28 Aug 2012Working Paper Summaries

Channels of Influence

by Lauren Cohen, Umit G. Gurun and Christopher J. Malloy

How do firms differentially navigate the global marketplace to buy and sell goods? The answer is critical to identifying which firms will ultimately succeed, and how investors should allocate capital amongst these firms. This paper analyzes the strategic entry choices of firms seeking to expand their businesses to overseas markets. Using customs and port authority data detailing the international shipments of all U.S. publicly-traded firms, the authors show that firms import and export significantly more with countries that have a strong resident population near the firm headquarters. In addition, by analyzing the formation of World War II Japanese internment camps in order to study external shocks to local ethnic populations, the authors also identify a causal link between local networks and firm trade. However, capital markets and sell-side analysts have difficulty deciphering even these observable channels, so make significant mistakes in assessing the positive impact of these links. Findings overall show a surprisingly large impact of immigrants' economic role as conduits of information for firms in their new countries. This research provides new evidence on the economic impact of immigration and ethnic diversity in the United States. Key concepts include:

Firms are significantly more likely to trade with countries that have a strong resident population near their firm headquarters.
Firms that exploit local networks in their international trade decisions experience significant increases in future sales growth and profitability.
Strategic importers and exporters outperform other importers and exporters by 5%-7% per year in risk-adjusted returns.
Although it is possible to predict which trade links, on average, are valuable for firms (using simple measures of connected population that are publicly available), the market seems to ignore this information.
The increased value of strategic traders is also missed by analysts. Analysts are significantly less accurate in their earnings forecasts on these firms, with these firms having significantly more positive earnings surprises.
One channel of the information network is through board members. A connected local population predicts more board members from that same country, and significantly higher returns for those firms that exploit connected board members in their trade decisions.

Author Abstract

We demonstrate that simply by using the ethnic makeup surrounding a firm's location, we can predict, on average, which trade links are valuable for firms. Using customs and port authority data on the international shipments of all U.S. publicly-traded firms, we show that firms are significantly more likely to trade with countries that have a strong resident population near their firm headquarters. We use the formation of World War II Japanese Internment Camps to isolate exogenous shocks to local ethnic populations, and identify a causal link between local networks and firm trade links. Firms that exploit their local networks (strategic traders) see significant increases in future sales growth and profitability, and outperform other importers and exporters by 5%-7% per year in risk-adjusted stock returns. In sum, our results document a surprisingly large impact of immigrants' economic role as conduits of information for firms in their new countries.