Foreign Exchange Rate Mode of Entry

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Foreign exchange rates and the corporate choice of

foreign entry mode

H. Young Baek a,b,

*, Chuck C.Y. Kwok c

a College of Business Administration, University of Texas-Pan American, 1201 W. University Drive,

Edinburg, TX 78539, USA bWayne Huizenga Graduate School of Business and Entrepreneurship, Nova SW University,

3100 Southwest 9th Avenue, Fort Lauderdale, FL 3331RR5, USAc Moore School of Business, University of South Carolina, 1705 College Street, Columbia, SC 29208, USA

Received 30 October 2000; received in revised form 27 February 2001; accepted 2 April 2001

Abstract

This study is the first attempt at examining the effects of foreign exchange (FX) rate and volatility

on the corporate choice of foreign entry mode and shareholder wealth. For all worldwide US-related

foreign direct investments (FDIs) announcements in 1995, we find evidence that, on average, a

stronger home currency is related to a higher propensity to choose a subsidiary and that the change in

shareholder wealth around subsidiary announcements is greater when the home currency is stronger

for non-US parents. On the effects of host currency volatility, the data support the flexibility option

(international diversification) hypothesis for the US (non-US) parents. D 2002 Elsevier Science Inc.

All rights reserved.

JEL classification: F21; F23; F31

Keywords: Foreign exchange; Volatility; Foreign direct investment; Diversification; Flexibility option

1059-0560/02/$ – see front matter D 2002 Elsevier Science Inc. All rights reserved.

PII: S 1 0 5 9 - 0 5 6 0 ( 0 1 ) 0 0 1 0 6 - X

* Corresponding author. Tel.: +1-954-262-5103; fax: +1-425-955-4025.

E-mail address: [email protected] (H.Y. Baek).

International Review of Economics and Finance

11 (2002) 207–227



1. Introduction

This study is the first attempt at examining the effects of foreign exchange (FX) rate level

and volatility on the corporate-level choice of foreign entry mode and shareholder wealth.

Thus far, studies on how FX affects foreign direct investments (FDIs) are mostly done at the

macro level. Among the authors who have studied the effect of currency strength on the level

of FDI between two national economies, Bell and Campa (1997), Blonigen (1997), Froot and

Stein (1991), and Kogut and Chang (1996) have observed that the real value of the home

currency is positively related to the level of direct investment in the host country. In a similar

vein, Crutchley, Guo, and Hansen (1991) and Ojah, Seitz, and Rawashdeh (1997) report that

the parent shareholders’ wealth gains around FDI announcements are significantly positive

only when the home currency is stronger than in the past.The effect of host currency volatility on the FDI level and on international trade has also

been documented only at the country level. Franke (1991) and Roy and Viaene (1998) argue a

positive relationship between host currency volatility and the volume of trade, and between

volatility and vertical FDI, respectively. Bell and Campa (1997), however, find that FX

volatility is negatively related to the net investment in a host country.

The current study is motivated by three streams of literature. The first stream of related

literature examines how FX affects FDI. As mentioned above, these studies are mainly con-

ducted at the macroeconomic level. While such studies provide some guidance to national

trade policymakers and FX administrators, they shed little light on the corporate responses tothe changes in currency values. Financial managers of multinational corporations (MNCs) can

only make indirect inferences. The focus of the present study is at the micro level, examining

how the corporate choice of foreign entry modes is affected by FX behavior.

The second stream of literature consists of studies conducted by international business

scholars (e.g., Agarwal & Ramaswamy, 1992; Hennart & Reddy, 1997 and so forth). They

have discussed why joint ventures (JVs) and subsidiaries are chosen as modes of foreign

entry. While other factors are mentioned, the role played by FX behavior in such choice has

not been adequately examined.

The third stream of literature consists of some recent studies (e.g., Kwok & Reeb, 2000)

that report distinct corporate behavioral patterns across MNCs of different countries. In short,

results obtained from US MNC data may not be generalized to all MNCs around the world.

The present study will examine the sample of both inbound and outbound US-related FDIs to

see if the results are different between US and non-US MNCs.

The present study, drawing upon these three lines of literature, is the first attempt at

examining the effect of home currency strength and host currency volatility on the corporate-

level choice between a subsidiary and a JV as a foreign entry mode, and on the parent

shareholders’ wealth changes. Specifically, this study examines two competing hypotheses on

why firms invest overseas: international diversification versus flexibility option effects. The

authors formulate mathematical models to theoretically predict the impact of a stronger cur-rency and a more volatile currency, respectively.

To empirically test the models, the authors use the data of inbound and outbound US

corporate FDIs in 1995. We find evidence from the sample of non-US firms that, on average,

H.Y. Baek, C.C.Y. Kwok / International Review of Economics and Finance 11 (2002) 207–227 208



a stronger home currency is related to a higher propensity to choose a subsidiary and that

subsidiary choosing shareholders’ wealth increase is greater when the home currency isstrong than when it is weak. We also find that host currency volatility acts differently with US

firms and non-US firms. The sample of US firms seems to favor the flexibility option

hypothesis, while the non-US sample favors the international diversification hypothesis.

In the next section, we will survey the literature on the FX rate and FDI, and develop

hypotheses on the effects of FX level on the foreign entry mode choice. In Section 3, we will

review previous studies on FX volatility and FDI, and develop the competing hypotheses on

the effects of FX volatility on the entry mode choice: the international diversification

hypothesis versus the flexibility option hypothesis. We will present data and methodology in

Section 4, and the test results in Section 5. A Discussion section will conclude this study.

2. FX rate and FDIs

Previous studies have examined the effect of FX rate only at the aggregate level of FDI.

They suggest that a stronger home currency leads to a higher level of aggregate FDI and an

increase in the wealth of the target and acquirer’s shareholders around FDI announcements.

Froot and Stein (1991) argue that, in an imperfect market, firms that visit credit markets have

to pay higher cost of capital rates because credit institutions pass the monitoring costs to the

borrowers. Firms investing in an appreciating currency can finance internally and reduce thecost of capital. If FX rates deviate from the purchasing power parity (PPP) rate at least in

the short run, a stronger home currency would encourage firms to invest in the host country.

