VIKALP GARG MBF

8/14/2019 VIKALP GARG MBF

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Multinational Corporation


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FromVIKALP GARG


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q The Rise of the MultinationalCorporation

q The Internationalization ofBusiness and Finance

q Multinational Financial Management:

MNC


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THE RISE OF THE MULTINATIONAL

CORPORATION

nWhat is an MNC ? a company with production and distribution facilities in more than

one country.


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Classical Theory Adam Smithand David Ricardo

n Rests on doctrine of comparative advantagen Each nation should specialize in the

production and export of goods that it can

produce with relative higher efficiencyn Assumption that goods and services can

move internationally but not factors ofproduction, such as capital, labour & land

n Assumed that a companys citizenship wasthe key determinant of its success


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Overturn of Classical Theory-Birth of MNCn Core nations have become more homogeneousn Factors of production tend to move rapidly in search

of higher returnsn Natural resources have been replaced by artificial

resourcesn Capital moves fast, labour no longer restrictedn Technology and know how have become a global

pooln Very existence of MNC is based on international

mobility of certain factors of productionn Corporate strategy has become more important that

national strengths


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THE RISE OF THE MULTINATIONALCORPORATION

n Forces Changing Global Marketsq Massive deregulationq Collapse of communism

q Privatizations of state-owned industries egsq Revolution in information technologyq Wave of M&Aq Emergence of free market policiesq Rise of Big Emerging Markets (BEMs)


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n MNC has become the prime Transmitter ofCompetitive Forces in the Global Economy:

q The MNC emphases group performance likeq Global coordinated allocation of resources by

single strategic managementq Market entry strategyq Ownership of foreign operationsq Production, marketing and financial activities

n

All these decisions are taken keeping inmind to what is good for corporationas a whole

q


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Fortune top 10no doubt theyare all MNCsn Wal Martn Exxonn Royal Dutch Shelln BPn Toyota Motorsn Chevronn ING Groupn Total

n General Motorsn Conoco Philipsn Daimler

Source: http://money.cnn.com/magazines/fortune/global500/2008/full_list/


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MNCs are the way forward..

n Falling regulatory barriers to overseas investmentn Rapidly declining telecommunications & transport

costsn

Freer domestic & international capital marketsq To buy and sell companiesq To raise fundsq To hedge currency risks

n

More can be done internationally, more cheaply andwith lower risks involved


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n MNC: Reasons to Go globalq More raw materialsq New marketsq Minimize costs of productionq


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n Raw Material Seekersq exploit markets in other countriesq historically first to appear, like east india company

protected by their respective governments, British,

French, Dutchq modern-day counterparts

n British Petroleumn Exxon

q These companies went after raw material, likeoil, and other commodities like coal, nickel,diamond etc


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n Market Seekersq Typical todays MNCq produce and sell in foreign markets

q heavy foreign direct investorsq representative firms:

n IBMn MacDonaldsn Nestlen Levi Strauss


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n Cost Minimizersq seek lower-cost production abroadq Look for lower cost production bases like

China, Indiaq Typically responsible for back offices in India

and large scale manufacturing facilities inChina

q Motive: to remain cost competitiven G.E.n Inteln Various back offices of banks like

Citigroup


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Process of Multinationalexpansion

Exporting

Licensing

SalesSubsidiary

ServiceFacilities

DistributionSystem

ProductionOverseas

1.Companies internationalize in phases2.Unplanned response to a series of random events3.Risk minimizing approach to a highly uncertain environment


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Process of Multinationalexpansionn Exporting

q Firms facing highly uncertain demandq Capital requirement and start up costs minimal

q Low riskq Immediate profitsq Works as a learning ground for future

expansion by studying a geographyq Increased communication with end users

decreases uncertainity


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Process of Multinationalexpansionn Overseas production

q Keep abreast with demandq Modify products to suit overseas domestic demandq Fill orders faster, provide better after sales service

q Also employ best brains in R&Dq Installs confidence in market e.g. SKF bearings in USAq Many steps, repairing, packaging, processing, assembly

to full manufacture

n Questions at this stage are also to create ownaffiliates ( bring own production strength) oracquire a local firm (immediate start, providesmarketing network etc)q

q


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Process of Multinationalexpansionn Licensing

q License a local firm to produce companysproducts in return of royalties and other form

of paymentsq Faster market entry, lower investments, less

legal risksq Lower cash flow, lower quality standards,

foreign licensee becomes a strong player initself , Hero Honda

E t th h t


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Export through agents ordistributors

n Export agents and distributors should have- Technical knowledge of the product

-

- Experience, expertise, and marketing contacts inthe foreign country

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- Experience and expertise in shipping,documentation, and trade credit

