Meeting 1 - Introduction to Multinational Enterprise and Multinational Financial Management

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International FinanceInternational FinanceSeminarSeminar

3 March 2007

“ Growing Together … A Place to Learn and Grow “

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Opening Profile:Opening Profile:

The Daimler-Chrysler AG Global AllianceThe Daimler-Chrysler AG Global Alliance

•The $92 billion merger of The $92 billion merger of Daimler-Benz and ChryslerDaimler-Benz and Chrysler to form Daimler-Chrysler to form Daimler-Chrysler Akteingesellschaft represents a triumph of the global economy and the end of Akteingesellschaft represents a triumph of the global economy and the end of car companies as national emblems of industrial might.car companies as national emblems of industrial might.•The two CEOs announced that they expect immediate growth opportunities by The two CEOs announced that they expect immediate growth opportunities by using each other’s facilities, capacities, and infrastructure. using each other’s facilities, capacities, and infrastructure. •DaimlerChrysler expects to realize benefits of DM 2.5bn ($1.4bn) through the DaimlerChrysler expects to realize benefits of DM 2.5bn ($1.4bn) through the exchange of components and technologies, combined purchasing power, and exchange of components and technologies, combined purchasing power, and shared distribution logistics, and they expect further synergies to accrue by shared distribution logistics, and they expect further synergies to accrue by sharing know-how in engineering and manufacturing.sharing know-how in engineering and manufacturing.•These are 2 giant industrial companies with a total of 421,000 employees. The These are 2 giant industrial companies with a total of 421,000 employees. The senior management will have 18 members drawn from both companies. senior management will have 18 members drawn from both companies.

While Chrysler’s past problems have turned it into a lean, profit-focused While Chrysler’s past problems have turned it into a lean, profit-focused organization, Daimler has been content with profit margins of 2% compared organization, Daimler has been content with profit margins of 2% compared with Chrysler’s 6.5% with Chrysler’s 6.5% ??? ???

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Brief Facilitator’s ResumeBrief Facilitator’s ResumeTony Silitonga has been working for more than twenty (20) years in different countries, different industries, with different multinationals, such as: IBM, Atlantic Richfield Oil & Gas Company (Indonesia), Standard Chartered Bank (Philippines), Merrill Lynch (USA), and China Development Corporation (Taiwan).

He is a member founder of Indonesian Finance Association (IFA), FORESPECT and Optima Quadra.

Graduated from Bandung Institute of Technology major in Petroleum Engineering, he has got his Master in Business Management (MBM) majoring in Finance and Strategic Management from Asian Institute of Management (AIM), Makati (Philippines), and MBA from Columbia Business School (CBS), New York (USA) Finance-Exchange scholars’ program. Recently, he is finalizing his Dissertation for Doctorate in Business Administration (DBA) from De LaSalle University – Manila (Philippines), major in Finance, Strategic Management, and Good Corporate governance.

He is now Executive Director of Indonesian Institute for Corporate Directorship (IICD), an institution that was founded in the year 2000 by 10 leading Indonesian Universities, members of IDEANET (International Directors East Asia Network), and was financed by leading International Institutions, such as: The World Bank, and Asian Development Bank. IICD has a vision of Internalizing Best Practices of Good Corporate Governance and Directorship.

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Selected Hands-on Selected Hands-on Advisories:Advisories:

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Selected Hands-on Selected Hands-on Consultancies:Consultancies:

STANDARD CHARTERED BANK, The PhilippinesSTANDARD CHARTERED BANK, The PhilippinesMERRILL LYNCH, New York, USAMERRILL LYNCH, New York, USASTERLING TRANSTRADE, Manila, The PhilippinesSTERLING TRANSTRADE, Manila, The PhilippinesDRUGSTORE, INC., Manila, The PhilippinesDRUGSTORE, INC., Manila, The PhilippinesELNUSA HOLDING CO., Jakarta, IndonesiaELNUSA HOLDING CO., Jakarta, IndonesiaGLOBAL FOREST, INC., SingaporeGLOBAL FOREST, INC., SingaporeVISEAN ONLINE PTY LTD, Richmond, VIC, AustraliaVISEAN ONLINE PTY LTD, Richmond, VIC, AustraliaGRANSTAR MOTOR, Manila, The PhilippinesGRANSTAR MOTOR, Manila, The PhilippinesPT.INHUTANI III, Jakarta, IndonesiaPT.INHUTANI III, Jakarta, Indonesia

