Globalization & the Multinational Firm Understand why it is important to study international finance. Distinguish international finance from domestic finance. 1. Foreign Exchange Risk 2. Political Risk 3. Market Imperfections 4. Expanded Opportunity Set

Foreign Exchange Risk The risk that foreign profits and wealth may evaporate in dollar terms due to unanticipated unfavorable exchange rate movements. Suppose $1 = ¥100 and you buy 10 shares of Toyota at ¥10,000 per share. One year later the investment is worth ten percent more in yen: ¥110,000 But, if the yen has depreciated to $1 = ¥120, your investment has actually lost money in dollar terms.

Political Risk Sovereign governments have the right to regulate the movement of goods, capital, and people across their borders, and legislation of taxation. Sovereign governments laws sometimes change in unexpected ways. Sovereign government and civil instability

Market Imperfections Legal restrictions on movement of goods, people, and money; e.g. tariffs. 1. Farley, NCB entries in Europe Transactions costs Shipping costs Tax arbitrage

Expanded Opportunities Markets, new and growing Intellectual capital Capital markets Taxation Economies of scale R&D Cheaper labor Lower prices Employment Technology Wealth

Primary Goal for International Corporate Financial Management Maximization of shareholder wealth? Other stakeholders 1. Employees 2. Suppliers 3. Customers

Keiretsu In Japan, managers have typically sought to maximize the value of the keiretsu—a family of firms to which the individual firms belongs.

Corporate Governance Corporate scandals 1. Enron 2. Tyco 3. WorldCom 4. Madoff Managers may pursue their own private interests at the expense of shareholders when they are not closely monitored. These catastrophic corporate events have painfully reinforced the importance of corporate governance; - the financial and legal framework for regulating the relationship between a firm’s management and its shareholders. Has SOX worked? Can we regulate behavior? Emerging and transitional economies legal protection of shareholders is weak or virtually non-existing.

Globalization of the World Economy Major Trends Emergence of Globalized Financial Markets Emergence of the Euro as a Global Currency Trade Liberalization and Economic Integration Privatization

Emergence of the Euro as a Global Currency Currently more than 300 million Europeans in 22 countries are using the common currency on a daily basis. The transaction influence of the euro may become larger than the U.S. dollar’s in the near future.

Euro Area

Global Economic Integration Over the past 50 years, international trade increased about twice as fast as world GDP. In more recent years there has been a change in the attitudes of many of the world’s governments who are abandoning mercantilist and centralized views and embracing free trade as the most effective route to prosperity for their citizenry. The highest affect for prosperity in free trade being derived from manufacturing.

Liberalization of Protectionism The General Agreement on Tariffs and Trade (GATT) World Trade Organization (WTO) The North American Free Trade Agreement (NAFTA) For Mexico, the ratio of export to GDP has increased dramatically from 2.2% in 1973 to 28.7% at the beginning of the 21st century.

Privatization The selling off of state-run enterprises to investors for the purpose of establishing a free market economy and the increase of individual wealth through business profits. Privatization increases the efficiency of the enterprise. Privatization typically accelerates a tremendous increase in cross-border investment.

Multinational Corporations A company that has incorporated in one country and has production and sales operations in other countries. Many MNCs obtain raw materials from one country, financial capital from another, produce goods with labor and capital equipment in a third country and sell their output in various other national markets.

Top 10 MNCs - 2010 Who ?

Top 10 MNCs - 2010 1.  Royal Dutch Shell $458 billion – Oil (Netherlands) 2. Exxon Mobil $443 billion - Oil 3. Wal-Mart $406 billion - Retail 4. BP $357 billion - Oil 5. Chevron $263 billion - Oil 6. Total $235 billion - Oil (French) 7. ConocoPhillips $231 billion - Oil 8. ING Group $227 billion – Bank (Netherlands) 9. Sinopec $208 billion - Oil (China) 10.Toyota $204 billion - Automobile

The Theory of Comparative Advantage Gains From Trade Definition: a comparative advantage exists when one party can produce a good or service at a lower opportunity cost than another party.

The Geometry of Comparative Advantage There are two countries, A and B, who can each produce only food and textiles. Initially they do not trade with one another.

Globalization Criticisms of globalization Offshoring of business services jobs to lower-wage countries (Outsourcing) Growing trade deficits Slow wage growth Environmental and social impacts

Europe Emergence of the EU as an operational economic union Economic linkages between the EU and newly emerging Central and Eastern European countries Foreign MNCs gain foothold in EU by Acquisitions Alliances Cooperative R&D efforts Challenge is to absorb former communist-bloc countries Privatization of traditionally nationalized industries

Central and Eastern Europe Perestroika—economic and political restructuring Dismantling of Russian price controls Privatization Inflation Membership in International Monetary Fund (IMF) Crime Political uncertainty

Asia Japan Phenomenal economic success in 1970s and 1980s Ministry of International Trade and Industry (MITI) Keiretsus Vertically integrated industries Holdings provide assistance needed in providing goods and services to end users Decade long recession in 1990s Bank loans backed by real estate or projected revenues By 2000, most major banks had billions of dollars in uncollectible loans International competition has increased

Asia The Four Tigers South Korea Hong Kong Chaebols (large family-held Korean conglomerates) Affected by declining economies of South east Asia in 1990s) Hong Kong Now part of People’s Republic of China Uncertainty about role the Chinese government intends to play in local governance

Asia Singapore Least hurt by economic downturn of 1990s Taiwan Progression from labor-intensive economy to one dominated by technologically sophisticated industries (banking, electricity generation, petroleum refining and computers)

Asia China Annual real economic growth of 10 percent during the 1980s and early 1990s More recent growth of 8 percent Healthy and growing economy GDP growth of 91 percent in 2003 Attractive to foreign investors despite major political risk Product pirating is major problem Complicated and high-risk venture

Developing and Emerging Country India Low per capita GDP Recent trend of locating software and high value-added services to this country Attractive to U.S. and British investors (well educated, English speaking, technologically sophisticated workers)