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The effect of international diversification strategy on the performance of Spanish -- based firms during the period 1991 - 1995 (1).


* This paper examines the relationship between international diversification and Spanish firm performance during the period 1991-1995. International diversification is measured in two ways, the Global Market Diversification index and the geographical market diversification categories constructed from Varadarajan's product diversification measure adapted to the international case. Performance is measured using accounting (profitability and its variability) and market value (Tobin's q) variables.

Key Results

* We find a positive relationship between economic performance and international diversification, but only when performance is measured by way of Tobin's q. However, the fact that diversification is related or unrelated, as this is measured in the paper, does not affect economic performance.


During the last thirty years, the study of the relationship or effect of diversification strategy on firm performance has generated considerable interest in the area of strategy. In particular, the work of Rumelt (1974) began a line of research that has subsequently been followed by numerous researchers. The first studies on this topic were concentrated solely on product diversification. More recently, a large number of researchers, influenced by the literature on product diversification, have considered internationalization as an international diversification strategy, defining it as expansion across the borders of global regions and countries into different geographic locations or markets (Hitt/Hoskisson/Ireland 1994, Hitt/Hoskisson/Kim 1997). The choice of international diversification strategy has been motivated both by the search for new opportunities for the firm and by changes in the environment. These changes have caused the opening of new markets and accelerated their globalization. In this way, sectors of local or multidomestic competition have become sectors of global competition.

International markets and, therefore, the operations associated with them, present firms with new opportunities. However, at the same time, they confront firms with new competitive challenges and greater local and international competition (Hitt/Hoskisson/Kim 1997). This situation explains the growing interest in analyzing the implications of this diversification strategy on performance. There is at least some degree of agreement in the literature that international diversification strategy has a positive effect on corporate performance (3). Having said that, there are some studies, albeit fewer, which find either no significant differences in the performance of domestic and multinational firms (4), or even a negative effect (5).

Most of these studies have focused on firms from leading developed countries and the evidence on this relationship for more recently developed countries does not yet exist. These latter countries have a significant growth potential, and therefore it would be interesting to analyze the effect of international diversification strategy on their performance.

The objective of this paper is to determine the relationship between international diversification strategy and the performance of Spanish firms, on the basis of a sample of non-financial firms quoted on the Spanish Stock Market during the period 1991-1995; that is to say, we try to establish a first approximation to the state of the relationship that exists between the diversification strategies and the performance of Spanish firms. Although some previous research exists on the topic of the internationalization of Spanish firms, this is the first paper that examines its effects on economic performance.

This paper has two principal differences with respect to previous studies, which make reference to the way the variables are measured. First, we use two measurements of international diversification: a continuous index that has been used before, and a second, non-lineal measurement, that allows us to classify firms into categories with different degrees of international diversification and which shows the direction of the international expansion (6). Secondly, we use accounting and market-valued performance measurements in a joint manner. International diversification researchers have previously used either accounting or market-valued measures, but not both together. Although these measures are interrelated, they reflect different aspects of performance. Moreover, we use Tobin's q as a measure of market-valued performance. This measure has not been used in international diversification literature, except in Morck and Yeung (1991), although it is widely used in product diversification studies.

Hypotheses and Literature Support

International business scholars are in agreement that international diversification offers several sources of advantage to firms. For example, it provides the opportunity to exploit foreign market opportunities and imperfections through internalization (Rugman 1981). In the presence of transaction costs and market failure (e.g. to price a public good), it could be more efficient for a firm to expand internationally by creating its own subsidiaries in foreign markets rather than using the export market.

Hymer (1976) identified imperfections in factor and product markets, such as the existence of intangible resources, that lead to the development of a firm-specific advantage for an international diversified firm. Intangible resources such as superior technical knowledge, patents, trademarks, consumer goodwill, learning experiences, organizational competence, management expertise, and so on (ownership factors) that are information based and increase their value as a firm becomes more international (Morck/Yeung 1991). Therefore, internalization allows firms with strong internal capabilities or core competence to apply them in international markets (Bartlett/Ghoshal 1989, Buckley/Casson 1976), ensuring the best application of these capabilities and, thus, enhancing firms' profitability (Porter 1990).

This resource sharing and coordination among business segments and geographic areas facilitates the exploitation of common sets of core competence and generates economies of scope or synergy (Teece 1980, Grant/Jammine/Thomas 1988). Additionally, integration across national markets provides firms with greater opportunities to achieve economies of scale by standardizing products, rationalizing production, and coordinating critical resource functions (Hitt/Hoskisson/Kim 1997). Thus, firms could increase their efficiency, learning and innovation. As Kim, Hwang and Burgers (1993) note, internationalization provides firms with opportunities of learning and developing diverse capabilities. That is to say, the application of firms' resources across national markets provides them with greater opportunities to achieve economies of scale, scope, and learning (Kogut 1985).

The possibility of obtaining tax advantages (Lessard 1979), factor cost advantage (Kogut 1985), and augmenting ownership specific advantage (Dunning 1998), have been other arguments raised in favor of increasing the international diversification of a firm. Internationalization enhances firm value because it gives firms more possibilities to avoid tax and/or to gain cost advantages by configuring each link of their value-added chain in locations that have the least cost. Dunning (1998) notes that there has been a change in the motives for making foreign investments during the last two decades. Nowadays, the increase of strategic asset-seeking foreign investment "is geared less to exploiting an existing ownership specific advantage of an investing firm, and more to protecting, or augmenting, that advantage by the acquisition of new assets, or by a partnering arrangement with a foreign firm" (p. 50).

These benefits, which not only exceed the cost of acting in a different environment, but also lead to better performance, have been confirmed throughout the literature (7). Using these arguments as a basis, the following hypothesis is proposed:

Hypothesis 1a. International diversification has a positive effect on the accounting profitability of firms

The benefits of international diversification at financial investor level are well documented. Grubel (1968), Lessard (1976), and Mathur and Hanagan (1983), among others, have shown that there are potential gains for investors from international diversification in financial markets. As long as financial asset returns across countries are not highly correlated, diversification will reduce risk.

