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Plenary lectures Multinational Finance
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Plenary lecture notes of the lectures Multinational Finance Radboud University
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Chapter 1What is this all about? MNCs
A corporation with facilities and other assets in at least one country other than its home country.
B
C
D Acquisition Subsidiary
Production
A Retail
Positive aspects of MNCs
• Provide investments
• Provide jobs
• Development of Infrastructure
• Transfer of technology
• Access among countries
Negative aspects of MNCs
• Decapitalization of countries
• Create income inequality
• Exploit poor workers/countries
• Shift responsibilities to others
• Dependency of countries
• Reduce domestic market shares
The International Financial Environment
M NC
For eign Ex change M ar k et s
Export and Investing and
Import borrowing
Imports and Dividend
Exports remittance
and lending
For eign For eign I nt er nat ional
Pr oduct Subsidiar ies Financial
M ar k et s M ar k et s
MNC – Goals and Conflict
• Goal financial manager: Maximize shareholders wealth
→ maximize value of entire MNC (max. share price)
• Constraints interfering with goals
o Environmental constraints (Pollution controls, building codes...)
o Regulatory constraints (Employee rights, tax law,…)
o Ethical constraints (Working standards, bribes to government...)
• Corporate Governance
System by which a company is directed and controlled
o Do managers act in the best interest of shareholders?
→ Agency Problem: Conflict of goals
1
,Recall: Agency Theory
• Agency relationship exists whenever
• someone (the principal) contracts with someone else (the agent) to take actions on behalf of the
principal and represent the principal’s interests.
Asymmetric
Information
Self performs Self
interest interest
hires
• Agency problem: agent’s and principal’s incentives not aligned
Agency costs and corporate control
Managers’ incentives not in line with MNC value maximization?
• Direct costs
o Monitoring, Compensation
• Indirect costs
o Free Cash Flow Hypothesis
o Managers decide in favor of other stakeholders
• Corporate control
o Compensation schemes aligned with shareholder 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
Agency costs in MNC
• Larger for MNCs than for purely domestic companies
o Monitoring distant managers
o Culture
o Complexity of operation and communication
• Do local managers maximize value of MNC or rather value of subsidiary?
• Reduction of agency cost via management control?
o Decentralized vs. centralized management styles
Agency costs and management control
Cash Cash
M anagement M anagement
I nv ent or y and I nv ent or y and
Account s Account s
Receiv able Receiv able
M anagement Financial M anagement
M anager s
of Par ent
Financing Financing
Capit al Capit al
Ex pendit ur es Ex pendit ur es
Direct control over foreign subsidiaries… reduce power of subsidiary managers… lower agency costs... but do
parent managers know the culture or the environment of the subsidiary to be able to manage it?
2
, Financial
Cash M anager s Cash
M anagement of Par ent M anagement
I nv ent or y and I nv ent or y and
Account s Account s
Receiv able Receiv able
M anagement Financial Financial M anagement
M anager M anager
Financing Subsidiar Subsidiar Financing
yA yB
Capit al Capit al
Ex pendit ur es Ex pendit ur es
Higher agency cost due to stronger affiliation of managers with their subsidiary…closer to subsidiary’s
operations and environment.
→ Internet allows for quicker control of the parent on the subsidiaries…
De-centralized
Pros:
• Subunit related knowledge and experience
• Higher management can focus on the big picture
• Efficient decision due to short chain of command
• Cultural skills
• Local network
Cons:
• Less control
• Focus on subunit: Suboptimal decisions
• Fragmented subunits
• Costs higher
• Inefficiencies due to duplication of activities
Why engage in international business?
Theories of international business
• Economic related – Does international business increase or decrease a nation’s wealth?
o Theory of absolute and comparative advantage
o Imperfect markets theory
• Business related – Why are firms motivated to expand their business internationally?
o Product cycle theory
o Global strategies
Absolute and comparative advantage
Absolute advantage:
A country enjoys an absolute advantage over another county in the production of a product when it uses fewer
resources to produce that product 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
lower cost in terms of other good.
3
, Example: Opportunity costs of Cheese
NL has opportunity costs of two beer to produce one cheese wheel, while B has opportunity costs of one beer
to produce one cheese wheel
→ NL would be better off to produce more beer and trade it with B who produces more cheese
Need for international business as due to specialization you need to rely for some products on other countries
→ You specialize on products you have the absolute advantage or specialize on products you have the
comparative advantage
Ricardian model where technological differences determine comparative advantage.
Heckscher–Ohlin theorem (H–O) theory: trade patterns based on countries' comparative advantage in certain
factors of production (such as capital and labour).
Leontief found that the US—the most capital-abundant country in the world—exported commodities that
were more labour-intensive than capital-intensive, in contradiction with Heckscher–Ohlin theory
Imperfect Market Theory
• Unrestricted mobility of production factors
o Freely transferable
o Removes comparative advantage
• Restricted mobility of production factors → reduces comparative advantages
o Labor, machinery, patents, property rights, resources
o Tariffs, Quotas, Tax
Imperfect markets: products cannot be easily and freely retrieved by the MNC. MNC must go to another
country to be able to retrieve the resources.
Tariffs and quotas, labor immobility: they just don’t want to life elsewhere…
Product Cycle Theory
As a firm matures, it may recognize additional opportunities outside its home country
Differentiate product from
competitors and/or
Accommodate expands product line in foreign
local demand country
or
Accommodate
foreign demand
Competitive advantages
are eliminated and
foreign business declines
Establish presence in
foreign country/
possibly to reduce
costs (subsidiary)
Global Strategy
Large investments can only be recouped if demand is sufficiently large → larger than the domestic consumer
base.
4
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