Note: Size judged on the basis of transaction value in millions of U.S. dollars.
Source: Thomson Securities Data Corporation, Mergers and Acquisitions Database.
Reduce Tax Expense through Arbitrage across Different Tax Jurisdictions
Marginal corporate tax rates vary dramatically across the globe. In January 2002, they ranged from a low of 16 percent in Hong Kong and Chile to a high of 42 percent in Sri Lanka with a mean of 31.39 percent for OECD countries (see KMPG (2002)). Some have argued that this disparity permits multinational corporations to shift operations globally in ways that profitably arbitrages away from high-tax jurisdictions and toward lower-tax jurisdictions.10 This is consistent with anecdotal evidence from practitioners (especially chief financial officers) about the importance of tax considerations in investment decisions. Nevertheless, empirical research at best gives mixed support for this motive.11
Reduce Risk through Diversification
If economic activity across countries is less than perfectly correlated, geographic diversification can reduce risk. This is a straightforward extension of modern portfolio theory. For instance, Adler and Dumas (1975) argued that international diversification pays when capital markets are not fully integrated. Whereas correlations among stock returns within a country can be high, correlations across countries are highly variable, and can be quite low or even negative. Exhibit 5.5 presents equity market correlations between the United States and various emerging markets countries. Rouwenhorst (1999) reported that from 1970 to 1998 the average correlation between index returns in Japan and the United States was 25 percent; between the United Kingdom and United States, it was 50 percent. Explanations for such variability across countries could be differing degrees of economic development and integration with global markets.12
Even though local market volatilities might be high, a low correlation with that market might make it attractive to invest there. This is the chief argument in favor of global diversification of equity investing. Madura and Whyte (1990) argued that “differences in characteristics between real assets and financial assets can cause different degrees of diversification benefits. For example, real sectors can cause different degrees of diversification than foreign financial sectors will offer greater potential diversification benefits if those sectors can be penetrated.” (Page 75) But does this translate into benefits for shareholders at the level of corporate investing? Some evidence suggests that the share prices of multinational corporations (MNCs) reflect well the geographic diversification, while other studies suggest that MNCs do not provide all the benefits of direct investment in foreign securities.13 Fatemi (1984) compared MNCs with purely domestic firms, and found that returns on MNCs fluctuate less than domestic firms, that the betas of MNCs are more stable than domestic firms. Thus, risk reduction through geographical diversification seems to work. Fatemi also reported that risk-adjusted abnormal returns for MNCs are similar to domestic firms. Mikhail and Shawky (1979) and Errunza and Senbet (1981) found that the degree of international presence has a positive effect on excess returns. Doukas and Travlos (1988) reported that investor reaction to news of entry into a new foreign market is positive and significant, and most pronounced when the entry is into an emerging market country.