The results of portfolio theory have been applied to studies of international diversification in real assets through direct foreign investment and, in this regard, a number of authors have suggested risk reduction as an argument to justify international diversification (e.g. Rugman 1976, Agmon/Lessard 1977, Madura/Rose 1987, Kim/Hwang/Burgers 1989, Heston/Rouwenhorst 1994).

Hirsch and Lev (1971), Rugman (1979), Miller and Pras (1980), Caves (1982), Kogut (1985), Kim, Hwang and Burgers (1989), have all argued that international expansion has the effect of stabilizing overall sales/returns/profits. First, the socioeconomic and political conditions are imperfectly correlated across different international market areas. Secondly, international expansion allows firms to minimize the effect of adverse changes in goods and factor prices (interest rates, wage rates, raw material prices). Firms could change source sites and production locations towards other more favorable markets. At the same time, they could avoid supply and demand variations across international market areas. Thus, global market diversification endows firms with operational flexibility that will serve to reduce not only costs, but also profit fluctuations.

Therefore, although international diversification implies that firms have to face a variety of external influences, this gradual global expansion can reduce external uncertainties and spread the risk they face.

The results of the theoretical and empirical studies allow for the following hypothesis to be proposed:

Hypothesis 1b. International diversification has a negative effect on the economic risks of firms.

The accounting rate of return and economic risks may be combined in a single measure of economic performance, such as Tobin's q (the measure of the market value of the firm used in this paper). The market value of the firm is equal to the present value of expected current and future profits discounted at the risk-adjusted cost of capital. Higher profits per unit of assets invested implies higher q, while higher risk implies a higher cost of capital and a lower q ratio. Moreover, the q ratio also measures the growth prospects of the firm and the rents from more tangible assets. Therefore, the q ratio is a performance measure that summarizes the wealth created by the firm (which is positive when q > 1 and negative otherwise) given that it is a function of current and future profits (growth prospects) and of the economic risks.

Apart from its relevance as a performance measure, Tobin's q has only been used by Morck and Yeung (1991) to study the relationship between international diversification and performance (8). Following the above line of reasoning, we postulate that Tobin's q is higher for more internationally diversified firms.

Hypothesis 1c. International diversification has a positive effect on the market-valued performance (Tobin's q) of firms.

This hypothesis should not be rejected as long as hypotheses la and lb are not themselves rejected, as more accounting profitability (less risk) implies a higher Tobin's q so long as risk (profitability) is the same. However, Tobin's q also captures growth prospects and intangible assets and, therefore, is more general than the accounting measures.

A second objective of the paper is to investigate if the effect of international diversification on performance is the same under both related and unrelated diversification, where in the paper such terms are given a similar meaning as in the case of product diversification. We believe that this research question is new in the international diversification literature.

Although a proper measure of related and unrelated diversification is presented in the empirical section, we consider that a firm is implementing related international diversification when it expands across countries that are relatively similar in terms of social, economic and cultural characteristics. Unrelated diversification, on the other hand, considers geographic expansion across different regions world-wide.

Our underlying hypothesis is that firms which carry out an unrelated international diversification strategy will outperform those firms which are implementing related international diversification strategies.

It may be argued that geographical proximity between the business will lower coordination costs and simplify the management of diversified firms, given that the markets, both consumer and input producer are more homogeneous (Geringer/Beamish/DaCosta 1989, Hitt/Hoskisson/Kim 1997). Once a firm has been established in a world region and has learned the idiosyncratic characteristics of that region, then important efficiency gains can be obtained from expanding within the region in order to spread the fixed costs of entry.

However, several authors (Johanson/Vahlne 1990, Ghoshal/Westney 1993) convincingly point out that, although social, economic and cultural differences across regions in the world still exist, these are being progressively reduced and economic markets are more homogeneous in terms of consumer tastes, worker preferences, deregulation processes, etc., than several years ago. Therefore, coordination and management costs across regions are likely to be progressively lower. On the other hand, world-wide expansion allows firms to optimize production costs, locating activities there where they can be more efficiently produced. Secondly, diversity is a source of learning and, as firms are present in more diverse geographical markets, they are able to share knowledge and experience and achieve higher operating efficiency. Kobrin (1991), for example, noted that global firms achieve scale economies in production and spread the fixed costs of R&D and product development over a broader base. Barlett and Ghoshal (1989) provide examples of firms which develop transnational capabilities to manage more efficiently across countries and to take advantage, in the form of higher profits, of sharing knowledge and other capabilities among different regions world-wide.

Therefore, adopting the underlying assumption that scale and scope production, R&D and marketing economies overcome the potentially higher coordination and management costs, the following hypothesis is postulated,

Hypothesis 2a. Unrelated international diversification strategy leads to higher accounting profitability than related international diversification strategy.

Furthermore, if greater international diversification implies a lower level of risk in operating activities, then the expected relationship would be that those firms with a related international diversification strategy would show higher levels of risk than those which expand in unrelated markets.

Uncertain future cash flows may be lessened with expansion into new potentially strong international markets (Hoskisson/Hitt 1990). Market diversification tends to stabilize the firm's sales or/and profits, and the larger the spread of this internationalization over several markets, the more stable the sales or/and profits (Hirsch/Lev 1971). Some researchers argue that a dispersed configuration, built by establishing value activities in a variety of locations, promotes operational flexibility. However, this expansion also generates control and coordination risks.

