International

Financial Management
7th Edition
by
Jeff Madura
Florida Atlantic University

PowerPoint® Presentation
by
Yee-Tien Fu
National Cheng-Chi University
Taipei, Taiwan
South-Western/Thomson Learning © 2003
 Chapter
1
Multinational Financial Management:
An Overview

South-Western/Thomson Learning © 2003

 Chapter Objectives

• To identify the main goal of the

multinational corporation (MNC) and
conflicts with that goal;
• To describe the key theories that justify
international business; and
• To explain the common methods used to
conduct international business.

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 Goal of the MNC

• The commonly accepted goal of an MNC is

to maximize shareholder wealth.
• Some publicly traded MNCs based
outside the United States may have
additional goals, such as satisfying their
respective governments, banks, or
employees.

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 Conflicts Against the MNC Goal

• For corporations with shareholders who differ

from their managers, a conflict of goals can
exist - the agency problem.
• Agency costs are normally larger for MNCs
than for purely domestic firms.
¤ The sheer size of the MNC.
¤ The scattering of distant subsidiaries.
¤ The culture of foreign managers.
¤ Subsidiary value versus overall MNC value.

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 Parent Control of Agency
Problems
• The parent corporation of an MNC may be able to
prevent agency problems with proper governance.
• It should clearly communicate the goals for each
subsidiary.
• The parent can oversee the subsidiary decisions to
check whether the subsidiary managers are satisfying
the MNC’s goals.
• The parent can also implement compensation
• plans that reward the subsidiary managers who
satisfy the MNC’s goals.

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 Corporate Control of Agency
Problems
• If the MNC’s managers make poor decisions that
reduce its value, another firm may be able to
acquire it at a low price and will likely remove the
weak managers.
• Institutional investors such as mutual funds or
pension funds that have large holdings of an
MNC’s stock have some influence over
management because they can complain to the
board of directors if managers are making poor
decisions.

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 How SOX Improved Corporate
Governance of MNCs
• If managers are serving themselves rather than the
investors, they may exaggerate their performance.
Enron and World com
• Enacted in 2002, the Sarbanes-Oxley Act (SOX) ensures
a more transparent process for managers to report on
the productivity and financial condition of their firm.
• It requires firms to implement an internal reporting
process that can be easily monitored by executives and
the board of directors.

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Some of the common methods used by MNCs to
improve their internal control process are:
•Establishing a centralized database of information
•Ensuring that all data are reported consistently among
subsidiaries
•Implementing a system that automatically checks data for
unusual discrepancies relative to norms
•Speeding the process by which all departments and all
subsidiaries have access to the data that they need
•Making executives more accountable for financial
statements by personally verifying their accuracy

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 Management Structure of an MNC
• The magnitude of agency costs can vary with the management
style of the MNC.
• A centralized management style reduces agency costs. However,
a decentralized style is more likely to result in higher agency
costs because subsidiary managers may make decisions that do
not focus on maximizing the value of the entire MNC.
• To the extent that subsidiary managers recognize the goal of
maximizing the value of the overall MNC and are compensated in
accordance with that goal, the decentralized management style
may be more effective.

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• Some MNCs attempt to strike a balance -
they allow subsidiary managers to make
the key decisions for their respective
operations, but the decisions are
monitored by the parent’s management.

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Centralized Multinational Financial Management
for an MNC with two subsidiaries, A and B

Cash Financial Cash

Management Managers Management
at A of Parent at B

Inventory and Inventory and

Accounts Accounts
Receivable Receivable
Management at A Management at B

Financing at A Financing at B

Capital Expenditures Capital Expenditures

at A at B
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Decentralized Multinational Financial Management
for an MNC with two subsidiaries, A and B

Cash Financial Financial Cash

Management Managers Managers Management
at A of A of B at B

Inventory and Inventory and

Accounts Accounts
Receivable Receivable
Management at A Management at B

Financing at A Financing at B

Capital Expenditures Capital Expenditures

at A at B
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 Impact of Management Control

• Electronic networks make it easier for the

parent to monitor the actions and
performance of foreign subsidiaries.
• For example, corporate intranet or internet
email facilitates communication. Financial
reports and other documents can be sent
electronically too.

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Theories of International Business

Why are firms motivated to expand

their business internationally?
 Theory of Comparative Advantage
¤ Specialization by countries can increase
production efficiency.
 Imperfect Markets Theory
¤ The markets for the various resources
used in production are “imperfect.”

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Theories of International Business

Why are firms motivated to expand

their business internationally?
 Product Cycle Theory
¤ As a firm matures, it may recognize
additional opportunities outside its home
country.

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 The International Product Life Cycle

 Firm creates  Firm exports

product to product to  Firm
accommodate accommodate establishes
local demand. foreign demand. foreign
subsidiary
to establish
presence in
a. Firm or foreign
differentiates b. Firm’s country
product from foreign and
competitors business possibly to
and/or expands declines as its reduce
product line in competitive costs.
foreign country. advantages are
eliminated.
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 International
Business Methods
There are several methods by which firms
can conduct international business.
• International trade is a relatively conservative
approach involving exporting and/or importing.
• This approach entails minimal risk because the firm
does not place any of its capital at risk.
¤ The internet facilitates international trade by
enabling firms to advertise and manage orders
through their websites.

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 International
Business Methods
• Licensing allows a firm to provide its technology (copyrights,
patents, trademarks, or trade names) in exchange for fees or
some other benefits.
• AT&T and Verizon Communications have licensing
agreements to build and operate parts of India’s telephone
system.
• Sprint Nextel Corp. has a licensing agreement to develop
telecommunications services in the United Kingdom.
• Eli Lilly & Co. has a licensing agreement to produce drugs for
Hungary and other countries.

