Are Multinational Corporations

Are Multinational Corporations Safer?
Author(s): Israel Shaked

Source: Journal of International Business Studies, Vol. 17, No. 1 (Spring, 1986), pp. 83-106
Published by: Palgrave Macmillan Journals
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ARE MULTINATIONALCORPORATIONSSAFER?
Israel Shaked*
Boston University
Abstract. The failure-probabilities of a sample of multinational

corporations (MNCs) are derived and compared with those of a
control group of domestic corporations (DMCs). The results suggest that the mean insolvency-probability of DMCsis significantly
higher than that of the MNCs. It is also observed that MNCs are
significantly more capitalized, and the standard deviation of their
equity as well as their averagesystematic risk are also significantly
lower. Furthermore, the average insolvency probability of the
DMCs is more sensitive to changes in the values of the parameters
than those of the MNCs.
While much has been written on the potential effects of international
diversification, relatively little has focused specifically on the risk-reduction via corporate international diversification. In this paper we directly
calculate the failure-probabilitiesof a sample of multinational corporations
(MNCs) and compare them with those derived for a control group of
domestic corporations (DMCs). Section one represents a discussion of the
relevance of international diversification at the corporate level, and the
second section considers the existing empirical evidence. The third section
provides the motivation of the proposed approach and in section four the
methodology, data and estimation procedure are presented. The results are
evaluated in the fifth section and the final section presents the summary.
AT
RELEVANCE
OFINTERNATIONAL
DIVERSIFICATION
THECORPORATE
LEVEL
The degree to which diversification can reduce risk depends on the correlation among security returns. Withina given economy, a strong tendency
* IsraelShakedis AssociateProfessorof Financeat BostonUniversity'sSchoolof
He earnedhis Doctorof BusinessAdministration
degreeat the Harvard
Management.
BusinessSchool,and his B.A. in economics,B.A. in statisticsandM.B.A.fromthe
He has publishedin the areasof corporatefinancial
HebrewUniversityof Jerusalem.
finance.His
financialinstitutionsandinternational
decisions,mergersandacquisitions,
book "TakeoverMadness:CorporateAmericaFights Back," publishedby John Wiley,
is forthcoming.
The authoris gratefulto AllenMichelandanonymousrefereesfor helpfulcomments
and to TeresaJonesfor excellentresearchassistance.Any remainingerrorsare, of
course,his own.
Date Received: March 27, 1984; Revised: October 30, 1984/April 14, 1985; Accepted: July 12,
1985.
83
84
JOURNAL OF INTERNATIONALBUSINESSSTUDIES, SPRING 1986
usually exists for economic phenomena to move more or less in unison,

which gives rise to periods of relatively high or low business activity. This
also holds true for individual securities and industries. The existence of a
relatively high degree of positive correlation within an economy suggests
the possibility that risk reduction might be facilitated by diversifying
securities portfolio internationally. That potential gain has been analyzed
by applying portfolio theory. Grubel [ 1968], was the first to apply it, and
his results have been subsequently confirmed and extended by Levy and
Sarnat [1970], Grubel and Fander [1971],Agmon [1972], Solnik ([1973,
1974]), Lessard ([1974, 1976]), and others in a book edited by Elton
and Gruber [1975]. If international capital markets are perfectly integrated, if transaction costs are low, and if investors are rational and risk
averse, then there are no diversification benefits inherent to multinational
corporations that could not be obtained by investors making direct portfolio investment in the countries in which the multinational corporations
would otherwise operate. That is, in the case of perfect financial markets
there is no systematic advantage to owning shares in multinational firms
versus holding shares directly in firms in different countries. Some assert,
however, that because of control on capital flows, differential trading
costs, different tax structures, and several other factors, markets are imperfectly integrated. Hence, investors may not actually be diversifying
internationally and thus foregoing advantages which could accrue to them
if they were willing to hold foreign securities. Thus, if markets are not perfectly integrated, the multinational corporation is performing a valuable
function for investors. Another aspect of corporate international diversification is the potential reduction in the probability of bankruptcy. In this
sense, the argument is perfectly analogous to the discussion of the benefits
of conglomeration. This discussion is based on the recognized distinction
between lender diversification and borrower diversification (Lewellen
[1971 ]): when a lender diversifies, he "spreadsthe risk" by lending small
fractions of his total portfolio to each of a number of different enterprises.
In this manner, he diminishes the probability that a very large percentage
of his loan will turn bad simultaneously, but he cannot thereby affect the
probability that any given individual borrower will be forced to default.
On the other hand, if certain of the borrowers should diversify by merging
their operations, the joint probability of default under the collection of
outstanding loans is reduced. The phenomenon produces enhanced ability
of diversified corporations to meet the cash-inadequacy test of lenders,
and thus creates additional borrowing capacity. Similarly, corporate international diversification has its own merit even if there are no barriersto an
investor's diversification in his own portfolio (see Shapiro [ 1978 ] ). Though
the potential for risk reduction is clear, the identity of the "true winner"
is less obvious. If bankruptcy is costless, then any increase in the value of
the firm's debt (if diversifying internationally at the corporate level reduces the probability that the firm would default on its debt) will be
exactly offset by a decrease in the value of equity. This argument has been
ARE MULTINATIONAL
CORPORATIONS
SAFER?
85
initiated for the conglomeration-analogy by Higgins [1971 ], and has been

rigorously proven by Rubinstein [1973], Higgins and Schall [1975], and
Galai and Masulis [1976]. However, the bondholders' gain yields greater
debt-capacity for the firm, which allows greater leverage and ultimately,
perhaps, greater gains for stockholders. In sum, the existing literature
recognizes the potential risk reduction via corporate multinational diversification. The relevance of this issue hinges on the generally believed proposition that for various reasons, markets are imperfectly integrated. However, even in a world with no imperfections, corporate multinational
diversification is supported by the potential for a reduced insolvencyprobability and the associated increase in debt-capacity.
AND RISKREDUCTION:
CORPORATIONS
MULTINATIONAL
EXISTINGEMPIRICALEVIDENCE
The issue of whether the market assignsdifferent measures of risk to MNCs