As Bartlett and Ghoshal (1989) and Kogut (1985) note, firms can adapt themselves to uncertainties by restructuring their activities, shifting operations between alternative locations. This advantage of risk reduction exists due to the possibility of diversification in various national economies, when socioeconomic conditions are imperfectly correlated across different international markets (e.g. Hirsch/ Lev 1971, Rugman 1979, Caves 1982, Kogut 1985, Kim/Hwang/Burguers 1989). Thus, the more unrelated the countries, the more different are the changes in the political-economic-social conditions.

Internationalization not only reduces risk, but also attracts new sources of demand, secures raw materials crucial for production, improves efficiency, and exploits relative advantages.


Hypothesis 2b. Unrelated international diversification leads to lower levels of economic risk than related international diversification.

On the basis of the two above-mentioned hypotheses, the unrelated international diversification strategy provides a better trade-off between profitability and risk than the related strategy. Firms implementing the unrelated strategy not only obtain a higher return on their assets, but these returns are more stable. Additionally, knowledge sharing and capabilities development and also likely to increase the growth prospects of firms which are present in more diversified geographical areas. Therefore, the capital markets are likely to place higher value on those firms.

Hypothesis 2c. Unrelated international diversification leads to higher market-valued performance (Tobin's q) than related international diversification.

The Sample

The population of interest is the non-financial firms whose shares were admitted to quotation on the Spanish Stock Market during the period 1991-1995. Data were collected from the Annual Auditors' Report of each firm and corresponding to each year covered by the study. The initial sample contained 152 firms whose accounting information was publicly available. However, we required additional strategic information, such as the activities carried out by the firm (9), as well as whether it remained quoted at the year-end (10). The non-availability of this information led to the exclusion of forty-nine firms from the initial sample, and thus, the results reported here are based on a final sample of 103 firms.

Other information that we required in order to evaluate international diversification was the foreign location and number of their subsidiaries and associated firms for each of the years under study. In this regard, the Annual Reports only detail the identification and location (11) of the subsidiaries and/or associated firms in which a significant participation is held, and which are included within the consolidation of accounts parameter as provided for in the Spanish Accounting Plan. We should emphasize that the biases present in our sample limit the interpretation of the results obtained. In particular, we face three limitations. First, we only have information available on large firms. Secondly, the industries are not represented equally. In this regard, we follow the criterion of main activity considered by the Spanish Securities and Exchange Commission, as well as the classification made by this Organization. Thus, the industrial distribution of the firms making-up the sample is as follows: Energy and Water, 18.45%; Basic Metals, 3.88%; Chemicals, 5.83%; Metal Transformation, 13.59%; Other transformation Industries, 20.39%; Construction, 6.80%; Transport and Communications, 4.85%; Trade, 3.88% and Property 9.71%. Finally, international diversification is likely to be somewhat undervalued in this study, in view of the failure to locate all the foreign subsidiaries; as mentioned earlier, the Annual Auditors' Reports of a company only identifies those subsidiaries in which the company has an important equity participation.

Despite these drawbacks, this study of international diversification does allow for a first contribution towards a better understanding of the policy lines followed by Spanish firms.

Measuring Firm International Diversity and Performance

The International Diversity Measures

The studies on international diversification have been based on measuring this strategy by way of simple unidimensional indicators, which reflect the activity of firms beyond their national frontiers. Some of these indicators correspond to the size of foreign operations (percentage of foreign sales/income/assets to total sales/income/assets) (12), number of foreign subsidiaries (13), number of countries where the firm is present (14) and market heterogeneity (15). Sullivan (1994) recommended a multidimensional measure, but Ramaswamy, Kroeck and Renforth (1996) tested and found little support for it.

In general, the literature does not contain either indexes or strategic classifications which establish the direction (related and unrelated) of the activities of the firm in its international expansion. Some approaches have been made (Kim/ Hwang/Burguers 1989, 1993 and Vachani 1991), but these combine product and international diversification. Moreover, the necessary information is largely unavailable in most countries, as is the case in Spain.

In this paper, we use two different measurements: a categorical classification and a continuous index. The first is introduced with the aim of identifying the type of international diversification strategy followed by the firms in our sample. It corresponds to the adaptation of the methodology established by Varadarajan (1986) to the international case (Ramirez 1997). This methodology, although extensively employed in the literature on product diversification, has not been used to analyze international diversification. The second measure is the so-called Global Market Diversification (GMD) index, which has been widely used in the literature. In this paper, the use of both measures has been motivated by the aim of capturing this multidimensional construction; that is to say, of reflecting not only the degree of international diversification, but also the direction that it takes. These measures are characterized by their ability to reflect the dispersion of the activities carried out by multinational firms (MNEs) between heterogeneous geographical regions, their objectivity, their ease of calculation, and by the fact that they do not require excessively detailed information on activity and market segment.

Adaptation of the Varadarajan Categorical Measure and its Application to the International Case

The methodology established by Varadarajan (1986) is based on a counting of the number of Standard Industrial Classification (SIC) codes. Varadarajan defines two dimensions: first, the total number of two-digit SIC industries in which a firm currently operates, as a measure of the firm's Broad Spectrum Diversity (BSD); secondly, Mean Narrow Spectrum Diversity (MNSD), defined as the total number of four-digit SIC industries in which a firm is involved, divided by the total number of two-digit SIC industries in which the firm currently operates.

With the aim of making this methodology effective for the case of international diversification, Ramirez (1997) established two similar dimensions: International Broad Spectrum Diversity (IBSD) and International Mean Narrow Spectrum Diversity (IMNSD). IBSD makes reference to the expansion in different geographical areas. Specifically, it represents the total number of areas (equivalent to the two-digit SIC industries) in which a firm currently participates. IMNSD reflects expansion beyond national frontiers, but within the geographical area to which it belongs. It is defined as the total number of countries in which a firm is involved (equivalent to the four-digit SIC industries), divided by the total number of geographical areas in which the firm is active; that is to say, it is the average number of countries in which the firm is present, by geographical area.

