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Multinational Finance summary
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Summary of the course Multinational Finance of the second year Economics and business economics at Radboud University.
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Multinational Financechapter 0 & 1; Overview
In recent years, many companies have consolidated (getting together) into larger and stronger companies. These
companies are known as multinational corporations. A multinational corporation (MNC) is a corporation with
facilities and other assets in at least one country other than its home country.
- Main goal of MNC is to maximize shareholders wealth (value of entire MNC).
- Pros of MNCs; Provide potential investments, Provide jobs, Help develop infrastructure by getting people
from A to B to work, Transfer technology, Access among countries.
- Cons of MNCs; Decapitalization of countries, Creates income inequality, Exploit poor workers/countries,
Shift responsibilities to others, Dependency of countries, Reduces domestic market shares.
- Corporate governance; the system by which a company is directed and controlled.
- Multinational corporations face conflict of goals (Agency problem), because the managers of a company will
not always act in the best interest of shareholders. The goal of the financial manager is to maximize
shareholders wealth by maximizing the share price of the entire MNC. However there are constraints;
o Environmental constraints; polution controls, building codes etc.
o Regulatory constraints; employee rights, tax law etc.
o Ethical constraints; working standards, bribes to government etc.
Agency Theory;
- Agency relationships exist whenever someone (the principal) contracts with someone else (the agent) to
take actions on behalf of the principal and the agent represents the principal’s interest.
o The agent is the manager
o The principal are the shareholders
- Both the agent and the principal have their own self interest that they want to maximize. If the agent is not
acting on behalf of the principal’s interest, then there is an agency problem. The agent knows more about
their behaviour than the principal, so there is asymmetric information.
- Agency problem = agent’s and principal’s incentives are not aligned.
o This will create costs;
▪ Direct costs; monitoring, compensation
▪ Indirect costs; free cash flow hypothesis, managers decide in favor of other stakeholders
! these costs are higher with MNC than purely domestic companies, because you have to monitor
distant managers, there is difference in culture and there is more complexity of operation and
communication.
- Corporate control mechanisms that shareholders (the principals) can use;
o Compensation schemes aligned with shareholders interest
o Hostile takeover threat; threat that new shareholders overtake the inefficiently managed company
and fire the manager (more a theoretical threat)
o Investor monitoring; monitoring by major shareholders with sufficient power
Management control;
- Centralized management
o Investors hold one person responsible
o Can reduce agency costs, because it allows managers of the parent to
direct control foreign subsidiaries and therefore reduce power of
subsidiary managers
- Decentralized management
o Every subsidiary has its own person responsible
o Every subsidiary manager makes their own decisions
o Results in higher agency costs because subsidiary managers may make
decisions that do not focus on maximizing the value of the entire MNC
Pros of decentralized management; Cons of decentralized management;
Subunit related knowledge and experience Less control
Higher management can focus on big picture Focus on subunit; suboptimal decisions
Efficient decision due to short chain of command Gradmented subunits
Cultural skills Costs higher
Local network Inefficiencies due to duplication of activities
,Theory of Absolute and comparative advantage;
- Absolute advantage; a country enjoys an absolute advantage over another country in the production of a
product when it uses fewer resources to produce than the other country does.
- Comparative advantage; a country enjoys a comparative advantage in the production of a good when that
good can be produced at a lower cost in terms of other goods.
- You specialize on producst that you have an absolute or comparative advantage on. Due to specialization,
there is a need for international business since you need to rely on some products of other countries.
- Heckscher–Ohlin theorem (H–O) theory: trade patterns based on countries' comparative advantage in
certain factors of production. A company exports the commodity in which it has comparative advantage.
- Ricardian model where technological differences determine comparative advantage.
- Leontief paradox; Leontief found that the most capital-abundant country in the world, exported
commodities that were more labor-intensive than capital-intensive, in contradiction with Heckscher–Ohlin
theory
Imperfect market theory;
- Imperfect markets; products cannot be easily and freely retrieved by MNCs. MNC must go to other country
to be able to retrieve the resources.
- Perfect market → Unrestricted mobility of production factors
o Freely transferable
o Removes comparative advantage
- Imperfect market → Restricted mobility of production factors
o Tariffs, quotas, tax
Product cycle theory;
- The product life cycle theory describes the stages that all products
go through
o Introduction → Growth → Maturity → Decline
- As a firm matures, it may recognize additional opportunities
outside its home country.
- Global strategy; large investments can only be recouped if demand is sufficiently large → larger than the
domestic consumer base. Only through economies of scale these investments are going te be worked out.
How to conduct international business?
- International trade by importing and exporting. Any firm is able to sent their products abroad by just using
a simple webpage, which means they are all mini multinationals.
- Licensing; selling copyrights, trademarks or trade names or legal rights (patents) in exchange for fees known
as royalties.
- Franchising; providing specialized sales or service strategy, support assistance and initial investment and
thereby earning fees.
- Joint ventures; joint ownership and operation with a foreign company
o In China, the partner of the joint ownership is required to be a government owned company. They
want to keep control over what foreigners are doing in their country.
- Acquisitions of existing operations; quickly gaining control over foreign operations and infrastructure or
over a foreign market share.
- Foreign subsidiaries; moving to a foreign country and building up your own part of your company there.
Return Risk
Licensing agreement Part of the benefits goes to the foreign firm No substantial investments, so less risk
Acquiring a foreign company All benefits accrue to the MNC Substantial investments, so large
upfront investment and higher risk
- Riks-return tradeoff depends on expected return, fund availability, alternative investment opportunities, etc.
Foreign Direct Investment (FDI); Investing in Acquisitions, subsidiaries, to some extend franchises or joint ventures
- Active investors; gain control on operations
- Long investment horizon
- Is affected by; removal of government barriers, privatizatoin, potential economic growth, tax rates,
exchange rates.
, Foreign Portfolio Investment (FPI); Investment in stocks and bonds
- Passive investors; no control on operations
- Short investment horizon
- Is affected by; tax rates on interest or dividends, interest rates
International opportunities;
- Investment opportunities
o Take advantage of immobile resources of foreign countries
o Take advantage of foreign infrastructures and markets
o Take advantage of greater diversification of risk
- Financial opportunities
o Take advantage of cheaper funding opportunities in foreign countries
o Access to international investors
o Take advantage of greater diversification of financial risk
Exposure to international risk;
➔ The risk for pure domestic corporations are different from multinational corporations.
- Exchange rate risk; fluctuations on a daily bases if the euro appreciates (export more expensive) or
depreciates (import becomes more expensive)
- Foreign economies; risk of a recession in other countries, in general the economic conditions play a role, but
also social political instability.
- Political risk; instable regimes, riots etc.
- Terrorism and war
International Cash Flows – Valuation
- Dometic model
- International model
- Together;
Chapter 2; International flow of funds
Balance of payments; summary of all transactions between domestic and foreign residents for a specific country
over a specified period of time
- Inflow of funds; credits (+) for the country’s balance = demand of domestic currency
- Outflow of funds; debits (-) for the country’s balance = supply of domestic currency
- Current account; balance of trade (export and import), factor income and transfer payments
- Financial account; summary of investments in stocks or shares (FDI, FPI and other capital investments)
Foreign exchange reserves; how many foreign currencies a country holds.
- If a country is more connected, it should hold more foreign exchange reserves.
The World Trade Organisation (WTO) intends to superfise and liberlize international trade. However, there always
will be trade disagreements, because countries have different environmental and labor or tax laws, there might be
bribery and manipulation and countries have different trade policies for political reasons.
- The EU is trying to establish many trade agreements. → CETA
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