The catalytic effect of internationalization on innovation

• Date: 01 September 2019
• Published date: 01 September 2019
• DOI: http://doi.org/10.1111/eufm.12190

DOI: 10.1111/eufm.12190

ORIGINAL ARTICLE

The catalytic effect of internationalization on

innovation

Ching-Hsing Chang

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Ching-Hung Chang

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Pi-Kun Hsu

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Sheng-Yung Yang

3

1

Department of BioBusiness, National

Chiayi University, No. 580, Sinmin Rd.,

Chiayi City 600, Taiwan

Email: chc@mail.ncyu.edu.tw

2

Department of Finance, National

Taiwan University, No. 1 Sec. 4,

Roosevelt Rd., Taipei City 106, Taiwan

Email: chinghungc@ntu.edu.tw

3

Department of Finance, National Chung

Hsing University, 250, Xingda Rd.,

Taichung 402, Taiwan

Emails: hsu5223@gmail.com;

shengyang@nchu.edu.tw

Funding information

College of Management, National Taiwan

University

Abstract

This paper examines how interna tionalization spurs

corporate innovation. Inter nationalization heighte ns the

competitive environment of firms, while increasing

financial flexibility. The increased competition red uces

agency problems and motivate s innovation projects which

are supported by improved fin ancial flexibility. We obtain

robust evidence with the di fference-in-differences and

instrumental variable ap proaches. The passage of ant i-

takeover laws and the 1989 Loma Prieta ear thquake are

treated as exogenous variati ons to corporate governance;

shocks on firm capital supply mea sured by mutual fund

redemptions are also consid ered. A less positive findin g

is that internationalizat ion motivates firms to focus o n

the appropriability of in novation rather than on basi c

research.

KEYWORDS

competition, financial flexibility, innovation, internationalization,

technological appropriability

JEL CLASSIFICATION

F23, F61, G30, G34, O31

We are grateful to John A. Doukas (the editor) and an anonymous referee for constructive comments and suggestions. We

are also grateful for valuable comments from Alex Edmans, Scott Hsu, Andrew Karolyi, Alexander Ljungqvist, and

participants at the 2015 Financial Management Annual Meeting. Chang acknowledges financial support from College of

Management, National Taiwan University. All errors are our own.

Eur Financ Manag. 2018;1–36. wileyonlinelibrary.com/journal/eufm © 2018 John Wiley & Sons, Ltd.

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942 © 2018 John Wiley & Sons, Ltd. wileyonlinelibrary.com/journal/eufm Eur Financ Manag. 2019;25:942–977.

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INTRODUCTION

Internationalization has become a prime factor affecting the strategic behavior of firms;

internationalization enables firms to seize market opportunities and to capitalize on market

imperfections in new territories (Buhner, 1987; Rugman, 1979, 1981). In this paper, we focus on the

nature of internationalization and its influence on multinational firms’innovation activities.

Internationalization or international diversification can be defined as the expansion of a firm across

geographic borders into different countries or global regions. The trend of internationalization is

changing the competitive environment of the international market. Multinational enterprises (MNEs)

face a growing number of international and local competitors operating in host countries, which means

new efforts are required to acquaint themselves with the tastes and demands of their customers (Hitt,

Hoskisson, & Kim, 1997).

1

Specifically, firms from developed countries may find it easy to seize

opportunities in foreign countries by exploiting current knowledge in the beginning stage. However,

they will find such opportunities nonexistent as more international players enter the market (Porter,

1986). Bartlett and Ghoshal (1990) also suggest that the advantages which MNEs possess tend to fade

over time.

2

The literature suggests that innovation may be the key to sustaining competitive advantage in

international markets (e.g., Cantwell, 1989, 2005; Porter, 1990). Yet, unlike projects based on physical

capital expansion, R&D comes with a lengthy learning process which gives rise to non-negligible

uncertainty and the increasing likelihood of failure. The agency view suggests that self-dealing

managers may squander corporate resources in pursuit of private benefits (Jensen & Meckling, 1976);

or they prefer routine tasks that offer quicker returns and shun valuable yet risky R&D projects

(Bertrand & Mullainathan, 2003). A competitive environment reduces the opportunities for managerial

slack and motivates managers to engage in value-maximizing projects (e.g., Hart, 1983). Thus, we

posit that an international competitive environment mitigates the principal and agent problem within a

corporation. In other words, internationalization helps to align the interests between managers and

shareholders, which in turn encourages more innovative activities that improve MNEs’competitive

advantage in the long term. We refer to this argument as competition hypothesis in the following text.