Although these equivalencies are developed between different concepts, i.e. the activities carried out by the firm (in Varadarajan's methodology), as against the markets in which they are present (in Ramirez's), the level of specificity is the same in both cases.

We have classified foreign markets into six relatively homogeneous global regions. The criterion we have followed is based on the political and economic conditions that prevailed in each country during the period under study, and has been used by other Spanish researchers and public organizations (e.g. DGEITE 1996). The areas so defined correspond to the European Union, USA, other OECD countries (16), Latin-America, Tax Havens (17) and the rest of the world.

The typology of strategies established by Varadarajan (1986) for the purpose of product diversification (18) is, therefore, maintained for international diversification. The critical values or cut-off points, which determine each strategy, refer to the sample average of each one of the dimensions (IBSD and IMNSD). Thus, the classification employed in this paper is as follows (Figure 1): Low International Diversity (LID), Related International Diversity (RID), Unrelated International Diversity (URID) and High International Diversity (HID) (19).


The identification of the strategy followed by each firm in our sample is carried out by means of these dimensions (IBSD and IMNSD), as well as their critical values obtained from the sample. However, this assignment of the strategy to every firm is very sensitive to the sample used (Varadarajan 1986). Therefore, with the aim of maintaining homogeneity and allowing for comparison between data, the average IBSD (1.796) and IMNSD (1.738) for the sample of firms obtained for 1995 are taken as cut-off points for the whole period under study. The use of these values results in the distribution of the firms over the four quadrants (20).

The distribution of the sample firms by reference to international diversification strategies (LID, RID, URID, HID) and for every year, is summarized in Table 1.

Application of the Continuous Global Market Diversification (GMD) Measure

Miller and Pras (1980) developed the Global Market Diversification index (GMD) on the basis of the methodology proposed earlier by Hirsch/Lev (1971). This index reflects the dispersion of activities carried out by firms amongst heterogeneous geographical regions.

The GMD, an entropy index, is defined as GMD [MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII], where fa is the ratio of the number of subsidiaries of a firm in a geographical area a to the total number of its foreign subsidiaries, and ln [f.sub.a] is the weight given to each area. The measure considers both the number of areas in which a firm operates and the proportion of total subsidiaries that each area represents. We use the same areas as defined earlier.

The value of this index increases with the degree of diversification of the firm. The results are set out in Table 2.

The Performance Measures

In general, the dependent variable used in models which analyze the diversification-performance relationship have been either accounting rates (e.g. Hitt/Hoskisson/Kim 1997, Tallman/Li 1996) or market valuation measures (e.g. Morck/ Yeung 1991, Geyikdagi/Geyikdagi 1989).

However, these measures, although interrelated, reflect different aspects of performance, with their respective advantages and limitations (Ross 1983, Keats 1988). On the one hand, accounting measures provide an historical record on the past and present situation of the firm; that is to say, they show the returns from resources employed by the firm when carrying out its activity. However, and as Myers (1972) and Espitia and Salas (1986) indicate, their use presents a series of difficulties or limitations, from amongst which the following should be highlighted: 1) they exhibit the differences between the accounting criteria used by firms (e.g. the rate of depreciation), which make comparisons difficult; 2) they do not allow the adjustment of differences in performance for differences in the risk supported by the firms; 3) they do not reveal investor expectations with respect to the maintenance of a specific level of performance; and 4) they do not reflect all the opportunity costs supported by the firm.

On the other hand, market measures provide information on the value of the firm as a going concern. Such data are not themselves free of problems, given that some markets may present inefficiencies or volatility on specific occasions.

As Ross (1983) indicates, the limitations of each measure might be solved through their joint use. Thus, market measures overcome the limitations resulting from the use of accounting data, and allow us to consider the risk supported by the firm and the capitalized value of the benefits of diversification (Lang/Stulz 1994), as well as to impute the equilibrium profits and to minimize the distortions resulting from tax laws and accounting standards (Wernerfelt/Montgomery 1988).

In this paper, two accounting-based measures are considered as indicators of firm performance, with the aim of completing the analysis with all the dimensions of the business performance vector. First, the Return on Operating Assets (ROOA), defined as ROOA = Net Operating Profit/Net Operating Asset and used as a profitability measure. This only considers the results of operating activities. Secondly, its standard deviation is used as a measure of risk (S. [D..sub.ROOA]) (21).

The market measure used is the Tobin's q, defined as q = Market value of the firm/Replacement cost of productive capital and based on the accounting information available from the firm's Annual Reports, as well as market information. The difficulty lies in how to make the Market Value of the Firm and the Replacement Value of the Assets measurements operative. The methodology employed to estimate this ratio is based on Espitia (1985), who, in turn, follows the methodology of Linderberg and Ross (1981). Its application to the firms in our sample has required that we make a number of adjustments, as follows:

* The calculation of the items in terms of replacement prices starts from the hypothesis that, following the application of the rules provided for in the Law on the Restatement of Asset Values (Ley de Actualizacion de Balances), companies have correctly estimated the replacement value of their fixed assets. The most recent set of rules for the restatement of asset values applicable in Spain at a national level date from 1983. No further revaluation has been permitted after that year and, therefore, the accounting statements of the firms in the sample corresponding to 1991 are not valued at replacement prices. Thus, we have applied an industrial correction factor to these firms with the aim of obtaining an approximation to the replacement value. This factor is obtained on the basis of an available sample of 101 firms quoted on the Stock Market during the period 1961-1991 (22).

* This problem has prevented us from calculating the rate of technical progress of the firms in our sample. Nevertheless, as an approximation, we have considered the average industrial rate obtained from the same sample mentioned as in the above paragraph (period 1961-1991).

* Finally, we should note that the calculation of the Tobin's q valuation ratio, by requiring information from the previous accounting period, limits the study of the diversification-performance relationship to the period 1992-1995.

