Topics 29. Globalization, Corporate Finance, and the Cost of Capital R. M. Stulz 2018/12/6 Hu - Globalization
Globalization can increase firm value Nestlé (A Swiss firm) Before November 1988 Bearer shares: Available for both local and foreign investors Registered shares: Available only for local investors Same dividends, same voting rights Registered shares price is only half of the bearer shares price 2018/12/6 Hu - Globalization
Globalization can increase firm value Nestlé (A Swiss firm) November 17, 1988 Company announced to remove ownership restriction Announcement effect: 36% for registered share and -25% for bearer share 10% in total 2018/12/6 Hu - Globalization
Globalization can increase firm value 12 countries with capital market liberalization (Henry, 2000) Average stock price increases 30% from four months before liberalization announcement to three months after that ADR listing 1.2% - 2.6% around the announcement or listing 2018/12/6 Hu - Globalization
Globalization reduces the cost of capital CAPM E(Ri) = Rf + bi * [E(Rm) - Rf] E(Ri): Expected return for firm I Rf: Riskfree rate bi: Market beta, which equals Cov(Ri, Rm) / Var(Rm) E(Rm) – Rf: Market risk premium 2018/12/6 Hu - Globalization
Globalization reduces the cost of capital Local CAPM E(RC) = Rf + bH * [E(RH) - Rf] Global CAPM E(RG) = Rf + bG * [E(RG) - Rf] E(RG) – Rf: Global market risk premium Return of the Morgan Stanley Capital International world index 6.6% annual risk premium from 1970/2 to 1989/5 2018/12/6 Hu - Globalization
Globalization reduces the cost of capital E(RG) < E(RC) because [E(RG) - Rf] < [E(RH) - Rf] bG < bH 2018/12/6 Hu - Globalization
Globalization reduces the cost of capital A lower market risk premium [E(RG) - Rf] < [E(RH) - Rf] Determined by risk and risk premium Risk The risk of global portfolio is smaller than the risk of home portfolio Risk premium per unit of risk Determined by investors’ risk attitude The risk will be shared by more people who have different risk attitude 2018/12/6 Hu - Globalization
Globalization reduces the cost of capital Giorgio de Santis and Bruno Gerard, 1997, International Asset Pricing and Portfolio Diversification with Time-Varying Risk, The Journal of Finance, Vol. 52, No. 5. (Dec., 1997), pp. 1881-1912. 2018/12/6 Hu - Globalization
Bekaert, Geert; Harvey, Campbell R Bekaert, Geert; Harvey, Campbell R., 1997, Emerging equity market volatility, Journal of Financial Economics 43: 1, pp. 29-77 2018/12/6 Hu - Globalization
Globalization reduces the cost of capital A lower market risk premium [E(RG) - Rf] < [E(RH) - Rf] Global portfolio is less correlated with personal human wealth 2018/12/6 Hu - Globalization
Globalization reduces the cost of capital 2018/12/6 Hu - Globalization
Globalization reduces the cost of capital A lower market beta bG < bH Nestlé bG = 0.6, bH = 0.9 2018/12/6 Hu - Globalization
Globalization reduces the cost of capital A lower transaction cost Transaction cost and cost of capital A lower transaction cost means a lower expected return required by investors Globalization can reduce transaction costs It can increase investor pool It can reduce the probability of insider trading Companies can choose the exchange with the lowest transaction cost 2018/12/6 Hu - Globalization
Globalization can also increase expected cash flows Better governance, stronger monitoring Reduce information asymmetry Reduce agency costs Asset substitution Underinvestment Overinvestment 2018/12/6 Hu - Globalization
Globalization can also increase expected cash flows Better governance, better monitoring Board Using foreigners A greater pool of talents Capital market Using outside professionals, e.g., investment banks Global knowledge Higher reputation to protect 2018/12/6 Hu - Globalization
Globalization can also increase expected cash flows Better governance, better monitoring Legal system Limit on expropriation from major shareholders Class actions Provide mechanism for shareholder monitoring Active shareholders Large shareholders Institutional shareholders 2018/12/6 Hu - Globalization
Institutional investors’ view Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002 2018/12/6 Hu - Globalization
Institutional investors’ view Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002 2018/12/6 Hu - Globalization
Institutional investors’ view Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002 2018/12/6 Hu - Globalization
Institutional investors’ view Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002 2018/12/6 Hu - Globalization
Institutional investors’ view Source: McKinsey Global Investor Opinion Survey on Corporate Governance, 2002 2018/12/6 Hu - Globalization
Standard and Poor’s criteria Ownership Structure and External Influences Transparency of Ownership Structure Concentration and Influence of Ownership and External Stakeholders Shareholder Rights and Stakeholder Relations Shareholder Meeting and Voting Procedures Ownership Rights and Takeover Defenses Stakeholder Relations Transparency, Disclosure and Audit Content of Public Disclosure Timing of, and Access to, Public Disclosure The Audit Process Board Structure and Effectiveness Board Structure and Independence Role and Effectiveness of the Board Director and Senior Executive Compensation 2018/12/6 Hu - Globalization
Globalization can also increase expected cash flows Better governance, better monitoring Market for corporate control Greater competition for control Greater pressure to open the market for control Disclosure Transparency Cross-listing or listing in foreign exchanges can commit to disclose 2018/12/6 Hu - Globalization
Companies need to choose Globalization can also increase expected cash flows Better governance, better monitoring Companies need to choose Companies that participate global market Companies that do not participate 2018/12/6 Hu - Globalization
Globalization reduces transaction costs 2018/12/6 Hu - Globalization
Globalization reduces the cost of capital 2018/12/6 Hu - Globalization
Globalization reduces the cost of capital 2018/12/6 Hu - Globalization