than to otherwise comparable firms has been researched by Hughes, Logue
and Sweeney [1975]. Comparing various risk measures of 46 MNCs with
100 DMCs (for the period 1970-1973), they have observed that multinational corporations have lower systematic risk (3) as well as lower unsystematic risk. Hence, MNCs also have a lower total risk (as measured by the
standard deviation of the rates of return on equity). Thus, they concluded
that their results support the view that investors perceive multinational
corporations as providing substantial diversification benefits.
Following Hughes et al., Agmon and Lessard [1977] published their work,
focusing on the question of whether investors appear to recognize the
diversification opportunities provided by shares of MNCs. They ranked
217 U.S. firms according to their degree of international activity, and
grouped them in deciles in order to reduce the influence of differences
other than the extent of international activity. Then they regressed the
composite monthly return series (1959-1972) for the resultant portfolios
on the indices for the U.S. stock market and the rest of the world. Their
results indicated that the betas relating the returns on each of the portfolios to the U.S. index are much higher for those portfolios with little
international involvement. Hence, they concluded that the market recognizes the geographically diversified nature of the U.S.-based multinational
corporations as well as the extent of their international involvement. In
sum, empirical evidence indicates recognition of the different systematic
risk of MNCs by the market.
THE MOTIVATIONOF THEPROPOSEDMETHODOLOGY
There have been a number of studies on predicting corporate financial performance in general and insolvency-risk in particular. The most notable
published contributions are Altman (1968, 1971, 1973, 1977), Altman,
Haldeman and Narayanan [1977], Altman and McGough [1974], Edmister [1972], Deakin [1972], and Beaver (1966, 1968a, 1968b). The
86
JOURNALOF INTERNATIONALBUSINESSSTUDIES, SPRING 1986
methodologies employed in these papers can be broadly divided into two

groups:
(i) Those based on some sort of financial ratio analysis: Typically, the
analysis provides the reader with a qualitative statement on each ratio
along with industry-wide comparisons. While each ratio alone conveys useful information, the relevant assessment of the firm's financial strength must be based on the interaction of a set of ratios. In
order to evaluate the significance of any particular ratio and the
prudence of the firm's overall position, a fuller understanding of that
interaction is necessary. The important point is that individual financial variables and ratios should not be evaluated in isolation. An
important part of this literature consists of dichotomous classifications and discriminant analyses. Specifically, the financial ratios of
bankrupt firms and matched sample of solvent entities are "differentiated." However, this technique requires a reasonably long observation period to yield statistically significant results.
(ii) Those based on portfolio analysis, where the risk indicator is the systematic risk (i.e., the beta): The idea is that since unsystematic risk
can be eliminated simply by holding well diversified portfolios, investors are not compensated for bearing unsystematic risk. However,
since bankruptcy is a function of the total risk (systematic plus unsystematic), the relevant variability for solvency assessment is asset
return variability rather than equity systematic risk. Although higher
systematic risk of equity returns implies (ceteris paribus) higher variability of asset returns, a firm whose equity has greater nondiversifiable risk than its competitor's may well have lower asset return
variability.
This paper presents an alternativeapproach. Rather than determiningwhich
variables are most strongly correlated with the historical incidence of
failure, we directly calculate the failure probabilities of 58 MNCs and
compare them with those derived for a control group of 43 DMCs. These
probabilities are derived by assuming that asset returns are lognormally
distributed and then calculating the parameters of that distribution for
each company.
The same analytical framework has been applied and tested for commercial banks (Marcusand Shaked [1984]), for insurance companies, (Shaked
[1985]), for evaluating the impact of airline-deregulation on air-carriers'
insolvency probabilities (Michel and Shaked [1984]), and for comparing
the insolvency probabilities of conglomerates and nonconglomerates
(Michel and Shaked [1985]).
The proposed methodology differs in two ways from existing ones. First,
unlike frameworks which are based on some sort of regression analysis (and
thus, require a long observation period to yield a sufficiently large number
of observations), the probability of insolvency can be computed using data
over reasonably short time periods. Thus, the assumption that the data
ARE MULTINATIONAL
SAFER?
CORPORATIONS
87
collected are still relevant to the problem at hand is far more palatable.
More importantly, dichotomous classification and discriminant analyses
use a sample consisting of firms with an ex post "zero-one" probability
of bankruptcy. In contrast, our framework provides an opportunity to
directly locate many firms along a continuum of ex-ante failure rates
which are derived independently from any actual (historical) failure-rates.
DATAAND ESTIMATIONPROCEDURE
METHODOLOGY,
TheBasicFramework
Asset return dynamics can be described reasonably well by the lognormal

distribution. (For a review of the literature, see Smith [ 1976] .) The major
objection to the lognormal distribution results from evidence summarized
by Fama and Miller [1972] which indicates that the distribution of actual
returns on individual assets exhibits fatter tails than predicted by the
normal or lognormal distributions. This suggests that asset returns might
be more appropriately described by the stable or log-stable Paretian family
of distributions. However, the incidence of extreme rates of return seems
to be best modelled as a jump (poisson) process superimposed upon a lognormal diffusion process. However, Merton (1976) describes the arguments
against the use of the stable Paretian hypothesis. This paper employs the
lognormal assumption. If Ao represents the current value of a firm's asset
portfolio and At is its value at some later date, t, then ln(At/Ao) is distributed normally.
For a firm with Do dollars of debt and Eo dollars of equity, the total asset
portfolio is Ao = Do + Eo. At time t, a firm remains solvent when
(1)
At > Doegt
where g is the promised interest rate on debt.' Assuming , is the expected

rate of return on assets, and 6 is the dividend payout rate per unit of assets,2 then ln(At/Ao ) is distributed normally with mean (, - 6)t and
variance which is denoted by a2 t. Thus, the probability that (1) is satisfied equals
ln(Ao)
(2)
- ln(Do)
+ (-
g)t
N(
aAo
where N(.) is the cumulative standard normal distribution. Given estimates of

