INTERNATIONAL

FINANCIAL
MANAGEMENT
Augustine Matovu
 Multinational Corporations are defined as firms that engage in some
form of international business (Jeff Madura, 2018).

The goal of these managers is to maximize the firm’s value by

carrying out international investing and financing decisions.

Managing an
The commonly accepted goal of an MNC is to maximize
MNC shareholder’s wealth and thus managers are expected to make
decisions that maximize the stock price.

Many MNCs have additional goals such as, meeting government

regulations, satisfying creditors or employees etc.
 Since Finance is used to make investment and finance decisions for
a Multinational Corporation, common Finance decisions for an MNC
include:
Role of Whether to discontinue operations in a particular country

Finance in Whether to pursue new business in a particular country

Whether to expand business in a particular country
MNCs How to finance expansion in a particular country.
The decision to pursue new business in a particular country is based
on comparing cost and potential benefits of expansion.
  There often there are instances where managers pursue goals that
conflict with an MNCs goal for wealth maximization.
 For example, a decision to establish a subsidiary in one location
versus another may be based on the locations appeal to a
particular manager rather than potential benefits to shareholders.
Agency  The decision to expand to a subsidiary may be motivated by the
problem manager’s desire for a higher pay rather than on potential benefits
to shareholders.
 The costs of ensuring that managers maximize shareholder’s
wealth (agency costs) are normally larger for MNCs than purely
domestic firms.
  Monitoring costs:

Reasons why Monitoring the managers of distant subsidiaries in foreign countries

is more difficult.
MNCs face  Cultural diversity:
higher agency foreign subsidiary managers who are raised in different cultures
costs than may not follow uniform goals.
 Size:
domestic Large MNCs are more complex to monitor subsidiary managers thus
firms creating more agency costs.
Lack of monitoring can lead to substantial losses for an MNC.
  Governance:
The Parent company should put in place governance structures that
enable to communicate goals to subsidiaries to focus on
maximizing value of the MNC.
Parent  Compensation plans:
Control for These plans should focus on rewarding managers who satisfy MNC
Agency goals. These normally include rewarding high performing
managers with stock or stock options (option to buyback back
problems that stock at a given price).
Once a manager’s compensation is aligned to the stock price, then
the objective of shareholder wealth maximization can be attained.
However this could have a downside, like?
  In some cases where the MNCs goal deviate from shareholder
wealth maximization agency problems are bound to occur.

Corporate  Corporate control measures become the next best alternative to

alleviate agency problems.
control of the  When managers make poor decisions that reduce the MNC’s
Agency value, then they become target for acquisition at a lower price.

problem  Moreover, institutional investors (e.g., mutual and pension funds)

with large holdings of an MNC’s stock have some influence over
management because they complain to the board of directors if
managers are making poor decisions.
  Because manager’s compensation is tied to the objective of
wealth maximization, managers may exaggerate firm’s
performance.
Sarbonese  Examples such as Worldcom and Enron are classic examples of
Oxely Act and fraudulent financial reporting to exergerate stock price.

Corporate  The Sarbonese Oxely Act (SOX) was enacted in 2002 to ensure
transparency when reporting on productivity and financial
Governance condition on an MNC.
 The Act requires firm’s to put in place internal controls that can
easily be monitored by firm managers and board of directors.
  Establishing a centralized database of information
 Ensuring that all data are reported consistently among
Methods used subsidiaries.
 Implementing a system that automatically checks data for unusual
to increase discrepancies relative to norms
internal  Speeding up the process by which all departments and
subsidiaries access needed data,
control  Making executives more accountable for financial statements by
processes. personally verifying their accuracy.
SOX provided for better transparency and accountability by MNC
executives.
Management
Structure of
an MNC

(Centralized
vs
Decentralized
styles)
Management
Structure of
an MNC

(Centralized
vs
Decentralized
styles)
  A centralized management style can reduce agency costs;
 it allows managers of the parent to control foreign subsidiaries by
reducing power of subsidiary managers.
 A decentralized management style, could result in higher agency
costs;
What  Because subsidiary managers may make decisions that fail to
management maximize the value of the entire MNC.

style reduces  This style gives more control to managers who are closer to the
subsidiary’s operations and environment.
agency costs?  When subsidiary managers are compensated in accordance with
that goal of value maximization, the decentralized management
style may be more effective.
 Given the clear trade-offs between centralized and decentralized
management styles, some MNCs attempt to achieve the
advantages of both.
  There a number of theories that explain the reasons why firm’s are
Why MNCs motivated to expand internationally:

pursue  They are categorized into the:

International
 Classical country based theories
Business  Modern Firm based theories
  Mercantilism
Classical  Absolute advantage
Country based  Comparative advantage
theories  Factor proportions theory
  Country similarity
Modern Firm  Product life cycle
based theories  Global strategic rivalry
 Porter’s national competitive advantage
  This theory has its roots in the gold standard and thus emphasizes
maximizing exports and limit imports.
 This is because between the 16th-18th century countries that
exported increased their gold and silver bullion reserves and
countries that imported had a reduction in bullion reserves thus a
deficit balance of trade.
Mercantilism  Economies focusing on mercantilism will subsidies export
industries
 This theory introduced challenges such as;
 Low domestic consumption and reduction in domestic demand
 Trade wars because no country will be willing to let go of its gold
reserves.
  Proposed by Adams Smith who observed that countries should
specialize in the production of goods and services where they have
Absolute absolute advantage;
 Meaning that countries should concentrate on producing goods
advantage where they meet lower cost
 This might be due to technological superiority, resource
endowments, demand patterns and commercial policies in
comparison to another country.
  Postulated by David Riccardo, this theory notes that there are
countries that are able to produce particular goods or services at
lower opportunity costs;
Theory of  Meaning ability to sale goods or services at lower price and realize
Comparative a greater sales margin than trade partners.
 This can be a result of economies of scale that arise from superior
Advantage technology or human skills .
 The theory of comparative advantage provides a rationale for
international trade because different countries/ economies or
regions are endowed differently and thus an international reliance
on that kind of advantage by other nations.
  In a two-country, two-factor, and two-commodity framework
different countries are endowed with varying proportions of
different factors of production.
 Some countries have large populations and large labour resources
and others have large capital.
 A country with a large labour force will be able to produce the goods
at a lower cost using a labour intensive mode of production.
Factor  Similarly, countries with a large supply of capital will specialize in
proportions goods that involve a capital intensive mode of production.
 The former will export its labour intensive goods to the latter and
theory import capital intensive goods from the latter.
 Heckscher–Ohlin theorem observes “A capital-abundant country
will export the capital-intensive good, while the labor-abundant
country will export the labor-intensive good."
 After the trade, both the countries will have two types of goods at
the least cost.
 (contrast with Leontief’s Paradox)
  The Leontief paradox, presented by Wassily Leontief in
1951, found that the U.S. (the most capital-abundant country in
the world by any criterion) exported labor-intensive commodities
Factor and imported capital-intensive commodities;
proportions  An apparent contradiction with the Heckscher–Ohlin theorem.

theory  However, if labor is separated into two distinct factors, skilled

labor and unskilled labor, the Heckscher–Ohlin theorem is more
(CONTD) accurate.
 The U.S. tends to export skilled-labor-intensive goods, and tends
to import unskilled-labor-intensive goods.
  Postulated by Steffan and Linder,
 Intra trade tends to take place between countries with similar
levels of development or demand patterns.

Country  When a company develops a new product for the local market, the
Similarity firm will later export the product to a country with similar levels of
development after meeting the need of the local market.
theory  Reasons: Similarity of location, culture, tastes and preferences
and political and economic interests (after making agreements i.e
EU & EAC)
  The theory of perfect markets premised on the assumption that
economic entities maximize value in a world with no transaction
and information costs .
 However, in the real world the market is not saturated with
information rather the reality is that of asymmetric information.
Imperfect  This is a characteristic of imperfect markets, therefore the
imperfect markets theory for international trade looks at the
Markets reality of markets and posits that;
theory  Because information is hard to get by and some economic entities
are privy to more information than others implying information on
efficient technology, resources, Labour and others.
 It becomes apparent that for that reason nations trade with one
another and by virtue of the imperfect markets international trade
thrives because it emerges as a result of that imbalance of
information.
  The theory proposed by (Vernon, 1966) brings to recognition that
a product goes through the typical phases of introduction, growth,
maturity and decline.
 At the introduction stage have low qualities and with no
standardizations, therefore firms export their product to markets
in developed countries.
 When the product moves to the growth stage, standardization
increases firms endeavor to cut production costs and rely on
economies of scale;
Product life  at this point the firm moves investment to developed countries
cycle theory with moderate income such as those in Europe.
 At maturity stage then the firm moves its investment to
developing countries where the product is new without
competition;
 this enables the firm to offset the low profit margins from
developed nations were the product is faced with a lot of
competition from firms entering the same line of business.
  The Global Strategic Rivalry Theory of international trade was
developed in the 1980s by such economists as Paul Krugman and
Kevin Lancaster
 The theory examines the impact on trade flows arising from global
strategic rivalry between Multi-National Corporations.
Global  It explores the notion that in order to stay viable, firms should
exploit their competitive advantage globally and try to keep it
Strategic sustainable.

