Chapter 1:
Globalization & the Multinational Firm
Chapter Objectives
 Understand why it is important to study international finance.
 Distinguish international finance from domestic finance.
Chapter Outline
1.
2.
3.
4.
What’s Special about “International” Finance?
Goals for International Financial Management
Globalization of the World Economy
Multinational Corporations
1
What’s Special about
“International” Finance?
 Foreign Exchange Risk
 Political Risk
 Market Imperfections
 Expanded Opportunity Set
2
What’s Special about
“International” Finance?
 Foreign Exchange Risk

The risk that foreign currency profits may evaporate in home currency
terms due to unanticipated unfavorable exchange rate movements.
e.g. Recent surge in Canadian dollar value against US dollar
 Political Risk

Sovereign governments have the right to regulate the movement of
goods, capital, and people across their borders. These laws sometimes
change in unexpected ways.

e.g. Chinese ban on canola imports from Canada in 2002
3
Decomposition of Political Risk
4
What’s Special about
“International” Finance?
 Market Imperfections
 Legal restrictions on movement of goods,
people, and money
 Transactions costs
 Shipping costs
 Tax arbitrage
5
The Example of Nestlé’s Market
Imperfection
 Nestlé used to issue two different classes of common stock bearer shares
and registered shares.
 Foreigners were only allowed to buy bearer shares (More expensive).
 Swiss citizens could buy registered shares.
 On November 18, 1988, Nestlé lifted restrictions imposed on foreigners,
allowing them to hold registered. Following this, the price spread
between the two types of shares narrowed dramatically.
 This implies that there was a major transfer of wealth from foreign
shareholders to Swiss shareholders.
 Foreigners holding Nestlé bearer shares were exposed to political risk in a
country that is widely viewed as a haven from such risk. The Nestlé
episode illustrates both the importance of considering market
imperfections and the peril of political risk.
6
Nestlé’s Foreign Ownership
Restrictions
12,000
10,000
Bearer share
SF
8,000
6,000
4,000
Registered share
2,000
0
11
20
31
9
18
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Source: Financial Times, November 26, 1988 p.1. Adapted with permission.
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What’s Special about
“International” Finance?
 Expanded Opportunity Set
 It doesn’t make sense to play in only one market.
 True for corporations as well as individual
investors.
Investor’s perspective
 Risk reduction through international diversification.
Corporation’s perspective
 Access to cheaper production inputs
 Access to consumers
 Access to capital
8
Goals for International Financial
Management
 Shareholder Wealth
Maximization
Predominant in North
America, UK
 Goal:
Maximize return to
shareholders
 “one-share-one-vote”
 Agency theory dictates
managerial behaviour
 Stakeholder Welfare Maximization
France, Germany
 All parties associated with the firm are
treated equally (shareholders, employees,
customers, suppliers, creditors, govt.)
 Goal: Maximize long-term return for all
interest groups
 In Japan, Korea, managers have typically
sought to maximize the value of the
keiretsu-a family of firms to which the
individual firms belongs- through increased
market share
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Other Goals
 As shown by recent corporate scandals at companies like Enron,
WorldCom, managers may pursue their own private interests at
the expense of SHs when they are not closely monitored.
 These calamities have painfully reinforced the importance of
corporate governance i.e. the financial and legal framework for
regulating the relationship between a firm’s management and its
shareholders.
 These types of issues can be much more serious in many other
parts of the world, especially emerging and transitional
economies, such as Indonesia, Korea, and Russia, where legal
protection of shareholders is weak or virtually non-existing.
 No matter what the other goals, they cannot be achieved in the
long term if the maximization of shareholder wealth is not given
due consideration.
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Globalization of the World
Economy: Recent Trends




Emergence of Globalized Financial Markets
Advent of the Euro
Trade Liberalization and Economic Integration
Privatization
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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
12
Advent of the Euro
 A momentous event in the history of world financial
systems.
 Currently more than 320 million Europeans in 17 countries
are using the common currency on a daily basis.(Belgium,
Germany, Greece, Spain, France, Ireland, Italy, Luxembourg, the
Netherlands, Austria, Portugal, Slovenia, Slovakia, Estonia, Finland,
Malta, and Cyprus).
 The “transaction domain” of the euro may become larger
than the U.S. dollar’s in the near future.
 For more info on euro, visit the European Central Bank's Web site at
www.ecb.int.
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Trade Liberalization and Economic
Integration
 Over the past 50 years, international trade increased about twice as fast as
world GDP.
 There has been a sea change in the attitudes of many of the world’s
governments who have abandoned mercantilist views and embraced free
trade as the surest route to prosperity for their citizenry.
 The General Agreement on Tariffs and Trade-GATT (later replaced with
WTO) a multilateral agreement among member countries has reduced
many barriers to trade.
 The North American Free Trade Agreement (NAFTA) calls for phasing
out impediments to trade between Canada, Mexico and the U.S. over a 15year period.


For Canada, the ratio of exports to GDP has increased dramatically from
19.2% in 1973 to 45.2% in 2003.
The increased trade will result in increased numbers of jobs and a higher
standard of living for all member nations.
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Privatization
 The selling off state-run enterprises to investors is
also known as “Denationalization”.
 Often seen in socialist economies in transition to
market economies.
 By most estimates this increases the efficiency of the
enterprise.
 Often spurs a tremendous increase in cross-border
investment.
 It Fuels economic growth
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Multinational Corporations
 A firm that has incorporated on one country and has production and
sales operations in other countries.
 There are about 60,000 MNCs in the world.
 Many MNCs obtain raw materials from one nation, financial capital
from another, produce goods with labor and capital equipment in a
third country and sell their output in various other national markets.
 Advantages of the global economy for MNCs:
1. Spreading fixed costs like R&D over global sales.
2. Global purchasing power over suppliers
3. Lower labor costs, maybe.
4. Better access to capital.
5. Greater operational efficiencies
16
Top 10 MNCs by Revenues 2011
1
Wallmart
United States
2
ExxonMobile Corporation
United States
3
Royal Dutch/Shell Group
Netherlands/ UK
4
BP
UK
5
Sinopec
China
6
Toyota Motor Corporation
Japan
7
Petro China
China
8
TotalFina SA
France
9
Chevron
United States
10
Japan Post Holdings
Japan
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Mini Case: Nike’s Decision
Nike, a U.S.-based company with a globally recognized brand name, manufactures
athletic shoes in such Asian developing countries as China, Indonesia, and Vietnam
using subcontractors, and sells the products in the U.S. and foreign markets. The
company has no production facilities in the United States. In each of those Asian
countries where Nike has production facilities, the rates of unemployment and
underemployment are quite high. The wage rate is very low in those countries by the
U.S. standard; hourly wage rate in the manufacturing sector is less than one dollar in
each of those countries, which is compared with about $18 in the U.S. In addition,
workers in those countries often are operating in poor and unhealthy environments and
their rights are not well protected. Understandably, Asian host countries are eager to
attract foreign investments like Nike’s to develop their economies and raise the living
standards of their citizens. Recently, however, Nike came under a world-wide criticism
for its practice of hiring workers for such a low pay, “next to nothing” in the words of
critics, and condoning poor working conditions in host countries.
Evaluate and discuss various ‘ethical’ as well as economic ramifications of Nike’s
decision to invest in those Asian countries.
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