6,, UA, and g, expression (2) can be computed. Financial and
market data are used to calculate the parametersin (2). Additional information on data sources and a detailed description of the estimation procedure
is provided in the following subsections.
AuditingFrequency
A time interval of one year is assumed. A public company may go no longer

than one year without an audit of its financial statements. Such a one-
88
JOURNAL OF INTERNATIONAL BUSINESS STUDIES, SPRING 1986
year maturity is important to creditors because if the insolvency probability is considered too high when the annual audit is performed, creditors
can initiate some of the provisions typically associated with debt covenants. This may include a request for additions to the firm's equity base. It
is important to realize, however, that qualitative arguments for considering longer, as well as shorter, time intervals should not be ignored. The
quality of the auditing review makes a strong case for the development of
longer time horizons. On the other hand, to account for management review and possible intervention, it is useful to consider the possibility of
shorter time horizons. Thus, summary results indicating the failure-probabilities for other intervals are also presented.
Estimatingthe Varianceof Asset Returns
The variance of asset returns (a' ), is based on the variance of equity return (o ). This value is calculated using 3 months of daily data at the end
of years 1980, 1981 and 1982. Asset return variance is related to the variance of equity returns by the formula3
(3)
A = oE(E/A)2
Estimates of variance rates are typically precise because the standard error
of aE is calculated by aE ,T \/ 2n, where UE T is the true standard deviation and n is the number of observations (Clark and Schkade [1969]).
Daily series of stock returns for firms listed on the American and New York
Stock Exchanges are provided by the CRSP tapes. These series were used
to calculate o.
Assets, Debt and Inflow/Outflow ParametersEstimation
1. Total Assets and Debt. Total assets are estimated by the sum of market
value of equity and book value of total debt as reported by Industrial
Compustat for the years 1980, 1981 and 1982. Marketvalue of equity
is based on actual stock prices and number of outstanding shares. Given
the basic framework and the Equation 3 used to estimate the variance
of asset returns, an overestimation of the value of debt using book values
during a period of rising interest rates will yield a "too low" estimate of
variance on asset returns (and vice versa). This thus reduces the probability of insolvency. Simultaneously, however, increases in the firm's
insolvency-probability is caused by increased level of debt. This, in turn,
causes the derived probability of insolvency to reflect two potential,
but opposite direction, measurement errors. Therefore, a sensitivity
analysis of the results will also be reported. It will indicate the failureprobabilities for debt values "around" the reported levels.
2. Inflow/Outflow Parameters: The dividend payout rate per unit of asset
is represented by 6. It is estimated by the ratio of total dividends paid
to total assets. The parameter p represents the rate of return on assets
available to both the firm's creditors and shareholders. Therefore,
ARE MULTINATIONAL
CORPORATIONSSAFER?
89
subtraction of the cost of debt gives the return per unit of assets available to equity holders. Practically, the term (u - g) in equation (2) can
be estimated using either an accounting or market approach to the estimation of cash flow.
(i.) The accounting measure cash flow approach (AMCF), is based on
the expected net cash flow per unit of capital. It is estimated by
(4-A)
(net income + depreciation)/assets
or by including changes in working capital in the cash flow,

(4-B)
[net income + depreciation? (Aworkingcapital)] /assets
where the data on each of the inputs to equation 4-B (income, depreciation and changes in working capital) are taken from the Industrial Compustat tapes. It may be argued, however, that financial
distress may be correlated with poor performance of the asset portfolio. If so, current tax outflow will be an overestimation of the
expected tax outflow. To account for such an argument the use of
earnings before taxes rather than net income figures in equations
4-A and 4-B is also considered.
(ii.) The market measure cash flow approach (MMCF),is based on the
expected net cash flow per unit of capital. It is estimated by
(5)
[E(RA)A-
gD] /A
where
E(RA) = RF + A [E(RM) - RF]
and
E
OA=-OE + - OD
with the following notation:

E( )=
RF =
RM =
=
fj
expectation operator
risk-free rate of interest
rate of return on the value-weighted market portfolio
Cov(R , Rj)/oa = systematic (nondiversifiable) risk of securiy j.
and the parametersestimated as follows:
3j: = Insolvency probabilities are computed at the end of 1980, 1981
and 1982. The beta of each firm's equity is estimated based on the
preceding 60 monthly returns. An approximation of .44, reflecting
the beta of the corporate bond index is used to estimate the beta
of the debt for each firm.
RF: = The Treasury-bill rate on the estimation date is used to compute
insolvency probabilities at year end.
90
[E(RM ) - RF ]: The long-term historical risk premium is used. In the

period 1926-1978 the average annual return of common stocks and
short-term Treasury bills were 11.3 percent and 2.5 percent respectively. Thus the ex-ante estimate of the annual market risk premium
is 8.8 percent.
g: The cost of debt is estimated by the ratio of interest expense to book
value of interest bearing debt. One may argue that the yield to maturity on the firm's publicly traded bonds is a better economic predictor
of the marginal cost of future debt. However, in periods of rising
interest rates this measure overestimates the "true actual" interest
expense within a short time interval. Thus, to measure short-term
insolvency, given the existing level of debt, net return on assets and
asset variability, the ratio of interest expense to book value of debt
may be more appropriate for estimating g than the yield to maturity.
Defining the RelevantPopulationand EstablishingSamplingCriteria
1. Defining the relevant population.
Since Lilienthal [1960]
first coined
the term, multinational has been used with varying degrees of precision to
denote a wide range of business entities. Briefly, the theoretical literature
has stressed behavioral, structural, and strategic characteristics in efforts
to explain the phenomenon of the global company. While obviously everyone will agree that a firm having interest in a single foreign country is not
really a MNC, a generally accepted definition for empirical work does not
exist at this time.4
Most researchershave focused on some percent of foreign sales or operating
profits, amount of capital investment, number of employees abroad, or
some combination of these variables, as means of distinguishing the MNCs.
Using percentage of foreign sales as a definition is a way of incorporating
reliance upon international markets into the sample. That is, a company
that generates a large part of its sales abroad should be more likely to think
of its business in world-wide terms. The "true" MNC is, after all, presumed
to maximize net gains internationally. The second most commonly applied criterion, the extent of direct foreign investment (e.g., number of
countries) serves a dual purpose. Geographical diversification explicitly
recognizes DFI as a critical identifying feature, apart from sales. The
potential for economies of scale and other efficiences through, for example, international rationalization of production, are advantages unique
to MNCs (simultaneously, of course, other risks such as possible expropriation are often created). Using a measure of capital dispersion precludes
firms whose foreign commitments are narrowly concentrated. In addition,
it has the virtue of eliminating companies that depend primarily upon
license fees or management contracts with foreign income.
2. Establishing Sampling Criteria. After reviewing the relevant population
and the commonly applied definitions as well as the available source of