Rivalry  According to this view, firms struggle to develop some sustainable

competitive advantage, which they can then exploit to dominate
the global marketplace.
 Like Linder’s approach (country similarity), global strategic rivalry
theory predicts that intra-industry trade will be commonplace.
  The Porter Diamond, properly referred to as the Porter Diamond
Theory of National Advantage, is a model that is designed to help
understand the competitive advantage of nations

Porter’s
 These four factors:
national  firm strategy
competitive  structure and rivalry
advantage  related supporting industries
 demand conditions and factor conditions
  International trade

Modes of  Licensing
 Franchising
Conducting  Joint ventures
International  Strategic alliances
Business  Mergers and acquisitions
 Foreign Direct Investment
  International trade is a relatively conservative approach that can
be used by firms to penetrate markets (by exporting) or to obtain
supplies at a low cost (by importing).
 This approach entails minimal risk because the firm does not place
any of its capital at risk.

International  If the firm experiences a decline in its exporting or importing, it

can normally reduce or discontinue that part of its business at a
trade low cost.
 Many large U.S.-based MNCs, including Boeing, DuPont, General
Electric, and IBM, generate more than $4 billion in annual sales
from exporting.
 Nonetheless, small businesses account for more than 20 percent
of the value of all U.S
  Licensing is an arrangement whereby one firm provides its
technology (copyrights, patents, trademarks, or trade names) in
exchange for fees or other considerations.
 Many producers of software allow foreign companies to use their
Licensing software for a fee.
 In this way, they can generate revenue from foreign countries
without establishing any production plants in foreign countries, or
transporting goods to foreign countries
  Under a franchising arrangement, a franchisor provides a
specialized sales, service strategy, support assistance and possibly
an initial investment in the franchise in exchange for periodic fees
from a franchisee allowing local residents to own and manage the
units.
 For example, McDonald’s, Pizza Hut, Subway, and Dairy Queen
have franchises that are owned and managed by local residents in
Franchising many foreign countries.
 As an example, McDonald’s typically 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.
  A joint venture is a venture that is jointly owned and operated by
two or more firms.
 Many firms enter foreign markets by engaging in a joint venture
with firms that already reside in those markets.
 Most joint ventures allow two firms to apply their respective
comparative advantages in a given project.

Joint Ventures  Joint ventures often require some degree of DFI, while the other
parties involved in the joint ventures also participate in the
investment.
 CureVac (German Biotech) and GSK (British GlaxoSmithKline) are
developing a vaccine that can target multiple coronavirus variants
in a single jab.
 Boeing and Lockheed Martin created ULA (United Launch
Alliance) in a 50/50 joint venture to compete with SpaceX
  Strategic alliances are agreements between two corporations
designed to co-operate in product development, manufacturing
and marketing of goods and services.
 Though the alliance is mutually beneficial for both companies
each company retains its independence.
Strategic  The agreement is less complex in comparison to joint ventures
where firms embark on creating a separate business entity.
alliance  Its interesting that many successful strategic alliances are formed
by companies that have nothing in common.
 Example: Uber’s partnership with Spotify lets Uber riders easily
stream their Spotify playlists whenever they take a ride.
 Starbuck and Barnes and Noble
  A merger is a consolidation of two companies into a new entity.
The newly formed entity could take on an entirely new name or
retain both names of the former companies.
Mergers are voluntary after mutual agreement of both companies
and normally merging firms are of relatively the same size and
scope.
Mergers and A merger will introduce new ownership and change of
acquisitions management structure.
 The rationale of mergers is:
 A reduction in operating costs.
 Expansion into new markets.
 Benefits of economies of scale and scope
  Mergers can take the form of horizontal, vertical or conglomerate.
 Horizontal merger: Two companies at the same level of
production, marketing or procurement (Glaxo-SmithKline~Glaxo
Wellcome and SmithKline Beecham)
 Vertical merger: Two companies at different levels of production,
Mergers and marketing or procurement.

Acquisitions  Conglomerate merger: Two or more companies at different levels

of production, marketing or procurement.
 Citigroup is a conglomerate of Citi-Bank, Travellers insurance
(that had previously acquired Salmon brothers a major bond
dealer and Shearson lehman a retail brokerage firm)
.
  An Acquisition is where a firm takes over or buys out another firm
and the acquired entity ceases to exist as a single entity in
operations) e.g. Microsoft acquiring Zenimax
 Mergers and acquisitions are always subject to anti-trust laws
 Anti-trust laws are regulations that encourage competition by
limiting market power of a particular firm.
Mergers and  They ensure that mergers and acquisitions do not consolidate
market power to form monopolies.
Acquisitions  These laws monitor firms colluding, forming cartels and price
fixing

