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The study of multinationals has received very much attention in literature. Absolutely, it has become a subject of controversy among the college students. On the one hand, some researchers including Reeb , Mansi (2001), Chkir , Cosset (1999) and Chen et approach.

(1997) emphasize the variation benefits to multinationals because of risk reduction inherent in operations within just imperfectly correlated markets. While on the other hand, the more recent research by simply Reeb, Kwok , Baek (1998) and Bartove, Bodnar , Kaul (1996) notes a positive romance between internationalization and high debtholder monitoring costs. Against this backdrop, this kind of analysis suggest an alternative upstream-downstream hypothesis where the overall a result of internationalization around the risk and leverage of multinationals relies on the market circumstances of the sponsor and target country. The paper examines the theory that multinationals needs to have lower risk and higher power than non-multinationals and clarifies the difference among this theory and the upstream-downstream hypothesis. Included as well in this research, is an explanation for the documented puzzle that multinationals tend to have decrease levels of long-term debt but more utilization of short-term financial debt than non-multinational firms.


The study of multinationals has received much attention in literature. During the last few decades, it is now a subject of controversy among the scholars. It has generated even more heat than light with a suggesting diversity benefits to multinationals, while others point out to the positive relation between a firm risk and internationalization. Against this backdrop, we recommend an alternative upstream-downstream hypothesis whereby the overall effect of internationalization within the risk and leverage of multinationals relies on the market circumstances of the web host and focus on country.

Earlier researchers which includes Reeb, Mansi , Alee (2001), Chkir , Cosset (2001) and Chen ainsi que al. (1997) found an optimistic relationship among internationalization and debt proportion due to risk reduction natural in operations within imperfectly correlated market segments. On the contrary, Burgman (1996) and Lee , kwok (1988) demonstrated a negative relationship between internationalization and debt proportion that results from increased hazards due to agency costs, and political and exchange rate risks.

Likewise, while the findings obtained from Preliminary research by simply Hughes, Logue , Sweeny (1975) are consistent with the diversification benefits, the greater recent analysis by Reeb, Kwok , Baek (1998) and Bartove, Bodnar , Kaul (1996) found an optimistic association involving the risk of a strong and internationalization. Additionally , whilst focusing on influence, Burgman (1996) noted that internalization may result in higher debtholder monitoring costs and thus significantly reducing the levels of leverage. Consistent with greater agency costs, Shelter , Kwok (1988) and Chen ain al. (1997) found that the domestic corporations would generally speaking tend to have substantially higher personal debt ratios relative to the MNCs. Clearly, via what can be discerned, the study of internationalization of firms has become a controversial concern among students.

This evaluation is as a result an attempt to shed light on the above by discovering on both international diversification benefits plus the upstream downstream hypothesis. All of us begin away analysis simply by examining the upstream and downstream hypothesis


Kwok , Reeb (2000) argue that there is certainly an increase in risk and a decrease in debt consumption when companies from stable economies make investments internationally (downstream). Conversely, the danger is decreased and financial debt usage improved when companies from sluggish economies commit internationally (upstream). It therefore employs that the total effect of internationalization on business’s leverage and risk depends on the attributes of the home and target economy.

The firms’ behaviour towards international activity or rather the overall effect of internalization on businesses leverage and risk is dependent upon whether the firm is moving upstream or perhaps downstream (Kwok , Reeb 2000). For example , for multinationals based in the United States (which is among the most stable financial systems in the world), their overseas expansion often exacerbate risk. This embrace risk may not be totally offset by the risk reduction as a result of international diversification and thus creating a downward adjustment of the firms’ leverage.

On the converse, intended for firms inside the emerging financial systems, investment internationally in the developed economies causes a reduction in company risk and subsequently an upward modification of leverage.


The upstream downstream discussion can be expanded to the organized risk region. Multinationals, by definition, get their operations varied into several countries. The systematic likelihood of an ith operation may therefore be defined as? i actually (Reeb, Mansi , Allee 2001).