Froot and Stein predict that the overall FDI level from a country will increase when the home

currency is stronger than a PPP-compatible rate, and find that the change in foreign assets in

the US has a negative relationship with the real value of the US dollar during the 1973–1988

period. The negative relationship seems to be more prominent in the industries with a higher

level of potential information asymmetry (e.g., chemical and machinery industries). Kogut

and Chang (1996) find for 95 Japanese firms in the Tokyo Stock Exchange (TSE) electronics

industry that a real appreciation of the Japanese yen leads to more entries into the US duringthe 1976–1989 period. Blonigen (1997) also reports for the 1975–1992 period that the real

exchange rate between the Japanese yen and the US dollar has a positive relationship with the

number of Japanese acquisitions in the US, especially in the manufacturing industries with

more firm-specific assets (proxied by research and development expenditures). Consistent

with the above studies is Bell and Campa’s (1997) observation that the level of chemical

product investments in European Union countries by US companies is negatively related to

the average level of the IMF trade-weighted exchange rate index for the host country during

the 1977–1989 period.

Harris and Ravenscraft (1991) study the wealth effect of the shareholders of the targets of

foreign and US buyers. Shareholders of the targets of foreign buyers experience significantlyhigher wealth gains than targets of US firms, and target shareholders’ wealth gains are higher

when the buyer’s currency is stronger than its 17-year average. Crutchley et al. (1991) find for

Japanese–US JVs that shareholder wealth gains are significantly positive only for the firms




that announced JV formation when their home currency is stronger. Ojah et al. (1997) report

that the shareholders of US firms that announce offshore JVs experience a significantly positive (negative) wealth effect when dollar in the previous year is stronger (weaker) than the

average during the 1981–1990 period.

Froot and Stein (1991) also report that the sensitivity of the number and dollar-amount of

FDI to the real exchange rate is greater for mergers and acquisitions than for the JV.1 Since a

stronger home currency requires less capital outlay for a fixed investment in local currency,

some firms that were previously discouraged from a subsidiary investment due to capital

rationing would be able to afford a wholly owned subsidiary when their home currencies

become stronger, cet par.

2.1. A model

To further analyze, let us suppose a US-based firm that needs to decide the investment

amount and share ownership in two potential foreign projects. Let X , X 1, and X 2 be one plus

the rate of return in local currencies for domestic, the first, and the second foreign projects,

respectively. We assume that all the projects have the same initial capital outlay and the same

expected rate of return in local currency.

E ½ X ¼ E ½ X 1 ¼ E ½ X 2 ð1Þ

Let p (0 < p < 1) denote the fraction of total capital invested in foreign projects, and let a and

(1Àa) denote the percentage ownership in Projects 1 and 2, respectively.2 Since Projects 1 and

2 are the same in initial investment and return, the sum of share ownership in Projects 1 and 2

is 100%. R, the total rate of return to the US firm at the end of the period will be (Eq. (2)):

R ¼ ð1 À pÞ X þ pa X 1 f 1 þ pð1 À aÞ X 2 f 2, ð2Þ

where f j denotes one plus the appreciation rate for currency j during the period. If the

covariance between local-currency return and the currency appreciation rate is zero, the

expected total return to the firm will be:

E ½ R ¼ ð1 À pÞ E ½ X þ pa E ½ X E ½ f 1 þ pð1 À aÞ E ½ X E ½ f 2

¼ E ½ X ð1 À p þ pa E ½ f 1 þ pð1 À aÞ E ½ f 2Þ ð3Þ

Suppose that f 1 and f 2 are binomial variables. f 1 will take the value of f h with the

probability of q1, and f l with (1Àq1) probability. f 2 will take f h with the probability of q2 and

1

The coefficients from the regression of the dollar FDI level on the real exchange rate with other controllingvariables are À 0.057 for the mergers and acquisition data and À 0.0056 for the JV data. The coefficients from the

similar regression with the number of FDIs as a dependent variable are À 1.8996 for mergers and acquisitions and

À 0.2422 for JVs. All coefficients are statistically significant.2 (1 À p) + p*a+ p*(1 Àa)=100%.




f l with (1Àq2) probability ( f l <1< f h). qi is a monotonic function of the ith currency’s

deviation from PPP-rate. When the current exchange rate is PPP-equivalent, qi will be 0.5. Asa currency is more devalued relative to PPP-rate, qi will become higher. When the Foreign

Currency 1 is more devalued against the PPP-rate than the Foreign Currency 2, q1 will be

greater than q2.3 Eq. (3) can be rewritten as Eq. (4).

E ½ R ¼ E ½ X

1 À p þ pan

q1 f h þ ð1 À q1Þ f l o

þ pð1 À aÞn

q2 f h þ ð1 À q2Þ f l o

ð4Þ

2.2. Comparative statics analyses

Suppose Currency 1 is more devalued from its PPP-rate than Currency 2 (i.e., q1 > q2).

Since E [ R] is a function of p( q1,q2), a( q1,q2), q1 and q2, comparative static analyses are

obtained in Eqs. (5)–(8).

@ p

@ q1

¼E pq1

E aa À E pa E aq1

E pp E aa À E pa E a p

¼À pðq1 À q2Þð f h À f l Þ2

Àðq1 À q2Þ2ð f h À f l Þ2¼

p

q1 À q2

> 0 ð5Þ

@ p

@ q2

¼p

q1 À q2

> 0 ð6Þ

@ a

@ q1¼ Àaðq1 À q2Þð f

h

À f

l

Þ

2

Àðq1 À q2Þ2ð f h À f l Þ2 ¼ aq1 À q2

> 0 ð7Þ

@ a

@ q2

¼1 À a

q1 À q2

< 0 ð8Þ

E jk represents the partial of @ E / @ j over partial k . Eqs. (5) and (6) predict that, regardless of a

currency’s degree of devaluation from its PPP-rate, a little more deviation from PPP-rate (i.e.,

a small increase in q1 or q2) would lead to an increase in overall foreign investment ( p). When

Currency 1 is devalued relative to the PPP-rate to a more degree and its probability to

appreciate later is higher than Currency 2, a small increase in q1 would lead to an increase in a,i.e., a higher share ownership in an affiliated firm in Country 1. A small depreciation of the

Currency 2 would lead to a decrease in a, i.e., less investment in the Country 1 affiliate and

more share ownership in Country 2 affiliate.

2.3. Hypotheses

If the US firm’s objective is to maximize its expected total return and if the local-currency

rate of return is independent of the currency exchange rate, the MNC would increase the

overall level of foreign investment ( p) and especially the affiliation share ownership in a

3 The short-run exchange rate deviations from and long-run reversion to PPP-rates are widely accepted in the

theoretical and empirical literature. See, for example, Kim (1990).




country whose currency is further devalued. The firms that maximize their expected returns

would increase a (share ownership in Country 1 affiliates) and would be more likely tochoose a subsidiary form in the host country whose currency becomes weaker. From these

arguments, we propose the following hypotheses.

