Chapter 1

Multinational Financial Management:

An Overview
Specific Objectives
Identify the main goal of the MNC and conflicts with that goal
Describe the key theories that justify international business
Explain the common methods used to conduct international business
Outline
Goals of the MNC
Maximize shareholder wealth
roblems encountered in meeting goals!
"# $gency problems larger for MNCs than purely domestic firms because!
a# monitoring more difficult because of geographic distance
b# different cultures
c# MNC size
d# subsidiary managers may maximize the %alue of their subsidiary but not of the
MNC as a whole
&# Centralized %s' decentralized management
a# centralized reduces agency costs because it gi%es parent more
control( downside is that local managers may be better
informed
b# decentralized management increases agency costs but may
result in better decisions
c# Internet may facilitate monitoring of foreign subsidiaries
)# Corporate control used to reduce agency problems
a# executi%e compensation with stock
b# threat of hostile takeo%er
c# monitoring by large shareholders
Constraints encountered in meeting goals
"# En%ironmental * other countries may be tougher +e'g', pollution
controls#
&# -egulatory * e'g', currency con%ertibility, remittance of profits, etc'
)# Ethical * e'g', bribes may be more acceptable in other countries
Theories of International Business
.heory of Comparati%e $d%antage
countries specialize in the production of goods they can produce with relati%e efficiency
and trade for other products
Imperfect Markets .heory
factors of production +labor and other resources# are immobile'
/irms can capitalize on imperfect markets by exploiting foreign opportunities'
roduct Cycle .heory
firm introduces product in home market, then exports it, then establishes a subsidiary,
then differentiates the product +see Exhibit "') on p' "0#
"
& Chapter "
International Business Methods
International .rade
export and import
low risk
Internet facilitates ad%ertising and sales
1icensing
obligates firm to pro%ide its technology in exchange for fees or other benefits +e'g',
$.2. and Nynex Corp had licensing to build and operate India3s telephone system#
no major in%estment re4uired
difficult to ensure 4uality control
Internet facilitates brand name ad%ertising
/ranchising
obligates firm to pro%ide a specialized sales or ser%ice strategy, support assistance and
possibly an initial in%estment in exchange for periodic fees
5oint 6entures
a %enture that is jointly owned and operated by two or more firms
allow firms to apply comparati%e ad%antage +e'g', 7eneral Mills and Nestle#
$c4uisitions of Existing 8perations
ac4uire a firm in a foreign country to penetrate foreign markets
ad%antage! full control o%er foreign business
disad%antage! risky because of large in%estment and uncertainty
some firms make partial ac4uisitions, but these do not allow full control e%en though they
are less risky
Establishing New /oreign 9ubsidiaries
establish new operations in foreign country to penetrate market
ad%antage! can tailor exactly to firm3s needs
disad%antage! must establish customer base, unfamiliarity with local customs
Methods re4uiring a direct in%estment are referred to as direct foreign in%estment +D/I#
includes franchising, joint %entures, ac4uisitions, and foreign subsidiaries
International Opportunities
8pportunities
higher growth potential
larger in%estment opportunity set
lower borrowing costs due to more funding sources
result in lower cost of capital and higher returns for projects
limitations!
no feasible foreign opportunities
foreign projects may be riskier than domestic ones
8pportunities in Europe
9ingle European $ct +":;<#
remo%al of =erlin >all
inception of the euro
8pportunities in 1atin $merica
N$/.$
7$..
