign markets to develop further their firm-specific resources and competitive advantages in their home market, then the results should reveal that FDI Granger causes investment in intangible assets of technological know-how and marketing ability in a firm’s home market. Hypothesis 2. Feedback will exist from a firm’s foreign subsidiaries to its technological knowhow and marketing ability. 3. Performance effects from multinationality The second issue that is analyzed in this paper is how the performance effects from a firm’s foreign operations change as a firm’s level of international activity changes. In the previous section, we analyzed the relationship between a firm’s intangible assets of technological know-how and marketing ability and its intangible asset of multinationality.2 In this section, we examine the performance effects from a firm’s intangible asset of multinationality (its foreign operations) and how other firm-specific intangible assets (including technological know-how, marketing ability and managerial capabilities) may moderate this relationship. 2 These are the most commonly included intangible assets in empirical tests of both the internalization theory and the resource-based view because of the relative ease of operationalization.

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Building on the view that firms are bundles of resources and routines that are utilized in specific product and geographic markets, shareholder valuation of firms will depend on the value of a firm’s resources and routines in the markets in which they are employed. In this study, we use a firm’s Tobin’s q ratio to examine the performance effects from a firm’s intangible resources.3 We build on Morck and Yeung (1991) by applying their argument that a firm’s multinationality will increase firm value because it enhances a firm’s intangible assets of marketing ability and technical know-how, but not by itself. However, we go beyond Morck and Yeung by distinguishing between an initial and more advanced stage of multinationality. We predict that the performance effects from a firm’s multinationality will change over time. We distinguish between an initial and more advanced period of international expansion by firms4 to focus on a uniquely international resource that is likely to provide benefits to firms: foreign experience. This firm specific asset has not yet been considered in studies that examine the performance effects from a firm’s multinationality. We move beyond Morck and Yeung’s findings and posit that after a firm has obtained experiential knowledge and learning from prior foreign investment, its foreign operations will be valued beyond simply enhancing the firm’s intangible assets of technological know-how and marketing ability from its home market. The reasoning for these predictions is based on both the experience a firm gains from establishing and operating foreign subsidiaries, and the type of information that is available to shareholders at each of these stages. We discuss both the initial and advanced stages in more detail below. 3.1. Initial stage of foreign expansion In what we are calling an initial expansion period, firms have no experience establishing and operating subsidiaries in any market outside of their home market. As Hymer notes, a firm that decides to enter a foreign market is at a disadvantage compared to local firms in that market. As Zaheer (1995) has shown, foreign firms face a substantial “liability of foreignness”. Managers from a foreign firm do not know the local environment, they may not be sensitive to cultural differences, and they may not have access to or realize what type of information is needed to succeed in other countries. Further, a firm’s managers may not be able or capable of managing operations in foreign countries. As Hymer and others have noted, all of these disadvantages in foreign markets make a firm’s strong intangible assets of technological know-how and marketing ability from its home market crucial in determining the success of initial entries into foreign markets. Equally important for performance effects, when a firm is initially expanding abroad, shareholders have little or no information about how successful a firm will be outside its home market. While investors have knowledge about a firm’s strong intangible assets of technological knowhow and marketing ability from its home market, they do not know how well the managers will be able to transfer these assets from their home market to foreign markets. Mitchell et al. (1992) have shown that successful international expansion requires preparedness, focused management and learning from international experience. Through their analysis of firms in the American medical diagnostic imaging equipment industry, they show that firms encountering difficulties during their initial attempts to expand internationally may not survive or, less seriously, may suffer market 3 This approach has also been used by Tobin and Brainard (1977), Errunza and Senbet (1981, 1984), Kim and Lyn (1986) and Morck and Yeung (1991), among others. 4 We note that the distinction between a firm’s initial expansion and its more advanced levels of expansion is an empirical question, which we discuss below.

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share losses. Further, Li (1995) has shown that first time entrants are more likely to fail than repeat entrants. These studies confirm that international operations are risky and that not all firms attempting to become international will be successful. In this study, we argue that the first few foreign entries by a firm will provide a good test of the skills of the firm’s managers to succeed outside their home market for shareholders. Until a firm has shown investors that it can succeed in foreign markets, a firm’s shareholders may discount its initial FDI. 3.2. More advanced stage of foreign expansion After this initial period of foreign expansion, however, the performance effects from a firm’s multinationality may change. As firms gain more experience operating in foreign markets, they provide information to shareholders that they are capable of operating outside the home market. In addition, those firms that encounter severe difficulties in their initial foreign expansion may not be able to expand abroad further. Those firms that continue to expand into a more advanced stage are providing information to shareholders that they can successfully enter and operate in foreign markets. These firms are showing investors that they have the preparedness and focused management that Mitchell et al. (1997) have shown that successful international expansion requires. No longer being a first-time entrant in international expansion, these firms no longer fall into Li’s first-time foreign entrant category (which he found were more likely to fail than repeat entrants). By focusing on a firm’s foreign experience, we are focusing on the capabilities firms gain that transcend specific foreign markets. The Uppsala school in the international management literature argues that some of the knowledge and learning about the foreign expansion process that managers gain through their initial entries in foreign markets will be useful to their expansion in other countries. Johanson and Vahlne (1977) build on Penrose’s (1959) distinction between objective knowledge, which can be taught, and experiential knowledge, which can only be learned though personal experience. Market specific knowledge can be gained mainly through experience in the market whereas knowledge of the operation and of knowledge gained from operating in foreign countries can often be transferred from one country to another. Within the Uppsala school, experience has to be acquired through a long learning process in connection with current activities. In this view, knowledge gained through foreign operations can be considered to be an important firm specific resource. In a more recent article, Vahlne and Johanson (2002) discuss how changes in the environment are affecting the way modern companies internationalize. They conclude that their model and their focus on experiential learning is still relevant and useful for understanding the internationalization process of firms. Empirical studies have found that firms can learn both from their initial entries and from interactions across the subsidiaries in their network. Barkema et al. (1996) analyzed the survival rates of 13 Dutch firms’ foreign subsidiaries and found that firms benefit from previous experience in the same country as well as previous experience in countries with a similar culture. Chang (1995) has also found that learning from earlier foreign market entry experience enables firms to build up firm specific capabilities or internationalization knowledge that are then used in subsequent market entries. Terpstra and Yu (1988) and Yu (1990) have shown that a firm’s prior international experience matters because firms gain knowledge from investments that can be used in other markets, while Blandon (2001) has shown that prior foreign involvement significantly explains entry into the Spanish banking sector by foreign banks. In addition, managers may build organizational routines that allow firms to expand abroad in many markets efficiently (Westney, 1988; Johanson and Mattsson, 1988; Madhok, 1997). Delios and Henisz (2000) have shown that firms build hazard-mitigating capabilities that provide benefits for future market entries. Further,

