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LEARNING OUTCOMES/ OBJECTIVES

✓ Identify the management goal and

organizational structure of the MNC.

Chapter 1 ✓ Describe the key theories about why MNCs

Lecturer: Dr. Tien Trung, Nguyen
engage in international business.
✓ Explain the common methods used to
conduct international business.
✓ Provide a model for valuing the MNC.
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Questions and Answers

❖How do you think or describe an international

corporation?

PART I

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1. Multinational corporations (MNCs) 1. Multinational corporations (MNCs)

❖MNCs are defined as firms that engage in some
form of international business.
➢export products to a certain country or import supplies
from a foreign manufacturer
➢recognize additional foreign opportunities and
eventually establish subsidiaries in foreign countries
❖International financial management, which involves
international investing and financing decisions that
are intended to maximize the value of the MNCs.
Lecturer: Dr. Tien Trung, Nguyen
❖International financial management is important
even to companies that have no international
business.
❖These companies must recognize how their foreign
competitors will be influenced by movements in
exchange rates, foreign interest rates, labor costs,
and inflation.
❖Such economic characteristics can affect the foreign
competitors’ costs of production and pricing policies
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OPERATIONAL OBJECTIVES OF MNCs 1-1. Managing the MNC

maximize
❖The commonly accepted goal of an MNC is to
shareholder
wealth maximize shareholder wealth.
❖Managers employed by the MNC are expected
to make decisions that will maximize the stock
Satisfy demand price,
of government ,
lenders ,
employees ❖thereby serving the shareholders’ interests.

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2

1-2 How Business Disciplines Are Used to
Manage the MNC
❖ Management develops strategies that will motivate and guide
employees who work in an MNC and to organize resources so that
they can efficiently produce products or services.
❖ Marketing seeks to increase consumer awareness about the
products and to recognize changes in consumer preferences.
❖ Accounting and information systems record financial information
about revenue and expenses of the MNC, which can be used to
report financial information to investors and to evaluate the
outcomes of various strategies implemented by the MNC.
❖ Finance makes investment and financing decisions for the MNC.
Lecturer: Dr. Tien Trung, Nguyen
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1-3 Agency Problems
❖Managers of an MNC may sometimes make
decisions that conflict with the firm’s goal
of maximizing shareholder wealth.
➢For example, a manager’s decision to establish a
subsidiary in one location versus another may be based
on the location’s appeal to the manager rather than on
its potential benefits to shareholders.
❖The conflict:
a firm’s managers’ goals <> shareholders’ goals
→ is often referred to as the agency problem.
Lecturer: Dr. Tien Trung, Nguyen
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1-2 How Business Disciplines Are Used to
Manage the MNC
❖Common finance decisions include the following:
■■ Whether to pursue new business in a particular country
■■ Whether to expand business in a particular country
■■ How to finance expansion in a particular country
■■ Whether to discontinue operations in a particular country
9 Lecturer: Dr. Tien Trung, Nguyen 10
1-3a Agency Problems
❖ The costs of ensuring that managers maximize shareholder wealth
(referred to as agency costs) are typically larger for MNCs than
they are for purely domestic firms, for several reasons.
➢ First, MNCs with subsidiaries scattered around the world may experience
larger agency problems because monitoring the managers of distant
subsidiaries in foreign countries is more difficult.
➢ Second, foreign subsidiary managers who are raised in different cultures
may not follow uniform goals. Some of them may believe that the first
priority should be to serve their respective employees.
➢ Third, the sheer size of the larger MNCs can create significant agency
problems, because it complicates the monitoring of all managers
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Example: page 5
Two years ago, Seattle Co. (based in the United States) established a
subsidiary in Singapore so that it could expand its business there. It
hired a few managers in Singapore to manage the subsidiary. During
the last two years, sales generated by the subsidiary have not
grown. Even so, the managers in Singapore hired several employees
to do the work that they were assigned to do, and the subsidiary has
incurred losses recently because it is so poorly managed. The
managers of the parent company in the United States have not
closely monitored the subsidiary in Singapore because it is so far
away and because they trusted the managers there. Now they
realize that there is an agency problem, and the management in
Singapore must be more closely monitored.
❖Lack of monitoring can lead to substantial losses for
MNCs.
❖Example:
The large New York–based bank JPMorgan Chase & Co.
lost at least $6.2 billion and had to pay more than $1
billion in fines and penalties after a trader in its office in
London made extremely risky trades. The subsequent
investigation revealed that the bank had maintained poor
internal controls and failed to provide proper oversight of
its employees.