? i actually = (? im? i)/? m

Wherever? im represents the correlation between the industry return and firm’s come back

? i signifies the business’s return common deviation

? meters refers to the market return’s common deviation

An ith operation is therefore influenced by nature with the business procedure and the economy of the country where the operation takes place (Reeb, D. M., S. A. Mansi and J. M. Allee, 2001). Take for example a project that is located in a more unstable emerging overall economy. This project would tend to have a higher worth of total risk,? my spouse and i. Unless there is an offset of the large standard deviation by a lower correlation coefficient? im, the systematic risk? i would become higher.

Within the converse task management that is located in a more secure economy generally have a lower worth of the total risk,? i. In the same way, unless there is a substantially higher value of correlation successful? im, the systematic risk? i tend to be lower.

For just about any multinational, their overall organized risk is just the weighted average of the betas (? i) of all its organization operations inside the various countries (Reeb, Mansi , Allee, 2001).

? mnc =? Wi? i

Exactly where Wi signifies a fraction of the total capital invested by MNC in the ith country’s operation.

Consequently , for a company that is based in a more steady economy, growth of it is operations into a less stable market would increase the total beta (? mnc) from the firm, as a result of potentially higher environmental risk for the new operation (Reeb, Mansi , Allee, 2001). On the other hand, when a firm that is headquartered in an appearing economy extends its immediate investments into a developed overall economy, its general beta may possibly decrease.

A chance to arbitrage market segments may too differ because of the economic dissimilarities of the home and target economies (Reeb , Kwok 2000). Take for example, the shift of income. To be able to have the profits shifted between different duty regimes depends on the degree of style of the web host and concentrate on government (Reeb , Kwok 2000). Firms that are operating out of economies which are more developed and with higher resources, generally have fewer possibilities for changing their salary (Reeb , Kwok 2000).

In contrast, organizations that are located in the unpredictable emerging financial systems tend to have diverse opportunities to arbitrage labour and capital marketplaces (Reeb , Kwok 2000). That is, businesses that are shifting upstream have more opportunities to seek the services of employees based on a sets of skills and experience than patients that are moving downstream. This implies that firms’ behaviour to international activity varies with all the characteristics of the home and target audience. Therefore , the entire effect of internationalization on the companies risk and leverage is determined by whether the company is going upstream or perhaps downstream.


Aligning with all the above, the association between internationalization and firm risk suggests a leverage impact as well. Traditional capital composition theory posits that while firm risk increases the debt utilization lessens (Reeb , Kwok 2000). Hence, intended for firms which can be based in the more volatile growing economies, their particular overseas expansion may lead to even more debt utilization, as they may well gain access to debt that has not been previously offered. The communicate is also true.

This view of the power aspect of upstream-downstream hypothesis implies a negative connection between leverage and internationalization for companies based in a lot more developed economies and the other way round (Reeb , Kwok 2000). That is, organizations that are going upstream tend to have a positive romantic relationship between the firms leverage and internationalization when those moving downstream tend to have a negative association. This implies which the overall effect of internationalization around the leverage of multinationals is definitely equally determined by the home and target market circumstances.

This next section will check out on the corporate and business diversification theory and the effect of agency costs and interior capital marketplaces on the firms’ leverage. In particular, the firm conflicts and efficiency of internal capital markets to be used in featuring an explanation as to the reasons multinationals tend to have lower amounts of long-term debt but even more use of initial debt than non-multinational firms.


The organization international diversity theory posits that multinationals should have manage risk and larger financial leverage than the household corporations (Doukas , Pantzalis 2001). One of the primary reason as to why corporations would not take fully debt within their capital composition is because of the risk of insolvency (Doukas , Pantzalis 2001). Considering that this risk is not linear yet increases with higher personal debt levels, organizations can thus limit their leverage in order to avoid incurring bankruptcy costs.

There are a number of organization risks and opportunities that stem coming from corporate intercontinental diversification. Business risk which is typically tested by the movements of the functioning net income makes reference the cost of monetary distress to be more exact bankruptcy cost (Doukas , Pantzalis 2001). Both the home and international firms can also be faced with exchange rate risk. That is, the risk that changes in currencies will affect the demand and supply, price and cost attributes of the company.

There is also the risk of higher agency costs which will faces international firms. MNCs face larger agency costs due to auditing costs, monitoring costs, different accounting systems, different legal systems, sovereignty uncertainties, dialect differences, work market and capital defects as well as the several asset set ups (Doukas , Pantzalis 2001). Agency costs are seen to have a significant impact on the perfect debt level as will probably be discussed beneath (Doukas , Pantzalis 2001).

