Lecture 01 - Overview

Lecture Objectives
• Identify the management goal and organizational structure of the

Multinational Corporation (MNC).
• Describe the key theories that justify international business.
Lecture 1 • Explain the common methods used to conduct international

business.
International Financial • Provide a model for valuing the MNC.
Management: An Overview
Jeff Madura, International Financial Management, 14th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, Jeff Madura, International Financial Management, 14th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, 2
copied or duplicated, or posted to a publicly accessible website, in whole or in part. copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Multinational Corporations Managing the MNC (1 of 4)
• A multinational corporation (MNC) is a firm that has been Managers are expected to make decisions that will maximize the
incorporated in one country and has production and sales shareholders’ wealth.
operations in other countries
– Approximately 60,000 MNCs in the world with over 500,000 Focus of this text: MNCs whose parents fully own foreign subsidiaries (U.S.
foreign affiliates parent is sole owner of subsidiary).
• Benefit from the economy of scale in many ways:
– Spreading R&D expenditures and advertising costs over their The concepts in this text also apply generally to MNCs based in countries other
global sales than the United States.
– Pooling global purchasing power over suppliers
– Utilizing their technological and managerial know-how
globally with minimum additional costs
Jeff Madura, International Financial Management, 14th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, 4
copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Managing the MNC (2 of 4) Managing the MNC (3 of 4)
Agency Problems
How Business Disciplines Are Used to Manage the MNC • The conflict of goals between managers and shareholders
• Common finance decisions include: • Agency Costs
o Whether to discontinue operations in a particular country o Definition: Cost of ensuring that managers maximize shareholder wealth.
o Whether to pursue new business in a particular country o Costs are normally higher for MNCs than for purely domestic firms for
o Whether to expand business in a particular country several reasons:
o How to finance expansion in a particular country • Monitoring managers of distant subsidiaries in foreign countries is more difficult.
• Foreign subsidiary managers raised in different cultures may not follow uniform
• Finance decisions are influenced by other business discipline goals.
functions: • Sheer size of larger MNCs can create large agency problems.
o Marketing
o Management
o Accounting and information systems
Jeff Madura, International Financial Management, 14th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, 5 Jeff Madura, International Financial Management, 14th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, 6
Managing the MNC (4 of 4) SOX Methods to Improve Reporting

Agency Problems (continued) Agency Problems (continued)
• Parent control of agency problems • How SOX Improved Corporate Governance of MNCs
o Parent should clearly communicate the goals for each subsidiary to ensure o Establishing a centralized database of information
managers focus on maximizing the value of the subsidiary. o Ensuring that all data are reported consistently among subsidiaries
• Corporate control of agency problems o Implementing a system that automatically checks for unusual discrepancies
o Entire management of the MNC must be focused on maximizing shareholder relative to norms
wealth. o Speeding the process by which all departments and subsidiaries have access to
• Sarbanes-Oxley Act (SOX) all the data they need
o Ensures a more transparent process for managers to report on the productivity o Making executives more accountable for financial statements
and financial condition of their firm.
Management Structure of MNC Exhibit 1.1a Management Styles of MNCs
Management Structure of MNC
The magnitude of agency costs varies with the MNC’s management style.
• Centralized management style (See Exhibit 1.1a)
o Allows managers of the parent to control foreign subsidiaries and therefore
reduce the power of subsidiary managers.
o Reduce agency costs
• Decentralized management style (See Exhibit 1.1b)
o Gives more control to subsidiary managers who are closer to the subsidiary’s
operation and environment.
o Increase agency costs
Exhibit 1.1b Management Styles of MNCs Why MNCs Pursue International Business (1 of 4)
Theory of Competitive Advantage: Specialization increases production

efficiency.
Imperfect Markets Theory: Factors of production are somewhat immobile,

providing incentive to seek out foreign opportunities.
Product Cycle Theory: As a firm matures, it recognizes opportunities outside

