Nowadays, business was influenced of global environment. Companies not only do their business at local market, but also consider develop their business in other country. In this context, a lot of companies start to do multinational investment or diversifying their investment in different country on the world. The company intend to be multinational can through this few method such as joint ventures, acquisition of existing operations and establishing new foreign subsidiaries. The purpose of the company to go abroad for investment is to increase the efficiency of the company operation because they enable increase the productivity of the production and gain the economics of scale. Normally, the company goes abroad to expand their business to the international market is attempt to reduce their risk and improve profitability and value of the company via the method of diversification.
Lummer and McConnell (1990) provide the prove that foreign joint ventures for the firm become MNC produce positive return as the joint ventures are viewed firm return enhancement. In addition, it was also discover that the share price reacted more significantly positive, especially when the venture partner is a foreign firm as opposed to a foreign government. Doukas and Travlos (1988) find out that the company announces acquisitions in less developed countries will most benefit the multinationals company. Madura (2000) argues that when firms develop beyond their national borders, they have to operate within new sets of national and the new corporate cultures. Unfamiliarly of different culture can represent tough challenge and they can offset the profit a firm might gain from international expansion of international business.
1.2Problem statement
The studies on company performance, risk reduction of multinational company in Malaysia are quite scarce. Besides that, the studies of researchers are focus on the company that has the subsidiary in developed market such as Middle East market. So, in order to determine the influence of the diversification, the researchers need to conduct this research. Another reason that motivates the researchers to conduct this research study is because there have no known research that anyone has conduct research study about the influence of multinational investment on risk and return performance of Malaysia's company. Furthermore, it is important that the multinational company have the awareness of the advantages and disadvantages of diversification.
Thus researcher will carry out two research questions for this:
Are the performances on return of Malaysia multinational companies have been influence by diversification?
Are the risk reductions of Malaysia multinational company improved by diversification?
1.3 RESEARCH OBJECTIVE
The first objective of the researchers attempts to determine whether the companies diversify their investment has any impact on their return performance. Second objective is attempts to find out whether the risk reduction of Malaysia multinational company will be improved by diversification. The researchers will access the international company of Malaysia to ensure that diversification is strongly benefit to the company in term of profitability and risk reduction by using standard deviation and average of return on asset (ROA) and return on equity (ROE).
CHAPTER 2
LITERATURE REVIEW
2.1 DEFINITION OF MNC
Multinational corporations (MNC) are defined as firms that engage in some form of international business and also known as the company that make a business at different country or in the other word the company do a business more than 1 country. The headquarters of the business is called the home country and the subsidiaries of the business at several other countries, called as host countries. Their managers conduct international financial management, which involves international investing and financing decision that are intended to maximize the value of the MNC. The goal of their managers is to maximize the value of the firm, which is similar to the goal of managers employed by domestic companies. Initially, firms may merely attempt to export products to a particular country or import supplier from a foreign manufacturer. Over time, however, many of them recognize additional foreign opportunities and eventually establish subsidiaries in foreign countries. Company classified as MNC involve in filed such as, oil, mining, and manufacturing, agriculture. Besides that, MNC also involve in service activities such as accounting, telecommunication, consulting, construction, legal, entertainment, advertising, banking, and some multinational corporations are very big, with investment that exceed some nations' GDPs. Multinational company can have a powerful impact in local economies, and even the world economy, and play an important role in multinational relations and globalization. Some businesses, such as ExxonMobil, Fortune Brands, and Colgate Palmolive, commonly generate more than half of their sales in foreign countries. A prime example is the Coca-Cola Co, which distribute its products in more than 160 countries and uses 40 different currencies. Over 60 percent of its total annual operating income is typically generated outside the united state.
2.2 ADVANTAGE AND DISADVANTAGE OF MULTINATIONAL COMPANY (MNC)
There are several advantages of MNC:
The first advantage of the MNC is can expand their business and penetrate into new markets by entering new country. This could help the MNC to increase their profit because larger markets ensure larger demand.
The second advantage is MNC can enjoy the economics of scale. This is because the larger demand mean the company needs to increase their production and this will help the company gain the economics of scale. Economic of scale occur when it costs less per unit to produce or operate at high levels of output. Grant, Jammine, and Thomas,
(1988) said that global market multinational business offers possibilities for exploitation of economies of scale and scope above and beyond the potential of product diversification.
Besides that, MNC can gain more stable cash inflow due to international diversification. More stable cash inflow mean lower risk of bankruptcy, corporations which are have the subsidiaries in foreign country usually are more lower risk compare to domestic corporations which are only focus on domestic market that is because the risk will be assigned by all the subsidiaries in different country.
Furthermore, the operation of multinationals into a country requires labor, therefore that create a new job opportunities. This may help a country to ensure job opportunities to their people and indirectly increase the earning per capita of a country.
