Presentation on theme: "INTERNATIONAL FINANCE"— Presentation transcript:
1 INTERNATIONAL FINANCE Lecture 2INTERNATIONAL FINANCE
2 International Finance An Overview Lecture 2International Finance An Overview
3 Chapter ObjectivesTo identify the main goal of the multinational corporation (MNC) and potential conflicts with that goalTo describe the key theories that justify international business.
4 Multinational Financial Management Multinational corporations are defined as firms that engage in some form of international business. Their managers conduct international financial management.International investment and financial decisionsMaximise the value of firmExport products or import suppliesAfter maturing in domestic market, the company can distribute in many countries e.g. Coca Cola (deals in different countries with various currencies)
5 Subsidiary ManagersA subsidiary company is one that is a 'sister' or a 'child' company of another usually larger company.So let's say there is company X. Company Y is another company owned by company X. Therefore company Y is a subsidiary of company X.
6 Goal of the MNCThe commonly accepted goal of an MNC is to maximize shareholder wealth.We will focus on MNCs that wholly own their foreign subsidiaries.
7 Goal of the MNC Financial managers throughout the MNC have a single goal of maximizing the value of the entire MNC.Managers are suppose to make the decisions that can maximise the stock price and therefore serve the stockholders.
8 Conflicts with the MNC Goal When a company’s shareholders differ from its managers, a conflict of goals can exist—the agency problem.
10 Agency ProblemA decision to establish a subsidiary in one location versus another may be based on the location’s appeal to a particular manager rather than on its potential benefit to shareholders.
11 Agency ProblemA decision to expand a subsidiary may be motivated by a manager’s desire to receive more compensation rather than to enhance the value of the MNC.
12 Agency ProblemsAgency costs are normally larger for MNCs than for purely domestic firms, due to:the difficulty in monitoring distant managers,the different cultures of foreign managers,the sheer size of the larger MNCs, and
13 Conflicts with the MNC Goal Subsidiary managers may be tempted to make decisions that maximize the values of their respective subsidiaries.
14 Parent Control of Agency Problem The parent corporation of an MNC may be able to prevent agency problems with proper governance.Clearly communicate the goals of the MNCMonitoring by parentImplement compensation plans that reward the subsidiary managersTo provide managers with the MNC’s stock (or options to buy the stock at a ﬁxed price) as part of their compensation
15 Corporate Control of Agency Problems In case of acquisitions due to poor performance of MNC the new management will replace the managers.Institutional investors can complain to board of directors and replace the poor management.
16 Impact of Management Control The magnitude of agency costs can vary with the management style of the MNC.CentralizedDecentralized
17 Centralized Multinational Financial Management for an MNC with two subsidiaries, A and BCapital Expendituresat AInventory andAccountsReceivableManagement at ACashManagementFinancing at AFinancialManagersof ParentCapital Expendituresat BInventory andAccountsReceivableManagement at BCashManagementFinancing at B
18 Decentralized Multinational Financial Management for an MNC with two subsidiaries, A and BFinancialManagersof ACapital Expendituresat AInventory andAccountsReceivableManagement at ACashManagementFinancing at ACapital Expendituresat BInventory andAccountsReceivableManagement at BCashManagementFinancing at BFinancialManagersof B
19 Impact of Management Control Some MNCs attempt to strike a balance – they allow subsidiary managers to make the key decisions for their respective operations, but the parent’s management monitors the decisions.Today, electronic networks make it easier for the parent to monitor the actions and performance of its foreign subsidiaries.
20 MNCs Improvement for Internal Control Process Establishing a centralized database of informationEnsuring that all data are reported consistently among subsidiariesImplementing a system that automatically checks data for unusual discrepancies relative to norms
21 MNCs Improvement for Internal Control Process Speeding the process by which all departments and all subsidiaries have access to the data that they needMaking executives more accountable for financial statements by personally verifying their accuracy
22 Impact of Corporate Control Various forms of corporate control can reduce agency costs:stock optionshostile takeover threatinvestor monitoring
23 Constraints Interfering with the MNC’s Goal MNC managers are confronted with various constraints:Environmental ConstraintsRegulatory ConstraintsEthical Constraints
24 Constraints Interfering with the MNC’s Goal A recent study found that investors assigned a higher value to firms that exhibit high corporate governance standards and are likely to obey ethical constraints.
25 Theories of International Business Why are firms motivated to expand their business internationally?Theory of Comparative AdvantageImperfect Markets TheoryProduct Cycle Theory
26 1. Theory of Comparative advantage Allows firms to penetrate foreign markets.Specialization by countriesMore efficiencyTechnological e.g. US, JapanAgriculture e.g. Jamaica, Mexico
27 2. Imperfect Market Theory If perfect market so factors of production are free mobile & equality of costs and returns.Imperfect market provides incentive to seek foreign opportunities, Where factors of production are immobile.Countries differs in term of resourcesCosts and restrictions related to laborRestriction on transferring funds & other sourcesMNC’s Nike and Gap capitalize on foreign resources
28 3. Product Cycle TheoryAs a firm matures in home market, it may recognize additional opportunities outside its home country.By ExportsCompetition will increase in foreign marketsStrategies to sustain
29 Centralized vs. Decentralized System ReviewGoals of MNCsAgency ProblemsCentralized vs. Decentralized SystemTheories of International BusinessSource: Adopted from South-Western/Thomson Learning. 2006