remo%al of in%estment restrictions
8pportunities in $sia
large population base
Multinational /inancial Management! $n 8%er%iew )
Exposure to International Risk
less exposure to domestic economy
exchange rate risk
need to con%ert currencies
exposure to foreign economies
political risk
actions taken by the go%ernment that affect cash flows +e'g', expropriations, buy*outs,
etc'#
Key Terms Matching
In the following exercise, place a letter from the right column with the correct number in the left
column'
?ey .erm Definition
"' $gency roblem@@@@ a' any method of increasing international business that
re4uires a direct in%estment in foreign operations, including
foreign ac4uisitions, the establishment of foreign
subsidiaries, franchising, and joint %entures
&' Comparati%e
$d%antage@@@@
b' the existence of a conflict of goals in a corporation +where
the shareholders differ from the managers#
)' Country -isk@@@@ c' conditions under which factors of production are immobile
A' Direct /oreign In%estment
+D/I#@@@@
d' the process by which a firm pro%ides a specialized sales or
ser%ice strategy, support assistance, and possibly an initial
in%estment in the franchise in exchange for periodic fees
B' /ranchising@@@@ e' political actions taken by the host go%ernment or the public
that affect an MNC3s cash flows
C' Imperfect Markets@@@@ f' firms become established in the home market as a result of
some percei%ed ad%antage they ha%e o%er existing
competitors' /oreign demands is first met by exporting'
9ubse4uently, the firm may establish subsidiaries in the
foreign country andDor differentiate its products so that the
product remains competiti%e
<' 5oint 6enture@@@@ g' the potentially ad%erse impact of a country3s en%ironment
on the MNC3s cash flows
;' 1icensing@@@@ h' a %enture that is jointly owned and operated by two or more
firms
:' olitical -isk@@@@ i' the process by which national go%ernments sell state owned
operations to corporations and other in%estors
"0' ri%atization@@@@ j' the process by which a firm pro%ides its technology
+copyrights, patents, trademarks, or trade names# in
exchange for fees or some other specified benefits
""' roduct Cycle .heory@@@@ k' an ad%antage a country possesses in the manufacture of
goods
Answers to Key Terms Matching
1. b
2. k
3. g
. a
A Chapter "
!. d
". c
#. h
$. j
%. e
1&. i
11. f
Definitional Problems
1. $s for a purely domestic firm, the goal of a multinational corporation +MNC# is the
@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@'
2. 8ne of the most pre%alent factors conflicting with the realization of the goal of an MNC is
the existence of @@@@@@@@@@@@@@@@@'
3. $mong the constraints interfering with the realization of the goal of an MNC are
@@@@@@@@@@@@@@@, @@@@@@@@@@@@@@@, and @@@@@@@@@@@@@@ constraints'
. $ @@@@@@@@@@@@@@@ management style trades off reduced agency costs with potentially poor
decisions by parent company managers'
!. $ @@@@@@@@@@@@@@@ management style trades potentially good decisions by subsidiary
managers with increased agency costs'
". .he @@@@@@@@@@@@@ states that countries tend to use their ad%antages to specialize in the
production of goods that can be produced with relati%e efficiency, while trading for other
goods'
#. .he @@@@@@@@@@@@@ states that factors of production are somewhat immobile, allowing firms
to capitalize on a foreign country3s resources'
$. .he @@@@@@@@@@@@@ states that firms first become established in their home country and then
penetrate foreign markets %ia geographic andDor product differentiation'
%. .he least risky method of conducting international business is probably
@@@@@@@@@@@@@@@@@@@@'
1&. $ %enture jointly owned and operated by a domestic and a foreign firm is referred to as a
@@@@@@@@@@@@@@@@@@'
11. .he two primary methods of conducting international business that constitute foreign direct
in%estment are @@@@@@@@@@@@@@@@@@@ and @@@@@@@@@@@@@@@@@@@@@@'
12. Due to an increased opportunity set, the marginal return on projects for an MNC is generally
@@@@@@@@@@@ than that of a purely domestic firm' $nalogously, due to a larger opportunity
set of funding sources, the cost of capital for an MNC is generally @@@@@@@@@@@@@@ than that
of a purely domestic firm'
13. If MNCs ha%e more projects to select from and a lower cost of capital than purely domestic
firms, their size should be @@@@@@@@@@@@@@ than that of a purely domestic firm'
Multinational /inancial Management! $n 8%er%iew B
1. =y expanding internationally, a firm may be less exposed to fluctuations in the home country
economy' Ne%ertheless, MNCs occur additional risks in the form of @@@@@@@@@@@@@@,
@@@@@@@@@@@@@@@@, and @@@@@@@@@@@@@@'
Answers to Definitional Problems
