flexibility in internationalization: is it valuable during an economic crisis?

Strategic Management JournalStrat. Mgmt. J., 30: 537–555 (2009)

Published online 13 January 2009 in Wiley InterScience (www.interscience.wiley.com) DOI: 10.1002/smj.742

Received 18 July 2006; Final revision received 20 October 2008

FLEXIBILITY IN INTERNATIONALIZATION: IS ITVALUABLE DURING AN ECONOMIC CRISIS?

SEUNG-HYUN LEE1 and MONA MAKHIJA2*1 School of Management, University of Texas at Dallas, Richardson, Texas, U.S.A.2 Fisher College of Business, The Ohio State University, Columbus, Ohio, U.S.A.

This study investigates the value of the strategic flexibility provided by firms’ international invest-ments during an economic crisis, defined here as an unanticipated significant downturn in theeconomy. To avoid below-par performance, firms need to adapt quickly to this significant changein their environment, making real options very valuable to them. Although firms’ internationalinvestments can potentially provide such flexibility, this issue has not been empirically examinedin a context of such dramatic negative change. We consider two types of international investmentsby firms in this regard, foreign direct investments and export-related international investments,developing two measures that directly assess the flexibility derived from each that are new tothe literature. Based on these measures, we find evidence that both types of international invest-ments provided valuable flexibility for Korean firms during the economic crisis conditions. Thisstudy contributes to the literature by showing that firms with real options investments in placehave a greater ability to flexibly adapt their overall operations in line with unforeseen negativeenvironmental change, in contrast to firms without such investments. Copyright 2009 JohnWiley & Sons, Ltd.

INTRODUCTION

An economic crisis in a firm’s market can causeunpredictable, fundamental downward shifts in thelevel of demand and in the relative costs of inputs,causing firms to scramble to adjust or even to rad-ically reconfigure their value chains in responseto threats to profitable production (Kogut, 1991).The quandary is that the likelihood of such a threatoccurring is mostly unknown to the firm, makingit difficult to know in advance how to configureits current investments so that it can be addressed.Researchers have noted that successfully compet-ing in markets characterized by such instability

Keywords: flexibility; real options; economic crisis;export; foreign direct investment; uncertainty*Correspondence to: Mona Makhija, Fisher College of Business,The Ohio State University 724 Fisher Hall, 2100 Neil Avenue,Columbus, OH 43210, U.S.A. E-mail: [email protected]

requires resources, capabilities, and strategies thatare fundamentally different from those that arelikely to lead to success in more stable markets(Bowman and Hurry, 1993; Kogut and Kulatilaka,2001). In particular, a firm with the flexibility torespond advantageously to unanticipated adversechanges in its environment will be better off thana firm locked into a single course of action (Foss,1998; March, 1991).

Firms can make a variety of investments thatexpand the range of potential actions they cantake to deal with unanticipated yet significantdownturn in their operating environment, suchas an economic crisis (Sanchez, 1993, 1995).Investments in research and development (R&D),for example, allow the firm to change prod-uct attributes more rapidly than their competitors(McGrath, 1997; Pakes, 1986; Amram and Kulati-laka, 1998). Flexible manufacturing capabilities let

Copyright 2009 John Wiley & Sons, Ltd.

538 S.-H. Lee and M. Makhija

the firm adapt product configurations to unknownfuture demand (Worren, Moore, and Cardona,2002). Similarly, firms’ international investmentscan also be vehicles of strategic flexibility, pro-viding preferential access to rent-enhancing futureopportunities across national contexts (Mello, Par-sons, and Triantis, 1995; Tang and Tikoo, 1999;Allen and Pantzalis, 1996). Having an establishedexporting infrastructure allows firms to respondrapidly to unanticipated downward changes indemand in both domestic and international markets(Roberts and Tybout, 1997), by shifting sales fromthe less beneficial markets to new customers inother more beneficial markets. By the same token,firms can use their existing configuration of inter-national investments, consisting of both foreigndirect investments (Campa, 1994; Dunning, 1980)and exporting investments (Broll, 1999; Robertsand Tybout, 1997), to adapt their operations tounanticipated threats in ways not possible withoutsuch investments already in place (Tang and Tikoo,1999). Firms with production facilities located inmultiple countries can benefit from their ability tochange production locations in response to unex-pected adverse changes in any given country, suchas increases in labor costs or exchange rate volatil-ity (Reuer and Leiblein, 2000; Kogut and Kulati-laka, 1994), as well as increased political risks(Makhija, 1993).

Despite ample evidence in the literature thatmanagers are primarily concerned with mitigat-ing the downside effects of uncertainty (Kahne-man and Tversky, 1979; Miller and Reuer; 1996),there is relatively little empirical evidence onthe value of options associated with internationalinvestments that give rise to flexibility under suchconditions. This is understandable in light of thechallenging requirements for a viable experimentto test for this issue, which include: (1) a size-able sample of firms that differ in their config-uration of international investments; (2) a defin-able moment when the rate of change shifts ina dramatically adverse direction, permitting com-parisons of periods reflecting economic stabilityand economic crisis; and (3) measurable ex postperformance outcomes for the differing ex antestrategies. If international investments help firmsto exercise flexibility under unanticipated adverseconditions, this flexibility would be associated withhigher firm value under such conditions, allowingsuch firms to outperform those firms without suchinvestments. Since international flexibility is less

beneficial under conditions of relative stability, wewould not expect it to be associated with higherfirm value during this time. The purpose of thisstudy is to investigate this issue.

Specifically, our objectives are (a) to assesswhether firms’ international investments provideflexibility under the downside conditions of uncer-tainty, and (b) to analyze whether the flexibil-ity afforded by these international investmentsare associated with higher firm value under theseconditions. We examine these objectives in thecontext of a naturally occurring experiment embed-ded in the Asian economic crisis experiencedby Korean firms. We utilize a large sample of552 publicly traded firms listed on the KoreanStock Exchange (KSE) during 1996–1998, whichincludes the period of the Asian economic cri-sis that began suddenly toward the end of 1997and became full-blown in 1998. According to ana-lysts’ and news reports at the time, the crisis washighly unanticipated (Ang and Ma, 2001), pro-viding another crucial feature for our investiga-tion.

Given the prevalence of both exporting and for-eign direct investments by Korean firms, our size-able sample permits a study of the differentialflexibility effects of both types of internationalinvestments, which has not been previously con-sidered. To do so, we develop two new measures offlexibility relating to each type of investment, onereflecting shifts in production among firms’ foreignsubsidiaries, and the other reflecting the proportionof export sales to new and nonroutine customers.These measures provide a more direct assessmentof flexibility than previously demonstrated in theliterature. These measures contrast with those inprior research that simply impute flexibility fromthe level of international investments by a firm.Our findings lend credence to the argument thatinternational investments provide value-enhancingflexibility benefits in an economic crisis in com-parison to conditions of stability.

PRIOR WORK ON INTERNATIONALINVESTMENTS AND FLEXIBILITY

Conceptual underpinnings

International investments, including those relat-ing to exporting and foreign direct investment,have been recognized as having the ability to

Copyright 2009 John Wiley & Sons, Ltd. Strat. Mgmt. J., 30: 537–555 (2009)DOI: 10.1002/smj

International Flexibility during an Economic Crisis 539

provide flexibility under uncertainty by a num-ber of researchers, including Broll (1999), Kogut(1983, 1985), Bowman and Hurry (1993), and oth-ers. The underlying argument is generally basedon real options logic. For example, a firm thathas made investments in exporting is able toallocate sales of its domestic production amongboth domestic and foreign markets. In the face ofextreme exchange rate change (Broll and Eckw-ert, 1999), or a rapid decline in domestic demand,the firm’s ability to shift lost domestic sales toforeign markets increases the value of its export-ing related investments. For example, when thedomestic currency depreciates significantly relativeto another currency, exporting can be increasedin line with more advantageous realized priceselsewhere. When the domestic currency appreci-ates relative to another currency, exporting canbe switched to other more promising markets thatare less affected by this change, or to the domes-tic market. When the exchange rate once againpermits profitable exports, the firm resumes export-ing (Broll and Eckwert, 1999). In either case, thefirm has opportunities to recover the loss due todecreased domestic or foreign demand by focusingon other markets in which it has already estab-lished exporting infrastructure.