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NATURALRESOURCES

TECHNOLOGY

LEGALPOLITICAL

ECONOMIC

SOCIAL

NEW ENTRANTS

SUBSTITUTE

SUPPLIER RIVALRYBUYER

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International FinanceInternational Finance11stst Meeting Meeting

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Multinational Multinational Enterprise and Enterprise and Multinational Multinational Financial Financial ManagementManagement

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I.I. The Rise of the Multinational The Rise of the Multinational CorporationCorporation

II.II. The Internationalization ofThe Internationalization ofBusiness and FinanceBusiness and Finance

III.III. Multinational Financial Multinational Financial Management: Management: Theory and Theory and PracticePractice

TopicsTopics

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PART I. THE RISE OF THE PART I. THE RISE OF THE MULTINATIONAL CORPORATIONMULTINATIONAL CORPORATION

I. The MNC: DefinitionI. The MNC: Definitiona company with production and a company with production and distribution facilities in more distribution facilities in more than one country.than one country.

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A. Forces Changing Global MarketsA. Forces Changing Global MarketsMassive deregulationCollapse of communismPrivatizations of state-owned industriesRevolution in information technologyWave of M&AEmergence of free market policiesRise of Big Emerging Markets (BEMs)


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B.B. Prime Transmitter of Competitive Prime Transmitter of Competitive Forces in the Global Economy:Forces in the Global Economy:

The MNC emphases group performance The MNC emphases group performance such assuch as

Global coordinated allocation of resources Market – entry strategyOwnership of foreign operationsProduction, marketing and financial activities


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C. EVOLUTION OF THE MNCC. EVOLUTION OF THE MNCReasons to Go Global:

1. More raw materials2. New markets3. Minimize costs of

production


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RAW MATERIAL SEEKERSRAW MATERIAL SEEKERSexploit markets in other countriesexploit markets in other countries

historically first to appearhistorically first to appear

modern-day counterpartsmodern-day counterpartsBritish PetroleumExxon


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MARKET SEEKERSMARKET SEEKERSproduce and sell in foreign marketsproduce and sell in foreign markets

heavy foreign direct investorsheavy foreign direct investors

representative firms:representative firms:IBMMacDonald’sNestleLevi Strauss


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COST MINIMIZERSCOST MINIMIZERSseek lower-cost production abroadseek lower-cost production abroad

motive: to remain cost competitivemotive: to remain cost competitiveTexas InstrumentsIntelSeagate Technology


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D. THE MNC: A BEHAVIORAL VIEWD. THE MNC: A BEHAVIORAL VIEW

State of mind:State of mind:committed to producing,undertaking investment

andmarketing, and financing globally.


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E. THE GLOBAL MANAGERE. THE GLOBAL MANAGER1. Understands political and economic differences;

2. Searches for most cost- effective suppliers;3. Evaluates changes on

value of the firm.


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Part II. The Internationalization of Part II. The Internationalization of Business and FinanceBusiness and Finance

GlobalizationGlobalizationA. Political and Labor Union

Concerns

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B.B. Consequences of Global Consequences of Global CompetitionCompetition

Acceleration of the global economy

Part II. The Internationalization of Part II. The Internationalization of Business and FinanceBusiness and Finance

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PART III. MULTINATIONAL FINANCIAL PART III. MULTINATIONAL FINANCIAL MANAGEMENT: THEORY AND PRACTICEMANAGEMENT: THEORY AND PRACTICE

I. THE MULTINATIONAL I. THE MULTINATIONAL FINANCIAL SYSTEMFINANCIAL SYSTEMA. Main Objective of MNC:A. Main Objective of MNC: Maximize shareholder wealthB. Other Objectives ReflectB. Other Objectives Reflect Ability to Link:via affiliate transfer mechanisms

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C. Mode of Transfer:C. Mode of Transfer: Reflects freedom to select a

variety of financial channels.