data, the following sampling procedures have been followed.
ARE MULTINATIONAL CORPORATIONS SAFER?
91
(i) CriteriaApplied to Both The MNCs and The Control Group: First,
because accounting data provided in Annual Reports constitutes both
the most accessible and reasonably standardized information, only publicly held corporations are included. Secondly, because it is probable
that industries are effected differently and respond idiosyncratically to
the same conditions, both groups are composed only of business engaged in manufacturing (i.e., SIC codes in the range 2000-3999). Third,
since it also seems that the relative size of the firm might confound an
assessment of total risk, the groups were confined to Fortune 500 companies for the fiscal year ending 1979, the year prior to the first test
period.
(ii) Sampling the Group of MNCs: Initially, corporations have been
classified as multinationals on the basis of two conditions:
a) foreign sales account for at least 20 percent of revenues.
b) direct capital investment exists in at least 6 countries outside the
United States.5
The genesis of the sample was the Forbes list of America's 125 MNCs,
according to volume of foreign sales. Forbes publishes the percent of
foreign sales in its rankings. The scope of direct foreign investment was
determined by reference to the 1979 edition of The Directory of
American Firms Operating in Foreign Countries. The Directory catalogues those countries in which a company has "substantial direct
capital investment, [While] Foreign firms in which American firms
participate only on a royalty or profit-sharing basis are omitted."
Cross-reference was then made to the 1982 Annual Reports and 10-Ks
of companies for which 10 or fewer countries were mentioned to insure
that no significant disinvestment had taken place since the statistics had
been compiled. At the same time, Forbes lists for fiscal years 1980 to
1982 were used to gather sales data for the study period. The final
sample of 58 U.S.-based multinationals has been obtained after the following elimination process:
125 Forbes MNCs
(58) nonmanufacturing SIC codes
(3) did not meet the foreign sales criterion
(5) did not meet the DFI criterion
(1) other reasons
58 Final Sample
(iii) Sampling the Control Group: Developing the control group was
somewhat more problematic. The primary difficulty in isolating uninational firms was to guard against the inclusion of companies that were
in the process of internationalizing their sphere of operations. The first
step was to sort out businesses with capital investments in more than
one foreign country. Again, the Directory was used, although this time
only as a first approximation. For the control group, Annual Reports
92
for each period were consulted and searched for evidence of omissions
or new DFI since the Directory's publication, as well as for levels of
foreign sales. With the advent of FASB's statement 14-mandating disclosure of segment information when 10%or more of total sales, profits,
of identifiable assets can be traced to foreign sources-the mere absence of such data confirmed the status of many of the DMCs. In one
case, a control company (Handy and Harmon) did have foreign sales
above 10% but these were confined to Canada. A few others had export sales in some years in the range of 10-15%, but virtually no DFI.
Finally, some eligible companies were eliminated because they were
either closely held, traded only on the regional exchanges or OTC or,
data was unavailable through both Industrial Compustat tapes and Annual Reports. The final sample of 43 DMCshas been obtained after the
following elimination process:
375 Fortune 500 and not on Forbes list of 125 MNCs.
(249) Sales in more than 1 foreign country.
( 73) Not publicly traded, or traded only on OTC or on regional exchanges.
( 5) Major changes within the research period in foreign sales
or DFI.
( 5) Data availability and other reasons.
43
Final Sample
RESULTS
ProspectiveFailureProbabilities
Summary statistics of prospective failure probabilities (multiplied by 1

million for ease of presentation) are provided in Table 1. Though the
probabilities calculated for both the MNCs and the control group are typically small, the results are clearly suggestive. As indicated by the table, in
every year of the study period (1980-1982) the mean and the weighted
(by assets) average failure-probability of the DMCs are higher than those
derived for the MNCs. Moreover, as can be observed by reviewing the four
panels of Table 1, this relationship holds, independent on the measure used
to estimate the expected return on assets. In general, the reported mean
probability of the DMCsis largerthan that of the MNCs by a factor of five,
where depending on the ROA version, this factor varies from three to nine.
In order to determine whether the differences between the mean values
are statistically significant we have performed a set of twelve t-tests (i.e.,
3 years, 4 ROA versions). The tests' results indicate that the mean insolvency-probability of the DMCsis significantly higher than the corresponding values of the MNCs (in every year and for each ROA measure). The tstatistics of the twelve tests ranged from -3.52 to -15.54 (i.e., the results
are significant at a better than 1 percent level). In addition, to test whether
the two sets of insolvency-probabilities are from the same population we
93
CORPORATIONSSAFER?
ARE MULTINATIONAL
TABLE1
ProspectiveProbabilitiesof Insolvency(Times 1 Million):SummaryStatistics
1980
1982
1981
MNCs
DMCs
MNCs
DMCs
MNCs
DMCs
I. Based on ROAI
Mean
Weighted Aver.*
1346
896
7339
4165
1476
558
10,303
6,350
5504
3355
20,678
21,925
II. Based on ROA11

Mean
Weighted Aver.
1098
291
5848
5423
1200
414
6,444
6,821
5115
3088
16,594
18,802
III. Based on ROAIil

Mean
Weighted Aver.
1304
837
6575
3962
1046
490
9,621
5,479
4721
2708
20,338
21,852
IV. Based on ROAIV

Mean
Weighted Aver.
456
142
2789
1816
1010
304
2,686
1,670
4925
3667
15,640
17,757
= (N.I. + DEPR)/ASSETS
Notes: ROAI
ROA1I = (N.I.+ DEPR.+ A(W.C.))/ASSETS
ROA111 = (N.I.+ DEPR.+ TAXES)/ASSETS
ROAIV = is the CAPM version.
* Each firm's value (i.e., debt plus market value of equity) is used as a weight.
have performed a set of twelve non parametric Mann-Whitney U tests.

