Amsterdam Business School
Chasing Alpha: Do Good by Doing Good
Master in International Finance, Master Thesis
January 2014
Written by Kris Nikho Fernandus
Supervised by Dennis Jullens
Table of Contents
I Introduction ... 3
II Theory and Hypothesis ... 6
III Method... 15
IV The Sample ... 17
V Result ... 22
VI Conclusion & Practical Implication ... 26
I Introduction
In today’s environment, Corporate Social Responsibility (“CSR”) has become an important issue to many multi-national companies. CSR is often misinterpreted as a philanthropic and/or community involvement activity. Therefore, it is regarded as a “peripheral activity” that a business performs, and subsequently it establishes a positive contribution to society at large. In this paper, the term CSR covers a broader definition; it involves the integration of environmental, social, and governance consideration in the context of corporate behavior.
In his paper “Establishing Long-Term Value and Performance”, Fulton presents many studies that substantiate positive correlation between Environmental, Social, and Governance (“ESG”) scores and Corporate Financial Performance (“CFP”). Corporate Financial Performance generally covers both financial accounting measures (e.g.: Return on Asset) and market measures (usually stock performance of the company).
Furthermore, he presents a negative correlation between ESG scores and Corporate Cost of Capital. Corporate Cost of Capital covers both the cost of debt as measured by the cost of bond issued or loan and the cost of equity as measured by earning multiples.
By using ESG scores as parameters, I do not analyze philanthropic activities that a company does with their profit, but I analyze how the company operates its business in order to have positive effects on the stakeholder. I am trying to determine if a business manager can execute profit maximization for shareholders with long-term ability to remain a going concern to stakeholders. The stakeholder, in general, refers to shareholders, customers, employees, suppliers, and the local community.
A large business has a tremendous opportunity to be beneficial. To be sustainable, businesses must deliver real value that improves the customers’ quality of life. Big
businesses create employment, give returns to investors, and boost economic activities in society where they operate. The question is, “Can a business unite its financial
performance with its social responsibility?” Consequently, a business can deliver robust financial performance while operating responsibly. In other words: “do good by doing good”. Operating responsibly within a Fast Moving Consumer Goods (“FMCG”) market can often result directly in financial performance. For example, by reducing the
packaging, FMCG companies will not only cut cost, but reduce emissions and resource requirements. By integrating healthier foods and beverages, a company can increase the permissible of its products, thus increasing revenue. Those two examples reflect
environmental (resource reduction and emission reduction) and social (product responsibility) commitment.
FMCG is an industry sector that affects a large scale of the population. As their products are sold quickly at a relatively low cost, this sector has the opportunity to expand its business operations, thus reaching every corner of the world. By having a vast
distribution network and operating responsibly, a FMCG business can drive its bottom-line and contribute to the society in which it is operating. For example, Procter &
Gamble, a hygiene products company, promotes awareness of hygienic practices in rural woman in India.1 Milkiland, Lactalis, PepsiCo, and Danone join their forces to promote three dairy products a day in the Ukraine. They ensure the availability of the most affordable dairy products that are sources of protein, calcium, potassium, vitamins and other nutrients2.
Markowitz coined the theory that volatility is the definition of risk. This was part of his contribution under the modern portfolio theory. Step two was beta, which goes back to the work of William Sharpe, among others. Beta, said Sharpe, is the variability of an individual security’s returns against the market return. According to Michael Jensen,
1
alpha is the excess return that one is left with once all the beta-driven return has been accounted for.
Solnik has substantiated that an international diversified portfolio is likely to carry a much smaller risk than a typical domestic portfolio (Solnik 1974). Moreover, he has also found that when observing Swiss companies, the multi national companies deliver higher alpha compared to domestic companies (Solnik 1999).
To the extent that domestic economy is not highly correlated with foreign economy, will investing in stock of companies with high foreign sales be an alternative to direct
holding of foreign securities to reduce the systematic risk to domestic economy? I will answer if this is applicable to the United States FMCG public companies.
As the dataset used for this research involves FMCG public companies for the United States, S&P 500 will be used as the stock market index benchmark.
Furthermore, as the ESG score is positively correlated with corporate finance performance and negatively correlated with the cost of capital, will responsible and sustainable operation even further increase both systematic risk reduction and excess return generation?