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studies that focus on the foreign subsidiary in an MNEs network show that firms may be able to optimize the roles played by each subsidiary and create synergies and learning that go beyond the mere sum of the firm’s foreign activities (Birkinshaw et al., 1998; Frost, 2001; Andersson et al., 2002). While it is obvious that managers need to learn about country-specific issues (including the specific cultural and institutional differences) with each entry into a foreign country, they can also build on the parent level firm-specific information and learning from their initial entries (Chang, 1995; Barkema et al., 1996; Pennings et al., 1997; Madhok, 1997). The parent level firm resources that may be developed through previous international experience include but are not limited to parent level managerial capabilities to coordinate activities across borders, to identify successfully foreign markets in which opportunities exist for the firm, to manage foreign employees, to deal successfully with foreign governments, and to deal with cultures and institutions that are different from the home market. As firms gain experience with each of these activities, they will also be developing managerial capabilities that will be useful for future foreign expansions. Importantly, these capabilities result from learning that derives from experiences and discoveries in particular country settings and learning that transcends individual markets and derives from interactions across a firm’s network of subsidiaries. In terms of the performance effects from a firm’s more advanced levels of multinationality, the exploitation of a firm’s intangible assets of technological know-how and marketing ability from their home market into foreign markets provides one reason for investors to value a firm’s international investments. In fact, this is the reasoning that is used by Morck and Yeung (1991). This reasoning is likely to influence the valuation of both initial and advanced levels of foreign expansion. More specifically, if a firm exploits its intangible assets of technological know-how and marketing ability from its home market, then the interaction terms between these intangible assets and multinationality would be positive and significant in both an initial and advanced level of international expansion. However, there are other reasons a firm’s international operations in an advanced stage may be valued beyond providing the firm with additional markets in which to exploit their home-based technological and marketing knowledge. Shareholders may value a firm’s access to profitable markets (this may be even more valued during economic downturns in the home market) or as suggested above in Hypothesis 2, shareholders may value a firm’s access to new types of technological know-how or marketing knowledge in foreign markets that can be transferred elsewhere. Further, as Kogut (1983) argues, one advantage of a multinational firm lies in the global network that is available to the firm. Shareholders may value the arbitrage and leverage opportunities Kogut describes as being available to firms with a more advanced level of multinationality. More specifically, shareholders may value a MNEs ability to arbitrage institutional restrictions, informational externalities and the cost savings gained by joint production in marketing and manufacturing. After a firm has established subsidiaries abroad and has invested in more advanced levels of international expansion, we predict that FDI will increase firm value beyond simply enhancing the parent firm’s intangible assets of technological know-how and marketing ability. Firms with more advanced levels of investment abroad have shown shareholders that they can succeed in foreign markets. These firms are providing a signal to investors that they are successfully able to expand in foreign markets. Further, we argue that firms acquire competencies as they are expanding abroad, especially managerial and operational competencies that can be applied to other markets as a firm continues to expand abroad. Finally, these firms have the ability to tap into foreign know-how and potentially more profitable foreign markets (Kogut, 1985; Kogut and Chang, 1991; Wesson, 1993; Kuemmerle, 1997). These reasons lead us to predict that as a firm gains higher levels of activity abroad (and after a firm has experience and learning from operating foreign subsidiaries),

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a firm’s FDI may be valued by investors beyond simply enhancing the parent firm’s intangible assets of technological know-how and marketing ability. Hypothesis 3. Relative to an initial stage of international expansion, during a more advanced stage of international expansion a firm’s FDI will be valued positively and significantly by investors. One study that found the opposite of what we are suggesting is Doukas and Travlos (1988), who analyzed the impact of US firms’ foreign acquisitions on the market value of the firm. They found differences between shareholder valuation of MNEs that already operate in a foreign country and MNEs that do not already operate in the foreign country; first time foreign acquisitions into a country are positively valued by investors, while acquisitions by firms already operating in the target market are insignificantly valued by investors. One reason their results are different from our hypothesis may be because they limited their sample to include only acquisitions. We suspect that at an initial stage, this entry mode may be valued differently. By acquiring a firm in a local market, an MNE is buying an already established firm in a foreign market. This provides the firm with an operation that has already proven itself in this market, and already has access to local distribution, marketing and general information. The firm is reducing the amount of risk it will be subject to in this new market. Further, managers from the parent firm may be able to learn less about the local market on their own because they are buying an operation that is already up and running. At an advanced stage, however, we are not sure why Doukas and Travlos find insignificant results since our reasoning about the benefits from foreign experience should apply to all entry modes. In the present study, we consider all foreign direct investment, the majority of which is via greenfield investment for Japanese MNEs to test our hypotheses.5 Hypotheses 1 and 2 complement Hypothesis 3. In Hypotheses 1 and 2, we focus on firm motives and causality in strategic actions as we examine the causal relationship between the accumulation of intangible assets and FDI. In addition, we examine whether Japanese FDI has been asset-exploiting (Hypothesis 1), asset-seeking (Hypothesis 2), or both. In Hypothesis 3, we test the outcomes from this investment and the perceptions of valuation by shareholders. We test whether FDI (at both initial and advanced foreign investment levels) creates excess value because firms are exploiting their intangible assets and/or because of other reasons. Through these three hypotheses, we analyze the process of resource accumulation and overseas expansion by MNEs and examine how this overseas expansion is a source of value to firms. In all three of our hypotheses, we have focused on a firm’s foreign direct investment in our discussion of a firm’s multinationality. However, we believe that it is important to consider exports in addition to a firm’s FDI to analyze more fully a firm’s multinationality. Trade models have shown that exports and FDI can have either a substitution or complementary relationship (or both), depending on whether a firm is exporting intermediate or final goods (Swedenborg, 1979; Lipsey and Weiss, 1981; Blomstr¨om et al., 1988; Markusen, 1995). In addition, from a more practical point of view, Japanese manufacturing firms had very high levels of exporting prior 5 In fact, in our sample, only 5% of the subsidiaries were acquired. Interestingly, beyond the acquisition entry mode, Delios and Beamish (2001) have analyzed whether there are differences across other types of entry modes and found differences in subsidiary survival for joint venture and wholly owned subsidiary modes. We do not separate our hypotheses or analysis into entry mode types because our analysis is at the level of the parent firm. While a small proportion of the Japanese firms in our sample pursue acquisitions, most pursue both joint venture and wholly owned subsidiary entry modes, making it difficult to categorize the parent firm based on this issue.

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to the mid-1980s. With the appreciation of the yen and a series of trade disputes, there was a decline in Japanese export growth and an increase in Japanese foreign direct investment starting in the late 1980s. As the literature is not clear on the relationship between FDI and exports (and because exports could occur either because a firm (or country) has a comparative advantage in cheap inputs or because a firm possesses superior technological or marketing capabilities), and because we do not have intra-firm trade information for our firms, we do not pursue specific hypotheses on the performance effects from a firm’s exports.6 However, to analyze more fully the performance effects from a firm’s multinationality, we include both FDI and exports in our analysis. We include a firm’s exports as an intangible asset of the firm in our models below because similar to FDI, we believe that a firm’s exports provides benefits beyond the capital investment made by the firm. Further, regarding hypotheses one and two above, we test the relationship between exports and multinationality to analyze more fully the data and the causal links between a firm’s multinationality and its intangible assets of technological know-how and marketing ability. 4. Methods 4.1. Data Our sample consists of all publicly traded manufacturing firms that are listed in the Japanese Development Bank (JDB) Database from 1974 to 1997 and that provide information on their advertising and R&D expenditures throughout this time period. Similar to US firms, Japanese firms do not consistently report their R&D and advertising expenditures over time. Because of the missing R&D and advertising data, our sample includes 3384 observations for 141 firms over this 24-year period.7 After factoring in lags, we end up with a sample of 2961 observations for our panel of firms. Because we have limited our sample to include only those firms reporting their R&D and advertising expenditures, we compared our sample of firms and the entire population of publicly traded manufacturing firms and found that our sample is representative of the population.8 All firm-level financial information is based on data reported in either the JDB Database or the Japan Company Handbook. All financial figures are real annual figures deflated to the base year 1970 using Japanese GDP deflators published in the Bank of Japan’s Economic Statistics Annual. Table 1 gives summary statistics of the main variables and reports the product moment correlations between these variables. Table 2 describes the operationalization of each of the variables (including