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- Reliability and financial stability


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branches/subsidiaries

(versus agents ordistributors)n Advantages- Higher sales potential

- Retains control over production, marketing,distribution

nDisadvantages- Higher resource commitment

-

Slower entry- High country risks and costs


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Contract-based entry

nAdvantages- quick and easy

- low resource commitment

- low cultural costs and risks

- avoids import and investment barriers

nDisadvantages- limited fees/royalties on license agreements

- loss of control over production technology

- potential creation of competitors


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nves men - aseentrynAdvantages

- Potential for higher sales

- Potential for lower costs

- Diversifies manufacturing base and matches foreigncurrency costs to revenues

- Avoids import quotas and tariffs

nDisadvantages- Higher resource commitment

- Higher exit costs

- Must overcome cultural differences

- Must overcome investment barriers

n es men ase


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nves men - aseentry

International jointventures

Mergers andacquisitions

FDI: plantexpansions

FDI: newinvestment

Source: Ernst & Young

nves men ase


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nves men - aseentry

n Foreign direct investment

- Relatively slow entry- Maintains control over assets

n Cross-border M&A- Relatively rapid entry, but possibly at a high

price (acquisition premium)

n Cross-border joint ventures- May avoid investment restrictions

- Less exposure to country risks

- Potential loss of control over intellectualproperty


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Governance of the MNC

Board of Directors

Management

Share-

holders

Debt

Assets

Equity

Mu t nat ona corporate


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Mu t nat ona corporatestrategy

n Invest in core competencies

- Core competencies are the thingsthat a corporation does well

- Core competencies derive frompeople and processes

- The MNC must leverage its corecompetencies into new products

and technologies


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n MNC : Behavioral Viewq State of mind: committed to producing,

undertaking investment and

marketing, and financing globally.q Focus: Figuring out and building on what

a company does best


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n The Global Managerq Understands political and economic differences;

q Searches for most cost- effective suppliers;q Evaluates changes on value of the firm.


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MNC: MaximizingShareholders Valuen Main objective is to maximize shareholders value as

measured by share pricen Shareholders are legal owners of the firm,

management has a fiduciary responsibility to act

in their best interestsn Since they provide the risk capital, their claim

becomes superior to other stake holdersn Provides the best defense against takeovers

higher stock pricen Easier to attract equity capitaln Enhances companys cash flow generating abilityn


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MNC Financial ManagementSystemn Transfer pricing

q the pricing of contributions (assets, tangible and intangible,services, and funds) transferred within an organization.

q For example, goods from the production division may be soldto the marketing division, or goods from a parent companymay be sold to a foreign subsidiary.

q Since the prices are set within an organisation (i.e.controlled), the typical market mechanisms that establishprices for such transactions between third parties may notapply.

q The choice of the transfer price will affect the allocation of thetotal profit among the parts of the company.

n Timing flexibility by payment leads and lags in its variousinternal units, liquidity is very efficiently managedn Value By shifting profits from a high tax to a low tax nation,

MNC can reduce its global tax payments, circumvent currencycontrols, and other regulations , which is not possible forothers

n

n
http://en.wikipedia.org/wiki/Pricinghttp://en.wikipedia.org/wiki/Pricing


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Equilibrium Exchange Rates

n Setting the equilibrium exchange ratesq market-clearing prices that equilibrate

the quantities supplied and demanded

of foreign currency.


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Equilibrium Exchange RatesB. How Americans Purchase British Goods

Foreign Currency Demand -derived from the

demand for foreign countrys goods,services, andfinancial assets.e.g. The demand for British goods by Americans


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n Foreign Currency Supply:n derived from the foreign countrys demand for local

goods.n They must convert their currency to purchase.n e.g. German demand for US goods means British

will convert GBP to USDin order to buy.


