Existing Theories Of Multinational Companies Economics Essay

In recent times, emerging economies have surprisingly produced their own indigenous multinational companies. This development is described as surprising, simply because neither earlier economic theories nor more recent theories of the multinational enterprise anticipated such a development. Theories suggest investments should flow into, and not out of deprived countries, and also that companies attain the multinational status particularly as a result of innovations which are expected to be present in highly developed countries, rather than in emerging economies (Goldstein, 2007). However, these assumptions have been increasingly challenged by multinational companies from countries like India, China, South Africa, Brazil, Egypt and in this particular case Nigeria.

Companies from most of the countries mentioned above are a combination of manufacturing and service companies, which include the likes of Ranbaxy, an Indian pharmaceutical company, Lenovo a Chinese computer manufacturer, such as Tata, Wipro, and Infosys all Indian technology services companies, South African brewer SAB-miller, Brazil’s Embraer, one of the world’s leading aircraft makers and China’s Huawei Technologies Co. Conversely, the highest proportion of Nigerian companies expanding to foreign countries are Nigerian Banks. A considerable number of which now own and operate branches or subsidiaries in various countries within the West African region and beyond. The multinationalisation of these banks represents the main focus of this study, with a microscopic look at the challenges they face and the impact of internationalisation on their performance. But before I proceed, I present some empirical data about the magnitude of multinational banking amongst Nigeria banks, highlighting the name of the bank, country where they are located, the type of presence and the year of first entry into the country.

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2.1 Existing theories of Multinational Companies

The internationalisation of companies has been studied using various contextual frameworks. Over time, numerous authors from different disciplines such as economics, business management, and sociology have examined this trend among companies, particularly those from developed economies. According to research, a company may engage in international business through importing and exporting, the licensing or sale of technology, foreign management contracts, trade of turnkey projects, strategic alliances, or through Greenfield foreign direct investments. The eclectic paradigm, behavioural models, dynamic capabilities and resource based view, the monopolistic advantage and product life cycle, are all examples of theories which have been developed to explain the internationalisation of firms.

2.2 Definition of Multinational Banking

A bank may be typically defined as an institution where people and other institutions can invest or borrow local or foreign money. Mark Casson (1990) suggests that the definition of a bank varies depending on the context of analysis. He describes a bank as “an institution specializing in the purchase and claim of currency, or claims to currency”. Banks sometimes specialise in various activities, as banking can be segmented, hence it is not a standardized activity. According to Casson (1990), banking consists of a group of unique but related activities which can, and are often conducted by different individuals, in different locations. Therefore, as banks conduct there core banking activities such as receiving deposits, giving out loans, and exchanging currency, they also provide such services as the issuing of notes, securities services, clearing and settlement related services and so on. Casson (1990) then describes the Multinational bank as “a bank that owns and controls banking activities in two or more countries”. This definition of the multinational bank is widely encompassing, as it stresses the importance of not just owning banking activities in another country other than the home country, but the bank in question must also control (manage) such banking activities, meaning there has to be some kind of modification in the bank’s organisational configuration. Hence, these definitions will be adopted for the purpose of this study.

2.3 History and Evolution of Multinational Banking

It is important to note that multinational banking is not a new phenomenon. According to Jones (1990), multinational banking occurred in two waves. The first of which emerged in the 19th century, with British banks being the broadest example. Appearing in the 1830s, British multinational banks operated with headquarters in Britain, but seldom conducted domestic banking activities in Britain. By the early 19th century they had set up huge branch networks in parts of the British Empire, particularly in South Africa and Australasia. The international expansion of banks varied from country to country. Other banks from different countries like Germany soon followed the British banks, with branches in London and subsidiaries in different locations such as Asia and Latin America. However, the multinational banks from Germany were mostly established by major German domestic banks through consortiums. Multinational banks from France adopted a comparable approach to multinational banking as their German counterparts; they too were set up by domestic banks. On the other hand Japanese banks foreign expansion was highly facilitated by the Japanese government in response to western initiatives (Tamaki, 1990). Surprisingly, American banks weren’t very active in international banking in the 19th century. Swiss banks are believed to have also had little international presence during this period, though they undertook international banking activities. Cassis (1990) suggests that this may have been due to Switzerland’s lack of colonial activities, a phenomenon closely linked with multinational banking during the 19th century.

