Fundamentals of

international financial
management
International financial
management 2022 (1)
Joanna Błach
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Content
 Types of financial decisions
 Types of business firms
 Model approach to corporations
 Modern theories of corporate finance

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TYPES OF FINANCIAL
DECISIONS

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Flow of funds in the economy

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 Corporate Finance - definition
• an integrated decision making process
concerned with acquiring, financing and
managing assets
• focuses on how a corporation can create and
maintain value
• the science concerned with the efficient and
effective management of the finances of
corporation in order to achieve the objectives
of that corporation

• the “science of managing money in a

business environment”
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Main problems of corporate finance
 where funds are raised from? (the provision of resources)

 where funds are deployed to? (the allocation of resources)

 whether funds are being used effectively or not? (the control of

resources)

 how much dividend should be paid to the shareholders? (dividend

policy)

 How much working capital should a firm have and how should it be
financed?

 How should risk be managed?

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 Five functions of corporate
finance
1) External financing – raising capital to support operations and investment
programs

2) Capital budgeting – selecting the best investment projects (risk-return

analysis)

3) Financial management – managing internal cash flows and mix of debt and
equity financing to maximize the value of company and maintain long-term
solvency

4) Corporate governance – developing ownership and corporate governance

structures to make the managers behave ethically and make decisions that benefit
shareholders

5) Risk-management- managing risk exposure to all types of risk

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 Major types of decisions

Financial decisions

FINANCING WORKING CAPITAL

INVESTMENT MANAGEMENT
DECISIONS
DECISIONS DECISIONS
How should the
What long-term How should the
corporation raise money
investments should the corporation manage its
to fund these
corporation undertake? short-term assets and
investments?
liabilities?

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 Investment decisions
 involve determining the type and amount of assets that the
corporation wants to hold (investing concerns allocation of
funds)

 concerns all types of assets and often involve buying, holding,

replacing, selling and managing assets

 involve decisions that create profits, but also decisions that

save money

 the process of planning and managing a corporation’s long term

investments is called capital budgeting

 should follow the investment principle

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 Investment principle

 the corporation should invest in assets

and projects yielding a return greater than
the minimum acceptable hurdle rate
 a hurdle rate – the minimum acceptable
rate of return for investing resources in a
project

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 Financing decisions
 involve acquisition of funds needed to support investments –
corporation can obtain funds:
1) externally – from investors (creditors and owners)
2) internally – by retention and reinvestment of operating profit
 influence the corporation’s capital structure
 capital structure – a the mix of long-term debt and equity the
corporation uses to finance its operation
 connected with a corporation’s dividend policy – dividend pay-out
ratio determines the amount of retained earnings (internal sources of
funds)
 should follow the financing principle and the dividend principle

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 Financing principle

• the corporation should choose a financing

mix that:
1) maximises the value of investments
made
2) reduces the potential risk:
• financing should be matched to the
assets being financed
• the cash inflows from assets being
financed should be matched with the
cash outflows used to finance this assets
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 Dividend principle

 the corporation should return cash to the

owners (in a form of cash dividend) if
there are not enough investments that
earn hurdle rate

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 Working capital management
decisions

 reflect corporation’s day-to-day investments

and financing decisions
 involve decisions about short-term (current)
assets and liabilities
 the company should manage its current
assets and current liabilities with respect to
liquidity
 concern the amount of net working capital
net working capital = current assets –
current liabilities

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Operating cycle

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TYPES OF BUSINESS FIRMS

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 Corporation - definition
 corporation is a separate legal entity owned by the shareholders (also
called stockholders)

 shareholders of common and preferred stock (ordinary and

preference shares) own the corporation’s equity securities, and are thus
often called equity claimants

 as a legal person a corporation has many of the rights, duties and

privileges of natural persons,
e.g.: corporation can enter into contractual agreements, own the
property (acquire assets), borrow money (incur obligations), sue
others and be sued

 to start a corporation the incorporators have to prepare articles of

incorporation and a set of bylaws
 the bylaws are the rules to be used by the corporation to regulate its
own existence

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 Types of companies

 Privately held – usually a small firm with

few owners who often are its managers
(not listed on the stock exchanges)

 Publicly held – one that sells shares

outside of a closed group of investors who
do not actively manage the company, it
can be listed on the stock exchange

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 Main features of corporation
 unlimited life – once created, a corporation has a perpetual life unless it
is explicitly terminated
 limited liability – owners (shareholders) cannot be held personally liable
for the corporation’s debts
 unlimited access to capital – the company itself (rather than its
owners) can borrow money from creditors, and it can issue various
classes of preferred and common stock to equity investors
 ease of ownership transfer – for publicly hold corporations,
stockholders can readily sell their stock on the open market
 proportional distribution of income – as a rule, corporations distribute
income by paying dividends in proportion to ownership interest
 separation of ownership and management – this feature rises co
called agency problem

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 Strengths of corporations comparing to
other forms of business organization
Sole propriotership Partnership Corporation
Low startup and Greater combined Owners’ liability limited to
organizational costs resources actual investment
All profits go to owner Greater total borrowing Large size possible through

Income taxed only as capacity issuance of additional shares

personal income of owner Income taxed only as and wide public ownership
Ease of moving partners’ personal income Ownership readily

Ease of dissolution Greater combined brain transferable

power Company’s lifespan
Secrecy
Mutual psychological unlimited
support Access to professional

Greater diversity of managerial talent

talents Access to capital markets

Better employee career

opportunities

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 Weaknesses of corporation comparing to other
forms of business organization
Sole propriotership Partnership Corporation
Owner has total liability Each partner has unlimited Profitsare taxed and
Continuity stops when liability dividends are taxed again
owner dies Difficult to transfer when paid to shareholders
Fund-raising power ownership Greater startup expense

limited to owner’s Difficult to grow very Greater government

resources large supervision
Limited career No access to capital Greater administrative
opportunities for markets expense
employees Public scrutiny of
operations

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Definition of multinational
corporation (MNC)
Definition
 Multinational corporations
 Transnational corporations
 Global corporations
These are firms that operate in an integrated
fashion in a number of countries
Core characteristics of MNC
 MNC has subsidiaries, branches, affiliates located in a
foreign country (it is headquartered all over the world)
 MNC obtains financing from major money centers
around the world in many differen currencies and
operates in different countries
 MNC often is owned by a mixture of domestic and
foreign stockholders
 Corporporations which ownership is dispersed
internationally are often called transnational
corporations

 MNC is managed from global perspective

Multinational corporation
explained
 https://www.youtube.com/watch?v=FCojp
FwWuG0
Reasons for going multinational
 Searching for new markets
 Searching for scarce raw materials
 Searching for production efficiency
 Searching for knowledge and new technology
 Searching for political safety (to avoid political and
regulatory hurdles)
 Searching for diversification
RESULT:
 A chance to lower cost of capital and rise
productivity
 A chance to improve value of company
Consequences of „going global” for financial
management

Different currency denominations (exchange rate effect and risk)

Economic and legal ramnification (each country has unique economic and
legal systems)

Language differences

Cultural differences

Role of governments (direct negotations between host governments and

MNCs)

Political risk (constraints on the transfer of corporate resources, risk of

expropriation of assets, terrorism risk)
Company’s foreign presence and foreign investments

1a. Production in
domestic country & 2a.Various forms of
exporting cooperation

company

3a. Joint venture & equity

alliances

1b. Production abroad

4a. Mergers with/

acquisitions of foreign
enterprise

2b. Control assets

abroad

3b.Wholly-owned
subsidiary

4b. Greenfield investment

2a. Forms of cooperation
Licensing agreement
• An agreement where MNC (licensor) permits a foreign
company (licensee) to produce its products in exchange for
fees (or other forms of compensation)

Contract manufacturing
• A MNC contracts with foreign manufacturer to produce
goods according to their specification (products are under
the MNC’s brand name)
Franchising agreements
• An agreement according to which the MNC (franchiser)
allows the foreign company (franchisee) to sell products (or
services) under a well-known brand name and following the
procedures
3a. Equity Investment

Joint ventures Equity alliances

Joint venture is owned by All alliances where one
at least two firms, company involves equity
company may penetrate in another company; often
foreign markets to form a the purpose is to solidify a
partner for joint venture collaborative contract
3b. Wholly-owned subsidiary

Greenfield Mergers &

investment acquisitions (M&A)
• Means constructing • A company acquires
a new plant a foreign company
(subsidiary) in a to penetrate foreign
foreign country market (quicker
• It represents the than greenfield
internal growth investment)
• It represents the
external growth
Types of M&A
1a. Friendly 1b. Hostile
The offer is made Acquiring company bypasses the target company’s
directly to the firm’s management and makes tender offer directly to the
management or board of shareholders
directors

2a. Horizontal 2b. Vertical 2c. Conglomerate

A merger of firms from A merger of firms A merger of firms from
the same line of forward (toward a unrelated businesses
business customer) or backward
(toward the supplier) in
the same line of
business
 M&A definition
 Merger – when two companies join to form a new one
 Acquisition – when one company absorbs another

Forms of transaction:
 Consolidation – acquiror absorbs the acquiree; acquiror absorbs both
the assets and the liabilities of the targeted company

 Purchase of stock – acquiror purchases a stock of the acquiree;

acquiror obtains both assets and liabilities of the targeted company; it
is possible to bypass the management and make a tender offer directly
to the shareholders

 Purchase of assets – acquiror purchases only the assets of the

acquiree; no liabilities are obtained; there is no problem with
shareholders minority disagreement, however this type of merging is
more complicated than two others
Core motives for M&A
 Achieve operating efficiencies and
economies of scale
 Realising tax benefits
 Capture surplus cash
 Grow more quickly and more cheaply
 Increase debt capacity
 Capitalisation rate
MODEL APPROACH TO
CORPORATION

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 Macroeconomic policy
Monetary policy
Fiscal policy
Economic Exchange rate policy
environment
GDP growth
Unemployment rate
Inflation rate
Government intervation
Business
environment

Banking system

Financial
environment

Financial markets

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Corporation and its environment
Corporation
Local
community
Country

Region

World
PEST analysis in the international business
environment

P • Political - legal

E • Economic

S • Socio-culutral

T • technological
 Dimensions and layers of the international environment (1)

Layers and Local country region World

dimensions community
Cultural and Families; local National Cultural Human rights;
social cutoms; school; culture; affinity across world regions;
urban or rural language; the region; consumer culture
sense of movement of
shared history people
between
countries
Economic Local National Degree of Global economic
businesses; industries; economic integration; WTO
predominat industrial integration; and mulitilateral
industries structure; regional trade trade
national income relations agreements;
and economic global companies
growth and industries
Dimensions and layers of the international
environment (2)
Layers and Local country region World
dimensions community

Political Local Political Degree of International

governments system; political co- governmental
and politics degree of civil operation; co-operation
and political shared (e.g. UN)
freedoms institutions (e.g.
the EU)

Financial Penetration of National Cross-border Global

banks and financial financial flows; financial flows;
financial system; regional international
services regulatory reputation institutions
system (e.g. IMF,
World Bank)
 Dimensions and layers of the international environment (3)
Layers and Local country region World
dimensions community
Legal Delegated Rule of law; Legal International
lawmaking; independent harmonization; law and the
planning; judiciary and mutual International
health; safety court system; recognition of Court of Justice
national court
legislation judgements
Technological Schools and National school Cross-border Global spread
colleges; system; research ties; of breakthrough
research universities; co-operation technology;
centres funding for among global R&D
R&D universities networks

Ecological Ecosystems; Areas of Regional Climate

pollution environmental institutions; co- change;
levels; air stress; operation over international
quality environmental regional co-operation on
protection laws resources emission
reduction
 Model approach to corporation

How the corporation

operates?

the set-of-contract
the investment-vehicle
model – the accounting model –
model – perceives the
perceives the company perceives the company
company through its
through its connections through the balance
connection with the
with the business sheet perspective
market
environment

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The set-of-contract model (1)

shareholders
customers
managers

employees
THE suppliers
CORPORATION

the government lenders

(banks and
bondholders)
the local community environment

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The set-of-contract model (2)

• it represents a refinement of the

investment-vehicle model
• recognises reciprocal relations that can
arise in the contracts (relationships)
among the company’s stakeholders

• contracts (relationships) are both explicit

and implicit (in explicit contracts a
company makes specific promises)
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 Business environment
Macroeconomic conditions Technology & infrastructure
Political system and law
regulations

shareholders

Socio-demographic environment
Managers
creditors

corporation
Community suppliers
information
Media and

Employees customers

Natural environment International environment

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 The investment-vehicle model

2 1
The corporation
Market Investors
3 4

 (1) investors provide funds in exchange for securities (shares, bonds,

etc.)
 (2) the corporation invests those funds (purchasing plant & equipment)
and (3) generates profit on these investments, finally it (4) pays
investors the returns (dividend, interest) and repay the capital
 it is assumed that the corporation’s managers are neutral intermediaries
who act only in the best interest of the shareholders

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 The accounting model (1)

SHORT-TERM
CURRENT FUNDS
current liabilities
ASSETS
NET WORKING
CAPITAL
LONG-TERM
FUNDS
FIXED ASSETS
tangible and intangible long-term liabilities
owners’ equity

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 The accounting model (2)

• it perceives the corporation through its

picture in the balance sheet
• it presents the investments in different types
of short-term and long-term assets, the
sources of funds used in investments, and
the amount of net-working-capital
management
• the model is corresponding with the core
types of decisions in corporate finance

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MODERN THEORIES OF
CORPORATE FINANCE

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Corporate objectives
 https://www.youtube.com/watch?v=RdQu
KwhCzGU

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 Rationale for Corporate Finance
Objective
 an objective specifies what a decision maker wants
to accomplish and provides measures that can be
used to choose between alternatives
 in most cases the objective is stated in terms of
maximising some function or variable
 if no objective is chosen there is no systematic way
to make the decisions
 the corporate finance requires an objective that:
 is clearly defined and unambiguous (a purposeful
behaviour requires the existence of single-value
objective)
 comes with clear and timely measure that can be
applied to evaluate the success or failure of decisions

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Corporate objectives
 Profit targets
 Market share targets  Maximising – seeking
 Share price growth the best possible
 Local and environmental outcome
concerns
 Contented workforce
 Satisficing – finding
 Survival
an adequate outcome
 Development
 …

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Shareholders vs stakeholders
 https://www.youtube.com/watch?v=Kvd8D
rKHo8M

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Two perspectives:

Shareholder theory

Stakeholder theory
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 Shareholder theory
 The main objective of corporate finance is nowadays
associated with shareholders (owners) wealth
maximisation

 Financial managers should take decisions which

balance returns and risk in order to maximise the
shareholders wealth (benefits) through:
 paying out dividends
 maximising market value of shares

 It is assumed that the shareholders wealth is

maximised if the value of the corporation is
maximised
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Shareholders wealth maximisation

• a justification for shareholders wealth

maximisation lies in the fact that:
– shareholders represent the most important group
of stakeholders because:
• they are the legal owners of a corporation
• they bear ultimate risk of loss

– shareholders require a return on their capital

involvement
• shareholders are investors – they invest money through
the purchase of shares
• investment is the sacrifice of present consumption in
the expectation (but not the guarantee) of a future
return
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 Stakeholder theory
 Managers should make decisions that take
into account the interests of all of a
company’s stakeholders: owners,
managers,employees, customers, suppliers,
investors, local community and the
government - Social Responsibility of a
company

 this approach is corresponding with the set-

of-contract model of a corporation

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Stakeholders approach
 corporation makes decisions after considering all
stakeholders groups, having tried to reach a
consensus of views
 this approach has several limitations:
 it involves multiple objectives
 some of those objectives may be conflicting
 It is difficult to serve many masters

 it is argued that:
 the company can take into account the stakeholders
interests only if the shareholders’ are satisfied
 But maximizing shareholder value is the only way to
maximize the economic interest of all stakeholders over time
 negligence of stakeholders interests can lead to
shareholders’ wealth destruction
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Stakeholder groups

internal
• Employees and pensioners, managers, directors

connected
• Shareholders, creditors, customers, investors, suppliers,
competitors
external
• Government, pressure groups, local and national
communities, professional and regulatory bodies

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Stakeholders and their objectives
Types of Objectives
stakeholder

shareholder Maximum wealth

directors Power, esteem,
remuneration
employees Pay and conditions, job
security, development
creditors Security, cash flow, long-
term prospects
trade creditors Short-term cash flow
community Environmental issues,
community support
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 How to measure shareholders wealth
 shareholders wealth maximisation requires a
transition into a measurable parameter
 this is required from a managerial point of view – the
management should know which parameter requires
maximisation from the shareholders point of view
 commonly the shareholders wealth maximisation is
associated with:
 accounting profit maximisation (or a profit based ratio):
EPS, ROE
 shares price maximisation (or a measure based on
shares prices): P/E
 shareholders return maximisation: TSR
 economic and market value added maximisation: EVA,
MVA
 Agency problem
https://www.youtube.com/watch?v=X0kEhjMNrTU

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 Agency theory
 Agency relationship – a relationship in which
one party (principal) delegates authority to
another party (agent)

 In large corporations managers and owners

represents separate groups (separation of
ownership and management)

 Managers (agents) should run the business in

the best interest of the company’s shareholders
(principals) but sometimes they may place their
own interest ahead of those of the owners which
leads to the conflict of interest

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 Agency problem
 Agency problem - any conflict between principals and agents

 the following factors can rise the conflicts:

1) in theory, managers should run the corporation in the best interests
of its owners, but in practice managers tend to maximise their own
benefits (e.g. remuneration, working conditions, benefits)
2) managers may be unwilling to take the risk that might jeopardise
their positions and thus they may turn-down the value creating
investment opportunities
3) managers may be focused on the short-term gains (effects),
whereas investors buy shares as a long-term investment
4) managers have detailed information that is generally unavailable to
shareholders – so called information asymmetry

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 Agency costs
 Agency cost – a direct or indirect expense that
the principal bears as a result of having
delegated authority to an agent
 Direct costs - corporate expenditures that
benefit management (incentives such as
bonuses, perquisites) and costs of monitoring
management’s activities
 Indirect costs - result from management’s
failure to make profitable investments because
of its aversion to risk

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 Information Asymmetry
 problem related to the agency theory

 one party of the transaction often knows something

relevant about it that the other party does not

this problem may occur between:

 shareholders and managers
 issuer of a security and investors
 lender and borrower

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Consequences of information
asymmetry
Adverse Selection -
problem created by Moral Hazard – problem
created by asymmetric
asymmetric information information after the
before the transaction transaction occurs;
occurs – it is the risk that the
– as we do not have borrower might engage in
enough information to activities that are
assess the risk of undesirable from the
potential investment lender’s point of view (it
lowers the probability that
projects we may decide the loan will be paid back)
to reject all of them,
even good ones

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Agency conflict and information asymmetry
can be addressed by:
• Effective corporate governance
• Effective investor relations
• Transparent accounting and financial
disclousers
• Independent auditors
• Compensation schemes harmonising
managers’ interests with owners
• Institutional and strategic investors
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Reducing agency problem (1)
Managerial reward schemes
 Management will make optimal decisions
from the shareholders’ point of view if the
are monitored and appropriate incentives
are given
 Remuneration incentives:
 Performance-related pay
 Rewarding managers with shares
 Executive stock option plans

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Reducing agency problem (2)
Regulatory requirements
 Corporate governance codes of best
practices
 Riskmanagement, internal control,
accountability, transparency, ethical
consideration, effectiveness
 Stock exchange listing regulations
 Transparency, compliance, efficiency of
transactions

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Activity of a corporation on the financial
markets

risk
management

financing investing

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Thank you!

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