International Financial Management
Lecture Topic:
International Financial Management
and the Multinational Firm
(國際財務管理與多國籍企業)
09/2003
By Professor Sheng-Yung YANG
1
Overview
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Introduction
Foreign Exchange Risks
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Political Risk
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Definition
Effects on Financial Management of MNEs
Macro Risks (Country Specific Risks)
Micro Risks (Firm Specific Risks)
Goal of Management
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Shareholder Wealth Maximization
Corporate Wealth Maximization
Corporate Governance
Operational Goals for MNEs
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1
Overview
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Universal Truth vs. Culturally Determined Norm
Market Imperfections: Rationale for the
Existence of the Multinational Firm
(Opportunities of MNEs from Market Imperfection)
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Why Do Firms Become Multinational?
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Markets
Raw Materials
Production Efficiency
Knowledge
Political Safety
Market Seekers vs. Raw Material Seekers
Defensive Investments
Opportunities of MNEs from Market Imperfection3
Overview
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The Theory of Comparative Advantage
Product Cycle Theory
Globalization of the World Economy: Recent
Trends
Multinational Financial Management vs.
General Financial Management
Exposure to International Risk
Valuation Model for an MNC
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2
Introduction
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This course is about international financial
management with special emphasis on the
multinational firm; why is it important to MNE?
The multinational enterprise or corporation (MNE or
MNC, 多國籍企業) is defined as one that has
operating (production and marketing) subsidiaries,
branches, and affiliates located in foreign countries;
e.g. Intel, Nokia, Walt Disney, Nestlé, TSM, UMC, and
Acer Group etc.
Purely domestic firms also often have significant
international activities including import and export,
foreign competition, international relationships with
customers and the suppliers, and foreign exchange
5
and credit risks of trade payments
Multinational Corporations
(MNCs, 多國籍企業)
Multinational Corporation (MNC)
Foreign Exchange Markets
Exporting
& Importing
Product Markets
Dividend
Remittance
& Financing
Subsidiaries
Investing
& Financing
International
Financial
Markets
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3
Top 10 MNEs Ranked by Foreign Assets (1997)
1
General Electric (304 B)
United States
2
Ford Motor Company (275 B)
United States
3
Royal Dutch/Shell Group (115 B) Netherlands / UK
4
General Motors (228 B)
United States
5
Exxon Corporation (96 B)
United States
6
Toyota (105 B)
Japan
7
IBM (82 B)
United States
8
Volkswagen Group (57 B)
Germany
9
Nestlé SA (38 B)
Switzerland
10
Daimler-Benz AG (76 B)
Germany
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Unique Risks Faced by MNEs: Foreign
Exchange Risks and Political Risks
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The normal domestic approach to the cost of capital,
sourcing debt and equity, capital budgeting, working
capital management, investment, taxation, and credit
analysis, and financial instruments etc. needs to be
modified to accommodate foreign complexity and risk
Foreign Exchange Risk (匯率風險): The risk that
foreign currency profits may evaporate in dollar
(domestic) terms due to unanticipated unfavorable
exchange rate movements; investors therefore
require a foreign exchange risk premium when
valuing the equity and debt of MNEs; how it affects
the cost of capital?
