Nature of International Business Environment

Learning Objectives

4.1 Introduction
4.1.1 The Forces
4.1.2 Bases for going global
4.1.3 The Frame work for analyzing International Business Environment
a).Methods
b).The PEST Analysis
c) The Macro-Environment
4.2 Political Environment
4.2.1 Types of Political Systems

4.2.2 Political Risks Of Global Business

4.2.3 Forecasting Political Risks

4.2.4 Good Corporate Citizenship

4.2.5 Strategies To Lessen Political Risks

4.2.6 Government Encouragement Of Global Business

4.2.7 Instruments used by government for trade control

4.2.8 The Impact of the Political System on Management Decisions
4.2.9 Formulating and Implementing Political Strategies
4.2.10 Governmental Influence On Trade
4.3 Legal Environment
4.3.1 Origins of International Law
4.3.2 Sources of International Law
4.3.3 International Dispute Resolution
4.3.4 Types of Legal Systems
4.4 Technological Environment

4.4.1 Technological phases in production

4.4.2 Benefits of Technology in Management Decision Making
4.4.4 Effect of Technology on Strategy & Competition
4.4.5 Features of Technology
4.4.6 Diffusion of Technology
4.4.7 The Technological Cycle
 4.4.8 Business Implications of Technology

4.5 Cultural Environment

4.5.1 The Concept Of Culture
4.5.2 Behavioral Practices Affecting Business
4.5.3 Reconciliation Of International Differences

4.5.4 The Elements of culture

4.6 Country Classifications
4.7 Economic Environment
4.7.1 Economic Environment
4.7.2 Classifying Economic Systems
4.7.3 Economic Trade Policies (Protectionism)

Learning Objectives
After reading this unit you should be able to
 Understand the nature of international business environment
 Understand the different forces acting upon international business
 Understand political environment and its implications on international
business
 Ascertain the legal practices in different countries
 Understand what difference technology can create and know various
technological tools used in international business
 Understand different cultures of the world and its impact on international
business
 Understand different economic policies.
Introduction

Business has fascinated man down the centuries, starting form barter system to
the global business. Business plays a pivotal role in the growth of the economy
of any nation. Because of the explosion of knowledge and invention of Internet,
time and distance are shrinking globally and the world has become a global
village.
In developing countries like India the traditional business are affected by
MNC‘s and many Indian firms are forced to compete with the global firms, and
it‘s the game of The survival of the fittest, and many local companies are forced
to merge with global firms Eg. Vishya bank has merged with ING forming ING
Vishya Bank, ICICI Bank has merged with Prudential forming ICICI Prudential
Life insurance etc.
As part of their expansion in international markets Indian firms like M.T.R,
Ranbaxy, Dabur, L.I.C, S.B.I etc are on their toes to globalize their operations.
In simple terms, the products which we use, in our day-to-day life are either
imported from other countries are produced in India in collaboration with
companies in other countries so international business is the process of
exchanging goods and services internationally for value.
4.1 Nature of International Business Environment
The business operations performed without any barriers, with the
implementation of L.P.G (Liberalization, Privatization, Globalization) there is
boom in the global business and the trade barriers have been liberalized.
This has given rise to
 Attracted F.D.I Foreign direct investment
 Encouraged flexible import and export policies
 Import of jobs in the field of I.T enabled services (B.P.O)
 Increase in foreign currency reserves
 Improved standard of living
 Increase in purchasing power
 Improved quality of goods and services
Today, any company which is going globally need to assess different
environmental factors like economic, technological, political, cultural, legal and
design their operations.
To understand the international business environment we divide the terms

International
Integration and interrelation of different nations.

Business
Systematic effort of an organization to meet the needs of customers with goods
and services for profit.

Environment
Environment is surroundings which we live in, the external forces acting upon
the business is business environment.
The environment includes the factors outside the firm, which can lead to
opportunities for or threats to the firm. These factors can be economic,
technological, political, cultural etc.
Thus international business environment is the business operations in different
countries with different external forces acting upon them.
Environment is further classified as domestic environment, foreign environment,
and international environment

Domestic Environment
Forces with in a country, which are very familiar and which are controllable or
uncontrollable

Foreign Environment
Forces outside the country, which are not very familiar and which are
controllable or uncontrollable
International Environment
Forces acting on business from different nations which are not familiar and
which are controllable or uncontrollable

4.1.1 The Forces

Forces acting upon business are classified as follows

Internal Environmental Forces

Forces with in the organization, which are controllable, like production, finance,
marketing, human resources research and development etc

External Micro Environmental Forces

Forces outside the organization, which are controllable, like competitors,
suppliers, creditors, consumers, financial institutions etc

External Macro Environmental Forces

Forces outside the organization, which are uncontrollable, like political
environment, legal environment, technological environment, economic
environment, cultural environment etc

External Macro Environmental Factors

Political Legal Technological

External Micro Environmental Forces

Competitors Suppliers

Internal Environmental Forces

Production Human
Resources
Busine
Finance ss
R&D
Marketing

Customers Creditors
Fig 4.1 Environmental Forces acting on Business

4.1.2 Basis for going global

a) Arability of Highly Skilled & Cheap Labour

India is a country with the potential of highly skilled human resources with
comparatively cheaper labour, which has attracted many M.N.C ‗s from U.S.A
and U.K to outsource these resources from India which will cut short their heavy
expenditure on wage and salary. Eg. T.I enabled services outsourced form India,
business process outsourcing (B.P.O) , knowledge process outsourcing (K.P.O),
recently legal process outsourcing (L.P.O)
b) Bigger Pie in Market Share
To increase the market share of the firm many companies are going global eg. In
1888, less than four years after William Hesketh Lever launched Sunlight Soap
in England, his newly-founded company, Lever Brothers, started exporting the
revolutionary laundry soap to India. By the time the company merged with the
Netherlands-based Margarine Unie in 1930 to form Unilever, it had already
carved a niche for itself in the Indian market. Coincidentally, Margarine Unie
also had a strong presence in India, to which it exported Vanaspati
(hydrogenated edible fat).
A year after the merger, Unilever set up the Hindustan Vanaspati Manufacturing
Company, its first subsidiary in India and went on to strengthen its position by
establishing two more subsidiaries, Lever Brothers India Limited and United
Traders Limited, soon afterwards. The three companies, which marketed Soaps,
Vanaspati and Personal Products, merged in 1956 to form Hindustan Lever
Limited

c) Sever Competition in Home Country

Due to many players in the home country and the increase in competition the
weaker companies, which are unable to withstand competition has moved its
operations to other countries

d) Quality Improvement and new product development

To improve the quality of existing products and developing new products the
companies with joint collaboration with companies of other countries has gone
globally eg. M.R.F a leader in Indian tyres market has entered into a technical
collaboration with the B.F. Goodrich Tyre Company of USA, which was
involved with the development of tyres for the N.A.S.A space-shuttle. With this
began a significant exercise in quality improvement and new product
development.

e) To Reach Higher Profits Level

To reach higher levels of profits the companies has expanded globally.eg The
roots of Nokia go back to the year 1865 with the establishment of a forest
industry enterprise in South-Western Finland by mining engineer Fredrik
Idestam. Elsewhere, the year 1898 witnessed the foundation of Finnish Rubber
Works Ltd, and in 1912 Finnish Cable Works began operations. Gradually, the
ownership of these two companies and Nokia began to shift into hands of just a
few owners. Finally in 1967 the three companies were merged to form Nokia
Corporation. Today we find Nokia in every part of the globe.
f) Free Trade Policies
The North American Free Trade Agreement (NAFTA) has lifted all the trade
barriers among U.S.A, Canada and Mexico which has enabled companies to
expand their operations among those countries eg. General Motors has 284
operations in 35 states and 158 cities in the United States. In addition GM of
Canada operates 21 locations, GM de Mexico operates 5 locations, and GM has
assembly, manufacturing, distribution or warehousing operations in 49 other
countries, including equity interests in associated companies.

g) Availability of Abundant Raw Materials

India is rich in natural resources like coal, iron etc which is attracting many
foreign companies to establish their facility. Eg. Volkswagan and Nokia are
planning to establish their facility in India

h) Government Regulations
Business firms prefer to enter the countries where there are flexible government
policies, which will not change because of political instability. Countries like
U.S.A has stable government policies which will attract business firms to enter
into their country eg. All the U.S automobile industry is flooded by Japanese
automobile companies like Toyota because of stable government regulations.

i) Availability of Technology
To keep abreast of world technology and to protect its competitive edge, Asian
Paints has from time to time entered into technology alliances with world
leaders in the paint industry. It has a 50:50 joint venture with Pittsburgh Paints
& Glass Industries (PPG) of USA , the world leader in Automotive coatings, to
meet the increasing demand of the Indian automotive industry.
j) Limited Home Market

Toyota motors of Japan has extended its base to U.S and India because of
limited home market and U.S and India has got a greater demand for
Japanese automobiles.
4.1.3 The Frame work for analyzing International Business Environment

a). Methods

There are three ways of scanning the International business environment:

 Ad-hoc scanning - Short term, infrequent examinations usually initiated

by a crisis
 Regular scanning - Studies done on a regular schedule (say, once a
year)
 Continuous scanning - (also called continuous learning) - continuous
structured data collection and processing on a broad range of
environmental factors .