In contrast to export-related investments, for-eign direct investment involves the establishmentof subsidiaries or affiliates in foreign locations.Because its operations are distributed across mul-tiple geographic locations, a multinational firmcan respond to country-specific negative environ-mental shocks and fluctuations by shifting factorsof production across national borders (Kogut andKulatilaka, 1994). Direct investments have sev-eral features that give rise to flexibilities that aredifferent from pure exporting investments. First,they can maximize profit by shifting productionto locations with more beneficial cost structures(Tang and Tikoo, 1999). For example, if an envi-ronmental change causes the labor costs in a givenlocation to rise, a firm with operational flexibilitycan shift labor-intensive operations to other lower-cost locations. As noted by Little (1986), firmswith operations in multiple countries ‘possess anextra degree of flexibility in adjusting to a newcompetition situation. These multinationals can . . .

expand output where relative production costs arefalling. . . Accordingly, intra-firm trade might beexpected to adjust more quickly to an exchangerate change than would trade between unaffiliated

and noncooperating firms’ (Little, 1986 : 46). Sec-ond, multinational firms may be able to vary thelocations in which to declare profits, dependingon differential taxation and permissible transferpricing policies in the countries in which they oper-ate. Third, they can modify the locations in whichto concentrate market power, depending on com-petitive forces. Hamel and Prahalad (1995) alsonote that multinational firms have the ability tocross-subsidize their operations, flexibly allocat-ing profits of some subsidiaries to support oth-ers experiencing unexpected environmental down-turns. Due to such cross-border intrafirm linkages,it is possible for multinational firms to take a sud-den downturn of an economy as an opportunityto produce at low cost and expand production atthe low-cost subsidiaries while decreasing produc-tion in high-cost subsidiaries (Tang and Madan,2003).

While such operational flexibility is of poten-tial value to the firm, it must be recognized thatmanaging a multinational network of subsidiariesis associated with higher costs as well (Rangan,1998). The complexity of managing such a net-work can offset the benefits of the flexibility of themultinational network. Hitt, Hoskisson, and Kim(1997) point to the large transactions costs associ-ated with the myriad of country-specific transac-tions in a given subsidiary, including those asso-ciated with the number of suppliers, customers,distributors, and government agencies, to namea few. In addition, the implementation of deci-sions to transfer production is not typically clear-cut. Transportation costs, changes in export andimport duties, and variations in deals made withthe government, for example, may make it dif-ficult to determine the true costs of switchingproduction from one location to another. Finally,the ability to transfer production from one loca-tion to another depends on the nature of the spe-cific operations in each country. To the extentthat the firm’s factories in different countries aregeared toward satisfying country-specific demand,the potential for transferring production from onecountry to another is greatly limited (Rangan,1998). In sum, while the potential for operationalflexibility may be enhanced by multinational oper-ations across multiple countries, firms need toconfigure operations in a way that such benefitsexceed the costs of managing the multinationalnetwork.



Prior empirical evidence on the operationalflexibility of international investments

The empirical evidence on the operational flexibil-ity of international investments is both limited andmixed. For example, Allen and Pantzalis (1996)and Tang and Tikoo (1999) find support for oper-ational flexibility in their studies of breadth anddepth of multinational networks. They indicatethat firms with a broad distribution of subsidiariesacross many national contexts are associated withhigher market value than those characterized bya higher concentration of subsidiaries in a sin-gle country. Miller and Reuer (1998) also showsome evidence of benefits of flexibility derivedfrom exchange rate risk in the pricing strategies ofa small percentage of U.S. manufacturing firms.In contrast, Reuer and Leiblein (2000) observethat greater multinationality does not help firmsto reduce downside risk. Instead, they find thatsuch investments result in higher bankruptcy andincome stream risks. Rangan (1998) finds thatfirms attempt to manage flexibly, but the needfor localization in their foreign direct investmenthas the effect of impeding intended flexibility. Inaddition, Campa’s (1994) study on multinationalinvestment under uncertainty provides support forthe notion that such firms invest abroad for the pur-poses of risk diversification rather than operationalflexibility.

Clearly, the conflicting findings of these stud-ies point to the need for further investigationof the value of flexibility stemming from firms’international investments. Because real optionsresearchers have argued that flexibility is of greatervalue when firms face higher uncertainty, it isextremely important to consider the external con-ditions under which international investments areexamined. Miller and Reuer (1996), however,point out that managers are not simply concernedabout uncertainty per se. Drawing on the litera-tures of behavioral decision theory, finance, andmanagement, they note that the primary concern ofmanagers is to minimize the potential for downsideoutcomes, as these are likely to result in below-target performance. Despite this, much of the priorempirical work discussed above has not tendedto examine multinational flexibility under specificconditions of unanticipated environmental down-turns, but instead, are concerned with a generalnotion of uncertainty.

At the same time, it is often assumed thatexchange rate risks are the greatest source ofuncertainty faced by multinational firms. It is notclear if exchange risk is always a source of greatuncertainty, however, especially when firms areoften able to hedge these risks (Allayannis andOfek, 2001; Click and Coval, 2002). In contrast,extreme and negative unanticipated changes inindustry context, political risks, and operationalconditions are likely to have larger implications forthe firm’s need for flexibility (Allen and Pantza-lis, 1996; Tang and Tikoo, 1999). In line with thisargument and those of Miller and Reuer (1996)above, it would be useful to examine operationalflexibility in the context of an unanticipated yetsignificant economic downturn, such as an eco-nomic crisis. A focus on an economic crisis reflectsthe downside aspects of uncertainty, and in doingso, better reflects the concerns of decision makerswithin firms and the circumstances under whichthey would most highly value flexibility. Nonethe-less, no research thus far has utilized such a contextto investigate international flexibility.

It is also interesting that past research, whileinformative, has tended to treat the firm’s posses-sion of international investments the same as thefirm’s operational flexibility. As noted by Ran-gan (1998), however, the two need not be thesame. International investments that are designedto maximize local responsiveness, for example, arenot likely to provide the firm with the ability toswitch operations from one country to another.A multinational corporation (MNC) that has sub-sidiaries in different countries can be overwhelmedby the complexity of coordinating different oper-ations (Rugman and Verbeke, 2004; Tong andReuer, 2007), which may reduce the benefits ofoperational flexibility that the MNC hopes to have(Doukas and Pantzalis, 2003; Roth, Schweiger,and Morrison, 1991; Tong and Reuer, 2007). Itmay also be the case that the value of nation-ally dispersed international investments reflectsthe benefits of diversification rather than opera-tional flexibility (Rugman, 1979). In this sense,just having subsidiaries in different countries maynot be enough for assessing operational flexibility.Instead, it is important to measure the actual flex-ibility associated with international investments,indicated in the literature as the ability of thefirm to quickly shift production to different inter-national locations or shift sales to new interna-tional customers. However, to date no research has



directly measured international flexibility in thismanner.

It is also important to note that, since virtually allof the prior studies have focused only on foreigndirect investment, the literature currently offers lit-tle or no evidence on the value of exporting, or onthe relative flexibility benefits of differing combi-nations of international investments. While export-ing entails fewer costs and is the preferred modeof entry for firms without extensive internationalexperience (Broll, 1999), foreign direct investmentis associated with potentially higher costs and ben-efits (Aulakh, Kotabe, and Teegen, 2000; Chang,1995; Chang and Rosenzweig, 2001). It remainsan empirical question, then, which is a preferablesource of flexibility for firms. In addition, becausefirms often use a combination of the two, theremay be synergistic benefits among them.

