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Multinational Corporations

Multinational Corporations

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Published by Sukumar Nandi

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Published by: Sukumar Nandi on Apr 03, 2008
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 Multinational Corporations and the Developing CountriesSukumar NandiIndian Institute of Management Lucknow
“Practical men, who believe themselves to be quite exempt from anyintellectual influence, are usually the slaves of defunct economist.Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribblers of a few years back.”
[ J. M. Keynes,
General Theory of Employment, Interest and Money]
The degree of integration of the capital markets of different countries hasincreased in recent times with the tremendous surge of capital mobility across political boundaries. This phenomenon has also increased the role of multinational corporations inthe economic development of the developing countries. Conceptually there are five waysin which a multinational corporation (MNC) can serve a foreign market:( i) invest directly by a Greenfield venture,(ii) invest directly by acquiring a local firm,(iii) invest directly by starting a joint venture with a local firm,(iv) enter into a strategic alliance with a local firm.The 5
th
alternative is no direct investment in the host country, but the MNC can serve thehost country market by exports or giving license to the local firm. The first four alternatives involve foreign direct investment (FDI) on the part of MNC. Whether thelatter will go for FDI or the 5
th
alternative depends on both the economic conditions of thehost country and the business strategy of MNC. In the case of developed countries likeOECD economies, the MNC has a free choice among the first four alternatives. But incase of developing countries and transition economies
1
there are restrictions and thechoices are limited. This is because capital markets in most of the developing countriesare not open and their currencies are not fully convertible. This places restraints on the behaviors of the MNCs who aspire to enter into such countries.
1
These are former command economies like Russia, Ukrain, Poland and other east European countries, CIScountries like Uzbekistan and others, China and Vietnam. The significant change of economic policies of these economies has changed the perception of foreign capital and FDI is welcome now.1
 
In developing countries with a developed capital market and large industrialsector, the acquisition of private firm is a realistic alternative to Greenfield entry
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.Exceptin countries like south Korea with an advanced technology base, merger with local firmsare troublesome because of huge gap in the level of technology, size and management philosophy. The same problem remains with strategic alliance with local firms of hostcountry.In the early phase of liberalization of the transition economies, the state ownedfirms are often put on sale and MNCs see it easy to acquire the state owned firms andthus they enter into the market of the host country. After that Greenfield entry becomesmore feasible with merger and acquisition remaining for the future. The behavior of theMNC regarding their entry and operations in the developing countries has attractedattention in the literature. The literature has identified three aspects regarding the MNC behaviors:-target country characteristics-investment characteristics , and-industry characteristicsThe most common framework is the transaction cost analysis, that is, MNC chooses themode of entry that involves minimum cost. The findings in the literature can be put in thefollowing form:First, larger MNCs are more prone to acquire than small ones. However, in recenttimes, smaller firms also have become more prone to acquire as the transaction cost of merger and acquisition ( M & A) has reduced.Second, MNCs with lower R&D intensity are more likely to buy technologicalcapabilities abroad by acquisition, and firms with strong technological advantages arelikely to set up Greenfield ventures.Third, the greater the cultural and economic differences between the home andthe host countries, the less the probability that MNC will go for acquisition. Generally,M&A concentrate in countries with similar cultural and business practices.Fourth, acquisitions by MNC are encouraged by capital markets imperfectionsthat lead to the undervaluation of the assets of firms. The same thing may happen in timesof economic crisis like the Asian Currency Crisis of 1997.Fifth, horizontal acquisitions are driven by the search for new markets, productsand brand and seldom for cost rationalization. But such acquisitions may lead to “assetrationalization” of the acquired firm and this often damages the capabilities of the latter.Sixth, Greenfield investments offer the MNC greater control and more ability tomould affiliate structure, system and culture than acquisition. Everything can bereplicated from the investing country.In sum, the entry of MNC in the developing countries induces certain importantchanges including technology transfer to the host country. But over time there is morereciprocal process of technology transfer and sharing of intangibles like tacit knowledge(Bressman
et al 
, 1999). From the investor perspective, M&A offer certain advantagesover Greenfield investment of rapid entry and access to existing proprietary assets. In
2
Where the MNC start new enterprise with the import of both capital and technology. This is done to takeadvantage of cheap labour and /or source of raw materials.2
 
the case of developing countries, M&A create advantage of rapid entry, access to localmarket knowledge and distribution system. It also create contacts with the governments,suppliers and the consumers, and also it may be the only form of FDI where other opportunities are absent.Sometimes established cultural and organizational inertia may create problem for MNC after acquisition of firms in host country and MNC may find it costly for thenecessary assimilation process. Even valuation of assets of the firms in host country for acquisition may be difficult as the capital market is often imperfect and not developed.Such problems generally emerge in large developing countries that are opening tointernational competition for the first time. In such situations, Greenfield investment will be more suitable for the MNCs.
Greenfield Investment and M&A : a comparison
Both the developing countries and the transition economies are rapidly integratingtheir economies to the world economic order. In the process the firms in such countriesface intensifying competition, accelerating technological change and increasinglyintegrated world production. They seriously lack two things: capital and new technology.Here lies the importance of the entry of MNC. Now a comparison of two principal modesof entry – FDI in Greenfield investment and M&A route – can be made from the perspective of the host country.It is recognized that FDI inflow in the developing country help in upgradingcompetitiveness. It is a powerful tool in case of countries where domestic technologicalcapabilities and skill are weak and that can not be raised at international level within ashort period. Even when the country is strong in availability of skill, the pace of technical change at global level is so strong that without MNC participation it becomesdifficult for the developing country to compete effectively( UNCTAD, 1999). In this caseM&A as a mode of FDI inflow is an important way to restructure and upgradecompetitive capability of the host country firm.FDI investment in both the modes – M&A and Greenfield way – adds to financialresources of the host country as neither is financed by raising resources domestically.While Greenfield investment adds new productive facility which is an addition toexisting production capacity of the economy, M&A transfer the ownership of existingasset into foreign hands. But money flows in both cases and the M&A transfer resourcesto the existing owners that can be invested in the economy. So the net financial effects arethe same in normal times except in one situation, when the acquired company is brokenup and different components are sold separately at a much higher price. This is known as
asset stripping 
in the literature. This is a sign of imperfect capital market as the latter failsto assess the true value of the assets.But in crisis situation (as in south Asia in 1997-98) many firms are sold atdepressed prices and foreign capital acquires firms in host country through M&Acheaply. This involves a cost to the host country. The cost increases and becomes a net
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