Firm internationalization and performance: case of companies listed at the Warsaw Stock Exchange

Firm internationalization and performance: case of companies listed at the Warsaw Stock Exchange Mariusz-Jan Radło 1, Dorota Ciesielska Abstract: In this study we test two hypotheses. The first of these is that there is a linear relationship between the level of internationalization of companies and their profitability. While the second hypothesis is that the relationship is U-shaped. The results of our econometric modelling of the impact of internationalization of Polish companies listed on the Warsaw Stock Exchange on their performance - measured by return on assets and return on equity - confirmed the hypothesis of a U-shaped relationship between these phenomena. This means that the internationalization in the initial phase may lead to a fall in their profitability, but with increasing internationalization we can expect an increase of profitability ratios. This observation is consistent with the results of other studies on the issue in question and raises important implications for both short and long-term decisions taken by the company and stock investors. Jel code: Keywords: internationalization, international diversification, performance 1 Corresponding author: Mariusz-Jan Radło, World Economy Research Institute, Warsaw School of Economics, al. Niepodległości 162, 02-554 Warsaw, Poland, email: mjradlo@sgh.waw.pl

1. Introduction One of the most important issues for companies opting for internationalization is to assess the impact of going abroad on the economic performance of the company. As indicated by Hennart (2007) the multinationality-performance relationship has been investigated by many researchers and described in over 100 empirical studies. Their theoretical approaches varied, including such perspectives like: portfolio diversification, resource based view, organizational learning theory, etc. Three key arguments in the literature explaining expected growth of profitability of companies as a result of internationalization include: exploitation of scale economies, better and more flexible access to resources, and learning. Nonetheless, findings of various empirical studies do not confirm that there is general positive dependence between internationalization and performance of companies. Some authors indicate a positive effect, other negative. There are also studies suggesting that there are no relationship between multinationality and performance or the relationship varies depending on the stage of internationalization, and is U-shaped or sigmoid (S-shaped). In addition, most studies describing the mentioned phenomenon relates to companies from developed markets and still there are very few studies based on data for emerging market multinationals. The development of emerging market multinationals is relatively new phenomenon, and some authors suggest that traditional theories - based on experience of multinationals from developed economies - cannot explain internationalization of companies from emerging markets. Thus the relationship between multinationality and performance in their case can also be different than that in case of multinationals from developed economies. In the above perspective, the aim of this paper is to assess the impact of the internationalization of Polish enterprises. This paper adds value to the existing research in a two areas. Firstly, it tests the hypothesis of a linear and U-shaped impact of internationalization on profitability of companies and shed additional light on this relationship. Secondly, it tests the mentioned relationship using data for companies - listed at the Warsaw Stock Exchange - that are still in relatively early stage of internationalization, and may reflect experiences of emerging market multinationals - thus our findings may also explain nature of internationalization of companies from emerging markets. 2. Empirical findings: stylized facts As shown in Table 1 there are various studies testing the impact of internationalization on companies. Studies enumerated there can be divided into a few groups depending on relationship between multinationality and performance. The first group of studies are these indicating that there is no mentioned relationship or the relationship is very weak. In example Tallman et al. (1996) in their study based on data for 192 large manufacturing corporations from the United States show that there is no relationship between the level of internationalization and profitability of enterprises, or the relationship is very weak. The level of internationalization was measured by the income from sales abroad in total revenues and the number of countries in which various companies located their foreign direct investments. Similarly, Singla and George (2013) pointed out the lack of impact of multinationality on the profitability of companies. They study was based on data for 237 exporting Indian companies listed on the stock exchange. Among these companies 101 were also foreign direct investors. The mentioned authors have indicated that that a lack of clear relationship between the performance companies and the internationalization may partly be due to the size of the Indian market, which is relatively absorbent. These authors suggest, however, that the results of their research, allow to formulate thesis that the higher the level of internationalization may increase the possibility of obtaining the benefits of internationalization. Other studies have shown, however, that there is a significant positive linear relationship between internationalization and profitability. This was confirmed in example by Ramsey et al. (2012), who

