International
Financial Management
by
Jeff Madura
Florida Atlantic University
Chapter
1
Multinational Financial Management
Chapter main Objectives
 To identify the main goal of the multinational corporation
(MNC) and conflicts with that goal;
 To describe the key theories that justify international
business; and
 To explain the common methods used to conduct
international business.
Introduction to International Financial
Management
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What is IFM??
 International Financial Management is also known
as International Finance or international macroeconomics.
 It is a popular concept which means management
of finance in an international business environment.
 it implies, doing of trade and making money through the
exchange of foreign currency.
 The International Financial activities help the organizations to
connect with international dealings with overseas business
partners- customers, suppliers, lenders etc.
 It is also used by Government organization and Non-profit
institutions
Conti…..
 The management of finance internationally occurs in
international financial environment.
 An international financial environment represents the
conditions for activity in the economy or in the
financial markets around the world.
 Governments, corporations, and other investors
around the world participate in purchasing the debt of
other nations as profit opportunities arise.
 Or they may simply invest their funds and expand their
business in other county.
The International Financial Environment
Multinational Corporation (MNC)
Foreign Exchange Markets
Exporting
& Importing
Product Markets
Dividend
Remittance
& Financing
Subsidiaries
Investing
& Financing
International
Financial
Markets
The International Financial Environment
1. A multinational corporation (MNC) or multinational
enterprise (MNE) or international corporation is a corporation
that is registered in more than one country or that has
operations in more than one country.
 It is a large corporation which both produces and sells goods
or services in various countries. They play an important role
in globalization.
2. FEM is a Market in which foreign currencies are bought and
sold and exchange rates between currencies are determined. It
is constructed of a global network of computers that connects
participants from all parts of the world.
The International Financial Environment
 The main participants in this market are the larger
international banks.
3. Remittance is the process of sending money to remove an
obligation. This is most often done through an electronic
network, wire transfer or mail.
 The term also refers to the amount of money being sent to
remove the obligation.
 Financing means finding funds for corporations from
investors.
Multinational Corporations
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What is a corporation and MNC??
 A corporation is a legal entity that is designed to protect its
individual members from financial liability and is engaged in
business activities within a country.
 A corporation that has its facilities and other assets in at least
one country other than its home country is called MNC.
 Such companies have offices and/or factories in different
countries and usually have a centralized head office where
they co-ordinate global management.
Types of MNCs
 There are four categories of multinational corporations:
(1) a multinational, decentralized corporation with strong
home country presence,
(2) a global, centralized corporation that acquires cost
advantage through centralized production whether
cheaper are available,
 Parent Company: Domestic branch is called main or
parent company.
 Subsidiaries Company: In other countries branches is
called subsidiaries company.
Centralized Multinational Financial Management
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
Inventory and
Accounts
Receivable
Management at B
Financing at B
Capital Expenditures
at B
Decentralized Multinational Financial Management
for an MNC with two subsidiaries, A and B
Cash
Management
at A
Financial
Managers
of A
Inventory and
Accounts
Receivable
Management at A
Financing at A
Capital Expenditures
at A
Financial
Managers
of B
Cash
Management
at B
Inventory and
Accounts
Receivable
Management at B
Financing at B
Capital Expenditures
at B
The main Goal of the MNC
 Corporations whether national or international are owned by
shareholders, and their purpose is to maximize profits for their
owners.
 The commonly accepted goal of an MNC is to maximize
shareholder wealth.
 Suppose a stock holder buys a stock at $10 and in ten years time the market
price of stock shoots up to $55.
There are two way to maximize the wealth:
1.
Capital Gain
2.
Dividend Increase
 Another objective may be to provide employment to the
citizens of another country.
The MNCs’ evolution
 It is the fact that non of the countries all over the world are
self sufficient. They lack some resources which are the need
of it. They may find those resources in other country. So this
fact gives birth to MNCs.
 Multinational firms arise because capital is much more mobile
than labor. Since cheap labor and raw material inputs are
located in other countries, multinational firms establish
subsidiaries there to fulfill their need.
 They may also arise as the result of export by a domestic
company or by foreign direct investment.
Conflicts Against the MNC’s Goal
 The MNCs while trying to achieve Its main goal ( maximization
of share holders wealth ) may face the following conflicts.
1. Agencies problems
2. Management problems
3. shareholders problems
What is agency Problem??
 The agency problem reflects a conflict of interests between
decision-making managers and the owners of the MNC.
 The agency problem is that the agent who is supposed to make
the decisions that would best serve the principal is naturally
motivated by self-interest, and the agent's own best interests
may differ from the principal's best interests.
 For example: A decision to expand a subsidiary may be
motivated by a manager's desire to receive more compensation
rather than to enhance potential benefits to shareholders.
 This conflict of goals between a firm's managers and
shareholders is often known as the agency problem.
 Agency costs occur in an effort to assure that managers act in
the best interest of the owners.
Conflicts Against the MNC’s Goal
 Agency costs are normally larger for MNCs than for purely
domestic firms because:
a) monitoring more difficult because of geographic distance
b) different cultures
c) MNC size
d) subsidiary managers may maximize the value of their subsidiary
but not of the MNC as a whole
 The parent corporation of an MNC may be able to prevent agency
problems with proper governance. It should clearly communicate
the goals for each subsidiary to ensure that all subsidiaries focus
on maximizing the value of the MNC rather than their respective
subsidiary values.
