of the wealth effects of international joint ventures report mixed results. However, little work has been done to explain this enigma. We explain this riddle by ...
Journal of
Journal ELSEVIER
of Multinational 8 (1998)
Financial 63-77
MULTINATIONAL FINANCIAL MANAGEMENT
Management
New evidenceon factors that influence the wealth effectsof international joint ventures Stephen F. Borde a,*, Ann Marie Whyte a, Kenneth Lorrie L. Hoffman a a University of’ Central Florida, Orlando, FL 32816-1400, b Florida Atlantic University, Boca Raton, FL33431-0991. Received
30 June 1996: accepted
30 November
J. Wiant b, USA USA
1997
Abstract Studies of the wealth effects of international joint ventures report mixed results. However, little work has been done to explain this enigma. We explain this riddle by identifying the factors which influence the wealth effects. Using a sample of 100 ventures that were announced between 1979 and 1994 we find that, on average, international joint ventures have virtually no immediate net impact on shareholder wealth. However, in-depth analysis reveals interesting findings that could explain why the results of previous studies are mixed. We find that the market reaction is more favorable when U.S. firms establish joint ventures in Asian countries, less favorable when the joint venture is established in lower risk developing countries, and less favorable when the joint venture is a manufacturing operation. In an increasingly globalized world, the results of this study hold important managerial implications. 0 1998 Elsevier Science B.V. All rights reserved. JEL
F23; G12; G14
cluss@ation:
Keywords:
International
joint venture;
Multinational
firm; Event study
1. Introduction
A number of firms in the United States have announced the formation of international joint ventures over the last several years. The extant literature has already provided some evidence regarding the impact of international joint ventures, but the overall results are inconclusive. We attempt to add to our understanding of
international observed
* Corresponding
joint ventures by focusing primarily
wealth
effects. Thus,
author.
Fax:
our primary
on the factors that influence the
contribution
+ 1 407 823 6676
1042-444X/98/$19.00 0 1998 Elsevier PII S1042-444X(98)00018-8
Science
B.V. All rights
reserved.
is not to identify
the wealth
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effects per se (which are generally mixed) but rather, to identify the factors that contribute to a value enhancing or value reducing joint venture. We achieve this objective by incorporating factors used in previous international joint venture studies, and by drawing on the international diversification literature, in general, to identify factors which have not previously been used in studies focusing on international joint ventures. We find that the market reaction is more favorable when U.S. firms establish joint ventures in Asian countries, less favorable when the joint venture is established in lower risk developing countries, and less favorable when the joint venture is a manufacturing operation. Thus, managers must take these factors into account when they evaluate international joint ventures. The remainder of the paper is organized as follows. First, the theoretical arguments surrounding the potential wealth effects of international joint ventures are developed to provide a framework for the literature discussion and to provide a basis for hypothesis development and analysis of the results. Next, the empirical evidence provided by previous studies is discussed and a synthesis of the theory and empirical evidence is provided. Subsequently, the hypotheses are developed, the data and methodology are outlined, and the empirical results are presented. Concluding remarks are presented in the final section of the paper.
