Profitability and Ownership

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1 Profitability and Ownership Structure of US Foreign Ventures Why US Joint Ventures Abroad Are Less Profitable Than Wholly Owned Ventures Ben Gomes-Casseres Mauricio Jenkins Peter Zámborský

2 Low profitability of US JVs abroad! US manufacturing joint ventures abroad earned an average 3% return on assets in ! Wholly-owned manufacturing affiliates earned 6.4% ROA

3 Profitability Gap, % 10.0% Manufacturing Majority Minority Gap 8.0% 6.0% 4.0% 2.0% 0.0% -2.0%

4 Possible explanations for gap We tested for:! Size! Age! Tax rates! Non-dividend payments! MNC s ownership-specific capabilities

5 Stylized facts emerging from data 1. There is a positive gap on average 2. It is largest in sectors where US MNCs are most competitive abroad 3. The gap shrinks over time on average

6 Related academic literature! Desai, Foley and Hines (2004) found sharply declining propensity of US MNEs to form JVs abroad! They focus on the determinants of ownership structure to explain this

7 Declining use of JVs by US MNEs Share of JVs on Total No. of US Foreign Ventures 100% 80% 60% 40% 20% 0% Other JV Share

8 Does globalization reduce rationale for international alliances and JVs?! Globalization reduces trade barriers and communications costs, making international alliances more attractive! On the other hand, it also increases the return to coordinating operations within multinational firms

9 Profitability Determinants Neglected! Desai finds return on assets (ROA) is decreasing function of foreign tax rates! Controls: affiliate leverage, sales, country GDP and GDP per capita! They don t perform any further analysis of ROA determinants

10 Profitability Gap Not Explored Yet! Desai et al did not uncover the profitability gap between wholly and partially owned ventures! Neither did other researchers

11 Profitability Gap Defined! Profitability Net Income/Net Assets! Wholly-owned majority-owned ventures, 90% of them are 100% owned! Joint Ventures All affiliates minus majority-owned Includes JVs, which account for about 54% of JV affiliates

12 Preview of data! Source: US Bureau of Economic Analysis! 1977 and ! Non-bank affiliates of non-bank parents! Industry level, 25 three-digit sectors! 2 & 1 digit sectors, countries, regions! Avg. no. of wholly owned foreign ventures in manufacturing: 6,349! No. of foreign manufacturing JVs: 856

13 Profitability Gap, % 10.0% Manufacturing Majority Minority Gap 8.0% 6.0% 4.0% 2.0% 0.0% -2.0%

14 Questions about ROA Gap! Where and when is it positive?! In which sectors, countries, regions?! Where and when is it negative?! Why is it positive/negative?! Is it shrinking? Growing? Where?

15 Top and Bottom 3 Sectors by Gap Sector (3-digit classification) ROA Gap Office machines, computers 8.7 Electronic components etc 5.8 Beverages 5.4 Paper and allied products -2.1 Lumber, wood and furniture -3.0 Soap, cleaners and toilet goods -4.9

16 SECTOR (3-DIGIT) Office and computing machines Electronic components & accessories Beverages Instruments and related products Radio, TV and telecom equipment Agricultural chemicals Motor vehicles and equipment Drugs Rubber products Fabricated metal products Grain mill and bakery products Construction and mining machinery Stone, clay, nonmetallic mineral goods Industrial chemicals and synthetics Printing and publishing Nonferrous Ferrous Household appliances Miscellaneous plastics products Textile products and apparel Glass products Tobacco products Paper and allied products Lumber, wood, furniture and fixtures Soap, cleaners and toilet goods ROA MAJ. OWNED 9.7% 7.4% 11.0% 7.5% 6.3% 6.1% 4.1% 11.4% 5.4% 5.0% 7.2% 2.4% 5.6% 5.4% 5.9% 3.0% 4.4% 4.1% 6.3% 4.2% 5.3% 11.3% 4.7% 3.3% 7.2% ROA MIN. OWNED 1.0% 1.6% 5.7% 2.8% 2.8% 2.6% 1.1% 8.9% 3.2% 3.1% 5.3% 0.8% 4.3% 4.9% 5.9% 3.0% 4.6% 4.4% 6.9% 5.2% 6.5% 12.9% 6.8% 6.3% 12.1% %-POINT ROA GAP 8.7% 5.8% 5.4% 4.7% 3.5% 3.3% 3.1% 2.5% 2.2% 1.9% 1.9% 1.7% 1.4% 0.5% 0.1% 0.0% -0.2% -0.3% -0.6% -1.0% -1.2% -1.7% -2.1% -3.0% -4.9% GAP AS % OF MAJ ROA 90.0% 78.3% 48.8% 63.1% 55.7% 56.9% 74.4% 22.2% 40.2% 37.4% 26.4% 68.8% 24.3% 9.3% 1.0% -0.4% -5.1% -6.3% -9.5% -23.4% -21.6% -14.7% -44.6% -91.7% -68.4%

