Multinational firms generate an estimated 25 percent of the world’s gross domestic product, but despite their dominance of the global economy — and in many ways because of it — they don’t fit neatly into the well-organized world of economic research or traditional organizational studies. This can create gaps in the overall understanding of how multinational corporations respond to and drive major economic cycles.

So this spring, a workshop supported by the Chazen Institute gathered a broad panel of economic researchers to share their findings and begin bridging those gaps. “This was an opportunity to learn from each other about empirical and theoretical work being done on multinationals that could benefit both international and organizational economics, as well as international business and strategy,” explained Catherine Thomas, a Chazen Senior Scholar and assistant professor at Columbia Business School.

Three Big Questions

Thomas and co-authors Maria Guadalupe, a Chazen Senior Scholar and associate professor at Columbia Business School, and Olga Kuzmina, an assistant professor at the New Economic School in Russia, published a paper last year that helps fill in the blanks. Their research examines the well-documented but poorly understood fact that subsidiaries of multinational firms generally outperform domestic firms.

Many economists theorize that this happens because the multinational parent can transfer its superior technologies and organizational practices to the acquired firm, Thomas says. But their paper, “Innovation and Foreign Ownership,” argues that other, more dominant factors could be at work.

Natural selection could be one such factor. The vast majority of multinational firms enter new markets by buying an existing business rather than starting one from scratch. This means that global firms do better because they select higher-quality businesses to acquire.

The second question is whether access to new markets through the parent company creates additional incentive for the acquired business to invest in innovations that improve efficiencies and boost production.

“We’re trying to shed light on why a multinational would acquire that firm instead of just buying its output or creating a joint venture,” Thomas says. “There must be some value being created through the merger that explains why, once the parent and the target come together, the activities of both of them are greater than the sum of their parts.”

The Path to New Markets

One of the variables the researchers tracked was a firm’s ability to access new markets through a foreign-owned parent. The authors suggest that it might not matter whether the acquired firm posted higher exports by selling its output to one of the parent’s other subsidiaries, or if it simply used the foreign parent’s channels to enter new markets. The acquisition itself creates additional incentives for the acquired firm to invest in innovation. “Now that they have access to all these export markets, demand for their product has increased and it’s worthwhile to pay the fixed costs for new machinery or invest in new technology,” Thomas says.

That also explains the issue of natural selection, Thomas says. Say General Motors wants to expand its European market share by taking advantage of Spain’s lower wages, and there are two manufacturers that it could acquire; a small one with lower levels of production or a larger one with higher output. Both would have to make similar investments to improve efficiencies and boost production to meet the greater demand generated by the acquisition. But the returns on that investment would be greater for the larger firm because the cost would be spread over its entire scale. “The benefit is proportional to the size of the operation,” Thomas says.

The Upshot

The same benefits that come from being part of an organization can exist even if the two companies are not in the same industry. Going back to the GM example, the automaker might decide that it wants to acquire a German engineering firm that specializes in sound systems. “If the acquisition guarantees a much larger market for their product, the acquired firm would see the value of upgrading their technology,” Thomas says. “This can help explain why we see multinationals expanding across multiple industries.”

Taken together, these findings can explain several lingering questions, Thomas says. First, why more productive firms innovate more; second, why foreign firms acquire the most productive firms within industries; and third, why foreign-owned firms increase their innovation upon acquisition. It also explains why it is often necessary to look across multiple fields of economic study to find the bigger picture.

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