Halle Institute for Economic Research (IWH) Corporate Governance and Financial Constraints in foreign owned Enterprises Gauselmann, Andrea Noth, Felix Ljubljana,

Contents 1. Motivation and Research Question 2. Data and Descriptives 3. Empirical Results 4. Conclusion and Policy Implications Ljubljana, Halle Institute for Economic Research (IWH)

Ljubljana, Halle Institute for Economic Research (IWH) Motivation Post-transition economies: institutional, many inter-firm structures and overall integration in the global economy were decisively influenced by Foreign Direct Investment (FDI) Post-transition economies: institutional, many inter-firm structures and overall integration in the global economy were decisively influenced by Foreign Direct Investment (FDI) important objectives of FDI: contribute to alleviation of capital shortage (Welfens and Borbély 2009; Stephan 2003; Stephan 2013) important objectives of FDI: contribute to alleviation of capital shortage (Welfens and Borbély 2009; Stephan 2003; Stephan 2013) investment decisions of firms – disregarding ownership structure – depend on financial factors such as internal finance and access to new finance (Črnigoj and Verbič 2013; Hubbard 1998; Francis et al. 2013) investment decisions of firms – disregarding ownership structure – depend on financial factors such as internal finance and access to new finance (Črnigoj and Verbič 2013; Hubbard 1998; Francis et al. 2013) 1 1. Motivation and Research Question

Research Question Are those subsidiaries that posses more power over their business decisions locally – and are therefore more independent from the headquarter – more likely to face financial constraints? Ljubljana, Halle Institute for Economic Research (IWH) 2 1. Motivation and Research Question

Literature Measures of corporate governance: either on the national level development (Hardi and Buti 2011, Aguilera and Jackson 2010) or ownership structure (Gugler and Peev 2010, Mykhaykiv and Zauner 2013) firm internal corporate governance structure in multinational enterprises not been widely discussed in IB literature yet we look only at foreign owned firms and use survey information on the distribution of power over business functions between headquarter and subsidiary Ljubljana, Halle Institute for Economic Research (IWH) 3 1. Motivation and Research Question

IWH FDI Micro database Ljubljana, Halle Institute for Economic Research (IWH) Host countries EST, HU, PL, SL, SK EG*, RO, HR, PL, SL EG EG, RO, SK, CZ, HU, PL EG EG, RO, SK, CZ, HU, PL EG EG, RO, SK, CZ, HU, PL Sectors Manufac- turing Manufac- turing, selected Services Manufact- uring, selected Services Type of FDI Inward Inward Outward Focus Pilot Survey Techno- logy Transfer Business Forecast Investment motives & location Business Forecast Production & Innovation Linkages Business Forecast Upgrading, Financial Restrictions FundingIWH EU FP5 IWH EU FP6 IWH IWH EU FP7 Note: *EG = East Germany 4 2. Data and Descriptives

Table 1: Financial constraints in subsidiary per country 2013 in % (N=609) Ljubljana, Halle Institute for Economic Research (IWH) shows the share of firms per country that experienced financial constraints in 2013 we find that on average 13% of firms were financially constrained ranging from only 4% in Slovakia to roughly 32% in Romania Data and Descriptives

Table 2: Decision power over business functions between HQ and subsidiary Ljubljana, Halle Institute for Economic Research (IWH) 6 2. Data and Descriptives Source: Questionnaire 2013, Q 19, IWH FDI Micro database 2013.