Most commentators feel that in today's turbulent business environment the

best scanning method available is continuous scanning. This allows the firm
to act quickly, take advantage of opportunities before competitors do, and
respond to environmental threats before significant damage is done.

b). PEST analysis

PEST analysis stands for "Political, Economic, Social, and Technological

analysis" and describes a framework of macroenvironmental factors used in
environmental scanning. It is also referred to as the STEP, STEEP or PESTLE
analysis (Political, Economic, Socio-cultural, Technological, Legal,
Environmental). Recently it was even further extended to STEEPLED, including
ethics and demographics.
It is a part of the external analysis when doing market research and gives a
certain overview of the different macroenvironmental factors that the company
has to take into consideration. Political factors include areas such as tax policy,
employment laws, environmental regulations, trade restrictions and tariffs and
political stability. The economic factors are the economic growth, interast rates,
exchange rates and inflation rate. Social factors often look at the cultural aspects
and include health consciousness, population growth rate, age distribution,
career attitudes and emphasis on safety. The technological factors also include
ecological and environmental aspects and can determine the bassiers to entry,
minimum efficient production level and influence outsourcing decisions. It looks
at elements such as R&D activity, automation, technology incentives and the
rate of technological change.

The PEST factors combined with external microenvironmental factors can be

classified as opportunities and threats in a SWOT analysis

Political Environment
Economic Environment

Business

Technological
Environment
Social
Environment
Fig 4.2 PEST analysis
A PESTLE analysis of Tesco must consider all the factors affecting a large supermarket company.

A PESTLE analysis, in general, must create a good overall picture of the external impacts on an
organisation by breaking them into useful, and obvious, categories.
In Jamie Oliver's world, a pestle is a bowl in which different ingredients are mixed together to
create an overall good result. That's exactly what a PESTLE analysis aims to achieve. It looks
at all the "ingedients" that affect a company and tries to mix them together to create a tasty dish.
The external factors affecting a company range from the political to the environmental. The
political impacts can be local, national or international. Many governments can be involved.
For instance, Tesco might have to deal with British and Columbian politics in regards to its
coffee supply.
Economic factors have a large impact. Fluctuations in the stock market, or tax increases, can
seriously affect the bottom line of a company like Tesco
Sociological factors are more subtle, but still important.
Less subtle are the obvious impacts new technologies can have on a large corporation. For
instance, online shopping has become a major factor in Tesco's recent success. The nexus of
change created by all these factors lead to many legal problems, which keep the lawyers busy.
Last, but not least, any large organisation has a massive environmental impact. For instance,
Tesco uses up vast amounts of fossil fuel in its transport network. Reducing this demand on
planetary resources is a major challenge for Tesco and similar organisations.
Any PESTLE Analysis for Tesco, must consider each external factor in detail, and how their
impact continually changes. Examples of possible drastic changes that could affect Tesco in the
next few years or decades:
Political: government bans the sale of alcohol to people over the age of 21.
Economic: the government decides to put a tax on food.
Sociological: Tesco moves into Russia, tries to adapt to the different shopping patterns of the
native population..
Technological: Hydrogen powered lorries impact on Tesco's distribution costs.
Legal: Mad cow disease has a long term impact. How can Tesco avoid paying large
compensation claims?
Environmental: Climate change decimates Tesco's third world suppliers. How can it adapt?
Case Study 4.1

c) The Macroenvironment
Environmental scanning usually refers just to the macroenvironment, but it can
also include industry and competitioe analysis, consumer analysis, product
innovations, and the company's internal environment. Macroenvironmental
scanning involves analysing:

The Economy
 GNP or GDP per capita
 GNP or GDP growth
 Unemployment rate
 Inflation rate
 Consumer and investor confidence
 Inventory levels
 Currency exchange rates
 Merchandise trade balance
 Financial and political health of trading partners
 Balance of payments
 Future trends

Government
 Political climate - amount of government activity
 Political stability and risk
 Government debt
 Budget deficit or surplus
 Corporate and personal tax rates
 Payroll taxes
 Import tariffs and quotas
 Export restrictions
 Restrictions on international financial flows

Legal
 Minimum wage laws
 Environmental protection laws
 Worker safety laws
  Union laws
 Copyright and patent laws
 Anti- monopoly laws
 Sunday closing laws
 Municipal licences
 Laws that favour business investment

Technology
 Efficiency of infrastructure, including: roads, ports, airports, rolling
stock, hospitals, education, healthcare, communication, etc.
 Industrial productivity
 New manufacturing processes
 New products and services of competitors
 New products and services of supply chain partners
 Any new technology that could impact the company
 Cost and accessibility of electrical power

Ecology
 Ecological concerns that affect the firms production processes
 Ecological concerns that affect customers' buying habits
 Ecological concerns that affect customers' perception of the company or
product

Socio-Cultural
Demographic factors such as:
 Population size and distribution
 Age distribution
 Education levels
 Income levels
 Ethnic origins
 Religious affiliations
Attitudes towards:
 Materialism, capitalism, free enterprise
 Individualism, role of family, role of government, collectivism
 Role of church and religion
 Consumerism
 Environmentalism
 Importance of work, pride of accomplishment
Cultural structures including:
 Diet and nutrition
 Housing conditions
Potential suppliers
 Labour supply
 Quantity of labour available
 Quality of labour available
 Stability of labour supply
 Wage expectations
 Employee turn-over rate
 Strikes and labour relations
 Educational facilities

Material suppliers
 Quality, quantity, price, and stability of material inputs
 Delivery delays
 Proximity of bulky or heavy material inputs
 Level of competition among suppliers

Service Providers
 Quantity, quality, price, and stability of service facilitators
 Special requirements
Scanning these macroenvironmental variables for threats and opportunities
requires that each issue be rated on two dimensions. It must be rated on its
potential impact on the company, and rated on its likeliness of occurrence.
Multiplying the potential impact parameter by the likeliness of occurrence
parameter gives us a good indication of its importance to the firm

Activity 4.1
Visit an MNC and study the method used by the firm to study the
macroenvironmentmental forces acting on the firm and list the forces
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
______________________________________________

4.2 Political Environment

The critical concern Political environment has a very important impact on every
business operation no matter what its size, its area of operation. Whether the
company is domestic, national, international, large or small political factors of
the country it is located in will have an impact on it. And the most crucial &
unavoidable realities of international business are that both host and home
governments are integral partners. Reflected in its policies and attitudes toward
business are a governments idea of how best to promote the national interest,
considering its own resources and political philosophy. A government control's
and restricts a company's activities by encouraging and offering support or by
discouraging and banning or restricting its activities depending on the
government. Here steps in international law. International law recognizes the
right of nations to grant or withhold permission to do business within its
political boundaries and control its citizens when it comes to conducting
business. Thus, political environment of countries is a critical concern for the
international marketer and he should examine the salient features of political
features of global markets they plan to enter.

The Sovereignty Of Nations

From the international laws point of view a sovereign state is independent and
free from external control; enjoys full legal equality; governs its own territory;
selects its own political, social, economic systems; and has the power to enter
into agreements with other nations. It is extension of national laws beyond a
country's borders that much of the conflict in international business arises.
Nations can and do abridge specific aspects of their sovereign rights in order to
coexist with other countries. Like the European Union, North American Free
Trade Agreement (NAFTA) are examples of nations voluntarily agreeing to give
up some of their sovereign rights in order to participate with member nations for
common, mutually beneficial goals.
The ideal political climate for a multinational firm is stable, friendly
environment. Unfortunately, that is never really the case, it's not always friendly
and stable. Since foreign businesses are judged by standards as variable as there
are nations, the friendliness and stability of the government in each country must
be assessed as an ongoing business practice.

Stability Of Government Policies

The most important of the political conditions that concern an international
business is the stability or instability of the prevailing government policies.
Political parties may change or get reelected but the main concern for MNCs is
the continuity of the set rules or code of behavior regardless of the party in
power. A change in the government does not always mean change in the level of
political risks. In Italy the political parties have changed 50 times since the end
of World War II but the business continues to go on as usual inspite of the
political turmoil. In comparison is India, where the government has changed 51
times since 1945 but however much of the government policies remain hostile to
foreign investments. Conversely, radical changes in policies toward foreign
business can occur in the most stable of the governments. Some of the African
countries are among the unstable with seemingly unending civil wars, boundary
disputes and oppressive military regimes. Like one of the region with the
greatest number of questions concerning long-term stability is Hong Kong as
since China has gained control, the official message is that nothing will change
and thus everything is seemingly going smoothly but the political analysts say
that it is too early to say how will the business climate change, if it will. If there
is potential for profit and if given permission to operate within a country, MNCs
can function under any type of government as long as there is some long-term
predictability and stability.

Political Parties
Particularly important to the marketer is the knowledge of all philosophies of all
major political parties within a country, since anyone might become dominant
and alter prevailing attitudes. In those countries where there are two strong
political parties where usually one succeeds the other, it is important to know the
direction each of the parties is likely to take. Changes in direction a country may
take toward trade and related issues are caused not only by political parties but
also by politically strong interest groups and factions within different political
parties, which cooperate to affect trade policies.