Besides that, the competition that cause by the entering of MNC will encourage local companies to create or innovate their product in order to compete with the MNC. This situation will increase the consumer satisfaction because consumer will have more choice and can consume higher quality product.
In addition, MNC will bring in advanced technology to the country they invested. This may help the country gain the advance of technology and become a more developed country.
There are several disadvantages of MNC:
First disadvantage is MNC is more complicated than domestic company because of their size, capacity, labor force and the cash flow. Therefore, if the management team has no higher knowledge of international business and information about the global market condition, the company will have a higher bankruptcy risk.
.Second disadvantage of MNC is share of profit remitted to the parent company reduces the amount of money created. The host company will need to transfer back their profit to the parent company; consequently, the host company will have less money to use.
Besides that, MNC is exposure to exchange rate risk. If the host country currencies - suddenly weaken against the home country currencies, the cash flow received by MNC will decreased. This may reduce the value of the MNC.
Furthermore, the disadvantage also includes uncertainty surrounding an MNC's cash flow. The MNC's future cash flow is subject to uncertainty because of its exposure to international, political condition, and exchange rate risk , economic condition.
Furthermore, multinationals may abuse resources such as labor and natural resources to gain competitive advantage in international markets. This may cause a unfairness to the country that provide labor and natural resources to the MNC.
In addition, the MNC is exposure to international political risk. Political risk in any country can affect the level of an MNC's sales. A foreign government may increase taxes or impose barriers on the MNC's subsidiary. Alternatively, consumers in a foreign country may boycott the MNC if there is friction between the government of their country and the MNC's home country.
Last but not least, MNC is exposure to international economic condition. The income earned by consumer in that country influence the amount of consumption in that country. If economic conditions is bad , the income of consumers will decreased and cause the consumer decrease purchase the products and indirectly influence the sale of the in that country and cause the sales is out of estimate. As a result, will reduce the MNC's cash flow and therefore in its value.
2.3 History of Malaysian MNC's Background 1990's - 2010
Bala (1999) conducted a survey of foreign investment conducted by firms listed a KLSE in order to identify Multinational Corporations originating from Malaysia. From the 436 listed firms (as at October 1997), he discovers that 207 firms are actively involved in foreign investment activities and they can be considered as Multinational Corporations.
In the survey, it was also discovered that 17 companies have more than 20 ongoing foreign investment projects in various countries. Top of the list is Sime Darby with 110 ongoing foreign investment activities spanning in 19 countries. Second is Amsteel with 70 ongoing foreign investment activities and this is followed by MBF Holdings with 60 (Bala. 1999)
The geographical spreads of Malaysia's Multinational Corporations investment activities are also wide. In total, the top Malaysia Multinational Corporations had an ongoing foreign investment in 63 countries around the world. The Northeast Asia and the Asian region received the most of Malaysia's Multinational Corporations foreign investment compare with other developed regions. Perhaps, this is due to the inferiority of technology and "know-how" of the Malaysia Multinational Corporations. In general, these two factors may have deterred many Multinational Corporations based in developing countries from venturing into the western countries and compete with the much-sophisticated firms in those market (Lall, 1986) In the more recent study, Annuar, Supian, and Anuwar (1996) consider companies like Technology Resource Industries (TRI), Sapura Telecommunications Berhad, Telekom Malaysia, and Petronas as Malaysia major Multinational Corporations United Nations Conference on Trade and Development (UNCTAD) (1999), in their study to identify Third World multinationals firms listed Petronas and Sime Darby in their top 50 multinationals firms from developing countries based on foreign assets invested.
2.4 THE EFFECT OF INTERNATIONAL DIVERSIFICATION OF FIRM ON RISK AND RETURN PERFORMANCE
Diversification is a strategic option that many company use to improve their company's' performance (Pandya and Rao 1998) . Diversifications also indicate the company implement multinational investment. Moreover, risks have been reduced by diversification because the risk will be assigned by all the subsidiaries in different country. Kim et al. (1993) empirically prove the notion that multinational company can increase returns and reduce risks via the diversification. The beneficial impact of international diversification arises partially from a significantly stronger association between profitability and value, and capital expenditures and value for multinational firms ( Bodnar and Weintrop 1997). Diversification can improve debt capacity, reduce the chances of bankruptcy by penetrate to new markets (Higgins and Schall 1975, Lewellen 1971), and improve the return of the asset and improve the profitability of the company (Teece 1982, Williamson 1975). Skills developed in one business transferred to other businesses, can increase labor and capital productivity. A diversified firm can transfer funds from cash surplus subsidiaries to cash deficit subsidiaries without transaction costs and this will reduce the risk of bankruptcy (Bhide 1993). Diversified firms pool unsystematic risk and reduce the variability of operating cash flow and gain comparative advantage in hiring because key employees may have a greater sense of job security (Bhide 1993). The value based studies determine that the return and value of multinational company was increasing in the degree of international diversification ( Eruzza and Senbet ,1981, 1984).
