Multinational Financial Management:

An Overview

Chapter 1
Chapter Objectives
This chapter will:
A. Identify the management goal and organizational structure of
the Multinational Corporation (MNC).
B. Describe the key theories that justify international business
C. Explain the common methods used to conduct international
business
D. Provide a model for valuing the MNC
Multinational Corporation
 Multinational corporation (MNC): Firms that
engage in some form of international
business
Managers’ goals in MNCs
 What is the goal of an MNC’s mangers?
 Is there any difference between maximizing

the value of the entire MNC or maximizing

the value of each foreign subsidiary?
Agency problems
 Agency Problem: conflict of goals (interests)
between managers and shareholders
 Example: an MNC manager may decide to
establish a new subsidiary in one location which
not motivated by increasing shareholders’ wealth
(may be based on the location appeal to the
manager)
 Agency costs: costs ensuring that managers
maximize shareholders’ wealth. Give an example!
Agency problems (cont’d)
 Proper corporate governance prevent agency
problems. Example: rewarding foreign
managers who are satisfying the parent’s
goals (mechanisms and incentives to align
manager’s goals and MNC’s goals)
 Agency Conflict Reduced by:
◦ Parent control of agency problems
◦ Corporate control of agency problems (e.g., Takeover)
◦ Sarbanes-Oxley Act (SOX) of 2002
Management Structure of MNC
1. Centralized (refer to Exhibit 1.1 p. 7)
2. Decentralized
Why Firms Pursue International
Business
1. Theory of Competitive Advantage
2. Imperfect Markets Theory
3. Product Cycle Theory
 These theories overlap and complement each

others to provide a rationale for international

business
Why Firms Pursue International
Business (cont’d)
1. Theory of Competitive Advantage: specialization in
the production of goods that can be produced with
relative efficiency increases production efficiency
(e.g., china for basic labor cost). If one country
specializes in some products, it may not produce
other products and therefore trade between
countries occur
2. Imperfect Markets Theory: factors of production are
somewhat immobile (e.g., lands, labor force, …)
providing incentive to seek out foreign
opportunities (perfect market assumption assumes
that production factors are easily transferable)
Why Firms Pursue International
Business (cont’d)
 Product Cycle Theory: as a firm matures, it
recognizes opportunities outside its domestic
market. Initially the firm exports to foreign
countries and then to limit competition, this firm
may decide to produce its products in foreign
countries to reduce its costs (transportation, …)
International Product Life Cycle
How Firms Engage in International
Business
 A firm can penetrate a new market through:
1. International trade
2. Licensing (e.g., Starbucks)
3. Franchising (e.g., Pizza Hut, Subway, Dairy
Queen
4. Joint Ventures (e.g., Xerox and Fuji)
5. Acquisitions of existing operations (e.g.
DANONE)
6. Establishing new foreign subsidiaries
How Firms Engage in International
Business (cont’d)
 Any method of increasing international
business in a foreign country that requires a
direct investment of the MNC in the foreign
country is referred as Direct Foreign
Investment (DFI) ( aka FDI: Foreign Direct
Investment)
 Many companies (e.g., IBM) use a

combination of methods to increase their

international business
Valuation Model for an MNC:
Domestic Model
n
  E  CF $, t   
V    
 1  k  
t
t 1

 where E(CF$,t) represents expected cash flows

to be received at the end of period t,
 n represents the number of periods into the
future in which cash flows are received, and
 k represents the required rate of return by
investors (cost of capital. Why?)
Valuation Model for an MNC:
International Cash Flows


E  CF$,t    E  CF j ,t   E  S j ,t  
m

j 1

 where CFj,t represents the amount of cash flow

denominated in a particular foreign currency j at the end
of period t,
 Sj,t represents the exchange rate at which the foreign
currency (measured in dollars per unit of the foreign
currency) can be converted to dollars at the end of period
t
Cash Flow Diagrams for MNCs
Uncertainty Surrounding MNC Cash
Flows
1. Exposure to international economic
conditions
2. Exposure to international political risk
3. Exposure to exchange rate risk