4.2.1 Types of Political Systems

a). Democracy
Democracy is for the people, by the people, and of the people, its similar to
participative management, in this system people are encouraged to participate in
decision making, a peoples representative can be selected by the people through
a process of election, and the responsibility of leading the nation is kept on the
shoulders of the elected representative. Eg. India
b). Dictatorship

It is also called as authoritarianism, which is quite opposite to democracy, here

the hole power is in the hands of the leader, and people should follow the leader,
all the policies related to economy, business etc are governed by the leader. Eg
Saudi Arabia

4.2.2 Political Risks Of Global Business

a) Confiscation
The most severe political risk is confiscation, which is seizing of company's
assets without payment.
b) Expropriation
Which requires reimbursement, for the government seized investment.

c) Domestication
Which occurs when host country takes steps to transfer foreign investments to
national control and ownership through series of government decrees.
A change in the government's attitudes, policies, economic plans and
philosophies toward the role of foreign investment is the reason behind the
decision to confiscate, expropriate or domesticate existing foreign assets.

Assessing Political Vulnerability

Some products are more politically vulnerable than others, in that they receive
more government attention. This special attention may result in positive or
negative actions towards the company. Unfortunately there are no absolute
guidelines for marketer's to follow whether the product will receive government
attention or not.
Politically Sensitive Products
There are some generalizations that help to identify the tendency for products to
be politically sensitive. Products that have an effect upon the environment
exchange rates, national and economic security, and the welfare of the people
are more apt to be politically sensitive. For products judged non essential the
risk would be greater, but for those thought to be making an important
contribution, encouragement and special considerations could be available.

4.2.3 Forecasting Political Risks

A number of firms are employing systematic methods of measuring political
risk. Political risk assessment can:
 Help managers decide if risk insurance is needed
 Devise and intelligence network and an early warning system
 Help managers develop a contingency plan
 Build a database of past political events for use by corporate
management Interpret the data gathered and getting forewarnings about
political and economic situations

Reducing Political Vulnerability

Even though the company cannot directly control or alter the political
environment, there are measures with which it can lessen the susceptibility of a
specific business venture.

4.2.4 Good Corporate Citizenship

A company can reduce its political vulnerability by being a corporate citizen and
remembering:
1. It is a guest in the country and should act accordingly
2. The profits are not it's solely, the local employees and the economy of
the nation should also benefit.
3. It is not wise to try and win over new customers by totally
Americanizing them.
4. A fluency in the local language helps making sales and cementing good
public relationships.
 5. It should train its executives to act appropriately in the foreign
environment.

4.2.5 Strategies To Lessen Political Risks

MNCs can use other strategies to minimize political risks and vulnerability.
They are:
 Joint ventures
 Expanding the investment base
 Marketing and distribution
 Licensing
 Planned domestication
 Political payoffs

4.2.6 Government Encouragement Of Global Business

Foreign Government Encouragement

Governments also encourage foreign investment. The most important reason to

encourage investment is to accelerate the development of an economy. An
increasing number of countries are encouraging investments with specific
guidelines toward economic goals. MNCs may be expected to create local
employment, transfer technology, generate export sales, stimulate growth and
development of the local industry.

National Government Encouragement

The US government is motivated for economic as well as political reasons to
encourage American firms to seek opportunities in the countries worldwide. It
seeks to create a favorable climate for overseas business by providing the
assistance by providing the assistance that helps minimize some of the
troublesome politically motivated financial risks of doing business abroad.

Basic ways government controls trade

Economic Rationales for Governmental Intervention
 Unemployment
 Protection of infant industry
 Using intervention to increase industrialization
 Economic relationships with other countries
Non-Economic Rationales for Governmental Intervention
 Maintaining essential industries
 "Unfriendly" countries
 Maintaining spheres of influence
 Preserving culture and national identity

4.2.7 Instruments used by government for trade control

Trade Restrictions / Trade Barriers

 Dumping
 Subsidies
 Countervailing Duties
 Tariffs
 Quotas
 VERs - Voluntary Export Restraints

Tariffs and the "Political Environment"

"The United Steelworkers union [in Canada] wants provincial governments to

lobby Ottawa to protect the country's steel industry now that federal officials
have decided against penalizing low-cost imports....A spokesperson for Finance
Minister John Manley confirmed yesterday that the government had decided
against imposing tariffs on steel imports"
Canadian Press (as quoted by the Toronto Star 2003 Oct 7th) reported
This is a part of the "Political Environment" because if the Steelworkers do not
get tariffs they may go on strike, or they may work to make sure the local
Member of Parliament is not re-elected in that constituency. If the governing
party [in the case the liberals] really needs to hold that constituency they may
give in

Non-Tariff Barriers

 Subsidies
 Aid (loans and grants)
 Customs valuation
 Quotas
 "Buy national" policies
 Standards
 Trade sanctions

The WTO Initiative

The WTO has become increasingly involved in dealing with the "challenging"
area of non-tariff barriers. It is challenging because more and more countries are
trying to show they will abide by bi-lateral and multi-lateral trade agreements so
they cut tariffs - but at the same time, domestic political pressure cause the
politicians to think of ways they can erect non-tariff barriers to still keep out
lower priced foreign products, so that domestic industries can still sell
competitively to their citizens.
 Case: The Taipan's Dilemma

Hong Kong comprises Hong Kong Island, Kowloon Peninsula and

the New territories. Mutual distrust and misunderstanding
between the Chinese and foreigners. Trade with foreigners
restricted to the port of Macao Around the early 1830s, trade
between Britain and China became particularly important (tea
for opium). Three opium wars. Netted for the British
temporary ownership of Hong Kong. Lease expired June 30,
1997. The new arrangement, China assumed control of Hong
Kong, two systems Hong Kong will retain its separate
political and economic status for 50 years. Democracy has
never been a major part of the political landscape in Hong
Kong. Given the political instability in Hong Kong, why don't
more companies leave? Hong is the world's eighth-largest
trading nation, boasts a higher per capita income than
Britain, has one of the world's lowest tax rates. It was once
a heaven for low cost manufacturing. Manufacturing jobs are
moving to China. Singapore is trying to grab away business
from Hong Kong.

Case Study 4.2

4.2.8 The Impact of the Political System on Management Decisions

Managers must deal with varying degrees of governmental intervention and
varying degrees of political stability.
Managers must understand the critical functions that a government performs in
the economy.
In a democracy, for instance:
a) Protect the liberty of its citizens
b) Promote the common welfare of its citizens
c) Provide for public goods
d) Handle market defects ; and spillover effects
The political process also affects international business through laws that
regulate business activity at both the domestic and international levels.
In addition government action is not always consistent.
For instance in the U.S. at least three government agencies share responsibility
for regulating nonagricultural exports (The Department of Commerce; The State
Department; and the Department of Defense).
4.2.9 Formulating and Implementing Political Strategies
Political action always is a sensitive area. However, there are certain steps that a
company must follow if it wants to establish an appropriate political strategy:
a) What is the specific issue facing the firm - protectionism, environmental
rights, worker rights?
b) Assess the potential political action of other companies and of special interest
groups.
c) Identify important institutions and key individuals
d) Formulate strategies and implement

Case: United States - Japanese Auto Trade

Imports started in 1973
VERs: ceiling 1.68 million cars (Voluntary Export Restraints)
Arguments for helping the U.S. industry:
- The costs of unemployment are higher than the increased
costs to consumers
- Help overcome temporary problems
Antiprotectionists: blame poor management and taxpayers should
not be expected to reward the companies
Efforts to penetrate the Japanese market

Case Study 4.3

4.2.10 Governmental Influence On Trade

The Rationale For Governmental Intervention
a) Unemployment

Import restrictions may lead to retaliation by other countries, may decrease

export jobs. Loss of jobs in industries that rely on imported Products
Cost of protectionism: higher prices, low quality, lack of Innovation
b) Infant Industry Argument
Production becomes more competitive over time because of increased
economies of scale and greater workers efficiency
c) Industrialization Argument
Countries seek protection to promote industrialization Because:
a) Brings faster growth than agriculture
b) Diversifies the economy
c) Brings more price increases than primary products do.
d) Shifting Workers from Agriculture into Manufacturing
a) Output increases if the marginal productivity of agricultural workers is very
low.
b) Social concerns
e) Promoting Investment Inflows
Import restrictions increase direct investment
f) Diversification
g) Terms of Trade
Deterioration of terms of trade may prompt countries to protect and promote
industrialization
h) Import Substitution versus Export Promotion
Export-Led Development
i) Balance-of-Payments Adjustments
-Countries may choose to restrict the least essential Imports
-Export restrictions
- Import Restrictions may prevent dumping
j) Maintaining Essential Industries
k) Preserving Cultures and National Identity