6 We do note, however, that if FDI and exports are complements, when FDI is valued by shareholders, it is likely that exports will be valued by shareholders as well. If, on the other hand, FDI and exports are substitutes, when FDI is valued by investors, exports may or may not be valued by investors. 7 Somewhat surprisingly, in their analysis of US multinationals, Morck and Yeung (1991) assumed that if a firm did not report its advertising or R&D expenditures, then it did not engage in these activities (this allowed them to maintain a sample size of 1600 firms). This seems problematic, as many firms do not want their competitors to know the amount that is spent on these activities. Therefore, in the present study no assumptions of zero values are used. Also, because we create stock variables, missing values for R&D and advertising expenditures limit our ability to reflect accurately the stock value for these variables. 8 Comparisons between our sample and the population of firms that report R&D and Advertising in 1985 reveal no statistically significant differences between the mean R&D/sales and advertising/sales of our sample and the entire population (997 firms) of publicly traded manufacturing firms (comparing both by industry and overall). In addition, there is no statistically significant difference between the mean from our sample and the mean from the population for our number of foreign subsidiaries variable.

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Table 1 Descriptive statistics and product moment correlations

Number of observations Mean S.D. Minimum Maximum

1. ADStock

2. RDStock

3. Debt

4. FDI

4a INDFDI

4b LDCFDI

5. Exports

3384 3848 7517 1.36 65840

3384 15560 53984 1.19 6914557

3384 120109 271335 1720 3431605

3384 21 13.2 0 89

3384 14.8 7.8 0 57

3384 15.92 8.5 0 55

3384 7728 83658 0 1256143

1. ADStock 1. ADStock 2. RDStock 3. Debt

2. RDStock

3. Debt

4. FDI

4a INDFDI

4b LDCFDI

1 0.31 −0.12

1 0.36

4. FDI 4a. INDFDI 4b. LDCFDI

0.14 0.20 0.03

−0.28 0.29 0.16

0.15 0.06 0.18

1 0.79 0.77

1 0.72

1

5. Exports

0.08

0.05

0.07

0.03

0.02

0.051

1

the control variables to test for the robustness of the results), while the main variables of firm performance, marketing ability, technical know-how, exports and FDI are discussed in more detail below. 4.1.1. Firm performance We use a firm’s Tobin’s q-value to measure firm performance. Tobin’s q is defined as the ratio of the market value of the firm to the replacement cost of its tangible assets. The attractiveness of Tobin’s q is that, first, it provides an estimate of the firm’s intangible assets, and second, no risk adjustment or normalization is required to compare q across firms (Lang and Stulz, 1994). In this paper, JDB financial data have been used to create Tobin’s q-values and Hoshi and Kashyap’s (1990) methodology for calculating Tobin’s q-values for Japanese firms has been followed. In this methodology, a number of corrections have been made to the data that are reported by Japanese firms to correct for the fact that Japanese firms’ book values tend to be much lower than replacement values, with land values being the most prominent problem. (For more discussion of this methodology, see Appendix A.) Chart 1 shows the average Tobin’s q-values for the firms in the sample. 4.1.2. Marketing ability (ADStock) A firm’s annual expenditure on advertising has been used as a proxy for marketing ability in many studies (Pugel et al., 1996; Kogut and Chang, 1991; Morck and Yeung, 1991, 1992; Belderbos and Sleuwaegan, 1996). However, a better proxy for marketing ability should capture a firm’s accumulation of “marketing capital” as studies on advertising expenditures have found a long-term effect on sales that carry over to multiple years (Peles, 1971; Hirschey and Weygandt, 1985; Broadbent, 1993). To reflect the marketing ability a firm gains from its advertising expenditures more accurately, an advertising stock measure (that includes both accumulated and current period expenditures) is used to proxy for a firm’s marketing ability. While there is no consensus in the literature on the rate of depreciation, we follow Hirschey and Weygandt (1985) and use a depreciation rate of 50% for previous years’ expenditures going back 2 years. We use advertising

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Table 2 Operationalization of variables Q

ADStocka

RDStocka

Firm performance is measured by Tobin’s q ratios—the ratio of a firm’s market value to the replacement cost of its tangible assets, following Hoshi and Kashyap (1990). All variables are inflation adjusted using Bank of Japan GDP deflators ADStock (a firm’s marketing ability) is the total value of 100% of a firm’s current year expenditures on advertising, plus spending from the previous 2 years depreciated at a 50% rate. Yearly firm level data come from JDB and are inflation adjusted (mil of yen) RDStock (a firm’s technological know-how) is the total value of 100% of a firm’s current year expenditures on R&D, plus R&D spending from the four previous years depreciated at a 15% rate. Yearly firm level data come from the JDB and are inflation adjusted (mil of yen)

FDIa INDFDI LDCFDI

A firm’s number of foreign subsidiaries according to the Toyo Keizai Shinposha Directory Using World Bank definitions, the number of foreign subsidiaries in Industrialized countries Using World Bank definitions, the number of subsidiaries in Less Developed Countries

Exportsa Debta

A firm’s inflation adjusted level of exports (mil of yen) The market value of a firm’s short and long term debt, as described in Appendix A. All values are inflation adjusted using GDP deflators (mil of yen) Yen real exchange rate as published by the IMF. Interaction terms (Yen × FDI and Yen × exports) are used to capture the firm-level effects The 3-year change in the number of employees for each firm Takes a value of 1 after the firm’s first 3 years of investing abroad and 0 otherwise Dummy variable horizontal Keiretsu membership which equals one if the firm is affiliated with one of the six main banks in Japan, including Mitsui, Mitsubishi, Sumitomo, DKB, Fuyo and Sanwa. This affiliation comes from Weinstein and Yafeh (1995) 2-Digit SIC industry dummies using the JDB codes, including (number of firms) foods (10), textiles (8), chemicals (38), machinery (22), electrical equipment (24), transportation (6), precision instruments (5), plastics (7), and a miscellaneous category for firms that mostly use raw materials (including paper and pulp (1), rubber products (4), stone, clay and glass (2), iron and steel (2), fabricated metal products (4), nonferrous metals (4) and misc (4))

Yen FirmGrowtha AdvanceDummyb Keiretsu

Industry

A firm is classified as group affiliated with one of the six groups if at least one of the following holds: (1) a group’s main bank is the firm’s biggest lender for 3 consecutive years, and total shareholding by members exceeds 20%; (2) main bank loans account for at least 40% of the firm’s loans for at least 3 years; (3) the firm is historically affiliated with a group. a These variables are scaled by the replacement cost of tangible assets (see Appendix A for calculation) to control for firm size. b We also tested an AdvanceDummy variable that takes a value of 1 after a firm’s first 5 years of investing abroad and 0 otherwise. As the results were the same, we only report the AdvanceDummy variable using the 3-year cut-off in Table 4.

expenditures as reported in unconsolidated financial reports of the Japanese firms in our sample, which means that only home-country advertising expenditures are included in this variable. 4.1.3. Technical-know how (R&DStock) Following other studies, a firm’s R&D expenditures are used as a proxy for technical knowhow. Similar to the arguments for the long-term effects of advertising expenditures, Griliches and Mairesse (1984) have argued that a firm’s R&D expenditures have long-term effects that influence a firm’s market values over time. Thus, an R&D stock measure (which includes both accumulated and current period expenditures) is used to proxy for a firm’s technical know-how. In this study, Griliches and Mairesse are followed, and a depreciation rate of 15% is applied to the firm’s previous year expenditures going back 4 years. Similar to the advertising expenditures, we use R&D expenditures as reported in unconsolidated financial reports of the Japanese firms in our sample, which means that only home-country R&D expenditures are included in this variable.

