1. Financial Management in International Business20
Chapter
Financial Management in International Business

2. Case: Global treasury management at Proctor & Gamble
60% of P &G’s revenues from international sales Products sold in 130 countries
Has centralized global treasury management function
Management of all foreign exchange transactions
P& G trades currency between subsidiaries, cutting out banks and saving on transaction costs
P & G is pooling foreign exchange risks and buying an purchasing an umbrella option to cover risks associated with various currency options
Subsidiaries can invest in and borrow money from other P &G entities instead of dealing with banks

3. Scope of financial management
Scope of financial management includes three sets of related decisions:
Investment decisions
Decisions about what activities to finance
Financing decisions
Decisions about how to finance those activities.
Money management decisions
Decisions about how to manage the firm’s financial resources most efficiently

4. Investment decisions Capital budgeting: Complicated process:
Quantifies the benefits, costs and risks of an investment
Managers can reasonably compare different investment alternatives within and across countries
Complicated process:
Must distinguish between cash flows to project and those to parent
Political and economic risk can change the value of a foreign investment
Connection between cash flows to parent and the source of financing must be recognized

5. Project and parent cash flows
Project cash flows may not reach the parent:
Host-country may block cash-flow repatriation
Cash flows may be taxed at an unfavorable rate
Host government may require a percentage of cash flows to be reinvested in the host country

6. Adjusting for political and economic risk
Political risk:
Expropriation - Iranian revolution, 1979
Social unrest - after the breakup of Yugoslavia, company assets were rendered worthless
Political change - may lead to tax and ownership changes
Examples. Collapse of communism in Eastern Europe
Attack on the world trade center
Economic risk
Inflation

7. Financing decisions
When considering options for financing a foreign investment, Int. businesses have to consider two factors
Source of financing
Financial structure

8. Source of financing Global capital markets for lower cost financing.
Impact of host country-host-country may require projects to be locally financed through debt or equity
Limited liquidity raises the cost of capital.
Host-government may offer low interest or subsidized loans to attract investment.
Impact of local currency (appreciation/depreciation) influences capital and financing decisions

9. Financial structure Financial structure:
Debt/equity ratios vary with countries.
Tax regimes
Follow local capital structure norms?
More easily evaluate return on equity relative to local competition
Good for company’s image
Best recommendation: adopt a financial structure that minimizes the cost of capital

10. Global money management -The efficiency objective
Minimizing cash balances:
Money market accounts - low interest - high liquidity
Certificates of deposit - higher interest - lower liquidity
Reducing transaction costs (cost of exchange):
Transaction costs: changing from one currency to another
Transfer fee: fee for moving cash from one location to another

11. Global money management The tax objective
Countries tax income earned outside their boundaries by entities based in their country.
Can lead to double taxation
Tax credit allows entity to reduce home taxes by amount paid to foreign government
Tax treaty is an agreement between countries specifying what items will be taxed by authorities in country where income is earned
Deferral principle specifies that parent companies will not be taxed on foreign income until the dividend is received
Tax haven is used to minimize tax liability

12. Corporate income tax rates

13. Moving money across borders: Attaining efficiencies and reducing taxes
Unbundling: A mix of techniques to transfer liquid funds from a foreign subsidiary to the parent company without piquing the host-country
Dividend remittances
Royalty payments and fees
Transfer Prices
Fronting loans
Selecting a particular policy is limited when a foreign subsidiary is part owned by a local joint-venture partner or local stockholders

14. Dividend remittances Most common method of transfer.
Dividend varies with:
tax regulations.
Foreign exchange risk.
Age of subsidiary.
Extent of local equity participation.

15. Royalty payments and fees
Royalties represent the remuneration paid to owners of technology, patents or trade names for their use by the firm.
Common for parent to charge a subsidiary for technology, patents or trade names transferred to it.
May be levied as a fixed amount per unit sold or percentage of revenue earned.
Fees are compensation for professional services or expertise supplied to subsidiary.
Management fees or ‘technical assistance’ fees.
Fixed charges for services provided

16. Transfer prices
Price at which goods or services are transferred within a firm’s entities.
Position funds within a company.
Move founds out of country by setting high transfer fees or into a country by setting low transfer fees.
Movement can be within subsidiaries or between the parent and its subsidiaries.

17. Benefits of manipulating transfer prices
Reduce tax liabilities by using transfer fees to shift from a high-tax country to a low-tax country.
Reduce foreign exchange risk exposure to expected currency devaluation by transferring funds.
Can be used where dividends are restricted or blocked by host-government policy.
Reduce import duties (ad valorem) by reducing transfer prices and the value of the goods.

18. Problems with transfer pricing
Few governments like it.
Believe (rightly) that they are losing revenue.
Has an impact on management incentives and performance evaluations.
Inconsistent with a ‘profit center’.
Managers can hide inefficiencies.

19. Fronting loans
Loan between a parent and subsidiary is channeled through a financial intermediary (bank).
Allows circumvention of host-country restrictions on remittance of funds from subsidiary to parent.
Provides certain tax advantages.

20. An example of the tax aspects of a fronting loan
Fig 20.1

21. Techniques for global money management
Need cash reserves to service accounts and insuring against negative cash flows.
Should each subsidiary hold its own cash balance?
By pooling, firm can deposit larger cash amounts and earn higher interest rates.
If located in a major financial center can get information on good investment opportunities.
Can reduce the total size of cash pool and invest larger reserves in higher paying, long term, instruments.

22. Centralized depositories
Day-to-Day Cash Needs (A)
One Standard Deviation (B)
Required Cash Balance (A+3xB)
Spain
$10 $1
$13
Italy $6 $2
$12
Germany
$ 12 $3
$21
Total
$28
$46

23. Techniques for global money management
Ability to reduce transaction costs.
Bilateral netting.
Multilateral netting - simply extending the bilateral concept to multiple subsidiaries within an international business

24. Cash flows before multilateral netting
Fig 20.2A

25. Cash flows after multilateral netting
Fig 20.2C

26. Net receipts
Fig 20.2B

27. Managing foreign exchange risk
Risk that future changes in a country’s exchange rate will hurt the firm.
Transaction exposure: extent income from transactions is affected by currency fluctuations.
Translation exposure: impact of currency exchange rates on consolidated results and balance sheet.
Economic exposure: effect of changing exchange rates over future prices, sales and costs.

28. Strategies for reducing foreign exchange risk (a)
Primarily protect short-term cash flows.
Reducing transaction and translation exposure:
Buying forward and currency swaps.
Lead strategy: collecting receivables early when currency devaluation is anticipated and paying early when currency may appreciate.
Lag strategy: delaying receivable collection when anticipating currency appreciation and delaying payables when currency depreciation is expected.

29. Strategies for reducing foreign exchange risk (b)
Reducing Transaction and translation exposure
Lead strategy
Lag strategy
Reducing economic exposure:
Key is to distribute productive assets to various locations so firm is not severely affected by exchange rate changes

30. Managing Foreign Exchange Exposure
No agreement as to how, but commonality of approach does exist:
Central control of exposure.
Distinguish between transaction/translation exposure and economic exposure.
Forecast future exchange rate movements.
Good reporting systems to monitor firm’s exposure to exchange rate changes.
Produce monthly foreign exchange exposure reports.

31. Case: Motorola’s global cash management system
Pre netting and post netting info flows
Fig C2
Fig C1

32. Case: Motorola’s global cash management system
Fig C1

33. Case: Motorola’s global cash management system: Currency netting model
Fig C3

34. Case: Motorola’s global cash management system