Activity 4.2
Visit an MNC and study the impact of political system on management’s
decision making
________________________________________________________________
________________________________________________________________
________________________________________________________________
Activity 4.3
List out the instruments used by Indian government to control the trade
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
4.3 Legal Environment
All business occurs within a particular legal and regulatory environment
the current legal environment in the United States spins on a variety of complex
issues that have an impact on business: international trade, capital gains taxes,
unemployment, aging baby boomers, technology, employment laws, and social
concerns such as health care, child care, and job training. This legal tapestry
means businesses must be even more vigilant to include consideration of the
legal environment in their strategic planning. The legal environment is well
recognized as one of the most significant influences with which strategic plans
must contend.
4.3.1 Origins of International Law
There is no comprehensive system of laws or regulations for guiding business
transactions between two countries. The legal environment consists of laws and
policies from all countries engaged in international commercial activity. Early
trade customs centered around the law of the sea and provided, among other
things, for rights of shipping in foreign ports, salvage rights, and freedom of
passage. During the Middle Ages, international principles embodied in the lex
mercatoria (law merchant) governed commercial transactions throughout
Europe. Although laws governing international transactions were more
extensive in some countries than others, the customs and codes of conduct
created a workable legal structure for the protection and encouragement of
international transactions. The international commerce codes in use today in
much of Europe and in the United States are derived in part from those old
codes.
4.3.2 Sources of International Law
The main sources of international commercial law are the laws of individual
countries, the laws embodied in trade agreements between or among countries,
and the rules enacted by a worldwide or regional organization—such as the
United Nations or the European Union. There is no international regulatory
agency or system of courts universally accepted for controlling international
business behavior or resolving international conflicts among businesses or
countries. International law can be enforced to some degree through (1) the
International Court of Justice, (2) international arbitration, or (3) the courts of an
individual country. However, the decisions of those tribunals in resolving
international business disputes can be enforced only if the countries involved
agree to be bound by them.
a) International Trade Agreements
Countries improve economic relations through trade agreements that cover a
variety of potential commercial problems. This helps the investment and trade
climates among countries. For example, virtually all industrialized countries
have bilateral tax agreements to prevent double taxation of individuals and
businesses. Two important trade agreements for the U.S. are the North American
Free Trade Agreement (NAFTA) and the World Trade Organization (WTO)
b) North American Free Trade Agreement
NAFTA is a treaty that was ratified by the legislatures in Canada, Mexico, and
the U.S. and went into effect in 1994. It reduces or eliminates tariffs and trade
barriers among those nations. Although some tariffs were eliminated
immediately, many are phased out through the year 2009. The industries most
affected include agricultural products, automobiles, pharmaceuticals, and
textiles. NAFTA will create the largest free trade area in the world; 360 million
people. NAFTA includes a variety of issues not usually found in trade
agreements, such as protection of intellectual property and the environment, and
the creation of special panels to resolve disputes involving unfair trade practices,
investment restrictions, and environmental issues. NAFTA could eventually
include North and South America; 850 million people with over $18 trillion in
annual purchasing power.

c) World Trade Organization

For 48 years, GATT worked to reduce trade barriers imposed by governments.
GATT focused on trade restrictions (import quotas and tariffs); it published
tariff schedules to which its signers agreed. Tariff schedules were developed in
multinational trade negotiations or ―rounds.‖ In the most recent round—the
Uruguay Round—124 nations participated. GATT was replaced by the WTO,
one of the most significant developments of the last round. Since 1995, WTO
has overseen the trade agreement and has a dispute-resolution system, using
three person arbitration panels. The panels follow strict schedules for rendering
decisions. WTO members cannot veto decisions, unlike before (unless they
withdraw from the agreement). The latest round will eventually lower world
tariffs by 40 percent. The U.S., Japan, members of the EU, and other
industrialized nations agreed to eliminate all tariffs in 10 industries:
Beer
Construction equipment
Distilled spirits
Farm machinery
Furniture
Medical equipment
Paper
Pharmaceuticals
Steel
Toys
The WTO agreement provides world protection for intellectual property; 7 years
of protection for trademarks, 20 years for patents, and up to 50 years for
copyrights (generally moving to 75 years plus in most places). Only in the film
and television industry was the U.S. not able to gain a barrier to trade reduction
in Europe. France was particularly adamant about maintaining the barrier
because of its concerns about the heavy cultural influence of such programming
(and the demise of the not very successful French film industry).
d) Import Policy
Countries have long imposed restrictions or prohibitions on the importation and
exportation of certain products. In addition, export laws and regulations are
often enacted to encourage international business activity by domestic
industries.
e) Taxes on Imports
Restrictions on imports may be imposed to generate revenue for the government
or to protect domestic industries from foreign competition. Import licensing
procedures, quotas, testing requirements, safety and manufacturing standards,
government procurement policies, and complicated customs procedures are all
ways to regulate imports. The most common means of regulating imports into a
country is through tariffs.
Tariff Classes
A tariff is a duty or tax levied by a government on imports. Tariffs can be
classified into:
Specific Tariffs which impose a fixed tax or duty on each unit of the product,
Ad Valorem Tariffs which impose a tax based on a percentage of the price of
the product. In the U.S. the duty or tax is published in the Tariff Schedules that
apply to all products entering U.S. ports. Customs officials classify products and
determine the tariff rates when products enter the country. Any tariff imposed
must be paid before the good may enter the country. Most disputes that occur in
this area arise over the classification of products under the tariff schedules.
f) Import Controls
The Department of Commerce, the International Trade Administration (ITA),
and the International Trade Commission (ITC) have certain abilities to restrict
foreign imports. The agencies are concerned with foreign companies that
practice ―dumping‖ or receive a subsidy from their governments to lower their
costs of production. The agencies may also restrict imports in the absence of
dumping or subsidies. As barriers to trade are lowered, some domestic industries
and their workers face economic hardships due to foreign competition. The ITC
can temporarily restrict imports to provide those industries with an opportunity
to adjust to the new competitive environment created by the lower trade barriers.
Antidumping Orders—Under both the WTO and U.S. antidumping laws,
dumping ―is the business practice of charging a lower price in the export market
then in the home market, after taking into consideration important differences in
the sale (such as credit terms and transportation) and the goods being sold.‖ This
was first prohibited in 1916, when Congress enacted the Antidumping Duty
Act. If a company is dumping goods in the U.S., an antidumping order will be
issued. Goods from the company are subject to payment of an antidumping duty
(tax). The amount of the duty is determined by comparing the market price in
the company‘s home market with the price charged in the U.S. The percentage
difference between the home and U.S. markets will form an ad valorem duty to
be applied to the price when sold in the U.S. This duty is paid to Customs by
cash deposit at the port, normally by the importer. Duty orders generally remain
in place until the importer has demonstrated three consecutive years of ―fair
market value‖ sales and Commerce is convinced there is a low likelihood of
―less than fair market value‖ sales in the future.

g) Export Regulation and Promotion

Most governments encourage exporting to stimulate domestic employment and
bring in foreign exchange. This is believed needed to help prevent a trade
deficit. at the same time, for policy reasons, it a governments may restrict
exports of certain products.

Export Restrictions
The U.S. imposes restrictions on the sale of a good or a technology may
a) Injure domestic industry (e.g., the export of a raw material in short
supply),
b) Jeopardize national security (e.g., selling military hardware to the wrong
country)
c) Conflict with national policy (e.g., selling goods to a country the
government has embargoed because of terrorist activities).
Restrictions are managed by licensing according to terms of the Export
Administration Act (EAA).Commerce imposes licensing requirements under
strict standards. Licensing Agreements. The EAA allows Commerce to require
the following export licenses, depending on the type of good or technology
being exported:
1) A validated license, authorizing a specific export;
2) A qualified general license, authorizing multiple exports;
3) A general license that applies to most U.S. goods; and
4) Other licenses as may assist in the implementation of the Act.
The Commodity Control List lists products subject to licenses and the
restrictions imposed. Goods not on the List are subject to a general license—
which often only requires a Shipper‘s Export Declaration filed with Commerce.
A validated export license is required for the export of certain goods on the List
because of national security. Commerce may impose controls ―only to the extent
necessary to restrict the export of goods and technology which would make a
significant contribution to the military potential of any other country or
combination of countries which would prove detrimental to the national security
of the United States.‖ Application to Reexported U.S. Goods. Commerce‘s
licensing requirements apply to the reexport of U.S. goods. That is, an export
license is needed to ship U.S.-origin controlled goods from say, India to Taiwan.
This is to stop shipment of sensitive goods from the U.S. to a ―safe‖ country and
then to a controlled country.

Case: International Perspective: Controlling International Pirates

The U.S. International Trade Commission estimates that pirates (companies or

individuals that copy or clone) cost U.S. industry more than $100 billion in
lost profits each year. Microsoft Corporation found an extensive network
pirating its Windows software. The group was talented enough to even copy
the hologram used to discourage pirating. Microsoft filed a lawsuit privately
and elicited the
assistance of the International Trade Commission to sanction Taiwan (the
location of the pirating organization). For the computer industry, pirating is
one of the most serious problems facing management.

Case Study 4.4

h) Foreign Corrupt Practices Act

Government is more involved in business in many countries than in the U.S.
When approval of business action is at the discretion of a government official,
the likelihood of corruption rises. Scandals shook many countries in the 1990s,
notably in Italy, Japan, and Korea. The Foreign Corrupt Practices Act (FCPA)
prohibits U.S. companies from bribing foreign officials. A study of U.S.
companies by the SEC found the practice was wide spread—over 400
companies (117 were Fortune 500 companies) admitted making bribes to
foreignofficials.
Corruption
Many countries are rife with corruption; even the U.S. only gets a score of 7.5
on a 10 point scale used by experts on international corruption of government
officials.

i) International Antibribery Movement

The U.S. encourages other countries to enact antibribery laws, but until recently
has been the only nation with such a law. Numerous other nations have agreed
in principle to the Convention on Combating Bribery of Foreign Officials, but
while Congress ratified the treaty in 1998, other countries have been slow to act.
j) Antibribery Provisions
The FCPA prohibits U.S. companies from ―corruptly‖ paying or offering
to pay a ―foreign official‖ to gain assistance in obtaining or retaining business.
The Act also prohibits payments to a person—such as a foreign agent—when
the payment will go to bribe an official. The ability to know of such payments
by an agent is controversial. An exception is made for a payment that is a
―facilitating or expediting payment ... the purpose of which is to expedite or
secure the performance of a routine government action.‖ Routine actions may
include processing visas and providing utilities. The basic test of whether the
bribe is allowed focuses not on the person to whom payment is made, but on the
purpose for which payment is made. It is complicated by the fact that payments
are often made by local freight forwarders or other service organizations without
the knowledge of the U.S. manager.
k) International Contracts
The basis for any international agreement is the contract between parties.
International contracts often involve parties from differing cultural backgrounds
who do not know each other well at the outset of negotiations.
i) Cultural Aspects
Sensitivity to cultural differences is important in international contracting.
Although language should not be a barrier, contract terms must be clearly
defined and understood. Attitude toward relationships is a cultural difference in
some countries. Contracts based on trust are often relatively short in length, with
few contingencies expressly provided. The expectation is that issues can be
worked out as they arise with the parties working to maintain the underlying
relationship.
ii) Financial Aspects
In managing financial risks that may arise, care should be taken in the
specification of the method of payment and the currency in which payment is to
be made.

iii) Exchange Markets

Foreign exchange markets allow trading (buying and selling) currencies. In
general, trade between countries can occur only if it is possible to exchange the
currency of one country for the currency of another country. Exchange of money
is not always simple. Losses in international business sometimes center on
exchange risk—the potential loss or profit that occurs
between the time the currency is acquired and the time the currency is
exchanged for another currency.

iv) Financial Instruments Used in International Contracts

Although many financial instruments are available, two commonly used are bills
of exchange and letters of credit.
A bill of exchange is a written instrument that orders the payment of a certain
sum of money to the party specified by the bill. Payment is made at the time
specified on the bill or understood from the form of the standardized bill used. A
sight bill specifies immediate payment upon receipt of the goods by the buyer. A
time bill specifies payment at a later date, usually 30, 90, or 180 days after the
goods have been received by the buyer.
A letter of credit is an agreement or assurance by the buyer‘s bank to pay a
specified amount to the seller upon receipt of documentation proving that the
goods have been shipped and that any other contractual obligations on the seller
have been fulfilled. The usual documentation required includes a certificate of
origin, an export license, a certificate of inspection, a bill of lading, a
commercial invoice, and an insurance policy. Letters of credit can be either
revocable or irrevocable.

v) Repatriation of Monetary Profits

Repatriation refers to the ability of a foreign business to return money earned in
the foreign country to its home country. It is often governed by a country‘s laws.
vi) Key Clauses in International Contracts
Certain clauses are often included in international contracts and have become
standard items to consider.

a) Payment Clauses
How payment is to be received should be clearly specified. The problems of
repatriation should be addressed. Problems with inflation and currency exchange
risks, especially in unstable economies or in long-term agreements, should also
be addressed in this clause of the contract.
b) Choice of Language Clause
A word or phrase in one language may not be readily translatable to another. A
contract should have a choice of language clause, which sets out the language by
which the contract is to be interpreted.
c) Force Majeure Clause
Force majeure is a French term meaning a ―superior or irresistible force.‖ It
protects the contracting parties from problems or contingencies beyond their
control.

d) Forum Selection and Choice-of-Law Clauses

To reduce uncertainty in the event of a dispute, the parties select the court in
which disputes are to be resolved and the law that is to be applied. This
eliminates the possibility that the parties will go ―forum shopping‖—looking for
the most favorable forum for the resolution of a dispute.
e) UN Convention on Contracts: Most major trading countries have agreed to
the U.N. Convention on Contracts for the International Sale of Goods. Contracts
that incorporate that law are subject to rules very essentially the same as the
Uniform Commercial Code. See 71 F.3d 1024.
f) Loss of Investment
Governmental action can result in loss of investment through nationalization,
expropriation, and confiscation. Investors concerned about such losses may
purchase insurance.

g) Nationalization
Occurs when a country takes over, or nationalizes, a foreign investment.
Compensation by the government is often less than the true value of the
business. The stated purpose of nationalization is related to public welfare.
Nationalization is not uncommon, averaging over 100 incidents per decade.
h) Insuring against Risk of Loss
Investors concerned with the risk of loss of investment may obtain insurance.
An all-risk insurance policy can help in case of nationalization or upon
occurrence of a specific problem. Outstanding risks such as currency blockages,
embargoes, and a government‘s arbitrary decision to recall letters of credit may
be insured through major insurers such as Lloyds of London. Some countries
have agencies to assist in insuring their exporters from risk of loss. In the
U.S., the Overseas Private Investment Corporation (OPIC) insures investors
willing to invest in less-developed countries friendly to the U.S.
4.3.3 International Dispute Resolution
Contract disputes arise for any number of reasons. Disputes must be resolved as
parties wish to enforce their rights under a contract.

a) Litigation
Parties in a contract dispute may seek relief in the court system of either
country. Litigation is complicated; evidence, individuals, and documents central
to the dispute are often located in two or more countries. If the action is in a
foreign court, the U.S. participant may encounter a very different judicial
system. Courts in some countries are influenced by political pressures. Another
difficulty may be attempting to establish jurisdiction. U.S. courts require proof
of ―minimum contacts‖ within the country for the courts to have proper
jurisdiction over a foreign defendant.
b) Arbitration
Courts are not effective in resolving many international disagreements. One of
the most effective alternative techniques has been the arbitration process.
Attempts to standardize arbitral rules resulted in creation of organizations such
as the U.N. Commission on International Trade Law, the International Chamber
of Commerce, the American Arbitration Association, the InterAmerican
Commercial Arbitration Commission, and the London Court of Arbitration. In
over fifty countries, including the United States, enforcement of arbitral awards
is facilitated by the 1958 U.N. Convention on the Recognition and Enforcement
of Foreign Arbitral Awards. U.S. federal district courts have jurisdiction to
entertain motions to confirm or challenge a foreign arbitration award involving a
U.S. business.
c) International Court of Justice
Certain disputes may be taken to the International Court of Justice (ICJ) for
resolution. The ICJ is headquartered at The Hague, Netherlands, and is a part of
the United Nations. Only countries have standing to go before the Court;
individuals and businesses have no standing to initiate a suit. The countries
decide whether to pursue claims on behalf of their citizens. IJC decisions
providing monetary judgments or injunctive relief may be referred to the United
Nations Security Council for enforcement.
d) Doctrine of Sovereign Immunity
This allows a court to give up its jurisdiction over foreign parties that otherwise
would be subject to the court‘s jurisdiction. This is based on traditional notions
that a sovereign should not be subject to litigation in a foreign court. The
application of the doctrine can have severe consequences on parties when the
suit involves a commercial transaction. The Foreign Sovereign Immunities Act
(FSIA) of 1976 is intended to provide a uniform rule for the determination of
sovereign immunity in legal actions in U.S. courts and to bring the U.S. into
conformity with other countries in its application of the doctrine.

4.3.4 Types of Legal Systems

a) Common Law System
Based on tradition, precedent, and custom and usage, and the courts fulfill an
important role in interpreting the law according to those characteristics.
b) Civil Law System or a Codified Legal System
Based on a very detailed set of laws that are organized into a code. This code is
the foundation for doing business. Over 70 countries operate on a civil law
basis.
The two legal systems differ primarily in that common law is based on the
courts interpretation of events, whereas civil law is based on how the law is
applied to the facts. Ex: Contracts.
c) Theocratic Law System
Based on religious preceps. Islamic law

The U.S. has the most lawyers of any country in the world and is one of the
highest in the number of lawyers per capita. Ex: 312 lawyers per 100,000
compared to 101 lawyers per 100,000 in Japan
Activity 4.4

Visit an MNC and study impact of legal system on business operations

________________________________________________________________
________________________________________________________________
________________________________________________________________
4.4 Technological Environment
Technology has played a major role in the life of people, right from snail mail to
e-mail the way we live has dramatically changed from the past decade.
Technology has removed the global barriers like distance, time etc thanks to the
latest technological developments like Internet, e-mail, video conferencing, cell
phone etc that plays a major role in international business.

4.4.1 Technological phases in production

a) Cottage System
Before 1700s
b) Industrial Revolution 1770-1800s
Eight inventions were made
Substitution of machine power from man power
Establishment of factory system
c) Scientific Management
Developing science for each person‘s work
Selecting workers scientifically
Dividing work & responsibility
d) Human Relations Movement
Basic understanding of workers & their attitudes towards their work
e) Operations Research(O.R)
Mathematical techniques to solve management problems
First OR team formed by British army to solve complex problems in
World war II
f) Computers & Advanced Production Technology
Clerical Job
Decision Support System (DSS)
Executive Support System(ESS)
Artificial Intelligence
Neural Networks
g) Service Revolution
Design Engineers
Computer Operators
Production Planners
4.4.2 Benefits of Technology in Management Decision Making
The managerial decisions are of two types
a) Structured or programmed decisions
b) Un-structures or non-programmed decisions
Technology helps the manager to make decisions related to business in the
following ways
a) Decision Support System
It is an information system which collects the information from various sources
like government, customers and suppliers and global market and competitors
and helps the manager to interact with the mathematical decision models to
make decision.
b) Group Decision Support System
An expert system with set of hardware, software & procedures that support a
group of people engaged in a decision-related meeting
c) Office Automation System
An office automation system uses computers or networks to carry out various
office operations
d) Transaction Processing System
A system that handles the processing and tracking of transactions is called TPS
e) Management Information System
MIS is a set of software tools that enables managers to gather, organize, &
evaluate information about a workgroup, department or entire organization
f) Expert System
Expert System is a specialized application that performs tasks that would
normally be done by a human.
Ex: Medical diagnosis
Credit History
4.4.3 Communication Tools used in International Business
a) Video Conferencing
b) E-mail
c) Internet
d) Laptop
e) Cell Phone
4.4.4 Effect of Technology on Strategy & Competition
a) Creating Barriers to entry
The cutting edge technology used by MNCs has created barriers for the new
entrants into the industry and also caused a major threat to the domestic
industries this has given rise to the increase in competition and importance for
companies to invest in research and development
b) Generating New Products
Technology has always created new to the world products and modified new
products; there is a greater need for the business organizations to invest in large
volumes in research and development to bring out new products
Some minor changes in features of the product with the same technology has
given rise to new products eg. The modified features of the tape recorder has
given rise to Walkman where both uses the same technology
c) Changing Relationships with Suppliers
The relationships maintained by the suppliers has dramatically changed from
traditional procurement to e-procurement, e-supply chain management, global
integration etc which has given rise to quality, efficiency, of production in less
time.
d) Changing the Basis for Competition
Technology has formed as a main basis for competition, the superior technology
used by the business firms has resulted in improved quality of producing goods,
improved efficiency by automation and mechanization, Total Quality
Management (TQM)
4.4.5 Features of Technology
a) Technology Brings Change
Technology brings change in every walk of life, like the way we cook, the way
we commute, the way we communicate etc. technology has brought lot of
changes in business from barter system to e-business
b) Technology Reduces Time
Technology has drastically reduced time between conceiving an idea and
implementing that idea. The world has become a global village, which has no
barriers by the invention of internet technologies which has reduced time of
transferring information in no time.
c) Technology Reduces Distance
With the invention of advanced transportation systems which has reduced the
time to travel
e.g. By the invention of supersonic jets etc
d) Technology Improves Quality of Life
The quality of life of people has definitely improved, the advancements of
medical technology the life expectancy rate is increased and the control of
various diseases is possible
4.4.6 Diffusion of Technology
Diffusion is a process of spreading, if a bottle of perfume is opened the
molecules will diffuse in the entire atmosphere similarly the technology will
diffuse in the following ways
Joint Ventures
Two companies A and B can jointly work on a venture for a certain period by
exchanging technology, human resources etc
Licensing
Companies in the domestic market can produce the produce the products by
license permission from MNCs
E.g. Coco-cola is produced in India by the way of license
Technological Transfer
Technology can be transferred from on country to another by way of
collaboration many times we hear terms like German collaboration, Japanese
collaboration etc
e.g. Maruti Suzuki is collaboration between Maruthi Udyog of India and Suzuki
motors of Japan
4.4.7 The Technological Cycle
The technological cycle is an organized way to develop technology
  Needs analysis
 Design of Technology
 Development of Technology
 Implementation of Technology
 Maintenance of Technology

Phase 1: Need Analysis

Defining the problem and deciding weather to proceed and analyzing the
current system in depth and developing possible solutions to the problem and
selecting the best solution and defining its function
Phase 2: Designing Technology
The project team describes how the selected solution will work. Each system
activity is identified
Phase 3: Development of Technology
Includes creating or customizing the technology for various parts of the system.
There two alternative paths:
1.Acquisition 2.Local development
Technical & user documentation is written testing is also integral part of this
phase
Phase 4: Implementation of Technology
The technology is installed in the user environment
Phase 5: Maintenance of Technology
Training & support to the users of technology, improvements to the technology
are made regularly during the remaining cycle.

Need
Analysis

Maintenan Designing
ce Technology
 Fig 4.2 The Technological Cycle
4.4.8 Business Implications of Technology
 Launch new products and services to your sales force without taking
them out of the field.
 Highlight introductions and product releases to employees, shareholders,
and clients.
 Provide certification programs to geographically dispersed audiences.
 Conduct focus group sessions to help bring products to market faster.
 Create personalized sales presentations for your customers and reduce
timely sales cycles.
 Provide a simple but effective way to get more out of training sessions
by giving your audience something for their eyes as well as their ears.
 Great for Human Resources departments to get out information about
policy and procedure changes. Ideal for new employee orientations and
employment interviews.

4.5 Cultural Environment

When doing business abroad, a company first should determine whether a usual
business practice in a foreign country differs from its home-country experience.
Understanding the cultures of groups of people is useful because business
employs, sells to, buys from, is regulated by, and is owned by people.
4.5.1 The Concept Of Culture

The word culture, from the Latin colo, -ere, with its root meaning "to cultivate",
generally refers to patterns of human activity and the symbolic structures that
give such activity significance Culture consists of specific learned norms based
on attitudes, values, and beliefs, all of which exist in every society. Culture
cannot easily be isolated from such factors as economic and political conditions.
4.5.2 Behavioral Practices Affecting Business
a) Group Affiliation
A person's affiliations reflecting class or status.
b) Role of Competence
Rewarded highly in some societies. Seniority in Japan
c) Gender Based Groups
There are strong country-specific differences in attitudes towards males and
females.
d) Age-Based Groups
Many cultures assume that age and wisdom are correlated
e) Family-Based Groups
f) Importance of Work
Protestant ethic, belief in success and reward; work as a habit, high-need
achiever.
g) Need Hierarchy
People try to fulfill lower-order needs sufficiently before moving on to higher
ones. The hierarchy of needs theory is helpful for differentiating the reward
preferences of employees.

h) Importance of Occupation
The importance of business as a profession
i) Self-Reliance
Uncertainty avoidance, trust, fatalism, individual versus group
j) Preference for Autocratic versus Consultative Management
4.5.3 Reconciliation Of International Differences
a) Stereotypes
A generalized picture of a person, created without taking the whole person into
account; to make such a generalization.

When we stereotype a group of people, we depict all of the individuals within

that group as having the same characteristics Differences in our society are
many, including age, religion, physical and mental abilities, gender, sexual
orientation, income, family or social status, and physical appearance. Anyplace
where differences are found leaves room for stereotypes.
Stereotypes are generalizations about people usually based on inaccurate
information or assumptions rather than facts. Stereotypes do not take into
account the great diversity of people within a group of people. Nor do
stereotypes consider the present circumstances of the individual. Even worse,
stereotypes can lead to prejudicial or discriminatory behavior
b) Cultural Shock
The term, culture shock, was introduced for the first time in 1958 to describe the
anxiety produced when a person moves to a completely new environment. This
term expresses the lack of direction, the feeling of not knowing what to do or
how to do things in a new environment, and not knowing what is appropriate or
inappropriate. The feeling of culture shock generally sets in after the first few
weeks of coming to a new place.

c) Polycentrism
Polycentrism is the principle of organisation of a region around several political,
social or financial centres. An example of a polycentric city is the Ruhr area in
Germany: Today, the area is a large city that grew from a dozen smaller cities.
As a result, the "city" has no single centre, but several.
A county is said to be polycentric if its population is distributed almost evenly
among several centres in different parts of the county.
d) Ethnocentrism
The belief that one's own culture is superior to all others and is the standard by
which all other cultures should be measured. Early social scientists in the
nineteenth century operated from an ethnocentric point of view. So-called
primitive tribes, for example, were studied by anthropologists to illustrate how
human civilization had progressed from ―savage‖ customs toward the
accomplishments of Western industrial society. The feeling that one's group has
a mode of living, values, and patterns of adaptation that are superior to those of
other groups. It is coupled with a generalized contempt for members of other
groups. Ethnocentrism may manifest itself in attitudes of superiority or
sometimes hostility. Violence, discrimination, proselytizing, and verbal
aggressiveness are other means whereby ethnocentrism may be expressed.

The view of things in which one‘s group is the center of everything, all others
are scaled & rated with references to his own cultural value.

Symptom: ―self reference criteria‖

Example : criticism about diet patterns.

Danger : provoke retaliation

e) GeocentrismThe view of things in which one looks at positive aspects of

both home & host cultures & accept the differences.

e) Cultural Dimensions

Sl.No Dimension Criteria

1. Low Context Vs High Context Communication Style
2. Doing Vs Being Amount of action
3. High Contact Vs Low Contact Amount of physical contact
4. Dionysian Vs Apollonian Ways to handle emotion
5. Masculine Vs Feminine Attitude towards sex
6. Collective Vs individualistic Attitude about themselves
7. High Vs Low Risk avoidance Amount of anxiety
8. High Vs Low Power distance Attitude about power
9. Universalistic Vs Particularistic Obligation
10. Regressive Vs Progressive Time

4.5.4 The Elements of Culture

The major elements of culture are material culture, language, aesthetics,

education, religion, attitudes and values and social organisation.
a) Material Culture
Material culture refers to tools, artifacts and technology. Before marketing in a
foreign culture it is important to assess the material culture like transportation,
power, communications and so on. All aspects of marketing are affected by
material culture like sources of power for products, media availability and
distribution. For example, refrigerated transport does not exist in many African
countries. Material culture introductions into a country may bring about cultural
changes which may or may not be desirable.
b) Language
Language reflects the nature and values of society. There may be many sub-
cultural languages like dialects which may have to be accounted for. Some
countries have two or three languages. In Zimbabwe there are three languages -
English, Shona and Ndebele with numerous dialects. In Nigeria, some linguistic
groups have engaged in hostile activities. Language can cause communication
problems - especially in the use of media or written material. It is best to learn
the language or engage someone who understands it well.