These tests have been performed because of the likely non-normality of
the distribution. In this test the groups are combined, and cases are ranked
in order of increasing size. The test statistic U is computed as the number
of times a score from group 1 precedes a score from group 2. The rationale
is that if the samples are from the same population, the distribution of
scores from the two groups in the ranked list will be random; a non-random pattern will be indicated by an extreme value of U. For large samples
(N > 30), U is transformed into a normally distributed statistic, Z. The
tests' results indicate that the hypothesis that the two samples (of insolvency probabilities) are from the same population is rejected (in all the
twelve cases) at a better than 1 percent level of significance.
Obviously, the financial condition of firms in both samples are sensitive to
overall fluctuations in the general economy. Therefore, as indicated by
Table 1, the failure-probabilities of the two groups tend to change from
year to year in the same direction. It is reflected by the fact that in 1982
the mean and weighted average values for both samples are, in general,
higher than those of 1981. Similarly, the reported statistics for both groups
are, in general, higher in 1981 than those of 1980. However, the absolute
value increases in the value of these statistics are larger for the DMCs. We
return to the issue of sensitivity below. Two points should be noted concerning the alternative measures of return on assets. First, interestingly, the
use of equation 4-B, which accounts for the change in working capital in
94
the cash flow estimation, causes the insolvency-probabilities (in some cases)
to decline. This can be observed by comparing the figures in Panel I of
Table 1 with the corresponding values in Panel II. Typically, including the
change in working capital reduces available cash flows, which in turn increases insolvency risk. The drop in insolvency-probabilities has been
caused by the decline in the firms' working capital. From the model's perspective, the declining insolvency-probability resulted from the increased
cash flow generated by reducing the level of working capital. Obviously,
such a situation is unstable and cannot continue without equity value
deteriorating, thus producing increased insolvency-probabilities. Since the
model considers the firm in a short-term steady-state condition, the results
based on the version where changes in working capital were included may
well be misleading.
Secondly, note that if one expected the sampled firms to earn the return
on assets implied by the Capital Asset Pricing Model (i.e., ROAIV) in the
period 1980-1982, then the implied failure probabilities would have been
lower than those implied by the other versions. However, as noted earlier,
it seems that in periods of simultaneous recession and high interest rates
the results derived under the AMCF approach may be more realistic than
those generated by the alternative (MMCF)approach.
Finally, we have calculated (for both the MNCs and DMCs) the financial
ratios that have been suggested by Altman (1968) as most significant in
discriminating the financially distressed firms from the solvent ones. Using
these ratios, the firms' z-scores have been derived.6
Interestingly, the discriminant analysis yields mixed results for the period
1980-1982. Specifically, while the average z-scores for the group of MNCs
for the years 1980, 1981, and 1982 are respectively 4.00, 3.79, and 3.79,
the corresponding figures for the group of DMCswere 4.12, 4.00, and 3.57.
Thus, the traditional discriminant analysis implies that the group of DMCs
was, on the average, safer than the MNCsin 1980 and 1981, and the MNCs
scored "better" in 1982.
The fact that our model leads to different results than those derived by
Altman's discriminant analysis is not surprising. The two models used different financial information as an input. For example, while the z-score reflects the ratio of working capital to total assets (as a "proxy" for liquidity),
in our model the changes in working capital are used only to adjust the
traditional (net income + depreciation) cash-flow measure. Furthermore,
while the z-score is based on the ratio of pre-tax earnings to assets (as a
"proxy" for return), our model assigns a heavier weight to cash-flow per
unit of assets. Though being biased, we believe that for solvency assessment, the cash flows, rather than the traditional earning figures, are more
relevant. Similarly, while Altman's model utilizes total assests based on
book value, our model has been applied using market value of equity plus
debt.
In sum, although a detailed comparison of the discriminant analysis method
with our model is beyond the scope of this paper, the different results
95
derived by using these two alternative methods are not unexpected. Nevertheless, further research on the compatibility of the two methods might
add insight to this issue.
Selected Financial Variables
The fact that the insolvency-probabilities of the two samples are significantly different suggests that the two groups differ also in the values of
the financial variables inserted into the basic framework. In the following
subsections we discuss the results derived by comparing the values of the
two groups' capitalization ratio, return on assets, standard deviation of
equity and betas of each firm in the samples.
1. Capitalization Ratio. A priori, one would expect MNCs to be highly
leveraged. First, multinationals face more onerous restrictions on the payment of dividends to the parent than on the payment of interest or principal on an intercompany loan (see Hoyt [1972] and Ch. 31 in Brealey
and Myers [1981] ). Therefore, it is generally believed that it may be better
for the parent of a MNC to put up part of the funds in the form of a loan.
Secondly, the total risk of a firm is composed of two elements: business
risk, associated with the operations of the firm; and financial risk, that resulting from leveraging the firm. Thus, if diversifying internationally at the
corporate level does reduce the business-risk, the MNC should be able to
increase borrowing (up to a certain level) while maintaining its total risk at
a level similar to an otherwise comparable DMC.
However, as indicated by Panel I of Table 2, the MNCs are, on average,
more capitalized than the DMCs.
TABLE2
CapitalizationRatio, Equity Variabilityand Systematic Risk: SummaryStatistics
1. Average Capitalization Ratio (E/A)

MNCs
DMCs
t-statistic
(significant)
1980
,598
.505
1981
.577
,492
1982
.599
.521
2.55
(.014)
2.30
(.023)
2.13
(.036)
I. Average Variability of Equity (UE)

MNCs
DMCs
t-statistic
(significant)
1980
.344
.394
1981
.311
.366
1982
,446
.473
-2.62
(.010)
-2.90
(.005)
-1.11
(.312)
96
TABLE2 (Continued)
II. Systematic Risk (3)

Range
.60
.00.61.90
.91 -1.20
1.21 - 1.50
1.51 - 1.80
1.81 - 2.10
Mean 3
t-statistic
(significant)
Frequency Distribution
DMCs
MNCs
.103
.093
.414
.310
.419
.103
.326
.093
.069
.069
1.000
1.253
1.000
.954
-4.70
(.000)
While the average capitalization ratio for the MNCs in the period 19801982 is in the range of .577 -.599, the comparable range for the DMCs
is .492 -.521. Results of the three t-tests indicate that the mean capitalization-ratio of the two samples are significantly different, at a better than
4 percent level. It might be (partially) explained by the fact that in some
countries, regulations require that equity investment in a firm under foreign control be at least as large as reported net fixed assets; and in other
countries, the remittance of dividends and profits is limited to a certain
percentage of registered capital. Such provisions put an effective floor
under the amount of equity capital that must be supplied (for a discussion,
see Hoyt [1972]).
2. Standard Deviation of Equity: Panel II of Table 2 provides the annual
average standard deviation of equity of the two groups. As indicated by
the results, the average standard deviation of equity of the DMCs,is consistently higher than that of the MNCs. A set of three t-tests has been performed, indicating that in 1980 and 1981 the averagesof the two samples
are significantly different, at a better than 1 percent level. Though the
MNCs have a lower equity variability also in 1982, the test's results for
this year are not statistically significant. Note however, that as expected,
the direction of the year-to-year change in UE is the same for both groups.
Thus, the averages in 1981 are both lower than in 1980, and the averages
in 1982 are both higher than in 1981.
The lower equity-variability reported for the MNCs is consistent with the
theoretical hypothesis on risk-reduction as well as with the empirical findings reported by Hughes, Logue and Sweeney [1975].
3. Systematic Risk (Beta). Frequency distributions of the betas are presented in Panel III of Table 2. The results are clearly suggestive; while only
9 percent of the DMCs have beta lower than .90, the comparable figure
for the MNCs is 51 percent. As further indicated by the Table, the mean
beta of the two samples (.95 for MNCs vs. 1.25 for DMCs) differ significantly at a better than 1 percent level. The lower systematic risk recorded
97
for the MNCs is consistent with findings reported by Hughes, Logue and
Sweeney [1975], Rugman [1977] and Agmon and Lessard [ 1977].
4. Return on Assets: The literature lists various theoretical propositions,
typically arguing that MNC has a potential advantage, expected to be reflected in its profits. For example, Hirsch [1976] suggests a cost saving
that permits an increase in the export of intermediate products as well as
entry to market of new products sharing production economies. Agmon
and Lessard [1977] and Lessard [1979] note the incremental value of
being able to arbitrage tax regimes, and Vernon [1979] stresses the information and profit scanning functions of a multinational network. However, the empirical evidence comparing profitability of MNCs with DMCs
is mixed. While one group of studies has reported higher profit rates for
MNCs (e.g., Reuber, et al. [1973], Horst [1975], and Fajnzylber and
Martinez-Tarrago[1976]), a second group has reported higher profit rates
for DMCs (e.g., Newfarmer and Marsh [1981a], [1981b] and Mooney
[1982]) and a third group found no significant differences in profitability
(e.g., Lall and Streeten [1977]). Table 3 presents data on the average return on assets of the two samples under the four alternative measures.
TABLE3
AverageReturnon Assets Basedon AlternativeMeasures
I.
II.
ROA' = [N.I. + Depr.] /Assets