In this research, we attempt to address each ofthese concerns. The next section develops threesets of testable hypotheses assessing the value offlexibility stemming from two types of interna-tional investments of Korean firms, followed bytests using two new direct measures of interna-tional flexibility in the context of a severe eco-nomic crisis.

HYPOTHESES DEVELOPMENT

Value of flexibility afforded by exportinginvestments

As we noted earlier, exporting involves productionin one national market, often the home country ofa firm, and sales in other national markets. In orderto engage in exporting, firms must invest in over-seas relationships and the infrastructure necessaryfor selling their products. The investment costsassociated with exporting include market research,procurement of export licenses that involve gov-ernmental review processes, the development ofa distribution network possibly facilitated throughlocal distributors, and training and machinery foradapting the product as necessary to local tastesand requirements, among others. These nontrivialcosts allow the firm to initiate the exporting pro-cess. Without such investments in position, oppor-tunities that arise due to unanticipated changes inexchange rates, economic conditions, or consumerdemand, cannot be taken advantage of in a timelymanner. In this way, the investing firm obtains

preferential access to opportunities compared tocompetitors who did not make these investments.

In comparison to foreign direct investment,exporting investments typically require lower ini-tial and subsequent capital outlays. These lowercapital outlays are due to the fact that a singledomestic factory can usually provide a productionplatform geared toward several other countries. Incontrast, both wholly owned and joint venture for-eign direct investments necessitate upfront invest-ment into productive capacity in specific countries.In addition, exporting investments are significantlyoriented toward the building of relationships withdistributors and partners in other countries, whichalso reduces the risks of adverse outcomes. Suchrelationships not only help the firm to share risksassociated with market entry, they also allow thefirm to focus on its own core capabilities and ben-efit from those of its partners.

Exporting investments provide the firm withflexibility by providing a foothold into anothercountry’s market. It can take the form of a trialentry into the country, without necessarily havingto be large. Structuring the investment in this man-ner cushions downside risks of future investmentin the following way. If conditions in one coun-try become adverse to the firm, as in the eventof an economic crisis, the firm may elect to stopfurther investment and limit losses to the (rela-tively low) sunk costs associated with the discon-tinued project (McGrath, 1997). Instead of beingtied down to a market characterized by such adownturn in demand, the firm can use this oppor-tunity to expand its initial investments in othermore promising markets. The firm can now useits already existing investments to switch sales tonew customers located in these markets. Withoutthe initial foothold investment, however, it wouldbe difficult for the firm to identify and lock ontonew customers in these markets. The procuring ofsignificant new international customers requires apriori investments into market research and dis-tributor relationships. In this way, a priori export-ing investments allow firms to maintain high salesin the face of an unanticipated economic crisis.

In light of this argument, we present the follow-ing hypothesis:

Hypothesis 1: During a period of economiccrisis, flexibility afforded by firms’ exportinginvestments will be positively associated withfirm value.



It is important to note that, in contrast to theabove, firms would not benefit as much fromthe flexibility created by export-related invest-ments during periods characterized by relativeeconomic stability. Since there is no need forflexibility under such conditions, the possessionof flexibility-creating investments would thereforenot provide firms with additional value. Under con-ditions of stability, then, the flexibility associatedwith export-related investments would likely beassociated with negligible firm value.

Value of flexibility afforded by foreign directinvestments

Firms can also invest in productive capacity acrossmultiple countries, creating a multinational net-work that draws from localized factors of produc-tion as well as intrafirm leveraging of relationships,assets, and capabilities (Rangan, 1998). Althoughsuch foreign direct investment may also requirethe firm to invest in local market research anddistribution relationships in a manner similar toexporting investment, a main distinction betweenthe two is the importance of investment in country-based productive assets. Once in place, foreigndirect investments provide preferential access toopportunities from which the firm would other-wise be isolated. Some of these are similar toexporting, including those stemming from changedeconomic conditions or consumer demand. How-ever, they also allow the firm to benefit froman enhanced understanding of the local environ-ment, and deeper relationships with governmentofficials, universities, workers, and other local enti-ties (Boasson et al., 2005). The firm is also in abetter position to exploit differences in production,labor, transportation, storage costs, etc. It may evenreduce capital costs through better banking rela-tions locally. Such benefits, which also could notoccur without the investment in place, allow thefirm to take advantage of newly emerging localconditions more rapidly and with greater effective-ness than its competitors.

As we noted above, rapidly changing global con-ditions can be a threat to the strategy of a firm. Itis very difficult for firms to accurately forecast thedirection of economies due to the inherent com-plexity underlying such change. Since the 1970sto the present, the number of countries under-going economic crises has continued to be high,

whether due to banking sector collapse, rapid cur-rency devaluation, or some other issue (Dreher andRupprecht, 2007). In light of this, a critical featureof foreign direct investments can be the ability towait and see how future conditions develop, andthen adapt the investment accordingly. The ini-tial investment made in the foreign country servesto hold the opportunity open for subsequent full-scale commitment there. For example, a firm maywish to enter the large market of Russia. However,the path of the Russian economy has been unpre-dictable, government policies amenable to change,and the nature of capitalism evolving there quiteunique. In light of this, such a firm wishing totake a long-term view would find it valuable tomake investments in a manner that preserves theright to take action in the future. Thus, foreigndirect investments can confer the right to later deci-sions, made ‘when the time is right,’ which wouldnot have been feasible without prior investment.This includes abandoning the investment with onlylimited sunk cost if circumstances prove to beunpromising.

While the initial capital outlays associated withforeign direct investment are likely to be sub-stantially higher than those related to exporting,due to the need to invest in productive assets ineach country and accompanying costs of hiringand training personnel and establishing operationsin that country, firms derive important benefitsthat limit their downside risk. A multinational firmcan spread its investments, keeping investments inany one country relatively low. It has the abil-ity to leverage and arbitrage factors of productionacross national borders (Kogut, 1983, 1985). Inthe event of negative changes in local demand, thefirm can shift sales to other locations where pricesare higher and/or demand is increasing. If inputcosts increase locally, production can also poten-tially be shifted elsewhere. These benefits help thefirm throughout its value chain, rather than only itssales. This ability to flexibly shift production fromone subsidiary location to other locations can beobserved in changes in the firm’s intrafirm trade.

In light of the arguments above, we expect thatfirms with foreign direct investments will havegreater ability to exercise valuable flexibility in theevent of an economic crisis. This flexibility stemsfrom the ability derived from such investments toshift production from less beneficial markets tothose that are more beneficial. Thus,



Hypothesis 2: During a period of economic cri-sis, flexibility afforded by firms’ foreign directinvestments will be positively associated withfirm value.

In contrast, we do not expect that in periodscharacterized by relative economic stability, theflexibility created by international investments willyield significant benefits to the firm. This is due tothe fact that firms would not need to take advantageof flexibility under such periods. For this reason,under stable conditions the flexibility associatedwith such investments will add negligible firmvalue.

The relationship between exporting andforeign direct investments

It has been noted that the value of a portfolio ofoptions differs from that of individual options byadding or subtracting additional value to individualoptions in line with characteristics of underlyingassets and uncertainty conditions (Vassolo, Anand,and Folta, 2004). This is likely to apply in thecase of those associated with international invest-ments as well. Our discussion above noted overlap-ping benefits of flexibility associated with export-ing and foreign direct investments, particularly interms of access to overseas markets. Both typesof investments allow the firm to gain flexibility bylimiting initial investments. In both cases, firmsbenefit from the ability to differentially apportionsales across multiple markets rapidly in response tothreatening changes in demand in any given mar-ket. Once invested, firms are well situated to gainimportant insights into environmental conditionsthat can negatively affect their operations beyondthose achieved by competitors who are not so well-situated.

