THE FINANCIAL MANAGEMENT OF FOREIGN DIRECT INVESTMENT: A CASE STUDY OF DUTCH FIRMS INVESTING IN EUROPE

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THE
FINANCIAL MANAGEMENT
OF
FOREIGN
DIRECT INVESTMENT
:

A CASE STUDY OF
DUTCH FIRMS INVESTING IN EUROPE








Wim Westerman

July
2005








**********************************************



Dr. W. Westerman


Faculty of Management and Organization

Universit
y of Groningen

P.O. Box 800

9700 AV Groningen

The Netherlands

Telephone: +31
-
50
-
3637088

Fax: +31
-
50
-
3637356

Internet:
w.westerman@bdk.rug.nl




1

The financial management of foreign direct investment:

A case study of

Dutch firms investing in Europe




Summary


We examine the
financial
management

of

seven
cases on industry
-
leading Dutch firms

invest
ing in Europe
.
Our
r
esults are as follows.
W
hile the internationalisation of the firm is
largely fixed before a

current investment, quite varying strategic analyses
do
shape the outline
of the actual financial analysis. As financial modelling gets more detailed and diverse over
time,
the
emphasis shifts from accounting to present value selection methods. Financial
risks
do not always matter that much, but financing aspects receive a place in the process.
Organisation and behaviour do not play independent roles, but it matters to nurture culture
and communication. The firms’ investment patterns
found
mainly vary

as

t
o growth strateg
ies

(acquisition
s

or greenfields), size of the firm, investment size and corporate governance style.




1.

Introduction


An increasing number of firms grow by investing abroad. Though mostly nearby countries are
at stake, investment processes

soon become complex. Even so, we still need a framework that
reconciles foreign direct investment processes in adjoining countries. Dutch practices in
Europe will be used to exemplify such a model. Dutch firms are among the world’s main
investors and thei
r investments in a changing Europe may be interesting.
We use

a financial
management perspective

to examine the processes with seven cases. T
he research strategy
employed and the research object
s

selected are accounted for in § 2.

A

comprehensive

conceptua
l
model on financial management with European investments is outlined in §
3
.
P
atterns of similarities and differences with the cases are searched for

in § 4
.
The c
onclusion
s
to
the

case study

are given in § 5. S
uggestions to practice and science finally f
ollow in

§ 6
.




2

2.

Research strategy and research object
s


The
research strategy

united the experience of the
reporting
researcher, a vast literature
survey and a multiple case research study.
A first research model was largely drawn from the
author’s involveme
nt with foreign direct investments (FDI’s) in
foremost
Europe.
The actual
results of the firms dealt with were
mostly
sati
s
fying, but
not always encouraging: some of
the

firms

even went bankrupt. T
here was much literature about many aspects of

FDI
processe
s
, which might have been of help to these investors
1
. However, often either
greenfield investments or mergers and acquisitions were studied
, whereas a

comprehensive

analytical financial management perspective
was

absent.
I
t was felt that research
on actual

pr
actices

would offer deeper and broader knowledge

on this matter
.

Therefore,
a
pr
ocess
oriented

field research approach dominated the research strategy in the years 1999 to 2001.



The field research was framed as a multiple case study.
Case research

was

partly carried out
real
-
time, balancing on the delineation between the research and its context, while the number
of variables mounted and information was tapped from various sources [Yin, 1994]. The
actual case selection and a small questionnaire added a

limited survey character

to the mainly
qualitative study.

The case research was divided into three largely discernable phases. In the
preparation phase, the problem statement was formulated and put into a conceptual
framework, at the same time practicing
with a case of a non
-
European investment. In the
execution phase, the seven cases were studied extensively, largely led by personal contact
with a key informant. The conceptual model was filled in during the analysis phase. Patterns
were searched for, the
model was examined and final remarks were formulated.


European investments

mainly occurred in the European Union (EU). The EU had a common
market, joint policies on growth, free markets and competitiveness, as well as much influence
in Central and Southe
ast Europe [http://europa.eu.int, 2002]. Local competition was fuelled
by corporate law harmonisation, preventive supervision on concentration and decreasing
fiscal competition. Liberalisation and deregulation of European banking, the advent of the
euro as

a single European currency and harmonisation of financial reporting and disclosure



1

T
he author’s personal
web
s
ite, accessible via http://www.rug.nl/fmo, contains a list of references, which
can
also

be
supplied on request.




