International

Financial Management
by
Jeff Madura
Florida Atlantic University

Course Teacher
Md. Shariful Islam
Institute of Business Administration
University of Rajshahi
Chapter
1
Multinational Financial Management:
An Overview
 A few good talks

”We know that advanced economies

with stable governments that borrow
in their own currency are capable of
running up very high levest of debt
without crisis.”
- Paul Krugman
 Goal of the MNC

• The commonly accepted goal of an MNC is

to maximize shareholder wealth.
• Often for MNCs it is not possible to follow
the wealth maximizing goal.
 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.
 Causes of Agency Cost

¤ The scattering of distant subsidiaries.

¤ The culture of foreign managers.
¤ The sheer size of the MNC.
¤ Subsidiary value versus overall MNC
value.
 Impact of Management Control

• 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 gives more control to those
managers who are closer to the
subsidiary’s operations and environment.
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
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
 Impact of Management Control

• Some MNCs attempt to strike a balance to

achieve the advantage of both style. They
allow subsidiary managers to make the
key decisions for their respective
operations, but the decisions are
monitored by the parent’s management to
ensure that they are in the best interest of
the entire MNC.
 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.
 Impact of Corporate Control

• Various forms of corporate control can

reduce agency costs.
¤ Stock compensation for board members
and executives.
¤ The threat of a hostile takeover.
¤ Monitoring and intervention by large
shareholders.
 Constraints
Interfering with the MNC’s Goal
• As MNC managers attempt to maximize their
firm’s value, they may be confronted with
various constraints.
¤ Environmental constraints such as building
codes, disposal of waste and pollution control.
¤ Financial regulatory constraints such as taxes,
currency convertibility, remittances.
¤ Ethical constraints.
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.”
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.
 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.
 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.
¤ The internet facilitates international trade
by enabling firms to advertise and manage
orders through their websites.
 International
Business Methods
• Licensing allows a firm to provide its
technology in exchange for fees or some
other benefits.
• 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.
 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.
• 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.
 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.
 International Opportunities

• Investment opportunities - The marginal

return on projects for an MNC is above
that of a purely domestic firm because of
the expanded opportunity set of possible
projects from which to select.
• Financing opportunities - An MNC is also
able to obtain capital funding at a lower
cost due to its larger opportunity set of
funding sources around the world.
 International Opportunities
Cost-benefit Evaluation for
Purely Domestic Firms versus MNCs

Purely
Investment
Domestic
Opportunities MNC
Marginal Firm
Return on
Projects MNC
Purely
Marginal Domestic
Cost of Firm
Capital
Financing Appropriate
Opportunities Size for Purely Appropriate
Domestic Firm Size for MNC

X Y Asset Level
of Firm
 International Opportunities

• Opportunities in Europe
¤ The Single European Act of 1987.
¤ The removal of the Berlin Wall in 1989.
¤ The inception of the euro in 1999.
• Opportunities in Latin America
¤ The North American Free Trade
Agreement (NAFTA) of 1993.
¤ The General Agreement on Tariffs and
Trade (GATT) accord.
 International Opportunities

• Opportunities in Asia
¤ The reduction of investment restrictions by
many Asian countries during the 1990s.
¤ China’s potential for growth.
¤ The Asian economic crisis in 1997-1998.
 International Opportunities

• Opportunities in South East Asia

¤ Resolution of LTTE problem in SriLanka.
¤ China’s potential for growth.
¤ Memorandum of Understanding between
India and Bangladesh.
¤ Transit between Bangladesh, India, Nepal
and Bhutan.
 Exposure to International Risk
International business usually increases an
MNC’s exposure to:
 exchange rate movements
¤ Exchange rate fluctuations affect cash
flows and foreign demand.
 foreign economies
¤ Economic conditions affect demand.
 political risk
¤ Political actions affect cash flows.