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1-3b Parent Control of Agency Problems 1-3b Parent Control of Agency Problems
❖ The parent corporation of an MNC may be able to prevent
❖→ One commonly used incentive is to provide
most agency problems with proper governance.
❖ The parent should clearly communicate the goals for each managers with the MNC’s stock (or options to
subsidiary to ensure that all of them focus on maximizing buy that stock at a fixed price) as part of their
the value of the MNC, rather than the value of their
respective subsidiaries.
compensation; thus, the subsidiary managers
❖ The parent can oversee subsidiary decisions to check benefit directly from a higher stock price when
whether each subsidiary’s managers are satisfying the MNC’s
they make decisions that enhance the MNC’s
goals.
❖ The parent also can implement compensation plans that value.
reward those managers who satisfy the MNC’s goals.
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1-3c. Corporate Control of Agency Problems Corporate Control of Agency Problems.

❖ In some cases, agency problems can occur because the goals of the entire ✓ Enron was, at one point, one of the largest
management of the MNC are not focused on maximizing shareholder wealth. companies in the United States.
THE ENRON SCANDAL
❖ Various forms of corporate control can help prevent these agency problems ✓ Enron began losing money in 1997. The company
and induce managers to make decisions that satisfy the MNC’s shareholders.
also started racking up a lot of debt
❖ If managers make poor decisions that reduce the MNC’s value, then another
✓ Fearing a drop in share prices, Enron's management Jeffrey Skilling
firm might acquire it at this lower price; the new owner would then probably
remove the weak managers.
team hid the losses by misrepresenting them (CEO)
through tricky accounting
❖ Moreover, institutional investors (for example, mutual and pension funds)
with large holdings of an MNC’s stock have some influence over management ✓ In 2001, share prices from over $90 to under $1.
and may complain to the board of directors if managers are making poor The company ended up filing for bankruptcy in
decisions. December 2001
❖ Institutional investors may seek to enact changes, including removal of high- ❖ => SEC inspected the company
level managers or even board members, in a poorly performing MNC.

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Case study: How SOX Improved Corporate

Governance of MNCs (page 6) 1-4 Management Structure of an MNC

❖The magnitude of agency costs can vary with the

Lecturer: Dr. Tien Trung, Nguyen
MNC’s management style.
❖Centralized management style: allows managers of
the parent to control foreign subsidiaries, which in
turn reduces the power of subsidiary managers.
❖ However, the parent’s managers may make poor
decisions for the subsidiary if they are less informed
than the subsidiary’s managers about its specific
setting and financial characteristics
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1-4 Management Structure of an MNC

❖Decentralized management style:

Lecturer: Dr. Tien Trung, Nguyen
❖More likely to result in higher agency costs
because subsidiary managers may make
decisions that fail to maximize the value of the
entire MNC.
❖This management style gives more control to
those managers who are closer to the
subsidiary’s operations and environment.
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PART II

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Question and Answer?