Hypothesis 1: Firms with a host currency that has weakened are more likely to choose a

subsidiary over a JV as a mode of foreign entry than firms with a stronger host currency,

ceteris paribus.

Hypothesis 2: Shareholder wealth change around foreign entry announcements will

be greater when firms with a weaker host currency choose a subsidiary over a JV,

ceteris paribus.

3. FX volatility and FDIs

International business textbooks often list international diversification and reaction to FX

rate movements as the motives for FDI (Madura, 2000, pp. 365–372). Since competitive

advantages in market demand, technology, access to raw materials, etc., have no immediate

relationship with FX rate movements, this study focuses on the benefits of international

diversification and flexibility option.For firms with international activities, an increase in exchange rate volatility would lead to

an increase in profit variability. If exporters are risk-averse and FX hedging is costly, an

increase in FX volatility will reduce the volume of international trade.4 Risk reduction

through international diversification seems to affect corporate decisions, as Bell and Campa

(1997) find that exchange rate volatility measured as the standard deviation of the monthly

change in the log of the exchange rate index for the host currency is negatively related to the

net investment in chemical products in European Union countries by US companies during

the 1977–1989 period.

On the other hand, Roy and Viaene (1998) argue that an increase in FX volatility may have a positive effect on the level of vertical FDI, and find in a simulation study that an oligopolistic

firm with a choice between FDI and importing would be more likely to choose FDI when

exchange rates are more volatile. Kogut (1996) and Kogut and Kulatilaka (1994) argue that a

flexibility option is the true source of the increased value of being multinational, although

exercise may be difficult due to organizational features. They contend that, neglecting

transportation and factor cost differentials, firms need to choose a plant location in a country

where the FX rate is the most volatile. When the exchange rate is more volatile, exercise of an

operating flexibility option is more likely and the option would be more valuable. For the

period of 1977–1993, Rangan (1998) finds that MNCs shift production among globally

4 Franke (1991) concisely summarizes the early papers on foreign exchange volatility and international trade

by Baron (1976), Clark (1973), and Ethier (1973).




located sites when FX rates change and confirms the idea that firms utilize operating flexibility.

In Sections 3.1 and 3.2, we would like to build a model and formulate competing hypotheses:international diversification hypothesis versus flexibility option hypothesis.

3.1. International diversification hypothesis

Under the hypothesis that one major motive of FDI is to reduce risk through investment in

different countries, a very volatile host currency would discourage foreign investments to the

country because the increased FX risk offsets at least some of the diversification benefits. If

the level of investment for a given company is fixed and cash flows from two JV operations

are less than perfectly correlated, firms investing in host countries with volatile exchange

rates would prefer to split their investment into multiple JVs than to invest in a whollyowned subsidiary.

Continuing the previous example of a US firm, let us suppose that two foreign currencies’

expected appreciation rates are the same:

E ½ f 1 ¼ E ½ f 2 ¼ F : ð9Þ

Since the local-currency rates of return have the same expected values and zero covariance

with exchange rates, the expected total return to the firm is derived from Eqs. (1) and (9), andis expressed in Eq. (10).

E ½ R ¼ ð1 À pÞ E ½ X þ pa E ½ X F þ pð1 À aÞ E ½ X F

¼ E ½ X ð1 À p þ pa F þ pð1 À aÞ F Þ ¼ E ½ X ð1 þ pð F À 1ÞÞ ð10Þ

As one can see from Eq. (10), the expected rate of return to the firm is independent of a.

A comparative static analysis still suggests that an expected return-maximizing firm would

increase p when F increases.5 That is, a firm maximizing its mean return would invest more in

foreign countries when foreign currencies are expected to appreciate in the future (i.e., when

US dollar is stronger than PPP-rate).

Suppose now that the firm chooses a level of a to minimize the variance of total return as

expressed in Eq. (11). For simplicity, we assume all the local-currency returns are the same

and nonstochastic ( X 1= X 2= X = X ).

V ½ R ¼ p2a

2 X 2s

21 þ p2ð1 À aÞ2

X 2s

22 þ 2 p2

að1 À aÞ X 2r12s1s2, ð11Þ

where s j denotes the standard deviation of f j (one plus the currency j ’s appreciation rate), andr12 the correlation coefficient between two-currency appreciation rates. When the US firm

5 The sign of @ p/ @ F would be equal to the sign of @ 2 E [TR]/ @ p@ F = E [ X ] >0.




chooses an optimal level of a=a(s12,s2

2) to minimize the variance of total return, @ a/ @ s12 will

take the opposite sign as@ 2

V [ R]/ @ a@ s1

2

in Eq. (12).@ 2V

@ a@ s21

¼ p2 X 2

2a 1 À r12

s2

s1

þ r12

s2

s1

ð12Þ

When a is not a small number, and s1 and s2 are similar in size, the sign of Eq. (12) is

positive. A variance-minimizing firm would decrease investment in a country (a) when its

currency is more volatile. As a decreases, a firm is more likely to set up a JV in the Host

Country 1. The prediction from this line of analysis, labeled as the ‘‘international diversifica-

tion hypothesis,’’ is that when the host currency is volatile, firms are less likely to choose a

subsidiary over a JV as a mode of foreign entry.

Hypothesis 3: Firms investing in a host country whose currency is relatively more

volatile are more likely to choose a JV over a subsidiary as a mode of foreign entry,

ceteris paribus.

Hypothesis 4: Shareholder wealth change around foreign entry announcements will be

greater when firms choose a JV over a subsidiary as a foreign entry mode in a host

country with volatile currency, ceteris paribus.

3.2. Flexibility option hypothesis

Franke (1991) views exporting as an option that is exercised if profitable, and argues that

under constant competition, the value of exporting is an increasing function of FX volatility.

His argument is consistent with the fact that a stock option value increases when the

underlying stock return volatility increases. Assuming that the costs of the initiation and

termination of exporting activities are increasing and concave for the exchange rate, Franke

argues that the trade volume of a net-present-value-maximizing firm grows with exchange

rate volatility. Sercu and Vanhulle (1992) also show in a model that as FX volatility increases,

exporters may be better off and firms may tolerate dumping.

JV partners are analogous to the multiple agents in a team. Holmstrom (1982) uses theterm ‘team’ as ‘a group of individuals who are organized so that their productive inputs are

related’.6 As Kandel and Lazear (1992) state, partnerships are different from hierarchical

organizations in that the members of the team are all residual claimants. All the multiple

partners of a JV have claims to a portion of joint output. Holmstrom argues in his Theorem 1

that, unlike the single-agent case, free-riding problems may occur in multiple-agent cases

even when the output function is not stochastic. A shirking agent cannot be identified when

the joint output is the only observable indicator of inputs.