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Unique Risks Faced by MNEs: Foreign
Exchange Risks and Political Risks
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Political Risk (政治風險): Sovereign governments
have the right to regulate the movement of goods,
capital, and people across their borders; these laws
sometimes change in unexpected ways
See, Exhibit 1.1, for the Micro-Macro decomposition
of political risks (need the political risk premium)
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Most contemporary political risk for MNEs is firm-specific and
affects operations rather than ownership
Forecasting political risk and finding strategies to reduce its
impact are major concerns of top management of MNEs
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Exhibit 1.1: Micro-Macro Decomposition of
Political Risk
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5
Analysis of Political Risks
Macro Risks
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Expropriation (無償徵收): is defined as official government
seizure of private property
Ethnic Strife (種族紛爭): e.g. the 911 attack of US, tension
between ethnic and religious groups in Asia
Micro Risks
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Goal Conflict (經營目標的衝突): the risk arises from a
conflict between the objectives of governments (for citizens)
and private firms (for stakeholders)
Corruption (貪污與賄賂): Transparency International (TI)
publishes monthly newsletter on corruption in international
business transactions; the indices help firms determine
political risk premium
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Transparency International’s Corruption
Perceptions Index for 2002
1
2
2
4
5
5
7
7
7
10
11
12
12
14
15
16
17
18
18
20
20
20
Finland
Denmark
New Zealand
Iceland
Singapore
Sweden
Canada
Luxembourg
Netherlands
United Kingdom
Australia
Norway
Switzerland
Hong Kong
Austria
USA
Chile
Germany
Israel
Belgium
Japan
Spain
9.7
9.5
9.5
9.4
9.3
9.3
9.0
9.0
9.0
8.7
8.6
8.5
8.5
8.2
7.8
7.7
7.5
7.3
7.3
7.1
7.1
7.1
0.4
0.3
0.2
0.4
0.2
0.2
0.2
0.5
0.3
0.5
1.0
0.9
0.9
0.8
0.5
0.8
0.9
1.0
0.9
0.9
0.9
1.0
8.9 - 10.0
8.9 - 9.9
8.9 - 9.6
8.8 - 10.0
8.9 - 9.6
8.9 - 9.6
8.7 - 9.3
8.5 - 9.9
8.5 - 9.3
7.8 - 9.4
6.1 - 9.3
6.9 - 9.3
6.8 - 9.4
6.6 - 9.4
7.2 - 8.7
5.5 - 8.7
5.6 - 8.8
5.0 - 8.1
5.2 - 8.0
5.5 - 8.7
5.5 - 7.9
5.2 - 8.9
9.5 - 9.9
9.3 - 9.7
9.3 - 9.6
9.2 - 9.7
9.2 - 9.4
9.2 - 9.4
8.9 - 9.2
8.7 - 9.5
8.8 - 9.1
8.4 - 8.9
8.0 - 9.0
8.0 - 8.9
7.9 - 8.9
7.8 - 8.6
7.6 - 8.1
7.2 - 8.0
7.0 - 7.9
6.7 - 7.7
6.7 - 7.7
6.6 - 7.6
6.6 - 7.4
6.5 - 7.6
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24
25
25
27
28
29
29
31
32
33
33
33
36
36
36
36
40
40
40
40
44
Ireland
6.9 0.9
Botswana
6.4 1.5
France
6.3 0.9
Portugal
6.3 1.0
Slovenia
6.0 1.4
Namibia
5.7 2.2
Estonia
5.6 0.6
Taiwan
5.6 0.8
Italy
5.2 1.1
Uruguay
5.1 0.7
Hungary
4.9 0.5
Malaysia
4.9 0.6
T rinidad & T o b
4.9
a go1.5
Belarus
4.8 1.3
Lithuania
4.8 1.9
South Africa 4.8 0.5
Tunisia
4.8 0.8
Costa Rica
4.5 0.9
Jordan
4.5 0.7
Mauritius
4.5 0.8
South Korea 4.5 1.3
Greece
4.2 0.7
5.5 - 8.1 6.4 - 7.4
5.3 - 8.9 5.6 - 7.6
4.8 - 7.8 5.9 - 6.8
5.5 - 8.0 5.8 - 6.9
4.7 - 8.9 5.3 - 6.9
3.6 - 8.9 4.3 - 7.3
5.2 - 6.6 5.4 - 6.0
3.9 - 6.6 5.2 - 6.0
3.4 - 7.2 4.6 - 5.7
4.2 - 6.1 4.6 - 5.6
4.0 - 5.6 4.6 - 5.2
3.6 - 5.7 4.6 - 5.2
3.6 - 6.9 3.8 - 5.9
3.3 - 5.8 3.3 - 5.4
3.4 - 7.6 3.7 - 5.9
3.9 - 5.5 4.5 - 5.0
3.6 - 5.6 4.1 - 5.3
3.6 - 5.9 4.0 - 5.1
3.6 - 5.2 4.0 - 4.9
3.5 - 5.5 4.0 - 4.9
2.1 - 7.1 3.9 - 5.1
3.7 - 5.5 3.8 - 4.6
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Goal of Management for MNEs
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It is a culturally determined norms
Two main theories in practice
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Shareholder wealth maximization model (US)
Corporate wealth maximization model (Japan)
The Shareholder Wealth Maximization Model (SWM):
the firm should strive to maximize the return to
shareholders, as measured by the sum of capital
gains and dividends, for a given level of risk
Assumptions of SWM:
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Efficient stock market (效率市場)
Risk, systematic vs. unsystematic (系統風險)
Agency theory (代理人理論)
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Goal of Management for MNEs
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The Corporate Wealth Maximization Model (CWM):
the firm should treat shareholders on a part with
other corporate interest groups, such as labor,
management, suppliers, creditors, and government
Assumptions of CWM:
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Market can be efficient or inefficient: the loyal long-term
shareholder should affect influence corporate strategy, not
the transient portfolio investor
Total risk (financial and operating) matters; risk is measured