2. Potential wealth effects of international joint ventures: theoretical underpinnings A number of theoretical arguments have been advanced to explain the potential wealth effects of international joint ventures. Some arguments suggest that significant benefits should accrue to the shareholders of firms involved in international joint ventures while others suggest that the effects may be negative or insignificant. We explore some of these arguments in detail. 2.1. Potentiulpositive
efJi?ctsqf internationaljoint
ventures
The theoretical arguments developed by Yu and Tang (1992) suggest that the benefits derived from international joint ventures outweigh the disadvantages, translating into a net positive effect on firm value. Gains may arise because the economies of different countries are less than perfectly correlated, allowing firms to reduce the variability of their earnings (Gray and Gray, 1981). International expansion may also allow shareholders to achieve diversification which they could not otherwise achieve on their own (Mathur and Hanagan, 1983). To the extent that shareholders value such diversification, positive wealth effects should be associated with international ventures. Firms may also gain scale economies and increase their market share by expanding internationally. An international joint venture may allow the firm to enter a market to which it would not otherwise have access. This is particularly true in those instances in which the foreign government prohibits 100% foreign ownership of subsidiaries. The venture may also reduce risks associated with international expan-
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65
sion to the extent that the venture partner is already familiar with the local environment, allowing for a smoother transition. 2.2. Potential
negative
effects
of
internationaljoint
ventures
In addition to the potential gains from international diversification, there are a number of arguments supporting negative wealth effects of international joint ventures. The Jensen (1986) ‘free cash flow’ theory suggests that managers may be inclined to overinvest in unprofitable projects which would have a negative effect on firm value. Barkema and Bell (1996) argue that when firms diversify beyond their national borders, they have to contend with a new national and a new corporate culture. These cultural barriers can represent formidable challenges and offset the gains from international expansion. The motivation for the venture may also lead to negative wealth effects. Knickerbocker (1973) argues that international ventures are often motivated by the expanding firm’s desire to deny benefits to competitors rather than to gain benefits of its own. Such ventures would not necessarily be value enhancing propositions. Rugman (1980) suggests that firms may also be motivated by the desire to obtain prestige and to engage in empire building rather than by the desire to increase shareholder wealth. Country risk may also reduce the potential benefits of international joint ventures. Changes in economic and political factors in the host country (such as policy changes brought on by changes in governments, blocked funds, or expropriation) may have adverse effects on the firm. Foreign investment is further complicated by exposure to exchange rates and potential conflicts with the joint venture partner which may also overwhelm the benefits of the joint venture. 2.3. Potential insignljicant efects
of
internationaljoint
ventures
When a firm announces the establishment of an international joint venture where none previously existed, the market has little information available with which to make a judgement on whether such expansion would enhance or diminish the value of the parent firm (Finnerty et al., 1986). This lack of information may make the potential benefits of a new venture unclear. Thus, the ultimate costs and benefits of a new foreign joint venture would be relatively uncertain in the announcement period. This suggests that market participants may be split in their assessment of the ultimate impact of such an investment abroad, causing positive and negative effects to offset each other. Chung et al. (1993) argue that some shareholders may view the announcement as evidence that a firm is pursuing the venture to improve its performance and thus, the venture may be seen as signal of poor performance resulting in a negative reaction. Other shareholders may view the same venture as a signal that future performance will be improved contributing to a positive reaction to the venture. Thus, the negative effect due to adverse inference regarding current firm performance may be offset by the positive effect of improved performance expectations resulting in an insignificant market reaction. Similarly, the net advan-
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tages cited by Yu and Tang (1992) may be offset by the negative influence of ‘free cash flow’ agency costs described by Jensen (1986).