its domestic market. (Exhibit 1.2)
Why MNCs Pursue International Business (2 of 4) Why MNCs Pursue International Business (3 of 4)
Theory of Competitive Advantage
Imperfect Markets Theory
• Some countries have a technology advantage and other countries have an • If each country’s markets were closed to all other countries:
advantage in the cost of basic labor. o There would be no international business.
• Countries tend to use their advantages to specialize in the production of • In extreme case, if markets are perfect then the factors of production are
easily transferable:
goods that can be produced with relative efficiency.
o This eliminates the comparative cost advantage which is rationale for
• A country that specializes in some products may not produce other products, international trade.
so trade between countries is essential. • In real world, market are imperfect where factors of production are somewhat
immobile:
• Comparative advantages allow firms to penetrate foreign market
o Costs and often other restrictions affect the transfer of labor and other resources
• Policy implication is that liberalization of international trade will enhance the used for production
welfare of the world’s citizens o Provide an incentive for firms to seek out foreign opportunities
Why MNCs Pursue International Business (4 of 4) Exhibit 1.2 International Product Life Cycles
Product cycle theory (Exhibit 1.2.):
• According to this theory, Firm first established its operation in home market:
o Because information about home markets and competition is more readily
available.
• Firm’s product is perceived by foreign consumers to be superior to that
available within their own countries, the firm may accommodate foreign
consumers by exporting.
• If the firm’s product becomes very popular in foreign countries, it may
produce the product in foreign markets, thereby reducing its transportation
costs.
• Firm’s foreign business diminishes or expands over time will depend on how
successful it is at maintaining some advantage over its competition.
How Firms Engage in International Business (1 of 9) How Firms Engage in International Business (2 of 9)
International Trade
International Trade
Licensing
Franchising • Relatively conservative approach that can be used by firms to:
Joint Ventures
Acquisitions of Existing Operations o penetrate markets (by exporting).
Establishment of New Foreign Subsidiaries o obtain supplies at a low cost (by importing).
• Minimal risk — no capital at risk
Licensing Franchising
• Obligates a firm to provide its technology (copyrights, patents, trademarks, or • Obligates firm to provide a specialized sales or service strategy, support
trade names) in exchange for fees or some other specified benefits. assistance, and possibly an initial investment in the franchise in exchange for
• Firm able to generate more revenue from foreign countries without periodic fees.
establishing any production plants in foreign countries or transporting goods • Franchising by an MNC often requires a direct investment in foreign
to foreign countries. operations, it is referred to as a direct foreign investment.
Joint Ventures Acquisitions of Existing Operations

• Acquisitions of firms in foreign countries allows firms to have full control over
• A venture that is jointly owned and operated by two or more firms. their foreign businesses and to quickly obtain a large portion of foreign
market share.
• A firm may enter the foreign market by engaging in a joint venture with firms • Subject to the risk of large losses because of larger investment.
that reside in those markets. • Liquidation may be difficult if the foreign subsidiary performs poorly.
• Partial international acquisitions requires a smaller investment and limits the
• Allows two firms to apply their respective cooperative advantages in a given potential loss to the firm if the project fails.
project. • firm will not have complete control over foreign operations that are only
partially acquired
Establishment of New Foreign Subsidiaries Summary of Methods
• Firms can penetrate markets by establishing new operations in foreign
countries. • Any method of increasing international business that requires a direct
• Large investment required. investment in foreign operations is referred to as direct foreign investment
• Operations can be tailored exactly to the firm’s needs.
(DFI).
• Firm will not reap any rewards from the investment until the subsidiary is built
and a customer base established. • International trade and licensing usually not included.
• Foreign acquisition and establishment of new foreign subsidiaries represent

the largest portion of DFI.
How Firms Engage in International Business (9 of 9) Exhibit 1.3 Cash Flow Diagrams for MNCs
Summary of Methods (continued)
• Exhibit 1.3 Cash Flow Diagrams for MNCs
o The first diagram reflects an MNC that engages in international trade.
International cash flows result from paying for imports or receiving cash flow from
exports.
o The second diagram reflects an MNC that engages in some international
arrangements. Outflows include expenses such as expenses incurred from
transferring technology or funding partial investment in a franchise or joint
venture. Inflows are receipts from fees.
o The third diagram reflects an MNC that engages in direct foreign investment.
Cash flows exist between the parent company and the foreign subsidiary.
Valuation Model for an MNC (1 of 6) Valuation Model for an MNC (2 of 6)

Domestic Model
Domestic Model (continued)
V   
  E CF$,t  
 n
   • Dollar Cash Flows

t 1  1  k 
t
  o The dollar cash flows in period t represent funds received by the firm minus funds
Where needed to pay expenses or taxes or to reinvest in the firm.
• V represents present value of expected cash flows • Cost of Capital

• E(CF$,t) represents expected cash flows to be received at the end of period t,
o The required rate of return (k) in the denominator of the valuation equation.
• n represents the number of periods into the future in which cash flows are
received, and o A weighted average of the cost of capital based on all the firms projects.
• k represents the required rate of return by investors.
Multinational Model Multinational Model (continued)
• Valuation of an MNC that uses two currencies

E CF$,t    E CFj ,t  E S j ,t  
m
o Could measure its expected dollar cash flows in any period by multiplying the
expected cash flow in each currency by the expected exchange rate at which that
j 1 currency would be converted to dollars and then summing those two products.
• Valuation of an MNC that uses multiple currencies
Where
• CFj,t represents the amount of cash flow denominated in a particular foreign

