Ch. Mulinaional Financial Mgm: Overview Topics Goal of he MNC Theories of Inernaional Business Inernaional Business Mehods Inernaional Opporuniies Exposure o Inernaional Risk MNC's Cash Flows & Valuaion Model for an MNC Inernaional Financial Environmen Mulinaional Company (MNC) Foreign Exchange Markes Exporing & Imporing Dividend Remiance & Financing Invesing & Financing Produc Markes Subsidiaries Inernaional Financial Markes How Business Disciplines Are Used o Manage he MNC Common finance decisions include: Wheher o disconinue operaions in a paricular counry Wheher o pursue new business in a paricular counry Wheher o expand business in a paricular counry How o finance expansion in a paricular counry Finance decisions are influenced by oher business discipline funcions: Markeing Managemen Accouning and informaion sysems 3
S&P 500: Global Sales Breakdown Source: Business Insider, July 9, 205 S&P 500: Degree of Foreign Business Disribuion of Corporae Power Who has power? Srucure of MNCs Curren public MNCs have evolved ino a very specific ype of srucure. Ownership is highly fragmened and mos power is in he hand of managers.. There is no doub ha he echnology and invesor demands have affeced on he srucure of he corporaions. More imporanly, he poliical and legal consrains also have a significan impac. (e.g. Sarbanes-Oxley Ac (SOX) of 2002) 2
Advanages of Common Sock Common sock residual claims of open corporaions are unresriced in he sense ha sockholders assume no oher role, heir residual claims are freely radable, and he residual claims are righs in ne cash flows for he life of he firm. Risk-bearing efficiencies: Separabiliy and radabiliy of common sock lead o he efficiencies in risk bearing hrough diversificaion. Disadvanages of Common Sock Problem of separaion of ownership from conrol An agency relaionship is a conrac in which he principals engage he agen o ake acions on behalf of he principals which involves he delegaion of some decision-making auhoriy o agens. Agency coss: he sum of he ou-of-pocke coss of srucuring, adminisering and enforcing conracs, plus residual loss. Sources of conflic Choice of effor Differenial risk exposure Differenial horizons Goals of The MNCs Shareholders desire wealh maximizaion. Do managers (i.e. agens) maximize shareholder value? Wha is he major challenge for managers of MNCs? Challenge: Consanly changing worldwide compeiive environmen. Inense compeiion is caused by global excess capaciy. 3
Causes of Excess Capaciy Typical Causes of Excess Capaciy. Demand reducion 2. Capaciy-expanding echnological change 3. Obsolescence-creaing echnological change 4. Many compeiors simulaneously rush o implemen new, highly producive echnologies Curren Forces Leading o Excess Capaciy. Macro policies 2. Technology 3. Organizaional innovaion 4. Globalizaion of rade 5. Revoluion in poliical economy 6. Demographics 7. Social changes Difficuly of Exi The asymmery beween growh and decline Informaion problem Conracing problem Conflics Agains he MNC Goal Agency coss are normally larger for MNCs han for purely domesic firms. The sheer size of he MNC. The scaering of disan subsidiaries. The culure of foreign managers. Subsidiary value versus overall MNC value. The magniude of agency coss can vary wih he managemen syle of he MNC. A cenralized managemen syle reduces agency coss. However, a decenralized syle gives more conrol o hose managers who are closer o he subsidiary s operaions and environmen. 4
Cenralized Mulinaional Financial Mgm Cash Managemen a A Invenory and Accouns Receivable Managemen a A Financial Managers of Paren Cash Managemen a B Invenory and Accouns Receivable Managemen a B Financing a A Capial Expendiures a A Financing a B Capial Expendiures a B Decenralized Mulinaional Financial Mgm Cash Managemen a A Financial Managers of A Financial Managers of B Cash Managemen a B Invenory and Accouns Receivable Managemen a A Invenory and Accouns Receivable Managemen a B Financing a A Financing a B Capial Expendiures a A Capial Expendiures a B Impac of Corporae Conrol Various forms of corporae conrol can reduce agency coss. Pay for performance Inernal monioring sysem Marke for corporae conrol Specialis monioring / Audiors Produc Marke Lawsui As MNC managers aemp o maximize heir firm s value, hey may be confroned wih various consrains. Environmenal consrains Regulaory consrains Ehical consrains 5