D. Timing Flexibility:D. Timing Flexibility: Most MNC have some flexibility in

timing of fund flows.


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E. ValueE. ValueThe ability to avoid national taxes

has led to controversy.


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II. FUNCTIONS OF FINANCIALII. FUNCTIONS OF FINANCIAL

MANAGEMENTMANAGEMENT

A. Two Basic Functions:A. Two Basic Functions:1. Financing2. Investing


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B. Additional Factors Facing B. Additional Factors Facing the the MNC Executive MNC Executive

1. Political risk2. Economic risk


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III. THEORETICAL FOUNDATIONSIII. THEORETICAL FOUNDATIONS

A. A. Useful Concepts from Useful Concepts from Financial Financial

Economics:Economics:1. Arbitrage2. Market Efficiency3. Capital Asset Pricing


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B. Importance of Total RiskB. Importance of Total Risk1. Adverse Impact

lower sales and higher costs2. Justifies hedging activities

of MNC3. Diversification reduces risk


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IV. THE GLOBAL FINANCIAL IV. THE GLOBAL FINANCIAL MARKET PLACEMARKET PLACEA. Inter-linkage by

ComputersB. Market Acts as A Global

Referendum Process:Currencies may rise or fall


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1. “Globalization and Its Critics: A Survey of Globalization” by the Economist: on profit, on the poor, on government, on legitimacy, on finance, on WTO, and on manifesto. 2. Amartya Sen, "How to Judge Globalism," The American Prospect vol. 13 no. 1, January 1, 2002 - January 14, 2002

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History of History of International International Financial SystemFinancial System

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There are three historically important There are three historically important periods in the evolution of the system:periods in the evolution of the system:

A. Pre-1944 Era (Gold Standard Era): exchange rates were based on gold;B. 1944-1973 Era (Bretton Woods): exchange rates were pegged;C. Post-1973 Era: exchange rates are market determined.

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A. Pre-1944 Era A. Pre-1944 Era (Gold Standard Era):(Gold Standard Era): exchange rates were based on gold;exchange rates were based on gold;

Currency is valued against Gold & mint parity is established between two currencies

Stage 1- Gold specie standard-currency in circulation was gold coins

Stage 2- Gold Bullion Standard-currency in circulation is paper currency convertible in fixed amount of gold

Stage 3-Gold exchange standard

eg:-1$=0.00125 ounce gold

1pound = 0.005ounce gold

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Fixed Exchange Rate System: “Rule of Game”

Each currency was set in value per ounce of gold:

$20.67/oz.; 4.25 British pound / oz.

==> Ex = $20.67/ 4.25

1 British pound = $4.86 (=par value)

Based on PPP or cross-rate:

Most traders quote currency values against the US$ if the exchange for a currency is stated without using US$ as a reference, it is known as a cross rate.

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Government stood ready to buy or sell gold at parity value and gold is allowed to move in and out of country add faith (credit) to currency.

Impacts ???Impacts ???A. Imposed monetary discipline on participating countries.A country could not expand its money supply at a rate faster than gold accumulation inherently anti-inflationary. B. Free-flow of gold may correct trade imbalanceGold flows out of trade-deficit country and reduces its money supply (Remember gold is money.) The economic and business activities slow down (due to higher interest rates). Residents consume less Reduce imports & balance trade.

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B. 1944-1973 Era (Bretton Woods): B. 1944-1973 Era (Bretton Woods): exchange rates were pegged;exchange rates were pegged;

1. Fixed Exchange Rate: “Adjustable peg”;

+/- 1% of par value; all currencies pegged to gold.

