Chapter 1-5

CENGAGE International Financial Management

• Edition: Fifth Edition

• Authors: Jeff Madura, Roland Fox

The International Financial Environment

• Key Topics:

  • Multinational Corporation (MNC)

  • Foreign Exchange Markets

  • Exporting and Importing

  • Dividend Remittance and Lending

  • Investing and Borrowing

  • Foreign Products Markets

  • Foreign Subsidiaries

  • International Financial Markets

Multinational Financial Management: An Overview

Chapter Objectives

• Understand the main goal of the MNC and potential conflicts.

• Outline common methods used to conduct international business.

Goal of the MNC

• Primary Aim: Maximize shareholder wealth.

• Focus on MNCs that wholly own their foreign subsidiaries, ensuring financial managers prioritize the overall value of the MNC.

Conflicts with the MNC Goal

• Agency Problem: Conflicts can arise when corporate shareholders’ goals differ from those of the managers due to separation of ownership and control.

  • Agency costs for MNCs are usually higher than for domestic firms due to:

    • Difficulty monitoring distant managers.

    • Cultural differences among managers in foreign locations.

    • Size and complexity of larger MNCs.

• Subsidiary managers might prioritize their subsidy’s value over the broader MNC goals, leading to increased information asymmetry and difficulties in controlling discretionary benefits (perquisites).

Impact of Management Control

• Agency costs depend on the management style:

  • Centralized Management: Reduces agency costs by central oversight.

  • Decentralized Management: Empowers local managers with more control, allowing them to respond better to local conditions.

• Modern electronic networks facilitate monitoring and oversight by the parent company over its subsidiaries.

External Influences on MNCs

• Hostile Takeovers: A threat if an MNC is poorly managed.

• Monitoring by External Entities: Includes shareholders such as investment trusts, pension funds, and insurance companies.

Constraints Interfering with the MNC’s Goal

• Types of Constraints:

  • Environmental

  • Regulatory

  • Ethical

• Corruption Example: High percentage of EU government contract costs attributed to bribes, affecting business integrity.

• MNCs face dilemmas regarding whether to adopt relative (country-specific laws) or absolute (global standards) practices.

Exposure to International Risks

• Exchange Rate Movements: Impacting nearly all international transactions.

• Foreign Economies: Both risks from volatility and opportunities for diversification.

• Political Risks: Changes in legislation affecting foreign investment, illustrated by South Africa's Medicines Control legislation.

• Terrorism and War: Ongoing global risks impacting operations.

MNC Valuation

• Stock Market Valuation: Primarily influenced by domestic economies despite international engagement.

• Book vs. Market Value: MNCs often have a discrepancy indicating excess market value; however, they are not uniquely advantaged.

International Business Methods

Modes of Entry

1. Exporting/Importing: Fundamental parts of international trade.

2. Licensing: Sharing technology for fees/benefits.

3. Franchising: Grants a sales/service model for fees.

4. Joint Ventures: Partnerships to operate in foreign markets.

5. Acquisitions: Quick control by buying existing operations.

6. New Subsidiaries: Setting up operations abroad.

7. Direct Foreign Investment (DFI): Economically significant investments requiring over 10% ownership.

Special Purpose Vehicles (SPVs)

• Legally independent entities created for specific projects by sponsoring MNCs; reliant on project's debt repayment success.

Investment Opportunities

• Foreign Direct Investment (FDI): Typically requires at least 10% ownership in foreign operations; encompasses more significant investments such as acquisitions and new subsidiaries.

Overview of MNC Cash Flows

Profiles of Cash Flow

Profile A: Focused on International Trade

• UK-based MNC relations with customers and foreign exporters, detailing transactions and payments.

Profile B: Trade and International Arrangements

• Involves fees for services in addition to trading.

Profile C: Trade, International Arrangements, and Direct Foreign Investment

• Demonstrates flows to foreign subsidiaries and remittances back to the parent company.

Financial Academic Models

Valuation Model for an MNC

• Decisions on operations and financing impact the MNC's exposure to international financial environments, which can be managed to mitigate risk.

Organization of the Text

• Chapters Overview:

  • Background on international financial markets (Chapters 2-5)

  • Exchange rate behavior (Chapters 6-8)

  • Long-term investment financing decisions (Chapters 13-16)

  • Short-term investment financing decisions (Chapters 17-19)

  • Risk management of exchange rate (Chapters 9-12)

  • Risk-return assessment of MNC value and stock price.