The Trouble With Being Public in Emerging Markets

Would the world’s major multinational, publicly traded firms have an advantage across the developing world over privately owned rivals? It’d be easy to assume so. Access to capital alone, one might think, would give those larger corporations the upper hand.

Not so, says new research from Maryland Smith’s Pablo Slutzky. And the reason why is a bit surprising.

In his paper, Slutzky examines how firms grapple with business regulations that limit their operations in emerging markets.

He looks closely at what happened in Argentina in 2012, when the government, in a bid to curb capital flight, banned foreign repatriation of profits. At the time, Argentina was still struggling in the wake of the global economic crisis and fighting its own battles.

The ban presented a challenge for multinational companies that were accustomed to sending profits home. They’d have to get creative.

Slutzky’s research – informed by a giant database that lists in precise detail transactions that passed through customs in Argentina – reveals a way they could do that.

“Suppose you’re a big listed company,” says Slutzky, assistant professor of finance at the University of Maryland’s Robert H. Smith School of Business. “And you’re making money in Argentina. Now, you can no longer send money home to the United States. So, what can firms do? They can overprice imports.”

And that’s what began happening. In his research, Slutzky exploited a natural experiment to show that a firm’s ownership structure impacts its degree of regulation compliance – with publicly listed firms complying more than privately held ones. The research also revealed that the differential compliance places a burden on publicly traded firms – a burden that helps explain their subsequent M&A decisions.

It’s a way of skirting regulations – something that’s difficult for closely scrutinized public firms to do.

Here’s how.

Let’s say Walmart in Argentina was importing laundry detergent from Walmart U.S., paying $10 to its U.S. counterpart, selling it in Argentina for $15 and repatriating the $5 profit back to the home office in Arkansas. Then, along comes this regulation, and Walmart no longer can send that $5 back to Arkansas. “So,” Slutzky says, “Walmart Argentina can import the same laundry detergent, but instead of paying $10 to the U.S., it pays $15. That way it is transferring the profits in the transit price.”

In his research, Slutzky focused on aftermarket engine parts. It was a natural for him – both his father and grandfather spent a career in the industry. “I know this industry really well,” he says. He knew that the engine parts would present a peculiarity. The exact same product would be imported by two different types of firms: affiliates of the manufacturer and independent distributors that sell spare parts to end users of auto repair shops. In other words, one affiliated, one not.

It’s what researchers look for, “a proper counterfactual,” Slutzky says. “Ford in Argentina imports an engine from Ford in the U.S., and at the same time, an independent distributor imports the exact same engine. I can compare the price paid by Ford Argentina and by an independent distributor, before and after the ban on profits repatriation.”

The price paid by independent retailers is bound to market conditions, so it is a perfect counterfactual for the study.

“If you want to bypass regulations in Argentina and overprice imports to repatriate capital, you probably have to bribe the regulator,” Slutzky says.

That means that if Walmart wants to repatriate money, hiding profits in the terms of the import price, it probably has to bribe a customs agent. But Walmart can’t do that, he says, because then Walmart would be liable in the United States under the Foreign Corrupt Practices Act. “But if you’re a private company in the United States, oversight is less strict,” Slutzky says. “My research shows that private companies bypass regulations more than publicly listed companies.”

Then, he shows what happens in the wake of new business-unfriendly regulations in developing economies. The differential cost of doing business triggers mergers and acquisitions, with private companies acquiring operations from listed firms. Private companies can increase the value of the operations of listed firms by bypassing regulations, therefore reducing compliance costs.

His paper reveals an additional cost faced by listed companies, identifies a new driver of M&A transactions, and shows evidence that high levels of regulation lead to opaque corporate structures.

What is the message of the paper? “Listed companies pay a hidden cost when operating in emerging markets because they are overseen by a larger number of agents, making it harder for them to bypass regulations,” Slutzky says. “But private companies can. And do.”

Read more: “The Hidden Costs of Being Public: Evidence from Multinational Firms Operating in an Emerging Market” is forthcoming in the Journal of Financial Economics.