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Chart 1. Average Tobin’s Q (1974–1997).

4.1.4. FDI variables Following other studies that have analyzed performance effects,9 the measure for FDI used in this study is a count for each firm of the number of foreign subsidiaries; the higher the number of subsidiaries, the higher the degree of FDI for that firm. For each of the 141 firms in the sample, a native Japanese speaker determined the number of subsidiaries for each year from the Japanese language directory of firms with foreign subsidiaries, the Toyo Keizai Shinposha Directory. As the directory for each year was examined, our data reflect entry and exit, and the global reconfiguration of activities by the 141 firms in our sample. Domestic firms (that are not multinationals and thus have no subsidiaries abroad) are included in the sample; a portion of these firms became multinational during the time period of this study. 4.1.5. Exports The share of exports in total sales was determined for each firm for each year from the Japan Company Handbook. This share was multiplied by the total sales of the firm to obtain a yen value amount for total exports from the parent firm. There are 15 firms that never report any values (0 or otherwise) for exports throughout the 24-year period. 4.1.6. Controls To ensure that our results are not driven by other firm characteristics that have been identified in other studies as influencing a firm’s q ratio, we include a number of controls in our analysis (see Lang and Stulz for a discussion of this literature). In firm-level analyses of the type we are considering, it is common to include some measure of the firm’s historical performance to capture the growth prospects of the firm.10 As a control, we include the growth rate of the firm’s labor force to address this issue.11 It is also common to include debt, to proxy for any 9

See, for example, Morck and Yeung (1991), Mitchell et al. (1998) and Dowell et al. (2000). See, for example, Errunza and Senbet (1981, 1984), Lee and Kwok (1988), Morck and Yeung (1991), Christophe (1997) and Dowell et al. (2000). 11 We also tested growth of the firm by using the sales of each firm which yielded similar results. 10

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variation in firm values because of differences in capital structure or differences in a firm’s ability to access financial markets.12 We also include a control for real exchange rate effects. There have been mixed theoretical arguments and empirical results on the question of whether there is a link between exchange rate movements and FDI.13 To ensure that we are not simply capturing exchange rate effects, the Yen real exchange rate is used to control for real exchange rate effects. (Real exchange rate interaction terms with FDI and exports are used to capture firm-level effects of exchange rate movements.) In addition, we include the keiretsu membership dummy variable. It has been argued that Japanese bank-centered business groups, know as keiretsu, have better access to capital than independent firms and are less liquidity constrained. This structure might provide an important source of competitive advantage (Gerlach, 1992) and allow those firms to invest more (Hoshi et al., 1990, 1991). By using a keiretsu dummy variable, we are controlling for these potential effects. Table 2 describes these control variables in more detail and also provides information on industry variables that were included to test for the robustness of the results. 4.2. Specifications In Hypotheses 1 and 2, we are interested in testing whether knowledge is being transferred from a firm’s home market to its foreign subsidiaries (Hypothesis 1) and whether knowledge is being transferred back to a firm’s home market from its foreign subsidiaries (Hypothesis 2). Granger’s test of causality (Granger) provides a means to test whether statistically one can detect the direction of causality when there is a lead–lag relationship between two variables. Granger causality tests are performed by joint F-tests of the hypothesis that the collective coefficients of the lagged causal variables in the model are significantly different from 0. Considering a hypothetical case of two variables, a and b, Granger’s test of causality can result in four cases: unidirectional causality from variable a to variable b, unidirectional causality from variable b to variable a, feedback (or bilateral causality), and independence of the two variables. In our estimation, feedback is captured by testing for increases in expenditures in the parent firm’s home market. (For a parent firm to use knowledge it has gained from its subsidiaries abroad, additional expenditures to absorb and fully exploit this knowledge in the home market would most likely be needed.) We applied Granger’s test of causality to consider the issue of precedence between the variables RDStock and ADStock and a firm’s FDI, between a firm’s exports and its FDI, and between a firm’s exports and its RDStock and ADStock. We use first differences of these variables to capture the changes to them. Using R&DStock and FDI as an example, the two equations for these variables are estimated by FDIit =

n  j=1

αj FDIi(t−j) +

n 

βk RDStocki(t−k) + εit

(1)

k=1

12 See for example, Shapiro (1975), Shaked (1986), Lee and Kwok (1988), Doukas and Travlos (1988), Morck and Yeung (1991), and Dowell et al. (2000). 13 On the one side is the view that when a domestic currency appreciates, domestic firms are able to purchase foreign assets more “cheaply”. On the other side is the argument that the price of foreign assets should not matter; rather, it is only the rate of return that is important. Empirically, Froot and Stein (1991) and Caves (1989) have found correlations between dollar depreciations and FDI in the US. Ray (1989), Stevens (1992) and Healy and Palepu (1993), however, have found little support for a relationship between exchange rate movements and FDI.

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and RDStockit =

n 

λj FDIi(t−j) +

j=1

n 

δk RDStocki(t−k) + εit ,

(2)

k=1

where variables are for firm i in year t, and n is the lag period. Granger causality tests are performed by joint F-tests of the hypothesis that the collective coefficients of the lagged causal variables in the model are significantly different from 0. With several lags of the same variable, each estimated coefficient may not be statistically significant, possibly due to multicollinearity. Therefore, we report the sum of the coefficients in Table 3. Because the results of the Granger causality test can be sensitive to the specification of the lag structure, we ran our tests separately using 3–6 lags in our equations. The equations are similar for the other sets of variables we test. One potential problem with our specification is that it may inappropriately aggregate firms in industries with different export and intangible asset accumulation experiences. Further, our results in this section could also be affected by the voluntary export restraints (VERs) that were imposed on the electric equipment, machinery and transportation industries in Japan. To test the robustness of the results, we eliminated firms in these three industries from our sample and re-ran the Granger causality tests. The methodology for testing Hypothesis 3 builds on the approach from earlier studies of market valuation. The financial market-based approach has strong theoretical and empirical foundations in the efficient-markets literature (Ross, 1983; Fama, 1970). In a well-functioning capital market, the financial market value of a firm provides the best available unbiased estimate of the value of a company’s assets (including both tangible and intangible assets). A basic assumption in this paper is that there is financial market efficiency and that the market value of a firm (V) is the sum of the value of its net tangible assets (T) and its net intangible assets (I). Thus, V = T + I.

(3)

For publicly traded firms, V is defined as the market value of its outstanding common shares plus estimates of the market value of its debt. The tangible assets variable is an estimate of the replacement value of the firm’s tangible assets. The intangible assets that are included in our model are technical know-how, marketing ability, exports and FDI. As indicated above, a leverage variable (debt) is also included to proxy for any variation in firm values owing to differences in capital structure. To control for firm size, all variables are scaled by the replacement cost of tangible assets14 : V T I (4) = + . T T T This causes the left hand side of the equation to become Tobin’s Q. Because we are interested in how a firm’s multinationality is valued, we test two equations. First, we test only the main effects of our variables: Qit = αi + β1 + β5

14

R&DStockit ADStockit debtit exportsit + β2 + β3 + β4 assetsit assetsit assetsit assetsit

FDIit + εit assetsit

Hoshi and Kashyap’s method for measuring the replacement cost of a firm’s tangible assets was used.