MNCs
1980
.108
1981
.118
1982
.096
DMCs
,116
.118
.089
1981
.112
.101
1982
.097
.101
1982
.131
.115
ROA1' = [N.I. + Depr. + A (W.C.)] /Assets

1980
.101
.103
MNCs
DMCs
III
ROAIII
[N.I. + Depr. + Taxes] /Assets
MNCs
1980
.159
1981
.170
DMCs
.160
.163
IV. ROAIV (Based on the CAPM)

1980
.166
MNCs
DMCs
.169
1981
.158
.162
1982
.112
,118
The results presented in the four panels of this table indicate that the
ROAs of the MNCs and the DMCs are only minimally different. A set of
98
twelve t-tests has been performed (3 years, 4 ROA versions), indicating

that once a particular measure of return on asset is considered, there is no
significant difference between the mean ROA of the two groups. Thus, although the MNCs and the DMCs do differ in their degree of financial
leverage, total risk of equity and systematic risk, they are reasonably comparable in the returnsgenerated by employing their available assets. Hence,
the findings presented in Table 3 are consistent with those reported by
Lall and Streetan.7
5. Size and Industry: Although, as noted earlier, both the MNCs and the
DMCs have been selected from the Fortune 500 list, there is a substantial
difference in the average size of the firms in these two samples. Using our
asset variable (A) to measure size, indicates that the average size of a firm
in the multinational sample in 1980, 1981 and 1982 is respectively $6.25
billion, $7.58 billion and $7.57 billion. The corresponding values for the
DMCs are $578 million, $620 million and $646 million. Note, however,
that in our basic framework the important element is the total debt relative to the total size of the firm (ln (A/D) in equation (2)). Thus, size per
se should not affect the probability-estimates generated by our analysis.
Nevertheless, it is useful to test whether the insolvency-probabilities of
the firms in the two groups differ because of the different extent of international activity or simply because of the size effect. The literature on
multinationals has reported few cases where the firm's size rather than its
international activities was the important explanatory variable. For example, Haegele [ 1974] has shown that while the betas of MNCsare slightly
lower than those of DMCs, when corrected for size, there is no significant
difference between the betas of the two groups. Similarly, size is a significant explanatory variable in the regression results reported by Miller and
Pras [1979].8 Therefore, we have performed a set of twelve one-way
ANOVA, with insolvency-probability as dependent variable, group type
(i.e., MNC vs. DMC) as independent variable and size as a covariate. Thus
we performed the analysis for each year and for each ROA version. The
tests' results indicate that in none of the twelve cases size is a significant
variable. Specifically, the F-statistics ranged in the interval .277 - 2.199
which imply that the corresponding significance levels of the twelve tests
ranged between 13 to 60 percent. Hence, despite the differences in size, it
could not account for the observed difference in the two groups' insolvency-probabilities.
Alternatively, one might want to know whether multinational corporations
are safer because they are multinational or because several of the MNCs
are in the chemical and machinery industries, while the DMCswere mostly
in a set of less technologically advanced material industries. Unfortunately,
the number of sampled firms from each type of industry is not sufficiently
large to generate reliable estimates. In order to derive significant results
for testing the "Industry Hypothesis," one needs a reasonably large number of observations in each industry-type subsample. However, this implies that the sampling criteria for MNCs and DMCswould have to be less
99
rigid. Therefore, we did not pursue this line of investigation within the
scope of this research.
SensitivityAnalysis
Though our main interest in this study is the relative size of the two groups'
insolvency-probability, additional insight might be gained by presenting
the results' sensitivity to changes in values of selected parameters.
1. Level of Debt: The sensitivity of the insolvency-probabilitiesis assessed
by determining the change in the probability, caused by a 10 percent
change in the level of debt. As indicated by the results presented in Panel
I of Table 4, a 10 percent increase in debt causes approximately 15 to 20
percent increase in the averageinsolvency-probability.
TABLE4
AverageProbabilityof Insolvency:1SensitivityAnalysis
I.
The Sensitivity of the Results to the Level of Debt (Do)

1980
D
D
D
= 1.1 Do
= Do
= .90Do
1981
1982
MNCs
DMCs
MNCs
DMCs
MNCs
1,586
1,346
8,312
7,339
6,475
1,693
1,476
11,382
10,303
6,393
5,504
1,283
9,342
4,705
1,133
The Sensitivity of the Results of Equity Variability (OE)

1980
1981
MNCs
DMCs
DMCs
MNCs
1,705
1,812
11.399
8,488
UE = 1.11E
1,476
10,303
1,346
7,339
OE = 0E
1,173
6,271
1,028
9,261
OE = -906E
DMCs
23,515
20,678
17,932
II.
1982
MNCs
DMCs
23,550
6,805
5,504
4,318
20,678
17,810
III. The Sensitivity of the Results to the Auditing Interval (T years)