3

came to pass. Confirming international trends, Dutch firms’ mergers and acquisitions,
peaking in 2000, had a much larger volume than their greenfields [Myiake and Sass, 200
0;
http://www.dnb.nl, 2002]. In the changing and growing Europe, many industries were
attractive to Dutch investors.
Actual
cases were reasonably spread over
these sectors
and
concerned diverse European countries
.


The Dutch
firms to be studied

had to stri
ve for European market development. This excluded
global firms such as Unilever and Philips, as well as primarily cost and tax driven investors.
In order to be relevant, financial considerations had to play a role in the investment selection.
Only expert f
irms, investing at least three times in Europe between 1995 and 2000, were
singled out. A balance between greenfields and acquisitions, having different speed of market
development, was struck. Other characteristics
that were
assessed
included both
the siz
e of
the firm and the size of the capital investment
,

the scope of an investor: the number of
countries to be invested in at once
, the organisation of the

relevant financial function

and the

location of corporate head
-
offices
as a proxy for

different
inves
tment styles

(
even in a small
country as The Netherlands actually is
)
. A so
-
called top 40 of corporate Dutch investors was
drawn up from different sources. Seven firms were selected ultimately.


The first
case

came from a nutrition firm with a success sto
ry: Numico. The Pan
-
European
merge of the Dutch Nutricia with the Milupa business of the German Altana firm made both
subsist. The temporary work firm Randstad did a large greenfield investment in Italy along
with a major German acquisition. NNZ was a repu
ted smaller regional grocery firm. Having
made a major acquisition before, she was active at the time as well. Dredging firm Boskalis
allowed studying a Scandinavian takeover. A co
-
steering strategy and business development
function drew attention here. Co
ntacts could be most frequent at the close by small machine
builder Bollegraaf that was conquering Europe (e.g. Spain) with her greenfields. The mid
-
sized coffee roaster Drie Mollen, located in another part of The Netherlands, had just
concluded a takeover

in Switzerland. The fish and meat chain firm Nutreco employed lasting
“M&A” functions. Targeted European businesses included the vast Norsk Hydro Seafood.






4

3.

Conceptual framework


Our analytical framework treats financial management processes with Europea
n investments.
F
inancial management

is limited to corporate capital budgeting and corresponding treasury
management issues.
European investments

primarily refer to foreign direct investments in the
European Union and the European Free Trade Organisation (E
FTA). The terminology used
takes a broad
process

approach. Words such as procedure, approach and activity
fit with this
.


The first major study on (even foreign) direct investment processes was written by Aharoni
[1966]. He focused on FDI decision process
es, not
on
the final decision
-
making. Bower
[1970] analysed the resource allocation process, covering more than just financial investment
selection. He delineates intellectual activities of perception, analysis and choice (decision
-
making) from social proc
esses when executing phrased strategies (organisational behaviour).
This distinction leads us to a
conceptual model

akin to a two
-
sided coin. Wissema [1985]
discerns strategic evaluation from financial evaluation. Financial risk and financing aspects
may
a
lso
be singled out in FDI processes [Buckley, 1996]. The front of the model culminates
in the capital investment selection. The back is on organisational and behavioural aspects that
shape FDI
-
processes too [Tomkins, 1991]. External to the model are firm c
haracteristics and
environmental characteristics that show up in various checklists [cf: Pike and Neale, 1993].


We follow the good
-
old Dutch business administration [Bouma, 1982] when aligning means
and goals in a hierarchical
chain of relations
. The fin
al goal of any investment is to ensure the
financial viability of the firm. The four capstones of financial management processes of FDI
in Europe include strategic investment analysis, capital investment selection, financial risk
and investment financing,
as well as organisation and behaviour. Each of these is assessed
both separately and in conjunction as to feasibility. Strategic investment considerations
(means) align to ways of capital investment selection (goals), taking financial risk and
investment f
inancing aspects (derived means) into account. Organisational and behavioural
aspects form boundary conditions of the investment process, but are also strived for (as goals)
and employed (as means) on their own (coherent) merits.
Figure 1

gives

the resulti
ng model.





