Chapter 3: Legal, technological, accounting, and political environments

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1 Chapter 3: Legal, technological, accounting, and political environments LEGAL ENVIRONMENT COMMON LAW Common law: is based on the cumulative wisdom of judges! decision on individual cases through history. Statutory law: those enacted by legislative action- also vary among the common law countries. CIVIL LAW Civil Law: is based on codification, or detailed listing, of what is and is not permissible difference between common law and cicil law system is apparent in the roles of judges and lawyers Common law system the judge serves as a neutral referee ruling on various motions by opposing parties lawyers lawyers are responsible for developing their clients! cases Civil law the judge takes on many of the tasks of the lawyers, determining, for example the scope of evidence to be collected and presented to the court RELIGIOUS LAW Religious Law: is based on the officially established rules governing the faith and practice of a particular religion. Theocracy: is a country that applies religious law to civil and criminal conduct BUREAUCRATIC LAW Bureaucratic Law: is whatever the country's bureaucrats say it is, regardless of the formal law of the land legal system in communist countries and in dictatorship is often described as bureaucratic law protections that may appear in the country's constitution may be ignored if government officials find them inconvenient DOMESTICALLY ORIENTED LAWS sometimes laws of a country in which an international business operates play a major role in shaping opportunities available to that firm some laws are primarily designed to regulate the domestic economic environment this affects firms domestic operations this may indirectly affect the ability of domestic firm to compete internationally by increasing their costs --> reducing their price competitiveness relative to foreign firms LAWS DIRECTLY AFFECTING INTERNATIONAL BUSINESS TRANSACTIONS such laws are often politically motivated as designed to promote a country's foreign policy or military objective

2 Sanctions: are restraints against commerce with a country a country may attempt to induce a second country to change an undesirable policy by imposing sanctions Embargo: a comprehensive sanctions against all commerce with a given country may be imposed by countries acting in unison or alone Dual-use: are products that may be used for both civil and military purposes many technologically advanced countries control the export of these products Extraterritoriality: when countries try to regulate business activities that are conducted outside their borders LAWS DIRECTED AGAINST FOREIGN FIRMS: Nationalization: is when governments choose to transfer ownership of resources from the private to the public sector Expropriation: the transfer that occurs when the host government compensates the private owners for their losses Confiscation: When the government offers no compensation for the firm Privatization: the conversion of state-owned property to privately owned property stems from political ideology and economic pressure many governments limit the foreign ownership of domestic firms to avoid their economies or key industries controlled by foreigners Repatriate: can also constrain foreign MNCs by imposing restrictions on their ability to return to their home countries the profits earned in the host country IMPACTS OF MNCs ON HOST COUNTRIES Economic and political impacts Positive effects include may make direct investment in new plants and factories creating local jobs work for other sectors of economy pay taxes to help improve education, transportations and other municipal services technology transfer Negative effects include compete directly with local firms may cause these firms to lose both jobs and profits local economy could become dependent on financial health of MNC Political Impact sheer size of MNC can often give them tremendous power in each country that they operate in Cultural Impacts raise local standards of living and introduce new products and services previously unavailable develop new norms, standards and behaviors DISPUTE RESOLUTION Four questions that must me asked 1. Which country!s law applies?

3 2. In which country should the issue be resolved? 3. Which technique should be used to resolve the conflict: litigation, arbitration, mediation or negotiation? 4. How will the settlement be enforced many business contracts specify answers to these questions if the first two questions are not answered then the firms must engage in forum shopping Forum Shopping: when each party seeks to have the case heard in the country system most favorable to its own interest Principle of Comity: whether a foreign court order is enforced in another country provides that a country will honor and enforce within its own territory the judgments and decisions of foreign courts with certain limitations for this principle to apply countries usually require three conditions to be met Reciprocity is extended between the countries the defendant is given proper notice the foreign court judgment does not violate domestic statues or treaty obligations Arbitration: is the process by which bother parties to a conflict agree to submit their cases to private individual or body whose decision they will honor because of speed, privacy and informality it can often be cheaper Foreign Sovereign Immunities Act of 1976: provides that the actions of foreign governments against US firms are generally beyond the jurisdiction of US courts TECHNOLOGICAL ENVIRONMENT availability or unavailability of resources affects what products are made in given country countries shape their technological environments through investments many developed countries have invested heavily in their infrastructure to make production of products easier many other countries have invested heavily in human capital Technology Transfer: the transmittal of technology from one country to another brand names, patents, copyrights, and trademarks are often basis of firms competitive advantage/ core competency in global marketplace weak protection for intellectual property rights can have high costs for international businesses ACCOUNTING ENVIRONMENT differences in the policies and procedures of national accounting systems can create significant operations and control problems for international business in common law countries accounting procedures normally evolve via decision of independent standards-setting boards accountants under these conditions usually follow so-called generally accepted accounting principles (GAAP) that provide a true and fair view of a firm!s performance based on the standards freed to by these professional boards accountants have leeway in practice of professional discretion