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n Equilibrium Exchange Rate:q occurs when the quantity supplied equals the

quantity demanded of a foreign currency at aspecific local price.


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n How Exchange Rates Change Increased demand as more foreign goods are demanded, the

price of the foreign currency in local currencyincreases and vice versa.


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3. Calculating a Depreciation:

Currency Depreciation

where e0 = old currency value e1 = new currency value

Note: Resulting sign is always negative

=

1

10

e

ee

=


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Currency Appreciation


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EXAMPLE: Pound Appreciation If the dollar value of the GBP goes from

$1.64 (e0) to $1.68 (e1), then the poundhas appreciated by

= (1.68 - 1.64)/ 1.64

= 2.4%


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EXAMPLE: US$ Depreciation

We use the first formula, (e0 - e1)/ e1 substituting (1.64 - 1.68)/1 .68 = - 2.3% which is the value of the US$

depreciation.


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Asset Market Model of ExchangeRates

n Simply the relative price of two financialassets is exchange rate

n Influenced by peoples willingness to hold the

existing quantities of the assets whichdepends on the future worth of the assets

n So, in effect, the value of the dollar dependsupon how strongly people still want to holddollar and dollar denominated assets theyheld yesterday

n


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Asset Market Model of ExchangeRatesn Asset market model says that exchange rate represents the price

that just balances the relative supplies of, and demands for,assets denominated in those currencies

n 1960s- USA was dominant nation low inflation (1%) highgrowth (5%) strong USD

n 1970s- Vietnam war, lack of political strength double digitinflation higher taxes slow growth USD declinesn 1980s-new political change back to lower inflation, tax cuts,

growth USD appreciatesn 1985 people fled USD, thinking government wants to

depreciaten Thus currency values are forward looking, today doesnt matter

tomorrow does in currency markets


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The Nature of Money

n

Character of moneyq Value of money depends upon its purchasingpower hence it is store of value

q Money also provides easy exchange withgoods and services, so it acts as store of

liquidityn The economic factors that affect a currencys valueq Its usefulness as a store of value determined

by its expected inflationq Demand for liquidity, determined by the volume

of transactions in the currencyq Demand for assets denominated in that

currency determined by the risk returnpattern on investment in that economy andwealth of its residents

q


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I. FUNDAMENTALS OF CENTRALBANK INTERVENTION A.Role of Exchange Rates: LINKS BETWEEN THE DOMESTIC

AND THE WORLD ECONOMY

Th e Role of Ce n tral Ban k


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B. THE IMPACT OF EXCHANGE RATE

CHANGES

1. Currency Appreciation: -domestic prices increase relative to

foreign prices.

- Exports: less price competitive

- Imports: more attractive

THE ROLE OF CENTRAL BANKS


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THE ROLE OF CENTRAL BANKS 2.Currency Depreciation

- domestic prices fall relative to

foreign prices.

- Exports: more price competitive.

- Imports: less attractive


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THE ROLE OF CENTRAL BANKS

n Foreign Exchange Market Interventionq Definition: the official purchases and

sales of currencies through the central

bank to influence the home exchangerate.


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Expectations & Central Bank

Behavior A. Central Bank Reputations

B. Central Bank Independence

C. Currency Boards


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PART I. ALTERNATIVEEXCHANGE RATE SYSTEMS

n FIVE MARKET MECHANISMS Freely Floating (Clean Float) Market forces of supply and demanddetermine rates.


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Free Float

n Forces influenced by

q price levels

q interest rates

q economic growth

n Rates fluctuate randomly over time.n


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Managed Float

n Managed Float (Dirty Float)q Market forces set rates unless excess volatility

occurs.

q

Then, central bank determines rate.q Smoothing out daily fluctuations

n To preserve a stable and orderly exchange rate

q Leaning against the windn To moderate fluctuation temporary in nature

q Unofficial pegging


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Target Zone Arrangement

q Rate Determination

q Market forces constrained to upper and lower range ofrates.

q Members to the arrangement adjust their nationaleconomic policies to maintain target.q

q Being followed by European Economic Union


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Fixed Rate System

q rate determinationq Government maintains target Rates.q rates threatened, central banks buy/sell

currency.q Monetary policies Coordinated.