Political risks arise from political events that may possess adverse effects on the economic well being of the company. For example , potential conflicts might arise between your goals with the government and others of the foreign firms. This is particularly the case with foreign direct investment, given their effect on the web host economy.

Among the benefits you want to by students is the look at that through international variation, firms can easily increase issues debt potential and reduce their very own bankruptcy costs (Doukas , Pantzalis 2001). It has been contended that risks are decreased by profile effects due to the imperfect relationship of overseas cash moves. In this regard, Fatemi (1984) and Agmon , Lessard (1977) point out that diversification rewards reduce the individual bankruptcy costs and increase the debt usage simply by multinationals.


The written about puzzle that multinationals generally have lower amounts of long-term financial debt but more use of initial debt than non-multinational organizations warrants evidence. There are many reasons as to why one would expect multinationals to have distinct leverage proportions relative to the domestic companies. First, presented the international nature of their operations, MNCs are expected to obtain access to even more capital resources unlike the domestic organizations (Doukas , Pantzalis 2001). Therefore , they can raise more capital by way of foreign personal debt financing with more favourable terms compared to the domestic corporations (Doukas , Pantzalis 2001).

Consider, for example , the case of multinationals which may have subsidiaries in countries with different tax costs. These multinationals can benefit a lot by asking for through international affiliates exposed to high taxes rates, hence increasing their tax protects (Butler 1999). It therefore employs that because of access to exterior sources of financing, these multinationals should on the whole have larger debt percentages than the home-based firms (Butler 1999).

One more as to why Multinationals should show higher financial debt ratios than non-multinational firms is that the foreign debt can be used as a hedging instrument up against the risk of forex trading (Butler 1999). Given that multinationals have larger levels of foreign exchange exposure in comparison to the domestic firms, they are hence expected to make greater make use of debt financing than the local firms (Butler 1999). In addition , since multinationals are be subject to political and exchange level risk exposures, it is predicted that these multinationals should have higher overall personal debt ratios relative to the local businesses (Butler 1999).

Thirdly, because of industrial and geographical diversity of operations of MNCs, they are expected to have reduced business and financial risk than the home-based firms (Doukas , Pantzalis 2001). It has the impact of reducing the price of debt and thus increasing power. This implies that the leverage of multinationals needs to have a positive regards with overseas involvement when financial relax should have a poor and increased bearing about DMCs’ leverage (Doukas , Pantzalis 2001).

However , although hedging, economical distress, liquidity and operating considerations imply that multinationals may have higher leverage compared to the domestic businesses, findings from empirical research shows that these multinationals have instead lower long-term leverage in accordance with the household firms (Doukas , Pantzalis 2001).

Three possible details can be presented for this finding. These include: (Doukas , Pantzalis 2001)

Efficiencies of interior capital marketplaces

Agency costs of personal debt

Legal and institutional dissimilarities across areas where multinationals operate.


Seeing that MNCs possess numerous partitions operating around countries, they tend to create intensive internal capital markets which might provide less costly financing relative to the external markets (Doukas , Pantzalis 2001). Therefore, where the interior capital companies are efficient, MNCs tend to count more upon internal financing than the external one. Because of this, they tend to obtain lower power than the home-based firms. As a result, a non-positive relation between your firms influence and its foreign operations can emerge once internal capital markets sidestep external capital market informational asymmetries (Doukas , Pantzalis 2001).

Within a recent study, Matsusaka , Nanda (1997) and Scharfstein , Stein (1997) analyzed the increased capital share in inner capital market segments and the associated agency costs for companies that got diversified their particular operations. They will found that diversified businesses could use internal capital markets in money profitable jobs, which would not be loaned in exterior capital marketplaces due to agency costs and information asymmetries.

This implies the external debt financing requirement of multinationals may be attenuated and the low levels of leverage intended for Multinationals should certainly reflect the strengths of internal capital markets (Doukas , Pantzalis 2001). This view undoubtedly indicates an adverse relation between industrial diversity and the power of multinationals. That is, MNCs debt proportions should exhibit a negative plus more pronounced association with commercial diversification compared to the domestic organizations.


