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Exchange Rates and the Choice of Ownership Structure of Production Facilities

  • Panos Kouvelis

    ()

    (Olin School of Business, Washington University, St. Louis, Missouri 63130)

  • Kostas Axarloglou

    ()

    (Economics Division, Babson College, Babson Park, Massachusetts 02457)

  • Vikas Sinha

    ()

    (Fuqua School of Business, Duke University, Durham, North Carolina 27708)

Registered author(s):

    The aim of this research is to study the effects of real exchange rates on the long-term ownership strategies of production facilities of firms entering foreign markets. Among the strategies considered are exporting (EXP), joint ventures with local partners (JV), and wholly owned production facilities (WOS) in the foreign country. Our research takes a first step in modeling the influence of exchange rates on the choice and dynamic adjustment of such strategies. The insights obtained from our modeling analysis are then translated into testable hypotheses and empirically verified with the use of firm level data from U.S. multinational corporations (both at the firm and a more aggregate level). An insightful result of our model is the identification of a hysteresis phenomenon that characterizes switching behavior between strategies in the presence of switchover cost. The magnitude of the hysteresis band, which is a measure of the inertia associated with keeping the current ownership structure, is affected by a multiplicity of factors such as exchange rate volatility and market power of the entering firm. Analytical and numerical results on the effects of such factors on the hysteresis band are provided. The four testable hypotheses generated from our modeling analysis are rigorously tested with the use of a multinomial logit model on data obtained from the Harvard Multinational Enterprise database, and a data set maintained by the Bureau of Economic Analysis, the U.S. Department of Commerce. The empirical results strongly support our insights that relatively depreciated real exchange rates (i.e., weak home currency) favor (a) the JV over the WOS and (b) EXP mode over the WOS or JV. Finally, we summarize our results into useful guidelines for global production managers.

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    File URL: http://dx.doi.org/10.1287/mnsc.47.8.1063.10227
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    Article provided by INFORMS in its journal Management Science.

    Volume (Year): 47 (2001)
    Issue (Month): 8 (August)
    Pages: 1063-1080

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    Handle: RePEc:inm:ormnsc:v:47:y:2001:i:8:p:1063-1080
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    1. Bruce Kogut & Nalin Kulatilaka, 1994. "Operating Flexibility, Global Manufacturing, and the Option Value of a Multinational Network," Management Science, INFORMS, vol. 40(1), pages 123-139, January.
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    9. Erin Anderson & Hubert Gatignon, 1986. "Modes of Foreign Entry: A Transaction Cost Analysis and Propositions," Journal of International Business Studies, Palgrave Macmillan, vol. 17(3), pages 1-26, September.
    10. Parsley, David C & Wei, Shang-Jin, 1993. "Insignificant and Inconsequential Hysteresis: The Case of U.S. Bilateral Trade," The Review of Economics and Statistics, MIT Press, vol. 75(4), pages 606-13, November.
    11. Yoshikawa, Hiroshi, 1990. "On the Equilibrium Yen-Dollar Rate," American Economic Review, American Economic Association, vol. 80(3), pages 576-83, June.
    12. Peter Hooper & Catherine L. Mann, 1989. "Exchange Rate Pass-through in the 1980s: The Case of U.S. Imports of Manufactures," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 20(1), pages 297-337.
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