Some major characteristics of multinational banking during the 19th century were highlighted by Jones (1990). Firstly, most of them focused on setting up branches in developing countries; Secondly, multinational banks offered diverse banking services in their foreign branches, such as trade finance, investment banking and domestic retail banking services; Thirdly, banking across borders extended into multinational investments in other sectors. For instance, Barings Brothers & Co Ltd, a British merchant bank, invested directly in land development in Maine, while they were operating in the United States in the 1790s.

The second wave of multinational corporate banking began in the 20th century (Jones, 1990). Leading this wave, Commercial banks from America expanded rapidly to foreign countries (Huertas, 1990) while American investment banks discarded their dependence on intermediaries and started making foreign direct investments (Scott-Quinn, 1990). Major British banks with previously few or no international presence, opened branches in foreign countries and acquired branches in the United States (Jones, 1990). Between the 1960s and 1980s, Japanese banks had significantly increased there international expansion, having over 200 foreign branches (Kawamoto, 1987). However, Jones (1990) also highlights the differences between the first and second waves of multinational corporate banking. Some of the features he highlighted include;

2.3.1 Geographical location- Though multinational banks from both waves established in major financial centres, London became a key destination for banks, as a result of the creation of the Eurodollar market in the 1950s. The rise of the Asian Dollar markets, in addition to the emergence of offshore centres in the 1970s, also made Singapore, Bahrain and Hong Kong magnets for multinational bank branches. He also notes that multinational banks from the second generation paid more attention on developed economies, rather than the developing economies which their predecessors focused on. Deregulation in the banking sector of Australia and Canada in the 1980s also, encouraged multinational banks to locate branches there. Yet some American banks continued the pattern of 19th century banks by locating in some developing economies, principally in South America.

2.3.2 Products offered – Multinational banks from both periods offered similar products, but some differences were present. He suggested that the Eurodollar and the Eurobond markets where the major differentiating factor between products offered in both periods. In addition, domestic retail banking in foreign countries was becoming an unpopular trend among the 20th century banks. Because of the widespread notion that foreign banks attempting a domestic retail banking strategy were almost likely to fail, except by acquiring a local bank (Huertas, 1990).

Other authors have studied the international expansion of banks from other countries. For example, trade finance has been described as a major factor that fuelled the internationalisation of Arab banks in the 1950s and 1960s (Shoker, 1990). Norwegian multinational banks like German banks were a product of consortia relationships with other Nordic banks, due to restrictive domestic regulation in Norway between 1960s and 1970s (Boldt-Christmas et al., 2001). All these studies simply indicate that the institutional environment in which a bank like every other enterprise operates has an impact on its behaviour.