These three measures have been used in order to reflect greater information on corporate performance (see Table 3). The accounting results are used as intermediate measures prior to the calculation of the valuation ratio, which is considered as a more complete global measure.


The earlier-mentioned hypotheses have been tested for the firms which make-up our sample for all five years under study. The methodology corresponds to an analysis that is similar to the tests on the differences between two means, one which has been extensively employed in the literature. The differences with the classical techniques are the result of the following: 1) historical information on the firm has been incorporated into the study, both for the performance and the strategic variables, with the objective being to gather better information on the activities carried out by the firms. 2) The individual characteristics of the industries are different, and these have an effect on the firms belonging to each of them; therefore, the industry effects are controlled by means of dummy variables, which represent each industry. 3) There is size discrimination by means of the natural logarithm of sales (Ln Sales) (23).

We propose General Least Squares (GLS), which reflects, on the one hand, the dependent variable (the corresponding performance measure) and, on the other, and as independent variables, the international diversification measure (the strategic category variables, or the continuous GMD index) and the control variables (year, sector and size). The category variables of international diversification, together with the sector and year variables, are represented by dummies (four in the first case, nine in the second and five (24) in the third). In these last cases, we have to leave one of each outside the model and use them as reference, given that we use intercept in the model.

Thus, in order to test the effect on performance of international diversification strategies pairwise, we have to carry out three regressions, one for each type of international diversification and for each performance measure. Their interpretation is always by reference to the dummy variable that has been left out of the model. We then analyze the differences in performance obtained between each pair of strategies; that is to say, the superiority (positive sign), or otherwise (negative sign) in performance of each strategic category, as compared with the rest.

Analysis, Results and Discussion

On the basis of the arguments and methodology described earlier, let us now consider the results and discuss their implications. These results make reference not only to the tendency that exits between the performance-degree of international diversity relationship (first block of hypotheses), but also to the differences in performance obtained between every strategic category (second block of hypotheses).

The tendency is analyzed by means of both international diversification measures. The hypotheses that establish a comparison between the related and the unrelated international diversification strategy can only be tested on the basis of the categorical measure (25). That is to say, the four types of international diversification strategies (LID, RID, URID, HID), not only allow us to identify whether or not there is an international diversification effect over performance, but also to establish comparisons, two by two, between each one of the categories. The relationships established when the different strategy categories are used are presented in Table 4, and when GMD is employed, in Table 5 (26). The number of observations is different, depending on the performance measure: 515 with ROOA, 103 with S.[D..sub.ROOA] and 412 with Tobin's q (27).

The first Hypothesis (H 1a) we propose, is that the international diversification strategy has a positive effect on the profitability where the Return on Operating Assets (ROOA) is used to measure that profitability. In the light of the results presented in Table 4, this hypothesis is rejected, in that we do not find any statistical differences between the different categories of international diversification strategy. This would imply that an expansion of the activities carried out by firms beyond their national frontiers does not result in higher performance, or does not increase returns. Nor is the observed tendency a clear one when attention is paid to the coefficients. We find that the impact of each strategy in performance is as follows: HID > LID > URID > RID. Although it is the extreme categories, that is to say, LID and HID, which appear to provide a certain improvement in return, this is hardly appreciable.

This finding is confirmed when analyzing the regression results for the relationship between ROOA and the GMD (Table 5). The hypothesis is rejected, given that we obtain a non-significant relationship. However, the coefficient is negative; that is to say, more international expansion implies less ROOA for the firm. We do not interpret this result as a contradiction; it could be due to the importance of firms with an LID strategy (some 50% of the sample), bearing in mind that in the previous analyses we found that LID firms perform better than the rest, save with respect to the HID strategy.

The results do not support the theoretical argument and previous findings, which suggest that the higher the degree of international diversification on the part of the firm, the better its performance. However, our results are consistent with the conclusions arrived at by Jacquemin, Ghellinck and Huveneers (1980), Rugman (1983), Aggarwal and Soenen (1987), and Sambharya (1995).

The second Hypothesis (H 1b), is that a higher degree of internationalization allows firms to reduce the risk (measured by means of S.[D..sub.ROOA]). This hypothesis is rejected for each international diversification measure, because the results are not statistically significant. The observed tendency is the inverse of that obtained with the first hypothesis. On the one hand, we find that there are no statistically significant differences between the different international diversification strategies (Table 4). The extreme categories present lower risk levels, although equally inappreciable. Specifically, we obtain the following order: S.[D..sub.ROOA] (LID) < S.[D..sub.ROOA] (HID) < S.[D..sub.ROOA] (URID) < S.[D..sub.ROOA] (RID). On the other, when we analyze the GMD, we find a positive relationship (Table 5).

Here, our results are consistent with those of Senchack and Beedles (1980), Brewer (1981), Aggarwal and Soenen (1987), and Geyikdagi and Geyikdagi (1989). However they are opposite to the conclusions of Solnik (1974), Rugman (1976), Agmon and Lessard (1977), Aggarwal (1979), Miller and Pras (1980), Fatemi (1984), Madura and Rose (1987), and Brewer (1989).

Thus, if we jointly analyze both profitability and risk, we find that less diversified firms have the best risk-return combination. Additionally, using the categorical measure, we find that firms implementing an HID strategy have high returns and low risk. However, neither result is significant.

Despite the fact that economic and financial theory associates high returns with high risk, Bowman (1980) found that such a relationship is possible. Other authors, such as Bettis and Mahajan (1985) have obtained the same relationship.

We could explain these results by making reference to the characteristics of Spanish firms. On the one hand, the size of Spanish firms is generally smaller than their North-American and European counterparts. Moreover, the degree of international diversification of Spanish firms is not particularly high. Most firms in the sample are domestic (some 50% of the sample). Thus, LID firms would be achieving advantages of specialization in the domestic market. They would focus on segments of the Spanish market where they have a competitive advantage which allows them to obtain benefits and makes them superior to the rest of the competitors which are implementing different international strategies.