2. Only governments can convert US $ into gold:

$35/oz.gold.3. Trade imbalance Deficits: selling foreign currency and buying home currency to

prevent it from devaluation below par value. Surplus: buying foreign currency and selling home currency to

prevent it from appreciating above par value.4. IMF, World Bank, SDR to improve economic cooperation and

liquidity.

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B. 1944-1973 Era (Bretton Woods): B. 1944-1973 Era (Bretton Woods): exchange rates were pegged;exchange rates were pegged;

Collapse in 1971 because:Collapse in 1971 because:

(1) budget deficit and high inflation in US -- financing Vietnam War.

(2) oversupply of US dollar and inadequate amount of gold to be converted.

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C. Post-1973 Era: exchange rates are C. Post-1973 Era: exchange rates are market determined.market determined.

The exchange rate is determined by supply supply and demandand demand which are affected by inflation rates, interest rates, growth, expectation, etc. may have high volatility.

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Alternatives Exchange Rates SystemAlternatives Exchange Rates System

A. Free Float

B. Managed Float

C. Target Zone

D. Fixed Rate

E. Hybrid (Any Combination of A, B, and C)

Degree of government controlDegree of government control

Least

Most

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Alternatives Exchange Rates SystemAlternatives Exchange Rates SystemManaged FloatManaged Float

Reducing uncertainty of exchange rate movement by controlling bank intervention (buy or sell foreign currency).

(1) Smooth out daily fluctuations, eliminate “excessive” volatility.

(2) Lean against the wind; delay exchange rate adjustment.

(3) Unofficial pegging.

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Alternatives Exchange Rates SystemAlternatives Exchange Rates SystemTarget-zone arrangementTarget-zone arrangement

linking currencies in a target-zone and adjusting economic policy to keep exchange rate in a range/zone.

European Monetary System

European currency unit coordination of econ. policy: fiscal deficits, growth,

money supply, etc.

Intervention will not work if the monetary policy is inappropriate.

Exchange rate cannot be stabilized.

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Alternatives Exchange Rates SystemAlternatives Exchange Rates SystemFixed RateFixed RateThese countries depend on international trade with each other for

survival. Fixed rate aids trade.

The success of such a system relies heavily on the willingness of individual govt. to sacrifice internal econ. policy goals for the maintenance of external policy goals (i.e. fixed rate).

It requires a single banking system and single monetary policy so that capital can flow freely between countries and yet maintain a fixed rate system.

Higher interest rates will attract massive capital flows which threaten the fixed rate system.

In order to maintain the fixed rate system, interest rate differences must be eliminated by having one solid monetary policy (and therefore one interest rate) for all of the community.

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Monetary SystemMonetary System

Domestic Monetary System (DMS)Domestic Monetary System (DMS)International Monetary System (IMS)International Monetary System (IMS)Function of DMS

1. Provision of adequate liquidity2. Operation of smooth adjustment mechanism is process in the economy that work to assure a nation external economic equilibrium, well balanced international payment system3. Confidence in the system: Govt. policies must be such that they gain confidence of private sector business firms and investors

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Monetary SystemMonetary System

Domestic Monetary System (DMS)Domestic Monetary System (DMS)International Monetary System (IMS)International Monetary System (IMS)Components of IMS

1. IMF2. Foreign Exchange market3. Official Reserves4. Private Demand for Foreign Exchange5. Intervention & swap network

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International Monetary System (IMS)International Monetary System (IMS)EvolutionEvolution

Gold Exhange Standardafter world war1, countries found it difficult to stick to gold standard because of increased differential inflation. world trade declined thoroughly and faced great depression in 1930’s..Then came the world war 2...after its conclusion in 1944,

