Multinational Firms, Internal Capital Markets, and the Value of Global Diversification

Over the period 1980-2007 multinational firms' investment grew four times faster than worldwide GDP. Yet the evidence on whether global diversification is valuable is inconclusive. This paper uses detailed FDI data for 251 UK multinational firms and 4,676 subsidiaries to show that multinational firms exhibit, on average, a global diversification premium compared with a country-industry matched portfolio of focused firms. I investigate this result and show that the premium is greater for multinational firms with better governance, both in absolute terms and relative to focused firms. Further, the value premium is positively related to "winner-picking" transfers in internal capital markets, and more so for better-governed firms. The results are robust to alternate specifications, endogeneity, and self-selection. The findings help explain why multinational firms' investment and global diversification have significantly increased over the past three decades.