The Effects of Cultural Differences on Knowledge Assets and U.S. MNCs' Firm Value: A Three-Valuation Approach

Abstract

This study examines the effect of cultural differences (CD) between U.S. multinational companies (MNCs) and their foreign subsidiaries on the firm value of the U.S. parent company. The study uses three different valuation models: (1) Tobin's Q; (2) Weighted Cost of Capital (WACC); and (3) Market Value Added (MVA). Analysis using the Tobin's Q model found an inverse relationship between CD and firm value. In contrast, examination of firm value using the WACC and MVA models indicated a direct relationship. These findings suggest that CD has a relationship with the U.S. parent company's firm value, but leave open the question of direction. The analysis reveals that risks or rewards can result from the exchange of knowledge and other intangible assets, and points to Weighted Average Cost of Capital as the optimal model for assessing the effects of cultural distance on firm value. Damodara's (2006) results confirm this apparent lack of consensus. The author found that firm value can be both understated and overstated at the same time depending on the parameters of the different valuation models; these may be narrow or broad, producing different estimates firm value. The present study is similar to a linear programming solution in which a minimization model (Tobin's Q) and maximization model (Market Value Added) are used to formulate the optimal solution point, Weighted Average Cost of Capital (Gartner, & Matousek, 2006). It can be argued that the WACC Model is an optimal solution point, since this approach is by far the most widely used method to compute firm value (Graham & Harvey, 2001) and has a high correlation. Copeland, Koller, and Murrin (2000) applied a WACC-based model to 35 MNCs and found a 0.94 correlation between the model's estimated values and actual market values. Mc Cafferty (1999) surveyed Chief Financial Officers of MNCs and found WACC to be the most popular model among these practitioners for estimating the value of potential acquisitions. Based on these findings and the results of our own research, we deduce that WACC is the best model among the three tested, and we conclude that cultural distance enhances, rather than reducing, the firm value of U.S.-based multinational companies.