3. Empirical evidence on wealth effects of international joint ventures Consistent with the conflicting theoretical arguments, the empirical evidence regarding the wealth effects of international joint ventures is inconclusive. Some studies document positive effects while others find negative or insignificant wealth effects. 3. I. Studies documenting positive wealth @xts Several studies document positive effects of international joint ventures. Yu and Tang ( 1992) find that the benefits (including cost and risk reduction) exceed the disadvantages of profit-sharing with a joint venture partner. Lummer and McConnell ( 1990) provide evidence that international joint ventures, on average, tend to enhance firm value, especially when the venture partner is a foreign firm as opposed to a foreign government. Crutchley et al. (1991) find that both U.S. and Japanese shareholders benefit when joint venture announcements are made, and U.S. shareholders earn larger excess returns when their firms are smaller than the Japanese partner. Moreover, they find that when the dollar is relatively strong (high yen per dollar), gains to Japanese shareholders are relatively high, while the converse is true for the shareholders of U.S.-based partners. Chen et al. ( 1991) find that international joint ventures are value-creating investments for U.S. firms although the magnitude of the wealth gain is negatively related to the size of the investment. Furthermore, they find that prior presence in the Far East market, the number of foreign subsidiaries, and the size of parent firms cannot explain the variation in the wealth effects across sample firms. Etebari ( 1993) examines the valuation effects of 25 joint ventures between U.S. firms and Eastern and Central European countries and finds a relatively strong positive valuation effect for the participating U.S. firms, though this result ought to be interpreted with caution because of the relatively small sample size. 3.2. Studies documenting negutive we&h efikcts In contrast, other studies document negative effects. Lee and Wyatt ( 1990) find that investor reaction to joint ventures with foreign firms is negative and only joint ventures with firms in less developed countries elicit non-negative wealth effects. Overall, they conclude that firms may systematically overinvest in ventures at the expense of firm value, which could be one manifestation of the Jensen (1986) ‘free cash flow’ problem. Chung et al. (1993) find that the market tends to react unfavorably regardless of the economic status of the host countries, the foreign partners, and the specific industries involved. However, statistically significant positive cumulative abnormal returns are experienced by those who joined with two or more foreign
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partners and those who formed joint ventures with other operations in the host countries. 3.3. Studies documenting insign@ant
wealth eflects
Yet another group of studies finds that the reaction is insignificant. Chen and Hu ( 1991) find insignificant stock valuation effects but find that the change in shareholders’ value is positively related to the amount of investment made by the U.S. firms. They also find that firms with less prior international involvement are more likely to experience positive excess returns by expanding into Eastern European countries. Finnerty et al. (1986) find no significant market reaction to 208 domestic and international joint ventures. They attribute the insignificant reaction to the fact that, as a new operation, the venture has no performance history. Thus, investors have little information upon which to base a firm value adjustment.
4. Synthesis
Though many arguments have been offered by various researchers in an attempt to explain the contradicting and confusing results observed in previous studies of international joint ventures, none seem particularly compelling. Given the conflicting theoretical and empirical evidence, it is clear that another study which simply focuses on wealth effects would not add materially to our understanding of international joint ventures. The literature will be enhanced, however, by a study that examines the factors that could explain the conflicts appearing in both theory and evidence. We increase the understanding of international joint ventures by identifying factors that influence the wealth effects associated with these ventures. We achieve this objective by incorporating factors used in previous international joint venture studies, and by drawing on the international diversification literature to identify factors which have not previously been analyzed in studies that focus on international joint ventures.
5. Hypotheses
Based on theoretical arguments and empirical evidence, we hypothesize that the wealth effects are related to several venture-specific factors. Each hypothesis is articulated in detail and the specific variable used to test each hypothesis is defined. 5. I. Geographic region
The market reaction may vary with the geographic location of the joint venture. Chung et al. (1993) find that U.S. firms pursuing international joint ventures tend to do so more frequently with partners in Europe and Japan. This may suggest that U.S. firms may be more familiar with these areas and, as such, are better able to
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capitalize on the gains. Thus, when firms announce international joint ventures in Europe or Asia, the market may react more favorably than when the joint ventures are to be established in other regions. Three binary variables are used to indicate the three primary geographic areas in our sample: Asia, Europe, and Latin America. These variables are referred to as ASIA, EURO, and LATIN, respectively. 5.2. Host country development and risk level The wealth effects may also be dependent on the degree of host country development and the relative level of host country riskiness. Doukas and Travlos (1988) find that the market reaction is more favorable when firms expand into less developed countries. Similarly, Errunza and Rosenberg (1982) find that investment risks are lower in developing countries than they are in developed countries. These findings suggest that the potential for reaping greater benefits from international cash flow diversification may be higher in developing countries since the economies of these countries are often not highly correlated with those of industrialized countries. However, some developing countries may be inherently more risky than others. This suggests that the benefits of international cash flow diversification may be negated when country risk is relatively high. Conversely, when country risk is relatively low, the benefits of international cash flow diversification may dominate. Thus, the reaction should be more favorable when projects are established in less developed countries with relatively low country risk. Developing countries are identified using the International Monetary Fund’s classification system, and country credit risk ratings from the Institutional Investor are used to categorize countries into different risk classes. Using a similar approach to that of Waheed and Mathur (1995), two binary variables are used to separate low-risk developing countries (LRSK) from high-risk developing countries (HRSK). 