Material
Language Culture

Aestheti
cs

Social
Organization Culture Education
Fig 4.3 Elements of Culture
c) Aesthetics
Aesthetics refer to the ideas in a culture concerning beauty and good taste as
expressed in the arts -music, art, drama and dancing and the particular
appreciation of colour and form. African music is different in form to Western
music. Aesthetic differences affect design, colours, packaging, brand names and
media messages. For example, unless explained, the brand name FAVCO would
mean nothing to Western importers, in Zimbabwe most people would instantly
recognise FAVCO as the brand of horticultural produce.
d) Education
Education refers to the transmission of skills, ideas and attitudes as well as
training in particular disciplines. Education can transmit cultural ideas or be
used for change, for example the local university can build up an economy's
performance.
The UN agency UNESCO gathers data on education information. For example it
shows in Ethiopia only 12% of the viable age group enrol at secondary school,
but the figure is 97% in the USA.
Education levels, or lack of it, affect marketers in a number of ways:
  Advertising programmes and labeling
 Girls and women excluded from formal education (literacy rates)
 Conducting market research
 Complex products with instructions
 Relations with distributors and,
 Support sources - finance, advancing agencies etc.

e) Religion
Religion provides the best insight into a society's behaviour and helps answer
the question why people behave rather than how they behave.
A survey in the early 1980s revealed the following religious groupings (see table
3.1)3.
Table 3.1 Religious groupings

Groups Million

Animism 300

Buddhism 280

Christianity 1500

Hinduism 600

Islam 800

Shinto 120

Religion can affect marketing in a number of ways:

 Religious holidays - Ramadan cannot get access to consumers as shops
are closed.
 Consumption patterns - fish for Catholics on Friday
 Economic role of women – Islam
 Caste systems - difficulty in getting to different costs for
segmentation/niche marketing
 Joint and extended families - Hinduism and organizational structures;
 Institution of the church - Iran and its effect on advertising, "Western"
images
  Market segments - Maylasia - Malay, Chinese and Indian cultures
making market segmentation
 Sensitivity is needed to be alert to religious differences.

f) Attitudes and values

Values often have a religious foundation, and attitudes relate to economic
activities. It is essential to ascertain attitudes towards marketing activities which
lead to wealth or material gain, for example, in Buddhist society these may not
be relevant. Also "change" may not be needed, or even wanted, and it may be
better to relate products to traditional values rather than just new ones. Many
African societies are risk averse, therefore, entrepreneurialism may not always
be relevant. Attitudes are always precursors of human behaviour and so it is
essential that research is done carefully on these.
g) Social Organisation
Refers to the way people relate to each other, for example, extended families,
units, kinship. In some countries kinship may be a tribe and so segmentation
may have to be based on this. Other forms of groups may be religious or
political, age, caste and so on. All these groups may affect the marketer in his
planning.
There are other aspects of culture, but the above covers the main ingredients. In
one form or another these have to be taken account of when marketing
internationally.
Activity 4.5
Visit an MNC and study the impact of culture on business
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
4.6 Classifying Countries
A country's international competitiveness is a function of several factors,
including factor conditions and demand conditions
Factors Conditions
Essential inputs to the production process (human resources, physical resources,
knowledge resources, capital resources, and infrastructure)
Demand Conditions
Composition of home demand, the size and pattern of growth of home demand.
Gross National product (GNP): broadest measure of economic activity. Defined
as the market value of final goods and services newly produced by domestic
factors of demand.
Note: the production by domestic factors could take place at home or abroad.
a) Gross Domestic Product
Measures the value of production that occurs within a country's borders without
regard to whether the production is done by domestic or foreign factors of
production.
b) Per Capita GNP
Low-income ($725 or less),Mozambique ($80)
Middle-income ($726-$8,955) Colombia ((2,140)
High-Income ($8,956 or more)
Ex: Luxemburg (45,360)
Japan (40,940)
U.S. (28,020)
Low-and middle-income countries is where the vast majority of the world's
population lives.
North-South Dialogue

c) Relative Importance of High-Income Countries

They represent only 21% of the number of economies and 15.2% of the
population, but they generate 79.5% of the world's GNP.

d) Relative Importance of Middle-Income Countries

They represent 28.1% of the world's population, 15.6% of its GNP, and
represent 48.3% of the total countries.
e) Relative Importance of Low-Income Countries
Account for 30.6% of the number of economies in the world, 56.7% of the
population, but only 4.9% of the GNP.
f) Purchasing Power Parity (PPP):

The basic idea is to identify the number of units of a country's currency required
to buy the same amounts of goods and services in the domestic economy as one
dollar would buy in the U.S.

Thus, even though per capita GNP is the primary measure of wealth in a
country, purchasing power GNP is an alternative way to measure wealth that is
more indicative of the purchasing power of a country's currency.
Structure of Production: percentage of GDP generated by agriculture, industry,
manufacturing, and services.

The key is to note that as income rises, the percentage of GDP devoted to
agriculture falls, and the percentage devoted to services rises.

g) Other Indicators

i) Quality of Life

Life expectancy, educational standards, individual purchasing power, health,

sanitation, and treatment of women (Canada, the U.S., Japan, Norway, the
Netherlands)
ii) Capability Poverty Measures

Rate of female illiteracy, number of children in school, proportion of tended

births. Widening Gap between the Rich and Poor; Income Distribution

Sector-Wise Distribution of GDP

GDP
Country Agriculture Industry Service
World 3.9 29.8 66.3
Australia 3.5 26.1 70.4
Brazil 7.4 28.3 64.3
China 15.9 50.9 33.2
Egypt Arab Republic 16.7 33.1 50.2
France 2.8 25.3 71.8
Germany 1.2 31.5 67.3
Hong Kong 0.1 14.3 85.6
India 24.9 26.9 48.2
Indonesia 17.0 47.0 35.9
Itlay 2.9 29.2 67.9
Japan 1.4 31.8 66.8
Korea Republic 4.7 42.4 52.9
Malaysia 8.7 51.2 40.1
Mexico 4.1 27.9 68.0
Nepal 40.7 22.1 37.2
Netherlands 2.7 27.2 70.1
Nigeria 29.5 46.0 24.5
Norway 1.8 42.9 55.2
Philippines 15.9 31.1 52.9
Portugal 3.7 30.5 65.8
Russian Federation 6.4 39.0 54.6
Singapore - 34.7 65.2
South Africa 3.2 30.9 65.9
Spain 3.7 30.3 66.0
Sri Lanka 19.5 27.5 53.0
Sweden 1.8 28.0 70.2
Thailand 10.3 40.5 49.3
Turkey 15.4 25.3 59.4
United Kingdom 1.1 28.7 70.3
USA 1.6 24.9 73.5

POPULATION
(Million)
2001 2002 2003
World 6130.1 6214.8 6271.6
Australia 19.4 19.6 19.8
Brazil 172.4 174.4 176.5
China 1300 1280.4 1288.4
Egypt Arab Republic 65.2 66.3 67.5
France 59.2 59.4 59.7
Germany 82.3 82.4 82.5
Hong Kong 6.7 6.7 6.8
India 1000 1048.6 1064.3
Indonesia 209 211.7 214.4
Italy 57.9 57.6 57.6
Japan 127 127.15 127.2
Korea Republic 47.3 47.6 47.9
Malaysia 23.8 24.3 24.7
Mexico 99.4 100.8 102.2
Nepal 23.6 24.1 24.6
Netherlands 16 16.1 16.2
Nigeria 129.9 132.7 135.6
Norway 4.5 4.5 4.5
Philippines 78.3 79.9 81.5
Portugal 10 10.1 10.1
Russian Federation 144.8 144 143.4
Singapore 4.1 4.1 4.2

South Africa 43.2 47.6 45.2

Spain 41.1 40.9 41.1

Srilanka 18.7 18.9 19.1

Sweden 8.9 8.9 8.9

Switzerland 7.2 7.2 7.3

Thailand 61.2 61.6 62

Turkey 68.5 69.6 70.7

United Kingdom 58.8 59.2 59.2

USA 285.3 288.3 291

(Source: World Development Indicators Database: World Bank

GNI (Fomerly )GNP

(Billion US$)
2001 2002 2003
World 31400 31483.9 34491.4
Australia 385.9 386.6 430.5
Brazil 528.9 497.3 478.9
China 1100 1209.5 1417.3
Egypt Arab Republic 99.6 97.6 93.8
France 1400 1342.7 1523
Germany 1900 1870.3 2084.6
Hong Kong 170.3 167.6 173.3
India 477.4 501.5 567.6
Indonesia 144.7 149.8 172.7
Italy 1100 1097.9 1242.9
Japan 4500 4265.6 4389.7
Korea Republic 447.6 473 576.4
Malaysia 79.3 85.9 93.6
Mexico 550.2 596.7 637.1
Nepal 5.8 5.6 5.8
Netherlands 390.3 386.7 426.6
Nigeria 37.1 38.6 42.9
Norway 160.8 171.7 197.6
Philippines 80.8 81.4 87.7
Portugal 109.3 108.7 123.6
Russian Federation 253.4 307.9 374.9
Singapore 88.8 86.1 90.2
South Africa 121.9 113.4 125.9
Spain 588 594.1 698.2
Srilanka 16.4 15.8 17.8
Sweden 225.9 221.5 258.3
Switzerland 277.2 274.1 292.8
Thailand 118.5 122.2 136
Turkey 167.3 173.9 197.2
United Kingdom 1500 1486.1 1680.3
USA 9800 10110 10945.7
(Source: World Development Indicators Database: World Bank)

