Global Diversification and Political Risk: Discount or Premium?

• In Event: Globalization and Financial Markets

Abstract

Does global diversification lead to a “diversification discount”? Firms are increasingly globally diversifying, or expanding their operations to other countries. Of the nearly 5,000 publicly-traded US firms with subsidiaries, more than 1,000 have operations in at least one foreign country. This is puzzling, given that the existing literature tells us that there is a “diversification discount,” or that firms that diversify are valued at a discount relative to comparable, un-diversified firms. I argue that the literature fails to account for the fact that firms both reap the benefits of investing in developing countries (lower corporate taxes, looser regulation, cheaper labor and inputs, direct access to a new and possibly untapped market) and hedge against the heightened political risk in those countries by globally diversifying. This is because political risk across different countries is largely uncorrelated. Further, I argue that the diversification discount (premium) varies by industry. I test my theory using data on all publicly-traded US multinational firms. I find that the extent of their global diversification positively affects the extent to which they are valued relative to the market.

Author

• Anne Jamison, Princeton University