Table 3: Power division between HQ and subsidiary 2013 in % (N=609) Ljubljana, Halle Institute for Economic Research (IWH) around 8% of subsidiaries hold all the decision power while in 30% the decision power is only with the headquarter highest concentration of decision power within the headquarters in firms in Romania and Slovakia Source: own calculations, IWH FDI Micro database Data and Descriptives ~ 65%

Empirical results I – probit estimation Ljubljana, Halle Institute for Economic Research (IWH) BaseFinancialsW/o GermanyIV-Regressions Power (Investment)Power (Financing) Power division0.0077*0.0082*0.0083*0.3185** (0.0045)(0.0043)(0.0044)(0.1273) Cash ** * ** ** (0.1070)(0.1040)(0.7151)(0.1036)(0.1081) Working capital (0.0315)(0.0326)(0.1516)(0.0313) Sales (0.0067)(0.0074)(0.0441)(0.0068) Profits *** *** *** *** (0.0782)(0.0839)(0.7412)(0.0783)(0.0787) Equity (0.0327)(0.0329)(0.1315)(0.0335)(0.0339) Power (Investment) (0.0303) Power (Financing)0.0494* (0.0287) IndustryYes CountryYes Observations Pseudo R Log Likelihood Source: own calculations, IWH FDI Micro database Empirical Results

Empirical results II – squared terms results Ljubljana, Halle Institute for Economic Research (IWH) Source: own calculations, IWH FDI Micro database Empirical Results

Conclusion Allocating more decision power to subsidiaries only increases financial constraints if the decision power is initially very concentrated with the headquarter Allocating more decision power to subsidiaries only increases financial constraints if the decision power is initially very concentrated with the headquarter Square term results show that the effect of financial constraints within the subsidiary decreases and finally turns insignificant when decision power moves from headquarter to subsidiary Square term results show that the effect of financial constraints within the subsidiary decreases and finally turns insignificant when decision power moves from headquarter to subsidiary in order to alleviate financial frictions as much power as possible should be allocated to the subsidiary in order to alleviate financial frictions as much power as possible should be allocated to the subsidiary Ljubljana, Halle Institute for Economic Research (IWH) Conclusion and Policy Implications

Policy advice economic policy should encourage foreign investors to leave/give as much power over corporate governance structures to/ in the subsidiary as possible economic policy should encourage foreign investors to leave/give as much power over corporate governance structures to/ in the subsidiary as possible extent of decision power also depends on the affiliate’s position in the global value chain within MNE extent of decision power also depends on the affiliate’s position in the global value chain within MNE not only quantity but also structure of incoming FDI important: value-adding FDI  more decision power over business function and less financial restriction  fosters further investments not only quantity but also structure of incoming FDI important: value-adding FDI  more decision power over business function and less financial restriction  fosters further investments Ljubljana, Halle Institute for Economic Research (IWH) Conclusion and Policy Implications

Thank you for your attention! Ljubljana, Halle Institute for Economic Research (IWH)

Literature II Measures of financial constraints: firms’ financial reporting that indicate financial constraints like sales or profitability (Whited and Wu 2006, Hadlock and Pierce 2010) or estimation of the sensitivity of investments to cash flows (Almeida and Campello 2007 or Behr et al. 2013) we follow first way to measure financial constraints and use survey information indicating whether management regards the firm as financial constrained or not Ljubljana, Halle Institute for Economic Research (IWH)

Major findings Our results show that the marginal effect is only significantly positive, if the subsidiary has decision power over less than 5 business functions Our results show that the marginal effect is only significantly positive, if the subsidiary has decision power over less than 5 business functions If the decision power is highly concentrated in the subsidiary, allocating more decision power to the subsidiary has no significant effect on financial constraints If the decision power is highly concentrated in the subsidiary, allocating more decision power to the subsidiary has no significant effect on financial constraints Ljubljana, Halle Institute for Economic Research (IWH)

Policy advice economic policy should encourage foreign investors to leave/give as much power over corporate governance structures as possible economic policy should encourage foreign investors to leave/give as much power over corporate governance structures as possible extent of decision power also depends on the affiliate’s position in the global value chain within MNE  extent of decision power also depends on the affiliate’s position in the global value chain within MNE  not only quantity but also structure of incoming FDI important: value-adding FDI  more decision power over business function and less financial restriction  fosters not only further investments but also positive external spillovers Ljubljana, Halle Institute for Economic Research (IWH)