Recently, I read a fascinating paper titled by Marcus Biermann and Kilian Huber, published in The Journal of Finance. The study provides profound insights into how multinational firms transmit economic shocks across countries through their internal capital markets [1]. The paper’s findings are particularly compelling as they illuminate the mechanisms by which financial disturbances in one country can ripple through the global economy, affecting numerous international affiliates and ultimately impacting real economic growth. The paper demonstrates that multinational firms play a crucial role in transmitting economic shocks across borders via their internal capital markets.
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Introduction
Biermann and Huber's study focuses on a specific credit supply shock to parent firms in Germany, notably induced by a lending cut from Commerzbank, one of Germany's largest banks. The researchers meticulously trace the repercussions of this shock, revealing how international affiliates of these German parent firms became financially constrained, leading to diminished real growth and a cascade of economic impacts across borders. Their findings highlight a critical duality in managerial behavior within multinationals: while managers adopt a "Darwinist" approach towards international affiliates, prioritizing efficiency and performance, they exhibit "Socialist" tendencies within the home country, showing a bias towards protecting domestic affiliates.
The Role of Internal Capital Markets
The intricate dynamics of internal capital markets within multinational firms are central to understanding how economic shocks are transmitted internationally. Biermann and Huber's research delves into the mechanisms of these internal capital flows and their substantial influence on global capital movements.
Internal Capital Markets
Internal capital markets refer to the financial interactions and transactions that occur within a multinational firm, encompassing both the parent company and its international affiliates. These internal flows can include loans, equity investments, and other financial transfers. The significance of these markets is underscored by the fact that, in recent years, internal capital flows between multinational parents and their affiliates have accounted for over 50% of total capital inflows into the median country and constituted approximately 4% of the gross domestic product (GDP) in the median country.
Case Study: The Commerzbank Lending Cut
The research focuses on a specific instance of internal capital market dynamics: the lending cut by Commerzbank, a major German bank, during the 2008/09 financial crisis. This lending cut directly affected German parent firms but did not initially impact their international affiliates. However, the internal capital markets facilitated the transmission of this shock. Affiliates in other countries increased their internal lending to support their German parents, which resulted in financial constraints and lower growth for these affiliates.
Empirical Evidence and Findings
Biermann and Huber provide robust empirical evidence supporting the critical role of internal capital markets. Their findings indicate that the real effects of the Commerzbank lending cut were concentrated among affiliates that increased internal lending to their parent firms. These affiliates experienced significant declines in sales and employment, highlighting the adverse consequences of internal capital reallocations during financial shocks. The study also reveals that affiliates with access to developed external credit markets were better able to mitigate these negative effects, underscoring the importance of well-functioning financial markets.
Broader Implications
The implications of these findings are far-reaching. They emphasize the need for policymakers to consider the role of internal capital markets in the global economy. During times of financial distress, the interconnectedness of multinational firms can amplify the transmission of shocks, affecting multiple countries and regions. Understanding these dynamics is crucial for developing effective policy responses that can mitigate the adverse impacts of financial crises and promote global economic stability.
Methodology
The methodology employed by Biermann and Huber in their research combines detailed microdata with a quasi-experimental research design. This approach allows the authors to isolate the effects of a specific credit supply shock on multinational firms and their international affiliates.
Quasi-Experimental Design
To identify the causal impact of a credit supply shock on multinational firms, Biermann and Huber exploit a quasi-natural experiment provided by the lending cut of Commerzbank, a large German bank. This lending cut, which occurred during the 2008/09 financial crisis, serves as an exogenous shock to the credit supply of German parent firms. The key advantage of this approach is that it allows the researchers to distinguish the effects of the shock from other confounding factors that might simultaneously affect both parent firms and their affiliates.
Data Sources
The study utilizes three primary data sources:
- Microdatabase Direct Investment (MiDi): This database, maintained by Deutsche Bundesbank, provides detailed balance sheet information on international affiliates of German parent firms, including data on internal capital market positions.
- Corporate Balance Sheets (Ustan): Also from Deutsche Bundesbank, this dataset contains annual balance sheets of German parent firms, offering insights into their financial health and credit relationships.
- Credit Rating Agency Data: Data from Creditreform, a German credit rating agency, is used to identify the relationship banks of German parent firms, which is crucial for measuring their dependence on Commerzbank.
Identification Strategy
The identification strategy hinges on comparing the growth of international affiliates of German parent firms that were dependent on Commerzbank for credit (treatment group) to those that were not (control group). By focusing on firms with varying levels of dependence on Commerzbank, the authors can isolate the impact of the lending cut.
Measuring Commerzbank Dependence
To quantify the dependence of German parent firms on Commerzbank, the researchers construct a measure based on the fraction of a parent’s relationship banks that were Commerzbank branches in 2006, before the financial crisis. This measure captures the extent to which a parent firm relied on Commerzbank for credit, providing a basis for the treatment and control comparisons.
