What Explains Cross-Country Difference in Corporate Valuations? Growth Opportunities or Profitability?

Abstract

We distinguish the valuation effects of growth opportunities and profits through a common lens, namely, corporate free cashflows (FCF) whose negative value means investments using external funds while positive value means internal funds available for payouts. The sign of FCF’s cross-sectional relation to firm value in a country (FCF beta) can show which one has a greater impact on country-wide corporate valuations. Using data from 43 countries for the period of 1992-2018, we show that firm values are higher in countries whose FCF beta is more negative—i.e., where externally funded corporate investments, not internally available corporate profits, are valued higher. The role of growth opportunities in country-wide valuations is more pronounced among growth firms. In contrast, mature firms are representative of the valuation of the global industry to which they belong, not their country. Finally, the FCF beta is more negative in common law countries than in civil law countries, suggesting that growth-supporting governance is more value-relevant than payout-securing governance at least at the country level.