E CF$,t    E CFj ,t  E S j ,t  
m
currency j at the end of period t,

j 1
• Sj,t represents the exchange rate at which the foreign currency (measured in o Derive an expected dollar cash flow value for each currency
dollars per unit of the foreign currency) can be converted to dollars at the end
of period t. o Combine the cash flows among currencies within a given period

Multinational Model (continued) Uncertainty Surrounding MNC Cash Flows (Exhibit 1.4)
• Valuation of an MNC’s cash flows over multiple periods
• Exposure to international economic conditions — If economic conditions
o Apply single period process to all future periods
in a foreign country weaken, purchase of products decline and MNC sales in
o Discount the estimated total dollar cash flow for each period at the weighted cost
of capital that country may be lower than expected. (Exhibit 1.5)
• Exposure to international political risk — A foreign government may
 E CF  E S 
m
increase taxes or impose barriers on the MNC’s subsidiary.
n j ,t j ,t
• Exposure to exchange rate risk — If foreign currencies related to the MNC
V 
j 1
t 1 1  k  2
subsidiary weaken against the U.S. dollar, the MNC will receive a lower
amount of dollar cash flows than was expected.
Exhibit 1.4 How an MNC’s Valuation is Exposed to Exhibit 1.5 Potential Effects of International
Uncertainty Economic Conditions
How Uncertainty Affects the MNC’s cost of Capital Summary (1 of 4)
How Uncertainty Affects the MNC’s cost of Capital • The main goal of an MNC is to maximize shareholder wealth. When
managers are tempted to serve their own interests instead of those of
• Due to increase in uncertainty of an MNC’s future cash flows, investor’s shareholders, an agency problem exists. MNCs tend to experience greater
agency problems than do domestic firms. Proper incentives and
expectations increases with higher expected rate of return as leading to communication from the parent may help to ensure that subsidiary managers
increase in cost of obtaining capital and reduction in valuation. focus on serving the overall MNC.
• The uncertainty surrounding economic conditions that influence cash flows

declines, the uncertainty surrounding cash flows of MNCs also declines and
results in a lower required rate of return and cost of capital for MNCs. And
result in increase in valuations.
Summary (2 of 4) Summary (3 of 4)
International business is encouraged by three key theories. • The most common methods by which firms conduct international business
• The theory of comparative advantage suggests that each country should use are international trade, licensing, franchising, joint ventures, acquisitions of
its comparative advantage to specialize in its production and rely on other foreign firms, and formation of foreign subsidiaries. Methods such as
countries to meet other needs. licensing and franchising involve little capital investment but distribute some
of the profits to other parties. The acquisition of foreign firms and formation of
• The imperfect markets theory suggests that because of imperfect markets, foreign subsidiaries require substantial capital investments but offer the
factors of production are immobile, which encourages countries to specialize potential for large returns.
based on the resources they have.
• The product cycle theory suggests that after firms are established in their
home countries, they commonly expand their product specialization in
foreign countries.
Summary (4 of 4)
• The valuation model of an MNC shows that the MNC’s value is favorably
affected when its expected foreign cash inflows increase, the currencies
denominating those cash inflows increase, or the MNC’s required rate of
return decreases. Conversely, the MNC’s value is adversely affected when
its expected foreign cash inflows decrease, the values of currencies
denominating those cash flows decrease (assuming that they have net cash
inflows in foreign currencies), or the MNC’s required rate of return increases.
Jeff Madura, International Financial Management, 14th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned, 39
copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Lecture 01 - Overview

Uploaded by

Copyright:

Available Formats

Lecture 01 - Overview

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Lecture 01 - Overview

Uploaded by

Copyright:

Available Formats

Lecture Objectives

• Identify the management goal and organizational structure of the

Lecture 1 • Explain the common methods used to conduct international

Multinational Corporations Managing the MNC (1 of 4)

Managing the MNC (4 of 4) SOX Methods to Improve Reporting

Theory of Competitive Advantage: Specialization increases production

Imperfect Markets Theory: Factors of production are somewhat immobile,

Product Cycle Theory: As a firm matures, it recognizes opportunities outside

• Minimal risk — no capital at risk

Joint Ventures Acquisitions of Existing Operations

• Foreign acquisition and establishment of new foreign subsidiaries represent

Valuation Model for an MNC (1 of 6) Valuation Model for an MNC (2 of 6)

Where needed to pay expenses or taxes or to reinvest in the firm.

• V represents present value of expected cash flows • Cost of Capital

currency j at the end of period t,

Valuation Model for an MNC (5 of 6) Valuation Model for an MNC (6 of 6)

How Uncertainty Affects the MNC’s cost of Capital Summary (1 of 4)

• The uncertainty surrounding economic conditions that influence cash flows

You might also like