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Learn from past examples before expanding overseas Back  
Companies should learn from the examples of AIB and Marks & Spencer and think twice before expanding overseas says Gael Hardie-Brown.
Corporate diversification decisions and their consequent value impact have received a great deal of attention from both academics and practitioners in recent years.

Corporate diversification includes two forms: industrial and geographic diversification. It is the geographic form of diversification that dominates, as companies strive to strategically position themselves in an increasingly competitive global marketplace. There are a number of theories that attempt to explain the rationale for choosing to geographically diversify or more importantly to explain why shareholders appear to value multinationality, these include:

• The internalisation theory - a firm can increase its value by internalising overseas markets for certain of its intangible assets, such as superior production skills, patents, marketing abilities, consumer goodwill etc.

• Imperfect world capital markets - perhaps there are restraints preventing investors from optimally diversifying their portfolios. A geographically diversified firm provides an indirect route to such diversification.
• Tax avoidance and low cost inputs - a wider geographic spread provides greater potential for tax avoidance. In addition with access to less developed countries the cost of inputs may decrease.
However in addition to these value-adding theories there are those that predict an erosion of value, these include:
• Managerial objectives - large complex organisations may allow managers to pursue self-interest above shareholder value, as the costs of maintaining an effective monitoring process become prohibitive.
• Increased market risk - an increase in systematic or market risk can result from increased foreign exchange risk and political risk. Risk can also increase due to more subtle impacts, such as a lack of knowledge concerning foreign markets which increases the uncertainty of future cash flows (asymmetric information).
These competing theories make it difficult to predict the market reaction to a corporate geographic diversification choice, as such much of the work in academia has focused on the empirical testing of theory against practice.

Current thinking
Research in this field has primarily focused on US Corporations where there has been a resounding ‘thumbs up’ for geographic diversification. This is even after controlling for other factors that are known to impact firm value, such as capital structure, level of research and development expenditure, firm size etc. This would suggest, assuming the philosophy of ‘shareholder wealth maximisation’, that a rational management team should promote a geographically diversified firm, since on average those firms that have adopted this strategy in the past, have created more value than their equivalent domestic counterparts.

Let’s take a second look
In a more recent study of UK firms, the perceived wisdom of geographic diversification being value enhancing was undermined. In particular it was identified that the specific industry to which the firm belongs may be crucial. Industries have very different characteristics and therefore different value responses to geographic diversification, as compared to the statistical average.

There was evidence of a value erosion impact of 14 per cent, when focusing on a narrow range of UK industries including the retail, restaurant and pub and house building sectors.
This would suggest that there are industries that are more sensitive to demographic and cultural issues. These issues perhaps become more acute in the case of geographic diversification.

Recent press articles have supported this view with a discussion of Marks and Spencer’s failure in both continental Europe and the USA, followed by Boots’ poor performance in Asia and Europe. Much of this poor performance in the retail sector has been attributed to cultural differences in the customer base that precludes the direct export of a successful domestic formula. In contrast, other industries, such as the hotel sector whose customer base is dominated by the international business traveller, suffer less from cultural issues as their customers expect a homogeneous service wherever they may be in the world.
Fairly recent high profile financial services scandals, such as Allied Irish Bank and Barings, where the problems originated outside the home country of the company, also suggests that the value destroying theory of ‘managerial objective’ may be more relevant to the financial services industry. It is an area that needs further investigation as generally empirical studies in the field of corporate diversification, exclude financial services companies from the population. However it doesn’t take a huge leap of faith to hypothesise that the complexity of a financial services company requires more comprehensive and therefore more costly monitoring processes and as such is more vulnerable to management participating in non value-added activities, such as unauthorised speculative trading.
In conclusion, companies considering geographic expansion should carefully assess their firm in the context of potential positive and negative influences of such a strategy on firm value, paying particular attention to their industry. If, having assessed their sensitivity to these factors, they believe they are more likely to fall within the general pack that have historically benefited from such a strategy, then all well and good. But if they should identify themselves as falling within industries that in the past have suffered some significant problems in expanding overseas, then ‘buyer beware’.

Gael Hardie-Brown BSc, ACA, MBS, is a lecturer in the Accounting, Finance and Information Systems department of University College Cork.

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