1. maximization of shareholder wealth
2. agency problems
3. en%ironmental( regulatory( ethical
. centralized
!. decentralized
". .heory of Comparati%e $d%antage
#. Imperfect Markets .heory
$. roduct Cycle .heory
%. international trade +importing and
exporting#
1&. joint %enture
11. the ac4uisition of existing operations(
the establishment of new foreign
subsidiaries
12. higher( lower
13. greater
1. exchange rate risk( exposure to foreign
economic conditions( political risk
True/alse Problems
1. .he goal of a multinational corporation +MNC# is the maximization of shareholder wealth'
2. If a firm were composed of only one owner who was also the sole manager, the agency
problem would not be completely eliminated'
3. If managers of foreign subsidiaries make decisions that maximize the %alues of their
respecti%e subsidiaries, they automatically maximize the %alue of the entire corporation'
. $ centralized management style, where major decisions about a foreign subsidiary are made
by the parent company, results in an automatic increase in agency costs'
!. $ decentralized management style, where subsidiary managers make the rele%ant decisions
regarding their subsidiary, may result in better decision making, as subsidiary managers are
generally better informed about their subsidiary3s operations'
". $lthough MNCs may be confronted with additional pollution controls +an en%ironmental
constraint#, these are irrele%ant, as the MNC is fully reimbursed by the E'9' go%ernment for
any additional costs upon remittance of proper receipts'
#. $ gi%en country3s go%ernment, if it chooses to, may pre%ent the remittance of earnings by a
subsidiary to the parent company'
$. In some countries, bribes are commonplace' If a E'9'*based MNC decides to adhere to a strict
code of ethics and not pay bribes, its subsidiary may be at a competiti%e disad%antage in the
foreign country'
%. .he .heory of Comparati%e $d%antage begins by assuming that a gi%en firm first becomes
established in its home country and may subse4uently penetrate foreign markets %ia
geographic or product differentiation'
C Chapter "
1&. Ender the Imperfect Markets .heory, it is assumed that factors of production are entirely
mobile, so that firms can capitalize on a foreign country3s resources'
11. Ender the .heory of Comparati%e $d%antage, trade between countries results from the
nonproduction of certain goods in a gi%en country due to inefficiency'
12. Ender the roduct Cycle .heory, foreign demand can be initially satisfied by exporting'
13. /ranchising obligates a firm to pro%ide its technology +such as copyrights, patents,
trademarks, or trade names# in exchange for fees or some other specified benefits'
1. In a joint %enture, one firm is obligated to pro%ide another firm with a specialized sales or
ser%ice strategy in exchange for periodic fees'
1!. 1icensing allows firms to use their technology in foreign markets without a major in%estment
in foreign countries'
1". >hile allowing for the highest degree of control of foreign business, the ac4uisition of
existing operations in a foreign country andDor the establishment of foreign subsidiaries also
entail the highest degree of risk when compared to the other methods of conducting
international business'
1#. International trade is the most common form of direct foreign in%estment +D/I#'
1$. urely domestic firms face a larger opportunity set than MNCs and their projects pro%ide a
lower marginal return than projects faced by MNCs'
1%. Due to the larger opportunity set of funding sources around the world from which an MNC
can choose, an MNC may be able to obtain capital at a lower cost than a purely domestic
firm'
2&. .he 9ingle European $ct of ":;< made regulations more uniform among European countries'
Fowe%er, the cost of achie%ing this goal resulted in the imposition of additional taxes on
goods traded between these countries'
21. .he North $merican /ree .rade $greement +N$/.$# of "::) eliminated trade barriers
between the Enited 9tates and Mexico'
22. $lthough MNCs may need to con%ert currencies occasionally, they do not face any exchange
rate risk, as exchange rates are stable o%er time'
23. $ purely domestic firm may be affected by exchange rate fluctuations if it faces at least some
foreign competition'
2. $lthough the exposure of MNCs to fluctuations in the home country3s economy is less than
that of a purely domestic firm, it is more highly exposed to economic fluctuations of the
foreign country in which it operates'
Multinational /inancial Management! $n 8%er%iew <
Answers to True/alse Problems
1. .
2. /
3. /
. /
!. .
". /
#. .
$. .
%. /
1&. /
11. .
12. .
13. /
1. /
1!. .
1". .
1#. /
1$. /
1%. .
