How emerging economy firms lose money

22 August 2014

How emerging economy firms lose money

 How do the financing strategies of foreign acquisitions impact on the subsequent financial performance of emerging economy firms?

 

Globalisation may not improve performance for emerging economy firms.

In the past three decades, firms from emerging economies have expanded internationally in an aggressive manner. Cemex (Mexico); Vale (Brazil); Huawei, Lenovo and TCL (China); Tata Motors, Tata Steel, Tata Consulting Services, Infosys, Hindalco and Sulzon (India); and Lukoil (Russia) are among these firms. A number of them have engaged in cross-border acquisitions by buying out Western firms. Yet, the financing strategies of such foreign acquisitions have been largely ignored.

We have studied the financing strategies of foreign acquisitions and their impact on the subsequent financial performance of emerging economy firms. To do so, we examined the capital structure of the firm, i.e. the specific mixture of long-term debt and equity the firm uses to finance its operations.

We have three important findings that are relevant to managers:

 

  1. We find that debt is the major financing source that emerging economy firms use to pay for foreign acquisitions.
  2. Debt financing increases the risk profiles of emerging economy firms and weakens their capacity for servicing interest and principal repayment obligations. This is due to poor financial performance in the post-acquisition period. As a consequence, some of these mega acquisitions end in divestments and asset disposals, in which the proceeds are used to reduce debt and redress the balance sheet. This heavy reliance on debt financing reflects serious agency problems in emerging economy firms.
  3. Many of these emerging economy firms have failed to develop the new dynamic capabilities needed to augment their current capabilities and to exploit the new firm-specific assets obtained through acquisitions.

 

Overall, cross-border acquisitions are very difficult, and can result in financial losses, not just for emerging economy firms, but also for Western firms.

 

Dr Quyen T K Nguyen 
Lecturer in International Business and Strategy, Henley Business School, University of Reading

 

Professor Alan M Rugman (1945 - 2014) 
Head of International Business and Strategy, Henley Business School, University of Reading

(In Memoriam, Professor Alan Rugman 1945-2014)

To read more about how emerging economy firms lose money, please read the full paper.