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Current System

n A hybrid systemq Major currencies:use freely-floating methodq Other currencies move in and out of various fixed-rate

systems.

A BRIEF HISTORY OF THE


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A BRIEF HISTORY OF THEINTERNATIONAL MONETARY SYSTEM

n THE USE OF GOLD

n Desirable Propertiesq Durable, storable, portable, easily recognized,

divisible and easily standardized

q In short run: High production costs limit changes.

q In long run: Commodity money insures stability.


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The Classical Gold Standard (1821-1914)

n Major global currencies on gold standard.n Nations fix the exchange rate in terms of a specific

amount of gold.n Nations maintained that price by willing to sell or buy

gold to anyone at that pricen GBP maintained at GBP 4.2474 per ounce of goldn USA maintained at USD 20.67 per ounce of goldn Exchange rate was simply 20.67/4.2474 =

$4.8665/gbp


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Gold Standardn The price stability maintained for 100 years upto

WW 1 was amazing and roughly constantn Fiat Money nonconvertible paper money

backed only by the faith that the monetaryauthorities will not cheat ( by issuing moremoney)

n In Gold standard, governments cant cheat. Itneeds to acquire more gold before it canissue more currency

n Price-specie-flow-mechanism

q More gold is more money in circulationq Efficiency decreases price, causes more exports,

more inflow of gold, more money supply,increase in prices

G ld St d d


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Gold Standard

n Price-specie-flow mechanism adjustmentswere automatic:

n When a balance of payments surplus led to agold inflow;

n Gold inflow led to higher prices whichreduced surplus;

n Gold outflow led to lower prices and

increased surplus.

o xc ange an ar -


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o xc ange an ar 1931)

A. Only U.S. and Britain allowed tohold gold reserves.

B. Others could hold both gold, dollars orpound reserves.


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Gold Exchange standard

n Currencies devalued in 1931- led to tradewars.

n Beggar thy neighbour

n Bretton Woods Conferencen called in order to avoid future protectionist

andn

destructive economic policies


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A BRIEF HISTORY

V. The Bretton Woods System (1946-1971)

1. U.S.$ was key currency; valued at $1 - 1/35 oz. of gold.

2. All currencies linked to that price ina fixed rate system.


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A BRIEF HISTORY

3. Exchange rates allowed to fluctuate by1% above or below initially set rates.

B.Collapse, 1971 1. Causes: a. U.S. high inflation rate b. U.S.$ depreciated sharply.


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A BRIEF HISTORY

V. Post-Bretton Woods System (1971-Present)

A. Smithsonian Agreement, 1971: US$ devalued to 1/38 oz. of gold. By 1973: World on a freely floating

exchange rate system.


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A BRIEF HISTORY

B.OPEC and the Oil Crisis (1973-774) 1. OPEC raised oil prices four fold;

2. Exchange rate turmoil resulted;

3. Caused OPEC nations to earnlarge surplus B-O-P.


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A BRIEF HISTORY

4. Surpluses recycled to debtornations which set up debt crisis of1980s.

C. Dollar Crisis (1977-78) 1. U.S. B-O-P difficulties 2. Result of inconsistent

monetary policy in U.S.


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A BRIEF HISTORY

3. Dollar value falls as confidenceshrinks.

D. The Rising Dollar (1980-85) 1. U.S. inflation subsides as the Fed

raises interest rates

2. Rising rates attracts global capital to

U.S.


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A BRIEF HISTORY

3. Result: Dollar value rises.E. The Sinking Dollar:(1985-87) 1. Dollar revaluated slowly

downward; 2. Plaza Agreement (1985) G-5 agree to depress US$ further.


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A BRIEF HISTORY

3. Louvre Agreement (1987) G-7 agree to support the

falling US$. F. Recent History (1988-Present)

1. 1988 US$ stabilized 2. Post-1991 Confidence

resulted in stronger dollar 3. 1993-1995 Dollar value falls


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PART III.

THE EUROPEAN MONETARY SYSTEM

I. INTRODUCTION A. The European Monetary System

(EMS) 1. A target-zone method

(1979) 2. Close macroeconomic

policy coordination required.