At the same time, the two forms of internationalinvestments provide firms with differing benefits.As noted earlier, firms with overseas exportingrelationships benefit from lower initial setup costsas well as reduced coordination costs in compar-ison to foreign direct investment. Export-relatedbenefits also stem from the potential to increaseefficiency of capital-intensive domestic operations.On the other hand, foreign direct investments pro-vide benefits stemming from differentiated pro-duction capability across geographical locations.The ability to produce in specific overseas marketsmay reduce exchange rate exposure in comparison

to exporting, due to lower need to export pro-duction across national boundaries (Williamson,2001). This allows firms to benefit from the flex-ibility of exporting from other countries in whichthey have production-related investment, provid-ing incrementally greater flexibility to the firm.Closer involvement with the local environmentshould also allow direct investors to engage inmore learning in comparison to firms with onlyexporting-related investments. In this way, theincreased market-related knowledge and learningafforded by one type of investment can be lever-aged to fine-tune the options associated with theuse of the other type of investment. Such bene-fits can influence the adoption of globally inte-grated strategies on the part of firms, in which bothexporting- and production-related investments playa prominent role (Kobrin, 1991; Makhija, Kim, andWilliamson, 1997).

In sum, we argue that the combination of the twotypes of international investments provides addi-tional benefits of flexibility in comparison to thoseafforded by a single type of investment, since theoptions provided by one can enhance the valueof the options provided by the other. We there-fore expect a positive interaction effect betweenthe two during an economic crisis (McGrath andNerkar, 2004), reflecting the incremental additionalvalue derived from the possession of both typesof international investments. Thus, we propose thefollowing hypothesis:

Hypothesis 3: During an economic crisis, therewill be a positive interaction effect betweenthe flexibility afforded by exporting and foreigndirect investments on firm value.

As we have noted before, under conditions ofstability, firms’ need for flexibility is far lessimportant, and is likely to take a backseat toother goals associated with international expan-sion. Thus, the enhanced flexibility associated withthe combination of exporting and foreign directinvestment provides little incremental value tofirms at this time.

DATA AND METHODS

Data and measurement of variables

The purpose of this research is to examine whetherfirms’ international investments provide them with



valuable flexibility. To do so, we focused onKorean firms over (a) a period of relative eco-nomic stability (1997), and (b) the highly unsta-ble period of the Korean economic crisis (1998).Although the Korean economic crisis began in late1997, it was the year 1998 in which the eco-nomic crisis became full-blown, and therefore, theyear of significant negative economic conditionsfor Korean firms. This crisis was largely unantici-pated, as could be seen in numerous articles in boththe Korean and international business press in themonths and days leading to the crisis. The Koreancurrency experienced unprecedented devaluationin comparison to other hard currencies, decliningto less than 40 percent of its value by 1998. Amassive decline in gross domestic product (GDP)also occurred in 1998 after years of extremely highgrowth rates, while inflation and unemploymentrates more than doubled.

The Appendix contains a more complete descrip-tion of the origins of the Korean economic crisis.In comparison to 1998, the years of 1996 and 1997reflect a period of relative stability. For this rea-son, this case provides an excellent opportunity totest the value of flexibility of Korean firms’ inter-national investments under unanticipated adverseconditions.

We use the WISEfn database of Korean firms,consisting of all publicly listed firms in the KoreaStock Exchange (KSE), and the Korea ListedCompanies Association (KLCA) foreign affili-ate database, covering the period of 1996–1998.Financial services firms are omitted due to dif-ferences in their accounting practices that makethem incompatible with firms in other industries(Chang and Hong, 2000). Thus, the number offirms included in the analysis ranged from 455 inthe 1996–1997 period to 459 in the 1997–1998period. We control for chaebol1 membership in ouranalysis to take into account this unique organiza-tional feature of Korean firms, identified throughthe Korea Fair Trade Commission (Korea FairTrade Commission, 1996–1997). Totals of 105 and104 chaebol-affiliated firms were identified for theyears 1996 and 1997, respectively.

1 A chaebol is a type of business conglomerate in South Korea.Since the 1960s, dozens of large Korean family-controlled chae-bols have, with the assistance of the government, played a majorrole in the economy of South Korea, and helped to develop awide range of industries. The largest chaebols include Samsung,Hyundai Motor Company, LG, SK, Hanjin, Hyundai HeavyIndustries, Lotte, Doosan, Hanhwa, and Kumho Asiana (Changand Hong, 2000).

In order to measure the flexibility afforded byfirms’ international investments (the independentvariables of concern), we required detailed infor-mation relating to the firms’ exports and intrafirmtrade. We obtained this data from the quarterlyand annual auditor reports provided by WISEfn.2

The data included total firm exports, transactionsamong all subsidiaries and parent, as well as exportsales to existing long-term customers, for the firmslisted in the KSE. While the auditor reports hadintrafirm trade information, they did not includeinformation on the location of the subsidiaries.We therefore undertook further investigation todetermine their location, including whether theywere domestic or foreign subsidiaries. Because weare interested in examining the value of intrafirmtrade, we dropped transactions among the domes-tic subsidiaries. To find country information foreach intrafirm transaction, we examined the com-pany homepage and further searched for com-pany news and affiliate/country information usingLEXIS/NEXIS, and the KSE information Web site.

Dependent variable

Due to our interest in assessing the value of theflexibility afforded by international investments,we use Tobin’s q as the dependent variable. Asshown below, Tobin’s q is a standardized mea-sure of the value ascribed to a firm by investors.While the denominator represents the investmentinputs in the firm, the numerator captures the valuecreated by the firm with these inputs. This is aparticularly appropriate measure for assessing thevalue of flexibility because it is a ‘forward looking’measure that adjusts for risk. Alternative measuressuch as return on equity (ROE) are expected todiffer across firms depending on the risk of thefirm. Tobin’s q allows us to capture the valuecreated from investments in flexibility after con-trolling for other traditionally recognized sourcesof value.3 We calculate Tobin’s q for 1997–1998 in

2 The authors would like to express their gratitude to WISEfnfor giving them access to this data source.3 Tobin’s q is a widely used measure of value creation because itincorporates market valuation relative to investment input (bookassets). Because the gain in market value over the book valuealso represents the growth potential of the firm, the interpretationof Tobin’s q is consistent with the growth potential associatedwith flexibility. Another interpretation of Tobin’s q is that themarket value of the firm depends on the growth potential andthe efficiency of management to actualize it. This interpretationof Tobin’s q as a performance measure is also consistent with



the manner suggested by Chung and Pruitt (1994),as follows:

Market value of

common stock+ book value of

preferred stock+ book value

of debtBook value of total assets

Market value of common stock is calculated as theyear-end share price multiplied by the number ofshares outstanding.

Independent variables: flexibility associatedwith international investments

Measure of flexibility relating to exportinginvestments

The flexibility of a firm’s exporting investmentsis seen in the extent to which the firm is able tosell its products abroad (i.e., export) to nonrou-tine and new international customers. To assessthis using the available data, we first subtractedthe firm’s export sales to its foreign subsidiariesand to existing long-term customers from its totalexport sales. We then divided the resulting valueby the firm’s total export sales. The resulting valueprovides us with the proportion of the firm’s exportsales that was newly developed to cope with thesudden downturn of the Korean economy.

Thus, the following measure is used to proxyexporting flexibility: [total exports − (exports toforeign subsidiaries + exports to significant andregular foreign customers)]/total exports.