17 35.00% 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% -5.00% % % % Gap positive, falling in most sectors Office and Computing Machines Majority Minority % Pt Gap

18 But in some stays stable, negative Soaps and Toiletries Majority Minority 30.00% 25.00% % Pt Gap 20.00% 15.00% 10.00% 5.00% 0.00% -5.00% % % % %

19 Gap close to zero in some countries United Kingdom 15.0% Gap Maj Min 10.0% 5.0% 0.0% % -10.0% -15.0%

20 Some regions are closing the gap Asia and Pacific Gap 15.0% Maj Min 10.0% 5.0% 0.0% -5.0%

21 Theoretical Explanation: Ownership-specific capabilities! Ownership-specific capabilities of MNE! Reflect competitive advantage of MNE compared to local rivals abroad

22 Determinants of ownership and profitability! If the ownership-specific capabilities are strong, MNE likely to choose whole ownership, profits high! If they are weak, MNE likely to seek additional capabilities from local firm, profits likely to be lower

23 Return to the firm Cost of capital Projects done Projects not done Investment projects or Capital invested Marginal return to capital (MRC)

24 MRC Extent of competitive advantage of MNC Capital Invested MRC MNC MRC Local

25 Cost of capital for MNC MRC MNC MRC Local A WO B WO C WO DF JV D E EG JV F G ix viii vii vi v iv iii ii i MNC projects Local firm projects

26 Measures of ownership-specific capabilities! Should reflect international competitive advantage of MNE/industry! Sales of US corporations abroad/ Sales of US corporations in the US! Sales of US firms abroad/ Sales of all firms in the US! Sales data from BEA and Census of US Manufacturers

27 Foreign Sales of US Firms/US Sales in their Sector Average Ferrous Textile products and apparel Paper and allied products Electronic components and accessories Beverages Office and computing machines 0% 20% 40% 60% 80% 100%

28 Sectors with largest gap have largest ratio of foreign/us sales Industry 3-digit Office machines, computers Avg ROA Gap 8.6% US FSales/ US Sales 89% Beverages 6.3% 31% Electronic components 4.6% 34% Instruments 4.4% 20% Radio, TV, communications 4.2% 23% Motor vehicles, equipment 3.9% 57%

29 Sectors with lowest gap have lowest ratio of foreign/us sales Industry 3-digit Paper and allied products Avg ROA Gap -1.6% US FSales/ US Sales 16% Textiles and apparel -0.5% 10% Ferrous -0.3% 3% Nonferrous 0.2% 9% Rubber and plastics 0.7% 17% Stone, clay and glass 1.1% 12%

30 Correlation between the Gap and the sales ratios is 0.30! Sales of US firms abroad/ Sales of all firms in the US Correlation Coefficient=0.30! Sales of US corporations abroad/ Sales of US corporations in the US Correlation Coefficient=0.30

31 Limitations of sales ratios as measures of intl. comp. advantage! Foreign/domestic asset ratios would be perhaps more appropriate! Foreign/domestic sales ratio has been rising in all sectors, while the gap has been shrinking in most sectors

32 Limitations of data! Small number of observations for JVs, particularly for 3-digit sectors! Small number of industry-level data points, no access to firm level data

33 Tests for stat significance of gap! T-test for stat significance of gap estimates confirms results for most 1 & 2 digit sectors! Only mining, fabricated metals insignificant! Many 3-digit sectors have < than 20 JVs

34 1-digit industries, # JVs # Other Gap All industries 1,911 23, %** Petroleum 320 1, %** Manufacturing 856 6, %** Services %** Mining Finance 327 7, %**

35 3-digit industries, 2003 # JVs Drugs 12 Soaps, toiletries 16 Office machines, comps 3 Motor vehicles 51 Electronic components 10 Textiles 13 # Other

36 Future econometric tests: Dependent variable: ROA Explanatory variables:! Sales ratio! Partial ownership (JV) dummy! JV dummy interacted with sales ratio! Full ownership (FO) dummy! FO dummy interacted with sales ratio! Country/industry, year fixed effects! Controls

37 Other possible explanations for gap We tested for:! Size! Age! Tax rates! Non-dividend payments Other ideas?! Policy changes

38 Postscript: JVs in India and China! Wall Street Journal reported on the troubles of international JVs in India! China Business Online reports on the declining numbers of JVs in China

39 Causes of falling JV numbers in India! Less government restrictions! Differences between partners! Clashes over expansion plans! Competing interests of firms

41 Declining use of JVs in China Share of JVs on FDI flows to China % % 80.00% 60.00% 40.00% 20.00% 0.00% Other JVs

Profitability and Ownership Structure of US Foreign Ventures: Are Majority-Owned Ventures More Profitable Than Other Ventures?

Profitability and Ownership Structure of US Foreign Ventures: Are Majority-Owned Ventures More Profitable Than Other Ventures? Benjamin Gomes-Casseres, Mauricio Jenkins and Peter Zámborský This version: