Module I

The International Financial Environment

Multinational Corporation (MNC)

Foreign Exchange Markets

Exporting & Importing

Dividend Remittance & Financing

Investing & Financing International Financial Markets

Product Markets

Subsidiaries

The globe is not a level playing field - ANONYMOUS

-Firms devise strategies to improve their cash flows, Indian and foreign firms / MNCs alike.
-Many barriers to entry into foreign markets both product & funds market have been eased. -Both global as well as purely domestic firms are affected in todays globalizing world similarly than few decades ago: bcz. Competition will be affected by movements in exchange rates, foreign interest rates, labor costs and inflation. Such changes can affect the market players relative cost of production& pricing policy.

Notes:A level playing field is a concept about fairness, not that each player has an equal chance to succeed, but that they all play by the same set of rules

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Discussion Objectives
To identify the main goal of the multinational corporation
(MNC) and conflicts with that goal; To describe the rationale / key theories that justify international business strategy; To explain the common methods used to conduct or expand global business; To examine global business opportunities and potential exposure to exchange rate risk& uncertainty; and To assess exchange rate exposure and its impact on value of an MNC and concluding remarks. Exercises:

Case study: Ranger Supply Company. Article Review& Discussion: Finance Function in a Global
Corporation, Harvard Business Review .

Self-assessment: Blades Inc. Case & Small Business Dilemma

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The Context of a Global Corporation

Global companies present new opportunities and challenges Apart from the usual capital structure and dividend decisions,
they also have to manage capital structure and profit repatriation policies of their subsidiaries.

Capital budgeting decisions and valuation must reflect not only

the divisional differences but also the complications introduced by currency, tax and country risk factors.

Incentive systems need to measure and reward country

managers / CFOs operating in diverse socio-economic, cultural and financial settings.

The existence of Internal Capital Markets gives MNCs a

powerful mechanism for arbitrage across national financial markets.
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Goal of the MNC

The commonly accepted goal of an MNC is
to maximize shareholder wealth / achieve a positive EVA (i.e. return on total capital cost of capital . Total capital ).

We will focus on MNCs and that wholly own

their foreign subsidiaries.

This is the most common form of ownership of MNCs

and it enables financial managers / CFOs throughout the MNC to have a single goal of maximizing value of the entire MNC instead of maximizing the value of any particular foreign subsidiary.
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Note:
Any MNC operating in India through a local joint
venture can set up a wholly owned subsidiary or a joint venture with a controlling stake for itself only if a no-objection certificate is obtained from its Indian joint venture partner.

The current thinking is that mostly those joint

ventures will continue which are necessitated by the governments norms, such as in the areas of insurance, retail and telecommunications.

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Conflicts Against the MNC Goal

For corporations with shareholders who differ
from their managers, a conflict of goals can exist - the agency problem.

Agency costs* are normally larger for MNCs

than for purely domestic companies.

The sheer size of the MNC and the scattering of distant subsidiaries. If Wal-Mart were a country, its revenues would make it on par with the GDP of the 25th largest economy in the world. The culture of foreign managers. .
* cost of ensuring that managers maximize shareholders wealth

.
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Conflicts Against the MNC Goal

Subsidiary value versus overall MNC value subsidiary decisions yet times may not be in accordance with parent companys E.g. If estimated after-tax benefits received by the parent were more than off-set by the cost of financing the project by the subsidiary company. E.g. GM, Energy giant AES, Ashi Glass. Think of tax laws, exchange rates, production costs, socio-economic dynamics.

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Agency costs, Mgt style, Impact of Management Control & Effective Mgt.

The magnitude of agency costs can vary

with the management style of the MNC.

A centralized management style reduces

agency costs. However, a decentralized style gives more control to those managers who are closer to the subsidiarys operations and environment.

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Centralized Multinational Financial Management

Consider an MNC with two subsidiaries, A and B Cash Management at A Inventory and Accounts Receivable Management at A CFO of Parent Cash Management at B Inventory and Accounts Receivable Management at B

Financing at A
Capital Expenditures at A

Financing at B
Capital Expenditures at B
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Decentralized Multinational Financial Management

Consider an MNC with two subsidiaries, A and B Cash Management at A Inventory and Accounts Receivable Management at A CFOs Of A CFOs Of B Cash Management at B Inventory and Accounts Receivable Management at B

Financing at A
Capital Expenditures at A

Financing at B
Capital Expenditures at B
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Impact of Management Control

Barings Bank collapse in 1995, Nick Leeson Some MNCs attempt to strike a balance - they allow
subsidiary managers to make the key decisions for their respective operations, but the decisions are monitored by the parents management.

