sealPurdue News

June 2001

Going global in the global economy? Not so fast

WEST LAFAYETTE, Ind. – Despite the globalization of the economy, starting operations in other countries does not benefit a company's shareholders, says a Purdue University finance professor.

Diane K. Denis

"There are companies that are successful in global diversification," says Diane K. Denis, an associate professor of management at the Krannert School of Management. "But for the average firm, the costs of global diversification appear to outweigh the benefits."

Global diversification has been on the rise in the last several years, while domestic industry diversification has fallen out of favor. Denis' research, conducted with Krannert School colleague David J. Denis and doctoral candidate Keven Yost, focuses on 44,288 firm-years over the period 1984-1997. Exports alone do not qualify a firm as globally diversified.

"Firms today tend to start from the presumption that global expansion is the way to go," Denis says. "Actually, the first question for a company should be, 'What can I do better in another country than a local firm in that country can do?'"

The issue, she says, is a question of dollars and cents: Is the move going to create enough new cash flow to cover the cost of globalizing and add value to the firm?

"For example, it's often not just as simple as lowering labor costs by moving an operation to another country," says Denis. "Along with lower labor costs can come lower productivity."

Denis says solid reasons for firms to diversify internationally include putting a company's strengths – such as production or marketing – to work in competitively conducive environments, increasing operating flexibility and satisfying investors' desire to hold a globally diversified portfolio.

Also, once a firm has set up foreign operations, there can be a reluctance to scale them back, and profitable domestic divisions end up subsidizing unprofitable foreign operations.

Denis says global diversification's increased costs can come from the travel and living expenses of American managers setting up operations and living abroad, fluctuating currency exchange rates and competing in a culture where the rules of business can be very different than they are in the United States.

Or, as with any business venture, unforeseen crises can – and do – arise. They are more likely – and more difficult to manage – in a more complex organization that must communicate across oceans, continents and time zones.

To be successful, Denis says, companies must exploit some sort of advantage, such as providing a better product in a new market or using its reputation to gain a competitive advantage.

Some companies that have successfully globally diversified (but are not industrially diversified) are: Eli Lilly & Co., Fruit of the Loom Inc., Intel Corp., Kellogg Co., Rubbermaid Home Products and Toys R Us.

Denis says these companies appear to have more than covered the cost of diversification by the creation of new revenue.

"All things being equal, though, it's still difficult to compete with local companies who know their market, understand the language and culture and have no currency exchange risks," she says.

So why do companies diversify internationally?

Denis says there is sometimes a divergence between the points of view of management and shareholders when it comes to global diversification.

"Management tends to like it because there is more to manage, a more complex organization to run and, therefore, more prestige and compensation for top company officials," she says. "But this can be to the disadvantage of the shareholders because our research shows that, on the average, global diversification decreases the value of the company."

"In the '60s, '70s and '80s, domestic industrial diversification was the thing for American companies to do," Denis says. "In the late '80s and '90s, the trend was for companies to focus on their core strengths."

Denis says when the companies and investors did the math, they realized that the firm's parts or industries were often worth more separately than together. So in the last decade, the trend has been to sell, or "spin off," those parts of the company that don't fit the company's central strategic direction.

"The market generally prefers focus, and after a company spins off parts, stock prices often pop," Denis says.

Global diversification has not replaced its industrial counterpart, though. Denis' research shows a correlation between companies that have diversified within the United States and those that have started operations internationally. This means that companies that like to diversify their operations domestically also like to diversify internationally.

Some firms that have successfully diversified globally and industrially are: Alcoa, Bristol- Myers Squibb Co., Pepsico Inc. and Quaker Oats Co.

There is the widespread general perception among investors that participating in the global economy is a healthy portfolio choice. But when companies announce global diversification plans, their stock prices tend to drop. So despite the conventional wisdom, the markets have an awareness of the risks involved in global diversification for companies.

In addition to international finance, Denis lists corporate governance as her top research interest. "We'd like our research results to help minimize the conflicts between management and shareholder interests that show up in areas such as global diversification," she says.

Source: Diane K. Denis, (765) 494-8265,

Writer: J. Michael Lillich, (765) 494-2077,

Purdue News Service: (765) 494-2096;


"Global Diversification, Industrial Diversification,
and Firm Value

David J. Denis, Diane K. Denis, and Keven Yost

Using a sample of 44,288 firm-years over the period 1984-1997, we document an increase in both the incidence and the extent of global diversification over time. This trend does not, however, reflect a substitution of global for industrial diversification. We also find that global diversification results in average valuation discounts of approximately the same magnitude as those for industrial diversification. Analysis of the changes in excess value associated with changes in diversification reveals that increases in global diversification reduce excess value, while reductions in global diversification increase excess value. These findings are consistent with the view that the costs of global diversification outweigh the benefits.

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