Theories of Inernaional Business Why are firms moivaed o expand heir business inernaionally?. Theory of Comparaive Advanage Specializaion by counries can increase producion efficiency. 2. Imperfec Markes Theory The markes for he various resources used in producion are imperfec. 3. Produc Cycle Theory As a firm maures, i may recognize addiional opporuniies ouside is home counry. Inernaional Business Mehods. Inernaional rade is a relaively conservaive approach involving exporing and/or imporing. 2. Licensing allows a firm o provide is echnology in exchange for fees or some oher benefis. 3. Franchising obligaes a firm o provide a specialized sales or service sraegy, suppor assisance, and possibly an iniial invesmen in he franchise in exchange for periodic fees. 4. Firms may also penerae foreign markes by engaging in a join venure (join ownership and operaion) wih firms ha reside in hose markes. Inernaional Business Mehods 5. Acquisiions of exising operaions in foreign counries allow firms o quickly gain conrol over foreign operaions as well as a share of he foreign marke. 6. Firms can also penerae foreign markes by esablishing new foreign subsidiaries. In general, any mehod of conducing business ha requires a direc invesmen in foreign operaions is referred o as a direc foreign invesmen (DFI). The opimal inernaional business mehod may depend on he characerisics of he MNC. 6
Inernaional Opporuniies Invesmen opporuniies: The marginal reurn on projecs for an MNC is above ha of a purely domesic firm because of he expanded opporuniy se of possible projecs from which o selec. Financing opporuniies: An MNC is also able o obain capial funding a a lower cos due o is larger opporuniy se of funding sources around he world. Inernaional Opporuniies Europe Sruggle in he Eurozone Russia s disrupive influence Migran crisis Lain America Mexico s illegal drug indusry Brazil s poliical unres and economic problems Asia Growing influence of China s miliary power Rise of India Middle Eas & Africa Ongoing conflics and weakened commodiy markes Africa s dependence on China Exposure o Inernaional Risk Inernaional business usually increases an MNC's exposure o:. Exchange rae movemens 2. Foreign economic condiions 3. Poliical risk 7
Overview of an MNC's Cash Flows Domesic Firms Paymens for producs Paymens for supplies U.S. Cusomers U.S. Businesses Overview of an MNC's Cash Flows MNCs focused on Inernaional Trade, Inernaional Arrangemens, and Foreign Direc Invesmen U.S.- based firm U.S.- based MNC Paymens for producs Paymens for supplies Paymens for expors Paymens for impors Fees for services Coss of services Funds remied Funds invesed U.S. Cusomers U.S. Businesses Foreign Imporers Foreign Exporers Foreign Firms Foreign Subsidiaries Managing for Value Like domesic projecs, foreign projecs involve an invesmen decision and a financing decision. how much business o conduc in each counry how much financing o obain in each currency MNC's financial decisions deermine is exposure o he inernaional environmen. Maximize NPVs of projecs Maximize firm value Maximize shareholder value 8
Valuaion Model for an MNC ( CF $, ) ( k ) n E Value of Domesic CFs = = + E (CF $, ) = expeced cash flows o be received a he end of period n = he number of periods ino he fuure in which cash flows are received k = he required rae of reurn by invesors Valuaion Model for an MNC Value of Inernaional CFs = [ ( ) ( )] m E CF n j, E ER j, j= = ( + k ) E (CF j, ) = expeced cash flows denominaed in currency j o be received by he U.S. paren a he end of period E (ER j, ) = expeced exchange rae a which currency j can be convered o dollars a he end of period k = he weighed average cos of capial of he U.S. paren company Valuaion Model for an MNC Impac of New Inernaional Opporuniies on an MNC's Value Exposure o Foreign Economies Exchange Rae Risk n j= = m [ E ( CF ) E ( ) ] j, ER ( + k ) j, Poliical Risk 9