For quite some time, the globalization of Spanish business and commerce has been a topic of great interest for academics and business executives in Spain and Latin America. This process, which began during the 1990s, has had an enormous economic impact on Spain. In 1990, the total value of Foreign Direct Investment made by Spanish companies represented 3% of Spain’s GDP. By 2002, that figure was 34.3% — higher than the average in other industrialized countries. Most of these investments were targeted at Latin America. In barely one decade, Spain became the second-largest investor in that region, behind only the United States.
Spain’s largest companies, listed on the Madrid Stock Exchange, have played a key role in this investment fever. Such familiar names as Repsol YPF, the petroleum company; Telefónica, the telecommunications giant; Endesa, the electricity firm, and such banks as Santander (SCH) and Banco Bilbao Vizcaya Argentaria (BBVA) have all been active overseas investors.
Spain’s public opinion has taken a very positive view of the country’s economic progress. Yet many Latin Americans have a critical view of foreign investment, which largely involved moving funds into firms that were privatized in the 1990s. Some Latin Americans believe that these investments have provided few benefits to their own people, and that foreign investors [including those from Spain] would jump ship at the first sign of crisis in Latin America. For example, between 1997 and 2002, incoming foreign capital in the region dropped by 61%.
Cristina López Duarte and Esteban García Canal, both professors of business administration at Spain’s University of Oviedo, have studied this historic trend from a novel point of view: the impact on share prices on the Madrid stock exchange. In their study in Universia Business Review, “Globalization of Spain’s Big Business: Its Impact on Share Prices in the Madrid Stock Market,” they show how the share prices of 56 Spanish companies moved in reaction to 191 different corporate decisions to make foreign direct investments from 1990 through 2003.
On average, note the professors, Foreign Direct Investment has had a positive impact on share prices of the companies that did the investing. However, 47% of the investments did not have a positive impact. Corporate acquisitions, which represent a very important part of Spain’s foreign direct investment, were also positively received by stock market investors. These results show that the famous phrase, “Spain is Different” — which has been used to define Spain’s idiosyncrasies — also applies in this arena. Some studies have suggested that financial markets usually react negatively when companies buy and sell other companies in foreign markets. José Manual Campa, a professor at IESE [business school in Spain], has written a study that indicates that trans-European mergers and acquisitions usually have a negative impact on share prices.
That seems logical, because the first reaction of shareholders to any decision to invest in a foreign country is often skepticism. Whenever a company moves into a foreign country, it exposes itself to the ‘foreigner’s disadvantage.’ The company enters a new market where it is in an inferior position competing with local companies. The newcomer does not know the local market or understand the business practices of that country. The new arrival also lacks “a network of relationships with the main economic, political and social players,” says the study. However, this kind of disadvantage can have a greater or lesser impact, depending on how the investment takes place, who is involved, and when and where it is, say the authors.
In the case of Spanish companies, the professors achieved a calculation of ‘abnormal profitability’ — what they call “the variation in share prices that is directly attributable to carrying out the foreign investment.” Their methodology involved studying the impact of new investment projects that the companies initiated in foreign markets.
According to their research, on the same day that a company announced its investment outside of Spain, there was a positive abnormal profitability of 0.3%. Statistically speaking, the study says, there is a 99% chance that this figure is correct. More simply, this means that “generally, foreign investors gave their blessing to international expansion projects.”
The Market Reacts to the ‘How’
Investors reacted positively in more than 50% of all cases in which a Spanish company established a wholly owned foreign subsidiary, a joint venture with a foreign partner, or acquired a foreign company. However, “On average, subsidiaries and joint ventures generate higher ‘abnormal profitability’ than acquisitions,” when measured by resulting stock prices. While news about subsidiaries and joint ventures generated abnormal profitability of 0.51% and 0.43%, respectively, news about acquisitions [of foreign companies] resulted only in [abnormal profitability of] 0.23%.
Why are acquisitions of foreign firms less highly valued by investors than other strategies for entering a foreign market? On the positive side, when a company decides to purchase a company in a foreign country, the acquiring firm benefits from the infrastructure that the local company has already put in place. As a result, the buyer overcomes the natural disadvantage of being a foreigner. However, the incoming company must pay the market price for the assets of the company that it is purchasing. And if the company winds up paying a premium for these local assets [because of competition to acquire the firm], that fact can raise doubts about the profitability of the acquisition, the authors explain. Nevertheless, when all is said and done, the Madrid stock exchange takes a generally positive view of acquisitions.
The authors explain a key reason for that optimism. Until only recently, say the authors, Spanish companies were significantly behind the times in their global expansion efforts. Buying out foreign companies is widely viewed as a way for Spanish firms to accelerate the globalization process [and catch up with the rest of the world].
The study stresses the importance that the stock market gives to the relevant global experience that companies accumulate. According to the authors, “Our results show that joint ventures are highly valued when companies are in their initial stages of international expansion because the [local] partner substitutes for any lack of experience that the [Spanish] company may have.” However, acquisitions tend to be more highly valued [than joint ventures] in the later stages of global expansion, when companies can take full advantage of their greater international experience.
Nevertheless, the authors warn that acquisitions made during privatization processes [in foreign countries] do not generate as much positive impact on share prices [as other kinds of acquisitions]. That is because the competition between companies to acquire the company raises the acquisition price and cuts into the possible profitability of the move.
According to the “Who”
The Theory of Internalization argues that companies that are better prepared to succeed in their global adventures — and overcome the disadvantage of being foreigners — are the companies that have accumulated a greater number of intangibles [that is unique expertise and strong brand image] in their own country of origin. These intangible factors provide a competitive advantage when the company faces off against players in a foreign country. The authors used the “Q” of Tobin — the quotient between the market value of the company and the value of the sum of its assets — to verify the degree to which owning intangible assets has an influence on a company’s market value. The data show that shareholders place a higher value on investments that are made by companies that have a greater accumulation of intangible assets.
The authors also show that there is a clear relationship between the method of entering the foreign market and this accumulation of assets. In the case of subsidiaries and acquisitions, “the market puts a higher positive value on foreign investments made by companies that have a greater accumulation of intangibles,” they write. Nevertheless, in the case of joint ventures, the Tobin Q is less — the lower this ratio, the lower the value of the intangibles. That is possibly because, “in those cases, companies can find intangible resources in their partners that compensate for their own lack of resources.”
‘Where’ the Investment Takes Place
As anticipated, the study shows that investments made by Spanish companies in less developed countries were viewed negatively by shareholders. Nevertheless, when those investments take place in a middle-income or rich country, the stock market reacts more positively. When it comes to investments in the world’s richest countries, the Madrid stock exchange prefers those that are made within the European Union (EU), especially joint ventures and acquisitions.
The Madrid market does not take as positive a view of investments in the EU that involve setting up wholly owned subsidiaries. One possible reason may be that “newly created manufacturing subsidiaries are not seen as something necessary for the globalization of Spanish companies within the framework of the nation states that comprise the European Union,” the authors comment.
Finally, investments in politically stable foreign countries generate a higher level of abnormal profitability than investments in countries where there is greater political uncertainty. It is no secret that global companies prefer to invest in countries that are politically stable, where the “rules of the game” are not subject to change. In many locations around the world, including Latin America, political instability and ever-changing rules of the game have given Spanish investors a great deal to talk about.