Measure of flexibility relating to foreign directinvestments

To assess the firm’s activities of shifting or switch-ing its production or sales from one location toanother, which reflect the ability of the firm toact flexibly, we developed a measure that takesinto account changes in the firm’s intrafirm salesfrom the previous period to the focal period (i.e.,1997 to 1998, 1996 to 1997).4 Intrafirm trade ismeasured as the total of all the transactions (both

our needs, as it reflects the ability of the firm to take actions inthe future. On empirical grounds, the Chung and Pruitt (1994)measure proxies the strict definition of Tobin’s q, which replacesreplacement value in the denominator with book value of totalassets. Even so, the Chung and Pruitt measure is known to behighly correlated (over 90%) with this strict measure.4 Rangan (1998) also refers to a similar construct, but at thecountry level. Others that have used intrafirm trade as a constructare Eichengreen and Bayoumi (1999) and Rana (2007).

sales and purchase) among foreign subsidiaries andbetween subsidiaries and headquarters in Korea ina given year (for a similar measure, see Kobrin,1991). The inclusion of the transactions betweenheadquarters and foreign subsidiaries is particu-larly relevant since the economic crisis occurred inKorea. Thus, our measure of multinational flexibil-ity for 1997 is (intrafirm sales in 1997—intrafirmsales in 1996)/intrafirm sales in 1996. For 1998, itwould be (1998–1997)/1997.

Note that for both measures of flexibility, aone-year lag was used to measure change, consis-tent with the expectation that flexibility-affordinginvestments already in place allow firms to respondextremely rapidly to future unforeseen events. Forthis reason, a longer time window would not be assatisfying a test of this theoretical perspective.

Measure of interaction between exporting andmultinational flexibility

In developing the interaction between the two vari-ables above, exporting flexibility and multinationalflexibility, we centered the two by using deviationsaround the mean to minimize potential multicolin-earity following Ito (1997) and Neter, Wasserman,and Kutner (1985).

Independent variables: control variables

To separate out the value effects of internationalinvestments from those stemming from other fac-tors, we include a number of control variablesin our analysis. The firm’s past performance, forexample, can confound current performance, and,therefore, we controlled for it by including thefirm’s prior year Tobin’s q in the equation. Inclu-sion of past performance as a control variable alsoserves as insurance against omission of importantdeterminants of firm profitability in a stable period,so that we can focus on the contribution of thevalue of flexibility afforded by international invest-ments in a period of an economic crisis.

Firm size may affect performance in that largerfirms contain resources that can mitigate the effectsof an adverse environmental condition such asan economic crisis. Therefore, we control for thiseffect by including the log of total assets, convertedto 1998 US$ at the current exchange rate basedon International Financial Statistics (InternationalMonetary Fund, 1998). Firm indebtedness can alsoinfluence our results. On the one hand, higher



leverage may convey financial distress, whichwould predict a negative sign. On the other hand,greater debt holdings in the capital-poor environ-ment of the economic crisis may reflect confidenceand certification on the part of banks and otherlenders (Cole and Park, 1983; Saraswathy andChatterjee, 1984; Makhija, 2003).5 Lower age of afirm may reflect an inability to develop a networkof international investments, but may also reflectthe agility of a more entrepreneurial or new firm,so this was controlled for as well. Chaebol firmsdiffer significantly from other Korean firms in anumber of ways. They tend to be larger and moreinternational, and may also have enjoyed preferen-tial treatment and cheaper loans during this period(Cole and Park, 1983). Because these attributesmay influence their international strategies, wechose to control for this type of membership aswell. We also controlled for the number of for-eign countries in which the firm had investmentsto control for other potential benefits coming frominvesting abroad (Allen and Pantzalis, 1996; Mansiand Reeb, 2002; Rugman, 1979).

Finally, since industry attributes can influencethe value of international investments, we controlfor this effect by including industry competitionand industry capital intensity. While greater rivalrymay imply a negative effect on 1998 Tobin’s q, itmay also be that firms facing greater competitionare likely to display more aggressive and flexi-ble responses during a crisis compared with otherfirms in less threatening environments. To betterrepresent the firms in an industry, for our sam-ple we totaled the domestic firms listed in KSEand KOSDAQ plus the number of foreign firmsin each industry. Data from KOSDAQ (equiva-lent to NASDAQ in the United States) was alsoacquired from WISEfn. Information on foreignfirms in Korea was collected using Foreign Busi-ness Contacts in Korea (Korea Data Bank, 2003),including only those firms that were establishedby 1996. Industries are classified according to theKorean Standard Industrial Classification (KSIC)at the two-digit level.

By the same token, capital intensity of the indus-try may influence the firm’s tendency to pur-sue international strategies for the purposes ofeconomies of scale, so this was controlled foras well. Industry capital intensity is measured by

5 We chose debt/fixed assets as our measure of leverage as itbetter captures investment-related debt of Korean firms.

average industry fixed capital as a proportion ofaverage industry total assets. Finally, we controlledfor the number of countries in which the firm oper-ates. Doing so allows us to assess the extent of thefirm’s international presence. The approach takenhere is arguably a conservative one since this andother control variables (e.g., size) may have mul-ticolinearity with the variables of interest, relatingto international flexibility.

Test specification

The relationships outlined in the hypotheses aretested with a cross-sectional linear regressionmethodology, with White’s adjustment for het-eroskedasticity (Stata Press, 2001). FollowingMiller and Leiblein (1996), we use separate equa-tions for the two different years representing theperiods of relative stability and economic crisis.The specific cross-sectional regression equationwith the variables related to Hypotheses 1 and 2are as follows for firm i (with the eight controlvariables listed first):

Tobin’s q 1998 = α + β Tobin’s q 97

+ γ Firm Age97

+ δ Log of Total Assets97

+ ε Debt/Assets 97

+ ζ No. of Competitors97

+ η Cap Intensity97

+ θ Chaebol dummy

+ ι No. of subsidiaries

+ κ Exporting Flexibility 98

+ λ Multinational Flexibility 98

+ e (1)

The equation relating to Hypotheses 3 takes thefollowing form:

Tobin’s q 1998 = α + β Tobin’s q 97

+ γ Firm Age97

+ δ Log of Total Assets97

+ ε Debt/Assets 97

+ ζ No. of Competitors97

+ η Cap Intensity97



+ θ Chaebol dummy

+ ι No. of subsidiaries

+ κ Exporting Flexibility 98

+ λ Multinational Flexibility 98

+ µ interaction term

+ e (2)

where the interaction term is Exporting Flexibil-ity98 × Multinational Flexibility98.

RESULTS AND DISCUSSION

Prior to testing our three sets of hypotheses,we examine the potential for multicolinearity inTable 1 with correlation coefficients between ourindependent variables. According to Judge et al.(1980: 459), the rule of thumb for problematicmulticolinearity is a correlation coefficient valueof 0.8 or more. The mean variance inflation fac-tor (VIF) is 1.31, with the highest VIF being 2.10.This suggests that multicolinearity is of little con-cern due to the fact that the VIF values are lessthan 10, which is the cutoff usually used to checkfor problematic multicolinearity. Overall, multico-linearity does not appear to be an issue for our setof independent variables.

The base model

We begin by discussing the results for the basemodel—which contains only the control variables—for each of the two periods of interest. Table 2contains these findings, with Panel A relating tothe economic crisis period of 1998 and Panel Bto the relatively stable period of 1997. Estimation1 shows that during the crisis period, three of theeight control variables contributed significantly tofirm value. Although we do not make explicit pre-dictions regarding our control variables, we findthat some of them played the role we might expect,while others did not. The coefficient for ‘Tobin’s q1997’ is positive and significant at the one percentlevel, indicating that the past year’s profitabilityinfluenced 1998 profitability. It appears that, dur-ing a crisis age may be a liability, seen in its nega-tive coefficient, significant at one percent. We alsofind that number of competitors affects firm, butin a positive direction, significant at five percent. Tabl

e1.