Through this paper, I would like to answer these questions:
1. Is the foreign sales percentage negatively correlated with the systematic risk for equity investors in FMCG businesses?
2. Is the foreign sales percentage in FMCG businesses positively correlated with excess return?
3. If these two questions mentioned above can be verified, by either a causal or correlational relationship, does a high ESG score amplify the correlation of
II Theory and Hypothesis
By the year end of fiscal year 2012, the three largest United States FMCG companies by market capitalization were P&G, Coca Cola Company, and PepsiCo. Their combined revenue was over USD 197 billion, in which USD 105 billion was from foreign sales (53%). They deployed closed to USD 273 billion asset (book value), in which USD 101 billion is foreign asset (37%). In order to drive foreign revenue, an FMCG company tends to invest in their international operation. The FMCG market has considerable global scale
businesses with local sourcing. Most of the operations from extraction, production, distribution, consumption, and disposal are done locally. Therefore, it is the presence of a FMCG business that tends to drive the economy output of the society where it is functioning. PepsiCo, for example, had 49% foreign sales and deployed 48% foreign asset (book value based) by fiscal year 2012.
There has been a considerable amount of evidence to substantiate the increasing demand of ESG analysis. The data on ESG performance has started to become widely available in financial terminal, such as Bloomberg and Thomson. A number of large banks, such as J.P. Morgan Chase and Deutsche Bank, have formed teams to analyze CSR data. According to Ioannou and Serafeim, in several countries around the world, governments have enacted laws and regulations that mandate CSR reporting as a part of efforts to increase the availability of CSR data and bring transparency around
nonfinancial performance. The first country to adopt a Mandatory Corporate Sustainability Reporting (“MSCR”) law was Finland, in 1997. Other countries that adopted a MCSR law include: Australia, Austria, Canada, China, Denmark, France, Germany, Greece, Indonesia, Italy, Malaysia, Netherlands, Norway, Portugal, Sweden and the United Kingdom. The number of signatories to UN Principles for Responsible Investment has grown steadily since 2005. As of April 2013, there were close to 1,200
signatories with a total Asset Under Management of close to USD 35 trillion.3 This is approximately 15% of USD 225 trillion, that being the total global financial asset as per second quarter of 20124. Finally, a number of CSR ranking and rating companies, such as ASSET4 and Sustainalytics, have emerged in the past few years. However, until today, ESG scoring has not been standardized in terms of score scaling and/or methodology.
The ESG scores for this research are obtained from ASSET4. ASSET4 is often used by academics and investors as a source for environmental, social, and governance performance data. Blackrock, one of the largest investment companies in the world, uses the ASSET4 data5. In producing equally weighted ESG scores, ASSET4 evaluated fours pillars. The first being economic performance, followed by environmental
performance, social performance, and corporate governance performance. Within the environmental and social factors, a number of categories are evaluated, such as resource reduction, emission reduction, human right, and products responsibilities. ASSET4 obtained their source data from publicly available information such as CSR reports, company websites, annual reports, NGO reports, and news. CO2 data is
obtained from the Carbon Disclosure Project. These data sources are gathered to create 250 KPIs. These KPIs are aggregated into a framework of 18 categories as illustrated below. These 18 categories are then grouped into four pillars that are integrated into a single overall score.
3 http://d2m27378y09r06.cloudfront.net/wp-content/uploads/sig_growth.png 4 http://www.mckinsey.com/insights/global_capital_markets/financial_globalization 5 http://www.sirp.se/Keynotes/web/page.aspx?refid=62&newsid=114346&page=6
Referring back to the Markowitz and Sharpe theory, the systematic risk of equity investors in holding specific stock, rather than market portfolio, is determined as the price volatility of stock comparable to the price volatility of the stock market index. This systematic risk is denoted as beta. The Capital Asset Pricing Model suggests that lower-beta stock should have lower return, and vice versa.
Under the Capital Pricing Asset Model, the equation for expected return in holding a single stock is denoted as follow:
ERi = Rf + B (Rm-Rf)
B = Covar (stock movement, S&P 500 movement) / Var (S&P 500 movement) ERi = Expected Return investment
Rf = Risk free rate B = Beta
Rm = Return market
A lower beta value is directly proportional to a lower systematic risk of an investor in holding specific equity security.
