Topic 1: Finance and Global Competition

Purpose: To integrate major concepts of macro finance and business strategy on a global scale

How should we think about corporations?

• Consider the corporation as an intermediary between investors and the basic activities of the firm.

• The securities issued by the corporation represent income from a package of activities.

• To the investors, any particular corporation represents a small part of a diversified portfolio.

• A corporation is part of a webwork of interactions among various economic sectors.

Highlights of Macro-Finance Theory

• Efficient money and capital markets are essential to assure adequate capital formation and economic growth.

• Capital is created when resources are used to make tools for future use

• Since antiquity, cultures have devised means to share the ownership of major capital assets (such as ships) in order to diversify the risk of loss

Highlights of Macro-Finance Theory

• Money is something accepted as a means of exchange,

– allowing values of different things to be expressed in terms of money (money is a unit of accounting)

– thus, money can be used to store value.

• Eurocurrency

– Examples: Eurodollars, Euro-Yen

– Regulatory Issues

– Role in international markets

Highlights of Macro-Finance Theory

• Primary securities:

– economic unit adds financial liabilities

• Indirect securities:

– issued by financial intermediaries, which in turn hold primary securities

– examples: bank deposits and insurance policies

Highlights of Macro-Finance Theory

• Derivative securities:

– value derived through contractual relationship with primary securities

– examples: forward contracts, futures, options, and swaps

• Price discovery process:

– mechanism by which savings-surplus economic units come into equilibrium with savings-deficit units

– market is pricing efficient if there are no persistent arbitrage opportunities

Questions for discussion:

• In a primitive barter economy, each economic unit must always be in balance with respect to savings and investment, and no economic unit could invest more that it saved. How would that lead to inefficiencies?

• How does the establishment of money lead to greater efficiency?

Questions for discussion:

• How do state and local governments keep their budgets in balance when spending exceeds revenue, even though they lack the power to create money?

• Does the federal government actually achieve a balanced budget in a similar way?

• What is the difference between investment and consumption in the government sector?

Questions for discussion:

• How might forcing a balanced federal budget lead to inefficienies?

• Within financial theory, what role is played by federal government debt obligations, and what assumptions are made about the amount of such debt?

Questions for discussion:

• If the government is unresponsive to market conditions, how likely is it that government decisions will result in efficient capital formation?

• What is the ultimate measure of a country’s economic efficiency?

Roles of financial intermediaries:

• Reduce transaction costs and enhance convenience

• Resolve informational assymetries

• Provide divisibility and flexibility

• Facilitate diversification and risk spreading (for example, by underwriting, investment bankers bear the risk of selling an issue of primary securities)

• Transform maturities

• Apply expertise

Disintermediation and securitization

• Financial innovation (new products or new processes)

– Resolve operational inefficiencies

– Make markets more complete

• Catalysts for change

– Tax law changes

– Technology changes

– Volatility of interest rates, exchange rates, or economic activity

– Regulatory change

How Do Multi-National Organizations Create Value?

• Earn economic rents through international commerce

– Example: Apple, Inc.

– MNCs may be large or small

• Exploit product and factor market imperfections

– trademarks

– patents

– marketing skills

• Organizational competencies or capabilities

The Net Present Value Rule:

• Undertake a venture if and only if the value of the securities issued as claims against it exceeds the cost of the resources committed to it.

– That is, do it if there is a profit for the entrepreneur.

– In case of a conflict, choose the project with the biggest profit.

• Practical aspect: following this rule is the only way to gain unanimous approval from all shareholders.

The Rate of Return Corollary:

• Undertake an investment only if return > competitive rate, at same level of risk.

– That is, do an investment if there are good prospects for earning an above-average rate of return on the capital invested.

The Basic Idea Behind NPV

• Almost a century ago, the argument was made that the pursuit of profits via the NPV Rule leads to optimal resource allocation

– and best possible standard of living for society as a whole

• The basic idea is to achieve the optimal pattern of consumption over time

– makes most efficient use of available investment opportunities.

Source of positive NPVs

• Positive NPV results from improved resource allocation through cooperation—or through innovation

• There would be no positive NPV if many individuals could accomplish the same actions on their own

– Economic rents would be competed away

Innovation-Based Multinationals

• Introduce new products

• Differentiate existing products

• Achieve economies of scope in distribution

• Achieve information dominance

Mature Multinationals

• Economies of scale

• Brand identity (i.e., Coca-Cola)

• Culture identity (i.e., Levi jeans, Marlboro)

Multinational Network Organizations

• Network Organizations

– Dynamic networks

– Static networks

• Strategic Alliances

– Equity alliances

– Non-equity alliances

• Joint Ventures

Porter’s Generic Product/Market Strategies

Porter’s method for analyzing competitive environment

Industry Rivals

Substitutes

CustomersSuppliers

New Entrants

The Generic Value Chain for a firm:

InboundLogistics

Operations OutboundLogistics

Marketing &Sales

Service

Primary Activities

Firm Infrastructure

Procurement

Human Resources Development

Technology Development

Su

pport

Act

ivit

ies

The Physical Value Chain from a Global Perspective

Basic Extraction

Distribution&Marketing

Fabrication

Refining

PhysicalPhysicalRealmRealm

Service

Value Added at Value Added at Each StepEach Step

Support Activities:•Technology Development•Human Resources Development

Virtual Value Chain & Information Operations

GATHER AND APPLY IN THE PHYSICAL REALM

STORE AND TRANSFORM IN THE INFORMATION REALM

InfosphereGATHER

APPLY

PRESENT

DISTRIBUTE

SYNTHESIZE

SELECT

ORGANIZE