more by product market variability than by short-term
variation in earnings and share price
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Corporate Governance (公司治理)
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The non-US markets are not characterized by the
corporate “one-share-one-vote” rule, shareholders might
not enforce their own objectives when management does
not act as their agent
Dual classes of voting shares (restrictions on voting
shares), banking system closely involved both in crossownership and as a prime lender, and many other antitakeover defenses exist make it difficult to replace the
existing management (Germany, France, and Japan)
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In some emerging market and Asia, many prominent firms
are owned by the government or friends or relatives of top
government officials; often overstaffed and over-financed
Nokia, the Finnish tele-com company, converted all their
share classes to one class with one-share-one-vote voting
rights in 1999
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Universal Truth vs. Culturally Determined Norm
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Exhibit 1.3 is a survey of takeover defenses in
nine non-US countries
Universal Truth vs. Culturally Determined
Norm:
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Firms are composed of competing and cooperating
stakeholder groups; which group dominates is a
culturally determined norm
Most firms try to maximize their return; how
return is measured and from whose perspective is
a culturally determined norm
Most firms are risk averse; how risk is measured is
a culturally determined norm
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Operational Goals for MNEs
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The primary operational goal of the MNEs is to
maximize consolidated profits, after-tax
Consolidated profits are the profits are the profits
of all the individual units of the firm, originating
in many different currencies but expressed in the
currency of the parent company
Consolidated financial reports, income statement,
balance sheet, and cash flows statement
Goals are frequently inconsistent and need
tradeoff (note: environmental, regulatory, ethical
constraints)
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Opportunities of MNEs from Market Imperfection
(Theories of International Business)
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Market Imperfections
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Legal restrictions on movement of goods, people, and
money
Transactions costs
Shipping costs
Tax arbitrage and tariff
MNEs are a gift of market imperfections
Large MNEs are better able to exploit competitive
factors such as economies of scale, managerial and
technological expertise, product differentiation, and
financial strength than are their local competitions
Arbitrage opportunities are from market imperfection
not from market inefficiency in the international
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settings
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Opportunities of MNEs from Market Imperfection
(Theories of International Business)
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The common stock of MNEs serve as a vehicle for
investors who wish to hold internationally diversified
portfolios (prevented from achieving diversification
because of perceived and real imperfections in the
market for financial assets)
Motivations for Firms Becoming Multinational
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Markets seeking
Raw material seeking
Production efficiency seeking: e.g. finding cheap labor
Knowledge: Silicon Valley, Taiwan Industrial Park
Political Safety
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Opportunities of MNEs from Market Imperfection
(Theories of International Business)
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Industry with oligopolistic competition can further
sub-classified their strategic moves as:
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Proactive investment: to enhance firm’s growth and
profitability
Defensive investment: to deny growth and profitability to
the firm’s competitors
Expand Opportunity Set: strategic motivation is to
seek new markets, cheap raw materials, production
efficiency, knowledge, and political safety
Defensive Investments: product cycle theory, follow
the leader and customer, creditability, growth to
survival, and knowledge seeking
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Opportunities of MNEs from Market Imperfection
(Theories of International Business)
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The Theory of Comparative Advantage
(Theories of International Business)
Without Free Trade
Country A
Country B
Total
Units of input (000,000)
Food (lbs.)
