The Relationship Between Corporate International Diversification and Firm Value: An Empirical Inquiry

Abstract

The increasing relevance of foreign operations has led to accounting regulation decisions, which in turn, provide significant changes in MNCs accounting and reporting practices. Specifically, FASB (1997) issued Statement of Financial Accounting Standards (SFAS) No. 131 to increase the profile of geographic segment disclosure. This study provides evidence on whether international diversification, as measured by foreign assets of U.S. firms is associated with market value of common equity. The paper finds evidence of market valuation of foreign assets that is consistent with theoretical expectations and robust to different approaches and specifications. Consistent with Errunza and Senbet (1984), I find that international diversification is significantly correlated with firm value, suggesting that firms that internationalize are rewarded with high equity value. The multivariate tests indicate the average annual value of a firm with foreign operations is 2.6% higher than firms without foreign assets. In firm-size comparison, I report that large firms experience significantly greater price responses than small firms. This finding is consistent with differential risk hypothesis in Easton and Zmijewski (1989) and Collins and Kothari (1989) but inconsistent with differential information hypothesis of Atiase (1985). In a comparison of U.S. domestic and foreign assets, the analysis indicates that investors' valuation of assets depends on the operating environment in which the firm is operating. That is, there is cross-sectional valuation differences arising from the market assessment of the probability of recovery of assets located in different jurisdictions.