Given the other partners’ free-riding and moral hazard problems faced by a JV partner,

exercises of a flexibility option from the viewpoint of a single JV partner may not be optimal.Since the exercise decision by a JV partner may not be optimal for all the partners and the

6 Each team player puts in its own effort, all the inputs jointly determine the output, and the payoff to an agent

depends on the joint output.




flexibility option of a JV may expire earlier than that of a subsidiary, a flexibility option in a JV

would be less valuable to a parent organization that in a wholly owned foreign subsidiary.To explore this line of reasoning, we will analyze the previous example in a different way.

Suppose that only when the firm chooses a subsidiary (a=1 or very close to 1), it can choose the

site of production depending on the FX rate between home and the foreign country. In the

presence of a flexibility option, the total rate of return to the firm ( RC) is the larger of the home

country rate of return and the foreign country return converted to home currency, as expressed

in Eq. (13).

RC ¼ max½ X , X 1 f 1 ð13Þ

The expected total return is expressed in Eq. (14).

E ½ RC ¼ E ½ X E ½maxð1, f 1Þ ¼ E ½ X 1 þ E ½maxð0, f 1 À 1Þ

¼ E ½ X 1 þ Callð f 1,1,s21Þ ð14Þ

where Call( f 1,1,s12) is the value of a European call option with f 1 (1+appreciation rate) as the

underlying asset price and 1 as the exercise price. It is well known that the value of a call

option is a positive function of the volatility of its underlying asset. By having a wholly

owned foreign subsidiary, the MNC may experience an increase in expected total return with

high volatility in FX rates, while the return is immune from the downside risk of large-scale

foreign currency depreciation.If the same firm chooses to have two foreign JVs, it loses the value of the call option in

exchange for diversification effects. An unexpected huge drop in one foreign currency price

may only be partly offset, unless the correlation between two foreign currencies is a perfect

negative one. When the exchange rate is more volatile and thus the flexibility option is more

valuable, return-maximizing firms would choose a subsidiary over a JV as an entry mode.

Under this ‘‘flexibility option hypothesis,’’ the following hypotheses are derived as alter-

natives to Hypotheses 3 and 4.

Hypothesis 3A: Firms investing in a host country whose currency is relatively more

volatile are more likely to choose a subsidiary over a JV as a mode of foreign entry,ceteris paribus.

Hypothesis 4A: Shareholder wealth change around foreign entry announcements will be

greater when firms choose a subsidiary over a JV as a foreign entry mode in a host

country with volatile currency, ceteris paribus.

3.3. Competing hypotheses

Readers should note that the two models presented above represent two different objective

functions of the firms that want to make a FDI. The international diversification modelexpressed in Eqs. (9)–(12) depicts a firm that attempts to minimize the variance of total

returns, while the flexibility option model in Eq. (14) portrays another firm of which objective

is to maximize the expected total return.




A natural question then is which firms are variance minimizers and which are expected

return maximizers. Firms currently operating in a less volatile environment may attempt to

maximize their expected returns without being overly restricted by concerns on additional

risks resulting from FDI. Those firms’ main motivation for FDIs may be to utilize the options

to flexibly control within their multinational network, and their behaviors may be better

explained by the flexibility option model. Other firms are operating in so volatile an

environment that their primary motivation for FDIs may be to reduce variance of returns

through diversifying into low-risk countries. The behaviors of such firms may be better

understood from the international diversification model.

In Table 1, we examine the stock return volatility and host currency volatility for US and

non-US firms. US firms experience lower standard deviation of stock returns during about

one year before FDI announcements than non-US firms, and the difference is significant

under the nonparametric Wilcoxon Rank Sum test. On the other hand, the average host

currency volatility faced by non-US sample firms is significantly lower than that by US firms.

Those two observations suggest the authors to predict that a primary motivation for FDIs by

US firms is utilization of flexibility options, while non-US firms attempt FDIs into the US to

reduce overall risk through international diversification activities.

4. Data and methodology

Unlike many previous studies that limit their analyses to the FDIs between two countries,7

this study draws the initial sample firms investing in Year 1995 into or from the US from the

Table 1

Stock return volatility and host currency volatility: US vs. non-US firms

US firms Non-US firms T test RS

Stock return volatility 1.76% 1.93% .3074 .0412**

Host currency volatility 2.71% 1.46% .0027*** .0001***

Predicted FDI motivation To utilize

flexibility options

To reduce risk through

international diversification

Stock return volatility denotes the average standard deviation of daily returns for common equity during 200

trading days before FDI announcements of 110 US firms and 54 non-US firms with available data. Host currency

volatility is measured as the average FXVOLAT for 139 US firms and 140 non-US firms with available data. T test

and RS represent the P values for the t tests of mean difference and the nonparametric Wilcoxon Rank Sum

test, respectively.

** Denotes statistical significance at the 5% level.*** Denotes statistical significance at the 1% level.

7

For example, Crutchley et al. (1991) examine 149 US–Japan JVs during 1979–1987. Hennart and Reddy(1997) examine 428 US entries by Japanese firms during the period 1978–1989, and Harris and Ravenscraft

(1991) use 159 acquisitions of US firms during 1970–1987. Alternatively, Hu and Chen (1996) examine 2434 JVs

in China. Woodcock, Beamish, and Makino (1994) use 322 North American entries by Japanese firms in 1992.

Agarwal and Ramaswamy (1992) surveys US firms that were leasing in 1986.




company news section of the Lexis–Nexis Academic Universe. The initial sample includes

182 parent organizations. Accounting information for the period 1990– 1994, and stock returndata for 200 trading days prior to and 10 trading days after the announcement are available

from Standard and Poor’s COMPUSTAT, Center for Researches in Security Prices (CRSP)

and Datastream databases. We exclude the abnormal returns (AR) for the parents with a

concurrent firm-specific event for five trading days before and after the announcement. Sup-

plemental sources of information for foreign-based companies include Compact Disclosure

and WorldScope.

Descriptive statistics on the variables are given in Table 2. Among the 182 parents that

announced an FDI in 1995, 115 are US firms and 67 are foreign ones. One hundred thirty firms

Table 2

Descriptive statistics

Variable N 1 0

GFIELD 182 130 52

SUBS 182 34 148

Variable N Min Med Max Mean S.D.

