Do multinational banks create or destroy shareholder value? A cross‐country analysis

DOIhttp://doi.org/10.1111/fmii.12091
AuthorCarlos Manuel Pinheiro,Alberto Franco Pozzolo,Mohamed Azzim Gulamhussen
Published date01 December 2017
Date01 December 2017
DOI: 10.1111/fmii.12091
ORIGINAL ARTICLE
Do multinational banks create or destroy
shareholder value? A cross-country analysis
Mohamed Azzim Gulamhussen Carlos Manuel Pinheiro
Alberto Franco Pozzolo
Correspondence
AlbertoFranco Pozzolo, Università degli Studi del
MoliseDipartimento di economia, Via De Sanctis,
86100Campobasso, Italy.
Email:pozzolo@unimol.it
Abstract
We question whether the international diversification of multina-
tional banks creates or destroys shareholder value. Based on a sam-
ple of 384 listed banks from 56 countries we provide new and robust
evidence that bank cross-border activities create shareholder value,
as shown by an economically and statistically significant premium
for international diversification. Our results are confirmed control-
ling for bank fixed effects, time-varying bank characteristics,reverse
causality,functional diversification, and instrumenting for the choice
to expandabroad. The increase in shareholder value is slightly larger
for banks in the middle range of international diversification and in
the case of expansion towards less developedcountries.
KEYWORDS
Foreign Direct Investment,Banks, Tobin'sq
JEL CLASSIFICATION
F23, G20
1INTRODUCTION AND MOTIVATIONS
Multinational corporations are a distinctive featureof today's global economy. And among multinational corporations,
multinational banks have a prominent role: according to Forbes,three of the five largest multinational corporations in
the world are banking groups. Indeed, in the years prior to the 2007-2008 financial crisis, global players such as Citi-
group (300,000 employees, approximately 16,000 offices and over 200 million customers in 140 different countries)
and HSBC (330,000 employees, 8,500 offices and 128 million customers in 86 countries) were viewed as trademarks
of globalization.
A large number of studies has analyzed the determinants, the patterns and the consequences of the cross-border
expansion of banking groups (Berger et al., 2001, Goldberg, 2004), with an increasing attention, after the 2007-2008
financial crisis, to understanding their role in spreading domestic shocks worldwide (Albertazzi & Bottero, 2012, 2014;
c
2017 New YorkUniversity Salomon Center and Wiley Periodicals, Inc.
Financial Markets,Inst. & Inst. 2017;26:295–313. wileyonlinelibrary.com/journal/fmii 295
296 GULAMHUSSEN ET AL.
Cetorelli & Goldberg, 2012a, b). However,this large amount of research has not yet lead to a consensus view on inter-
national banking. For example,while some studies show that domestic and c ross-border expansionsof banks are ben-
eficial for the economy (Hauswald & Bruno, 2014; Jayaratne & Strahan, 1996; Morgan & Strahan, 2004), most analy-
ses find weak evidence of economies of scale or scope, efficiency improvements, or an increase in shareholder value
(DeLong, 2001, and Cornett, Hovakimian, Palia, & Tehranian, 2003). This picture is even less clear when it comes to
understanding whether bank internationalization creates or destroysshareholder value (Amihud, DeLong, & Saunders,
2002). While recent evidenceshows the earnings-to-price ratios and the returns of multinational firms in the manufac-
turing sector are on averageabove those of other firms (Fillat & Garetto, 2014), no evidence is available for the banking
sector.
The discussion on internationalization is part of a broader debate on the benefits and costs of focusing or diversi-
fying the activities of firms that has a long tradition in the economic and business literatures. Froma theoretical point
of view, the arguments in favor of diversification can be grouped into three main categories. According to the market
power view (Edwards, 1955), firms havean incentive to diversify their lines of business as they can extend their market
power from one sector to another through predatory pricing, collusion with other large and diversified companies, and
the exclusion of smaller competitors (Montgomery,1994; Villalonga, 2004a and 2004b). This argument applies also
to the case of banks: according to Sharpe (1990) and Rajan (1992), lending relationships give banks a monopoly on
information about their borrowers that can be exploitedto gain monopoly power across the functional and geographic
dimension (e.g., Petersen& Rajan, 1994). For this reason, both functional and geographic internalization predominates
in banking with respect to other forms of entry into foreign marketssuch as licensing and franchising (Jones, 1992). The
second argument in favor of diversification is based on better resource management and hinges critically on the pres-
ence of economies of scope. In the case of banks, the importance of intangible technical, market-making and manage-
rial assets can be reinforced by the presence of monopolistic information on borrowers. A parallel justification, hinging
more on the financial aspects of firm management, is that diversification reduces the effect of idiosyncratic shocks
on cash flow variance, thereby increasing the stock market value (Lewellen, 1971). Developingon this idea, Fillat and
Garetto (2014) and Fillat, Garetto, and Oldenski (2015) have recently proposed a framework presenting a trade-off
between the benefits of international risk diversification and the fixed and sunk costs of entry into foreign markets1.
Finally, the third argument is based on lower agency costs centers on the functioning of firms'internal capital mar-
kets (Houston, James, & Marcus, 1997). The keyinsight is that firms'internal cash flows are a less expensive source of
funds than external capital so that better informed insiders can increase firm value by selecting the most remunera-
tive projects instead of paying out dividends that would be invested elsewhere by less informed outsiders (Cremers,
Huang, & Sautner,2008; Stein, 1997). Clearly, this argument applies also to the case of financial intermediaries (Barba
Navaretti et al., 2010; de Haas and Lelyveld,2010).
An equally large number of arguments oppose the positive view of diversification. Starting from the seminal contri-
bution by Jensen and Meckling (1976), a number of papers have emphasized the role of conflicts of interest between
insiders and outsiders (Amihud & Lev,1981; Jensen, 1986; Jensen & Murphy, 1990; Shleifer & Vishny,1990a & 1990b).
In addition, diversification may also negatively affect firm value by reducing its efficiency,e.g., by introducing expen-
sive additional layersof administrative and corporate control, and by allocating resources inefficiently across different
activities. These problems are particularly acute in the case of banks, as their activity is typically less based on hard
information and they are therefore more difficult to monitor for externalinvestors (Morgan, 2002).
As the theoretical literature has provided numerous explanations for why diversification can either increase or
decrease the value of a firm, the ultimate answer on its actual effects has been actively searched through the
empirical analysis. The typical exercise in this literature compares the value of a conglomerate (e.g., its Tobin's
q) with the imputed value obtained considering each segment of its activities as a stand-alone firm, using the so
called “chop-shop” approach initially proposed by LeBaron and Speidell (1987). But, unfortunately, also the empiri-
cal research provides a rather mixed picture, with evidenceboth in favor and against the presence of a diversification
premium.2
Inthe case of banks, a number of papers have recently started to study the link between diversification and the value
of banks using the methodology followed by the literatureon manufacturing firms. Using a large set of banks from over

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