1. INTERNATIONAL FINANCE
Lecture 2
INTERNATIONAL FINANCE

2. International Finance An Overview
Lecture 2
International Finance An Overview

3. Chapter Objectives
To identify the main goal of the multinational corporation (MNC) and potential conflicts with that goal
To 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 decisions
Maximise the value of firm
Export products or import supplies
After maturing in domestic market, the company can distribute in many countries e.g. Coca Cola (deals in different countries with various currencies)

5. Subsidiary Managers
A 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 MNC
The 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.

9. Agency Problem
Hires
Agent
Performs
Principal

10. Agency Problem
A 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 Problem
A 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 Problems
Agency 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 MNC
Monitoring by parent
Implement compensation plans that reward the subsidiary managers
To 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.
Centralized
Decentralized

17. Centralized Multinational Financial Management
for an MNC with two subsidiaries, A and B
Capital Expenditures
at A
Inventory and
Accounts
Receivable
Management at A
Cash
Management
Financing at A
Financial
Managers
of Parent
Capital Expenditures
at B
Inventory and
Accounts
Receivable
Management at B
Cash
Management
Financing at B

18. Decentralized Multinational Financial Management
for an MNC with two subsidiaries, A and B
Financial
Managers
of A
Capital Expenditures
at A
Inventory and
Accounts
Receivable
Management at A
Cash
Management
Financing at A
Capital Expenditures
at B
Inventory and
Accounts
Receivable
Management at B
Cash
Management
Financing at B
Financial
Managers
of 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 information
Ensuring that all data are reported consistently among subsidiaries
Implementing 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 need
Making 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 options
hostile takeover threat
investor monitoring

23. Constraints Interfering with the MNC’s Goal
MNC managers are confronted with various constraints:
Environmental Constraints
Regulatory Constraints
Ethical 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 Advantage
Imperfect Markets Theory
Product Cycle Theory

26. 1. Theory of Comparative advantage
Allows firms to penetrate foreign markets.
Specialization by countries
More efficiency
Technological e.g. US, Japan
Agriculture 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 resources
Costs and restrictions related to labor
Restriction on transferring funds & other sources
MNC’s Nike and Gap capitalize on foreign resources

28. 3. Product Cycle Theory
As a firm matures in home market, it may recognize additional opportunities outside its home country.
By Exports
Competition will increase in foreign markets
Strategies to sustain

29. Centralized vs. Decentralized System
Review
Goals of MNCs
Agency Problems
Centralized vs. Decentralized System
Theories of International Business
Source: Adopted from South-Western/Thomson Learning. 2006