Early work of the multinational company diversification conduct at return and risk measures and determines the mixed results (Mikhail and Shawky 1979 and Brewer 1981). Fatemi (1984) finds no significant difference in the rates of return to investors for multinational versus domestic company. Examining the dynamic interaction of product and international diversification using analysis data, Sambharya (1995) provides evidence that there is no significant gain from international diversification.
Pandya & Rao (1998) found that dominant undiversified company may perform well than a highly diversified firm on the return but the problem is its riskiness will be much greater. Studies on US firms using Tobin's q as the return measure determine that multinational diversification results in a decrease in the return from 6-17% (Christophe 1997 and Click and Harrison 2000).
CHAPTER 3
METHODOLOGY REVIEW
3.1 Data Collection
The data will be found from Kuala Lumpur stock exchange website. (www.klse.com.my) and the data will be most used are the companies' annual reports for the year of 2008 and 2009. From the annual report, the researcher needs to find out each company sales, net income, total assets and total equity for the purpose to convenience in calculate the ROA and ROE for this research analysis. Some of the data will obtain from different sources which were general sources, primary sources and secondary sources such as journal, news paper, book on specific subjects, reviews on research and so on. Besides that, the researchers will also get the journals related to their study through UPM's library network. (www.lib.upm.edu.my) and Google search engine. (www.google.com).
3.2 MEASUREMENT ON INTERNATIONAL DIVERSIFICATION
Researchers will choose to use ROA and ROE as a proxy measure for companies' performance. In addition, the researchers also use the Entropy which state as D to measure diversification on the research.
Entropy (D)
The entropy can be representing in the symbol of D. The D is use to measure the level of international diversification. The larger the D indicate that the higher the level of diversification or more international diversification activities of a MNC and in vice versa. Besides that, the researchers use variance, standard deviation as a measurement on risk and return performance of the MNC. Because the entropy concept has been applied in a roomy variety of academic disciplines, it has been appeal in empirical studies in management as well as in economic, finance, marketing and accounting (Attaran and Zwick 1989).segments" (Palepu 1985). The use of the entropy measure to measure diversification of the MNC has been recently validated (Hoskisson et al. 1993).
The measure of international diversification can be described as:
D= Siloge (1/Si)
Si represent the ratio of the number of subsidiaries that the MNC company holding in country or region i indicate the total number of foreign subsidiaries.
The first advantages of using entropy measure the level of diversification,because quantified as a continuous one, were well known for quite some time; but less of data for such a measurement prevented its widespread use. However, after Compustat and Trinet electronic databases became widely available, the field has witnessed an increased use of this method. Recently, the entropy measure was found to gain more validity than the other measures of company diversification (Hoskisson, Hitt, Johnson & Moesel, 1993) limitations in capturing the geographic scope of international activities of operations is one of the disadvantages of entropy.
3.3 MEASUREMENT ON PROFIT AND RISK
RETURN ON TOTAL ASSETS (ROA)
The ROA ratio measures the return on all of the firm's assets after interest and tax. ROA show how efficient?management is?at using its assets to generate profit.? ROA is displayed as a percentage. Sometimes this is referred to as "return on investment".
The formula shown below:
A firm with good control over its interest expense as well as efficient in utilizing its assets to generate sales will eventually have higher net profit. This will then be translated into higher return on total assets ratio.
RETURN OF COMMON EQUITY (ROE)
ROE is the amount of net income?returned?as a percentage?of shareholders equity.?ROE measure the rate of return on the shareholder's investment. In other words, it measures the firm's ability to earn return on the money that the shareholder has invested.
The formula shown below:
ROE is equal to a net income after tax (after preferred stock dividends but before common stock dividends) divided by total equity (excluding preferred shares) and expressed as a percentage. As with many financial ratios, ROE is best to use to compare companies return performance in the same industry. The higher ROE rate indicates the company have a high growth rate.
Variance (σ2)
In general, the variance is the difference of revenues, costs, and profit from the planned amounts. Variance is dispersion of returns around the expected value whereby a larger variance deviation indicates greater the dispersion. The idea is that the most disperse the expected return, the greater the uncertainty of future return. Although there are numerous potential measures of risk, some researcher will use the variance or standard deviation of returns because (1) this measure is somewhat intuitive, (2) it is correct and widely recognized risk measure and (3) it has been used in most of the theoretical asset pricing model.
Standard Deviation (σ)
In finance aspect, the standard deviation indicate that the risk related with a given portfolio security such as stocks, bonds and property. Standard deviation provides a numerical estimate of the uncertainty of future returns on the investment. The concept of the standard deviation is that the higher the standard deviation, the higher the return. In the other word, the company may receive the higher the return on investment when the risk of that investment is higher. Squaring the deviations can make variance difficult to interpret. What do units like percent squared tell an investor about the a investment risk? Because of this difficult, the researcher will use the standard deviation, σ, which is simply the square root of the variance.