The company cost of personal debt effect on power of multinationals arises from all their industrial diversity. Since their operations happen to be geographically spread, the cost of gathering and finalizing information is normally more costly to get MNCs compared to the domestic businesses (Doukas , Pantzalis 2001). Therefore , multinationals are expected to have more inherent agency concerns between the debtholders and investors due to their various geographic structure.

It therefore employs that bondholders will require bigger interest payment on loans to firms that have increased monitoring costs and are even more susceptible to asymmetric information concerns (Doukas , Pantzalis 2001). This implies that firms which may have diversified their operations may have their personal debt ratios lower than domestic firms. Further, companies with higher foreign participation are expected to get a negative and even more pronounced relationship between the organizations leverage and agency costs of debt, than the domestic firms (Doukas , Pantzalis 2001).

Several authors possess suggested that, unlike the domestic organizations, multinationals are likely to support more debt within their capital structures. Burgman (1999), however , tournaments this declare and in simple fact argues that multinationals have, in the actual sense, fewer debt in their capital structure. He details whether factors such as the personal and exchange rate risk and the agency costs may explain this kind of phenomenon. The findings of his examine show that multinationals tend to have higher firm costs which diversifying their particular operations will not lower their very own earnings unpredictability.


Evidently, there are natural business hazards as well options that stem from business diversification. While we do not disregard the cross-border benefits of corporate diversity, we suggest that the overall effect of internationalization around the firms risk and leveraging can be forecasted by an upstream-downstream hypothesis.


Agmon, T. and D. Lessard, 1977. “Investor recognition of corporate foreign diversification. Diary of Financial, 32: 1049-55.

Bartov, Electronic., G. Bodnar, and A. Kaul, mil novecentos e noventa e seis. “Exchange price variability as well as the riskiness of US multinational businesses: Evidence from your breakdown of Bretton Woods. Journal of Financial Economics, 42: 105-132.

Burgman, T. A., 1996. “An empirical study of multinational corporate capital structure Journal of International Business Studies, Volume 30, pp. 553-570.

Retainer, K. C., 1999, Multinational Finance, 2nd edition, Cincinnati oh., OH: South-Western College Posting

Chen, C. J. G., C. S i9000. Cheng, L. J. Agnes, and K. Jawon, 1997. “An investigation of the marriage between worldwide activities and capital structure Journal of International Organization Studies, g. 563-577.

Chkir, I. E. and M. C. Cosset, 2001. “Diversification strategy and capital composition of international corporations. Record of International Financial Managing 11, 17″37.

Doukas, L. A. and C. Pantzalis, 2001. Geographic diversification and agency costs of financial debt of multinational firms. Old Dominion College or university. accessed on 30th December 2011

Fatemi, A. 1984. “Shareholders Benefits from Corporate International Diversification, Journal of Finance Volume. 39 Number 5.

Hughes, L., Deb. Logue, and R. Sweeney, 1975. “Corporate international diversification and industry assigned actions of risk and diversification. Journal of economic and Quantitative Analysis, 10: 627-37.

Kwok, C. Con. Chuck and D. Reeb, 2000.  Internationalization and Firm Risk: An Upstream-Downstream Hypothesis, Journal of Intercontinental Business Studies, 31, 5, 611-629.

Shelter, K., and C. Con. Kwok, 1988. “Multinational businesses vs . home-based corporations: Foreign environmental factors and determinants of capital structure. Record of Intercontinental Business Research, vol nineteen, pp. 195-217.

Matsusaka. L, and Versus. Nanda, 1997, Internal capital markets and company refocusing, Functioning Paper, University or college of The south.

Reeb, D. M. and C. Kwok and They would. Y. Baek, 1998. “Systematic Risk of the Multinational Corporation, Journal of International Organization Studies, Second Quarter.

Reeb, D. M., S i9000. A. Mansi and L. M. Allee, 2001. “Firm internationalization and the cost of financial debt financing: facts from non-provisional publicly traded debt. Journal of economic and Quantitative Analysis thirty six, 395″414. Chkir , Cosset (1999)

Scharfstein, D. T, 1997, The dark side of internal capital market II, Working Daily news, MIT press.

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