2.4 The development of Multinational banking: A theoretical viewpoint

In comparison to the multinational bank, a lot more research has been conducted on manufacturing multinational companies. This resulted in the development of a theoretical framework for understanding the behaviour of the multinational company, while the multinational bank suffered from not having a definite theoretical structure for a long period. As a result, numerous authors, for example, Grubel (1977), Gray and Gray (1981), and Casson (1990), who attempted to develop a theory for the multinational bank, found it useful to analyse the multinational bank through the lens of the manufacturing multinational. These authors tried to assess the similarities or differences in behaviour between the multinational bank and the manufacturing multinational, by essentially seeking the likely motivations for banks to internationalise. For instance, Grubel (1977) made an attempt to tackle this problem by firstly analysing various types of operations of commercial banks, namely retail banking, wholesale banking and service banking, which he then compared against the theory of the multinational company. And this led to the development of the very first theory of multinational banking, where Grubel (1977) suggests that “the basic analytical question to be answered by a theory of multinational banking is identical to that present in the case of foreign direct investment: what is the source of comparative advantage accruing to a U.S bank in a place like Singapore, which is in competition with local banks having obvious advantages in their familiarity with local customers, capital markets, employees and government? Put differently and applied to the special problem of banking, the basic phenomenon to be explained by the theory of multinational banking is why a bank abroad can profitably offer lower lending rates and higher borrowing rates than its domestic competitors and thus attract customers from them”. Grubel (1977) argues that there are similarities between the theoretical explanation for multinational retail banking and that of foreign direct investment in the manufacturing multinational developed by Kindleberger (1969). Citing the use of management technology and marketing expertise, both of which can be deployed across borders at low marginal costs, as a source of competitive advantage to a multinational bank operating in a foreign country. Though he concedes that such advantages are trivial, considering the ease at which banking management technology can be accessed or acquired by banks generally. Grubel (1977) suggests that market imperfections from country-to-country enables multinational banks to stabilise their earnings through the geographic diversification of their business portfolio, and as such acts as an ample incentive for a bank to internationalise. Although a more recent study by Slager (2006) argues that not all multinational banks are able to stabilise their earnings through operating within different financial markets.

Furthermore, regarding multinational service banking, Grubel (1977) linked the growth of world foreign direct investment to the emergence and growth of multinational banking. He explains that banks internationalise in a bid to protect the business relationship they have built with there local customers, by going abroad to serve the banking needs of the customer’s foreign subsidiary, in order to avoid losing the customer to the domestic banks in the foreign country where the subsidiary is located. The ability of the banks to provide such services is based on the wealth of knowledge they possess about the business operations of their client, which makes it relatively cheaper and quicker to respond to the client’s financial needs than any local competitor in the host country. By drawing on the knowledge about the taste and preferences of tourists or business people from their home country, multinational service banks can also extend their services to these groups of individuals in foreign countries where they have a presence, in order to ensure their customers do not seek alternative services from domestic banks in the foreign country (Grubel, 1977). The strategy of protecting relationships established with both corporate and individual clients is referred to by Grubel (1977) as a “defensive” strategy. Regarding the provision of wholesale banking services, though domestic banks can provide similar wholesale banking services to local clients, Grubel (1977) suggests that multinational banks have an advantage over their domestic counterparts. An advantage borne out of factors such as lower operating risk and/or cost, exemption from some domestic regulatory requirements, avoiding the marginal cost associated with retail banking (since they deal mainly with large customers), they also diversify their risks through the relationships they have with other multinational banks, which they use in facilitating loans to their customers. Wholesale multinational banks as a group typically act as conduits for the flow of capital among nations, by identifying where there are excess funds and channelling them to locations where there are shortages through a fast and efficient system (Grubel, 1977). In opposition, Aliber (1984) in his evaluation of literature on international financial intermediation criticised Grubel’s attempt, claiming the theory fails to provide a solid explanation on the source of advantage which the multinational bank has over its domestic competitors.