Des

crip

tive

stat

istic

san

dco

rrel

atio

nsm

atri

x

Mea

ns.

d.1

23

45

67

89

10

1.To

bin’

sq t+

11.

040.

712.

Tobi

n’s

q0.

980.

430.

47∗∗

3.A

gea

32.8

812

.11

−0.1

8∗∗−0

.08∗∗

4.Si

zea

12.0

51.

39−0

.11∗∗

−0.1

8∗∗0.

24∗∗

5.D

ebt/fi

xed

asse

ts1.

601.

080.

19∗∗

0.42

∗∗0.

040.

026.

Com

petit

ion

61.0

040

.40

0.05

0.02

−0.0

2−0

.16∗∗

0.04

7.C

apita

lin

tens

ity0.

520.

100.

010.

00−0

.01

0.03

−0.4

1∗∗−0

.29∗∗

8.C

haeb

ol0.

170.

380.

00−0

.04

0.04

0.51

∗∗−0

.01

−0.0

7∗0.

019.

No.

ofco

untr

ies

inve

sted

1.23

2.24

−0.0

1−0

.03

0.10

∗∗0.

46∗∗

0.03

0.02

−0.0

50.

27∗∗

10.

Exp

orti

ngfle

xibi

lity

1.00

0.02

−0.1

6∗∗−0

.08∗

0.01

0.01

−0.1

3∗∗−0

.03

0.01

0.02

0.05

11.

Mul

tina

tion

alfle

xibi

lity

0.97

15.1

2−0

.01

−0.0

20.

050.

08∗∗

0.01

0.00

−0.0

20.

06∗

0.07

∗0.

00

aL

ogge

d†

p<

0.1;

∗p

<0.

05;

∗∗p

<0.

01



Table 2. Effects of exporting and multinational flexibility on firm value in an economic crisis

Panel APeriod of economic downturn

(Tobin’s q 1998)

Panel BPeriod of economic stability

(Tobin’s q 1997)

1 2 3 4 5 6

Tobin’s q 0.63 0.63 0.63 0.64 0.62 0.62(4.99)∗∗ (4.99)∗∗ (5.01)∗∗ (5.07)∗∗ (5.61)∗∗ (5.64)∗∗

Agea −0.01 −0.01 −0.01 −0.01 −0.01 −0.01(3.11)∗∗ (3.14)∗∗ (3.15)∗∗ (4.34)∗∗ (4.30)∗∗ (4.36)∗∗

Sizea 0.02 0.03 0.03 −0.03 −0.03 −0.02(0.99) (1.05) (1.13) (1.29) (1.33) (1.23)

Debt/fixed assets −0.04 −0.04 −0.05 0.19 0.16 0.15(0.97) (0.98) (1.03) (3.29)∗∗ (4.12)∗∗ (4.10)∗∗

Competition 0.00 0.00 0.00 0.00 0.00 0.00(2.22)∗ (2.23)∗ (2.37)∗ (2.08)∗ (1.72)† (1.72)†

Capital intensity 0.17 0.18 0.20 0.82 0.67 0.65(0.34) (0.36) (0.4) (2.40)∗ (2.68)∗∗ (2.66)∗∗

Chaebol 0.02 0.01 0.02 −0.02 −0.02 −0.02(0.22) (0.19) (0.2) (0.44) (0.48) (0.48)

No. of countries invested −0.01 −0.01 −0.01 0.02 0.02 0.02(0.55) (0.62) (0.76) (2.52)∗ (2.73)∗∗ (2.62)∗∗

Exporting flexibility 3.88 15.56 −4.52 −3.90(2.44)∗ (2.80)∗∗ (1.75)† (1.68)†

Multinational flexibility 0.00 0.02 0.00 −0.00(3.64)∗∗ (2.48)∗ (0.30) (0.62)

Exp flexibility × mult flexibility 5.45 0.48(2.34)∗ (0.85)

Constant 0.47 −3.68 −15.38 0.07 4.74 4.12(0.98) (2.12)∗ (2.67)∗∗ (0.33) (1.82)† (1.74)†

Observations 459 459 459 455 455 455R-squared 0.32 0.33 0.33 0.45 0.49 0.5F-statistics 8.37∗∗ 13.90∗∗ 14.44∗∗ 8.51∗∗ 9.29∗∗ 8.85∗∗

a Logged † p < 0.1; ∗ p < 0.05; ∗∗ p < 0.01

This suggests that firms that are used to dealingwith competition are likely to have skills that arehelpful to them during times of crisis. We find,however, that firm size does not make a differenceto firm profitability, in light of the fact that ‘logof assets’ remains insignificant. Our findings alsoshow that the level of ‘firm debt’ does not play asignificant role in our analysis, despite evidence inother research that firms with greater debt have astronger certification from banks and other lenders(Cole and Park, 1983; Saraswathy and Chatterjee,1984; Makhija, 2003), which may be of value in aperiod of flux. We had controlled for ‘industry cap-ital intensity’ to address the possibility that firmsin industries with high capital intensity may havegreater benefit in exploiting economies of scale andreduced costs internationally. However, this vari-able did not show itself to be significant in theanalysis. We had also controlled for the number

of countries in which the firm operates, and foundthat, interestingly, this variable does not influencefirm value during a crisis. Thus, the internationalpresence of the firm per se does not contribute tovalue during such conditions. The findings for con-trol variables remained largely consistent acrossestimations for the period of economic crisis.

In contrast to the base model for the period ofeconomic crisis, the base model for the period ofstability in Estimation 4 indicates that virtually allthe control variables are important in explainingfirm value. We find that several of the controlvariables that were not significant above are nowsignificant, along with Tobin’s q for 1996 andage. This interesting finding suggests that whilethe flexibility effects of smaller size, greater abil-ity to procure funding, potential to reap economiesof scale, and international presence, are not ade-quate sources of value in a period of economic



crisis, these attributes are sources of value duringa period of stability. The significance of interna-tional presence, measured by the number of coun-tries in which the firm has a presence, may reflectdiversification benefits of international operations(Rugman, 1979). These results underscore the dif-ferences in the sources of firm value under con-ditions of economic stability and crisis, and theimportance of considering other sources of flexi-bility for the firm under conditions of economiccrisis. It is clear that traditional sources of firmflexibility, reflected in our control variables, are notadequate in helping firms cope under conditions ofextreme change.

In our sample of Korean firms, the presenceof chaebol members can also potentially influenceour results. The value of chaebol members maydiffer from that of other firms during economiccrises, simply because they are uniquely structured.Researchers have noted that membership in suchan extensive network is valuable due to accessto resources not available to other firms duringsuch crises (Guillen, 2002; Chang, 1995; Axelssonand Johanson, 1992). Consequently, we included a(0, 1) dummy variable for chaebol membership.Throughout our analysis, however, this dummyis statistically insignificant. We do not find thatchaebol membership itself contributes to additionalvalue in this period of economic crisis. It may bethe case that firms are unable to reap additionalbenefit from their membership in chaebols duringa period of such great flux, since all member firmsare experiencing the same negative conditions.

Hypothesis 1: value of flexibility afforded byexporting investments under economic crisis

In Table 2, Panel A, we test Hypothesis 1 in whichwe argue that the flexibility afforded by firms’exporting investments are valuable under condi-tions of an economic crisis. Along with the set ofcontrol variables, the variable of particular inter-est for this hypothesis is ‘exporting flexibility.’As can be seen in Estimation 2, the coefficientfor ‘exporting flexibility’ is positive (coefficientvalue of 3.882) and significant at the five per-cent level. Given a mean value of Tobin’s q of1.00 for 1998, the exporting flexibility afforded byfirms’ international investments adds an economi-cally meaningful 3.88 percent to the value of thefirm during this period of economic crisis. Hypoth-esis 1 is therefore supported by our findings. These

and other results are examined for their economicsignificance in a subsequent section, and are foundto be meaningfully valuable.