Consider the case of GM in our class discussion

Finance Function in a Global Corp. - when the company balancing geographic boundary of its subsidiary vs. its financial performance moving away from clearly seen financial gains of a centralized one ; and also between financial incentives and operational effectiveness essentially a mid-path between centralized and that of decentralized operational structures!

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Impact of Management Control

Electronic networks make it easier for the
parent to monitor the actions and performance of foreign subsidiaries.

For example, corporate intranet or internet

email facilitates communication. Financial reports and other documents can be sent electronically too.

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Impact of Corporate Control

Various forms of corporate control can
reduce agency costs. Stock compensation for board members and executives. The threat of a hostile takeover. Monitoring and intervention by large shareholders. Quick Quiz: What happened during the Financial Market Crisis 2007-10?
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An Assessment of Factors that contributed to the Financial Market Crisis 2007-10

15
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The 2007-2009 Financial Crisis and Executive Compensation: An Analysis and a Proposal for a Novel Structure(2010)
by Alon Raviv International Business School, MA & Yoram Landskroner, Stern School of Business

During the 2007-2009 crises financial institutions have come under

increasing pressure from regulators, politicians and shareholders to change their compensation practices in order to remove the incentive for short-term excessive risk taking.
In this work they analyzed how commonly used executive compensation plans can lead to two socially undesirable outcomes?

: excessive risk taking at one extreme and complete freeze of new

lending on the other. We propose adding a new component to the executive compensation which is paid only if the value of the firm will be located in some predetermined range. This components will push the executive towards the first best solution in which an intermediate (internal solution) level of assets risk, an optimal one.
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Constraints Interfering with the MNCs GoalIts Value

As MNC managers attempt to maximize

their firms value, they may be confronted with various constraints.

Environmental constraints. Regulatory constraints - taxes, currency convertibility rules, earnings remittance restrictions and others, employee rights and protection; capital flows restrictions and potential changes in them in future. Ethical constraints standardized business conduct!. Wider economic& financial developments and potential changes in them.
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Rationale for Foreign Business(financial) Operations:

Theories of International Business

Why are firms motivated to expand their business internationally? Why firms are able to penetrate foreign markets? Why firms evolve into MNCs? A. Broad Rationale Theory of Comparative Advantage Specialization by countries can increase production efficiency.
Imperfect Markets Theory The markets for the various resources used in production are imperfect.

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Notes

Pure competition vs. Perfect

competition
Complete knowledge of all market information markets are symmetric Free mobility of resources or factors of production

Why these assumptions imply several important things about competitive markets ?!.
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Theories of International Business

Why are firms motivated to expand their business internationally?
International Product Cycle Theory

As a firm matures, it may recognize additional opportunities outside its home country. Ex: Minnesota Mining& Manufacturing (3M)Company uses one new product to penetrate foreign markets. After entering the market it expands its product line
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The International Product Life Cycle

Firm creates product to accommodate local demand. a. Firm differentiates product from competitors and/or expands product line in foreign country. Firm exports product to accommodate foreign demand. Firm establishes foreign subsidiary to establish presence in foreign country and possibly to reduce costs. 1,2&3

or
b. Firms foreign business declines as its competitive advantages are eliminated.

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II. Rationale for Foreign Business Operations - continued

B. Specific Rationale 1. 2. 3. 4. 5. Rate of return Diversification Sources of resources New technology Related concerns a. growth b. lower production cost c. prestige d. weaken labors power
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International Business Methods - How firms penetrate foreign markets? Define an MNC?
There are several methods by which firms can conduct international business. Each of the method in turn can be seen in terms of its risk and return features!

International trade is a relatively

conservative approach involving exporting and/or importing. The internet facilitates international trade by enabling firms to advertise and manage orders through their websites.
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International Business Methods

Licensing allows a firm to provide its
technology in exchange for fees or some other benefits. Ex. AT& T and Nynex Corp. have licensing agreements to build and operate parts of Indias telephone system.

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.
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International Business Methods

Firms may also penetrate foreign markets
by engaging in a joint venture(joint ownership and operation) with firms that reside in those markets.

Acquisitions of existing operations in

foreign countries allow firms to quickly gain control over foreign operations as well as a share of the foreign market.

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Tata Completes Jaguar Land Rover Acquisition

Tata Motors has eventually paid USD 2.3 billion in cash
while Ford has contributed USD 600 million to the Jaguar Land Rover pension plans, leaving Ford with USD 1.7 billion. Ford and Tata have agreed on long term cooperation plans in regards to the supply of engines, stampings and other components to Jaguar Land Rover.

Read more:
http://www.worldcarfans.com/10806041083/tatacompletes-jaguar-land-roveracquisition#ixzz1QmaPsc6N
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International Business Methods

Firms can also penetrate foreign markets
by establishing new foreign subsidiaries.

In general, any method of conducting

business that requires a direct investment in foreign operations is referred to as a direct foreign investment (DFI). Then which form of intrnational business is DFI?

The optimal international business method

may depend on the characteristics of the MNC.
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Degree of International Business by MNCs

Foreign Sales as a % of Total Sales Foreign Assets as a % of Total Assets
70% 60% 50% 40% 30% 20% 10% 0% Campbell's Soup Dow Chemical IBM Motorola Nike

62% 46% 26% 12%

66% 58% 50% 40% 33% 47%

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Online Application
Check out the following international trade
promotion sites.

Trade conditions for Industries: An outlook of international trade

conditions for each of several industries is provided at: http://www.ita.doc.gov/td/industry/otea

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Global Opportunities
Investment opportunities - The marginal
return on projects for an MNC is above that of a purely domestic firm because of the expanded opportunity set of possible projects from which to select.

Financing opportunities - An MNC is also

able to obtain capital funding at a lower cost due to its larger opportunity set of funding sources around the world.
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Global Opportunities
Cost-benefit Evaluation for Purely Domestic Firms vis-a-vis MNCs
Investment Opportunities Marginal Return on Projects Marginal Cost of Capital Purely Domestic Firm

MNC

MNC
Purely Domestic Firm Financing Opportunities Appropriate Size for Purely Domestic Firm

Appropriate Size for MNC

Asset Level of Firm

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Global Opportunities
Opportunities in Europe

The Single European Act of 1987. The removal of the Berlin Wall in 1989. The inception of the euro in 1999.
The North American Free Trade Agreement (NAFTA) of 1993 / Regionalisation of trade& currency consequences . The General Agreement on Tariffs and Trade (GATT) accord / WTO/ presence of BRIC nations.

Opportunities in Latin America

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International Opportunities
Opportunities in Asia

The reduction of investment restrictions by many Asian countries during the 1990s. Emerging markets such as Chinas and Indias potential for growth. The Asian economic crisis in 1997-1998. GE, P&G, and Coca-cola Co, were among the companies that acquired business units in Asia during this period.

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Online Application
For more information on the Asian crisis,
check out the following sites: http://www.stern.nyu.edu/~nroubini/asia/Asi aHomepage.html http://www.asienhaus.org/navigat/english/a sienhau.htm

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Whats Special about International Finance? Exposure to International Risk International business usually increases an MNCs exposure to:
exchange rate movements Exchange rate fluctuations affect cash

flows and foreign demand.

foreign economies Economy(ic) fundamentals / conditions

affect demand.
Country risk / political risk Political actions affect cash flows.
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Whats Special about International Finance?

3. Market Imperfections 4. Expanded Opportunity Set

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Exposure to International Risk

U.S. Firms Cost of Obtaining 100,000
$165,000 $160,000 $155,000 $150,000 $145,000 $140,000 $135,000 $130,000 Jan Mar May Jul Sep Nov Jan Mar May

2000

2001
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Online Application
Visit FRED, Fed's economic time-series
database, at http://www.stls.frb.org/fred for numerous economic and financial time series, e.g., balance of payment statistics, interest rates, foreign exchange rates.

Visit http://www.ita.doc.gov/td/industry/otea
(Office of Trade and Economic Analysis) for an outlook of international trade conditions for each of several industries.
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Overview of an MNCs Cash Flows

type of cashflow streams
Profile A: MNCs focused on International Trade
Payments for products

U.S. Customers
U.S. Businesses Foreign Importers Foreign Exporters

U.S.based MNC

Payments for supplies

Payments for exports

Payments for imports

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