5.3. Strength of U. S. dollar The size of the abnormal returns may be related to the relative strength of the U.S. dollar. Using a sample of foreign acquisitions in the U.S., Harris and Ravenscraft (1991) find that when a buyer’s currency is strong relative to the U.S. dollar, the wealth effect experienced by the U.S. target is more favorable. Froot and Stein ( 1991) argue that when the domestic currency depreciates, foreign acquisitions tend to increase because of an exchange rate induced change in wealth experienced by the bidders. Mathur et al. (1994) find that a decline in the value of the U.S. dollar is associated with more favorable abnormal returns to foreign bidders pursuing U.S. targets. Crutchley et al. (1991) find that Japanese-based joint venture partners experience greater gains when the U.S. dollar is relatively strong while U.S.-based partners experience greater gains when the yen is relatively strong. These findings suggest that targets or joint venture partners gain when the bidders’ or partners’ currency is relatively strong because the bidders or joint venture partners may overpay, resulting in a wealth transfer to the target firm or joint venture partner. We hypothesize that if the U.S. dollar is relatively strong, management may be more
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inclined to overinvest or be less cautious in its analysis of the potential advantages to be gained from the international joint venture. If this theory is valid, one might expect a less favorable market reaction to occur when the U.S. dollar is relatively strong. Thus, the size of the abnormal returns should be negatively related to the relative strength of the U.S. dollar. The variable (USD) is used to represent the relative strength of the U.S. dollar and is defined as the per cent difference between the announcement day exchange rate and the mean exchange rate over the previous two years. 5.4. rvpe of partner The magnitude of the market’s reaction may be affected by the type of partner with which the venture is being pursued. Lummer and McConnell ( 1990) find that joint ventures formed with foreign firms tend to generate significant increases in firm value, whereas ventures formed with foreign governments do not. Perhaps this is because the market perceives that greater inefficiencies may result when a government entity participates than when another firm is involved, as government entities may be more subject to bureaucratic inefficiencies than private firms. Based on this theory, we hypothesize that announcements of ventures with private firms should trigger a more favorable market reaction than announcements of ventures with government entities. The type of venture partner is defined as a binary variable (FIRM) coded one if the foreign partner is another firm and zero if the foreign partner is a foreign government. 5.5. Type of operations The wealth effects may be related to the type of joint venture operations. Chung et al. (1993) find that about half of all international joint ventures are manufacturing type ventures. Manufacturing operations often require substantial investments in fixed assets, when compared to service operations, which could imply that manufacturing operations may be inherently more risky. Two points are worth noting. First, operations that employ assets that cannot be easily moved may be more exposed to expropriation and other similar risks. Second, investments in fixed assets tend to increase operating leverage and thereby further increase risk. Thus, from a risk assessment standpoint, investors may perceive foreign service operations in a more favorable light than foreign manufacturing operations. This implies that the market may react less favorably when firms announce the establishment of manufacturing ventures. Type of operations is indicated using a binary variable (MFG) coded one for manufacturing ventures and zero otherwise. 5.6. Financial strength ofparent$rm The size of the announcement period abnormal returns may be related to the financial strength of the U.S. parent firm. Abel and Blanchard (1986) and Froot and Stein ( 1991) argue that corporate profits are a significant determinant of
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investment because such profits enhance corporate wealth and thereby improve companies’ ability to finance their investments. Waheed and Mathur ( 1995) argue that differential wealth effects should be associated with different levels of profitability since these differences may reflect differing levels of management efficiency. This implies that more profitable firms may experience a more favorable market reaction. Based on these arguments, investors are likely to respond more favorably when relatively strong firms announce international joint ventures. Thus, the abnormal returns should be positively related to the financial strength of the U.S. parent firm. Average return on equity of the U.S. parent firm over the three years prior to the announcement is used as a proxy for financial strength (STRN ).