In slight contrast to Grubel’s approach, where he conducted an analysis of the multinational bank by contrasting three different operational categories of commercial banks against the theory of the multinational company, Gray and Gray (1981) approached the analysis of the multinational bank by applying the core characteristics of the theory of the multinational company to the trend of multinational banking. Gray and Gray (1981) argued that the “conditions which generate efficiency gains and augment profits in multinational banking are the same as those which apply to non-financial multinational corporations”. They employed Dunning’s eclectic model as a tool for explaining the behaviour of the multinational bank, by looking at the ownership-specific advantages, internalisation incentive advantages and the location specific variables that may trigger the multinationality of a bank. In a bid to simplify the application of the eclectic theory to multinational banking, Gray and Gray (1981) decided to make the assumption that the ownership-specific advantages required for a bank to consider internalising its efficiencies already exist, therefore, they focus on the internalisation incentive advantages and location specific advantages of the theory. Further, Gray and Gray (1981) explain that before a bank can consider multinationality, it must possess the ability to provide a specialised service that can be applied beyond its home market, or it must possess a reputation for either efficiency, provision of quality information or creditworthiness (the assumed ownership specific advantages) which will enable it benefit from extending its operations beyond its domestic market. Building on Grubel’s (1977) study, Gray and Gray (1981) identified circumstances which may act as incentives for banks to expand into foreign markets. The conditions identified were based on the features of the eclectic theory; internalisation efficiencies and location specific considerations. The conditions include imperfections in product markets, economies of internal operation, preservation of established customer accounts, entry into growth markets, ensuring access to raw materials and the escape motivation from home or host country regulations. The commercial bank’s multinationality is derived from two sets of forces. The first set of forces lets the commercial bank reap the inherent benefits of having a presence in a foreign national market (which hosts both foreign and domestic banks), while the second makes it possible for the bank to operate in a supranational financial market (where activities are mostly confined to off-shore banking, with less regulatory constraints). Thus, the multinational bank is not only able to take advantage of different national markets like its non-financial opposite number, but it is also able to gain considerably from connecting national markets with the supranational market. And the latter point above was suggested to be a more significant factor in comparison to the former (Gray and Gray 1981).

The eclectic paradigm represents a basic reference in the multinational enterprise literature, due to its eclectic method, enormous explanatory strength, and improved measurability (Goldstein, 2007). Also, considering the fact that Dunning’s eclectic theory has been successfully employed by numerous authors (e.g. Grubel, 1977, Gray and Gray, 1981, Yannopoulos 1983, Casson 1990,etc) to the analysis of the multinational bank, this theory will be adopted for the purpose of analysing the multinationalisation of Nigerian banks, which represent the focus of this study. An overview of the eclectic theory is given below, followed by its application to the multinational bank.

2.5 John H. Dunning’s Eclectic Theory

According to John H. Dunning’s (1977, 1980) eclectic theory, the foreign direct investment decision is a combination of three interrelated factors. These factors are itemised as follows; Ownership specific, internalisation, and location specific factors. All three of the aforementioned factors of the eclectic theory are considered to have a crucial impact on the investment decision by the multinational enterprise. A combination of the internalisation, industrial organisation, and the location theories, the eclectic theory proposes that prior to becoming multinational, a company must possess an ownership advantage, which needs to be internalised (often as a result of market failure), following which location specific variables will determine the place (country) where the multinational enterprise invests.

Table 1.2 below highlights the eclectic framework of different investment types

2.5.1 Ownership Specific Advantages: According to Dunning (1988), these advantages (also known as firm specific advantages) are borne out of three things; they include, access to credit from the parent company at little or no cost, access to markets, as well as factors resulting from being multinational (e.g. exploitation of different markets). Normally referred to as “intangible assets”, these advantages will allow a company from one country to compete in another alongside the host country’s domestic organisations, who already possess the advantage of being home-grown, resulting from there being more familiar with the people, market and the environment in general. Such ownership advantages basically represent a precondition to becoming multinational. Examples of these advantages include innovation (e.g. research and development), product differentiation, economies of scope, core competence in managerial or entrepreneurial capacity, monopoly knowledge of markets or products, etc. Most of which are developed over time and allow the multinational to overcome the costs attributed to operating in a foreign country (Dunning, 1988).

2.5.2 Internalisation Advantages: Dunning (1988) argues that the need for internalisation is as a result of market failures. In order to take advantage of these market failures, the multinational company opts for an organisational form (varying from arm’s length transactions to a wholly owned subsidiary) which is most favourable to it. And by internalising numerous activities within the organisation, transaction costs can be reduced to the minimum in an inefficient market.