5

Figure 1.

Foreign direct investments in Europe: a process approach


Strategic investment
analysis



Capital investment

selection



Financial risk &
Investment financing


Organisation &
Behaviour


Strategic test
investment?

Asses
sment financial

value creation?




Effect financial risk &

investment financing?

Control organisation &
behaviour investment?




Internationalisation firm



nature advantages



design investment



motives investment

Financial modelling



design activities



prof
its, cash flows
and balance items



hurdle rates



Financial risk



business risk



currency risk



political risk

Organisation



management control



phasing activities



internal and exter
-

nal involvement



responsibilities



Strategic techniques



strategic design



strategic planning



strategic portfolio



strategic value
management





Selection methods



accounting



discounting



shareholder value








Investment financing



capital structure



pecking order of
financing



capital sources



settlement of
obligations



leg
al structures



fiscal techniques

Behaviour



aspirations



solving orientation



mental mapping



risk attitudes



timing



use of information



opportunism



reputations



Strategic

Feasibility

Feasibility when using
financial investment
selection criteria

Feasibili
ty after
applying risk and
financing aspects

Organisational, social
and personal feasibility










Feasibility investment







6

4.

C
ase study results


Elaborating on the
strategic investment analysis

above,
the internationalisation of the
firm

is
in

the
sample
l
argely resolved before a new investment

starts
.
Our sample of European
leaders is biased towards exploiters of market power advantages that simultaneously
capitalise on cost advantages
2

[Porter, 1990].
Almost all of
the
firms invest in Europea
n
markets that are still mainly local. Local market conditions lead them to either greenfields or
(rather)
acquisitions.
A
cquisitions may become platforms for greenfield courses, though.
Industry customs determine percentages of ownership issues. Europe is

really a regional bloc
[Rugman, 2003], but scopes differ when penetrating local

markets
. Concrete investment
motives are intrinsic to a firm’s ability to exploit her own advantages.
“Pure” acquirers
Numico, NNZ, Boskalis, Drie Mollen and Nutreco pursue gr
owth by utilising fit and synergy,
whereas “greenfielders” Randstad and Bollegraaf aim to grow by building on their capacities.


The internationalisation of the firm affects the use of
strategic techniques
, which are
assimilated in
private
checklists.
Four

groups of strategic techniques prevail [Mintzberg and
Lampel, 1999].
Design techniques
,

such as SWOT analyses
,

dominate greenfields
. P
lanning
techniques, including brainsto
r
ming, benchmarking and quantified plans,
or portfolio
techniques
,

such as
the famo
us BCG matrix
,
dominate acquisitions.
Foremost the l
arge firms
Numico, Randstad and Nutreco
tend to incline towards strategic value management
techniques

that focus on value chains and competencies
. Large investments are
just
little
more assessed than smal
l investments. Anglo
-
Saxon oriented firms (notably Nutreco and
Boskalis) put slightly more weight on strategic value management techniques than Rhineland
oriented firms (notably NNZ, Bollegraaf and Drie Mollen). Still, this may be a matter of time.


Next,

a
s to
capital investment analysis
, we find that large firms amply use
financial modelling

designs, notably for large investments. Depths and widths of modelling, case specificities of
cash flows and discount rates, as well as uses of sensitivity analyses,

also depend more or less
on sizes of firms and investments.
All firms normalise balance sheet, profit and loss and



2

This is reflected by the corporate priorities that range from being number 1 in the market (Bollegraaf) and belo
nging to the global top
(Randstad), via strengthening home market positions (Boskalis) and being a European private
-
label market leader (Drie Mollen), to
specialisation and integration (Numico), developing partnerships (NNZ) and strengthening chain activit
ies (Nutreco).




7

operational cash flow items

from a local point of view
. Financial cash flows are modelled
when financial limitations come up. Financial rati
os are routinely calculated, often later being
an input for further modelling.
Acquirers draw explicit distinctions between stand
-
alone and
synergy effects. Large firms care most for forecast terms and terminal values.
A
ll firms apply,
albeit with differen
t finesse, investment hurdle rates.