40
40
Textiles (yards)
20
20
Output per unit of input
Food (lbs.)
5
15
Textiles (yards)
3
4
Total output
Food (lbs.)
200
600
Textiles (yards)
60
80
Consumption
Food (lbs.)
200
600
Textiles (yards)
60
80
800
140
800
140
The opportunity cost of A to produce textiles is 5/3=1.67pd/y or 0.6y/pd;
The opportunity cost of B to produce textiles is 15/4=3.75pd/y or 0.27y/pd;
Country B has absolute advantage in producing both Food&Textiles;
while country B is relative efficient in Food (lower opportunity cost)
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The Theory of Comparative Advantage
(Theories of International Business)
With Free Trade
Country A
Country B
Total
Units of input (000,000)
Food (lbs.)
20
50
Textiles (yards)
40
10
Output per unit of input
Food (lbs.)
5
15
Textiles (yards)
3
4
Total output
Food (lbs.)
100
750
Textiles (yards)
120
40
Consumption
Food (lbs.)
225
625
Textiles (yards)
70
90
850
160
850
160
Country A can shift input (20) to produce textiles and B shift (10) to produce food;
The total production will increase (50 in food & 20 in textiles);
And via free trade of food (125 from B to A) and textiles (50 from A to B), both
countries can achieve consumption level higher than without free trade (happy)
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Product Cycle Theory
(Theories of International Business)
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Globalization of the World Economy: Recent Trends
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Emergence of Globalized Financial Markets: deregulation
of financial markets coupled with advances in
technology have greatly reduced information and
transactions costs, which has led to financial innovations
Such as, currency futures and options, multi-currency
bonds, cross-border stock listings, international mutual
funds
Trade Liberalization and Economic Integration: Over the
past 50 years, international trade increased about twice
as fast as world GDP
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Globalization of the World Economy: Recent Trends
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The General Agreement on Tariffs and Trade (GATT) a
multilateral agreement among member countries has
reduced many barriers to trade
The World Trade Organization has the power to enforce
the rules of international trade
The North American Free Trade Agreement (NAFTA)
calls for phasing out impediments to trade between
Canada, Mexico and the United States over a 15-year
period
Privatization
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Multinational Financial Activities
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Traditional areas of financial management
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Capital structure (best combination of debt, equity, MM
Theory)
Capital budgeting (investment decisions, NPV)
Long-term financing (financing decision)
Working capital management (cash, receivables, inventory)
For multinational finance and management activities,
attentions should pay to culturally-determined norms,
political issues, jurisdictional boundary, and
organizational goals, and foreign exchange risk and
related contract risk management
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Managing for Value
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Like domestic projects, foreign projects
involve an investment decision and a
financing decision
When managers make multinational finance
decisions that maximize the overall present
value of future cash flows, they maximize the
firm’s value, and hence shareholder wealth
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14
Valuation Model for an MNC
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Domestic Model
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Value = ∑
E (CF$, t )
t =1
(1 + k )t
E (CF$,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
Impact of New International Opportunities
on an MNC’s Value
Exposure to
Foreign Economies
Exchange Rate Risk
 m

E (CF j , t )× E (ER j , t ) 
n ∑


Value = ∑  j =1

t
(1 + k )
t =1 



[
]
Political Risk
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