6. Data and methodology 6.1. Datu We assess the overall valuation effects of international joint ventures by compiling a sample of foreign venture announcements from the Predicast F&S Index of Corporate Change, and the Wall Street Journal over the period from 1979 through 1994. The date of the Wall Street Journal announcement is defined as day t,. The Wall Street Journal reports the preceding day’s announcements which may be first available to the public either on the day of or the day preceding the announcement. We include those announcements that are free of potentially confounding corporate events occurring within the 13-day examination window (from day t-, to day t + 6). Daily returns are then obtained from the Center for Research in Security Prices (CRSP) tapes for those firms whose stock is publicly traded either on the New York Stock Exchange (NYSE) or American Stock Exchange (AMEX). Our final sample consists of 100 international joint ventures, and Table 1 reports the distribution of announcements by geographic location, showing the number of observations used in the analyses. Many ventures involve expansion into China (20) and Japan (17), though a wide variety of other countries comprise the vast majority of the sample. About half of the sample ventures involve expansion into developing countries. 6.2. Event study methodology Announcement period abnormal returns (ARs) are estimated using the standard event study methodology (Brown and Warner, 1980, 1985). The announcement period is defined as days t _ 1 and t,. This is consistent with conventional and widely used event study methodology. Market model parameter estimates are calculated for each firm over the estimation period (from day t- rsOthrough day t-,,) using time series ordinary least squares regression, and average daily ARs for the sample of announcements are calculated. The ARs are summed over various periods within the examination window to compute cumulative abnormal returns (CARS).
S. F. Borde Table 1 International
joint
ef al. /Journal
venture
of Multinational
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8 (1998)
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locations Event
Location
study
observations
Cross-sectional
2 2
Argentina Australia Belarus Brazil Canada China Colombia Dubai Europe Finland France Hong Kong India Indonesia Ireland Italy Japan Malaysia Mexico Netherlands Norway Puerto Rico Qatar Russia S. Africa S. Korea Saudi Arabia Singapore Spain Taiwan UK USSR W. Germany Indeterminable TOTAL Note: Some announcements.
Financial
observations
2 2 0 I I 20 1
20 1 I
0 0
I 1 3 2 I 2 I7 I 6 5
3 2 I 2 17 6 4 I 0 0 I
I 6 4
6 0 5 0 85
3 100 geographic
overlap
may
exist,
but
locations
are
shown
as reported
in the
published
6.3. Cross-sectional analysis The hypotheses developed earlier are tested using cross-sectional analysis. The relationship between announcement period CARS (from day t i to day to) and the above factors is assessed using weighted least squares regression analysis. The following model is estimated: CAR, =b, + b,ASIAi + B,EUROi + b,LATINi + b,HRSKi
+ b,USDi + b,FIRMi
+ b,LRSKi
+ 6,MFGi + b,STRNi + ei
(1)
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where bj = the regression coefficients, CAR, = announcement period (from day t _ i to day t,) cumulative abnormal return for firm i, ASIA, = binary variable coded one for joint ventures located in Asian countries and zero otherwise, EUROi = binary variable coded one for joint ventures located in European countries and zero otherwise, LATIN,= binary variable coded one for joint ventures located in Latin American countries and zero otherwise, LRSK,= binary variable coded one for relatively low-risk developing countries and coded zero otherwise (zero for relatively high-risk developing countries and developed countries), HRSK, = binary variable coded one for relatively high-risk developing countries and coded zero otherwise (zero for relatively low-risk developing countries and developed countries), USDi = relative strength of the U.S. dollar where a larger value represents a relatively strong U.S. dollar, FIRMi= binary variable coded one if the foreign partner is another firm and zero if the foreign partner is a government, MFGi = binary variable coded one if the joint venture is a manufacturing operation and zero otherwise, STRN,=financial strength of the U.S. parent firm proxied by the average return on equity over the three years prior to the announcement, and ri = a random error term.
