Multinational enterprises and costs of capital

The theory that multinational firms (MNE\u27s) might serve as proxies for internationally-diversified portfolios suggests that potential contributions of MNE\u27s to portfolio risk reduction would motivate investors to pay premiums for their shares. Previous empirical tests confirmed risk reduction benefits but were inconclusive on expected effects on returns.^ We hypothesize that MNE\u27s enjoy diversification benefits only when, or where, better alternatives for direct portfolio diversification are not available to the investor. The issue of when was addressed by other researchers who noted that results of empirical tests changed between time periods. They suggested that this effect might be the result of changes in capital market barriers. We address the issue of where by testing location of firms\u27 diversification.^ We use a dividend-growth model to estimate investor\u27s expectations of returns. This methodology, not previously used in tests of pricing of securities of multinational firms, allows us to test share prices in the late 1980\u27s, a period marked by increased availability of foreign shares and international mutual funds. All prior studies used data from earlier periods when barriers to international investing were more prevalent.^ Our findings indicate that investors do not price the international factor per se although regional factors may be priced. In particular, we find that firms\u27 diversification into regions outside the United States/European markets is relevant to pricing of shares. These are regions where barriers, particularly in the form of capital market information problems, are more prevalent and construction of home-made international portfolio diversification is more difficult.