 Students’ assignment:
In the Ugandan context, discuss with examples the major mergers
and acquisitions that have been executed in the past two decades
  Foreign direct investment (FDI) is a direct investment into
production or business in a country by a foreign company; either
by buying out a target company or by expanding operations.
 Foreign direct investment differs from portfolio investment, which
is a passive investment in the securities in a foreign country.
 It requires a significant degree of influence and control over the
company into which the investment is made.
Foreign Direct  Forms of Foreign Direct Investment
Investment  Green field investment; is a type of foreign direct investment
(FDI) where a parent company builds its operations in a foreign
country from the ground up.
 Brown Field Investment: is when a company or government
entity purchases or leases existing production facilities to launch a
new production activity.
  Managers of a firm are meant to make decisions that maximize
the value of the firm or maximize the value of shareholders (not
debt holders at the expense of shareholders).
Valuation for  In valuing a domestic company:

a Multi-  The firm’s value is given by obtaining the present value of the
firm’s expected cash flows.
National  Thus,
Corporation
E(CF$t) is the expected cash flow at the end of period t
N is the number of periods; K is the WACC or RRR
  In valuing a multi-national corporation:
 Cash flows are normally generated from various countries with
different countries using various currencies;
Valuation for  Thus,
a Multi-
National
Corporation  where; E(CFjt) is the expected cash flow denominated in a
particular currency
 E(Sjt) is the exchange rate of the foreign currency
  Example:
 XBOX has expected cash flows of $100,000 from local business
within the US. The corporation has 1,000,000 Mexican pesos from
it Mexican Subsidiary at the end of the year. Assuming that the
currency conversion rate is $0.09. Determine the expected dollar
Valuation for cash flow:

a Multi-
National
Corporation
= Cashflow from US operations + Cashflow from Mexico operations
= $100,000 + (1,000,000 x $0.09)
= $100,000 + 90,000
=$190,000
  Valuation of an MNC cash flows with multiple periods:
 The process described above assumes a single period and thus not
adequate when an MNC has multiple periods in which cash flows
Valuation for are received.
 1) Using the same process above to all future cash flows so that
a Multi- they are represented in a single local currency.
National  2) Discount the expected cash flows at the weighted cost of
capital
Corporation  3) Sum the discounted cash flows to estimated the value of the
firm
  Example
 Microsoft’s makes cash flows of $120,000,000 its Xbox
department operating in Britain forecasts cash flows as follows:

Valuation for Year Cash flow (euros)

a Multi- 1 50,000,000
2 55,000,000
National 3 60,000,000
Corporation
 The corporation has a weighted average cost of capital of 5% and
the dollar conversion rate is 0.8896 euros.
 Determine the corporations value inclusive of its department
operating in Britain.
 Year Cashflows Cashflows Discounting Discounted
(euros) converted ($) factor (5%) Cashflows
($)
Valuation for
a Multi- 1 50,000,000 44,480,000 0.952 42,344,960
National
Corporation 2 55,000,000 48,928,000 0.907 44,377,696

3 60,000,000 53,376,000 0.864 46,116,864

Value of the department in Britiain= 132,839,520

Value of the firm = 120,000,000 + 132,839,520
= $ 252,839,520
Uncertainty
faced by an
MNC.
  The balance of payments is an accounting method by which
countries measure all of the international monetary transactions
within a specified period of time.

INTERNATIO  It is an accounting of a country's international transactions over a

given period, usually a quarter or a year.
NAL FLOW  It accounts for transactions by businesses, individuals and the
OF FUNDS government.
(THE BALANCE OF  The balance of payments statement is composed of;
PAYMENTS) the current account
the capital account
the financial account.
  Merchandise exports and imports represent tangible products
such as smart phones, coffee, clothing etc., transported within
countries.

CURRENT  Services exports and imports represent services such as tourism,

legal, consultation services etc.
ACCOUNT  Service exports result into inflows while service imports result into
outflow of funds.
 The difference between total exports and imports in a country is
referred to as balance of trade.
  The capital account measures the flow of funds between one
country and all other countries due to non-financial assets
CAPITAL transferred across borders during course of business;
 This can be by people moving to a different country or due to sale
ACCOUNT of patents, copyright and trademarks, leases, franchises etc.
 Fixed assets that generate income
  Financial account measures the flow of funds between countries
that are due to;

FINANCIAL Direct foreign investment: Corporate Expansions

ACCOUNT Portfolio investment: Shares, bonds, acquisitions
Other capital investments: transactions involving short term
securities (money market securities).
 Assignment:
BALANCE OF
PAYMAMENT Discuss how the different monetary regimes chosen by a particular
S (CONTD) country impact its balance of payments and the consequences
thereof regarding imports and exports.
 Over the decades there have been major historical events that have
enabled the increase of trade volumes and international funds flow:
Fall of the Berlin wall
Single European Act (European parliament)
NAFTA (North American Free Trade Agreement) USA, Canada,
Historical Mexico trade barriers elimination
GATT (General Agreement of Tariffs)
events and European Union
trade volumes Inception of the Euro
Contrast with the BREXIT
East African Union:
Free trade area, Customs union, Monetary Union, Federation