Do multinational corporations flexibly respond to exchange rate fluctuations? A tale of two Korean MNCs
| Date | 02 August 2013 |
| DOI | https://doi.org/10.1108/JABS-07-2012-0034 |
| Pages | 262-277 |
| Published date | 02 August 2013 |
| Author | Young‐Ryeol Park,Sangcheol Song,Eun‐kyoung Rhee |
| Subject Matter | Strategy |
Do multinational corporations flexibly
respond to exchange rate fluctuations?
A tale of two Korean MNCs
Young-Ryeol Park, Sangcheol Song and Eun-kyoung Rhee
Abstract
Purpose – The purpose of this paper is to examine whether Korean multinational corporations (MNCs)
in the electronics and steel industries do shift their production across their foreign subsidiaries, located
in different countries, as exchange rates fluctuate in foreign countries.
Design/methodology/approach – A case study was taken as a qualitative methodology to examine
whether MNCs actually shift their production as multinational operational flexibility perspective predicts.
Findings – From a case study of two Korean MNCs (LG Electronics and POSCO), it was found that even
facing heightened production costs associated with host country currency appreciation, Korean MNCs
do not shift their production to less costly locationsdue to industrial characteristics, limited capacity, and
high tariff barriers. It was also found that they reduce the production costs internally and they also
negotiate the costs with employees and suppliers to adjust the production costs associated with
appreciated currency.
Practical implications – Our findings imply that certain industrial and environmental constraints make it
difficult for MNCs to take flexible actions as multinational operational flexibility perspective predicts. The
findings also shed additional light on the less-explored argument over operational flexibility and vertical
integration associated with cross-country shifts of value chain activities, including production or sales.
Originality/value – Almost all literature taking the multinational operation flexibility view argues that
MNCs are able to shift their productions for their own benefits. However, the authors of this paper find
from their case studies that firms take advantage of other methods than production shifts in their
responses to exchange rate fluctuations in their host countries. Thus this study gives an insight into when
and how firms behave as the theory predicts.
Keywords Multinational companies, Manufacturing industries, Production management,
Operations management, Exchange rates, Korea, Multinational operational flexibility, Exchange rates,
Production shifts
Paper type Case study
Introduction
When firms go abroad to do business, uncertainty is a major risk that they cannot avoid. In
other words, foreign direct investment (FDI) and uncertainty in foreign environments are
inseparable (Ramasamy, 2003). Thus, considering that multinational corporations (MNCs)
operate worldwide and are usually exposed to a high level of uncertainty associated with:
exchange rates (Chung et al., 2010; Huchzermeier and Cohen, 1996; Lee and Song, 2012);
demand (Cuypers and Martin, 2010), labor costs (Fisch and Zschoche, 2011); or institutions
(Cuypers and Martin, 2010), it is managerially important for MNCs to cope with those
uncertainties for their own benefit.
In that regard, MNCs’ ability to retain flexibility under conditions of uncertainty is essential for
their performance and longevity (Chung et al., 2010; Fisch and Zschoche, 2011;
Huchzermeier and Cohen, 1996; Lee and Makhija, 2009a, b; Lee and Song, 2012). Flexibility
here means that MNCs are able to change their strategies based on their established
investments without incurring significant costs (Lee and Makhija, 2009a, b; Lee and Song,
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VOL. 7 NO. 3 2013, pp. 262-277, QEmerald Group Publishing Limited, ISSN 1558-7894 DOI 10.1108/JABS-07-2012-0034
Young-Ryeol Park is based
at the School of Business,
Yonsei University, Seoul,
Korea. Sangcheol Song is
based at the Department of
Management, Saint
Joseph’s University,
Philadelphia, Pennsylvania,
USA. Eun-kyoung Rhee is
based at the School of
Business, YonseiUniversity,
Seoul, Korea.
This work was supported by the
National Research Foundation
of Korea Grant funded by the
Korean Government
(NRF-2012- S1A3A2-2012S1
A3A2033412).