(5)

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where Q is a firm’s Tobin’ Q ratio, R&DStockit a firm’s stock of technical know-how, ADStockit a firm’s stock of marketing ability, debtit a firm’s debt, exportsit a firm’s exports, FDIit the number of a firm’s foreign subsidiaries and assetsit is a firm’s total tangible assets. αi represents intangibles related to other factors; in Japanese firms, this term could represent such intangible assets as efficient use of human resources, management style or expertise, just-in-time delivery of components, or strict quality control. Finally, εit is an error term. Eq. (5) indicates that a firm’s value to shareholders (as measured by its Tobin’s Q) is a function of its technical know-how, marketing ability, leverage (debt), exports and FDI. Interaction terms between the FDI variables and both of the intangible assets are then added to test the interaction effects (between a firm’s multinationality and its intangible assets of technological know-how and marketing ability) in the following equation: R&DStockit ADStockit debtit exportsit FDIit + β2 + β3 + β4 + β5 assetsit assetsit assetsit assetsit assetsit     FDIit R&DStockit FDIit ADStockit + β7 + εit . (6) + β6 assetsit assetsit assetsit assetsit

Qit = αi + β1

Eq. (6) allows for consideration of whether a firm’s multinationality increases its value because it enhances a firm’s intangible assets of marketing ability and technical know-how, or if it increases a firm’s value independently.15 To test for the effects of a firm’s foreign experience (and differences between a firm’s initial and advanced levels of international investment) we included a dummy variable for firms at an advanced stage on international expansion. We include this advanced FDI dummy variable as a main effect in Eq. (5) and interact it with all of our FDI terms in Eq. (6). Because there is certainly some subjectivity in deciding when a firm has reached an advanced stage of investing internationally, we tested two separate dummy variables for the advanced stage. The first dummy variable we tested takes a value of 1 after the firm’s first 3 years of investing abroad and 0 otherwise. The second advanced dummy variable we tested takes a value of 1 after the firm’s first 5 years of investing abroad and 0 otherwise. We only report the first dummy variable results below (using the dummy variable for an advanced stage after 3 years of investing abroad), but note that the results are the same for each of these dummy variables.16 In addition, we test both Eqs. (5) and (6) including the controls for exchange rate and firm growth discussed above.17 Finally, we also tested our model including an FDI squared term, to ensure that we were not overlooking a non-linear relationship. (As the FDI squared term was positive but not significant, we do not report these results below.) In addition, we ran our models with an additional advanced dummy variable to capture differences at high levels of geographic expansion (for firms with 10 or more foreign subsidiaries and separately for a firm with 25 or more foreign subsidiaries). In both of these cases, the advanced dummy was positive and significant. 15 All scaled variables have been transformed by adding a constant and taking the natural log of this sum. Using the log transformation does not change the statistical significance of any of the variables of interest; it does, however, result in a better fit of the model (higher r2 - and F-statistics). 16 We also ran our models testing a dummy variable that took a value of 0 for a firm’s first investment into each foreign country and 1 for all subsequent investments in that country (in countries in which a firm is already active). However, as this produced insignificant results, we do not display these results below. 17 One might argue that there is a simultaneity bias in this equation because Tobin’s Q may influence FDI. We performed a Granger causality test between Q and FDI and found that a firm’s Tobin’s Q does not Granger cause its FDI, suggesting the validity of our specifications in Eqs. (5) and (6). We thank Takeo Hoshi for bringing this issue to our attention.

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Hsiao (1986) and Baltagi (1995) have noted that pooling data across time can result in serially correlated error terms. In fact, the combination of time-series and cross-section variables adds a dimension of difficulty to the problem of model specification because the error term may be correlated over time and over cross-sectional units. This serial correlation problem can introduce substantial bias into the efficiency of the estimators. To control for serial correlation problems, we use the first differences of all variables and include a first-order autoregressive term.18 By using first differences, we are capturing new investment by a firm for each variable in our models. We use generalized least squares (GLS) to test Hypothesis 3. To reduce the effects of multicollinearity between the main and interaction terms, we centered the variables involved with the interaction terms (Aiken and West, 1991). There are differences across industries in terms of the accumulation of intangible assets, level of exports and FDI. Thus, as with our Granger test of causality, one potential problem with our specifications for Hypothesis 3 is that they may inappropriately aggregate firms in industries with different export and intangible asset accumulation experiences. As a test for the robustness of the results, we performed four additional tests. First, we eliminated the observations in the three industries (electric equipment, machinery and transportation) that were affected by VERs and antidumping measures in the late 1980s.19 Second, we ran our equations with industry dummy variables (for all industries). Further, we included a keiretsu dummy variable in our models. Further, as noted above, there are 15 firms that do not report export data. To ensure that these missing data points that were assumed to be 0 are not driving the results, we also ran our models with a reduced sample of 126 firms. As the results are not affected by these firms, we report the results using the full sample. Finally, we ran our models using year dummies and excluding the bubble economy years (1986–1990) to test for the robustness of our results. 5. Results 5.1. Asset accumulation and investment abroad In Hypothesis 1, it was predicted that the accumulation of a Japanese firm’s intangible assets would precede its direct investment abroad. Table 3 reports the Granger causality results for firms in all manufacturing industries. This table provides the F-statistic for Granger causality, the number of observations, the sum of the lagged explanatory coefficients and the adjusted r2 -statistic for the pairs of bivariate relations. Table 3 reveals that for all manufacturing firms, RDStock and ADStock Granger cause FDI, providing support for the predicted relationship between a firm’s intangible assets of technological know-how and marketing ability and its investment abroad in Hypothesis 1.20 To test the robustness of this result, Table 3 also reports the Granger causality results excluding firms in the electric equipment, machinery and transportation industries, and for industrialized (INDFDI) and lesser developed country location FDI (LDCFDI) considered separately. With the reduced sample (excluding industries that have been affected by government regulations restricting exports), the only statistically significant relationship is that RDStock Granger causes FDI (the 18 By using an AR(1) model, our Durbin Watson statistic is within the acceptable range (2.12 and 2.05 for models 1 and 2 reported below, respectively). 19 This also provides a test for the robustness of the results because by dropping the firms in those industries affected by trade disputes, we are dropping firms that have the highest number of subsidiaries. 20 We also performed our tests using the level of each variable; this yielded qualitatively similar results.

H. Berry, M. Sakakibara / J. of Economic Behavior & Org. 65 (2008) 277–302 Table 3 Granger causality test results (OLS estimation in first differences (with four lags)) F

N

I. Results for firms in all manufacturing industries (126 firms) I. Bivariate relationship between RDStock and FDI and ADStock and FDI 2394 RDStock ⇒ FDI 11.28*** 2394 ADStock ⇒ FDI 6.12*** FDI ⇒ RDStock 1.29 2394 FDI ⇒ ADStock 0.56 2394



(Coeff.)

293

Adj. R2

0.06 0.04 0.01 0.01

0.15 0.13 0.07 0.03

0.029 0.024

0.13 0.04

III. Bivariate relationship between RDStock and Exports and ADStock and Exports RDStock ⇒ Exports 0.22 2394 −0.005 ADStock ⇒ Exports 0.19 2394 −0.002 Exports ⇒ RDStock 0.37 2394 −0.004 Exports ⇒ ADStock 0.18 2394 −0.002

0.04 0.02 0.05 0.01

II. Bivariate relationship between Exports and FDI Exports ⇒ FDI 5.45*** FDI ⇒ Exports 1.15

F

2394 2394

N



(Coeff.)