On the other hand, in general, firms follow a gradual path in their internationalization process. They start their expansion into related countries where the economic, social and political conditions are similar. As a result of their learning from international experience, they continue their international expansion into different countries. Thus, firms with the highest degree of international diversification (HID) would correspond to the first Spanish movers in their international expansion. Therefore, these firms would have more information about foreign markets (suppliers, demand ...) and how to manage their activities in a different environment. This knowledge allows them to perform better than the rest of the firms which have a lower degree of internationalization.

As regards the third Hypothesis (H 1c), we can accept that the international diversification strategy has some positive and significant effect on firm value for both measures (see Table 4 and 5). The results show that internationally diversified firms present a market value that is significantly higher than less internationally diversified firms.

Similar conclusions can be found in studies such as those of Thompson (1985), Kim, Hwang and Burgers (1993), and Qian (1997), although they measure the risk-return relationship in a different way. However, Morck and Yeung (1991), used Tobin's q and found that the international diversification in itself has no significant effect on it.

In particular, when we analyze the different strategies we find that URID and HID firms have a higher Tobin's q. However, we observe that the rate of increment in the performance decreases with a higher degree of international diversification. This would reflect a concave relationship between international diversification and performance similar to the inverted U-shape described by Geringer, Beamish and DaCosta (1989) or Hitt, Hoskisson and Kim (1997) (28).

This apparent contradiction between the conclusions that can be drawn from the accounting-based and the market-based results could be due to the characteristics of each one of the measures. As we have already noted, accounting measures evaluate the present and past adaptation of the organization, reflecting performance in the short-term. However, the market measure, Tobin's q, reflects the ability of the firm to adapt to, or to anticipate, environmental changes from a long-term perspective.

The firms in our sample are still weak in their international expansion, although the trend is towards a greater involvement in this direction. The effort made by these firms to adapt themselves to the new global markets which characterize the 1990's involves high levels of investment that are not immediately profitable. Whilst this aspect would be reflected by the accounting measures, Tobin's q would reflect the expectations for higher performance in the long-term. Thus, these results would confirm the theoretical arguments which hold that a high degree of international diversification implies a higher performance, although for the firms in the sample such performance is in terms of growth prospects more than current profits.

The second group of hypotheses is focused on the comparative study of the related and unrelated international diversification strategies. In particular, Hypothesis (H 2a) proposes that the former (RID) implies a lower profitability than the latter (URID). Hypothesis (H 2b) proposes that firms which follow an RID strategy present higher levels of risk than those which opt for URID. Finally, it should hold that firms with RID show a lower market value than those with URID (Hypothesis (H 2a)).

On the basis of the results contained in Table 4, all three of these Hypotheses are rejected. Contrary to what we expected, we have not found differences in performance between these types of strategy (RID and URID). There is a certain similarity in the performance obtained with either of them; although we can note a weak superiority, one that is not significant, in the URID category. This could be due to the location of subsidiaries that URID firms choose in their international expansion. Although there is a progressive homogenization of markets, some differences still exist. These could be greater in some areas, such as the Rest of the World, which include a set of markets that have only a few similarities between them and with respect to the rest of the markets. Therefore, the experience accumulated by these firms would be not enough to expand their activities into these markets, and they would have difficulties in transferring their ownership advantages to their foreign subsidiaries. Moreover, as Geringer, Beamish and DaCosta (1989) and Hitt, Hoskisson and Kim (1997) suggest, international diversification eventually becomes highly complex and difficult to manage. Coordination, logistical and distribution costs increase. Furthermore, institutional and cultural factors establish barriers to the transfer of ownership advantages across boundaries (Kogut 1985). Thus, the complexity of international diversification can outweigh the positive benefits of greater international diversification, and performance begins to suffer (Hitt/Hoskisson/Kim 1997).

In summary, we can note that the degree of international diversification has a significantly positive effect only on the market-valued performance of the firm, with this effect being limited to the superiority of the RID, URID and HID categories over that of LID. Furthermore, we find that there is a marked similarity between the RID and URID categories in their effect on the results of this study.


The relationship between diversification strategy and firm performance has been studied by a large number of researchers. However, although it has been the subject of extensive analysis, the results have been inconclusive and contradictory. Therefore, as Tallman and Li (1996) note, continued efforts in this direction would appear to be useful.

The present study makes three main contributions to the international diversification literature. First, we have used a new category measure. This allows us to reflect not only the degree of international diversification, but also the direction that it takes. Additionally, it is easy to calculate, and the required information is always available. The possibility of differentiating between categories of international diversification could highlight some new linkages between types of diversification strategies and performance. Various attempts to achieve this have been made in product-international diversification studies (Kim/Hwang/Burgers 1989, 1993, Vachani, 1991); however, either these measures do not reflect all the information or there are no data to calculate them. Although we consider it is important to establish this difference, in our analyses we find that RID is similar to URID in terms of performance.

Secondly, we have used multiple performance measures. In particular, we have used accounting and market measures, with the aim of completing the analysis with all the dimensions of the business performance vector. That is to say, the joint use of these measures results in more complete information being obtained. Our conclusions are that whilst the accounting results do not capture the effects of the international diversification strategy, we can observe a certain positive effect when that relationship is analyzed by way of the Tobin's q ratio. The difference found when using either the accounting or the market results could be due to the increase, albeit slight, in the degree of internationalization of Spanish firms. Thus, for Spanish firms international diversification implies important investment and growth prospects that are not reflected in current performance, although this strategy will allow the future performance of these firms to improve.

Finally, no international diversification studies have been carried out with respect to Spanish firms. Therefore, this paper could contribute towards our understanding of the behaviour of Spanish firms as regards international diversification strategy and its relation with performance. What we offer is no more than a first approximation, that might lead to the development of new studies on this topic in Spain.