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B. EMS Objective:

to provide exchange rate

stability to all members by holdingexchange rates within specified

limits.


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C. European Currency Unit (ECU) a cocktail of European currencies

with specified weights as the unit of

account.



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1. Exchange rate mechanism(ERM)

- each member determines mutuallyagreed upon central cross rate for its

currency.


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2. Member Pledge: to keep within 15%

margin above or below the central

rate.



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D. EMS ups and downs 1. Foreign exchange

interventions:

failed due to lack ofsupport by coordinated monetary

policies.n


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2. Currency Crisis of Sept. 1992 a. System broke down b. Britain and Italy

forced towithdraw from EMS.



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G. Failure of the EMS:

members allowed political

priorities to dominate exchangerate policies.

n


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H. Maastricht Treaty 1. Called for Monetary

Union by 1999 (moved to 2002)

2. Established a singlecurrency:

the euro



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3. Calls for creation of a single central EU bank

4. Adopts tough fiscalstandards


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I. Costs / Benefits of A Single Currency A. Benefits 1. Reduces cost of doing

business 2. Reduces exchange rate

risk

THE EUROPEAN MONETARY


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THE EUROPEAN MONETARYSYSTEM

B. Costs 1. Lack of national

monetary flexibility.

Integration of the worldsk


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gmarkets

for goods and servicesn Creation of the World Trade Organization (WTO)

n Emergence of China as a major trading partner

n Global trend toward free-market economies

n Industrialization of the Far East and Pacific Rimn Emergence of central and eastern Europe

n Reunification of East and West Germany

n Hong Kongs 1997 return to China

n Introduction of the euro

U S merchandise trade


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U.S. merchandise trade

Imports

Trade deficit

Exports

-800

-600

-400

-200

0

200

400

600

800

1000

1200

1400

1972 1977 1982 1987 1992 1997 2002

$

billions

Integration of financial


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Integration of financialmarkets

n An increase in cross-border financing

n Increasingly interdependent national financialmarkets

n An increasing number of cross-border mergers,acquisitions, and joint ventures

n An increasing number of cooperative linkagesamong securities exchanges

The Bretton Woods


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Agreement

n World Bank which now includesq International Bank for Reconstruction and Developmentq International Development Associationq International Finance Corporationq

Multilateral Investment Guarantee Agencyq International Centre for Settlement of Investment Disputes

n International Monetary Fund (IMF)q Responsible for ensuring the stability of the international

financial systemq Compiles balance-of-payments statistics

e . . a ance opayments


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payments 1992

2002Goods: Exports 440 683Goods: Imports -537 -1167 Trade Balance -97 -484

Services: Credit 177 289Services: Debit -116 -240 Balance on Goods & Services -36 -436

Income: Credit 132 245Income: Debit -109 -257 Balance on Goods, Services, & Income -14 -447

Current transfers: Net -35 -56 Current Account -49 -503

Source: U.S. Bureau of Economic Analysis (www.bea.gov)

e . . a ance opayments


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payments 1992

2002Capital Account: Net 1 1

Direct Investment Abroad -48 -124Direct Invest from Abroad 20 30

Portfolio Investment Assets -50 -26Portfolio Invest Liabilities 81 388

Other Investment Assets 23 -6Other Investment Liabilities 70 213

Financial Account 96 474

Source: U.S. Bureau of Economic Analysis (www.bea.gov)

Exchange rate systems


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Exchange rate systems

n

Pegged or fixed exchange rate systemsq Forges a direct link between inflation differentials

and employment levels

q Can result in large adjustments

n Floating exchange rate systems

q Allows exchange rates to adjust for inflationdifferences

q Allows employment levels and wages to equalize

through the exchange rate mechanism

xarrangements


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arrangementsFX regime Africa Asia/Pacific Europe/Mid East Americas

No separate WAEMU, Marshall Is, Euro Area Ecuador, legal tender CAEMC Micronesia Panama

Currency Libya, China, HK, Iran, Kuwait, Argentina, board or Sudan, Malaysia, Saudi Arabia, Bahamas, fixed peg Zimbabwe Taiwan Syria Suriname