Just Anglo
-
Saxon oriented firms hereby
look at country differences, applying capital asset pricing model notions

[Buckley, 1996]
.


All
firms

use multiple
financial investment selection
methods

[Walsh, 1996; Arzac, 2005]
.

All firms use accounting methods, including

revenues, profit and loss items,
price/profit
(per
share)
multiples, cash flows, intrinsic values, stand
-
alone and synergy values, liquidities and
solvencies, returns on sales or investment and payback periods
or break
-
even points.
Still,

all
firms but
the small
Bollegraaf
do

prefer discounted cash flow methods
3
: the net present value
method
,

the internal rate of return method and the flow
-
to
-
equity method. Shareholder value
methods
, favoured by the Anglo
-
Saxon
oriented firms,

extend
these
discounting methods
with a strategic component
[Rappaport, 1986]
or a reporting view

[Stewart, 1991]
.
Only
a
cquirers
explicitly
distinguish between stand
-
alone and synergy values. Greenfielders give
less
attention

to discountin
g methods than acquirers do
. Small firms do not use discounted
cash flow methods. Small investments

are typically subject to just a few accounting methods
.


Furthermore, firms pool corporate finance theory, agency considerations and institutional
approach
es on
financial risk and investment financing

[Tempelaar, 1986].
Sampled Dutch
f
irms map and reduce
financial risks

with European investments
manifold
4
. They
counter

business risks

with

fi
n
ancial
history analyses
,
credit controls, insurance policies,
procu
red
guarantees and prudent local co
n
duct
. Oddly, just investments in distinct countries at times
lower
these

risks. Outside of notably the euro zone, currency risks are hardly felt.
Even if
material, the
se

risks may be left unhedged.
Larger firms seem to h
edge
least
, probably due to
their financial buffers. Smaller investments often require less hedging. European political
risks differ a little per regional bloc
. If considered to be negative, they

are not permitted to be
too high
.
Political risks are felt h
ard to

quantify
, but the larger firms do give it a try
.





3

The actual number of financial investment selection method types applied for decision
-
making ranges from five to ten in the sample.




8

The
investment f
inancing

is
is limited by means of conservative
capital structure standards,
ruled by debt ratios, interest coverage ratios and at times liquidity ratios partly set by banks.
Financin
g mixes follow pecking orders mitigated by risk, taxes and control considerations.
Firms consecutively use up operational cash flows, short
-
term and long
-
term credit facilities,
possibly asset leases, mezzanine financing and deferred loans or shares.

Small

firms do not
issue shares for investments, just as Rhineland
-
oriented firms tend not to do this. Customs
determine the settlement of liabilities. The sampled firms employ legally allowed structures.
Greenfields by definition ask for new structures. The fi
scal potential in the host countries is
applied properly too, whereby opportunities with greenfields and acquisitions differ mutually.
In the sample, the care for financial risks and investment financing is of a more general
nature, while the adjusted pres
ent value method [Shapiro, 1988]
meets
little response
5
.


We finalise our discussion by
looking for patterns on
investment
organisation and behaviour
.
Organisation

is about who does what and how [Simon, 1976; Anthony and Govindarajan,
2004].
Management co
ntrol is mainly hard with large investments.
It is

subject to corporate
culture and corporate governance style.
Except for the project oriented Boskalis, firms
evaluate local subsidiaries. Only Nutreco once did post investment audits. The investment
activi
ties divide into three parts: idea framing, decision
-
making (informing, negotiating and
binding) and execution.
Greenfielding may take more time, but tends to be less structured
than acquiring. Informal investment teams cover key corporate functions. Anglo
-
Saxon
oriented firms have “M&A” specialists and may have more clear
-
cut responsibilities. Firms
direct core
(fi
n
ancial)
processes on their own
. However,
smaller firms have fewer
in
-
house
(financial) specialists

and banks, accountants and legalists step in

more here. The board of
d
irectors
does the

final
d
ecision
-
making
,
thereby
controlled by
the board of
commissioners.


