Foreign asset risk exposure, DOI, and performance: An analysis of Canadian banks

Abstract

The international business literature measures links between the degree of internationalization (DOI) of a firm's activities and its performance. Implicit in this literature is the idea that there must be a positive relationship between DOI and performance. This paper argues that if the research design does not address the issue of causality, a positive relationship cannot necessarily be interpreted as meaning that DOI has improved performance. Furthermore, the research design should consider risk exposure. For example, if the riskiness of a firm fell as a result of a move abroad, then one can envision a negative relationship and also conclude that the move abroad paid off. Using detailed quarterly data over the period 1994–2004 on the distribution of Canadian banks' assets across countries, and broken down by risk category, the analysis simultaneously accounts for endogeneity and risk exposure. The results establish a causal relationship between DOI and performance, but find that the nature of this relationship varies by bank, and also depends upon the riskiness associated with each bank's foreign asset exposures. These causal relationships are robust to the introduction of two formal risk measures: credit ratings and share price volatility. The authors discuss policy implications of their analysis.