1980
MNCs
T
T
T
= 2.0
= 1.0
= .50
8,786
1,346
121
1981
DMCs
25,844
7,339
1,021
MNCs
8,982
1,476
120
1982
DMCs
37,191
10,303
1,558
MNCs
26,578
5,504
566
DMCs
61,983
20,678
3,855
1. Notesa. The averages are multiplied by 1 million (for ease of presentation).

b. The results are based on ROA1 (similar sensitivity has been observed using the other ROA
versions).
Similarly, a 10 percent decline in the level of debt also results in approximately 15 to 20 percent decrease in the average probability. However,
creditors are most likely interested in the absolute value change (in the
probability) rather than in its percentage change. Therefore, it is important
100
to note that the absolute-value changes in the average insolvency-probabilities are larger for the DMCs.9
2. Equity (Asset) Variability: Another factor affecting the probability
of insolvency is the standard deviation of assets. As the standard deviation
increases, there is increased risk that the firm's anticipated debt level at
the end of the period will exceed its asset level, resulting in insolvency.
Given our estimation procedure (i.e., equation 3), the standard deviation
of assets is a linear function of the standard deviation of equity. Thus, for
a given capitalization ratio, the effect of a 10 percent change in aE is equivalent to that of a 10 percent change in oA. Results of such sensitivity
analysis are presented in Panel II of Table 4. As indicated by the results,
the effect of a 10 percent change in asset variability is approximately 15
to 20 percent change in the averageinsolvency-probability. Again, it is the
riskier group (i.e., the DMCs) which is most sensitive to changes in the
value of the parameters.
3. Auditing Interval."As indicated by Panel III of Table 4, by increasing
the auditing frequency by a factor of 2 (i.e., T = .5), the averageinsolvency
rate drops dramatically. On the other hand, reducing the auditing frequency by a factor of 2 results in at least a tripling of the average insolvency-probability. Again, it is interesting to note that when the auditing
frequency is reduced the absolute increase in the averageinsolvency-probability is larger for the DMCs.
SUMMARY
This study provides a comparison of insolvency-probabilities associated

with a sample of multinational corporations and a control group of
domestic corporations.
The results suggest that:
(a) the mean insolvency-probability of the DMCs is significantly higher
than that of the MNCs;
(b) the MNCs are significantly more capitalized than the DMCs;
(c) the average standard deviation of equity of the DMCs is significantly
higher than that of the MNCs;
(d) the average systematic risk (beta) of MNCsis significantly lower than
that of DMCs;
(e) the mean ROAs of the two groups are not significantly different;
(f) the fact that the MNCs are substantially larger than the DMCsis not
significant in explaining the observed difference in their insolvencyrates;
(g) the results are moderately sensitive to changes in financial leverage
and asset variability. However, they are highly sensitive to changes in
the assumed auditing frequency;
(h) the average insolvency-probability of the DMCs is more sensitive (to
changes in the values of the parameters) than those of the MNCs.
ARE MULTINATIONAL
CORPORATIONSSAFER?
101
Though the results are clearly suggestive, further research is needed in

order to determine a more specific relationship between risk and the extent of international activity. For example, one might consider a more
intensive utilization of our data on the ratio of foreign sales to total sales.
Hence, to study the differences within a sample of multinational corporations. We hope to report results of such a study in the future.
NOTES
1. Equation (1) abstracts from net changes in outstanding debt during the period. For reasonably
short periods, such net flows are of second order relative to the "stock of debt."
2. Dividends as a fraction of assets (rather than the traditional dividend payout ratio) is the variable of interest since we need to measure the effect of dividends on the expected growth rate of
assets backing the firm's liabilities. The measure is the appropriate one and has the same dimensionality as the other rates in equation (2).
3. This is a standard textbook adjustment for the effects of leverage. See, for example, the text by
Weston and Brigham [1982].
4. For an excellent review on the problem of defining a multinational firm see Aharoni [1971].
More recently, Miller and Pras [1979] reviewed the criteria most commonly used now.
5. This criterion is identical to the one used by Kelly and Phillippatos [1982].
6. Based on Altman's results, the z-score value of financial viability is calculated from the following financial data:
z = 1.2A + 1.4B + 3.3C + 1.OD + 0.6E
Where:
A
B
C
D
E
=
=
=
=
=
Working capital/assets
Retained earnings/assets
Pre-tax earnings/assets
Sales/assets
Market value of equity/liabilities
A firm scoring less than 1.8 is classified as troubled.
7. Note, however, that unlike other studies referred to in this subsection, we have used the debt
plus market value of equity rather than book value of equity in estimating the total asset parameters.
8. However, in their regressions, product diversification and geographic diversifications are also
significant explanatory variables.
9. Technically, this is fully explained by the shape of the normal distribution. The riskier firm will
be closer to the mean of the standardized distribution than the low risk firm; thus for a given change
in any of the parameters in equation 2, the change in the area under the normal curve is greater for
riskier firms.
102
Appendix 1: MNCs'Percentageof ForeignSales to Total Sales

