Global Financial Structure
P.V. Viswanath
International Corporate Finance
The cost of staying domestic
 Firms that are forced to source their long-term debt
and equity in a highly illiquid domestic securities
market will have
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a relatively high cost of capital and
limited availability of capital.
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Dimensions of Cost and Availability
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Segmented Capital Markets
 Capital Markets become segmented because of
market imperfections, such as:
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Regulatory Controls
Perceived Political Risk
Foreign Exchange Risk
Lack of Transparency
Asymmetric Information
Cronyism
Insider Trading
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Estimating the Global Cost of Equity
for Nestlé in Swiss Francs
Question: Would an MNE with access to global capital always
have a lower cost of capital than if it were restricted to
domestic sources?
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Market Segmentation and Market
Efficiency
 A market is segmented if the required rate of return on
securities in that market differs from the required rate of
return on securities of comparable risk that are traded on
other national securities markets.
 A market is efficient if security prices in that market reflect
all available information.
 Although segmented markets are likely to be inefficient, the
two concepts are independent. If security prices in a
segmented market reflect all relevant local information, that
market would indeed be efficient. However, foreign
investors would not be participants in such a market.
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Global Sourcing and Lower Capital Costs
 Local capital markets are likely to be smaller.
Hence, a firm that begins with a domestic capital
market and is forced to raised its capital locally
will, after a while, find that it has to pay a high
price for its capital needs.
 If it can access global markets, it can raise funds at
a cheaper rate for those additional capital needs.
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Global Sourcing and Lower Capital Costs
Marginal Return on Investments
Local Marginal Cost of Capital
C
B
Global Marginal Cost of Capital
A
Budget
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Global Sourcing and Lower Capital Costs
 However, this cannot be guaranteed once the domestic
capital market becomes completely integrated into the global
market.
 If investors in the domestic market do not have access to a
global market as well, they are essentially forced to invest
locally and may be satisfied with a lower rate of return.
 Hence it may be optimal for the global firm to tap the
cheaper local markets for its initial capital requirements, and
go global only once its needs get so great that it would be
very expensive to continue to use local markets
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Global Sourcing and Lower Capital Costs
 Once the domestic market becomes completely
integrated into global markets, investors will
demand the higher rates of return that may be
available in global markets. This would rob the
firm of the originally available bargain sources of
capital.
 Local business may be hurt, especially those with
monopolies, along with their owners and
employees. However, local investors will be better
off.
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Global Sourcing and the Price of Risk
The slope of a market’s capital allocation line
represent the reward to risk ratio in that market
Global Efficient Frontier
Domestic Efficient Frontier
Standard Deviation of Returns
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Global Sourcing and the Price of Risk
The price of risk for the firm with global
options can be lower at higher risk levels
Global Efficient Frontier
Domestic Efficient Frontier
Standard Deviation of Returns
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Global Sourcing and Investment Choices
 If a firm has access to global sources of capital, it
can make different decisions regarding the choice
of projects and their riskiness
 It can also make different decisions regarding
capital structure. For example,
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If it can sell off its assets in more liquid markets, its
bankruptcy costs would be lower.
If it can reorganize cheaper, its bankruptcy costs would
be lower.
If debt is cheaper relative to equity in global markets
 In such a case, the firm would choose more debt.
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