Behaviour

is about why (not) to do things somehow.
B
ehavioral theory of the firm [Cyert and
March, 1963], agency theory [Jensen and Meckli
ng, 1976] and behavioral finance
notions

[De Bondt and Thaler, 1994] shed light upon investor behaviour rationality. Corporate and
personal a
spirations levels align

and are set high.
In
vesting is all about solving problems,
though.
It

goes stepwise, unbund
led and cyclical.
Lucid strategic and financial “mapping” is






4

Sensitivity and scenario analyses, which all of the sampled firms but Bollegraaf use, have little impact
on the financial risk assessment.

5

Booth [2002] shows that the applicability of the APV
-
method is limited in practice because of the circular reasoning involved.




9

important with large investments. Risks are
smoothed away if needed
.
Corporate cultures
affect investment paces
. A
nglo
-
Saxon oriented firms
resolve on
the
se by
themselves. T
ime
pressures are

beni
gn
. I
nformation gaps
are
closed

by sourcing widely
. Anglo
-
Saxon
oriented

firms are opportunistic
. This also

goes for
greenfielders.

Confidence is built up over time.

Personal reputations are quite collective, as financial responsibilities are jointly felt.

Here as
well as before, culture is linked to communication: acculturation [Grotenhuis, 2001].



5.

Conclusions


A closing balance of our study on financial management of European investments by Dutch
firms can be made up

now
. The internationalisation of the
firm sets the outline for an actual
investment. The strategic investment feasibility is assessed with checklists. As
the
financial
modelling gets more detailed and diverse, the emphasis shifts from accounting to present
value selection methods. The capital

investment selection culminates in assessing the
financial value creation. Financial risks do not always matter that much. Investment financing
aspects receive a place in the financial valuation and
later on
. Organisational and behavioural
aspects usually

do not play an independent role, but nurturing culture and communication
aspects is important.
All in all,
financial management of
near
-
by FDI’s

is about aligning
strategy and finance, thereby having regard for structure, culture and communication aspects
.


As to
content aspects

(strategic investment analysis, capital investment analysis, as well as
financial risk and investment financing) of our framework, a broad profile matches the cases.
The firms make both greenfields and acquisitions in Europe. Inves
tment motives are foremost
commercial and stress synergy with the present firm. Strategic techniques are assimilated in
checklists used. Profits and cash flows are normalised along private standards and targeted to
the local situation. Discount rates are s
moothened, but slightly diversified per country. All
firms use more than one accounting method. Present value methods are not common, though.
A rise of business risks is evaded. Currency risks are hardly felt. Countries with political risks
that are too hi
gh are evaded. Financial structures are mainly determined by traditional
measures. Financing is done with private and bank funds. Liabilities are settled according to
local customs. Firms e
xploit

legally
allowed

structures. The fiscal potential is used
pro
perly
.




10

The
contextual aspects

(organisation and behaviour, including culture and communication)
can be commonly marked as follows.
The m
anagement control

of ne
w businesses

is hard
.
Investments occur in three phases: idea, design and execution. Corporate fi
nancial and other
officers, mutually sparring and using external help, perform the financial management. The
firm herself directs the team tasks. Financial core competencies must be available in
-
house.
When investing, the best for the firm is strived for.
Decent manners are united with trade
spirit. Division, co
-
ordination and process agreement effectuate solutions to problems.
Rationality and sense align when investing. Limited entrepreneurial risks are accepted. Time
pressures are hardly felt. Information

shortages are covered.
C
onfidence

is created over time
.
Firms seize their chances disciplined. Personal reputations are not
too
much at stake.


We turn to
content

d
ifferences

in the sample now. S
trategic investment analys
es
,

being

done
with checklists an
yway,

are subject

to growth strategies
.
A
s to capital investment selection,
variances
on

depth and breadth of modelling, calculating and weighting financial sensitivities,
forecast period and terminal value handling, cash flows and discount rates adjustmen
t,
number of selection methods applied and weight of accounting methods compared to discount

methods

can also be traced to investor size, investment size and governance style
.
Th
e same

goes for f
inancial risk and investment financing aspects

in the sample
.

These

vary

on
significance attached to risks, currency risk hedging, negatively or positively sensing political
risks, financing by (deferred loans or) new shares, legal structure development, as well as
on
fiscal treatments.
G
eographical
factors

do
have
more
of
a
n autonomous

role

here
.