pointed out that the relationship between internationalization and profitability is positive and linear. This is due to the fact that with increasing involvement in activities abroad, companies should acquire knowledge about running operations in international markets which should lead to better financial results. Gaining experience about the specificity of foreign markets will then lead to increasing the presence of companies on foreign markets, what - in turn - increase focus of managers on internationalization of companies. However, most studies presented in the mentioned table - support both positive and negative impact on the profitability of internationalization that varies with the degree of internationalization Table 1 The results of selected studies showing the impact of internationalization on the performance and value of companies Author, publication date Data Results Tallman, LI, 1996 192 large companies from the US, The level of internationalization has a positive but weak effect on data for 1988 the financial results of companies. Riahi-Belkaoui, 100 US companies - manufacturing Studies have confirmed S-shaped relationship between the level of 1998 and service industries internationalization and those in Ruigrok, Wagner, 2003 Capar, 2003 Bolaji, 2014 84 large German companies, panel data for the period 1993-1997 The test result indicates that the relationship between internationalization and performance of a company is U-shaped. Moreover, the study emphasized the importance of learning and knowledge and their positive impact on results in international activities Kotabe, 81 German companies in the The study indicated a U-shaped relationship between service industries Chris, 22 Nigerian banks, panel data for The study showed a significant U-shaped impact of the period 2008-2010 internationalization on the financial results of banks Chen, Hsu, 2010 224 Taiwanese companies, panel The impact of internationalization on the profitability of the S- data 2000-2005 shaped Contractor et al., 291 Indian companies, panel data The impact of internationalization on the profitability of the U- 2008 1997-2001 shaped Hsu, Pereira, 110 US multinationals Acquisition of market experience and social precedes 2008 internationalization and learning processes determine the impact on the profitability of the internationalization (U-shaped) Ramsey et al., 41 large Brazilian companies, panel The results of the study show that the impact of internationalization 2012 data 2008-2009 on profitability is positive. Singla, George, 237 listed Indian companies The study showed no positive impact on the financial results of the 2013 engaged in export activity, panel internationalization of Indian companies. data 2002-2008 Źródło: Opracowanie własne. The U-shaped relationship between internationalization and profitability was confirmed by the Ruigrok and Wagner (2003). They indicated, however, that the exact shapes of U-curve may vary. This may be due to differences in international expansion opportunities arising between countries. They also show the importance of learning and acquiring knowledge of a foreign operation that occurs in the process of internationalization and its impact on the profitability of the company. Similar results were also obtained Contractor et al. (2007), who analyzed the impact on the profitability of the internationalization of 291 Indian companies in 1997-2001. Also Hsu and Pereira (2008) supported the hypothesis of U-shaped multinationality-performance relationship - based on analysis of data for 110 US multinationals. They pointed out that the acquisition of market and social experience related to internationalization - i.e. learning processes - explain the analyzed relationship. The U-shaped relationship between internationalization and profitability was also confirmed by Capar and Kotabe (2012) who analyzed data for 81 German companies in the service industries.

Similar results were also presented by Bolaji and Chris (2014). They analyzed the performance of 22 Nigerian banks and relations between their profitability of internationalization in 2008-2012. Their study indicated the presence of a strong positive relationship between internationalization and profitability of the analyzed entities. This relationship, however, was not linear character. In the initial period there was a decrease in the internationalization of the profitability of banks. This was explained by the Uppsala model according to which at the initial stages of internationalization companies face a number of difficulties arising from insufficient knowledge of a foreign operation and cultural differences. As a result, at an early stage of internationalization companies are not able to reap the financial benefits related to internationalization. Nonetheless, with the passage of time and after gaining experience the corporate strategy will be adjusted to the specificity of international markets, the costs of operations on foreign markets will diminish, and profitability of internationalized companies will increase. Interestingly, some authors, indicate that the relationship between internationalization and performance is sinusoid (or S-shaped). Such relationship between internationalization and profitability was confirmed by survey results of Riahi-Belkaoui (1999) for the 100 US corporations in manufacturing and service industries. Similar results were also presented by Chen and Hsu (2008). Their analysis was based on data for 224 Taiwanese companies in the years 2000-2005. They indicated that the impact on the profitability of internationalization at the beginning of internationalization is negative, nonetheless after exceeding a certain level of internationalization it is positive, but then after exceeding higher levels of internationalization the relationship turns to be negative again. 3. Hypothesis, data, and model In this study we set the two hypotheses. The first of these is that there is a linear relationship between the level of internationalization of the Polish companies and their profitability. While the second hypothesis is that the relationship is U-shaped. To investigate these hypotheses we proposed - following Capar and Kotabe (2003) - two regression models describing linear and curvilinear impact of internationalization on profitability. These models took shape: 1. R = β 0 + β 1 Assets + β 2 F_rev + e 2. R = β 0 + β 1 Assets + β 2 F_rev + β 3 sq_f_rev + e where: R - profitability, Assets - value of total assets, F_rev the share of foreign revenues in total revenues, sq_f_rev - square of F_rev. The first formula represents linear model - describing linear relationship between the level of internationalization and profitability. While the second formula tests curvilinearity - i.e. U-shaped relationship between the level of internationalization and profitability. In this formula we added variable sq_f_rev. We assume, that if R-squared for the second model will be higher than the R- squared for the first model, and the second model will indicate higher and statistically significant impact of variable sq_f_rev on the depending variable (ROA or ROE) then U-shaped relationship between internationalization and profitability will be confirmed. In both models we use Assets as a control variable. The models were estimated using OLS regression (see: Capar i Kotabe, 2003). The model was tested using cross-sectional data for 75 companies listed on the Warsaw Stock Exchange. We took data only for those companies that in 2013 possessed foreign subsidiaries. The study used data on internationalization and the company's financial results for 2013. The surveyed companies represent a variety of service industries and manufacturing. The variables used in the study, their definitions and characteristics are described in Table 2 and Table 3. In the study we use two alternative dependent variables describing profitability, i.e.: return

