Download LECTURE 02

Lecture 2
INTERNATIONAL FINANCE
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Lecture 2
International Finance
An Overview
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Chapter Objectives
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
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.
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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 MNC
have a single goal of maximizing the value of the
entire MNC.
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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
Hires
Principal
Agent
Performs
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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:
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the difficulty in monitoring distant managers,
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the different cultures of foreign managers,
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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
Cash
Management
at A
Inventory and
Accounts
Receivable
Management at A
Financing at A
Capital Expenditures
at A
Financial
Managers
of Parent
Cash
Management
at B
Inventory and
Accounts
Receivable
Management at B
Financing at B
Capital Expenditures
at B
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Decentralized Multinational Financial Management
for an MNC with two subsidiaries, A and B
Cash
Management
at A
Financial
Managers
of A
Inventory and
Accounts
Receivable
Management at A
Financing at A
Capital Expenditures
at A
Financial
Managers
of B
Cash
Management
at B
Inventory and
Accounts
Receivable
Management at B
Financing at B
Capital Expenditures
at 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:
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stock options
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hostile takeover threat
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investor monitoring
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Constraints Interfering with the
MNC’s Goal
• MNC managers are confronted with various
constraints:
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Environmental Constraints
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Regulatory Constraints
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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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Theories of International
Business
Why are firms motivated to expand their business
internationally?
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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.
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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
¤ Costs
differs in term of resources
and restrictions related to labor
¤ Restriction
¤ MNC’s
on transferring funds & other sources
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.
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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
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