7. Empirical results 7.1. Event study results The results of employing the event study methodology are reported in Table 2. As expected, the observed daily ARs over the 13-day examination window (from day t p6 to day t +,J indicate that these announcements elicit no significant overall market reaction within the announcement period (from day t _ i to day to). The only statistically significant reaction appeared on day t -6r which is likely to be spurious, as only slightly more than half (55%) of the sample experienced positive returns (see Panel A). The cumulative effect of the joint venture announcements is also statistically insignificant over various cumulation intervals (see Panel B). Thus, on average, the establishment of international joint ventures is neither wealth enhancing nor wealth diminishing for shareholders of U.S. parent firms. This result is similar to those reported by Finnerty et al. (1986) and Chen and Hu ( 199 1) who observe insignificant market reactions to announcements of international joint ventures. However, these results are different from those reported by Lee and Wyatt (1990) and Chung et al. (1993), who find that overall investor reaction to announcements of international joint ventures is negative, and from Lummer and McConnell (1990), Crutchley et al. (1991), and Chen et al. (1991) who find that international joint venture announcements tend to enhance firm value. Our results are consistent with the theoretical arguments which suggest insignificant effects of international joint ventures. For example, Finnerty et al. (1986) contend that the lack of information surrounding international joint ventures may make the potential benefits of the venture unclear, causing market participants to be split in
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Table 2 Abnormal returns ( ARs) venture announcements Days
Panel
and cumulative
Daily abnormal returns ( ARs)
A: Daily
t~6
t-5 f-4 t 3 t 2 t 1 fo [+I t+z f-3 114 t+, h6
cthnormal
returns
abnormal
and daily
2.007 0.576 -0.449 -0.813 0.263 0.717 0.709 0.410 1.500 PO.780 1.009 0.089 0.145 returns
t-2 to t-2 TVfi to t,c ** Significant
abnormal
t-Statistic (for ARs)
0.00397** 0.00113 ~ 0.00089 -0.00161 0.00052 0.00142 0.00140 0.00081 0.00297 -0.00154 0.00200 0.00018 0.00286
Panel B: Cumulative f ~1 to t,,
oj’hfultinational
Financial
returns
(CARS)
Per cent positive (for ARs) cumulative
over specific
associated
returns
cf time
0.00282 0.00712 0.01065
with
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international
joint
Per cent positive (for ARs)
t-Statistic (for ARs)
55 59 54 55 54 51 56 59 60 55 55 56 56
2.007 1.826 1.232 0.661 0.709 0.940 I.138 1.210 I.640 1.310 1.553 I.512 1.493
51 61 56
1.008 1.620 1.493
(n = 1001
0.00397** 0.005 I I 0.00422 0.00261 0.00313 0.00455 0.00595 0.00677 0.00973 0.00819 0.01019 0.01036 0.01065 bvindows
8 (1998)
Cumulative abnormal returns (CARS)
abnormal
55 49 39 45 50 47 53 53 48 44 52 56 49
Management
(n = 100)
at the 0.05 level.
their assessment of the venture’s value. A similar argument was advanced by Chung et al. (1993). The results of our study are generally consistent with these assertions. 7.2. Cross-sectional results Results of the cross-sectional analysis are reported in Table 3. These results provide support for the argument that venture-specific factors are likely to influence the direction and magnitude of the market’s reaction to international joint venture announcements. Specifically, the market seems to react more favorably when ventures into Asian countries are announced. We conjecture that the positive relationship may be related to the fact that U.S. firms may be more familiar with these regions and are better able to secure gains from these ventures. This argument may also explain why Crutchley et al. (1991) find that both Japanese and U.S. shareholders benefit from announcements of joint ventures between firms in these two countries. Table 3 also shows that the market reacts less favorably when firms establish joint ventures in developing countries with relatively low country risk. This finding is surprising as a positive coefficient was expected on the basis that the benefits of international cash flow diversification derived from developing countries would dominate when country risk is relatively low. However, this does not seem to be the
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Table 3 Cross-sectional international CAR,
analysis of announcement joint venture announcements =b,
+b,ASIA, +b,USD,
+b,EURO, +b,FIRM;
Variable Dependent from day Intercept ASIA EURO LATIN LRSK HRSK USD FIRM MFG STRN
of Multinational
period, +b,LATIN,
+b,MFGi
Financial
cumulative
Parameter
t-
abnormal
+b,LRSK, +b,STRN,
Management
8 (1998)
returns
(CARS)
63-77
associated
with
+b,HRSKi
+P, estimate
(b,)
t-Statistic
variable is CAR , through day I, -0.002933 0.029888 0.012095 0.005645 - 0.009976 0.003470 -0.001716 -0.000003 PO.012733 0.005577
-0.216 3.390*** I.301 0.440 -1.871* 0.461 - 0.402 -0.003 ~ I .979* 0.260
Sample size = 85. Adjusted R2=0.15005. F-statistic = 2.64770**. * Significant at the 0.10 level. ** Significant at the 0.05 level. *** Significant at the 0.01 level. CAR,=announcement period (from day t- 1 to day to) cumulative abnormal return for firm i. ASIA, = binary variable coded one for joint ventures located in Asian countries and zero otherwise. EURO, = binary variable coded one for joint ventures located in European countries and zero otherwise. LATIN,= binary variable coded one for joint ventures located in Latin American countries and zero otherwise. LRSKi = binary variable coded one for relatively low-risk developing countries and zero otherwise. HRSK, = binary variable coded one for relatively high-risk developing countries and zero otherwise. USD, = relative strength of the U.S. dollar where a larger number represents a relatively strong U.S. dollar. FIRM, = binary variable coded one if the foreign partner is another firm and zero if the foreign partner is a government. MFG, = binary variable coded one if the joint venture is a manufacturing operation and zero otherwise. STRN, =financial strength of the U.S. parent firm as proxied by the average return on equity over the three years prior to the announcement.