Our study has two limitations. First, there is a possible bias in the results, due to the selection of firms for the analyses. The selected firms are larger than the average size in Spain, and the industries are not equally represented. A broader sample, in terms of size, would be more interesting. This limitation obviously restricts the conclusions and their generalization. Secondly, the category measure is not a consolidated one, although its adequacy to measure international diversification has been demonstrated in Ramirez (1997). Additionally, we have obtained similar results to those obtained using the Global Market Diversification index.

Despite these limitations, we believe that this study represents a useful step in analyzing the effects of international diversity on the performance of Spanish firms.

Appendix 1. Testing Inter-category Heterogeneity of the International Diversification Strategy.

We have tested whether the critical values established for IBSD and IMNSD allow us to distribute the firms into four categories which have clear differences between them (29). In order to test this, we have used the Multivariate Analysis of Variance (MANOVA). The results of the multivariate tests of significance (Pillais, Hotellings and Wilks (30)) reject the null hypothesis of equal averages for each group with respect to all the dependent variables; that is to say, there are indeed inter-group differences (Table 6).

When this hypothesis is rejected, it is more appropriate to examine the results of the univariate tests for each variable (for IBSD and IMNSD). These tests allow us to identify where these differences are; that is to say, which variables contribute towards explaining these differences. The null hypothesis is rejected for each dimension (p < 0.01); therefore, we observe statistical differences between the four categories (Table 7).
Table 1. Distribution of Firms by International
Diversification Strategy

 1991 1992 1993 1994 1995

LID No. Firms 49 48 47 47 48
RID No. Firms 21 17 17 17 16
URID No. Firms 13 17 17 15 18
HID No. Firms 20 21 22 24 21

TOTAL No. Firms 103 103 103 103 103
Table 2. Number of Subsidiaries and Global Market
Diversification (GMD) Values

 1991 1992 1993 1994 1995

SUBS Mean 3.971 3.952 3.903 4.107 4.233
 S.D. 8.605 7.588 7.179 7.728 7.601

GMD Mean 0.240 0.276 0.299 0.285 0.304
 S.D. 0.442 0.458 0.469 0.456 0.476

GM[D.sub.MNEs] (a) Mean 0.996 1.027 1.020 0.937 0.961
 S.D. 0.416 0.381 0.382 0.416 0.435

S.D.: Standard Deviation, SUBS: Subsidiaries firms,
MNEs: Multinational Firms

(a) Value of this index for those firms that meet the
condition established by Vaupel (1971) in order to be
considered as multinationals In particular, we consider
firms as multinationals when they are involved in more
than six countries.
Table 3. Sample Performance Statistics

 1991 1992 1993 1994 1995

ROOA Mean 0.12 0.09 0.07 0.15 0.14
 S.D. 0.20 0.23 0.21 0.49 0.28

S.D. Mean 0.08
 S.D. 0.15

Q Mean n.a. 0.75 0.89 0.90 0.84
 S.D. n.a. 0.39 0.45 0.47 0.49

S.D.: Standard Deviation. n.a.: not available
Table 4. Differences in Performance between Firms Implementing
Different International Diversification Strategies 1991-1995

 LID vs LID vs LID vs RID vs

ROOA (a) 0.004 (b) 0.002 -0.028 -0.002
S.[D..sub.ROOA] -0.051 -0.034 -0.001 0.018
q (a) -0.206 *** -0.270 *** -0.302 *** -0.064

 RID vs URID vs Adj. [R.sup.2] F-value
 HID HID (%)

ROOA (a) -0.033 -0.030 5.23 3.36 ***
S.[D..sub.ROOA] 0.050 0.033 8.22 2.14 **
q (a) -0.096 -0.032 17.22 6.34 ***

The value corresponds to the coefficient obtained. * p-value < 0.10;
** p-value < 0.05; *** p-value < 0.01.

(a) Autocorrelation problems are corrected by way of Generalized
Least Squares (GLS), where the parameter [??] is calculated through
the Prais-Winsten algorithm.

(b) The interpretation is that the coefficient of impact in
performance of, for example, LID strategy is 0.004 over the
impact of RID strategy. That is to say, the LID strategy
implies higher performance than the RID strategy. We read the
remaining pairs of strategies in the same way.
Table 5. Differences in Performance between Firms with Different
Degrees of International Diversification 1991-1995

 GMD Adj. [R.sup.2] (%) F-value

ROOA (a) -0.006 5.35 3.91 ***
S.[D..sub.ROOA] 0.020 7.85 2.24 **
q (a) 0.118 ** 10.21 4.34 ***

The value corresponds to the coefficient obtained.
** p-value < 0.05; *** p-value < 0.01.

(a) Autocorrelation problems are corrected by way
of Generalized Least Squares (GLS) where the parameter
[??] is calculated through the Prais-Winsten algorithm.
Table 6. Results of the Multivariate Tests


 Value approx.F p-value

1991 1.295 60.553 0.000
1992 1.187 48.200 0.000
1993 1.257 55.875 0.000
1994 1.160 45.558 0.000
1995 1.206 50.098 0.000


 Value approx.F p-value

1991 4.362 70.514 0.000
1992 3.599 58.191 0.000
1993 3.859 62.392 0.000
1994 3.316 53.609 0.000
1995 3.518 56.877 0.000


 Value approx.F p-value

1991 0.111 65.429 0.000
1992 0.145 53.073 0.000
1993 0.127 59.092 0.000
1994 0.158 49.505 0.000
1995 0.144 53.438 0.000
Table 7. Results of the Univariate F-Tests

 1991 1992 1993 1994 1995

IBSD (F) 95.815 74.818 84.149 67.873 67.543
p-value 0.000 0.000 0.000 0.000 0.000
IMNSD (F) 46.965 40.689 45.981 41.317 49.637
p-value 0.000 0.000 0.000 0.000 0.000


(1) This paper has been presented at the 23rd EIBA Conference in Stuttgart, December 1997 and has been supported by DGICYT Project Number PB 95-0808. The authors are grateful to Professor Arvind Phatak of Temple University (Philadelphia), Professor Vicente Salas of University of Zaragoza (Spain) and two anonymous referees for their helpful comments.