2.5.3 Location specific advantages: Also known as the country specific advantages, this element of the eclectic paradigm determine where the multinational will internationalise to. Dunning (1988) explains that a firm will expand to foreign markets to match its ownership advantages with available factors of operation in a country and earn revenues as a result. Hence, this advantage is interdependent with both the ownership and internalisation decisions. Location advantages may include the economic performance of the host country, institutional arrangements, input prices (e.g. labour costs), tax regimes, trade barriers, socio-political situations, cultural differences, etc. It is these country specific advantages that clarify why multinational company decides to have a presence in a certain host country through FDI, as opposed to conducting business with the country from a distance.

Therefore, the chronological nature of these advantages indicates that an ownership advantage has to exist, prior to internalisation of activities, due to market failure. Following which location specific factors will point to the direction where the investment goes (Dunning, 1988).

2.6 Application of the Eclectic Theory to Multinational Banking

In a bid to simplify the application of the Eclectic theory to multinational banking, Gray and Gray (1981) assumed that the multinational bank already possessed the required ownership advantages. This decision to make such an assumption resulted in a shift in focus to the location and internalisation advantages of the multinational bank. However, the approach was further developed by Yannopoulos (1983). According to Yannopoulos (1983) the eclectic theory was broad enough to accommodate the different markets where the multinational bank operates i.e. the national and supra-natural markets (e.g. Euromarkets). Ownership advantages are a very critical element of the eclectic model, as they are a prerequisite to the banks ability to neutralise or even overcome the advantage the domestic banks have in the host country. One of such ownership advantages is product differentiation, a noteworthy advantage in banking, which has been suggested by Yannopoulos (1983) to be a product of two factors: the first is the importance of certain major currencies (e.g. the dollar) in international trade and finance. While the second is the importance of non-price competition in the banking services market. Described by Aliber (1984) as the currency clientele, the importance of major currencies will attract customers to the bank which is incorporated in the country of origin of the transaction currency, due to the bank’s established ability to carry out transactions denominated in the currency in question. However, Lewis and Davis (1987) contend that banks do not require a physical presence abroad in order to exploit the currency clientele advantage. They suggest the advantage could equally be enjoyed through correspondent banking. Nonetheless, Yannopoulos (1983) went further to suggest that a multinational bank can engender both short-term and long-term advantages for itself through apparent differentiation and perceived product differentiation respectively. While apparent differentiation is associated with the terms of the service provided by the multinational bank, perceived differentiation is related to the bank’s credit rating, it’s supposed possibility of loan renewal, and its size. However, factors associated with perceived differentiation (e.g. bank size, credit rating, etc) are believed to produce a more sustainable advantage for the multinational bank, considering the difficulty of imitating them (Merrett, 1990).

Internalisation in multinational banking basically springs from information (Williams, 1997). For instance, the need of a multinational bank to internalise the relationship it has with a company from its home country by providing banking services to the company’s subsidiary in a foreign market is based on the information the bank possesses about the business needs and general operation of the parent company. Yannopoulos (1983) and Boldt-Christmas (1987) both advice that information has a vital purpose in multinational banking, giving that the relationship between a bank and its client is essentially based on information flow. Furthermore, due to factors such as the rather short valuable life of most information and the advantages of owning the information gathering process (Buckley and Casson, 1987) it is necessary for a bank to have a direct physical presence in foreign markets. Although they are crucial, location specific variables are not enough for a bank to internationalise (Williams, 1997). Yannopoulos (1983) highlights examples of location advantages in multinational banking to include varying regulatory structures, geographical distribution of the bank’s clients, investors risk exposure, labour migration leading to the banks accompanying their retail customers, access to skilled labour and information gathering.