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• Licensing allows firms to use their technology in foreign markets
without a major investment in foreign countries and without the
transportation costs that result from exporting.
• A major disadvantage of licensing is that it is difficult for the firm
providing the technology to ensure quality control in the foreign
production process.
• Springs, Inc., has set up a licensing agreement with a
manufacturer in the Czech Republic. When Springs receives
orders for its products from customers in Eastern Europe, it
relies on this manufacturer to produce and deliver the products
ordered. This expedites the delivery process and may even allow
Springs to have the products manufactured at a lower cost than
if it produced them itself.

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 Franchising
• Franchising obligates a firm to provide a specialized
sales or service strategy, support assistance, and
possibly an initial investment in the franchise in
exchange for periodic fees.
• For example, McDonald’s, Pizza Hut, Subway
Sandwiches, Blockbuster Video, and Dairy Queen
have franchises that are owned and managed by local
residents in many foreign countries.
• Franchising allows firms to penetrate foreign markets
without a major investment in foreign countries.

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 International
Business Methods
• Firms may also penetrate foreign markets by engaging in a
joint venture (joint ownership and operation) with firms that
reside in those markets.
• For example, General Mills, Inc., joined in a venture with
Nestlé SA, so that the cereals produced by General Mills
could be sold through the overseas sales distribution
network established by Nestlé.
• Xerox Corp. and Fuji Co. (of Japan) engaged in a joint
venture that allowed Xerox Corp. to penetrate the Japanese
market and allowed Fuji to enter the photocopying business.

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• Acquisitions of existing operations in foreign countries
allow firms to quickly gain control over foreign operations
as well as a share of the foreign market.
• For example, American Express recently acquired offices
in London, while Procter & Gamble purchased a bleach
company in Panama.
• Acquisitions allow firms to have full control over their
foreign businesses and to quickly obtain a large portion of
foreign market share.
• An acquisition of an existing corporation is subject to the
risk of large losses, however, because of the large
investment required.
• Some firms engage in partial international acquisitions in
order to obtain a stake in foreign operations.

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 International
Business Methods
• Firms can also penetrate foreign markets by
establishing new foreign subsidiaries.
• In general, any method of conducting
business that requires a direct investment in
foreign operations is referred to as a direct
foreign investment (DFI).
• The optimal international business method
may depend on the characteristics of the MNC.

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Degree of International Business by MNCs
Foreign Sales as a % of Total Sales
Foreign Assets as a % of Total Assets
66%
70% 62%
58%
60% 50%
46% 47%
50% 40%
40% 33%
30%
26%
20% 12%
10%
0%
Campbell's Dow IBM Motorola Nike
Soup Chemical

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 Online Application

• Check out the following international trade

promotion sites.

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http://www.tradenet.gov

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http://www.business.gov/busadv/
index.cfm

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http://www.trade.gov
http://www.export.gov
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Overview of an MNC’s Cash Flows

Profile A: MNCs focused on International Trade

Payments for products U.S. Customers

U.S.- Payments for supplies U.S. Businesses
based
MNC Payments for exports Foreign Importers
Payments for imports Foreign Exporters

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Overview of an MNC’s Cash Flows
Profile B: MNCs focused on International Trade and
International Arrangements

Payments for products U.S. Customers

Payments for supplies U.S. Businesses
U.S.-
based Payments for exports Foreign Importers
MNC Payments for imports Foreign Exporters
Fees for services
Foreign Firms
Costs of services

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 Overview of an MNC’s Cash Flows
Profile C: MNCs focused on International Trade, International
Arrangements, and Direct Foreign Investment
Payments for products
U.S. Customers
Payments for supplies
U.S. Businesses
Payments for exports
U.S.- Foreign Importers
based Payments for imports
MNC Foreign Exporters
Fees for services
Foreign Firms
Costs of services
Funds remitted
Foreign Subsidiaries
Funds invested
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 Managing for Value
• The value of an MNC is relevant to its shareholders and its
debtholders.
• When managers make decisions that maximize the value of
the firm, they maximize shareholder wealth (assuming that
the decisions are not intended to maximize the wealth of
debtholders at the expense of shareholders).
• When managers make multinational finance decisions that
maximize the overall present value of future cash flows, they
maximize the firm’s value, and hence shareholder wealth.

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 Valuation Model for an MNC

• Domestic Model
n
E CF$, t 
Value = 
t =1 1  k 
t

E (CF$,t ) = expected cash flows to

be received at the end of period t
n = the number of periods into
the future in which cash flows are
received
k = the required rate of return
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 Valuation Model for an MNC
• Valuing International Cash Flows
m 
n 
 
E CFj , t  E ER j , t  
 j 1 
Value =   
t =1  1  k  t

 
E (CFj,t ) = expected cash flows denominated in
currency j to be received by the U.S. parent at
the end of period t
E (ERj,t ) = expected exchange rate at which
currency j can be converted to dollars at the end
of period t
k = the weighted average cost of capital of
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 Valuation Model for an MNC

• An MNC’s financial decisions include how

much business to conduct in each country
and how much financing to obtain in each
currency.
• Its financial decisions determine its
exposure to the international environment.

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Valuation Model for an MNC
Impact of New International Opportunities
on an MNC’s Value

Exposure to
Foreign Economies Exchange Rate Risk

m 
n 
 
E CFj , t  E ER j , t  
 j 1 
Value =   
t =1  1  k  t

 

Political Risk
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 Uncertainty Surrounding an
MNC’s Cash Flows
International business usually increases an MNC’s
exposure to:
 Exposure to Exchange Rate Risk.
o Exchange rate fluctuations affect cash flows and foreign
demand.
 Exposure to International Economic Conditions
o Economic conditions affect demand.
 Exposure to International Political Risk
o Political actions affect cash flows.

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