on assets (ROE), and return on equity (ROE). Average value of ROA for companies in our sample stood at around 5% and ROE at about 6.3%. Values of ROE values ranged from -13.8% to 75%. In turn, the ROE from -72% to 90.6%. Table 2 Variables used in the model Variable Assets ROA ROE F_rev sq_f_rev Table 2 Data characteristics Definition Total assets (in Polish zloty) Return on assets - ratio of net profit to the value of total assets Return on equity - ratio of net profit to equity value The share of foreign revenues in total revenues Square of share of foreign revenues in total revenues Variable Average value Median value Minimum value Maximum value ROA 0,0499285 0,0354580-0,138256 0,751239 ROE 0,0627054 0,0674600-0,721012 0,905611 Assets 2,52267e+006 514109, 12912,0 5,16440e+007 F_rev 0,421253 0,409000 0,00800000 1,00000 sq_f_rev 0,245328 0,167281 6,40000e-005 1,00000 4. Results and discussion In Table 4 we present the results of estimation of the first (linear model) - with ROA as dependent variable. The regression coefficient describing the impact of internationalization on return on assets is positive and statistically significant (p-value = 0.00472). The impact of the control variable proved to be statistically insignificant. Table 4 OLS estimation of model 1 with ROA as dependent variable Model 1, number of observations: 75 Dependent variable (Y): ROE coefficient std. error t-ratio p-value const 0,00129378 0,0220638-0,0586 0,95340 Assets 1,40705e-09 1,56287e-09-0,9003 0,37096 F_rev 0,130021 0,0445872 2,9161 0,00472 *** Mean dependent var 0,049929 S.D. dependent var 0,104621 Sum squared resid 0,721116 S.E. of regression 0,100077 R-squared 0,109705 Adjusted R-squared 0,084975 F(3, 71) 4,436053 P-value (F) 0,015248 Log likehood 67,74622 Akaike 129,4924 Schwarz criterion 122,5400 Hannan-Quinn 126,7164 In Table 5 we present results of model estimation of the second (curvilinear) model with ROA as a dependent variable. The regression coefficient describing the impact of control variable is statistically insignificant. In contrast, both variables describing internationalization proved to be statistically significant. The regression coefficient describing the impact of internationalization turned out to be negative (p = 0.02735). While the regression coefficient of square variable describing the level of internationalization has been positive and higher than in the linear model at p = 0.00182. Moreover R-squared value in this model was higher than in the first model and amounted to 0.22 (in comparison to 0.11 in the first model). Summing up, the above results seems to confirm the existence of U-shaped relationship between profitability (measured by ROA) and internationalization (measured by share of foreign revenues in total revenues of the analyzed companies). Table 5 OLS estimation of model 2 with ROA as dependent variable Model 2, number of observations: 75