In relation to Hypothesis 1, we also argue thatexporting flexibility does not contribute to firmvalue during a period of stability. Estimation 5 inPanel B, Table 2, shows findings in relation to thisnotion. In contrast to those of Panel A, the resultsfor ‘exporting flexibility’ here show that this vari-able in fact has a negative, albeit weak, influenceon firm value (coefficient of −4.519), significantat 10 percent. While exporting flexibility providesvalue to firms in an economic crisis, it appears todestroy some value in a period of stability. It sug-gests that dropping established export customersfor new ones during stable times is not a valuableendeavor (Mascarenhas, 1986; Ito, 1997). We findthese results to be consistent with our argument.

Hypothesis 2: value of flexibility afforded byforeign direct investments under economiccrisis

Hypothesis 2 concerns the flexibility benefits offirms’ already established foreign direct invest-ments under conditions of an economic crisis. Thevariable of interest in this case is ‘multinationalflexibility,’ which reflects the change in intrafirmtrade occurring within the firms’ multinational net-works of subsidiaries. The findings associated withthis hypothesis are seen in Estimation 2 in Table 2,Panel A. The findings indicate that for the periodof the economic crisis, ‘multinational flexibility’ isboth positive (coefficient is 0.001) and highly sig-nificant at one percent. These results support thenotion that the flexibility afforded by firms’ foreigndirect investments contribute significantly to firmvalue during a period of economic crisis. Thus,Hypothesis 2 is supported.

In relation to Hypothesis 2, we argue thatfirms’ already established foreign direct invest-ments would not contribute to firm value in aperiod of stability. The finding in relation to thisargument can be seen in Estimation 5 of Table 2,Panel B. In this estimation, ‘multinational flexi-bility’ loses significance completely. This findingsupports our argument that firms’ multinationalnetwork does not contribute valuable flexibilityduring a period during stability.



Hypothesis 3: interaction between exportingand multinational flexibility

According to Hypothesis 3, we should expect apositive interaction effect between the flexibilityafforded by exporting and foreign direct invest-ments during an economic crisis. This is becauseeach type provides benefits that are complementaryas well as overlapping, enhancing the flexibilityof any one type that will be valuable during suchunsettled conditions. We introduced an interactionterm between exporting flexibility and multina-tional flexibility in Estimation 3 of Table 2, PanelA. We find that this term has a significant (at 5%)and positive (coefficient is 5.451) relationship tofirm value in this estimation. This suggests thatthere is an important additive effect of one typeof flexibility on the other, and that firms withboth types of international investments are ableto use the combination of the two more success-fully for achieving flexibility than firms with onlyone type in an economic crisis. Thus, Hypothe-sis 3 is supported as well. Note that, as expected,the value-enhancing role of exporting and multi-national flexibility continues to be supported.

In relation to Hypothesis 3, we had noted thatthe above relationship would not hold in a periodof relative stability. That is, the interactive effectsof the flexibility afforded by a combination ofexporting and foreign direct investment would notbe valuable during such a period. We expect thisto be the case due to the argument that firms donot need increased flexibility during periods ofstability. This result is given in Estimation 6 ofTable 2, Panel B. We find that the interaction termis insignificant here, supporting our argument.

Marginal effects

To assess the economic significance of the firm’sinternational flexibility, we also examined themarginal effects of exports to new and nonrou-tine customers, intrafirm trade, and their inter-action term on the value of the firm. Economicsignificance of marginal effects depends on themagnitude of change in the independent variables(Nickerson and Silverman, 2003). We report themarginal effects at the mean and one standard devi-ation (SD) above the mean while holding all thecontinuous variables at the mean and the dummyvariables at zero. Because the equation for the year1998 is significant and the one for 1997 is not, we

Table 3. Marginal effects of exporting and multinationalflexibility on the firm value in 1998

Explanatoryvariables

At themean

1 SD abovethe mean

Exporting flexibility 1.02∗∗ 1.24∗∗

Multinational flexibility 1.03∗ 1.34∗

Exp flex× mult flexibility 1.02∗ 1.29∗

† p < 0.10; ∗ p < 0.05; ∗∗ p < 0.01

obtained the marginal effects for the year of 1998only.

Table 3 presents the marginal effects of inde-pendent variables of interest. The results indicatethat Tobin’s q changes from 1.02 to 1.24 when wechange the mean value of new export to one SDabove the mean. Similarly, one SD upward changein intrafirm trade leads Tobin’s q to change from1.03 to 1.34. Likewise, one SD upward change inthe interaction between new export and intrafirmtrade, moves the value of Tobin’s q from 1.02 to1.29. These results are consistent with our argu-ment that both new export development and shiftof production are associated with economic valueat the time of economic downturn. Both newexport development and shift of production amongproduction facilities are associated with more thana 20 percent increase in the firm value along withthe interaction of the two.

Robustness check: examination of theHerfindahl index

Our analyses above showed that in the periodof the economic crisis, firms were able to usetheir international investments to engage in activi-ties that increased their flexibility, contributing tothe value of the firm. In order to further under-stand the adjustments undertaken by firms duringthis period, we examined additional aspects of thepattern of changes in sales for their foreign sub-sidiaries. We utilized the Herfindahl index to assesswhether a firm’s multinational network experi-enced greater concentration of sales during the cri-sis. An increase in concentration would imply thatonly specific markets, those judged to be the mostattractive, would become target markets within thefirm. Rather than a general dispersion of salesacross this network, it would be consistent witha flexibility argument that the firm’s multinationalnetwork allows it to ‘pick and choose’ where real-location of sales would be most beneficial. Indeed,



the Herfindahl index for sales among the foreignsubsidiaries increased from a mean value of 0.1866for the year 1997 to 0.2326 for the year 1998. Thisincrease of 0.0461 was significant at five percent.This finding supports our argument relating to theflexibility benefits of a firm’s international invest-ments in an economic crisis.

In all, our findings show that international invest-ments of Korean firms provide valuable flexibilityduring a period of unanticipated economic volatil-ity, but not under stability.

CONCLUSIONS AND IMPLICATIONSOF THIS RESEARCH

The main motivation in this study was to exam-ine whether or not international investments pro-vide valuable flexibility to firms under conditionsof unanticipated yet significant economic down-turns, such as an economic crisis, using a sampleof Korean firms over the 1996–1998 period. Ourfindings generally affirm that international invest-ments provide such flexibility, the value of whichis heightened during a period of economic cri-sis. A firm with such investments in place has agreater ability to flexibly adapt its overall oper-ations in line with unforeseen negative environ-mental change, in clear contrast to firms with-out such investments. Conceptually, one mightassume that firms are easily able to find new out-lets for exports and change production locations,but as past research reminds us, such shifts arein fact not easy to undertake rapidly or at thelast minute (Rangan, 1998). This research demon-strates how prior managerial choices relating tothe firm’s international investments influence itsoptions and subsequent performance under uncer-tainty. In doing so, the study contributes to boththe international strategy and strategic flexibilityliteratures, since the former is concerned with thestructuring of international investments and the lat-ter with the structuring of investments to deal withunknown future conditions.

Numerous researchers have pointed out thepotential of international investments to providefirms with necessary flexibility, yet few havedirectly measured any type of flexibility affordedby such investments. This research contributes tothe literature by providing key measures of inter-national flexibility that are theoretically linked totwo major types of international investments. In

contrast to the indirect measures seen thus far inthis literature, we employed direct measures offlexibility, reflecting the firm’s ability to shift pro-duction among its foreign subsidiaries and to sellto new and nonroutine overseas customers, in vary-ing environmental contexts. We believe that thesemeasures, which are specifically concerned withfirms’ overseas activities, can likewise help futureresearch attempting to assess international invest-ment flexibility.