Bretton woods conference took place & the new system of exchange rates .In the 60’s inflation had risen very high & private parties outside US to accumulate the dolar. Also the US trade deficit increased. It was clear that dolar had been overvalued & might have to be devalued to restore the equilibrium in he US trade balance. So every one wanted to change $ into hard European currency. Thus the US$ was devalued against most of the currencies & gold convertibility of $ was suspended. A new agreement “the smith sonian agreement “ was entered into. US$ was devalued & a wider range of currency fluctuation was permitted (2.25% instead of 1%)

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International Monetary System (IMS)International Monetary System (IMS)Evolution Evolution (Post War)(Post War)

1. Shortage (1946-52) – World demand for $ exceeded supply. American goods were in demand.2. Stability (1953-57) – By 1952, Western Europe had regained prewar levels of industrial production facilitated by generous provisions of $ credits and aids under “European recovery” program of 1947-52 (known as marshal plan healthy and stable economic environment). Forex markets in Europe were liberalized.3. Emerging payments problem (1958-63) - Formation of common market, common external tariff was introducedresulted in American corporations faced problems. They had to invest within the group. Sharp increase in the capital outflow from US to Europe showed adversely on BOP of US.4. Capital controls (1964-70) – In 1963 Kennedy government imposed interest equalization tax (IET). 15% tax was charged to US investors for buying foreign stock. This made funds costlier for foreign borrowers. This did not solve the problem, So further capital controls were introduced.5. International financial crisis (1971-73)5. International financial crisis (1971-73) – Bretton woods system was based upon strong and stable US $.

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6. Petrodollar (1974-81) -OPEC-organisation of oil exporting countries gave two Oil shocks & surplus is called Petrodollar7. International debt crisis (1982-83)- Mexico - due to widest debt service problems facing the developing nation (Debt service is the total debt at the end of the year in % of exports of goods and services in year indicated).8. Forex market Evolution(1985)Plaza accord – In 1981-84 US$ appreciated and imported goods become more attractive to Americans. This increase trade deficit was introduced. Two new supra-national institutions

were born “The IMF” and “The World Bank”.

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9. Emergence of Japan as leading international financial power & source of global capital I 1980’s10.In 1987 seven countries (G-7) reached accord in Paris to support the falling US $ by pegging exchange rates within a narrow range11.During 1989-92 many changed in political system from communist to multiparty govt. converting planned economies to free economies. 12. Unification of European market after NAFTA(north free trade agreement) between USA, Mexico and Canada 1993 & APEC(Asia Pacific Economic Corporation) has intensified regional development. Increasing importance of emerging capital market as a part of global finance in the 1990s13. South East Asian Currency Crisis of 1997-199814. Euro as a common currency in 1998 Eurobank,Eurocurrency,Eurograms,European currency-Euro?

Petrodollar recyclingPetrodollar recycling

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International Monetary System IMS)International Monetary System IMS)Application ???Application ???

A. EnglandGerman re-unification large expenses and high inflation tightened monetary policy to slow inflation rate Result: interest rates rose significantly capital flow from UK and Italy to earn high interest rates UK could not afford to increase interest rates high enough to keep capital at home. UK withdrew from the EMR UK withdrew from the EMR (Exchange rate mechanism)(Exchange rate mechanism)

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B. Mexico - Peso devalued in 1976 and 1982. Why?(1) Govt. overpromised: providing social service, education, medical care, etc. to buy vote.How to finance their subsidiary: increases taxes or borrow? (print Peso increase inflation) devaluation in 1976. (2) Discovered oil in the late 1970s and Mexico became rich. ==> spent and borrowed more (mortgaged oil). not enough print Peso Devaluation in 1982.

Summary:When oil price increased, Mexican govt. raised their living standard.When oil price decreased, Mexican govt. did not cut spending but borrowed more. maintained fixed Peso/dollar exchange rate which increased real value of Peso. Before 1982, real value of Peso was high and had balance of payments deficits.

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What about …

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Jeffrey Sachs, Aaron Tornell, Andres Velesco, “The Collapse of the Mexican Peso: What Have We Learned?”

Documents

Meeting 1 - Introduction to Multinational Enterprise and Multinational Financial Management