CPC
BLCKDECK
COLGATEP
GILLETTE
PFIZER
DOWCHEM
IBM
FORD
HEWLETTP
MERCK
STERLING
AVONPROD
AMERSTAN
XEROX
COCACOLA
JANDJ
WARNERLA
BUR ROUGH
SINGER
GOODYEAR
MINNMINE
HEINZ
EASTMKOD
SPERRY
ELILILLY
KIMCLARK
OWENSILL
SCOTTPAP
MOTOROLA
BRISTOLM
INGERSOL
AMERCYNA
FIRESTON
OCCIPETR
AMERHOME
LEVISTRA
TEXASINS
PANDG
UNIONC
DUPONT
MONSANTO
BORGWARN
DEERE
HONEYWEL
GENFOODS
CONTINGR
GENMOTOR
TRW
DRESSER
RALSTON
BEATRICE
UNITECH
LITTON
EATON
GENELEC
INTLPAP
PHILLIPS
CATERPIL
1980
1981
1982
66.4
67.1
61.4
60.5
56.8
51.7
52.6
50.3
50.8
49.5
47.0
49.0
47.4
46.7
44.7
45.6
47.0
43.7
43.4
44.1
41.5
41.1
41.5
39.6
39.9
41.3
38.7
36.3
38.2
36.6
37.3
35.6
36.9
44.7
35.2
34.6
34.3
32.4
31,5
28.3
32.1
32.5
29.6
30.6
27.2
29.8
27.9
29.2
28.1
25.0
23.6
23.8
20.7
20.9
22.5
24.9
20.8
21.5
64.4
63.2
58.7
57.3
56.8
47.9
48.1
48.4
48.2
46.7
46.2
47.9
44.8
44.5
45.0
44.0
42.6
40.2
40.6
41.0
39.3
39.9
38.0
39.3
38.2
36.5
37.8
36.6
36.4
36.0
34.0
35.0
34.9
31.7
33,6
33.0
31.9
32.8
31.4
29.5
29.9
31.0
28.2
29.0
30.9
25.1
25.0
23,9
23.0
24.0
23.1
22.1
24.5
24.1
20.9
20.7
21.3
18.6
65.2
62.7
58.5
55.4
52.6
52.2
44.6
44.6
41.3
44.0
45.0
40.6
43.7
42.9
42.7
42.6
41.7
41.5
39.8
38.4
38.3
37,2
38.7
37.9
35.9
35.2
36.1
37.1
32.5
34.0
35.1
35.3
31.2
25.4
30.8
31.9
30.7
31.2
33.2
33.3
29.1
25.1
30.4
27.4
25.0
24.4
23.0
22.4
22.6
24.0
23.0
21.5
22.1
18.8
20.2
17.0
19.4
19.3
3-year Average
65.3
64.3
59.5
57.7
55.4
50.6
48.4
47.8
46.8
46.7
46.1
45.8
45.3
44.7
44.1
44.1
43,8
41.8
41.3
41.2
39.7
39.4
39.4
38.9
38.0
37.7
37.5
36.7
35.7
35.5
35.5
35.3
34.3
33.9
33.2
33.2
32.3
32.1
32.0
30.4
30.4
29.5
29.4
29.0
27.7
26.4
25.6
25.2
24,6
24.3
23.2
22.5
22.4
21,3
21.2
20.9
20.5
19.8
Appendix2: The SampledMNCsand DMCs

MULTINATIONAL CORPORATIONS
BEATRICE FOODS CO
CPC INTERNATIONAL INC
GENERAL FOODS CORP
HEINZ (H.J.) CO
RALSTON PURI NA CO
COCA-COLA CO
LEVI STRAUSS & CO
INTL PAPER CO
KIMBERLY-CLARKCORP
SCOTT PAPER CO
JOHNSON & JOHNSON
MINNESOTA MINING & MFG CO
AMERICAN CYANAMID CO
DOW CHEMICAL
DU PONT (E. I.) DE NEMOURS
MONSANTO CO
UNION CARBIDE CORP
AMERICAN HOME PRODUCTS CORP
BRISTOL-MYERS CO
LILLY (ELI) & CO
MERCK & CO
PFIZER INC
STERLING DRUG INC
WARNER-LAMBERT CO
COLGATE-PALMOLIVECO
PROCTER & GAMBLE CO
AVON PRODUCTS
OCCIDENTAL PETROLEUM CORP
PHILLIPS PETROLEUM CO
FIRESTONE TIRE & RUBBER CO
OWENS-ILLINOIS INC
CONTINENTAL GROUP
GILLETTE CO
DEERE & CO
CATERPILLAR TRACTOR CO
DRESSER INDUSTRIES INC
BLACK & DECKER MFG CO
INGERSOLL-RAND CO
BURROUGHS CORP
HEWLETT-PACKARDCO
HONEYWELL INC
INTL BUSINESS MACHINES CORP
SPERRY CORP
GENERAL ELECTRIC CO
LITTON INDUSTRIES INC
SINGER CO
MOTOROLA INC
TRW INC
TEXAS INSTRUMENTS INC
FORD MOTOR CO
GENERAL MOTORS CORP
BORG-WARN ER CORP
EATON CORP
UNITED TECHNOLOGIES CORP
AMERICAN STANDARD INC
EASTMAN KODAK CO
XEROX CORP
DOMESTICCORPORATIONS
CONAGRA INC
FEDERAL CO
KANE-MILLERCORP
AMERICAN BAKERIES CO
AMSTAR CORP
CONE MILLS CORP
LOWENSTEIN (M.) CORP
INTERCO INC
VF CORP
LOUISIANA-PACIFIC CORP
SKYLINE CORP
FEDERAL PAPER BOARD CO
GREAT NORTHERN NEKOOSA CORP
HAMMERMILLPAPER CO
POTLATCH CORP
SOUTHWEST FOREST INDUSTRIES
HARCOURT BRACE JOVANOVICH
SCOTT & FETZER CO
DONNELLEY (R. R.) & SONS CO
DORSEY CORP
HOOVER UNIVERSAL INC
WALTER (JIM) CORP
ANCHOR HOCKING CORP
BROCKWAY INC
IDEAL BASIC INDUSTRIES
CARPENTER TECHNOLOGY
CYCLOPS CORP
NORTHWEST INDUSTRIES
NUCOR CORP
HANDY & HARMAN
INSILCO CORP
CECO CORP
TYLER CORP
BRIGGS & STRATTON
ROPER CORP
EAGLE-PITCHER INDS
BIG THREE INDUSTRIES
STORAGE TECHNOLOGY CORP
NORTH AMERICAN PHILIPS CORP
NATIONAL SERVICE INDS INC
BANGOR PUNTA CORP
TALLEY INDUSTRIES INC
DAN RIVER INC
103
104

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Are Multinational Corporations Safer?

Author(s): Israel Shaked

Abstract. The failure-probabilities of a sample of multinational

JOURNAL OF INTERNATIONALBUSINESSSTUDIES, SPRING 1986

usually exists for economic phenomena to move more or less in unison,

initiated for the conglomeration-analogy by Higgins [1971 ], and has been

The issue of whether the market assignsdifferent measures of risk to MNCs

JOURNALOF INTERNATIONALBUSINESSSTUDIES, SPRING 1986

methodologies employed in these papers can be broadly divided into two

Asset return dynamics can be described reasonably well by the lognormal

where g is the promised interest rate on debt.' Assuming , is the expected

where N(.) is the cumulative standard normal distribution. Given estimates of

A time interval of one year is assumed. A public company may go no longer

JOURNAL OF INTERNATIONAL BUSINESS STUDIES, SPRING 1986

(net income + depreciation)/assets

or by including changes in working capital in the cash flow,

[net income + depreciation? (Aworkingcapital)] /assets

with the following notation:

JOURNALOF INTERNATIONALBUSINESSSTUDIES, SPRING 1986

[E(RM ) - RF ]: The long-term historical risk premium is used. In the

Since Lilienthal [1960]

and the commonly applied definitions as well as the available source of