Dependent variable (Y): ROA coefficient std. error t-ratio p-value const 0,0689346 0,0300006 2,2978 0,02452 ** Assets 8,70913e-010 1,4783e-09-0,5891 0,55764 F_rev 0,340729 0,151235-2,2530 0,02735 ** sq_f_rev 0,51655 0,159449 3,2396 0,00182 *** Mean dependent var 0,049929 S.D. dependent var 0,104621 Sum squared resid 0,628251 S.E. of regression 0,094067 R-squared 0,224358 Adjusted R-squared 0,191584 F(3, 71) 6,845675 P-value (F) 0,000407 Log likehood 72,91600 Akaike 137,8320 Schwarz criterion 128,5620 Hannan-Quinn 134,1306 Źródło: Opracowanie własne. We have also testes both models using ROE as a dependent variable. In the table 6 we present the results of the of the first (linear model) with ROE as dependent variable. The regression coefficient describing the impact of internationalization on return on assets is positive and statistically significant (p-value = 0.02459). The impact of the control variable proved to be statistically insignificant. Table 6 OLS estimation of model 1 with ROE as dependent variable Model 1, number of observations: 75 Dependent variable (Y): ROE coefficient std. error t-ratio p-value const 0,0134299 0,0416471-0,3225 0,74803 Assets 2,08831e-09 2,95004e-09-0,7079 0,48130 F_rev 0,193241 0,0841619 2,2961 0,02459 ** Mean dependent var 0,062705 S.D. dependent var 0,193319 Sum squared resid 2,569304 S.E. of regression 0,188904 R-squared 0,070960 Adjusted R-squared 0,045154 F(3, 71) 2,749686 P-value (F) 0,070670 Log likehood 20,09910 Akaike 34,19820 Schwarz criterion 27,24574 Hannan-Quinn 31,42216 In Table 7 we present results of the estimation of model two (curvilinear) with ROE as a dependent variable. The regression coefficient describing the impact of the control variable is statistically insignificant. The regression coefficient describing the impact of the level of internationalization is negative, but statistically insignificant. The regression coefficient of the variable describing the square of the level of internationalization is statistically significant (p = 0.05643) and positive. Moreover in the second model the R-squared value, which amounts to 0.12, and is higher than in the first model (0.08). Summing up, the above tests also confirm the existence of U-shaped relationship between profitability (this time measured by ROE) and internationalization (measured by share of foreign revenues in total revenues of the analyzed companies). Table 7 OLS estimation of model 2 with ROA as dependent variable Model 2, number of observations: 75 Dependent variable (Y): ROE coefficient std. error t-ratio p-value const 0,0694248 0,0591238 1,1742 0,24423 Assets 1,45578e-09 2,91336e-09-0,4997 0,61884 F_rev 0,362145 0,298046-1,2151 0,22837 sq_f_rev 0,60942 0,314235 1,9394 0,05643 *

Mean dependent var 0,062705 S.D. dependent var 0,193319 Sum squared resid 2,440044 S.E. of regression 0,185383 R-squared 0,117699 Adjusted R-squared 0,080419 F(3, 71) 3,157148 P-value (F) 0,029931 Log likehood 22,03481 Akaike 36,06961 Schwarz criterion 26,79966 Hannan-Quinn 32,36822 5. Summary Summing up the results of our analysis we can indicate that results of our econometric modelling of the impact of internationalization of Polish companies (listed on the Warsaw Stock Exchange) on their performance - measured by return on assets and return on equity - confirmed the hypothesis of a U-shaped relationship between these phenomena. This means that the internationalization in the initial phase may lead to a fall in their profitability, but with increasing internationalization we can expect an increase of profitability ratios. This observation is consistent with the results of other studies on the issue in question and raises important implications for both short and long-term decisions taken by the company and stock investors. 6. References Barbopoulos L., Marshall A., MacInnes C., McColgan P. (2014) Foreign direct investment in emerging markets and acquirers value gains, International Business Review, Volume 23, Issue 3, June 2014, Pages 604-619. Bolaji H., Chris A. (2014) Relationship between Internationalisation of Firms and Economic Performance: A Case Study Selected Banks in Nigeria, Journal of Economics and Sustainable Development, Vol.5, No.5, 2014, pp. 160-166. Capar N., Kotabe M. (2003) The Relationship between International Diversification and Performance in Service Firms, Journal of International Business Studies, Vol. 34, No. 4 (Jul., 2003), pp. 345-355. Chen H., Hsu Ch-W. (2010) Internationalization, resource allocation and firm performance, Industrial Marketing Management, Volume 39, Issue 7, October 2010, Pages 1103-1110. Contractor F.J., Kumar V., Kunduc S.K. (2008) Nature of the relationship between international expansion and performance: The case of emerging market firms, Journal of World Business, Volume 42, Issue 4, December 2007, Pages 401 417. Hennart J-F. (2007) The Theoretical Rationale for a Multinationality-Performance Relationship, Management International Review, vol. 47, 2007/3, pp. 423 452. Hsu Ch-Ch., Pereira A. (2008) Internationalization and performance: The moderating effects of organizational learning, Omega, Volume 36, Issue 2, April 2008, Pages 188-205. Lin w., Liu y., Chen K. (2011) The internationalization and performance of a firm: Moderating effect of a firm's behavior, Journal of International Management 17 (2011) 83 95. Ramsey J., Barakat L., Cretoiu S. (2012) Internationalization and its possible impact on subjective and objective performance: Evidence from Brazilian TNCs, Transnational Corporations, Vol. 21, No. 2 (August 2012), s. 21-46. Riahi-Belkaoui A. (1998) The effects of the degree of internationalization on firm performance, International Business Review, Volume 7, Issue 3, June 1998, Pages 315-321. Riahi-Belkaoui A. (1999) The degree of internationalization and the value of the firm: theory and evidence, Journal of International Accounting, Auditing and Taxation, Volume 8, Issue 1, 1999, Pages 189 196.

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