case, but this finding concurs with results observed by Waheed and Mathur ( 1995) who find that announcement period valuation effects are less favorable when U.S. banks expand into non-risky developing countries. They contend that risky developing countries generally resist foreign investments to a greater extent than less risky developing countries. They explain that this tends to restrict competition in risky developing countries and therefore promotes higher profitability in those firms allowed to enter. Investors seem to react less favorably when the international joint venture is a manufacturing type of operation. This result provides support for the hypothesis
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that manufacturing operations, especially in an international context, may be inherently more risky than other types of operations because fixed assets may be more exposed to expropriation, and operating leverage is typically higher. Thus, managers may increase firm value to a greater extent or reduce firm value to a lesser extent by pursuing service oriented joint ventures abroad, as opposed to manufacturing ventures. Other factors examined in this study seem to have relatively little influence on announcement period valuation effects. For example, the relative strength of the U.S. dollar, the type of venture partner (a firm or government), and the financial strength of the U.S. parent firm seem to have little influence on the magnitude of announcement period abnormal returns. Our finding that the type of venture partner (government or private firm) has no apparent effect on the market’s reaction is in contrast to the finding of Lummer and McConnell (1990) that firm value is enhanced when the foreign partner is a private firm as opposed to a government entity. The insignificance of the relative strength of the U.S. dollar in explaining the observed results is in contrast to the findings of Crutchley et al. (1991). This difference in results may be attributable to the fact that their sample focused exclusively on joint ventures involving American and Japanese firms and, therefore, the relative strength of the yen versus the dollar was the only exchange rate considered. Conversely, our study encompasses a broad range of currencies. Our results make several important contributions to the literature. We enhance the international joint venture literature by drawing on the extant literature on international acquisitions and other forms of direct investment. We confirm results of previous international joint venture studies which find that ventures in Asia generate more favorable wealth effects. We find that valuation effects are less favorable when joint ventures are established in relatively low-risk developing countries. We find that manufacturing ventures are less favorably received by the market than service ventures. Other factors such as the relative strength of the U.S. dollar prior to the announcement, the type of venture partner, and the financial strength of the U.S. parent firm seem unrelated to the announcement period wealth effects.
8. Summary and conclusions Previous studies of international joint venture announcements have found positive, negative, and insignificant reactions to the announcements of such ventures, but little work has been reported in the literature to explain why the results of these studies are mixed. This is the primary impetus for this study. Using a sample of 100 international joint ventures that were announced between 1979 and 1994, we find that, on average, international joint ventures have virtually no immediate net impact on shareholder wealth. However, cross-sectional analysis of announcement period abnormal returns shows that market reactions are more favorable when U.S. firms establish joint ventures in Asian countries, are less favorable when firms establish
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joint ventures in low-risk developing countries, and are less favorable when the joint venture is a manufacturing operation as opposed to a service operation. Thus, managers ought to consider the influence of these factors when evaluating international joint ventures.
Acknowledgements We wish to thank an anonymous referee and Ike Mathur (Editor) for very helpful comments and suggestions. We also thank John Guardino, Daniel Chang, and Owen Dwoskin for assistance with data collection.
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