Chapter
1
Multinational Financial Management:
An Overview
Rashedul Hasan
South-Western/Thomson Learning © 2003
Multinational or Global
Corporation
A corporation that operates in two or
more countries.
The term Multinational or Global
Corporation is used to describe a firm
that operates in an integrated fashion
in a number of countries.
Decision making within the
corporation may be centralized in the
home country, or may be decentralized
across the countries the corporation
does business in.
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Why do firms expand into other
countries?
1.
To seek new markets.
2.
To seek raw materials.
3.
To seek new technology.
4.
To seek production efficiency.
5.
To avoid political and regulatory hurdles.
6.
To diversify.
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Reasons for going global
• To broaden their market:
After a company has saturated its home
market, growth opportunities are often
better in foreign markets. Thus some U.S.
firms like Coca-Cola, Pepsi are expanding
into overseas markets on the other hand,
Sony and Toshiba now dominate the U.S.
consumer electronic market.
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Reasons for going global
• To seek raw materials:
Many U.S. oil companies, such as Exxon
Mobil, have major subsidiaries around the
world to ensure access to the basic
resources needed to sustain the
company’s primary business line.
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Reasons for going global
• To seek new technology:
No single nation holds a commanding
advantage in all technologies, so
companies are scouring the globe for
leading scientific and design ideas. For
example, Xerox has introduced more than
80 different office copies in U.S. that were
engineered and built by its Japanese joint
venture, Fuji Xerox.
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Reasons for going global
• To seek production efficiencies:
Companies in high-cost countries are
shifting production to low-cost region. For
example, GE has production and
assembly plants in Mexico, South Koria
and Singapore.
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Reasons for going global
• To avoid political & regulatory hurdles:
The primary reason Japanese auto
companies moved production to the U.S.
was to get around U.S. import quotas.
Now Honda, Nissan, Toyota, Mazda and
Mitsubishi all have assembling plant in
U.S.A.
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Reasons for going global
• To diversify:
• By establishing worldwide production
facilities and markets, firms can minimize
the impact of adverse economic trends in
any single country. For example, GM
minimize the blow of poor sales in U.S.
market during 1990-1991 recession with
strong sales by its European subsidiaries.
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What factors distinguish multinational financial
management from domestic financial management?
1.
Different currency denominations.
2.
Economic and legal ramifications.
3.
Language differences.
4.
Cultural differences.
5.
Role of governments.
6.
Political risk.
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Theories of International Business
The commonly held theories why firms
become motivated to expand their business
internationally are,

