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Globalization & the Multinational Firm

• Understand why it is important to study international finance.

Distinguish international finance from domestic finance.

1. Foreign Exchange Risk

2. Political Risk

3. Market Imperfections

4. Expanded Opportunity Set

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Foreign Exchange Risk

– The risk that foreign profits and wealth may evaporate in dollar terms due to unanticipated unfavorable exchange rate movements.

– Suppose $1 = ¥100 and you buy 10 shares of Toyota at ¥10,000 per share.

– One year later the investment is worth ten percent more in yen: ¥110,000

– But, if the yen has depreciated to $1 = ¥120, your investment has actually lost money in dollar terms.

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Political Risk

– Sovereign governments have the right to regulate the movement of goods, capital, and people across their borders, and legislation of taxation.

– Sovereign governments laws sometimes change in unexpected ways.

– Sovereign government and civil instability

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Market Imperfections

– Legal restrictions on movement of goods, people, and money; e.g. tariffs.

1. Farley, NCB entries in Europe

– Transactions costs

– Shipping costs

– Tax arbitrage

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Expanded Opportunities

Markets, new and growing Intellectual capital Capital markets Taxation Economies of scale R&D Cheaper labor Lower prices Employment Technology Wealth

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Primary Goal for International Corporate Financial Management

Maximization of shareholder wealth?

Other stakeholders

1. Employees

2. Suppliers

3. Customers

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Keiretsu In Japan, managers have typically sought to

maximize the value of the keiretsu—a family of firms to which the individual firms belongs.

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Corporate Governance

Corporate scandals 1. Enron 2. Tyco 3. WorldCom 4. Madoff Managers may pursue their own private interests at the expense of shareholders

when they are not closely monitored. These catastrophic corporate events have painfully reinforced the importance of

corporate governance; - the financial and legal framework for regulating the relationship between a firm’s management and its shareholders.

Has SOX worked? Can we regulate behavior? Emerging and transitional economies legal protection of shareholders is weak or

virtually non-existing.

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Globalization of the World Economy Major Trends

Emergence of Globalized Financial MarketsEmergence of the Euro as a Global CurrencyTrade Liberalization and Economic Integration Privatization

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Emergence of the Euro as a Global Currency

Currently more than 300 million Europeans in 22 countries are using the common currency on a daily basis.

The transaction influence of the euro may become larger than the U.S. dollar’s in the near future.

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Euro Area

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Global Economic Integration

Over the past 50 years, international trade increased about twice as fast as world GDP.

In more recent years there has been a change in the attitudes of many of the world’s governments who are abandoning mercantilist and centralized views and embracing free trade as the most effective route to prosperity for their citizenry.

The highest affect for prosperity in free trade being derived from manufacturing.

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Liberalization of Protectionism

The General Agreement on Tariffs and Trade (GATT)

World Trade Organization (WTO) The North American Free Trade Agreement (NAFTA) For Mexico, the ratio of export to GDP has

increased dramatically from 2.2% in 1973 to 28.7% at the beginning of the 21st century.

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Privatization The selling off of state-run enterprises to investors for

the purpose of establishing a free market economy and the increase of individual wealth through business profits.

Privatization increases the efficiency of the enterprise.

Privatization typically accelerates a tremendous increase in cross-border investment.

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Multinational Corporations

A company that has incorporated in one country and has production and sales operations in other countries.

Many MNCs obtain raw materials from one country, financial capital from another, produce goods with labor and capital equipment in a third country and sell their output in various other national markets.

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Top 10 MNCs - 2010

Who ?

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Top 10 MNCs - 2010 1.  Royal Dutch Shell $458 billion – Oil (Netherlands) 2. Exxon Mobil $443 billion - Oil 3. Wal-Mart $406 billion - Retail 4. BP $357 billion - Oil 5. Chevron $263 billion - Oil 6. Total $235 billion - Oil (French) 7. ConocoPhillips $231 billion - Oil 8. ING Group $227 billion – Bank (Netherlands) 9. Sinopec $208 billion - Oil (China) 10.Toyota $204 billion - Automobile

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The Theory of Comparative Advantage

Gains From Trade Definition: a comparative advantage exists

when one party can produce a good or service at a lower opportunity cost than another party.

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The Geometry of Comparative Advantage

There are two countries, A and B, who can each produce only food and textiles.

Initially they do not trade with one another.

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Globalization

Criticisms of globalization– Offshoring of business services jobs to lower-

wage countries (Outsourcing)– Growing trade deficits– Slow wage growth– Environmental and social impacts

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Europe– Emergence of the EU as an operational economic union– Economic linkages between the EU and newly emerging Central

and Eastern European countries– Foreign MNCs gain foothold in EU by

Acquisitions Alliances Cooperative R&D efforts

– Challenge is to absorb former communist-bloc countries– Privatization of traditionally nationalized industries

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Central and Eastern Europe

– Perestroika—economic and political restructuring

– Dismantling of Russian price controls– Privatization– Inflation – Membership in International Monetary Fund

(IMF)– Crime– Political uncertainty

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Asia

Japan– Phenomenal economic success in 1970s and 1980s– Ministry of International Trade and Industry (MITI)– Keiretsus

Vertically integrated industries Holdings provide assistance needed in providing goods

and services to end users– Decade long recession in 1990s

Bank loans backed by real estate or projected revenues

By 2000, most major banks had billions of dollars in uncollectible loans

International competition has increased

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Asia

The Four Tigers– South Korea

Chaebols (large family-held Korean conglomerates)

Affected by declining economies of South east Asia in 1990s)

– Hong Kong Now part of People’s Republic of China Uncertainty about role the Chinese government

intends to play in local governance

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Asia

Singapore– Least hurt by economic downturn of 1990s– Taiwan

Progression from labor-intensive economy to one dominated by technologically sophisticated industries (banking, electricity generation, petroleum refining and computers)

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Asia

China– Annual real economic growth of 10 percent during

the 1980s and early 1990s– More recent growth of 8 percent– Healthy and growing economy– GDP growth of 91 percent in 2003– Attractive to foreign investors despite major political

risk– Product pirating is major problem– Complicated and high-risk venture

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Developing and Emerging Country

India– Low per capita GDP– Recent trend of locating software and high

value-added services to this country– Attractive to U.S. and British investors (well

educated, English speaking, technologically sophisticated workers)