RSHARE 179 0% 50% 100% 52.68% 28.47%

FXSTRONG 179 0.244 1.00 4.6091 1.2996 0.8514

FXVOLAT 179 0 2.65% 18.04% 3.23% 3.90%HOSTSIZE 182 162 2447 40,813 11,843 11,631

RELSIZEa 116 0 0.0182 5.1836 b 0.1938 0.6040

FSR 115 0% 28.9% 100%c 29.85% 26.74%

FCFRATIO 132 À 2.523 0.088 0.548 0.069 0.305

RDRATIO 94 0 0.012 0.222 0.033 0.044

BLOCKO 133 0% 20.2% 100% 26.35% 25.65%

INSTO 117 0% 49.8% 97.6% 48.06% 21.30%

Parent regions USA (115) Europe (35) Asia (28) Latin America (4)

Affiliate regions USA (32) Europe (47) Asia (77) Latin America (26)

GFIELD takes the value of 1 if a parent announces that it will build a foreign affiliate, and 0 if it announces that it

will purchase an existing business. RSHARE denotes an investing firm’s relative share ownership in its affiliateunder the assumption that any option to buy or sell more shares is fully exercised, and SUBS takes the value of 1 if

RSHARE is greater than 95%. FXSTRONG is the ratio of the announcement-year average exchange rate of the host

currency per ith parent’s currency over the average rate for the previous 3 years. FXVOLAT measures the standard

deviation of monthly changes in exchange rates of the host currency relative to the home currency unit for 3 years

prior to announcement. HOSTSIZE denotes the host country GDP in 1994 in million of US dollars. RELSIZE refers

to the ratio of total investment in the affiliate over total assets of the parent firm at the fiscal year-end prior to the

announcement. FSR is the ratio of the parent’s foreign sales over total sales during the previous fiscal year.

FCFRATIO denotes the ratio of free cash flow over total assets, and RDRATIO the ratio of R&D expenditure over

total assets. BLOCKO denotes the firm’s common equity held by shareholders with at least 5% ownership, and

INSTO the institutional ownership.a

The median and mean of the parent firm’s total asset are 12,493 and 43,797.5 million US$, respectively. Themedian and mean of the affiliate’s total investment are 200 and 627.87 million US$, respectively. The median and

mean investments in an affiliate by a parent firm are 80 and 332.12 million US$, respectively. b This affiliate size is five times that of the parent, which is a minority partner of a large JV.c For one parent, all sales are foreign originated.




(71.4%) announced plans to start a green-field operation (GFIELD), while 52 firms announced

plans to purchase an existing foreign operation. RSHARE denotes an investing firm’s relativeshare ownership in its affiliate under the assumption that any option to buy or sell additional

shares is fully exercised, and SUBS (subsidiary) takes the value of one if a relative ownership

is greater than 95%. Only 34 firms chose to have a wholly owned subsidiary. The majority

(148 firms; 81.3%) chose to have an international JV (IJV) as an entry mode. A median share

ownership in an affiliate is 50% and the mean value is 52.68%.

FXSTRONG represents the strength of the parent firm’s home currency in terms of host

currency. Following Ojah et al. (1997), we assign the ratio of the average announcement-year

exchange rate over the average for the previous 3 years. FXSTRONG variable has a median

value of 1, and a mean of 1.2996. On average, the home currency in 1995 was about 30%

stronger than the past 3 years’ average.FXVOLAT is a host currency volatility measure, proxied by the standard deviation of

monthly changes in host currency value relative to a home currency unit for 3 years prior to

the announcement. FXVOLAT ranges from 0% to 18.04% with a mean of 3.23% and a me-

dian of 2.65%.

To control for the other factors that may affect the entry-mode decision and shareholder

wealth, we select some variables examined in the literature. HOSTSIZE denotes the investing

firm’s host country gross domestic product (GDP) per capita in 1994, and has a median of

US$2447 and a mean of US$11,843. RELSIZE refers to the relative size of an affiliate,

computed as the ratio of total investment in the affiliate over total assets of the parent firm at the fiscal year-end prior to announcement. Although the average affiliate size is 19% of the

parent’s total asset, the median size is only 1.8%. FSR, the ratio of the parent’s foreign sales

over total sales during the previous fiscal year, represents the parent firm’s international

experience. The foreign sales ratio ranges from 0% to 100%, and has a mean and median of

about 29%.

Corporate managers may make decisions that are suboptimal from their shareholders’ point

of view, and efficient stock markets react unfavorably to the announcements made by those

firms. The degree of agency problems between shareholders and managers can be estimated

in different ways. In this paper, we follow Prowse’s (1990) research and development expenditure ratio (RDRATIO) and Jensen’s (1986) free cash flow ratio (FCFRATIO) as the

proxies of potential principal–agent problems.8 FCFRATIO denotes the cash flow in excess

of that required to fund all projects that have positive net present values. A high FCFRATIO

value suggests that a large amount of cash is under managers’ discretion and may be abused,

and a high RDRATIO value may represent the difficulty of shareholders’ monitoring. The

sample firms’ free cash flows range from À2.52 times to 0.55 times the sales, while its mean

and median are close to 7%. RDRATIO has an average of 3.3% and a median of 1.2%.

One way to reduce potential agency conflicts and suboptimal decisions is monitoring by

the active shareholders. In search of the proxy variables for the shareholder activism, we

follow the arguments of Shleifer and Vishny (1986) on the role of block shareholders and of

8 RDRATIO = research and development expenses/sales; FCFRATIO=(operating income + depreciation

expenses À interest expenses À taxes À dividends)/sales.




Pound (1988) on the role of institutional owners as active monitors. Following a typical

agency relationship and ownership study like McConnell and Servaes (1990), we use per-centage equity ownership held by block shareholders of 5% or more shares (BLOCKO), and

that by the institutional investors (INSTO).9 A high value of block ownership or institutio-

nal ownership represents an active monitoring from large and/or informed shareholders that

may reduce the suboptimal decisions by managers. Block ownership has a median of 20.2%

and a mean of 26.4%, while the mean (48%) and median (50%) of institutional ownership are

much higher.

5. Empirical findings

Following Brown and Warner (1985) and Ojah et al. (1997), we employ an event study

methodology to assess the effects of foreign equity investment announcements on the wealth

of the parent-firm shareholders. Since firms often release news during the nontrading hours,

we calculate cumulative abnormal return (CAR) of the investing firm’s common share on the

day of the news appearance on an electronic wire service (t =À1) and the next trading day

(t = 0) to capture the reactions from stock markets in different time zones.10

Table 3 shows the results from the tests of CAR difference between two groups divided by

each independent variable. A significantly higher CAR reflects that the stock market’s

reaction to the announcements of a foreign entry is more favorable. For the whole sample,CAR to the acquiring shareholders is 0.34% and is statistically insignificant.11 For the non-

US sample, firms with a stronger home currency experience a significantly higher average

CAR by 2.16%. Among the parents that chose subsidiaries, those with a stronger home

currency experience a higher CAR than those with weaker home currency by a statistically

significant 2.11%. When home currencies are weaker, the average CAR for the firms that

chose a subsidiary is significantly lower than that for the firms that chose a JV ( À2.01% vs.