Conflicts Against the MNC’s Goal
2. Management :
Management of MNCs ( centralized and decentralized) can also
have an impact against its goal.
 The magnitude of conflict can vary with the management style
of the MNC.
 A centralized management style may reduces conflict. However,
a decentralized style gives more control to those managers who
are closer to the subsidiary’s operations and environment so it
may increase the conflict to achieve MNCs goals.
 Centralized management reduces agency costs because it gives
parent more control but a local managers may better perform.
 decentralized management increases agency costs but may
result in better decisions
Conflicts Against the MNC’s Goal
3. shareholders problems:
They may also create a conflict for MNCs to meet their goal.
 By shareholders problems we mean
1. threat of hostile takeover
‫مخالف بغاوت کا خطرہ‬
‫تهدید از تصاحب خصمانه‬
2. monitoring by large shareholders
‫بڑی حصص یافتگان کے ذریعے نگرانی‬
‫نظارت سهامداران بزرگ‬
Solution to conflicts against MNC
goals
Following are some steps which may help reduce conflicts.
 Establishing a centralized database of information
 Ensuring that all data are reported consistently among
subsidiaries
 Implementing a system that automatically checks data for
unusual discrepancies relative to norms
 Speeding the process by which all departments and all
subsidiaries have access to the data that they need
 Making executives more accountable for financial statements by
personally verifying their accuracy
Constraints
Interfering with the MNC’s Goal
 As MNC managers attempt to maximize their firm’s value,
they may be confronted with various constraints.
Following are the most common one;
1. Environmental constraints.
e.g. other countries may be tougher in pollution etc…
2. Regulatory constraints.
e.g. currency convertibility, remittance of profits, etc.
3. Ethical constraints. e.g. bribes may be more acceptable in other countries
Theories of International Business
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Why firms are motivated to expand
their business internationally???
 OR
 WHY FIRMS PURSUE INTERNATIONAL BUSINESS???
Answer to these technical questions can be given by discussing
the theories of International Business. Which are;
1. The comparative advantage theory
2. The imperfect markets theory
3. The product cycle theory
1. The theory of Comparative
Advantage
 The ability of a firm or individual to produce a particular good
or service at a lower cost than other firms or individuals. (C.A)
This theory states that specialization by countries can increase
production efficiency.
 Some countries, such as Japan and the United States, have a
technology advantage, while other countries, such as Jamaica,
China, and Malaysia, have an advantage in the cost of basic labor.
These countries tend to use their advantages to specialize in the
production of goods that can be produced with relative efficiency.
 When a country specializes in some products, it may not produce
other products, so trade between countries is essential. This is the
argument made by the classical theory of comparative advantage.
2. The Imperfect Markets Theory
 A market where information is not quickly disclosed to all
participants in it and where the matching of buyers and sellers
isn't immediate.
This theory states that The markets for the various resources used in
production are “imperfect.” so one can get the benefit of factor of
production
 if markets were perfect so that the factors of production (such as
labor) were easily transferable, then labor and other resources
would flow wherever they were in demand. However, the real
world suffers from imperfect market conditions .
 MNCs such as the Gap and Nike often capitalize on a foreign
country's resources. Imperfect markets provide an incentive for
firms to seek out foreign opportunities.
3. The Product Cycle Theory
 According to this theory, firms become established in the home
market as a result of some perceived advantage over existing
competitors. Because information about markets and
competition is more readily available at home, a firm is likely to
establish itself first in its home country.
 Foreign demand for the firm's product will initially be
accommodated by exporting. As time passes, the firm may feel
the only way to retain its advantage over competition in foreign
countries and produce the product in foreign markets to reduce
transportation costs.
 The firm may develop strategies to prolong the foreign demand
for its product. A common approach is to attempt to
differentiate the product from its foreign competitors.
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.
International Business Methods
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International Business Methods
How FIRMS ENGAGE IN INTERNATIONAL BUSINESS????
 There are several methods by which firms can conduct
international business.
 Following are the most common methods used globally;
1. International trade
2. Licensing
3. Franchising
4. Joint venture
5. Acquisitions of existing operations
6. Establishing New Foreign Subsidiaries.
7. Direct Foreign Investment (DFI).
International
Business Methods
1. 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.
2. Licensing allows a firm to provide its technology in exchange
for fees or some other benefits.
3. Franchising obligates a firm to provide a specialized sales or
service strategy, support assistance, and possibly an initial
investment in the franchise in exchange for periodic fees.
International
Business Methods
4. Firms may also penetrate foreign markets by engaging in a
joint venture (joint ownership and operation) with firms that
reside in those markets.
5. 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.
6. Firms can also penetrate foreign markets by establishing new
foreign subsidiaries.
7. In general, any method of conducting business that requires a
direct investment in foreign operations is referred to as a
direct foreign investment (DFI).
International Opportunities
 Investment 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.
 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.
Chapter Review
 Goal of the MNC




Conflicts Against the MNC Goal
Impact of Management Control
Impact of Corporate Control
Constraints Interfering with the MNC’s Goal
 Theories of International Business
 Theory of Comparative Advantage
 Imperfect Markets Theory
 Product Cycle Theory
Chapter Review
 International Business Methods






International Trade
Licensing
Franchising
Joint Ventures
Acquisitions of Existing Operations
Establishing New Foreign Subsidiaries