❖Multinational business has generally increased ❖How well do you know about these theories?
over time. ❖(1) the theory of comparative advantage
❖Three commonly held theories to explain why
❖(2) the imperfect markets theory
MNCs are motivated to expand their business
❖(3) the product cycle theory
internationally are
❖(1) the theory of comparative advantage,
❖(2) the imperfect markets theory, and
❖(3) the product cycle theory.
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2.1 Theory of Comparative Advantage 2.1 Theory of Comparative Advantage

❖Specialization by countries can increase production ❖A country that specializes in some products
efficiency
may not produce other products, so trade
➢Japan and the United States, have a technology
between countries is essential.
advantage
➢China and Malaysia, have an advantage in the cost of ❖Comparative advantages allow firms to
basic labor
penetrate foreign markets.
➢Japan and the United States are large producers of
electronic products
➢Jamaica and Mexico are large producers of agricultural
and handmade goods
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2.2 Imperfect Markets Theory 2.3 Product Cycle Theory

❖The markets for the various resources used in ❖As a firm matures, it may recognize additional
opportunities outside its home country.
production are “imperfect.”
➢ a firm first becomes established in its home market, where

➢the real world suffers from imperfect market conditions
where factors of production are somewhat immobile.
➢Costs and often other restrictions affect the transfer of
labor and other resources used for production.
❖Imperfect markets provide an incentive for firms to
seek out foreign opportunities.
information about markets and competition is more readily
available.
➢ To the extent that the 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.
➢ As time passes, if the firm’s product becomes very popular in
foreign countries, it may produce the product in foreign markets,
thereby reducing its transportation costs.

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2.4 Methods to Conduct International Business

Firms use several methods to conduct international
business:

International Trade Joint Venture

Acquisition of existing
Licensing
operations
or
Franchising Establishing new
foreign subsidiaries

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2.4a International Trade 2.4b Licensing

❖Trading rather than investing abroad ❖Involves selling copyrights, patents, trademarks etc,
❖The relatively conservative approach that in exchange for fees (royalties) or other
can be used by firms to: considerations
www.trade.gov/mas/ian

➢ penetrate markets (by exporting) ❖A company is selling the right to produce their goods.

➢ or to obtain supplies at a low cost (by importing) ❖→ generate revenue from foreign countries without
❖ minimal risk: firm does not place any of its capital at risk. establishing any production plants in foreign countries
❖ experiences a decline in its exporting or importing → or transporting goods to foreign countries
reduce or discontinue that part of its business at a low
cost.
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2.4c Franchising 2.4c Franchising

❖ Under a franchising arrangement, one firm provides a specialized

❖ For example, McDonald’s, Pizza Hut, Subway, and Dairy Queen
sales or service strategy, support assistance, and possibly an initial
have franchises that are owned and managed by local residents
investment in the franchise in exchange for periodic fees, allowing
in many foreign countries.
local residents to own and manage the specific units.
❖ Own and managed by local residents ❖ As part of its franchising arrangements, McDonald’s typically

❖ Allows firms to penetrate foreign markets without major
investment.
❖ Because franchising by an MNC often requires a direct investment
in foreign operations, it is referred to as a direct foreign
investment (DFI).
Lecturer: Dr. Tien Trung, Nguyen
purchases the land and establishes the building.
❖ It then leases the building to a franchisee and allows the
franchisee to operate the business in the building for a
specified number of years (such as 20 years), but the
franchisee must follow standards set by McDonald’s when
operating the business.
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Joint Ventures Acquisitions of Existing Operations

Owned and operated by Firms frequently acquire other firms in

two or more firms foreign countries as a means of
penetrating foreign markets.
Many firms penetrate foreign Allow firms to have full control over
markets by engaging in a joint their foreign businesses and to quickly
venture with firms that obtain a large portion of foreign market
reside in those markets share.

Applying their respective comparative

advantages in a given project The fastest way to grow.

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Establishing New Foreign Subsidiaries Cash Flow OF MNCS

Feature Require a large investment

Tailored exactly to the firm’s needs

Need a lot of time

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QUESTION AND APPLICATIONS

Question17 Page 17

PART III

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3.1 Domestic Valuation Model 3.1 Domestic Valuation Model