2&. /
21. .
22. /
23. .
2. .
Multiple !hoice Problems
1. .he goal of a multinational corporation +MNC# is
a' .he minimization of taxes remitted from foreign subsidiaries'
b' .he establishment of subsidiaries in any country where operations would pro%ide a return
o%er and abo%e the cost of capital, e%en if better projects are a%ailable domestically'
c' .he maximization of shareholder wealth'
d' .he maximization of social benefits resulting from actions such as the employment of foreign
managers'
2. $gency costs faced by multinational corporations +MNCs# may be larger than those faced by
purely domestic firms because
a' Monitoring of managers located in foreign countries is more difficult'
b' /oreign subsidiary managers raised in different cultures may not follow uniform goals'
c' MNCs are relati%ely large'
d' a and b only
e' all of the abo%e
3. >hich of the following is correct regarding the monitoring of foreign subsidiary managersG
a' $ centralized management style results in increased agency costs but better decision making
by subsidiary managers'
b' $ decentralized management style results in increased agency costs but poor decision making
by subsidiary managers'
c' It is generally easier for an MNC to monitor the decisions made by subsidiary managers than
it is for a purely domestic firm'
d' 9ome MNCs allow subsidiary managers to make the key decisions about their respecti%e
operations, but the decisions may be monitored by the parent3s management'
e' 9ince an MNC3s foreign subsidiaries are separate legal entities, the monitoring of subsidiary
managers is inconse4uential'
; Chapter "
. >hich of the following is not mentioned in the text as a constraint interfering with an MNC3s
goalG
a' 1egal constraints
b' En%ironmental constraints
c' -egulatory constraints
d' Ethical constraints
e' $ll of the abo%e are mentioned in the text as constraints interfering with an MNC3s goal
!. >hich of the following is not mentioned in the text as a theory of international businessG
a' .heory of Comparati%e $d%antage
b' Imperfect Markets .heory
c' roduct Cycle .heory
d' 7lobalization of =usiness .heory
e' $ll of the abo%e are mentioned in the text as theories of international business
". >hich of the following e%ents would confirm the .heory of Comparati%e $d%antageG
a' $ E'9' firm manufacturing computers imports the needed components from .aiwan'
b' $ E'9' firm manufacturing widgets builds a plant in Mexico to reduce labor costs'
c' $ E'9' firm manufacturing computers establishes a plant in 7ermany in order to reduce
transportation costs and to retain its ad%antage o%er its 7erman competitors'
d' $ll of the abo%e
e' None of the abo%e
#. >hich of the following e%ents would confirm the Imperfect Markets .heoryG
a' $ E'9' firm manufacturing computers imports the needed components from .aiwan'
b' $ E'9' firm manufacturing widgets builds a plant in Mexico to reduce labor costs'
c' $ E'9' firm manufacturing computers establishes a plant in 7ermany in order to reduce
transportation costs and to retain its ad%antage o%er its 7erman competitors'
d' $ll of the abo%e
e' None of the abo%e
$. >hich of the following e%ents would confirm the roduct Cycle .heoryG
a' $ E'9' firm manufacturing computers imports the needed components from .aiwan'
b' $ E'9' firm manufacturing widgets builds a plant in Mexico to reduce labor costs'
c' $ E'9' firm manufacturing computers establishes a plant in 7ermany in order to reduce
transportation costs and to retain its ad%antage o%er its 7erman competitors'
d' $ll of the abo%e
e' None of the abo%e
%. .he most risky method+s# by which firms conduct international business is +are#!
a' /ranchising
b' .he ac4uisitions of existing operations
c' .he establishment of new subsidiaries
d' b and c only
e' $ll of the abo%e
Multinational /inancial Management! $n 8%er%iew :
1&. .he least risky method by which firms conduct international business is!