0.55%). The univariate test results suggest that shareholder wealth changes are greater when

firms choose subsidiaries under a stronger home currency, and support Hypothesis 2. It is

interesting, however, that only the non-US shareholders experience significant CAR difference, and those results direct the whole sample results.

Host currency volatility seems to lead to no difference in CAR for the combined sample of

all parents. For all the parents of subsidiaries, firms with more volatile host currencies

experience a significantly lower average CAR than others (À1.83% vs. À0.08%). For the

9 Institutional ownership denotes the percentage of common shares owned by institutional investors, and block

ownership the percentage of common shares owned by the shareholders of 5% or more shares.10 Suppose the news of a JV agreement between a Japanese firm and a US partner was released in Tokyo at

6:00 p.m. on a Thursday. Since 6:00 p.m. in Tokyo corresponds to 4:00 a.m. in New York on the same day, theannouncement could affect the trading on the TSE on Friday (t = 0), and that on the New York Stock Exchange on

Thursday (t = À 1).11 In a study of the US international acquisitions, Markides and Ittner (1994) reported a 2.07% CAR during

Days À 1 to + 3, and a positive relationship between dollar strength and CAR.




Table 3

Tests of mean differences of CARs around FDI announcements

SUBS and JVs SUBS only JVs only SUB – JV

Sample N CAR (%) N CAR (%) N CAR (%) Diff. (%)

Panel A: Home currency

All Stronger 57 0.35 12 0.10 46 0.39 À 0.29

Weaker 58 À 0.01 12 À 2.01*** 45 0.55 À 2.56***

Difference 0.36 2.11*** À 0.16

US Stronger 43 0.30 7 À 0.60 36 0.47 À 1.07

Weaker 42 0.51 7 0.30 35 0.55 À 0.25

Difference À 0.19 À 0.9 À 0.08

Non-US Stronger 15 0.56 6 0.52 10 0.35 0.17Weaker 15 À 1.60*** 4 À 5.98*** 10 0.17 À 6.15***

Difference 2.16*** 6.5*** 0.18

Panel B: Host currency

All More volatile 60 0.24 12 À 1.83*** 48 0.75*** À 2.58***

Less volatile 55 0.10 12 À 0.08 43 0.15 À 0.23

Difference 0.14 À 1.75*** 0.60*

US More volatile 46 0.78** 7 0.94 39 0.75** 0.19

Less volatile 39 À 0.01 7 À 1.24* 32 0.26 À 1.50**

Difference 0.79** 2.18** 0.49

Non-US More volatile 15 À 1.49*** 5 À 5.70*** 9 0.78 À 6.48***Less volatile 15 0.45 5 1.55 11 À 0.17 1.72*

Difference À 1.94*** À 7.25*** 0.95*

Panel C: Affiliate relative size

All Higher 43 0.05 12 À 1.36*** 31 0.86* À 2.22***

Lower 43 0.16 11 À 0.25 32 0.05 À 0.30

Difference À 0.11 À 1.11** 0.81

US Higher 30 0.75 6 0.43 23 0.99* À 0.56

Lower 29 0.05 7 À 0.12 23 0.06 À 0.18

Difference 0.70 0.55 0.93

Non-US Higher 14 À 1.69*** 5 À 4.77*** 9 0.34 À 5.11***Lower 13 0.54 5 0.61 8 0.13 0.48

Difference À 2.23*** À 5.38*** 0.21

Panel D: Host country size

All Higher 58 À 0.08 12 À 0.91*** 46 0.22 À 1.13***

Lower 58 0.40 12 À 0.99 46 0.68* À 1.67**

Difference À 0.48* 0.08 À 0.46

US Higher 44 0.27 7 0.20 36 0.26 À 0.06

Lower 41 0.58 7 À 0.50 35 0.80* À 1.30**

Difference À 0.31 0.70 À 0.54

Non-US Irrelevant

Panel E: Foreign sales ratio

All Higher 49 À 0.42* 10 À 2.47*** 38 0.01 À 2.48***

Lower 49 0.32 11 À 0.75 39 0.71 À 1.46*




parents of IJVs, the average CAR is higher when host currencies are more volatile. Theseresults seem to support the diversification Hypothesis 4.

When we divide the sample by parent country and entry mode, both hypotheses receive

some mixed support from the data. For the US parents, more volatile host currencies lead to a

SUBS and JVs SUBS only JVs only SUB – JVSample N CAR (%) N CAR (%) N CAR (%) Diff. (%)

Difference À 0.74** À 1.72*** À 0.70

US Higher 36 0.22 6 À 0.13 31 0.31 À 0.44

Lower 37 0.37 6 À 0.94 30 0.64 À 1.58*

Difference À 0.15 0.81 À 0.33

Non-US Higher 12 0.29 4 0.28 8 0.45 À 0.17

Lower 13 À 2.52*** 5 À 5.52*** 8 À 0.69 À 4.83***

Difference 2.81*** 5.80*** 1.14**

Panel F: Free cash flow ratio

All Higher 56 À 0.20* 11 À 3.04*** 45 0.48 À 3.52***

Lower 57 0.29 11 À 0.29 46 0.44 À 0.73

Difference À 0.49*** À 2.75*** 0.04

US Higher 41 0.22 6 À 1.22 36 0.28 À 1.50**

Lower 42 0.44 7 À 0.42 34 0.81* À 1.23**

Difference À 0.22 À 0.80 À 0.53

Non-US Higher 15 À 1.60*** 5 À 5.23*** 10 0.35 À 5.58** *

Lower 15 0.09 4 À 0.08 11 0.04 À 0.12

Difference À 1.69*** À 5.15*** 0.31

Panel G: Block ownership

All Higher 53 0.80 11 0.43 42 0.94* À 0.51Lower 54 À 0.32 11 À 1.14 43 À 0.16 À 0.98

Difference 1.12* 1.57** 1.10**

US Higher 42 0.83 7 0.34 34 1.09* À 0.75

Lower 40 À 0.02 7 À 0.64 34 À 0.02 À 0.62

Difference 0.85 0.98 1.11*

Non-US Higher 13 0.91 4 1.63 9 0.60 1.03

Lower 12 À 1.78** 4 À 3.06** 8 À 1.15 À 1.91*

Difference 2.69*** 4.69*** 1.75

This table presents the results of the tests to see if the average CAR around FDI announcements are different

between two groups. N denotes the number of observation in a group, CAR the average ( À 1,0) CAR for a group,

and Diff. the difference in CAR between two groups. Since the results for RDRATIO are qualitatively the same as

FCFRATIO, and those for INSTO are the same as BLOCKO, we only provide results for FCFRATIO and

BLOCKO. Shareholders of 79 parent firms that made announcements to make green-field affiliates experience the

CAR of 0.49%, which is significantly greater than that of À 0.55% for 37 parents that announce to merge or

acquire an existing operation. Shareholders of the US and non-US parents experience the similar wealth effects.