❖ The value (V) of the purely domestic firm is commonly specified as the
present value of its expected dollar cash flows:
❖ where E(CF$,t) denotes expected cash flows to be received at the end of
period t;
❖ n is the number of future periods in which cash flows are received;
❖ and k represents not only the weighted average cost of capital, but also the
required rate of return by investors and creditors that provide funds to the
MNC.
Lecturer: Dr. Tien Trung, Nguyen
❖ Dollar Cash Flows: The dollar cash flows in period t
comprise funds received by the firm minus funds needed to
pay expenses or taxes or to reinvest in the firm
❖ The expected cash flows are estimated from knowledge
about existing projects as well as other projects that will be
implemented in the future.
❖ A firm’s decisions about how it should invest funds to
expand its business can affect its expected future cash
flows, which in turn can affect the firm’s value.
❖ Holding other factors constant, an increase in expected cash
flows over time should increase the value of a firm
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3.1 Domestic Valuation Model 3.2 Multinational Valuation Mode

❖Cost of Capital: The required rate of return

(k ) in the denominator of the valuation
❖The expected dollar cash flows to be received
equation represents the cost of capital
at the end of period t = the sum of the
(including both the cost of debt and the cost of
products of cash flows denominated in each
equity) to the firm and is, in essence, a
currency j X the expected exchange rate at
weighted average of the cost of capital based
which currency j could be converted into dollar
on all of the firm’s projects.
cash flows

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3.3 Valuation of an MNC’s Cash Flows over

Example:
Multiple Periods
❖First, apply the same process described for a single
period to all future periods in which the MNC will
receive cash flows; this will generate an estimate of
total dollar cash flows to be received in every period in
the future.
❖Second, discount the estimated total dollar cash flow
for each period at the weighted cost of capital (k ) .
❖Third, add these discounted cash flows to estimate the
value of this MNC.

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3.3 Valuation of an MNC’s Cash Flows over

Example
Multiple Periods

❖where,
❖ CFj,t, is the cash flow denominated in a particular
currency (which may be dollars)
❖Sj,t denotes the exchange rate at which the MNC
can convert the foreign currency to the domestic
currency at the end of period t.
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4. Uncertainty Surrounding an MNC’s Cash

Flows
❖The MNC’s future cash flows (and therefore its
valuation) are subject to uncertainty because
of its exposure not only to domestic economic
PART IV
conditions but also:

➢international economic conditions

➢political conditions

➢exchange rate risk.

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4.1 Exposure to International Economic

Conditions
❖ the consumption in any country is influenced by the income
earned by consumers in that country.
❖ The cash inflows that an MNC receives from sales in a foreign
country during a given period depend on the demand by that
country’s consumers for the MNC’s products, which in turn is
affected by that country’s national income in that period.
❖ If economic conditions improve in that country, consumers there
may enjoy an increase in their income and the employment rate
may rise.
❖ In that case, those consumers will have more money to spend,
and their demand for the MNC’s products will increase

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4.1 Exposure to International Economic

4.2 Exposure to International Political Risk
Conditions
❖ Political risk in any country can affect the level of an MNC’s
sales. A foreign government may increase taxes or impose
barriers on the MNC’s subsidiary. Alternatively, consumers in
a foreign country may boycott the MNC if friction arises
between the government of their country and the MNC’s
home country.
❖ The term “country risk” is commonly used to reflect an
MNC’s exposure to a variety of country conditions, including
political actions such as friction within the government,
government policies (such as tax rules), and financial
conditions within that country

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4.3 Exposure to Exchange Rate Risk

❖If the foreign currencies to be received by a

U.S.-based MNC suddenly weaken against the
dollar, then the MNC will receive a lower
amount of dollar cash flows than expected.

❖ Therefore, the MNC’s cash flows will be

reduced

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QUESTION AND APPLICATIONS

Exercise 17 Page 17

Anheuser-Busch, the producer of Budweiser and other beers, has

recently expanded into Japan by engaging in a joint venture with Kirin

HOMEWORK Brewery, the largest brewery in Japan. The joint venture enables

Anheuser-Busch to have its beer distributed through Kirin's distribution

channels in Japan. In addition, it can utilize Kirin's facilities to produce

beer that will be sold locally. In return, Anheuser-Busch provides

information about the American beer market to Kirin.