Received 13 July 2012
Revised 5 December 2012
Accepted 25 December 2012
2012). Real options logic argues for multinational operational flexibility (i.e. an MNC’s ability
to buffer against potential risks by shifting value chain activities across their network of
operations in response to unexpected changes in macroeconomic factors (Chung et al.,
2010; Cohen and Lee, 1989; Hodder and Jucker, 1985; Huchzermeier and Cohen, 1996;
Kogut and Kulatilaka, 1994; Pantzalis et al., 2001). Among macro-economic factors,
exchange rates have been considered a most influential factor on overseas value chain
activities, including production and sales (Campa, 1993; Chung et al., 2010; Huchzermeier
and Cohen, 1996; Kogut and Kulatilaka, 1994, Lee and Song, 2012; Pantzalis et al., 2001). A
considerable amount of research supports the concept of multinational operational flexibility
under the influence of exchange rates. For example, Huchzer meier and Cohen (1996)
simulated the effects of value chain adjustments under different exchange rate exposures on
expected return. They argued that MNCs’ operational hedging behaviors with asymmetric
responses to favorable and unfavorable exchange rate changes are associated with higher
firm value. Lee and Song (2012) empirically supported MNCs’ production shifts as flexible
responses to exchange rate changes in their host countries.
However, prior studies in this regard have two embedded problems. First, they assume that
unexpected changes in macro-economic factors, including exchange rates in particular,
lead to cross-border production shifts. However, production shifts do not always take place
as the multinational operational flexibility perspective predicts. Therefore, in this paper we
attempt to answer the question of why cross-border production shifting does not occur,even
if it is expected. Second, there is a scarcity of consideration of industrial difference. Analyses
in most of the studies in this area remain at the firm level. Examples are, the Chung et al.
(2010) study about Japanese MNCs’ FDI in Asian countries, and Lee and Song’s (2012)
study concerning Korean MNCs’ FDI in foreign countries. However, considering that
different industries have dissimilar competition conditions and industrial traits related to
responses to exchange rate changes in international business, industrial differences
associated with transportation costs, production costs, and production factor mobility
should be taken into further consideration.
The purpose of this study is to address these limitations of prior research. For this purpose,
we examined two representative Korean MNCs’ responses to exchange rate changes in
other countries in two different industries. Specifically, we examined whether Korean MNCs
actually behave as the operational flexibility perspective predicts under the condition of
exchange rate fluctuation. If they do not, we question what their counter-plans for exchange
rate movements are. To examine industry differences, we interviewed two Korean
representative MNCs in electronics (i.e. LG Electronics) and steel manufacturing (i.e. The
Pohang Iron and Steel Company, POSCO) respectively. In spite of its own limitations
because of only two cases and industries, this exploratory study is expected to contribute to
an increase in studies that examine MNCs’ diverse responses to exchange rate fluctuations
in their international businesses in ways other than production shifts.
Theoretical background and hypotheses
Real options theory and multinational operational flexibility
Real options theory treats uncertainty not only as a risk, but also as an opportunity; for
example, focusing not only on cost reduction but also on value creation (Bowman and Hurry,
1993; Chung et al., 2010; Huchzermeier and Cohen, 1996; Lee and Makhija, 2009a, b). In
other words, real options theory claims that MNCs can actually benefit from uncertainty by
creating new options to maintain flexibility in response to a new environment (Buckley and
Casson, 1998; Li, 2007; Rivoli and Salorio, 1996). Foreign direct investment (FDI) as a real
option investment enables MNCs to hedge risk by shifting value chain activities across their
network of operations in response to exchange rate fluctuation, changes in market demand,
and variations in taxes and tariffs (Chung et al., 2010; Dasu and Li, 1997; de Meza and van
der Ploeg, 1987; Huchzermeier and Cohen, 1996; Kogut, 1985, 1989; Kogut and Kulatilaka,
1994; Lee and Song, 2012; Pantzalis et al., 2001).
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