* Denotes the statistical significance at the 10% level.

** Denotes statistical significance at the 5% level.

*** Denotes statistical significance at the 1% level.

Table 3 (continued )




significantly higher average CAR around FDI announcements than less volatile ones (0.78%

vs. À0.01%). Under a less volatile host currency, shareholders of the US parents experience asignificantly lower CAR when subsidiaries are announced than when JVs are. For the US

parents of subsidiaries, CAR is greater when host currency is more volatile. It seems that the

shareholders of US corporations experience wealth increases when firms make a decision that

increases the value of a flexibility option and the US sample supports the flexibility option

Hypothesis 4A.

For the sample of non-US parents, however, the relationship between host currency

volatility and CAR is quite different. For the non-US parents of subsidiaries, more volatile

host currencies seem to lead to a negative and significantly lower average CAR than less

volatile host currencies. Non-US parents of IJVs, however, experience a significantly higher

average CAR when host currencies are more volatile. When host currencies are more (less)volatile, the average CAR for the non-US parents of IJVs is significantly greater (lower) than

that of subsidiaries. Shareholders of non-US firms seem to experience wealth increases when

firms make a decision that diversifies their risks globally. The international diversification

hypothesis, Hypothesis 4, is supported for the non-US sample.

Regarding the results of the control variables, a negative relationship between the relative

size of an affiliate and the shareholders’ wealth seems to exist only for the non-US parents,

and derives the same relationship for the whole sample. Non-US parents with a higher foreign

sales ratio seem to experience a significantly higher average CAR around FDI announce-

ments than those with a lower FSR. Shareholders of non-US parents seem to gain morewealth when firms have more foreign experience, while those of US parents do not.

Alternatively, agency proxies and active ownership variables show a universal pattern of

shareholder wealth change across samples. Average CAR to the shareholders of the parents

with a higher FCFRATIO is significantly negative and significantly lower than that with a

lower FCFRATIO. Stock markets seem to react negatively to FDI announcements from firms

with high potential agency costs. Negative reaction is prominent to the announcements of

foreign subsidiaries, which are more subject to the managers’ abuse of free cash flows unlike

the foreign JVs that have at least one monitoring partner.

Parents with a higher block ownership consistently experience a higher average CAR thanthose with a lower block ownership, and in many cases, the difference is statistically

significant. The share ownership by active investors seems to lead to more favorable stock

market reactions around FDI announcements.

In Table 4, we show the results from three regressions of 2-day CAR against FX strength and

volatility with four control variables: relative size, host country size, FCFRATIO, and block

ownership. Since entry mode, currency strength, and volatility may interact to affect share-

holders’ wealth change, we also include SUBS, SUBS*FXSTRONG, and SUBS*FXVOLAT

to see the additional impact of subsidiary choice. The first column represents the coefficients

and P values from a regression for the whole sample. Results from regressions for the US and

non-US samples are presented in the second and third columns, respectively.Choosing a subsidiary instead of a JV seems to lead to a significantly negative CAR

(coefficient=À1.724). Home currency strength seems to have a significant negative effect on

CAR (À0.019 coefficient) for the parents of IJVs. For the shareholders of subsidiary parents,




however, the negative wealth impact is totally offset by a positive impact of home currency

strength (0.037 coefficient). The negative impact of home currency strength to JV parents,and the positive and greater additional impact to subsidiary parents seem to consistent for the

US sample and the non-US sample. We take these results to be consistent with Hypothesis 2.

For the whole sample, the host currency volatility has a positive relationship to CAR for

the JV parents, but its additional effect on subsidiary parents’ shareholder wealth is negative

and large enough to lead to negative total effect of volatility on subsidiary parents’

shareholder wealth. For the US firms, host currency volatility is positively related to

shareholder wealth and choice of a subsidiary form does not decrease shareholder wealth.

The US sample supports the flexibility option hypothesis (Hypothesis 4A). For the non-US

firms, volatility does not decrease the shareholder wealth when a JV is chosen but decreases

their wealth when a subsidiary is chosen. The non-US sample supports the internationaldiversification hypothesis (Hypothesis 4).

The size of foreign affiliate relative to parents seems positively related to the

shareholder wealth changes, and the relationship between host country GDP per capita and

Table 4

Results of OLS regressions of CARs around FDI announcements

Dependent variable: CAR

Sample All US Non-USa

Intercept 0.007 (.532) 0.011 (.385) À 0.010 (.756)

SUBS À 1.724* (.089) À 0.027 (.142) À 0.476**

FXSTRONG À 0.019** (.035) À 0.021* (.053) 0.012 (.668)

SUBS * FXSTRONG 0.037* (.059) 0.031 (.115) 0.524*** (.004)

FXVOLAT 0.005*** (.008) 0.006** (.020) À 0.001 (.891)

SUBS * FXVOLAT À 0.006 (.104) À 0.004 (.371) À 0.033*** (.002)

RELSIZE 0.010** (.032) 0.009** (.028)

HOSTSIZE À 0.002 (.276) À 0.001 (.614)

FCFRATIO À 0.013 (.306) À 0.018 (.157)BLOCKO 0.057*** (.000) 0.055*** (.003)

N 80 61 30

P value of Fitness .004 .003 .002

R2 .280 .370 .520

Adj. R2 .188 .258 .423

These three columns present the results from the regressions of 2-day CARs to the partners’ shareholders around

announcements. Reported in parenthesis are the P values from the tests to see if each coefficient is significantly

different from zero. Coefficients of HOSTSIZE are multiplied by 10,000. Substitution of RDRATIO with

FCFRATIO, or INSTO with BLOCKO does not qualitatively change the results. All variables are described in the

Table 1.a We dropped the four control variables for non-US sample, since the number of observation increases from 20

to 30 without changing the basic results. All the coefficients for the control variables from the regression were

insignificant.


