On the Origins of the Multinational Premium

How do foreign direct investment (FDI) dynamics relate to the risk premium of a firm? To answer this question, we compare the stock returns of US firms with different FDI and mergers and acquisitions (M&A) experience to study the evolution of stock returns as firms expand into foreign markets. We document three empirical regularities. First, there are cross-sectional risk premia associated with both multinational activity and mergers and acquisitions. Second, firm-level stock returns decline when a firm undertakes M&A activity and with merger deepening. Third, future multinational acquirers already have higher stock returns when compared with domestic non-acquirers prior to entering foreign markets, indicating that cross-sectional returns differentials are driven by selection based on common unobserved firm characteristics. We find that CEOs play an important role in explaining the relationship between firms’ risk premia and foreign expansion. To rationalize these facts, we develop a dynamic model in which managerial experience shapes the relationship between firm characteristics, selection into FDI, and risk premia. experience. First, we study the role of certain firm characteristics on expected returns. Firm characteristics include indicators of multinational and acquisition activity, among others. Second, we examine whether the covariance of these characteristics with aggregate risk factors drives the risk premia of multinationals and acquiring firms. This analysis takes the form of portfolio regressions in which the construction of the portfolios is based on multinational and acquisition status. role of managers and managerial practices on different aspects of firm performance. Inspired by this literature, we explore the role of managers play in determining simultaneously both firms’ expansion strategies and their risk premia. To this end, we investigate the relationships between management and firm status and between management and stock returns.