The literature has emphasized that environmen-tal uncertainty is a key antecedent for assess-ing strategic flexibility (Campa, 1993, 1994; Wor-ren et al., 2002), yet the environmental conditionshave often remained assumed or weakly mea-sured in previous empirical work. In the interna-tional arena, factors such as exchange rate volatil-ity are often easily and routinely hedged byfirms (Allayannis and Ofek, 2001; Click andCoval, 2002), and under ordinary circumstances,do not necessarily provide a compelling contextof uncertainty within which to examine flexibility.Nonetheless, currency fluctuation remains the pri-mary measure of uncertainty in the MNC flexibilityliterature. In contrast, this research has gone muchfurther to differentiate the important boundary con-ditions of predictability versus unpredictability. Weused a natural experiment setting of an economiccrisis, a context of dramatic adverse change thatwas not only unanticipated but also ‘unhedgeable.’By including the periods just prior to and duringthe Korean economic crisis in our research set-ting we were able to isolate a sharp change forthe worse in the economic environment for a largeset of firms, thus making it possible to examinethe value of flexibility in international investmentsof firms under conditions of appreciably differ-ent levels of predictability. Other researchers, suchas Rana (2007) and Eichengreen and Bayoumi(1999) have also noted the relevance of this set-ting in affecting firm strategies. We believe thatfurther consideration and employment of such nat-ural experiment settings will benefit the literatureon strategic flexibility.

An important contribution of this research isthat it takes into consideration and provides evi-dence on the fact that firms’ international strategiesencompass more than just foreign direct invest-ment, which has up to now been the primary focusin this literature. We have clearly shown that multi-national firms engage in and derive flexibility fromtheir exporting investments as well. The two types



of international investments, however, provide dif-ferent benefits in this regard. Consistent with thenature of these investments, a primary benefit offirms’ foreign direct investments is the ability toshift production from one location to another inresponse to negative changes in the environment,while an essential advantage of exporting invest-ments is the ability to rapidly identify and sellto new customers in foreign locations. To assessthese issues, we developed measures of each typeof flexibility. Our findings indicate that both typesof international investments are indeed able to pro-vide firms with such flexibility, which is valuableunder conditions of economic crisis. An invest-ment strategy involving a combination of bothexporting and foreign direct investment is seen toprovide additional value under such conditions, inlight of our finding that the interactive effect of thetwo types of flexibility positively influenced firmvalue. These findings point to both separate andsynergistic flexibility benefits from the two typesof investments.

As noted above, this research benefited from theuse of a severe economic crisis as the backdropwith which to examine flexibility effects. Whilewe were able to observe the flexibility benefitsunder conditions of such an unanticipated and neg-ative event, we would expect that other formsof uncertainty, relating to not only negative butalso positive events, are also relevant for firmsin this regard. In particular, firms are likely tobe influenced by those events pertaining specifi-cally to their own industries, involving technologi-cal disruptions, policy change, or new competitors.Incorporating such effects may in fact elicit differ-ent relationships between flexibility-related invest-ments and performance. We believe that it wouldbe useful to empirically compare firms’ strategicflexibility under not only differing levels but alsodiffering types of uncertainty.

Our sample used a large set of Korean firms withdiffering configurations of international invest-ments, allowing us to fully examine the effects ofinternational strategies on flexibility. We believethat replication of this study using samples offirms from other countries would provide addi-tional insight into the relationships of interest, andparticularly whether they hold for firms acrossinstitutional contexts. For example, it may be thatfirms in other countries pursue different types ofinternational strategies than those of Korean firmsdue to differing levels of economic development,

domestic opportunities, or competitive advantages.How would national differences in such featuresinfluence a firm’s ability to derive flexibility fromits international investments? The considerationof such issues would also help us to understandthe role of a firm’s national context in influenc-ing strategy. In addition, while this research hasfocused on a firm’s international investments, othertypes of investments thought to yield flexibilitybenefits, such as manufacturing modularization orR&D, can also make use of such settings.

Finally, the dependent variable in this researchassessed the value of investments, which allowsus to focus on expected rather than actual perfor-mance changes from the flexibility associated withthose investments. We chose not to measure actualchange in firm performance, since it would be diffi-cult to know the actual longer-term impact of thesechoices for some time into the future. Nonethe-less, we believe that future work can extend thisresearch by examining if the observed increases infirm value were borne out by actual improvementsin a firm’s future performance.

ACKNOWLEDGEMENTS

We thank Asli Arikan, Ilgaz Arikan, Jay Barney,Dong Lee, Michael Leiblein, Seongyeon Lim, AnilMakhija, Mike Peng, Jeff Reuer, Oded Shenkar,Heli Wang, and participants at the Fisher Collegeof Business seminar series for their helpful com-ments on previous versions of this article. We alsothank Editor Ed Zajac and two very thoughtfulreviewers for their insightful observations regard-ing this manuscript. This research was supportedby the Graduate School of The Ohio State Univer-sity.

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APPENDIX: ORIGINS OF THE KOREANECONOMIC CRISIS IN 1998

From the period of 1985 to 1999—prior to theKorean economic crisis—Korea’s GDP annualgrowth rates had remained very high, ranging from5.0 to 9.2 percent. In response, foreign portfolioinvestors invested heavily in the Korean economyto take advantage of its strong growth and stability.By 1997, such private flows to Korea had increasedfive-fold over 1990. During this period, Korea wasconsidered to be one of the safest places to invest(Krugman, 2000).



The huge inflow of investment funds affectedthe Korean economy in a number of ways. Becausethese investment flows were denominated in for-eign currency, they needed to be converted intolocal currency. This resulted in a surge in demandfor the won, causing the value of the won toincrease relative to other currencies. However, thewon was pegged to the dollar, and in order tokeep the value stable, the government increasedthe money supply (i.e., printing more money).Via the multiplier effect, the result was an expan-sion of credit in the economy due to both foreignloans and the increased money supply. Slowly,this ‘easy’ credit led to excessive investments inlower quality investments—such as office build-ings, real estate, and factories, whose rate of returnwas not as high—as well as speculation. Foreigninvestors began to slow their rate of investment. Atthe same time, increased imports reflected Kore-ans’ economic prosperity. While this had the effectof reducing the relative demand for the won, theKorean government managed to defend the valueof the won using its international reserves, keepingit on par with the dollar for most of this time.

While there was some indication of a slowdownin the years 1996 and 1997, the growth rates aver-aged 6.8 and 5.0 percent, respectively during this

period, and were nonetheless still very high incomparison to those experienced by most othercountries. Although the average exchange rate forthe won/$ registered a depreciation of the currencyin comparison to previous periods (804.5 and 951.3for 1996 and 1997, respectively), it was not undulyalarming. Both inflation (4.9 and 4.4%) and unem-ployment (2.0 and 2.6%) rates held steady at lowrates during this period.

On 17 November in late 1997, the won sud-denly plummeted in value, taking most analystsby surprise according to numerous news reportsand journal articles during this period. By 1998,the value of the won dropped to only 60 percentof what its value had been in 1997. Along with thisrapid change in the value of the currency, whichregistered as low as 1401.4 in 1998, the Koreaneconomic environment changed dramatically in anumber of other ways that were also unforeseen byKorean and Western analysts. In huge contrast tothe prior years of unabated high growth that char-acterized the Korean economy, there was a con-traction of the economy (−6.7%) in 1998. Inflationnearly doubled and unemployment tripled in 1998in comparison to 1997. According to numerousreports at this time, perceived uncertainty was atan all-time high.


flexibility in internationalization: is it valuable during an economic crisis?

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