In his paper, “Why not diversify internationally rather than domestically”, Solnik has substantiated that the gain from international diversification is substantial. In terms of variability of return, an internationally well-diversified portfolio will be one tenth as
risky as typical security, and half as risky as a well-diversified US portfolio of US Stock (with the same number of holdings). Even after factoring in the exchange risk, Solnik concluded that the risk of a portfolio that is unprotected against exchange risk is higher than a covered one. However, its total risks are still much smaller than those of a comparable domestic portfolio.
As our economy becomes more and more globalized, many trade and capital movement barriers have been lifted. Moreover, the development of technology has made it much easier for companies to operate internationally.
Company fair equity value is driven by its potential future cash flow to the shareholder and the discount rate (expected return to equity). To find this value, the following equation can be employed:
V = f (CF, dR)
When an investor expected return is based on market index (i.e.: S&P 500 for American investors), any return in excess of risk-adjusted expected performance is referred to as alpha. In this study, I assume that investor expected return on stock investment is benchmarked with the domestic stock market index. A positive-beta stock moves in the same direction as market index. When market index appreciates, the positive-beta stock is expected to appreciate, and conversely, when market index depreciates, positive-beta stock is expected to depreciate. Consequently, a negative return in the stock market index will often result in the negative return of a stock investment.
According to Berk and DeMarzo, stocks with negative beta may have an expected return below the risk free rate. While this may seem unreasonable at first, it must be noted that stock with a negative beta will tend to do well when the stock market is doing badly. Holding a negative stock beta will provide insurance against the systematic risk.
Therefore, risk-averse investors are willing to pay for this insurance by accepting a return below the risk-free rate.
Alpha is derived by deducting actual return with expected return.
Alpha = Actual Return - Expected Return Alpha = Actual Return - Rf + B (Rm-Rf)
Berk and DeMarzo mention in their book, Corporate Finance, that stock with positive alpha has an expected return that exceeds its required return. They also state that while the CAPM conclusion that the market is always efficient may not literally be true,
competition among investors who try to beat the market and earn positive alpha should keep the market close to efficient much of the time.
In this paper, one year alpha is calculated for an investment period from 1 January to 31 December. Beta coefficient for the expected return will be based on all information available as per 1 January. If the beta coefficient is indeed negatively correlated with the internationalization index, the beta of stock will be lower as the company indicates the increase in their international revenue portion through its financial statements. As the financial statement is published after 1 January, decrease in beta is expected to occur later after 1 January. Decrease in beta will translate into lower required return that subsequently increases the stock demand. This surge in stock demand will increase the stock price. As the stock price changes, so does the expected return. Subsequently, the expected return will converge to its required return.
There have been a number of prior literatures that advocate positive business impacts of operating responsibly. A paper written by Turban and Greening mentioned that companies with good CSR attract and retain a higher quality of employees. Freeman et al. argue that CSR may result in value creation by protecting and enhancing corporate
image. Moreover, according to Sen and Bhattacharya, good CSR may attract overall demand of products or services that a company created and reduce consumer sensitivity to price. Therefore, good CSR can also function as good advertising.
In their paper, “Voluntary nonfinancial disclosure and the Cost of Equity Capital: The Initiation of Corporate Social Responsibility Reporting”, Dhaliwal et al. concluded that a company with CSR performance superior to that of their industry peers enjoy a
reduction in the cost of equity capital after they initiate standalone CSR reporting. They argue that a company initiating CSR disclosure with superior CSR performance attracts dedicated institutional investors (Socially Responsible Investors) and analyst coverage. These analysts achieve lower absolute forecast errors and dispersion following such disclosure. These companies even appear to exploit the benefit of a reduction in cost of equity by conducting Secondary Equity Offerings to raise capital in the two years
following the initial disclosure. Moreover, the same study also concluded that a company with a high cost of equity in the prior years has the tendency to start issuing CSR report disclosure. This fact actually shows the recognized causal relationship by companies to benefit from cheaper cost of equity by issuing a CSR report.
In Fulton’s paper, he presents a negative correlation between ESG scores and Corporate Cost of Capital. He analyzed 19 leading academic studies. Although those academic papers, in majority, cannot substantiate the causal relationship, every report concluded the correlation between higher ESG scores and lower Corporate Cost of Capital with no neutral or mixed results evident.