Theory of comparative advantage

The imperfect market theory

The product cycle theory
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Theory of comparative advantage
Multinational business has generally increased
over time. Part of this growth is due to the
realization that specialization by countries can
increase production efficiencies. Some
countries, such as, U.S. Japan etc have
technological advancement, while other
counties, such as Bangladesh, Jamaica, Mexico
etc have advantage in the cost of basic labor.
Since this advantage cannot be easily
transferred or transported, countries tend to
use their advantages to specialized in
production of goods that can be produced with
relative efficiencies.
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The imperfect market theory
Countries differ with respect to resources
available for the production of goods. Moreover
the real world suffers from imperfect market
conditions where Factors of Production (land,
labor, capital & entrepreneurship) are
somewhat immobile. There are costs and other
restriction related to the transfer of labor and
other resources used for production. These
imperfect market conditions are one of the
important reasons for going global.
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The product cycle theory
• According to this theory, firms become
established in-home market first.
• As a firm matures, it may recognize additional
opportunities outside its home country.
Foreign demand for firm’s product will initially
be fulfilled by export. As time passes, the firm
may feel the only way to retain its advantage
over competitors in foreign countries is to
produce the product in foreign market, thereby
reducing its transportation cost. The different
phases of the product cycle theory are as
follows,
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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.
 Firm
establishes
foreign
subsidiary
to establish
presence in
foreign
country
and
possibly to
reduce
costs.
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International
Business Methods
There are several methods by which firms
can conduct international business.
•
•
•
•
•
•
International trade
Licensing
Franchising
Joint venture
Acquisitions of existing operations
Establishing new foreign subsidiaries.
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International trade
Is a relatively conservative approach
involving exporting and/or importing. This
approach entails minimum risk because
the firm does not place any of its capital at
risk.
The Internet facilitates international trade
by enabling firms to advertise and manage
orders through their websites.
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Licensing
Allows a firm to provide its technology
(copyright, patents, trademarks or trade name) in
exchange for fees or some other benefits. For
example, IGA, Inc. that operates more than 3000
supermarkets in U.S. has a licensing agreement
to operate supermarket in China and Singapore.
AT&T and Verizon communications have
licensing agreement to build and operate part of
India’s telecommunication services.
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Franchising
Obligates a firm to provide specialized sales
or service strategy, support assistance, and
possibly an initial investment in the franchise
in exchange for periodic fees. For example,
McDonald’s, Pizza Hut, KFC etc have
franchises that are owned and managed by
the local residents in many foreign countries.
Like licensing, franchising also allows firm to
penetrate foreign market without a major
investment in foreign countries.
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Joint venture
• Joint Venture is a venture that is jointly owned and
operated by two or more firms. Firms may also
penetrate foreign markets by engaging in a joint venture
(joint ownership and operation) with firms that reside in
those markets. Most joint venture allows two firms to
apply their respective comparative advantages in given
project. For example, General Mills have a joint venture
with Nestle so that the cereals produced by General Mill
could be marketed through the overseas sales
distribution network established by Nestle. Xerox Corp.
and Fuji Co. engage in a joint venture that allowed
Xerox to penetrate the Japanese market and allowed
Fuji to enter into Photocopy machine business.
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Acquisitions
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. For
example, Proctor & Gamble recently
purchased a bleach company in panama.
By doing so P&G has received a well
established production facilities as well as
marketing network.
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Foreign subsidiaries
Firms can also penetrate foreign markets
by establishing new foreign subsidiaries.
Like acquisition it requires a large
investments. But it is more preferred to
acquisition because the operation can be
tailored exactly to the firm’s need.
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Degree of International Business by MNCs
Foreign Sales as a % of Total Sales
Foreign Assets as a % of Total Assets
70%
62%
60%
46%
50%
66%
58%
50%
40%
33%
40%
30%
20%
47%
26%
12%
10%
0%
Campbell's
Dow
Soup
Chemical
IBM
Motorola
Nike
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http://www.tradenet.gov
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http://www.business.gov/busadv/
index.cfm
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http://www.trade.gov
http://www.export.gov
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How firm’s growth can be affected by foreign
Investment and Financing opportunities?
• International Opportunities
• Financing opportunities
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International Opportunities
The marginal return on projects for an
MNC is above that of a purely domestic
firm because of the expanded opportunity
set of possible projects from which to
select.
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Financing opportunities
An MNC is also able to obtain capital
funding at a lower cost due to its larger
opportunity set of funding sources around
the world.
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International Opportunities
Cost-benefit Evaluation for
Purely Domestic Firms versus MNCs
Purely
Domestic
Firm
Investment
Opportunities
Marginal
Return on
Projects
Marginal
Cost of
Capital
MNC
MNC
Purely
Domestic
Firm
Financing
Opportunities
Appropriate
Size for Purely
Domestic Firm
X
Appropriate
Size for MNC
Y
Asset Level
of Firm
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International Opportunities
• Opportunities in Europe
¤
¤
¤
The Single European Act of 1987.
The removal of the Berlin Wall in 1989.
The inception of the euro in 1999.
• Opportunities in Latin America
¤
¤
The North American Free Trade Agreement
(NAFTA) of 1993.
The General Agreement on Tariffs and
Trade (GATT) accord.
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International Opportunities
• Opportunities in Asia
¤
¤
¤
The reduction of investment restrictions by
many Asian countries during the 1990s.
China’s potential for growth.
The Asian economic crisis in 1997-1998.
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Factors affecting the MNC’s
Exposure to Risk
What are the factors increases the MNC’s
exposure to International Risk?
-Exchange rate movements
-Foreign economies
-Political risk
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Exchange rate movements
Exchange rate fluctuations affect cash
flows and foreign demand. Most
International Business results in the
exchange of one currency for another to
make payment. Since Exchange rate
fluctuates over time, the cash outflows
required making payment change
accordingly.
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Foreign economies
Economic conditions affect demand. When MNCs
enter foreign market to sell products, the demand
for these products is depended on the economic
conditions in those markets. Therefore the cash
flow of the MNCs can be affected adversely. For
example, during the Asian Crisis in 1998, NIKE,
experienced lower than expected cash flows
because of week Asian Market.
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Political risk
Political risk arises because the host Govt. or the
Public may take actions that can affect MNC’s cash
flow. The host Govt. may impose higher Taxes on U.S.
MNCs due to the bad bilateral relations. People’s
sentiment can also negatively affect the MNC’s cash
flow. For example, during the war in Iraq in 2003, antiAmerican protest against war in Middle-East countries
forced some U.S. based MNCs to shut down their
operations temporarily. Moreover the protest led to
decline in the demand for products produced by U.S.
based MNCs like Coca-Cola.
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Overview of an MNC’s Cash Flows
Profile A: MNCs focused on International Trade
U.S.based
MNC
Payments for products
U.S. Customers
Payments for supplies
U.S. Businesses
Payments for exports
Foreign Importers
Payments for imports
Foreign Exporters
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Overview of an MNC’s Cash Flows
Profile B: MNCs focused on International Trade and
International Arrangements
U.S.based
MNC
Payments for products
U.S. Customers
Payments for supplies
U.S. Businesses
Payments for exports
Foreign Importers
Payments for imports
Foreign Exporters
Fees for services
Costs of services
Foreign Firms
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Overview of an MNC’s Cash Flows
Profile C: MNCs focused on International Trade, International
Arrangements, and Direct Foreign Investment
Payments for products
Payments for supplies
U.S.based
MNC
Payments for exports
Payments for imports
U.S. Customers
U.S. Businesses
Foreign Importers
Foreign Exporters
Fees for services
Costs of services
Foreign Firms
Funds remitted
Funds invested
Foreign Subsidiaries
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