II. Results excluding firms in transportation, machinery, and electric equipment industries (70 firms) I. Bivariate relationship between RDStock and FDI and ADStock and FDI 1558 0.06 RDStock ⇒ FDI 12.63*** ADStock ⇒ FDI 3.9 1558 0.02 FDI ⇒ RDStock 1.02 1558 0.026 FDI ⇒ ADStock 0.55 1558 0.009 II. Bivariate relationship between Exports and FDI Exports ⇒ FDI 1.10 FDI ⇒ Exports 1.04

0.13 0.05 0.05 0.03

0.005 −0.021

0.09 0.05

III. Bivariate relationship between RDStock and Exports and ADStock and Exports RDStock ⇒ Exports 0.29 1558 −0.004 ADStock ⇒ Exports 0.15 1558 −0.001 Exports ⇒ RDStock 0.17 1558 0.002 Exports ⇒ ADStock 0.11 1558 0.001

0.05 0.01 0.08 0.02

F

1558 1558

Adj. R2

N



(Coeff.)

III. Results for industrialized FDI (INDFDI) and less developed country FDI (LDCFDI) (26 firms) I. Bivariate relationship between RDStock and ADStock and AdvancedFDI RDStock ⇒ INDFDI 15.52*** 2394 0.07 ADStock ⇒ INDFDI 7.44*** 2394 0.05 INDFDI ⇒ RDStock 1.11 2394 0.02 INDFDI ⇒ ADStock 0.84 2394 0.01 II. Bivariate relationship between RDStock and ADStock and developing FDI RDStock ⇒ LDCFDI 14.72*** 2394 2394 ADStock ⇒ LDCFDI 8.45*** LDCFDI ⇒ RDStock 0.74 2394 LDCFDI ⇒ ADStock 0.42 2394 * p < 0.10, ** p < 0.05, *** p < 0.01.

0.07 0.04 0.01 0.005

Adj. R2

0.12 0.11 0.04 0.02 0.13 0.07 0.03 0.02

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same results occur whether three, four, five or six lags are used). The ADStock variable does not Granger causes FDI in this reduced sample. In the sample where advanced and developing country locations are considered separately, each of the intangible assets of RDStock and ADStock Granger cause FDI in both of these locations. Further, each of the intangible assets of RDStock and ADStock Granger cause FDI at both initial and advanced levels of multinationality. Our results do not support Hypothesis 2 that there is feedback from FDI to either RDStock or ADStock. As can be seen in Table 3, we do not find feedback in the full sample, in the reduced sample excluding industries affected by export restrictions, or in our sample where industrialized (INDFDI) and less developed country FDI (LDCFDI) is considered separately. To test further for feedback from FDI to the parent firm’s intangible assets of technological know-how and marketing ability, we broke our sample into three additional subsamples: we limited our FDI variable to include only those observations from a firm’s advanced level of FDI, we broke our sample into decades (1980s and 1990s), and we excluded subsidiaries in China. Even when allowing for different motives across locations, differences depending on a firm’s prior international experiences and potential time effects, we were unable to find a significant feedback effect. 5.2. Shareholder valuation of multinationality Hypothesis 3 predicts that in a more advanced stage of a firm’s international investment (and after a firm has foreign experience), FDI will be valued directly by investors. Table 4 reports the standardized parameter estimates of the main and interaction effects models (with t-statistics in parentheses), and provides support for this hypothesis. As revealed in Table 4, the interaction between a firm’s FDI and the AdvanceDummy is positive and significant. Further, Table 4 Table 4 Shareholder valuation of intangible assets, FDI and Exports Dependent variable: Q, variables ADStock/Assets RDStock/Assets Exports/Assets FDI/Assets AdvanceDummy (FDI/Assets)AdvanceDummy (FDI/Assets)(ADStock/Assets) (FDI/Assets)(ADStock/Assets)* AdvanceDummy (FDI/Assets)(RDStock/Assets) (FDI/Assets)(RDStock/Assets)AdvanceDummy Debt/Assets Yen(FDI/Assets) Yen(Exports/Assets) FirmGrowth/Assets AR(1) F Adj. R2 n

Model 1(1) , main effects 0.04*** (2.71) 0.11*** (3.95) 0.06*** (3.58) −0.03 (−2.19) 0.01 (1.02)

0.03 (1.24) −0.02** (−2.32) −0.03** (−1.90) 0.04*** (3.41) 0.05*** (2.33) 8.83*** 0.059 2961

Model 2(1) , interaction effects 0.04*** (2.66) 0.12*** (3.91) 0.07*** (3.84) −0.03 (−2.08) 0.01 (1.09) 0.07** (2.21) −0.03 (0.28) −0.02 (−0.21) 0.02 (0.19) 0.02 (0.12) 0.03 (1.26) −0.02** (−2.54) −0.04** (−1.83) 0.04*** (3.30) 0.06** (2.26) 9.02*** 0.062 2961

(t-Statistics) variables are explained in text. All beta coefficients have been standardized, * p < 0.10, ** p < 0.05, *** p < 0.01. These models were also run with Keiretsu, industry and year dummies. Though some industry dummies were significant, these dummy variables are not reported here because their inclusion did not affect the significance of the other variables. The keiretsu dummy variable was not significant in either model.

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reveals that in both models (the main effects and interaction effects models) a firm’s initial FDI is negatively and significantly valued by shareholders. Regarding the economic significance of the intangible assets included in our models, a firm’s technological know-how is the highest valued variable. Our multinationality variables of FDI and exports are valued the second highest in our models, with each yielding similar increases to firm performance. We included many controls in our models, and overall, we find our results to be robust. The coefficient for debt was not significant in either model. Though not reported in the tables, the statistical significance of any parameter does not change with the inclusion of industry or year dummies, or keiretsu membership. While some industry dummies are significant, the keiretsu variable is not significant in any model. In addition, the results do not change when the 15 problem export firms are dropped from the sample. To test further for the robustness of the results, we also ran our models excluding firms in the electric equipment, machinery and transportation industries. We have not reported the results in Table 4 because with the reduced sample, the only difference is that the main effect of the ADStock variable is not significant. Finally, we attempted to include data on the type and location of each firm’s foreign subsidiaries. However, when we broke down our initial and advanced FDI variables into industrialized and LDC country location components, the highly correlated nature of the main effects FDI variables21 affected the reliability of the results. 6. Discussion and implications In this paper, we have examined both the motivation for a firm’s foreign direct investment and the outcome from this investment in terms of firm performance. By analyzing the relationship between a firm’s lagged technological know-how and marketing ability and its foreign direct investment, we provide a dynamic test of the exploitation motive for explaining firms’ FDI. In addition, we have moved beyond the exploitation motive to examine whether MNEs develop capabilities through their foreign direct investments that can be used in their home markets. By focusing on both firm exploitation and development of intangible assets, we more fully examine how firms build and sustain competitive advantage in both home and foreign markets. Further, because we use panel data in our analysis, we are able to examine whether there may be different motives for firms across investment locations (industrialized versus developing countries) or differences that could result from a firm’s prior international experiences. In our analysis of the performance effects from multinationality, we have focused on the firm-specific resource of firm experience to consider how this firm-specific intangible asset may impact the performance benefits from a firm’s multinational operations. By incorporating arguments in the international management literature about the managerial capabilities a firm can develop from its foreign expansion, we have included an important intangible asset that has not been considered among a firm’s resources and capabilities in previous studies that have analyzed the performance effects from a firm’s multinationality. The results from our analysis of the motivation for foreign direct investment provide very robust empirical support for the exploitation motive. Our analysis of Granger causality reveals that Japanese FDI has been asset-exploiting and provides support for the prediction that the accumulation of a firm’s intangible assets precedes its investment abroad (across both industrialized and developing countries and at both initial and advanced stages of internationalization).

