CHAPTER: ONE
INTRODUCTION
GLOBALIZATION AND THE MULTINATIONAL FIRM
Objectives:
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Understand why it is important to study international finance.
Distinguish international finance from domestic finance.
Outline of the lecture:
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Importance to study the International Financial Management.
What’s Special about “International” Finance?
Goals for International Financial Management
Multinational Corporations
1.1.
Definition of International Financial Management:
Before define the International Financial Management we have to know what is Financial Management?
Financial management is mainly concerned with how to optimally make various corporate financial
decisions, such as those pertaining to investment, capital structure, dividend policy and working capital
management, with a view to achieving a set of given corporate objectives. If we define the International
Financial Management, we can say, International financial management is concerned with financial
management in an international setting.
1.2.
Why Do We Need To Study International Financial Management?
We are now living in a highly globalized and integrated world economy. Like consumption, production of
goods and services has become highly globilized, to a large extent, this has happened as a result of
multinational cooperations’ (MNCs) persistent efforts to sources inputs and locates production anywhere
in the world where cost is lower and profit is higher. For example, IBM personal computers sold in the
world market might have been assembled in Malaysia with Taiwanese- made monitors; Korean- made
keyboards, US-made chips, and preinstalled software packages that were jointly developed by US and
Indian engineers. It has often become difficult to clearly associate a product with a single country of origin.
Recently financial markets have also become highly integrated. Development allows investors to diversify
their investment portfolios internationally. In addition many major corporations of the world, such as IBM,
Sony, have their shares cross-listed on foreign stock exchange, thereby rendering their shares
internationally tradable and gaining access to foreign capital as well.
Undoubtedly, we are now living in a world where all the major economic functions-consumption,
production and investment-are highly globalized. It is thus essential for financial managers to fully
understand vital international dimensions of financial management. So to study the international financial
management is very important.
What’s Special about “International” Finance?
If we examine how to international finance different from purely domestic finance, we see there are three
major dimensions set international finance apart from domestic finance, they are:
i. Foreign Exchange Risk, Political Risk
ii.
Market Imperfections
iii.
Expanded Opportunity Set
Foreign Exchange Risk and Political Risk:
When firms and individuals are engaged in cross-broader transactions, they are potentially exposed to
foreign exchange risk that they would not normally encounter in purely domestic transaction. Currently,
the exchange rates among such major currencies as the U.S. dollar, Japanese Yen, British pound and
Euro fluctuate continuously in an unpredictable manner. Exchange rate uncertainty will have a pervasive
influence on all the major economic functions, that is, consumption, production and investment.
Another risk that firms and individuals may encounter in the international setting is political risk. Political
risk ranges from unexpected changes in tax rules to outright expropriation of assets held by foreigners.
Political risk arises from the fact that a sovereign country can change the “rules of the game” and the
affected parties may not have effective recourse. That means sovereign governments have the right to
regulate the movement of goods, capital, and people across their borders. These laws sometimes change
in unexpected ways.
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Market Imperfections:
Although the world economy is much more integrated today than was the case 10 or 20 years ago, a
variety of barriers still hamper free movements of people, goods, services and capital across national
boundaries. These barriers include legal restrictions, excessive transaction and transportation costs, and
discriminatory taxation. The world markets are thus highly imperfect. Market imperfections, which
represent various frictions and impediments preventing markets from functioning perfectly, play an
important role in motivating MNCs to locate production overseas.
Imperfections in the world financial markets tend to restrict the extent to which investors can diversify their
portfolios. For example, Nestle Corporation, a well known Swiss MNC. Nestle used to issue two different
classes of common stock, bearer shares and registrar shares, and foreigners were allowed to hold only
bearer shares.
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Expanded Opportunity Set:
When firms venture into the arena of global markets, they can benefit from an expanded opportunity set.
Say, firm can locate production in any country or region of the world to maximize their performance and
raise funds in any capital market where the cost of capital is the lowest.
Individual investors can also benefit greatly if they invest internationally rather than domestically. Suppose
you have a given amount of money to invest in stocks. You may invest the entire amount in US (domestic)
stocks. Alternatively, you may allocate the funds across domestic and foreign stocks. If you diversify
internationally, the resulting international portfolio may have a lower risk or a higher return or both than a
purely domestic portfolio. This can happen mainly because stock returns tend to covary much less across
countries than within a given country. Once you are aware of overseas investment opportunities and are
willing to diversify internationally, you face a much expanded opportunity set and you can benefit from it.