Fulton’s paper analyzed one of the academic studies written by Ghoul et al. It argued that stronger CSR scores can be translated as company adherence to socially responsible business operation. Those companies with high ESG scores enjoy significantly lower cost of capital. This results in improved company valuation and diminished risk. They argued that a company with a low ESG score has a lower investor base. The capital market
equilibrium model of Merton implies that increasing the relative size of a company’s investor base will result in a lower cost of capital and higher market value for the company. They even further suggest that given stock analysts and the media are inclined to spend more time analyzing and reporting news about “good” companies; companies with high CSR score should actively disclose information about their CSR activities to the public.
By conducting negative screening through excluding the company with no ESG score or lower than average ESG score, we can expect that the correlation to both alpha and beta will be higher in absolute value.
Hypothesis 1: Will increase in foreign sales percentage result in a lower exposure of a company in the domestic market index? There is still low correlation between the economic growth of many countries. While the economy of most East and Middle East countries was growing above a level of 5% during 2012, the US and European economies were instead experiencing anemic growth (CIA the world fact book). As a result, the overall revenue volatility is less correlated to the domestic economy. Moreover, the benefit from international diversification arises from the relatively low level of correlation among national equity markets (Eiling et al 2012).
In their book, “Corporate Finance”, Berk and DeMarzo identified three major drivers for beta.
1. Company products. The company that sells product with sales and/or costs that are highly cyclical and sensitive to domestic economy will have high beta. Likewise, a company that sells discretionary products will have higher beta. FMCG companies tend to have relatively low beta. The demand for their products is often unrelated to the booms and busts of economy as a whole.
2. Operating leverage. The higher the company fixed cost is, the higher the beta. 3. Capital structure. The higher the leveraging of the company is, the higher the beta.
In order to exclude the capital structure impact, the unlevered beta will be calculated.
It is expected that there is variability in fixed cost structures among United States FMCG companies. In this research, I will not amalgamate the entire sample of foreign sales percentages and unlevered beta coefficients of all companies, then derive the correlation index of all samples. To exclude the different fixed cost structure among different companies (operating leverage) within FMCG businesses, the correlation analysis will be done company by company.
Finally, I will conclude the result by looking at the statistical trend of the correlation index. Therefore, as the domestic exposure decreases, it is expected that unlevered beta of the stock will decrease as the international exposure increases (a negative
correlation).
Hypothesis 2: The larger the foreign revenue is, the larger the foreign asset that a FMCG company has. As a result, a company can use its vast network to gain economies of scale for both revenue and cost, instigating an enhanced bottom-line. By deploying its large supply chain network, a FMCG company has the opportunity to enhance and expedite cash flow generation at the time of new product penetration. This competitive
advantage is often not priced directly, thus it may generate alpha.
Furthermore, in the book, “Investments and Portfolio Management”, written by Bodie, Kane, and Marcus, it is mentioned that beta not only informs managers of how to measure risks, but it also allows them to translate the risks directly into a hurdle rate. If indeed beta is negatively correlated with the internationalization degree, it is expected that the increase in international exposure will be positively correlated with alpha.
Hypothesis 3: ESG score is negatively correlated with Corporate Cost of Capital (Sustainable Investing, 2012). In 19 leading academic studies that Fulton analyzed,
strong corporate commitment to the ESG resulted in lower corporate cost of capital, both in debt and equity. These findings are evident in all of the studies that Fulton analyzed (with no neutral or mixed result evident). According to Dhaliwal, companies with good CSR performance tend to disclose their CSR activities to market.
When we exclude companies that have no ESG score and below average ESG score, the correlation to both alpha and beta is expected to be higher in absolute value.
III Method
1. Obtain the past daily returns data for FMCG public companies from 1 January 2001 to 31 December 2012;
2. Through Datastream database, obtain the split of revenue in domestic market and non domestic market from fiscal year end 2000 to fiscal year end 2011 and get their capital structure from fiscal year end 2001 to fiscal year end 2012;
I. Evaluate the beta movement from 2001 to 2012 (twelve years period)
3. Determine the one year beta of stock for period commencing 1 January to 31
December by comparing the daily return of stock against the daily return of the S&P500 index;
B = Covar (stock movement, S&P 500 movement) / Var (S&P 500 movement) 4. Using the capital structure (market capitalization and debt level), generate the unlevered beta;
Beta Unlevered = Beta / (1+(1-Tax Rate6) * (Debt/Market Capitalization)) 5. Observe the outcome to determine if unlevered beta is moving in an opposite direction from international exposure;
