Multinationals and regulation

I have been reviewing the literature on international expansion of firms in general and in regulation for a paper revision. Research on the relationship between firm internationalization and performance focuses on the exploitation of firms’ capabilities/resources that are difficult to replicate, so as to overcome the “liability of foreigness”. In these cases, the firm across several countries is used to exploit the specific assets, rather than the market, due to the difficulties of attaching value to the assets separately from the firm, transaction costs determining the optimal form of expansion (joint ventures, alliances, acquisitions…). These resources may be technological or marketing techniques which explain most of the expansion of multinational enterprises (MNE) from developed countries, or other non-conventional capabilities (such as political skills) that may explain at least in part the expansion of contemporary MNE originating in less developed countries.

Economies of scale or scope must be balanced with dis-economies of size or complexity, which may explain why some studies find a trade-off between international expansion versus product diversification. When costs and benefits are not carefully balanced, the consequence is a diversification discount: more diversified firms being associated with lower shareholder value. When managers are not well aligned with shareholders, they may be interested in more diversified and larger companies to benefit from empire building, beyond the optimal size from the point of view of firm value. However, the diversification discount may also show up in data sets because the characteristics that push a firm towards optimal diversification are characteristics that lower firms’ profits (such as more product market competition in the home market).

Some studies hypothesize and find evidence consistent with a non-linear relationship between geographic diversification and performance, probably S shaped, where the success of the strategies is related to the experience of the firm, the business cycle and the evolution of technology and competition.

 In industries where at least some segments are subject to regulation or at least to license conditions, geographical diversification strategies are mediated by regulation. Regulatory policies may constrain the international activities of regulated incumbents, and also the entry of foreign operators. The same firm operating in different markets may face different regulatory regimes, thereby sending the best managers and other assets where the regulatory regime allows higher profits.

Some scholars have also pointed out the specific characteristics of the market for corporate control in regulated industries, which also shapes the structure and performance resulting from internationalization. On the one hand, deregulation and regulatory reform have been found to be associated with mergers and acquisitions waves, with the persistence of regulatory elements constraining the efficient performance of the market for corporate control. On the other hand, the behavior of some incumbents has been used to illustrate the free cash flow theory, by which managers of sectors with limited growth opportunities in their core segments but stable cash flows tend to re-invest in new but not necessarily profit-maximizing markets instead of giving back the cash-flows to shareholders.