21

The correlation between the number of subsidiaries in Industrialized and LDC countries is 0.72.

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Our results do not support the existence of feedback from FDI to intangible assets, no matter how we break down the investment location or experience of the firm. Prior studies of international R&D management have revealed that firms have severe difficulties in coordinating offshore R&D subsidiaries (Bartlett and Ghoshal), which suggests that the asset-seeking motive may be quite difficult for firms to realize. Further, studies that focus on the role of foreign subsidiaries in an MNC’s network have analyzed factors that influence competence development within subsidiaries and transfer across other subsidiaries. For example, by focusing on subsidiary business relationships with customers and suppliers in the host country, Andersson et al. show that a subsidiary’s relational embeddedness in external networks influences competence development in the subsidiary. In addition, they suggest that headquarter managers play a crucial role in knowledge management, and more specifically in this context, in determining whether an MNC is able successfully to access and diffuse technological knowledge developed in an MNC’s foreign subsidiaries. While Birkinshaw et al. also focus on subsidiary level data as they analyze when subsidiaries can drive the process of competence development, their study further identifies the parent–subsidiary relationship as playing an important role in the development of subsidiary innovation. Each of these studies complements the arguments put forth above regarding the advanced skills required to run an extensive multinational network and confirms that it can be quite difficult not only for foreign subsidiaries to develop assets but also for MNC managers to coordinate foreign subsidiary activities and successfully tap into foreign subsidiaries for local knowledge to be used throughout the firm’s multinational network of operations. In light of these arguments, the findings for Hypothesis 2 suggest that Japanese firms may not have successfully developed the network management capabilities to undertake assetseeking activities (at least during the time period of our study). It might take years for firms to develop the managerial capabilities to allow FDI to work as a vehicle to transfer overseas knowledge back to parent companies; even in this 24-year study, however, this relationship was not captured for these Japanese firms. Interestingly, Mitchell et al. (1998) found support for feedback from FDI to intangible assets with their US sample. This suggests that US firms may have already reached the point where network management capabilities have been developed that allows some US firms’ FDI to serve as a vehicle to transfer knowledge back to the parent company. Alternatively, the lack of findings for Hypothesis 2 may suggest that there are differences between how US and Japanese firms establish and use their FDI that is causing different results across studies that focus on US and Japanese firms. For example, Japanese firms consistently had a lower return on assets than their US counterparts during the period of this analysis and, ironically, US subsidiaries in Japan are more profitable than Japanese firms (Porter et al.). An additional alternate explanation for our lack of findings for Hypothesis 2 could be based on the aggregate data we use in our analyses. Given our focus on a dynamic test, we have used data on foreign subsidiaries that is available over a 24-year period. Accordingly, our proxies for our variables are at fairly aggregated levels. Perhaps more detailed foreign subsidiary level data would reveal more asset-seeking motivations for Japanese FDI. A final alternate explanation is that our findings suggest that Japanese FDI is primarily oriented toward market expansion. Other studies (including Florida, 1997; Patel and Vega, 1999 and Le Bas and Sierra, 2002) have found that Japanese foreign R&D activities are also primarily asset-exploiting in nature. For example, Florida surveyed R&D labs in the US and found that Japanese firms’ investment in R&D abroad is primarily asset-exploiting. More generally, survey results have found that foreign R&D investments are a relatively small component of overall scientific and technological activities of all firms, regardless of nationality (Florida).

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Finally, regarding our examination of motives for FDI, we would note that in the present study our lack of support for an asset-seeking motive does not mean that asset-seeking does not occur. Rather, our results suggest that the mean-tendency explanation for Japanese foreign direct investment is asset-exploitation in industrialized and developing countries at both initial and advanced stages of internationalization. Clearly, additional study is needed to further our understanding of how broadly applicable the asset-seeking motive is. In the present large sample study of Japanese firms, this motive was not found to be a significant explanation for these firms’ foreign expansion, no matter how we broke up our sample. Regarding performance effects, as predicted, we found that a firm’s more advanced level of international investment in FDI is valued positively and significantly by shareholders. While the results from our test of the exploitation motive emphasize the importance of intangible assets from a firm’s home country, our performance effects results reveal that intangible assets are a necessary but not sufficient condition for performance benefits from multinationality. Not all firms that spend a few years operating abroad will experience performance benefits from increased multinationality. It is only after a firm has accumulated foreign experience and signaled to shareholders that it has managerial capabilities, experiences and learning that are required to manage operations in foreign markets that performance benefits will accrue to a firm. Our results suggest that while it is typical for Japanese firms to accumulate intangible assets in their home market prior to investing in foreign markets, firms need experience in foreign markets before a return on this investment will be realized. As also revealed in Table 4, contrary to the results from previous studies on US firms, no interaction terms between the FDI variables and a firm’s intangible assets (R&DStock and ADStock) are significant and positively valued in our model.22 Regarding marketing know-how, we believe our results suggest that given the cultural and linguistic differences between Japan and other nations (as well as differences between distribution systems), shareholders do not view a homefirm advantage in marketing capabilities as translating into a firm-specific advantage abroad for Japanese multinationals.23 However, the non-significant technological know-how interaction term with FDI is more difficult to explain. Japanese firms have certainly used their firm-specific advantages in technological know-how to expand into foreign markets. However, our results do not confirm that the value of a Japanese firm’s investment in foreign markets to shareholders is influenced by its investments in R&D. Our findings, together with Morck and Yeung’s (1991) findings for their US sample, suggest that there may be differences between how shareholders value Japanese and US firms’ foreign direct investment. As firms from Japan started investing abroad much later than firms from most other industrialized countries, a Japanese firm’s entry into foreign markets and its initial multinational status may not confer the same advantages it does in other countries. Further, given the high levels of exporting by Japanese firms, perhaps a Japanese firm’s prior exporting experience may be more valued by shareholders than the firm’s investment in its intangible assets of technological know-how and marketing ability. 22 We also tested our models excluding the years 1986–1990 to ensure that our results are not affected by what has been called the “bubble economy” in Japan. (During this period the value of Q might have been inflated.) The statistical significance of the variables of interest did not change. We further tested our models dropping the 1990–1993 period (separately and in addition to the bubble economy years) to ensure that the subsequent bursting of the bubble economy did not influence our results, and our results did not change. Finally, we ran the models including year dummies, which also resulted in no change. 23 For example, Porter et al. (2000) illustrate how the Japanese idiosyncratic demand conditions and archaic distribution system became obstacles for firms in advertising-intensive consumer packaged goods industries to gain international competitiveness.