II. Evaluate alpha from 2002 to 2012 (eleven years period)
6. Determine the beta of stock for the investment period (one year);
7. Use the beta value derived above to determine the expected return from 2002 to 2012.
8. Using the one year treasury yield as the risk free rate and the actual equity index one year return (i.e.: S&P 500), determine one year excess returns;
9. Observe if there is any trend, correlation, and consistency between the percentages of non domestic revenue with alpha;
6
III Measure the impact of sustainability operation to both alpha and beta.
10. Include only data from companies with higher than industry average ESG scores from the latest weighted average score (2012 report);
11. Do the same correlation and consistency evaluation;
IV The Sample
In order to get more global representation, initially, I was collecting data for the 50 largest FMCG public companies in the world as complied by Forbes Magazine. However, I encountered difficulty in utilizing this method, as most of the non US companies presented their annual report in accordance with the International Financial Reporting Standard (IFRS). Unlike the United States Generally Accepted Accounting Standard (US-GAAP), IFRS does not require that a company reports their revenue outside of their home country. As a result, I encountered a large amount of inconsistency while attempting to quantify the international revenue. Some European companies will dissect their revenue by region, while others do so by continent. With this limitation, I failed to use international companies as a proxy of my research. Consequently, I used US FMCG public companies instead.
As of December 2013, Datastream constituent list provides sixty three FMCG public companies in the US. In order to have good statistical analysis, I am aiming at using at least ten years of data. Therefore data as per the year end period of 2000 is required. There are fourteen US FMCG public companies that were listed after 2000; for example: Kraft Foods, Philip Morris, etc. Out of the remaining forty nine companies, ten of them have been operating domestically only. For that reason, I cannot gauge the
internationalization degree changes. Out of the remaining thirty nine, one company, Brown Forman Corp, has a double listing and therefore one stock was eliminated. Thus, the total number of companies that were evaluated is thirty eight.
The beta value of a company is calculated manually by evaluating the daily stock return of each company against the daily return of S&P 500 index. The daily stock price of these companies and S&P 500 index were collected from January 1, 2001 up to and including December 31, 2012. A one year beta value for each company is calculated by evaluating the stock movement from the period of January 1st until December 31st. With
twelve years of figures for thirty eight companies (456 data samples), beta ranges from a minimum of 0.01 (Molson Breweries in 2001) to 1.51 (Seaborne in 2012). The average and median values of beta are 0.66 and 0.62 respectively. The standard deviation is 0.25.
To exclude the leveraging impact in systematic risk, I calculated unlevered beta and used 34% as the average corporate income tax rate. With twelve years of figures for thirty eight companies (456 data samples), the beta value has a range from 0.01 (Molson Breweries in 2001) to 1.44 (Seaborne in 2012). The average and median values of beta are 0.55 and 0.52 respectively. The standard deviation is 0.21.
Table 1. Equity and Asset beta for thirty eight US FMCG public companies: 2001 to 2012
This table looks at the equity beta for the period of 2001 to 2012 in column 1 and the unlevered beta or asset beta for the period of 2001 to 2012 in column 2.
Number of Samples (n)
(1) (2)
Equity Beta Assets Beta
< 0.3 23 47 0.3-0.6 190 258 0.6-0.9 165 125 0.9-1.2 67 22 >1.2 11 4 Total Samples 456 456 Mean 0.66 0.55 Median 0.62 0.52 Standard Deviation 0.25 0.21
The average debt to equity ratio for these thirty eight companies from 2001 to 2012 is 0.31 with a standard deviation of 0.31.
The internationalization index was calculated by dividing the non-domestic sales by the total revenue. As I evaluated investment as per January 1, 2001, the financial statement analysis commences from the year end of 2000. With twelve years of figures for thirty
eight companies, the foreign revenue percentage has a range from 3% to 100% for Coca Cola Enterprise, a NYSE public company that bottles Coca Cola products for Western Europe. The average and median values of beta are 0.32 and 0.34 respectively. The standard deviation is 0.25.