Furthermore, the high-risk nature of R&D projects makes it hard for firms to obtain capital from

financial institutions without sizeable cost, partly due to asymmetric information between two parties,

as well as the absence of collateral value in R&D projects. Given their international diversified

structure, multinational firms’fundraising ability is less subject to impediments created by either

friction in international financial markets or tax systems. Such advantages help multinationals to better

access low-cost capital markets, transfer capital internally to reduce cash flow volatility, and seize

emerging investment opportunities (e.g., Arrow, 1962; Hall & Lerner, 2010). We posit that

1

Multinational enterprises (MNEs) have come to play a crucial part in the global economy. MNEs started in the mid-1950s;

when global production accelerated, they spurred transnational trade and cross-border investment (Porter, 1986). US MNEs

in the Compustat database quadrupled in the 35 years ending in 2011; meanwhile, foreign direct investment outflow

increased from 5.87% of GDP in developed economies in 1980 to 39.38% in 2011.

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Taking a well-known MNE, McDonald's, as an example. When McDonald's spread American culture worldwide by

expanding its franchises to other countries, it swept the global markets in the 1970s and 1980s (Curtis, 1982). Then, when

local cafeterias and other similar MNEs like KFC, Wendy's, Burger King, and Starbucks emerged globally, McDonald's is

finding its distinctive advantages gradually eroding. In response to this intense competition, McDonald's has become more

sensitive to local demands and has remained innovative by introducing new products. Customers today find that some of

McDonald's products vary across countries and states. One may think that if an MNE like McDonald's dedicates its efforts

to staying innovative when confronting competitions, other MNEs should follow suit. See Mourdoukoutas, Panos, ‘How

McDonald's Wins through Adaptation and Innovation,’Forbes, July 22, 2011.

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internationalization mitigates MNEs’financial friction related to innovation investment and leads to a

higher frequency of patenting activities (financing flexibility hypothesis).

To gauge the innovation productivity of a firm, we use proxies constructed with information from

patents issued to a firm and their subsequent citations. We measure each firm's degree of

internationalization in terms of its degree of multinationality, which is the ratio of foreign sales to total

sales (Fshare). We find support that internationalization stimulates greater innovation activities in

multinational firms, based on an unbalanced panel of 9,278 unique firms from year 1982 to 2003. A one

standard deviation increase in Fshare is associated with a 13% increase in patenting activity. We

observe similar results when using citation information as an alternative measure.

3

Our results hold under a battery of robustness checks. We first apply a difference-in-differences

approach to examine the impact of multinationality status on the degree of firm innovation by

comparing the change in innovation outputs for firms becoming multinational (treatment group) with

the changes in their local counterparts (control group). As a complementary test, we strengthen our

findings using an instrumental variable approach. We use a near-firm degree of multinationality ratio

and a broad currency index as our exogenous instruments for degree of firm multinationality. Both

variables are lagged for 1 year to further avoid reverse causality. These two analyses deliver

qualitatively similar results.

Next, to validate the competition hypothesis, we model the enactment of business combination laws

as an exogenous shock initiating a change in corporate governance, following Bertrand and

Mullainathan (2003).

4

The results support the competition hypothesis that, after the enactment of state

second-generation laws, firms are less innovative with exclusion of firms with a higher degree of

multinationality.

5

In addition, we obtain similar conclusions using the E-index of Bebchuk, Cohen, and

Ferrell (2009). Finally, we treat the 1989 Loma Prieta earthquake in San Francisco as an exogenous

event that reduced the domestic competition of the tech industry, as supplementary confirmation. We

observe a higher frequency of innovation activities within MNEs compared to their domestic

counterparts under the circumstance of reduced local competition.

In order to examine the financial advantage of MNEs on innovation activities, we empirically test

the hypothesis that the innovation activities of financially flexible firms can be sustained when facing

external shocks from the capital market. We treat price change resulting from mutual fund flows as an

exogenous shock in a firm's domestic capital supply, following Edmans, Goldstein, and Jiang (2012).

We expect that downward price pressure would have a negative impact on patenting activities, but such

impediment can be mitigated by internationalization. The regression results align with our prediction.

We also employ the credit spread as a proxy for firms’ability to access external financing. The results

hold consistently.

Our work makes a number of contributions to the literature. First, we provide evidence that with

lower agency conflict and greater financial flexibility, multinational firms have better ability to nurture

innovation in a stringent operational environment. More specifically, we find that global competition

strengthens corporate governance and leads in turn to greater innovation activities. Furthermore, prior

3

We adjust patent citations to mitigate concerns of truncation bias following Hall, Jaffe, and Trajtenberg (2005). With

regard to patent citations, we find that a one standard deviation increase in Fshare brings a 22% and 13% increase in

adjusted patent citations based on weighting index and fixed-effect approaches, respectively.

4

Atanassov (2013) and Sapra, Subramanian, and Subramanian (2014) also adopt the passage of state-level antitakeover laws

to examine the effect of corporate governance mechanisms on innovation.

5

Business combination laws refer to the second- and third-generation state antitakeover laws, including Business

Combination, Fair Price, and Control Share Acquisition. These antitakeover laws place a moratorium on transactions that

restrain corporate raiders’hostile takeover attempts.

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