Crawling peg Egypt Denmark, Bolivia,or horiz band Egypt, Israel Venezuela

Managed Algeria, India, Croatia, Iraq, Dom. Rep, float Ethiopia, Indonesia, Russian Fed., Guatemala, Kenya, Singapore, Yugoslavia Jamaica, Nigeria Thailand Trinidad

Independent Mozambique, Afghanistan, Czech Rep, Norway, Brazil, Canada, float S. Africa, Australia, Poland, Sweden, Chile, Colombia, Uganda Japan, Turkey, Switzerland, Mexico, Peru, S. Korea United Kingdom United States

Source: International Financial Statistics, April 2003 (as of Dec 2001)

Major exchange rate


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j gagreements

1946 Bretton Woods Conference 1971 Smithsonian Agreement 1972 European Joint Float Agreement 1976 Jamaica Agreement 1979 European Monetary System (EMS) created 1985 Plaza Accord 1987 Louvre Accord 1991 Treaty of Maastricht

1999 Introduction of the euro 2002 Euro begins public circulation

History of the international


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n 1946 Bretton Woods Conferenceq The U.S. dollar is convertible into gold at

$35/ounceq Other currencies are pegged to the dollarq Created the IMF and the World Bank

monetary system



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n 1971 - Exchange rate turmoilq Dollar falls off the gold standardq Most currencies float on world markets

n 1971 - Smithsonian Agreement (G-10)

q dollar devalued to $38/oz of goldq other currencies revalued against the dollarq 4.5% band adopted

n 1972 - European Joint Float Agreementq The snake adopted by EEC

monetary system



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monetary system

n 1976 - Jamaica Agreementq Floating rates are declared acceptable

n 1979 - European Monetary System (EMS)

q European Exchange Rate Mechanism (ERM)established to maintain EEC currencies within a2.25% band around central rates

q European currency unit (ECU) created



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n 1985 - Plaza Accord (G-10)q The Group of Ten agree to cooperate in

controlling exchange rate volatility and

bringing down the value of the dollarn 1987 - Louvre Accord (G-5)

q The Group of Five agree to maintain currentexchange rate levels

monetary system



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n 1991 - Treaty of Maastrichtq EC members agree to a broad agenda of

economic, financial and monetary reformsq A single European currency is proposed as the

ultimate goal of monetary unionn 1999 - Introduction of the euro

q Emu-zone currencies pegged to the euroq European bonds convert to the euro

n 2002 - Euro begins public circulation

monetary system

Currency crises


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Currency crises

n Recent currency crises

q Mexican peso crisis of 1995

q Asian contagion of 1997

q Russian ruble crisis in 1998

q Argentinian peso crisis of 1998

n Contributing factors in each crisis

q A fixed or pegged exchange rate system thatovervalued the local currency

q A large amount of foreign currency debt

Mexican peso crisis


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p

Mexican stock market value(Dec 1993 = 1.00; in pesos)

Mexican peso($/peso)

Asian currency values:$/ it


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$/unit(Dec 1996 = 1.00)

Thai bhat

Koreanwon

Indonesianrupiah

Asian stock market values (Dec 1996


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Thailand

Korea

Indonesia

s a s oc a e a ues ( ec 996= 1.00)

Russias currency crisis


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Russia s currency crisis

Russias stock market value(Dec 1995 = 1.0; in rubles)

Currency value: $/ruble(Dec 1995 = 1.0)

Argentinas currency crisis


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Argentinas stock market value(Dec 1998 = 1.0; in rubles)

Currency value: $/peso(Dec 1998 = 1.0)

Argentina s currency crisis

The debate over IMF lending


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n Proponents of IMF lending policies believeq Short term loans help countries overcome temporary

crises

n Critics of IMF lending believeq Belt-tightening is counterproductiveq Capital market liberalizations increase risksq Loans are often spent supporting unsustainable

exchange ratesq IMF loans last for decades

q IMF remedies benefit developed countries

IMF lending and moral hazard


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n Moral hazardq The existence of a contract can change the

behaviors of parties to the contract

n The IMFs challenge

q develop policies thatpromote economicstability

q and ensure that the consequences of poorinvestment decisions are borne by investors

and not taxpayers

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