Madura: International Financial Management
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Chapter Objectives
Chapter
Multinational Financial Management:
An Overview
• To identify the main goal of the multinational
corporation (MNC) and organizational structure of
the MNC;
• To describe the key theories that justify international
business;
• To explain the common methods used to conduct
international business; and
• Provide a model for valuing the MNC
• Opportunities and challenges of multinational
operations
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Goal of the MNC
Conflicts Against the MNC Goal
• The commonly accepted goal of an MNC is
• For corporations with shareholders who
to maximize shareholder wealth.
differ from their managers, a conflict of
goals can exist - the agency problem.
• Agency costs are normally larger for MNCs
than for purely domestic firms.
¤ The scattering of distant subsidiaries.
¤ The culture of foreign managers.
¤ The sheer size of the MNC.
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Madura: International Financial Management
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Parent Control of Agency Problems
Impact of Management Control
• The parent corporation of an MNC may be
• The magnitude of agency costs can vary
able to prevent most agency problems
with proper governance.
¤ Clearly communicate the goals for each
subsidiary
¤ Oversee subsidiary decisions
¤ Implement compensation plans
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
subsidiary’s operations and environment.
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Centralized Multinational Financial Management
Decentralized Multinational Financial Management
for an MNC with two subsidiaries, A and B
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
Cash
Management
at A
Inventory and
Accounts
Receivable
Management at B
Financial
Managers
of A
Inventory and
Accounts
Receivable
Management at A
Financing at B
Financing at A
Capital Expenditures
at B
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Cash
Management
at B
Inventory and
Accounts
Receivable
Management at B
Financing at B
Capital Expenditures
at A
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Financial
Managers
of B
Capital Expenditures
at B
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Madura: International Financial Management
Chapter 1
Impact of Management Control
Impact of Management Control
• Some MNCs attempt to strike a balance -
• Electronic networks make it easier for the
they allow subsidiary managers to make
the key decisions for their respective
operations, but the decisions are
monitored by the parent’s management.
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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Corporate Control of Agency Problems
Theories of International Business
• Various forms of corporate control can
Why are firms motivated to expand
their business internationally?
reduce agency costs.
¤ The threat of a hostile takeover.
¤ Monitoring and intervention by institutional
investors.
 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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Madura: International Financial Management
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Theories of International Business
Product Life Cycle (PLC) Theory
Why are firms motivated to expand
their business internationally?
 Product Cycle Theory
¤ As a firm matures, it may recognize additional
opportunities outside its home country.
¤ As products mature both the location of sales
and the optimal production location will
change affecting the flow and direction of
trade.
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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.
or
b. Firm’s
foreign
business
declines as its
competitive
advantages are
eliminated.
International
Business Methods
 Firm
establishes
foreign
subsidiary
to establish
presence in
foreign
country
and
possibly to
reduce
costs.
There are several methods by which firms
can conduct international business.
• 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
International
Business Methods
• Licensing allows a firm to provide its technology
• Franchising is a specialized form of licensing in which
the franchiser not only sells intangible property
(normally a trademark) to the franchisee, but also
insists that the franchisee agree to abide by strict rules
as to how it does business.
in exchange for fees or some other benefits.
• An arrangement whereby a licensor grants the
rights to intangible property to another entity
(the licensee) for a specified period, and in
return, the licensor receives a royalty fee from
the licensee.
• The franchiser will also often assist the franchisee to
run the business on an ongoing basis.
• As with licensing, the franchiser typically receives a
• Intangible property includes patents, inventions,
royalty payment, which amounts to some percentage of
the franchisee's revenues.
formulas, processes, designs, copyrights, and
trademarks.
• Whereas licensing is pursued primarily by
manufacturing firms, franchising is employed primarily
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by service firms.
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International
Business Methods
International
Business Methods
• Firms may also penetrate foreign markets
• Firms can also penetrate foreign markets
by engaging in a joint venture (joint
ownership and operation) with firms that
reside in those 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).
• 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.
• The optimal international business
method may depend on the characteristics
of the MNC.
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Madura: International Financial Management
Chapter 1
Overview of an MNC’s Cash Flows
Valuation Model for an MNC
• Domestic Model
E (CF$,t ) = expected cash flows to be received at
the end of period t
n
= the number of periods into the future
in which cash flows are received
k
= the required rate of return by
investors
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Valuation Model for an MNC
Uncertainty Surrounding an MNC’s
Cash Flows
• Valuing International Cash Flows
Value =
∑
E CF ,
• Exposure to International Economic
×E 𝑺,
Conditions
1+𝑘
• Exposure to International Political Risk
• Exposure to Exchange Rate Risk
E (CFj,t ) = expected cash flows denominated in currency j
to be received by the U.S. parent at the end of
period t
E (Sj,t ) = expected exchange rate at which currency j can
be converted to dollars at the end of period t
k
= the weighted average cost of capital of the U.S.
parent company
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Madura: International Financial Management
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How Uncertainty Affects the
MNC’s Cost of Capital
The Opportunities of Multinational
Operations
• If there is suddenly more uncertainty about
• Multinational Investment Opportunities
an MNC’s future cash flows, then investors
will expect to receive a higher rate of return.
¤
¤
• If the uncertainty surrounding conditions
Enhancing Revenues
Reducing Operating Costs
• Multinational Financial Opportunities
that influence cash flows declines, the
uncertainty surrounding cash flows of
MNCs also declines and results in a lower
required rate of return and cost of capital
for MNCs.
¤
¤
¤
Reducing cost of capital
Reducing taxes through multinational
operations
Financial market arbitrage
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Challenges of Multinational
Operations
Exposure to International Risk
International business usually increases an
MNC’s exposure to:
• Cultural differences
• Differences in legal, accounting, and tax
 Country risk
 Political risks
 Financial risks.
systems
•
•
•
•
•
Differences in personnel management
Differences in marketing
 Currency risk—also called foreign
exchange risk or forex (FX) risk
Differences in distribution
Differences in financial markets
Differences in corporate governance
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