** Denotes the statistical significance at the 5% level.

*** Denotes the statistical significance at the 1% level.




CAR is insignificant. Consistent with the univariate tests, agency problem proxies show

negative coefficients and active ownership proxies have a strong positive relationship

with CAR.

In Table 5, we provide the results from the logit regressions of the dichotomous variableSUBS against the FX strength, volatility, relative size, and host market size variables. Since

the regression for the whole sample does not show any significant results in the first column

of Table 5 and the tests of mean difference in Table 3 show some contrasting results for the

US and non-US parents, we divide the sample into US and non-US groups. The coefficient

for home currency strength is positive and significant for the non-US parents. For foreign

firms that plan to make direct investments in the US, a stronger home currency seems

to increase the propensity to choose a subsidiary as an entry mode and Hypothesis 1 is par-

tially supported.

The coefficients for the host currency volatility show opposite signs, too. Host currencyvolatility seems to be significantly negatively related to the propensity to choose a subsidiary

for non-US parents. Hypothesis 3 is supported for non-US firms. Although a positive

coefficient for US parents seems to support Hypothesis 3A, it is statistically insignificant. We

conjecture that non-US firms, when making foreign entry mode decisions, value international

diversification effects higher than the flexibility option effects, while the flexibility option

seems to be more important to the US firms.

6. Discussion

For the sample of FDIs related to the US in 1995, non-US firms are more likely to choose a

subsidiary when their home currencies are stronger. The shareholders’ wealth change around

the announcements of a foreign subsidiary is significantly higher under a stronger home

Table 5

Results of logit regressions of subsidiary versus JV

Dependent variable: SUBS

Sample All US Non-US

Intercept 1.052 (.198) 1.268 (.163) À 1.945 (.968)

FXSTRONG À 0.175 (.823) À 0.459 (.617) 2.418**

FXVOLAT 0.152 (.339) 0.207 (.287) À 1.15* (.080)

RELSIZE À 0.081 (.810) 0.366 (.617) 1.338 (.430)

HOSTSIZE À 0.300 (.153) À 0.100 (.692) À 1.90 (.992)

N 100 76 24

P value of Fitness .312 .635 .048

Three columns show the results from the logit regressions of subsidiary versus JV for the whole sample, the US

sample, and the non-US sample, respectively. Reported in parenthesis are the P values from the tests to see if each

coefficient is significantly different from zero. HOSTSIZE coefficients are multiplied by 10,000.


** Denotes the statistical significance at the 5% level.




currency than under a weak one. When the home currency is weaker than the average of the

previous 3 years, the average CAR for subsidiary parents is significantly less than that for JV parents for the whole sample and especially for the non-US sample.

International diversification hypothesis seems to better explain the non-US firms’ foreign

entry mode decisions and the stock market reactions to those choices. For non-US firms, host

currency volatility is significantly negatively related to the propensity to choose a subsidiary.

Shareholders of the non-US firms experience negative wealth change when host currency is

more volatile. Under more volatile host currencies, shareholders of the non-US firms benefit

significantly more when firms choose a JV than when they choose a subsidiary. Under less

volatile host currencies, however, the shareholders of non-US subsidiary parents benefit more

than those of JV parents. We interpret the results as a support to the international

diversification hypothesis (Hypothesis 3).For the US sample, however, empirical support seems to be mixed. In a multiple logit

regression of subsidiary/JV, host currency volatility is insignificantly positively related to the

choice of a subsidiary. When US firms make a subsidiary choice, CAR is significantly higher

when the host currency is more volatile than when it is less volatile. Additionally, CAR for

the JV-choosing US firms is significantly positive only under volatile host currencies. When

host currencies are less volatile, CAR for the subsidiary choosers is significantly lower than

CAR for the JV choosers in the US sample.

A multiple regression of US shareholders’ wealth changes, host volatility seems to be

positively related to the CAR of JV parents’ shareholders but insignificantly related to theCAR of subsidiary parents’ shareholders. The observations are not consistent with the joint

hypothesis that the flexibility option held by an MNC is more valuable when exchange rates

are more volatile and when the affiliate is a subsidiary, and that stock markets recognize the

value of the flexibility option. Either the value of the flexibility option does not increase when

a parent chooses a foreign subsidiary under a volatile host currency, or the stock markets fail

to recognize the value, or both.

The phenomenon that firms and stock markets behave differently in the US and in non-US

countries is consistent with the upstream–downstream hypothesis expressed in Kwok and

Reeb (2000). When the US firms make FDI decisions (i.e., downstream investments), theyusually invest into a riskier country. Since the original risk level is relatively low, the increase

in overall risk due to a foreign investment may not be significant. Those US firms, with little

consideration of risk diversification, can choose a foreign entry mode that maximizes value

through an expansion of their investment opportunity set. If free-riding problems are

prevalent among JV partners, a JV partner may not be able to make the optimal decisions

to switch production around different economies. A foreign subsidiary, in which the parent

has full discretion over decisions, increases the value of a flexibility option more than an IJV

does. The flexibility option hypothesis has more explanatory power for the firms operating in

a relatively low-risk environment.

Alternatively, non-US firms, especially firms in the developing countries are operating in arelatively high-risk environment, and one of their motivations for upstream FDIs is risk

reduction through international diversification. Of course, the value of a flexibility option

should be the same for two different organizations regardless of risk levels. However, some




non-US firms, especially the ones headquartered in developing countries, cannot afford to

acquire the flexibility option at the expense of additional risk to the already-high level.In conclusion, this study investigates the effect of FX level and volatility on the corporate-

level choice of foreign entry mode and on the shareholder wealth. By examining the sample

of inbound and outbound US-related FDI announcements in 1995, the authors expand the

literature on the FX and FDI to the company level. Nonetheless, the current study may further

improve. Since a sovereign government maintains its own policies on corporate governance,

FX, and foreign equity ownership, an examination of the different countries with different

policies will provide a better understanding of the effect of those variables in foreign affiliate

share ownership.

Acknowledgments

The authors would like to thank McKinley Blackburn, Gregory Niehaus, Kendall Roth,

and the seminar participants at the Southwestern Federation of Administrative Disciplines

2000 Annual Meetings for their valuable comments. This paper has also benefited from the

comments of Editor Chen and anonymous reviewers. Chuck C.Y. Kwok gratefully

acknowledges the support of the Center for International Business Education and Research

(CIBER) at the University of South Carolina for this research project.

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