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CHAPTER 1

Multinational Financial Management :


An Overview
After studying this chapter, you should be able
to:
 
> Identify the main goal of the MNC and potential
conflicts with that goal
> Describe the key theories that justify international
business
> Explain the common methods used to conduct
international business
Goal of the MNC

The commonly accepted goal of an MNC is to maximize


shareholder wealth. Developing a goal is necessary
because all decisions should contribute to its
accomplishment. Thus, if the objective were to
maximize earnings in the near future, rather than to
maximize shareholder wealth, the firm’s policies would
be different.
Conflicts with the MNC Goal

It has often been argued that managers of a firm may


make decisions that conflict with the firm’s goal to
maximize shareholder wealth. For example, a
decision to establish a subsidiary in one location for
the appeal.

A conflict of goals can always exist – this conflict is


referred to as the agency problem
Constraints Interfering with the MNC's Goal

When financial managers of MNCs attempt to


maximize their firm's value, they are confronted with
various constraints that can be classified as
environmental, regulatory, or ethical in nature
Environmental constraints : Each country enforces
its own environmental constraints. Some countries
may enforce more of these restrictions on a subsidiary
whose parent is based in a different country. Building
codes, disposal of production, waste materials, and
pollution controls are examples of restrictions that
force subsidiaries to incur additional costs. Many
European countries have recently imposed rougher
antipollution laws as a result of severe pollution
problems.
Regulatory constraints : Each country also enforces its
own regulatory constraints pertaining to taxes, currency
convertibility rules, earnings remittance restrictions, and
other regulations that can affect cash flows of a subsidiary
established there.

 
Ethical Constraints : There is no consensus standard of
business conduct that applies to all countries. A business
practice that is perceived unethical in one country may be
totally ethical in another.
Example : Bribes, Sexual products in Arab countries.
Theories of International Business
 
The commonly held theories as to why firms
become motivated to expand their business
internationally are (1) the theory of comparative
advantage, (2) the imperfect markets theory,
and (3) the product cycle theory. The three
theories overlap to a degree and can
complement each other in developing a
rationale for the evolution of international
business.
Theory of Comparative Advantage
Multinational business has generally increased over time. Part of this
growth is due to the heightened realization that specialization by
countries can increase production efficiency. Some countries, such as
Japan and the United States, have a technology advantage, while other
countries, such as Jamaica, Mexico, and South Africa, have an advantage
in the cost of basic labor. Since these advantages cannot he easily
transported, countries tend to use their advantages to specialize in the
production of goods that can be produced with relative efficiency. This
explains why countries such as Japan and the United States are large
producers of computer components, while countries such as Jamaica and
Mexico are large producers of agricultural and handmade goods.
Specialization in some products may result in no production of other
products, so that trade between countries is essential. This is the
argument made by the classical theory of comparative advantage.
Comparative advantages allow firms to penetrate foreign markets.
Imperfect Markets Theory

Countries differ with respect to resources available for the


production of goods - Yet, even with such comparative
advantages, the volume of international goods would be limited
if all resources could be easily transferred among countries. If
markets were perfect, factors of production would be freely
transferable and mobile.
The unrestricted mobility of factors would create equality in costs
and would remove the comparative advantage.
However, the real world suffers from imperfect market conditions
where factors of production are somewhat immobile. There are
costs and often restrictions related to the transfer of Labor and
other resources used for production.
Product Cycle Theory 

The product cycle theory is a theory made of few


steps that follow each other:
1_ Firm creates to product to accommodate local
demand
2_ Firm exports product to accommodate foreign
demand
3_ Firm establishes foreign subsidiary to establish
presence in foreign country to minimize cost
4a_ Firm differentiates product from competitors
and/or expands product line in foreign country.
4b_ Firm's Foreign business declines as its
competitive advantages are eliminated
INTERNATIONAL BUSINESS METHODS

Firms use several methods to conduct


international business. The most common
methods are these:
 International trade

 Licensing

 Franchising

 Point Ventures

 Acquisitions of existing operations

 Establishing new foreign subsidiaries


International Trade
International trade is a relatively conservative approach
that can be used by firms to penetrate markets (by
exporting) or to obtain supplies at a low cost (importing).
This approach entails minimal risk because the firm does
not place of its capital at risk. If the firm experiences a
decline in its exporting or importing it can normally reduce
or discontinue this part of its business at a low cost.

Licensing
Licensing obligates a firm to provide its technology
(copyrights, patents, trademarks, or trade names in
exchange for fees or some other specified benefits.
A good point about Licensing is that no exporting and
transferring costs are required but as a disadvantage, the
company can not assure quality control.
Franchising
Franchising obligates a firm to provide a specialized sales
or service strategy,
support assistance, and possibly an initial investment in
the franchise in exchange for periodic fees
 
Joint venture
A joint venture is a venture that is operated by two or
more firms.
Example Fuji & Xerox.
Acquisitions of Existing Operations
Firms frequently acquire other firms in foreign countries as
a means of penetrating foreign markets. For example, SCB
acquired American Express
Disadvantage : Very high capital needed.
 
Establishing New Foreign Subsidiaries
Firms can also penetrate foreign markets by establishing
new operation subsidiaries to produce and sell their
products. Like a foreign acquisition, this process requires a
large investment.

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