Switching Options and Coordination Costs in Multinational Firms
42 Pages Posted: 27 Oct 2005
Date Written: October 2005
In this study, we investigate how foreign direct investment (FDI) and multinationality affect firms' risk levels. Our investigation builds on the idea from real options theory that international operations offer multinational corporations (MNCs) switching options, yet we also emphasize different sources of coordination costs that can mitigate the benefits of operational flexibility. The findings from Heckman models and Tobit two-stage models with selectivity underscore the importance of unobserved heterogeneity in the relationship between foreign investment and organizational risk. Consistent with the coordination costs surrounding international operations, we find that the relationship between multinationality and downside risk is curvilinear: risk first declines and then increases as a firm's portfolio of international investments becomes extensive. In addition, downside risk is an increasing function of the average cultural distance between a firm's home base and the host countries in which its foreign subsidiaries operate.
Keywords: Real Options, Multinationality, Performance, Downside Risk
Suggested Citation: Suggested Citation