a' /ranchising
b' .he ac4uisitions of existing operations
c' International .rade
d' .he establishment of new subsidiaries
e' 1icensing
11. >hich of the following does not constitute a form of direct foreign in%estmentG
a' /ranchising
b' International trade
c' 5oint %entures
d' $c4uisitions of existing operations
e' Establishment of new foreign subsidiaries
12. >hich of the following is not mentioned in the text as a reason for the increased globalization
of businessG
a' $n increase in 7N of %irtually all countries in recent years'
b' $n increase in international trade'
c' 7rowth in direct foreign in%estment in recent years'
d' Increased pri%atization in recent years'
e' $n increased standardization of products and ser%ices across countries in recent years'
13. >hich of the following is true regarding MNCsG
a' MNCs generally face a smaller opportunity set than purely domestic firms because it is more
costly to establish subsidiaries in foreign countries'
b' MNCs generally face a larger opportunity set than purely domestic firms due to possible cost
ad%antages andDor re%enue opportunities'
c' MNCs may be able to obtain financing at a lower cost than purely domestic firms'
d' a and c only
e' b and c only
1. >hich of the following is true regarding MNCsG
a' .he marginal return on projects faced by MNCs is always lower than the return on projects
faced by purely domestic firms'
b' .he cost of capital faced by MNCs is always larger than that faced by purely domestic firms'
c' .he cost of capital faced by MNCs is always smaller than that faced by purely domestic
firms'
d' $lthough MNCs may ha%e an ad%antage relati%e to purely domestic firms in terms of funding
sources, its cost of capital may be higher than that of a purely domestic firm because foreign
projects are riskier than domestic projects'
e' .here are always feasible foreign projects for an MNC'
1!. >hich of the following is not a pro%ision or result of the 9ingle European $ct of ":;<G
a' Increased regulatory uniformity among European countries
b' .he phasing in of a common currency for all European countries by "::&
c' .he remo%al of many taxes on goods traded between European countries
d' /irms3 ability to achie%e economies of scale
e' $ll of the abo%e
"0 Chapter "
1". >hich of the following is not mentioned in the text as an additional risk resulting from
international businessG
a' Exchange rate fluctuations
b' olitical risk
c' /inancial risk
d' Country risk
e' Exposure to foreign economies
1#. Many E'9' firms %iew @@@@@@@@@@@ as the country with the highest growth potential'
a' China
b' 5apan
c' 7ermany
d' Mexico
e' ?orea
1$. >hich of the following is not an example of how an MNC can be affected by exchange rate
mo%ementsG
a' Due to exchange rate fluctuations, the number of units of a firm3s home currency needed to
purchase foreign supplies can change e%en if suppliers ha%e not adjusted their prices'
b' >hen the home currency strengthens, products denominated in that currency become more
expensi%e to foreign customers, which may reduce foreign demand for the MNC3s products'
c' >hen the home currency weakens, products denominated in that currency become cheaper to
foreign customers, which may increase foreign demand for the MNC3s products'
d' -emitted earnings from the foreign subsidiary of a E'9'*based MNC may increase due to a
stronger home currency'
e' -emitted earnings from the foreign subsidiary of a E'9'*based MNC may increase due to a
weaker home currency'
1%. 1icensing obligates a firm to pro%ide @@@@@@@@@@@@@, while franchising obligates a firm to
pro%ide @@@@@@@@@@@@@@@'
a' $ specialized sales or ser%ice strategy( its technology
b' Its technology( a specialized sales or ser%ice strategy
c' Its technology( its technology
d' $ specialized sales or ser%ice strategy( a specialized sales or ser%ice strategy
e' Its technology( an initial in%estment
2&. In general, MNCs may be expected to ha%e a @@@@@@@@@@@ marginal return on projects than
purely domestic firms and a @@@@@@@@@@@@ cost of capital'
a' Figher( higher
b' 1ower( lower
c' 1ower( higher
d' Figher( lower
e' None of the abo%e
21. >hich of the following is not a way in which agency problems can be reduced through
corporate controlG
a' Executi%e compensation
b' .hreat of hostile takeo%er
c' $c4uisition of a foreign subsidiary
d' Monitoring by large shareholders
e' None of the abo%e
Multinational /inancial Management! $n 8%er%iew ""
Answers to Multiple !hoice Problems
1. c
2. e
3. d
. a
!. d
". a
#. b
$. c
%. d
1&. c
11. b
12. a
13. e
1. d
1!. b
1". c
1#. a
1$. d
1%. b
2&. d
21. c