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The implications of our findings are different for firms versus shareholders. First, our results reveal that for all manufacturing industries, firms typically invest first in intangible assets and then in foreign expansion. (This finding holds even after export-oriented industries are taken into account.) Equally important, our results reveal that FDI itself is valued by shareholders after a firm has experience in foreign markets. This suggests that initially flat performance effects as a result of increased multinationality need not be viewed with nervousness. Rather, managers should concentrate on ensuring that their initial ventures abroad are successful to provide evidence to shareholders that the firm is able to compete in foreign markets. Managers should allow for foreign experience and learning to be gained prior to evaluating whether FDI is contributing to or detracting from overall firm value. For shareholders, our results suggest that it is important to wait and see which firms will be successful in foreign markets before rewarding this type of expansion. It is only after a firm’s initial expansion abroad that foreign experience has been gained and that shareholders have information about whether a firm has the necessary international managerial capabilities to succeed in international endeavors. In addition, our findings suggest that shareholders do indeed view firms as the resource-based view suggests: as bundles of resources and routines. Increased multinationality can add value to a firm if it offers the potential for the creation of additional rents from the firm’s resources. One way shareholders can determine that a firm will be able to create additional rents in foreign markets is if the firm has signaled that it has acquired international managerial capabilities that it can use in its foreign expansion. An important distinction between our work and much of the work that has analyzed the performance effects of multinationality is the setting of our sample. Most of the existing studies have used US samples where a firm’s initial overseas investments are not observed for a majority of the firms in the sample (due to the lack of good historical data sources on the initial international expansion of large US publicly traded firms). With cross-sectional work in particular, findings of performance increases when US MNEs have intangible assets could in fact be due to both the firm’s intangible assets and its foreign experience. Without good historical data on the initial overseas investments of firms, we are unable to conclude how a firm’s foreign experience may be influencing the results. The Japanese sample used in this study provides an ideal setting to explore the foreign experience variable because of the superior historical record for the initial international expansion of these firms. Finally, there are limitations to this study. While the positive aspects of using a Japanese sample have been explained above, the fact that only Japanese firms have been included in the sample limits the generalizability of the results. Similar analyses need to be performed on other samples (that have good data on the initial international expansion period of the firms that are included in the sample) to ensure that these results are not unique to Japanese MNEs. An additional limitation of this study is that the degree of multinationality variable is measured simply as a count of the number of foreign subsidiaries. A better measure would take into consideration additional issues to provide more information on the type of foreign experience a firm is gaining such as the size of the foreign subsidiaries, the number of employees, the market value of the subsidiaries, or the actual R&D or advertising expenditures at the foreign subsidiary level to reflect specific knowledge-seeking activities in foreign countries. Further, our proxy for technological and marketing activities is certainly imperfect. While R&D and advertising expenditures are fairly consistently used in the international management and strategy literatures to operationalize these variables, it is certainly debatable how realistic these input measures are to evaluate the output types of activities that we are trying to capture. Overall, we believe that the strengths of our approach outweigh the limits as we can analyze the dynamic aspects of a firm’s exploitation and

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development of its intangible assets with our approach (given that these variables are consistently available over our 24-year time period). In the end, we believe that both large sample analyses (as found in the present study) and smaller, more detailed (and perhaps survey) analyses to get at richer levels of analysis are needed in the quest to understand better both firm motivations for FDI and the performance effects from this foreign investment. Acknowledgements We would like to thank Richard Caves, Michael Darby, Robert Dekle, Vit Henisz, Takeo Hoshi, Naomi Lamoreaux, Marvin Lieberman, Hideki Yamawaki, participants in the 1999 NBER Japan Project Meeting, workshops at UCLA and UC Santa Cruz, anonymous referees and Coeditor Claude M´enard for helpful comments. We would also like to thank Emi Morita, Hidefumi Takeuchi and Tatsuo Ushijima for research assistance. Financial support from the Center for International Business Education and Research at the UCLA Anderson Graduate School of Management (4400980-IN-23496-RGMS97) is gratefully acknowledged. Appendix A. Supplementary data Supplementary data associated with this article can be found, in the online version, at doi:10.1016/j.jebo.2005.07.007. References Aiken, L., West, S., 1991. Multiple Regression: Testing and Interpreting Interactions. Sage Publications, Newbury Park. Andersson, U., Forsgren, M., Holm, U., 2002. The strategic impact of external networks: subsidiary performance and competence development in the multinational corporation. Strategic Management Journal 23, 979–996. Bain, J., 1956. Barriers to New Competition. Harvard University Press, Cambridge. Baltagi, B., 1995. Econometric Analysis of Panel Data. Wiley and Sons, West Sussex. Barkema, H., Bell, J., Pennings, J., 1996. Foreign entry, cultural barriers and learning. Strategic Management Journal 17, 151–166. Bartlett, C.A., Ghoshal, S., 1989. Managing across Borders: The Transnational Solution. Harvard Business School Press, Boston. Belderbos, R., Sleuwaegan, L., 1996. Japanese firms and the decision to invest abroad. Review of Economics and Statistics 78, 214–220. Birkinshaw, J., Hood, N., Johsson, S., 1998. Building firm-specific advantages in multinational corporations: the role of subsidiary initiative. Strategic Management Journal 19, 221–242. Blandon, J.G., 2001. The timing of foreign direct investment under uncertainty: evidence from the Spanish banking sector. Journal of Economic Behavior and Organization 45, 213–224. Blomstr¨om, M., Lipsey, R., Kulchycky, K., 1988. US and Swedish direct investment and exports. In: Baldwin, R. (Ed.), Trade Policy Issues and Empirical Analysis. University of Chicago Press, Chicago, pp. 259–297. Broadbent, S., 1993. Advertising effect. Journal of the Market Research Society 35, 37–49. Buckley, P., Casson, M., 1976. The Future of the Multinational Enterprise. Holmes & Meier, New York. Cantwell, J., 1995. The globalisation of technology: what remains of the product life cycle. Cambridge Journal of Economics 19, 155–174. Cantwell, J., Narula, R., 2001. The eclectic paradigm in the global economy. International Journal of the Economics of Business 8, 155–172. Caves, R., 1974. Causes of direct investment: foreign firms’ share in Canadian and United Kingdom manufacturing industries. Review of Economics and Statistics 56, 279–293. Caves, R., 1989. Exchange-rate movements and foreign direct investment in the US. In: Audrestsch, D.B., Claudon, M.P. (Eds.), The Internationalization of US Markets. New York University Press, New York, pp. 199–228.

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Westney, E., 1988. Domestic and foreign learning curves in managing international cooperative strategies. In: Contractor, F.J., Lorange, P. (Eds.), Cooperative Strategies in International Business. Lexington Books, Lexington. Wesson, T., 1993. An Alternative Motive for Foreign Direct Investment. Ph.D. Dissertation. Harvard University Press, Boston, pp. 339–346. Yu, C.M., 1990. The experience effect and foreign direct investment. Weltwirtschaftliches Archives, 560–579. Zaheer, S., 1995. Overcoming the liability of foreignness. Academy of Management Journal 38, 341–363. Heather Berry is an assistant professor at the Wharton School at the University of Pennsylvania. In her research, she examines the global strategic choices of firms as they expand abroad. Her current research analyzes why shareholders value different international investment strategies for firms given heterogeneous firm resources, experiences and location choices. Her papers have appeared in the Strategic Management Journal. Mariko Sakakibara is an associate professor at the Anderson Graduate School of Management at the University of California, Los Angeles. Her research interests are in innovation and technical change, business strategy and international business. She has published in economics and management journals such as the American Economic Review, RAND Journal of Economics, Journal of Economic Perspectives, Journal of Industrial Economics, Review of Economics and Statistics, Strategic Management Journal and Research Policy.