(2) Dr. Ramirez gratefully acknowledges the support provided by the Spanish Secretary of State for Universities, Research and Development, which has enabled her to attend the Institute of Global Management Studies and Strategic and General Management Department of Temple University, Philadelphia, USA, in the capacity of Visiting Scholar.

(3) Vaupel (1971), Vernon (1971), Rugman (1976), Miller and Pras (1980), Grant (1987), Grant, Jammine and Thomas (1988), Geringer, Beamish and DaCosta (1989), Kim, Hwang and Burguers (1993), Qian (1997).

(4) Horst (1972), Hughes, Logue and Sweeny (1975), Buckley, Dunning and Pearce (1978), Brewer (1981), Rugman (1983), Aggarwal and Soenen (1987).

(5) Siddhartan and Lall (1982), Kumar (1984), Shaked (1986), Collins (1990), Mitchell, Shaver and Yeung (1992), Cantwell and Sanna-Randaccio (1993).

(6) By contrast to product diversification, researchers in international diversification do not reflect the direction it takes.

(7) Although the results of empirical research are mixed, most of them confirm the theoretical arguments.

(8) However, this measure has been widely used in product diversification studies (such as those of Wernerfelt/Montgomery 1988, Lang/Stulz 1994, Berger/Ofek 1995).

(9) This paper is part of a wider research study, in which the product diversification strategy of Spanish firms has also been analyzed.

(10) Firms had to be quoted on the Spanish Stock Market during every year of the period under consideration.

(11) These Annual Reports detail the foreign countries in which the subsidiary or associated firms of the parent firm have their registered offices.

(12) Rugman (1976), Buckley, Dunning and Pearce (1978), Aggarwal (1979), Grant (1987), Grant, Jammine and Thomas (1988), Geringer, Beamish and daCosta (1989), Geyikdagi and Geyikdagi (1989), Roth and Morrison (1990), Ramaswamy (1993), Sambharya (1995), Tallman and Li (1996).

(13) Vernon (1971), Errunza and Senbet (1984), Morck and Yeung (1991), Mitchell, Shaver and Yeung (1992), Sambharya (1995).

(14) Vaupel (1971), Mork and Yeung (1991).

(15) Hirsch and Lev (1971), Miller and Pras (1980), Errunza and Senbet (1984), Kim, Hwang and Burguers (1989, 1993), Hitt, Hoskisson and Kim (1997).

(16) Although Mexico became a member of the OECD in 1994, it has been excluded from this group and included within the Latin-American group of countries, with which it has greater economic and political similarities.

(17) The countries included within the Tax Havens group are those considered to be such according to Spanish Royal Decree 1080, 5th July 1991.

(18) Varadarajan establishes four types of product diversification strategy: low diversity, related diversity, unrelated diversity and, finally, high diversity.

(19) We have demonstrated elsewhere (Ramirez 1997), that this adaptation of Varadarajan's methodology reflects the degree of international diversification. This is achieved by comparing the results obtained using this methodology with those obtained using Global Market Diversification index, by way of an analysis of the variance. The result of this statistical analysis indicates a certain validity of construction as between the measurements employed, in such a way that they could be considered as possible substitutes.

(20) Before distributing the sample firms by reference to strategy, we have tested if statistical differences exist between the four categories. The results demonstrate such differences, as can be seen in Appendix 1.

(21) We use the standard deviation of ROOA for the whole period under study.

(22) This sample is based on the set of firms employed by Espitia (1985), and subsequently extended by other members of the Department of Business Management at the University of Zaragoza (-Spain).

(23) Descriptive Statistics (mean, standard deviation): 1991 (10.11, 2.03); 1992 (10.18, 1.88); 1993 (10.21, 1.80); 1994 (10.31, 1.74); 1995 (10.44, 1.71).

(24) When we analyze the Tobin's q, and lose one year because of the data, we create four dummies.

(25) These comparisons cannot be made when the Global Market Diversification is used, given that this is a continuous index.

(26) The control variables do not appear in the Tables, given that their study is not the aim of this paper. The size has a significant effect on ROOA and Tobin's q; the years are only important when we analyze the market value measure; finally, we have found differences between industries for all the measures, but not for every industry.

(27) For ROOA we have information for 103 firms during five years (515); we have the S. [D..sub.ROOA] for the whole period, and thus, we have only 103 observations for this measure. Finally, we only have 4 years for the market value, because we lose one year in order to calculate this measure; thus, we have 412 observations.

(28) We have tested the curvilinear model for the GMD index. The results show that this non-linear relationship only exist when the measure of performance is the Tobin's q. The coefficients of GMD and GM[D.sup.2] are significant (0.554 and -0.371 respectively, both with a p-value = 0.01).

(29) We analyze if the four groups are heterogeneous among themselves by reference to the strategy followed by each firm.

(30) Wilks' lambda can be interpreted as a measure of the proportion of total variability not explained by group differences.


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Manuscript received August 1998, revised September 1999, revised January 2000.

Marisa Ramirez-Aleson (2), Assistant Professor of Management and Organization, School of Business Administration, University of Zaragoza, Spain.

Manuel Antonio Espitia-Escuer, Professor of Management and Organization, School of Business Administration, University of Zaragoza, Spain.
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Author:Ramirez-Aleson, Marisa; Espitia-Escuer, Manuel Antonio
Publication:Management International Review
Article Type:Statistical Data Included
Geographic Code:1USA
Date:Jul 1, 2001
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