Goals for International Financial Management:
International financial management is designed to provide today’s financial managers with an
understanding of the fundamental concepts and the tools necessary to be effective global managers. That
mean we have to know, how to deal with exchange risk, and market imperfections, using the various
instruments and tools that are available, while at the same time maximizing the benefits from an
expanded global opportunity set.
Effective financial management is important for the application of the newest business techniques or
operating more efficiently. There must be an underlying goal. The fundamental goal of sound financial
management is shareholder wealth maximization.
Shareholder wealth maximization means that the firm makes all business decision and investments with
an eye toward making the owners of the firm-the shareholder-better off financially, or wealthier, then they
were before.
in some company they tend to strive to maximize market share rather than shareholder wealth, for
example Mitsubishi.
It is pointed out, however that is capital markets are becoming more liberalized and internationally
integrated in recent years, and even managers in France, Germany, Japan, and other non-Anglo- Saxon
countries are beginning to pay serious attention to shareholder wealth maximization.
Obviously the firm could pursue other goals. This does not mean, however, that the goal of shareholder
wealth maximization is merely an alternative, or that the firm should enter into a debate as to its
appropriate fundamental goal. Quite the contrary, if the firm seeks to maximize shareholder wealth, it will
most likely simultaneously be accomplishing other ultimate goals that are perceived as worthwhile.
Shareholder wealth maximization is a long- run goal. A firm cannot stay in business to maximize
shareholder wealth if it treats employees poorly, produces shoddy merchandise, waste raw materials and
natural resources, operates ineffective or fail to satisfy costumers. Only a well-managed business firm
that profitably produces what is demanded in an efficient manner can expect to stay in business in the
long run and thereby provide employment opportunities.
Meaning of globalization:
Development of extensive worldwide patterns of economic relationships between nations or we can say A
set of processes leading to the integration of economic, cultural, political, and social systems across
geographical boundaries so we understand that globalization is the process of developing, manufacturing,
and marketing software products that are intended for worldwide distribution. This term combines two
aspects of the work: internationalization (enabling the product to be used without language or culture
barriers) and localization (translating and enabling the product for a specific locale).
Causes of globalization:
The most important causes of globalization differ among the three major components of international
market integration:
a. Trade,
b. Multinational production and
c. International finance.
The information technology revolution has made it very difficult for governments to control cross-border
capital movements, even if they have political incentives to do so. Governments can still restrict the
multinationalization of production, but they have increasingly chosen to liberalize because of the
macroeconomic benefits.
It is certainly not attributable to conquest, the source of most previous historical episodes where a single
economic system has held sway over a vast geographical terrain. The source lies instead in the
development of technology. The costs of transport, of travel, and above all the costs of communicating
information have fallen dramatically in the postwar period, almost entirely because of the progress of
technology.
A 3-minute telephone call from the USA to Britain cost $12 in 1946, whereas today it can cost as little as
48 cents, despite the fact that consumer prices have multiplied by over eight times in the intervening
period. The first computers were lumbering away with piles of punched cards in the early postwar years,
and telegrams provided the only rapid means of written communication. There was no fax or internet or email or world-wide web, no PCs or satellites or cell-phones. Today we witness phenomena that no futurist
dreamed of half a century ago, such as Indians with medical degrees residing in Bangalore who earn a
living by acting as secretaries to American doctors by transcribing their tapes overnight.
It is clearly the availability of cheap, rapid and reliable communications that permits such phenomena, just
as this is the key to the integration of the international capital market. I presume the same factor is
important in nurturing the growth of multinational corporations, since it is this which enables them to
exploit their intellectual property efficiently in a variety of locations without losing the ability to maintain
control from head office.
It is true that other factors are also at work, such as the spread of consumer knowledge about what is
available that comes from travel and from advertising, itself encouraged by the communications
revolution and its children like CNN. The reduction in transport costs is also a key factor underlying the
growth
in
trade.
Some questions for review.
1. Write down the meaning of International Financial Management. Why we study the International
financial management.
2. Discuss some special things that apart International financial management from domestic
finance.
3. Goals of International Financial management.
4. What is the meaning of globalization? Identify different factor that affect globalization.
5. Point out different reason that why we study the international financial management.
6. What are the different dimensions that apart international financial management from domestic
finance.
7. What is globalization? Main causes of globalization.
Course instructor:
Shahadat Hossain
Assistant Professor
Department of Finance & Banking
University of Chittagong
Cell: 01815503067
E mail: sh_762002@yahoo.com