Econometric Model
The main econometric model used in the study is a panel regression that estimates the impact of parent Commerzbank dependence on various outcomes for international affiliates, such as sales, employment, and internal lending. The model includes affiliate fixed effects to control for time-invariant characteristics of the affiliates and year fixed effects to account for macroeconomic shocks. Additionally, the model incorporates controls for size, industry, country, and leverage, all interacted with time fixed effects.
Robustness Checks
To ensure the robustness of their findings, Biermann and Huber conduct several additional analyses:
- Pre-treatment Trends: They verify that affiliates of parents with high Commerzbank dependence and those with low dependence were on parallel growth paths before the lending cut.
- Alternative Specifications: The authors test the robustness of their results to different definitions of the treatment variable, balanced panel data, and additional controls.
- Excluding Confounding Factors: They perform analyses to exclude affiliates in countries where Commerzbank had a significant presence, ensuring that the observed effects are not driven by direct credit supply changes to these affiliates.
Transmission Mechanism
Understanding the transmission mechanism of financial shocks within multinational firms is crucial for comprehending how these shocks propagate across borders and impact global economies. Biermann and Huber's research provides detailed insights into this mechanism, highlighting the pivotal role of internal capital markets.
Internal Lending and Financial Constraints
The core mechanism identified in the study is internal lending. When the parent firm in Germany faced a credit supply shock due to Commerzbank's lending cut, it turned to its international affiliates for financial support. This internal lending, while temporarily alleviating the parent's financial distress, imposed significant financial constraints on the affiliates. Affiliates that provided internal loans to their parent firms experienced a reduction in their own available capital, leading to decreased investment, lower sales, and reduced employment.
Evidence from Sales and Employment Data
The empirical evidence shows a marked decline in sales and employment among international affiliates that increased internal lending to their parent firms following the Commerzbank lending cut. The researchers found that affiliates with higher levels of internal lending experienced a substantial drop in sales, which persisted for several years before beginning to recover. Employment data mirrored this trend, with affected affiliates reducing their workforce in response to the financial constraints imposed by internal lending.
Darwinist vs. Socialist
The study reveals a dual approach in managerial behavior within multinational firms. Managers exhibited "Darwinist" tendencies towards their international affiliates, prioritizing support from affiliates with higher growth potential while allowing weaker affiliates to face the full brunt of the financial constraints. This selective support strategy aimed to maximize the overall performance of the multinational firm by allocating resources to the most promising affiliates.
Conversely, within the home country, managers displayed "Socialist" behavior, showing a bias towards protecting domestic affiliates regardless of their performance. This home bias resulted in less severe impacts on German affiliates, even if they were financially weaker. The contrast in managerial behavior highlights the complex decision-making processes within multinational firms during times of financial distress.
Role of Developed Credit Markets
The study also examines the role of external credit markets in mitigating the effects of internal capital market shocks. Affiliates located in countries with developed credit markets were better able to access external financing, which helped cushion the impact of the internal lending demands from their parent firms. This access to external credit allowed these affiliates to maintain higher levels of sales and employment compared to those in less developed credit markets.
Distinction Between Financial and Nonfinancial Shocks
An important finding of the research is the differential impact of financial versus nonfinancial shocks. While the Commerzbank lending cut—a financial shock—had significant adverse effects on international affiliates, a nonfinancial shock, such as a flooding event affecting parent firms, did not produce similar outcomes. This distinction underscores the unique nature of financial shocks and the critical role of access to finance in determining the resilience of multinational firms.
Empirical Challenges and Solutions
To address potential empirical challenges, the researchers carefully controlled for common shocks and other confounding factors. By focusing on a quasi-experimental design, they were able to isolate the effects of the Commerzbank lending cut and attribute the observed outcomes to the internal capital market dynamics within multinational firms.
Key Findings
Biermann and Huber's empirical analysis provides robust evidence on the impact of the Commerzbank lending cut on multinational firms and their international affiliates. This section delves into the key empirical findings of their study, emphasizing the mechanisms through which financial shocks are transmitted and the resultant economic outcomes.
Impact on Affiliate Growth
The study's results indicate a significant decline in the growth of international affiliates following the lending cut. Affiliates with greater parent Commerzbank dependence saw their sales and employment drop markedly compared to those with lesser dependence. This effect was particularly pronounced in the immediate aftermath of the financial shock, from 2008 to 2010, highlighting the acute short-term impact on affiliate growth.
- Sales Decline: Affiliates that increased internal lending to their German parents experienced a sharp reduction in sales. The analysis shows that these affiliates' sales fell by approximately 9.7 log points on average during the period from 2008 to 2010. This decline underscores the significant real economic impact of financial constraints imposed through internal capital markets.
- Employment Reduction: In tandem with the decline in sales, the affected affiliates also reduced their workforce. The study finds that employment at these affiliates dropped by about 4.5 log points in the same period. This reduction in employment reflects the broader economic distress caused by the financial shock and the subsequent need for affiliates to cut costs and scale down operations.
Long-term Recovery
While the short-term impacts were severe, the empirical results suggest a recovery in affiliate performance after 2011. Affiliates gradually restored their sales and employment levels, indicating a degree of resilience and adjustment over time. By 2011, the negative effects on sales and employment had diminished, and the affiliates' growth trajectories began to align more closely with those of unaffected affiliates.