4 countries that rely on code law are likely to codify their national accounting procedures and standards accounting practices are determined by law, not by collective wisdom of professional accounting groups country!s legal system also affects enforcement id accounting practices in codified law because procedures are laid down by law government plays a major role in monitoring accounting practices common law relies to a greater extent on private limitations to enforce the accuracy and honest of firms! accounting practices international political ties are also important determinants of county!s accounting procedures eg countries of Common Wealth adopt British accounting system county!s economic system also influences accounting practice centrally planned accounting system is driven by the need to provide outputoriented information to state planners market oriented economies have accounting systems which serve the needs of managers and investors who require information about profit and cost orientation DIFFERENCES IN ACCOUNTING PRACTICES Valuation and revaluation of assets most countries! accounting systems begin with the assumption that a firm's assets should be valued on a historical cost basis an asset is carried on the firm!s books according to asset!s original cost, less depreciation because of inflation the market value of an asset is often higher than its historical cots resolution of this problem differs among national accounting systems these differences in asset revaluation procedures suggest the need for valuation when comparing the strength of balance sheets of firms from different countries Valuation of inventories LIFO and FIFO in times of inflation's LIFO tends to raise the firm!s reported costs of goods sold, lower the book value of its inventories and reduce reported profits FIFO produces a clearer estimate of the value of firms existing inventories than does LIFO in comparing the performance of two firms one needs to know which technique each uses to value its inventories Dealing with the tax authorities accounting records form the basis for assessing its income tax burden US firms (common law) commonly report two different financial statements one to shareholders and one for Internal Revenue Services (IRS) this way they can take advantage of special tax code provisions to decrease tax paid German (codified law) forced to choose one or the other often choose to report lower income and pay less taxes by having an accelerated depreciation rate Use of accounting reserves:

5 Accounting Reserves: accounts created in a firm!s financial reports to record foreseeable future expenses that might affect its operations used to account for bad debts and returned merchandise use of accounting resources are carefully monitored in US (common law) by IRS because charges on these accounts reduce taxable income in Germany the use of accounting reserves in liberally permitted this hamper!s outside investor!s ability to asses firms! performance often these firms use reserve accounts to smooth out fluctuations in their earning flows by adding large sums to their reserves in good years and dipping into them in poor years Other differences: Capitalization of financial leases: common law usually must capitalize whereas codified may do so but are not required to do so Preparations of consolidated financial statements: mandatory in some (usually common law) countries and others (usually codified) may exclude consolidating subsidiaries under certain circumstances Capitalization of research and development (R&D) expenses: most countries permit capitalization, but practice is forbidden in US except in certain circumstances Treatment of goodwill: Goodwill: value that a firm pays when acquiring a second firm that is over and in excess of book value can amortize although some countries give the option of doing it instantaneously of over a prolonged period Impacts on Capital Markets these differences can distort the measured performance of firms incorporated in different countries comparing the financial reports of firms from different countries is exceedingly complex making it more difficult for international investors to asses the performance of the world!s businesses SEC-mandated accounting rules (for NYSE) must be followed by publicly traded corporations under SEC!s jurisdiction these rules emphasize full and comprehensive disclosure of a firm!s finical performance information NYSE fears the rules discourage foreign firms from listing on the exchange but this form of disclosure results in reliable numbers for assessing the riskiness of potential loans International Financial Reporting Standards: an alternative transparent approach to financial reporting issued by the International Accounting Standards Board (IASB) POLITICAL RISK Political Risk Assessment: a systematic analysis of the political risks they face in foreign countries Political risks: are any changes in the political environment that may adversely affect the value of a firm!s business activities Three categories:

6 Ownership risk: in which property of a firm is threatened through confiscation or expropriation Operating risk: in which the ongoing operations of a firm and/or the safety of its employees are threatened through changes in laws, environmental standards, tax codes, terrorism, armed insurrections and so forth Transfer risk: in which the government interferes with a firm!s ability to shift funds into and out of the country Macropolitical risk: affects all firms in a country; example is civil war Micropolitical risk: affects only the specific firm or firms within a specific industry employees posses firsthand knowledge of the local political environments and are valuable source of political risk information views of local staff should be supplemented by view of outsiders embassy officials and international chambers are often rich sources of information greater and longer-lived a firm!s investment the broader its risk assessment should be some degree of political risk exists in every country although the nature and importance of these risks vary if a firm is considering an investment in a politically risky environment it should be sure that it can obtain rates of return that are high enough to offset the risks of entering that market firms already operating in high risk country may choose to take steps to reduce their venerability firm can reduce its financial exposure by reducing its net investment in local subsidiary or a firm might build a domestic political support in the host country by being a good corporate citizen to reduce risk of foreign operations most developed countries have created government-owned or government-sponsored organizations to insure firm against political risk Overseas Private Investment Corporation (OPIC): insurance US overseas investments against nationalization, insurrections or revolutions and foreign exchange inconvertibility Multilateral Investment Guarantee Agency (MIGA): a subsidiary of the World Bank provides similar insurance against political risk

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