GLOBAL PROFIT MAXIMIZATION AND THE EXPORT PERFORMANCE OF FOREIGN SUBSIDIARIES IN INDIA*
| Date | 01 May 1983 |
| Published date | 01 May 1983 |
| DOI | http://doi.org/10.1111/j.1468-0084.1983.mp45002005.x |
GLOBAL PROFIT MAXIMIZATION AND THE
EXPORT PERFORMANCE OF FOREIGN
SUBSIDIARIES IN INDIA*
Homi Katrak
I. INTRODUCTION
In recent years research into the operations of multinational firms
(MNFs) has turned up the interesting hypothesis that such firms pursue
the objective of global profit-maximization (GPM), i.e. the maximiza-
tion of their net global profits. An important feature of this objective
is that it has implications for the MNF's global resource allocation
decisions. GPM requires that the parent company takes account of the
interdependences of profits among the various units of the MNF,
rather than allowing each unit to try and maximize independently.
This hypothesis has theoretical and practical implications for govern-
ment policies towards MNFs and has also enabled the formulation of
empirically testable hypotheses.1
This paper builds upon the GPM hypothesis to analyse the export
performance of an MNF's overseas subsidiaries. We envisage situations
in which the exports of a subsidiary affect the profits of the parent
company and thus give rise to profits-interdependences. It will be
shown that such interdependences may induce the parent to regulate
the exports of the subsidiary. More specifically, it will be shown that if
the subsidiary is partly owned by host country shareholders, the
amount that the subsidiary may export will depend on the parent
company's ownership share in the subsidiary. This hypothesis will then
be tested with reference to the export performance of foreign sub-
sidiaries in India: the Indian situation seems an interesting testing
ground for the hypothesis since a number of the foreign subsidiaries
in that country are partly owned by local interests. The results of the
empirical test may be of interest in themselves and also in evaluating
an aspect of the Indian Government's Foreign Exchange Regulations
Act (FERA) of 1973.
* I am grateful to Dr S. Lau, Professor J. Spraos and an anonymous referee for helpful
comments on the framework and empirical tests employed in this paper and to Dr J. P. Agarwal
for kindly providing me with some data of foreign-owned firms in India. Acknowledgement is
also due to the Leverhulme Trust Fund for financial support for this research.
'The relevance of the global-maximization hypothesis for the analysis of multinational
firm's activities has been recognized, among others, by Caves (1974), Kopits (1976a) and
Jenkins (1979). Theoretical analysis of government policies in the context of that hypothesis
have been undertaken, among others, by Horst (1971) and Katrak (1981).
205
206 BULLETIN
Section II describes a simple model of an MNF's profits-interdepend-
ences and shows that under the GPM objective the quantities exported
by the subsidiary may depend on the parent company's share in the
subsidiary's equity; some of the theoretical arguments of this section
are further examined in an Appendix. Section III turns to some further
factors that may affect the subsidiary's exports: the influence of
tariffs and capital-labour intensities and firm-specific technology are
considered. Section IV discusses the data used in the empirical tests
and Section V reports the main results. Section VI provides a summary
of the paper and discusses some of its implications.
II. AN MNF'S PROFITS-INTERDEPENDENCES AND ITS SUBSIDIARY'S EXPORTS
To begin with I describe a simple model of an MNF and its profits-
interdependences. The MNF is assumed to produce in its parent country,
in a subsidiary in our host country and, perhaps, also in a third country
subsidiary. I envisage a plausible situation where the subsidiaries are
owned partly by local shareholders but where the parent company
retains full control over the subsidiaries' operations; and for simplicity
I assume that all three units are financed by equity capital only. The
parent company's objective is to maximize its net global profits (NGP);
these profits consist of the net profits from the parent's own operations
plus its share in the net profits of the subsidiaries.2 The global profit-
maximization (GPM) objective requires that the parent will take account
of any profits-interdependences between its own operations and those
of the subsidiaries. Profits-interdependences may arise if, for example,
the sales of a subsidiary affect the sales of some other unit of the MNF.
I will consider two alternative scenarios for profits-interdependences.
In each scenario the products of the parent and of the subsidiaries are
assumed to be differentiated from each other with respect to quality,
design, etc.; typically, the subsidiaries' products may be a technologic-
ally older version of those of the parent. Correspondingly, the sub-
sidiaries' unit cost of production may also differ from those of the
parent.
In the first scenario the MNF need have a subsidiary only in our host
country. Profits-interdependences may arise if the subsidiary and the
parent export competing products3 to, say, an unrelated party in some
2The parent's net global profits are less than the net profits of the MNF as a whole since
the latter also includes the profits accruing to the local shareholders in the subsidiaries. The
global profit.maximization objective postulated in the text thus differs from one where the
maximand is the net profits of the MNF as a whole. In other words, our hypothesis is that the
profits to the local shareholders do not feature in the parent's maximand. The resource
allocation implications of this are spelt out later in the text.
'Parent's and subsidiaries' products may be competing as they are similar to, though differ-
entiated from, each other. What is required is that the cross-elasticity of demand be positive
but less than infinity. This requirement is incorporated in the analysis of the Appendix.
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