Role of Internal Capital Markets
The findings highlight the critical role of internal capital markets in the transmission of financial shocks. Affiliates that were more integrated into their parent firms' internal capital networks, evidenced by pre-existing internal loans, were disproportionately affected by the lending cut. These affiliates experienced larger declines in sales and employment, emphasizing the significance of internal financial dependencies in amplifying the impact of external shocks.
Managerial Preferences and Home Bias
The study also uncovers distinct managerial preferences within multinational firms. Affiliates located in Germany were less adversely affected compared to their international counterparts, even if they were financially weaker. This "Socialist" preference towards domestic affiliates indicates a home bias among managers, who prioritized the stability of operations within the home country. In contrast, the "Darwinist" approach towards international affiliates led to greater financial strain and reduced support for less profitable foreign operations.
Mitigation Through Developed Credit Markets
The availability of developed external credit markets played a crucial role in mitigating the adverse effects of the financial shock. Affiliates located in countries with high credit-GDP ratios were better able to access external financing, which helped alleviate the financial constraints imposed by internal lending demands. This access to external credit allowed these affiliates to maintain higher levels of sales and employment compared to those in countries with less developed credit markets.
Differential Impact of Nonfinancial Shocks
The research further distinguishes the impact of financial shocks from nonfinancial ones. The analysis of a nonfinancial flooding shock in 2013 showed that such shocks had relatively weak effects on international affiliates. Unlike financial shocks, nonfinancial disturbances did not force parent firms to withdraw capital from affiliates, underscoring the unique and potent nature of financial crises in disrupting multinational operations.
Biermann and Huber's empirical findings provide a comprehensive understanding of the transmission mechanisms and the real economic impacts of financial shocks within multinational firms. By elucidating the roles of internal capital markets, managerial behavior, and external credit access, their study offers critical insights for policymakers and business leaders aiming to enhance the resilience of global economies in the face of future financial disturbances.
Policy Implications & Future Research
Biermann and Huber's research not only enhances our understanding of the internal dynamics of multinational firms but also highlights broader economic and policy implications. Their findings underscore the need for nuanced regulatory approaches and strategic economic policies that can mitigate the transmission of financial shocks through multinational networks.
Policy Recommendations
Given the significant findings of the study, several policy recommendations emerge to help mitigate the adverse effects of financial shocks on the global economy:
- Strengthening Financial Market Development: Policymakers should prioritize the development of robust financial markets, particularly in countries that host a significant number of multinational affiliates. Access to external credit markets can help cushion the impact of internal financial constraints, allowing affiliates to maintain operations and growth even during periods of financial distress.
- Enhancing International Financial Regulation: There is a need for improved international coordination and regulation to monitor and manage the internal capital flows within multinational firms. Regulatory frameworks should be designed to ensure transparency and stability in these internal markets, reducing the risk of amplifying financial shocks.
- Supporting Diversification of Financing Sources: Encouraging firms to diversify their sources of financing can help reduce their vulnerability to shocks from any single financial institution. Policies that promote access to a broad range of financial instruments and markets can enhance the resilience of both parent firms and their international affiliates.
- Promoting Managerial Best Practices: Training and incentivizing managers to adopt balanced approaches in resource allocation can help mitigate the adverse impacts of financial constraints. Encouraging a balance between "Darwinist" and "Socialist" management strategies can lead to more equitable and stable outcomes for both domestic and international affiliates.
- Developing Contingency Plans: Governments and firms should develop contingency plans to address potential financial shocks. These plans could include strategies for maintaining liquidity, accessing emergency financing, and ensuring the continuity of operations during periods of financial distress.
Future Research Directions
Biermann and Huber's study opens several avenues for future research:
- Long-term Effects of Financial Shocks: Further research could explore the long-term impacts of financial shocks on multinational firms and their affiliates. Understanding the lasting consequences of such shocks can inform policies aimed at fostering sustainable economic growth.
- Comparative Studies Across Regions: Comparative studies examining the effects of financial shocks across different regions and industries can provide deeper insights into the specific factors that influence the transmission of these shocks. Such research can help tailor policy responses to the unique characteristics of different economic environments.
- Role of Technological Advancements: The impact of technological advancements on internal capital markets and financial shock transmission is another promising area of study. Exploring how digitalization and financial technologies influence these dynamics can offer valuable insights for future regulatory and policy frameworks.
Conclusion
Biermann and Huber’s research on the international transmission of financial shocks through multinational firms provides profound insights into the intricate dynamics of global economic interdependencies. Their study illustrates how internal capital markets within multinational firms act as conduits for financial distress, transmitting shocks from parent firms to their international affiliates and beyond. The findings emphasize the importance of understanding these internal mechanisms to develop effective policies that can mitigate the adverse impacts of financial crises.
Reference
- Biermann, M., & Huber, K. (2024). Tracing the International Transmission of a Crisis through Multinational Firms. The Journal of Finance, 79(3), 1789-1805. https://doi.org/10.1111/jofi.13338