An additional application of the eclectic model to multinational banking by Cho (1985) provided other explicit examples of the three elements of the model in relation to multinational banking. Considered to have the possibility of being short-lived (Williams, 1997) ownership advantages were classified by Cho (1985, 1986) to consist of managerial resources, wide spread and efficient banking networks, favourable financial sources, experience and knowledge in multinational operations, skilled human resources, prestige, ascertained credit worthiness, differentiation of banking products, and expertise in servicing a certain customer type. He went further to suggest that information provides the opportunity for the bank to distinguish itself by targeting its products to a specific group of customers or markets on the basis of having greater knowledge. Cho (1985 and 1986) then classified location advantages into five categories; regulatory frameworks, effective interest rate differences, different economic situations, nationality of banks, and socio-economic differences. Also classified in to five categories are internalisation advantages, the first category is the availability and cost of fund transfer within the multinational banks, second is efficient customer contacts, third is transfer pricing manipulation, fourth are improved networks for information gathering and the last is the potentially reduced earning variability.

2.7 Incentives for banks to expand abroad

Various factors influence the decision of banks to venture into foreign markets. The following section explains some of the factors that influence the decision of where banks go when expanding abroad.

Kindleberger (1983) examined the customer leading and customer following incentives of banks to internationalise. He concluded that banks can act both as leaders of customers to foreign markets, and also as followers of their customers to foreign markets, explaining that neither internationalisation incentive overrides the other. Aliber (1984) suggested that banks based in countries with a high ratio of market to book value seem better placed to expand to foreign countries. Furthermore, research on Japanese banks’ international expansion indicated that regulation could act as a catalyst for a bank’s foreign expansion (Poulsen, 1986), while regulation has also been identified to be an obstacle to the entry of banks into foreign markets (Tschoegl, 1987). Jones (1990), attributes the internationalisation of banks to “entrepreneurial perceptions of profitable opportunities in conditions of expanding territories and imperial frontiers, a desire to apply domestic banking skills in foreign markets, the wishes of politician for banks”, the value of having a presence in major international financial centres and the establishment of branches in foreign countries in order to maximise profit by limiting the role of intermediaries. There are also arguments about the most suitable theory to be employed in analysing the reasons why banks internationalise, and their ensuing performance therein. Williams (1997) argued that the internalisation theory provides a more encompassing framework for examining the multinationalisation of banks, than the eclectic theory which has been used by numerous authors. Although he concedes there is little between both theories regarding there ability to provide an explanation for multinational banking. Table 1.3 below highlights some of the main incentives put forward by a host of authors to explain why banks internationalise. This is then followed by an individual analysis of the incentives.

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2.7.1 Customer

Like the Japanese automobile component manufacturers who accompanied Japanese car makers to the US (Banerji and Sambharya, 1996), banks also follow their customers abroad. According to Metais (1979, cited in Aliber, 1984) the act of banks following and serving their customers abroad can be described as the gravitational pull effect. This action has been attributed to numerous reasons. For instance, it has been suggested that due to the inability of domestic banks in the host country to effectively service the needs of foreign company subsidiaries or branches, banks from the home country of these companies are encouraged to internationalise, especially in a situation where the level of financial innovation or expertise in the host country is inferior to that which is obtainable in the home country. This factor has been proposed as an explanation to the development of overseas branches of colonial banks in the nineteenth century whose branches were mainly located in developing economies (Aliber, 1984). Another reason why banks tag along with their customers during international expansion is that banks try to mitigate the risk of loosing their customers to domestic banks in the host country where their customers expand to, especially if the level of banking in the host country is more advanced than that of the home country. According to Walter (1988) a bank’s presence in a foreign country helps it strengthen its relationship with firms from its home country. Thereby ensuring the client-bank relationship is further enhanced. Put simply, banks follow their clients abroad to maximise the internalisation benefits developed in the home country, thereby providing additional collective gains for both parties (Slager, 2006). On the other hand, banks can also act as leaders of their domestic customers into foreign markets. Walter (1988) suggests that a bank with a strong presence abroad can offer the services required to support the decision of a company to expand to the host country where the bank already has a presence. Given their experience operating in such host countries, multinational banks can spot business opportunities which may be favourable to their domestic clients back home, and facilitate their entry into the market by making use of their knowledge of the environment.