Table 2. Foreign sales portion for thirty eight US FMCG public companies: 2001 to 2012 Number of Samples (n) (1) Foreign Sales <0.2 182 0.2-0.4 99 0.4-0.6 96 0.6-0.8 53 0.8-1 26 Total Samples 456 Mean 0.34 Median 0.32 Standard Deviation 0.25
For an eleven year period from 2002 to 2012, the lowest expected one year return of these thirty eight companies was for Tyson Foods during 2008. With -50% actual one year returns on the S&P 500 index, Tyson Foods had a beta coefficient of 1.11 and an expected one year return of -54%. The highest one year expected return was for Beam Inc. during 2009. With 21% actual one year returns on the S&P 500 index, Beam Inc. with 1.40 one year beta coefficient, had an expected one year return of 29.42%. The average and median values of an expected one year return are 2.26% and 5.28% respectively. The standard deviation is 13.76%.
Actual one year return is calculated as follows:
(Market Price Year End + Dividends Per Share + Special Dividend -Quarter 1 + Special Dividend-Quarter 2 + Special Dividend-Quarter 3 + Special Dividend-Quarter 4) / Last Year's Market Price-Year End - 1) *100
For an eleven year period from 2002 to 2012, the lowest actual one year return of these thirty eight companies was -78% for Altria Group during 2008. The highest one year actual return was 255% for Seaborne during 2004. The average and median values of actual one year return are 11.26% and 10.6% respectively. The standard deviation is 28%.
The worst underperformance was -80.33% for Hillshire Brand during 2012. With an expected return of 10.95%, the actual return was -69.38%. The best overall performance was 252.72% for Seaborne during 2004. With an expected return of 2.24%, the actual return of the company was 254.96%. The average and median values of one year excess return are 9% and 7.19% respectively. The standard deviation is 25%.
Table 3. Expected and Actual Return for thirty eight US FMCG public companies: 2002 to 2012
This table looks at the expected return based on equity beta for the period of 2002 to 2012 in column 1, the actual return for the period of 2002 to 2012 in column 2, and the excess return for the period of 2002 to 2012 in column 3.
(1) (2) (3)
Expected Return Actual Return Excess return
-100 to -30 19 21 10 -30 to -20 16 17 21 -20 to -10 30 34 39 -10 to 0 49 57 74 0 to -10 198 77 98 10 to 20 97 89 75 20 to 30 9 46 44 30 to 100 0 74 54 >100 0 3 3 Total Samples 418 418 418 Mean 2.26 11.26 9.00 Median 5.28 10.58 7.19 Standard Deviation 13.76 28.19 24.99 Min (54.37) (77.85) (80.33)
The ESG scores were retrieved from Datastream and provided by ASSET4. The ASSET4 ESG comprises 4000 companies, providing history up to 2002 for about 1000 companies. All scores are normalized using z-scoring, equally weighted and benchmarked against the complete universe of 4000 companies. The average equally weighted ESG scoring for US FMCG public companies is eighty. Out of the thirty eight companies in the sample, ten of them do not disclose sufficient information to be scored. Out of the remaining twenty eight, nine of them are lower then the industry average. The number of companies to be tested during the second round is nineteen.
V Result
To exclude the influence of non-systematic risk (such as operation leveraging efficiency) to the unlevered beta and alpha analysis, the companies samples are evaluated
separately in timeliness analysis rather then pooled collectively. The end result is concluded based on the statistic trend. Therefore, the conclusion will be based on the mean and median values of the sample.
Out of the analysis, the outcomes for systematic risk or beta coefficient analysis are listed below:
1. The correlation index between asset beta and international exposure among multinational companies is very low.
2. Out of thirty eight companies, only sixteen companies have negative correlation. 3. The mean and median correlation index for those thirty eight companies is positive, being 0.06 and 0.09 respectively.
4 The correlation index between one year excess return and international exposure among multinational companies is very low.
5. Out of thirty eight companies, only fifteen companies have positive correlation. 6. The mean and median correlation index for those thirty eight companies are negative, being -0.06 and -0.07 respectively.
Table 4. Correlation index between beta and alpha vs foreign sales percentage for thirty eight US FMCG public companies
This table looks at the correlation of Beta vs foreign sales percentage for the period of 2001 to 2012 in column 1 and the correlation of alpha vs foreign sales percentage for the period of 2002 to 2012 in column 2.