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QUESTION AND APPLICATIONS ASSIGNMENT

a) Explain how the joint venture can enable Anheuser-Busch to achieve its
objective of maximizing shareholder wealth.
b) Explain how the joint venture can limit the risk of the international business.
c) Many international joint ventures are intended to circumvent barriers that
normally prevent foreign competition. What barrier in Japan is Anheuser-Busch
circumventing as a result of the joint venture? What barrier in the United States is
Kirin circumventing as a result of the joint venture?
d) Explain how Anheuser-Busch could lose some of its market share in countries
outside Japan as a result of this particular joint venture.
Question 22 Page 19
Nantucket Travel Agency specializes in tours for American tourists. Until
recently, all of its business was in the U.S. It just established a subsidiary in
Athens, Greece, which provides tour services in the Greek islands for
American tourists. It rented a shop near the port of Athens. It also hired
residents of Athens, who could speak English and provide tours of the Greek
islands. The subsidiary's main costs are rent and salaries for its employees
and the lease of a few large boats in Athens that it uses for tours. American
tourists pay for the entire tour in dollars at Nantucket's main U.S. office
before they depart for Greece.

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ASSIGNMENT Corporate Control of Agency Problems.

a) Explain why Nantucket may be able to effectively capitalize on international opportunities
such as the Greek island tours.
b) Nantucket is privately-owned by owners who reside in the U.S. and work in the main
office. Explain possible agency problems associated with the creation of a subsidiary in
Athens, Greece. How can Nantucket attempt to reduce these agency costs?
c) Greece's cost of labor and rent are relatively low. Explain why this information is relevant Conflict between firm’s manager and shareholders
to Nantucket's decision to establish a tour business in Greece.
d) Explain how the cash flow situation of the Greek tour business exposes Nantucket to
exchange rate risk. Is Nantucket favorably or unfavorably affected when the euro
(Greece's currency) appreciates against the dollar? Explain.
e) Nantucket plans to finance its Greek tour business. Its subsidiary could obtain loans in Representative cost in multinational companies is
euros from a bank in Greece to cover its rent, and its main office could pay off the loans
over time. Alternatively, its main office could borrow dollars and would periodically often larger than domestic companies
convert dollars to euros to pay the expenses in Greece. Does either type of loan reduce
the exposure of Nantucket to exchange rate risk? Explain.
f) Explain how the Greek island tour business could expose Nantucket to country risk.

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GOVERNANCE STRUCTURE OF A
RESTRICTIONS OBSTRUCT OBJECTIVES
MULTINATIONAL COMPANY

Regulative Centralize multinational

Restriction
financial Management
- Tax
- Money transaction
- Transfer income
abroad

Decentralize multinational
financial Management

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CENTRALIZE GOVERNANCE DECENTRALIZE GOVERNANCE

Manager of mother Managers of Managers of

subsidiary A subsidiary B
company

Cash governance of Cash governance of Cash governance of Cash governance of

subsidiary A subsidiary B subsidiary A subsidiary B

Receivable and inventory Receivable and inventory Receivable and inventory Receivable and inventory
subsidiary A governance subsidiary B governance subsidiary A governance subsidiary B governance

Expenditure Expenditure
Finance in Expenditure in Finance in Finance in Expenditure in Finance in
in subsidiary in subsidiary
subsidiary A subsidiary B subsidiary B subsidiary A subsidiary B subsidiary B
A A
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Theories of International Business Theories of International Business

Why are firms motivated to expand

their business internationally? Why are firms motivated to expand
their business internationally?
Theory of Comparative Advantage
Product Cycle Theory
➢Specialization by countries can increase
production efficiency. ➢As a firm matures, it may recognize additional

Imperfect Markets Theory opportunities outside its home country.

➢The markets for the various resources used in

production are “imperfect.”
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Product Cycle Theory RISKS OF INTERNATIONAL BUSINESS

❖ International Economic conditions: the consumption

in any country is influenced by the income earned by
consumers in that country.
❖ International Political risk
❖ Exchange rate risk

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QUESTION AND APPLICATIONS

Question 22 Page 19

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