We finalise our conclusions with a reference to the
context differences

found in
our
case
research study.
Organisation aspects vary as to manner and degree of investment phasing
structuring, overall division of responsibi
lities, chief financial officer responsibility, presence
of specific M&A officers and data collection outsourcing.
This is especially due to corporate
governance styles and ways of acculturation.
The same factors also largely determine the
d
ifferences in b
ehaviour
. These

differences
concern accuracy of mental framing at an
investment, initiating on forwarding a process and style of negotiating away controversies
.

The
relatively
low organisational and behavioural
variety

may be
due

to
sample
homogeneity
,
as

the
seven Dutch
case firms share many corporate and environmental characteris
t
ics.




11

6.

Recommendations


Extending the conclusions

now
, various recommendations
apply here
.
Fi
nancial management
of a European investment start
s

with an apprehension of the interna
tionalisation of the firm
.
This

sets the table for result patterns. Understanding strategic backgrounds will help to
develop and correctly apply suitable checklists. Financial management tones must already
firmly resonate
here
. Financial modelling deals wi
th deepening

the former
, as for stand
-
alone
power and synergy effects, in terms of (semi
-
) long
-
term cash flows and discount rates.
Proper usage of several selection methods, not inevitably the most difficult ones,
will
enable
multiple financial assessment
s. Inevitable risks
must

be taken care of, as well as effects of the
financing on financial structures.
A
lso
,

a solid investment organisation, as well as a (fitting)
feeling and a (hard working) mind, will have to accommodate the procedure. The financial
m
anagement function should as a rule have a co
-
steering say in an investment process.


If financial management does have a guiding role in the FDI process, the literature should
accommodate this more than up to now. Internationalisation aspects are hardly
judged
scientifically on financial value management merits. Also, connecting links from production
strategy to financial valuation should become more apparent. Scientific value management
approaches do actually provide for this, but concretisations are too

easily left to practitioners.
Current firewalls between accounting models and present value models may well be
overcome by developing effective and efficient shortcuts. It is also wise to sort out which
capital selection method has to come first under wha
t circumstances.
Realigning ambiguous
risk classifications will lead to increased coverage of

f
inancial risk in capital investment
selection.
F
inancing
has got to

be

included in capital investment selection
more
univocally

than the APV method suggests
. If
not,

financial valuation will too often remain fragmented.


Control of FDI processes is a mix of management control, organisational control and task
control. Management control during an investment is of higher importance than the literature
suggests.
The
re is

a need
of studying

financial activities

next to the

financial function

itself
.
We singled out several aspects that may guide investor behaviour in a broad sense. We
revealed a lot of results, such as on information handling and entrepreneurial attitu
des, which



12

ask for further in
-
depth research. If including a behavioural factor into organisational,
strategic and financial aspects, interdependencies and dynamics in processes may be captured
well. Our study shows that culture and communication variables

may help to unveil neglected
aspects of financial management of FDI. Values and norms, knowledge and experience, feel
and ratio, sense and phrase, as well as rituals and routines can be key elements

to

study

l
ocal
differences. This may
further insights w
ith

FDI processes
, especially

in the now enlarged EU.


References


Aharoni, Y.,
The Foreign Investment Decision Process
, Harvard Business School, Boston,
1966.

Anthony, R.N.; V. Govindarajan,
Management Control Systems
, Irwin, Homewood Il, 11th
edition 20
04.

Arzac, E.R.,
Valuation for mergers, buyouts, and restructuring
, John Wiley, Hoboken, 2005.

Booth, L., Finding Value Where None Exists: Pitfalls in Using Adjusted Present Value,
Journal
of Applied Corporate Finance
, Volume 15 Number 1, Spring 2002, pp.

95
-
104.

Bower, J.L.,
Managing the Resource Allocation Process: A Study of Corporate
Investment
, Harvard Business School Press, Boston Mass, 1970 (reprint 1986).

Bouma, J.L.,
Leerboek der Bedrijfseconomie, deel 1; Inleiding
, Delwel, Wassenaar, 1982.

Buckle
y, A.,
Multinational Capital Budgeting
, Prentice
-
Hall, London, 1996.

Cyert, R.M.; J.G. March,
A Behavioral Theory of The Firm
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-
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