Number of Samples (n)
(1) (2)
Beta vs Internationalization Alpha vs Internationalization
-1 till -0.7 3 0 -0.7 till -0.4 6 5 -0.4 till -0.1 6 12 -0.1 till 0 1 6 0 till 0.3 7 11 0.3 till 0.6 9 3 0.6 till 1 6 1 Total Samples 38 38 Mean 0.06 (0.06) Median 0.09 (0.07)
7. When the sample is refined to the nineteen companies that have above average ESG scores, the results do not significantly change. The correlation index between asset beta and international exposure among multinational companies is very low with average and median values of -0.03 and -0.06 respectively. The correlation index between one year excess return and international exposure among multinational companies is very low with average and median values of 0.12 and 0.08 respectively.
8. When the sample is refined to those with an above average ESG score, the correlation index is moving to the expected level, being negative correlation for beta and positive correlation for alpha. However, the correlation index is still very low.
Table 5. Correlation index between beta and alpha vs foreign sales percentage for nineteen US FMCG public companies with above average ESG scores
This table looks at the correlation of Beta vs foreign sales percentage for the period of 2001 to 2012 in column 1 and the correlation of alpha vs foreign sales percentage for the period of 2002 to 2012 in column 2. The total sample is nineteen; using US FCMG companies with ESG score above the industry average.
Number of Samples (n)
(1) (2)
Alpha vs Internationalization Beta vs Internationalization
-1 till -0.7 2 0 -0.7 till -0.4 2 3 -0.4 till -0.1 3 4 -0.1 till 0 0 5 0 till 0.3 3 4 0.3 till 0.6 5 2 0.6 till 1 4 1 Total Samples 19 19 Mean 0.12 (0.03) Median 0.08 (0.06)
From the above analysis, we can conclude:
1. Holding stock in an international company does not give investors diversification benefits as a direct holding in foreign securities.
2. As the excess return is not positively correlated with internationalization,
internationalization in US FMCG public companies does not give any additional benefit for US companies to lower the cost of capital. It therefore does not drive excess return to shareholder.
3. Good business practice has a positive impact to systematic risk reduction and excess return generation; however, in the sample of US FMCG public companies in my study, the impact is not substantial.
What could be the explanation of this outcome? As both the outcome for beta and alpha are consistent, the most plausible explanation might depend on the S&P500 index itself. Since I evaluated the systematic risk and excess return of holding one of these stocks against the S&P 500 index, the maximum diversification benefit through internationalization may not be achieved as S&P 500 index movement itself has been largely driven by global economy. Utilizing revenue and market capitalization as per year end 2012, below is the internationalization degree of S&P 500 index. Over half of the companies that build a S&P500 index have over 25% foreign sales. From this we can conclude that S&P 500 is not only exposed toward domestic economy, but also
international economy. Companies with 30% or more international revenue comprise approximately 60% of market capitalization of the total S&P 500 index.
Table 6. Foreign sales percentage as per end 2012 for S&P 500 constituent lists. Number of Samples (n) (1) Foreign Sales <25 204 25-50 126 50-75 100 >75 34 Total Samples 4647 7
Foreign sales data were not available in DataStream database for 36 companies that build S&P 500 constituent lists.
VI Conclusion & Practical Implication
An extremely low average correlation index between the beta value and foreign sales percentage, as well as between alpha and the foreign sales percentage, indicates a minimum reduction of systematic risk and minimum generation of excess return against the S&P 500 index. A possible explanation for this unexpected outcome is that the S&P 500 index is already exposed not only to the domestic economy, but also the
international economy. As a result, it can be concluded that a well-diversified investor needs to have a direct holding of foreign security to reduce the systematic risk against the S&P 500 index.
For a business manager, the low correlation index can be translated so an
internationalization degree has no positive or negative impact to the company cost of capital. Therefore, the internationalization degree has no influence to the company hurdle rate. As specified earlier in this report, company equity value is driven by the company’s future cash flow to the shareholder as well as the discount rate (expected return to equity). We concluded that internationalization does not positively impact the discount rate, and we can expect that an increase in the internationalization degree can boost future cash flow. In conclusion, I am still convinced that an increase in the
internationalization degree is good for an investor.
Good business practice has been evidenced to benefit the investor both by reducing the cost of capital as well as improving the financial performance of the company. However, this benefit cannot be realized in a short-term period. The benefit will start to be
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