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INTERNATIONAL FINANCE
Lecture 2
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Lecture 2
International Finance
An Overview
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Chapter Objectives
To identify the main goal of the multinational corporation (MNC) and potential conflicts with that goal
To describe the key theories that justify international business.
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Multinational Financial Management
Multinational corporations are defined as firms that engage in some form of international business. Their managers conduct international financial management.
• International investment and financial decisions
• Maximise the value of firm
• Export products or import supplies
• After maturing in domestic market, the company can distribute in many countries e.g. Coca Cola (deals in different countries with various currencies)
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Subsidiary Managers
• A subsidiary company is one that is a 'sister' or a
'child' company of another usually larger
company.
• So let's say there is company X. Company Y is
another company owned by company X. Therefore
company Y is a subsidiary of company X.
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Goal of the MNC
• The commonly accepted goal of an MNC is to
maximize shareholder wealth.
• We will focus on MNCs that wholly own their
foreign subsidiaries.
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Goal of the MNC
• Financial managers throughout the MNChave a single goal of maximizing the value of the entire MNC.
¤Managers are suppose to make the decisions that can maximise the stock price and therefore serve the stockholders.
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Conflicts with the MNC Goal
• When a company’s shareholders differ from its
managers, a conflict of goals can exist—the
agency problem.
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Agency Problem
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Agency Problem
• A decision to establish a subsidiary in one
location versus another may be based on the
location’s appeal to a particular manager
rather than on its potential benefit to
shareholders.
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Agency Problem
• A decision to expand a subsidiary may be
motivated by a manager’s desire to receive
more compensation rather than to enhance
the value of the MNC.
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Agency Problems
• Agency costs are normally larger for MNCs
than for purely domestic firms, due to:
¤ the difficulty in monitoring distant
managers,
¤ the different cultures of foreign managers,
¤ the sheer size of the larger MNCs, and
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Conflicts with the MNC Goal
• Subsidiary managers may be tempted to make decisions that maximize the values of their respective subsidiaries.
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Parent Control of Agency Problem
The parent corporation of an MNC may be able to prevent agency problems with proper governance.
Clearly communicate the goals of the MNC
Monitoring by parent
Implement compensation plans that reward the subsidiary managers
To provide managers with the MNC’s stock (or options to buy the stock at a fixed price) as part of their compensation
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Corporate Control of Agency Problems
In case of acquisitions due to poor performance
of MNC the new management will replace the
managers.
Institutional investors can complain to board of
directors and replace the poor management.
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Impact of Management Control
• The magnitude of agency costs can vary with the management style of the MNC.
• Centralized
• Decentralized
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Centralized Multinational Financial Management
for an MNC with two subsidiaries, A and B
FinancialManagersof Parent
Capital Expendituresat A
Inventory andAccounts
ReceivableManagement at A
CashManagement
at A
Financing at A
Capital Expendituresat B
Inventory andAccounts
ReceivableManagement at B
CashManagement
at B
Financing at B
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Decentralized Multinational Financial Management
for an MNC with two subsidiaries, A and B
FinancialManagers
of A
Capital Expendituresat A
Inventory andAccounts
ReceivableManagement at A
CashManagement
at A
Financing at A
Capital Expendituresat B
Inventory andAccounts
ReceivableManagement at B
CashManagement
at B
Financing at B
FinancialManagers
of B
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Impact of Management Control
• Some MNCs attempt to strike a balance – they
allow subsidiary managers to make the key
decisions for their respective operations, but the
parent’s management monitors the decisions.
• Today, electronic networks make it easier for the
parent to monitor the actions and performance of
its foreign subsidiaries.
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MNCs Improvement for Internal Control Process
• Establishing a centralized database of
information
• Ensuring that all data are reported consistently
among subsidiaries
• Implementing a system that automatically
checks data for unusual discrepancies relative
to norms
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MNCs Improvement for Internal Control Process
• Speeding the process by which all departments
and all subsidiaries have access to the data that
they need
• Making executives more accountable for financial
statements by personally verifying their accuracy
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Impact of Corporate Control
• Various forms of corporate control can reduce agency costs:
¤ stock options¤ hostile takeover threat¤ investor monitoring
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Constraints Interfering with the MNC’s Goal
• MNC managers are confronted with
various constraints:
¤ Environmental Constraints
¤ Regulatory Constraints
¤ Ethical Constraints
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Constraints Interfering with the MNC’s Goal
A recent study found that investors
assigned a higher value to firms that
exhibit high corporate governance
standards and are likely to obey ethical
constraints.
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Why are firms motivated to expand their business internationally?
Theories of International Business
1. Theory of Comparative Advantage
2. Imperfect Markets Theory
3. Product Cycle Theory
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1. Theory of Comparative advantage
Allows firms to penetrate foreign markets.
¤ Specialization by countries¤ More efficiency¤ Technological e.g. US, Japan¤ Agriculture e.g. Jamaica, Mexico
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2. Imperfect Market Theory
If perfect market so factors of production are free mobile & equality of costs and returns.
Imperfect market provides incentive to seek foreign opportunities, Where factors of production are immobile.
¤ Countries differs in term of resources
¤ Costs and restrictions related to labor
¤ Restriction on transferring funds & other sources
¤ MNC’s Nike and Gap capitalize on foreign resources
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3. Product Cycle Theory
As a firm matures in home market, it may recognize additional opportunities outside its home country.
By Exports Competition will increase in foreign markets Strategies to sustain
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Review
• Goals of MNCs
• Agency Problems
• Centralized vs. Decentralized System
• Theories of International Business
Source: Adopted from South-Western/Thomson Learning. 2006