Surface Area
(Million Sq. KM)
World 133.80
Australia 7.70
Brazil 8.50
China 9.60
Egypt Arab Republic 1.00
France 0.55
Germany 0.36
India 3.30
Indonesia 1.90
Italy 0.30
 Japan 0.38
Korea Republic 99.26
Malaysia 0.33
Mexico 2.00
Nepal 0.15
Netherlands 41.53
Nigeria 0.92
Norway 0.32
Philippines 0.30
Portugal 91.98
Russian Federation 17.10
South Africa 1.20
Spain 0.51
Srilanka 0.07
Sweden 0.45
Switzerland 41.29
Thailand 0.51
Turkey 0.78
United Kingdom 0.24
USA 9.60
(Source: World Development Indicators Database: World Bank)

4.7.1 Economic Environment

As a company considers where in the world to build factories and sells products,
it must analyze the countries in which it may do business
Country analysis requires, understanding national goals, priorities, and policies.
It also involves understanding economic performance, as indicated by economic
growth, inflation, and budget and trade deficits.
4.7.2 Classifying Economic Systems
Economic Systems usually are classified as capitalist, socialist, or mixed. No
country is purely market or purely command.
As the economy moves to more balance, between market and command or
between public and private ownership, it is considered mixed.
We can also classify economic systems according to two other criteria:
- Type of property ownership
- Method of resource allocation and control
a) Market Economy:
The individual and the company play important roles.
The market mechanism involves an interaction of price, quantity, supply and
demand for resources and products.
The key factors that make the market economy work:
-consumer sovereignty
-freedom of the enterprise to operate in the market
In addition, freedom from government restrictions, and legal and Institutions
frameworks to safeguard economic freedoms
b) Centrally Planned Economy:
The government coordinates the activities of the different economic sectors.
Goals are set for every enterprise in the country.
The government determines how much is produced, by whom, and for whom.
c) Mixed Economy
Partly Free, Mostly Not Free
Government intervention can be classified in two ways:
- Government ownership of the means of production
- Government influence in decision making

Ex: MITI was organized to guide industrial development through "strategic

planing and authority over investment and production priorities."
d) Political-Economic Synthesis
Clearly, numerous combinations of political and economic systems are possible
Asian experience, Latin American experience, European, U.S.
 Case: McDonald's Corporation
- Burgers round trip back to Russia
- Overseas moves compatible with McDonald's growth strategy
- From 1990-1995, 56% of the new restaurants have been opened
overseas
- Of the 1,007 restaurants added in 1995, 45% were from 6
foreign markets (Australia, Canada, England, France, Germany,
and Japan)
- Supply procurement, a major problem
- 27,000 Russian applicants for its 650 positions
- 30,000 people were served during the first day of
operations
- strong investment in training

Case Study 4.5

4.7.3 Economic Trade Policies (Protectionism)

Protectionism is the economic policy of restraining trade between nations,

through methods such as high tariffs on imported goods, restrictive quotas, and
anti-dumping laws in an attempt to protect domestic industries in a particular
nation from foreign take-over or competition. This contrasts with free trade,
where no artificial barriers to entry are instituted.
The term is mostly used in the context of economics, where protectionism refers
to policies or doctrines which "protect" businesses and living wages by
restricting or regulating trade between foreign nations:
Subsidies - To protect existing businesses from risk associated with change,
such as costs of labour, materials, etc.
Tariffs - to increase the price of a foreign competitor's goods. ( Including
restrictive quotas, and anti-dumping measures.) on par or higher than domestic
prices.
Quotas - to prevent dumping of cheaper foreign goods that would overwhelm
the market.
Tax cuts- Alleviation of the burdens of social and business costs.
Intervention - The use of state power to bolster an economic entity.
Protectionism has frequently been associated with economic theories such as
mercantilism, the belief that it is beneficial to maintain a positive trade balance,
and import substitution. There are two main variants of protectionism,
depending on whether the tariff is intended to be collected (traditional
protectionism) or not (modern protectionism).

Modern protectionism
In the modern trade arena many other initiatives besides tariffs have been called
protectionist. For example some commentators, such as Jagdish Bhagwati, see
developed countries' efforts in imposing their own labor or environmental
standards as protectionism. Also, the imposition of restrictive certification
procedures on imports are seen in this light.
Recent examples of protectionism are typically motivated by the desire to
protect the livelihoods of individuals in politically important domestic
industries. Whereas formerly blue-collar jobs were being lost to foreign
competition, in recent years there has been a renewed discussion of
protectionism due to offshore outsourcing and the loss of white-collar jobs. Most
economists view this form of protectionism as a disguised transfer payment
from consumers (who pay higher prices for food or other protected goods) to
local high-cost producers.

Traditional Protectionism
In its historic sense, protectionism is the economic policy of relying on revenue
tariffs for government funding in order to reduce or eliminate taxation on
domestic industries and labor (e.g., corporate and personal income taxes). In
protectionist theory, emphasis is placed on reducing taxation on domestic labor
and savings at a cost of higher tariffs on foreign products. This contrasts with
the free trade model, in which first emphasis is placed on exempting foreign
products from taxation, with the lost revenue to be compensated domestically.
Traditional protectionism sees revenue tariffs as a source of government
funding, much like a sales tax, that can be used to reduce other domestic forms
of taxes. The goal of traditional protectionism is to maximize tax revenue from
the purchase of foreign products with the goal of being able to reduce or
eliminate other forms of domestic taxation (income taxes, sales taxes, etc.) as a
result. Tariffs were the predominant source of tax revenue in the United States
from its founding through World War II, allowing the country to operate
through most of that period without income and sales taxes. Traditional
protectionism remains highly dependent on large amounts of imports. It also
requires tariffs to be kept at reasonable rates to ensure maximum government
revenue.

a) Dumping

A practice of charging a very low price in a foreign market for such economic
purposes as putting rival suppliers out of business.
If a company exports a product at a price lower than the price it normally
charges on its own home market, it is said to be ―dumping‖ the product. Is this
unfair competition? The WTO agreement does not pass judgement. Its focus is
on how governments can or cannot react to dumping — it disciplines anti-
dumping actions, and it is often called the ―Anti-dumping Agreement‖.
Legal Framework
Based on Article VI of GATT 1994
Customs Tariff Act, 1975 - Sec 9A, 9B (as amended in1995)
Anti-Dumping Rules [Customs Tariff (Identification, Assessment and Collection
of Anti Dumping Duty on Dumped Articles and for Determination of Injury)
Rules,1995] Investigations and Recommendations by Designated
Authority, Ministry of Commerce Imposition and Collection by Ministry of
Finance

b) Subsidies
In economics, a subsidy is generally a monetary grant given by government to
lower the price faced by producers or consumers of a good, generally because it
is considered to be in the public interest. Subsidies are also referred to as
corporate welfare by those who oppose their use. The term subsidy may also
refer to assistance granted by others, such as individuals or non-government
institutions, although this is more usually described as charity. A subsidy
normally exemplifies the opposite of a tax, but can also be given using a
reduction of the tax burden. These kinds of subsidies are generally called tax
expenditures or tax breaks.
Subsidies protect the consumer from paying the full price of the good consumed,
however they also prevent the consumer from receiving the full value of the
thing not consumed – in that sense, a subsidized society is a consumption
society because it unfairly encourages consumption more than conservation.
Under free-market conditions, consumers would make choices which optimize
the value of their transactions; where it was less expensive to conserve, they
would conserve. In a subsidized economy however, consumers are denied the
benefit of conservation and as a result, subsidized goods have an artificially
higher value than expenditures which do not consume. Subsidies are paid for by
taxation which creates a deadweight loss for that activity which is taxed
c) Countervailing Duties

Means to restrict international trade in cases where imports are subsidized by a

foreign country and hurt domestic producers. According to WTO rules, a
country can launch its own investigation and decide to charge extra duties. Since
countries can rule domestically whether domestic industries are in danger and
whether foreign countries subsidize the products, the institutional process
surrounding the investigation and determinations has significant impacts beyond
the countervailing duties.

d) Tariffs
A tariff is a tax on imported goods. When a ship arrives in port a customs officer
inspects the contents and charges a tax according to the tariff formula. Since the
goods cannot be landed until the tax is paid it is the easiest tax to collect, and the
cost of collection is small. Smugglers of course seek to evade the tariff.
An ad valorem tax is a percentage of the value of the item, say 10 cents on the
dollar, while a specific tariff is so-much per weight, say $5 per ton.
A "revenue tariff" is a set of rates designed primarily to raise money for the
government. A tariff on coffee imports, for example (by a country that does not
grow coffee) raises a steady flow of revenue.
A "protective tariff" is intended to artificially inflate prices of imports and
"protect" domestic industries from foreign competition For example, a 50% tax
on a machine that importers formerly sold for $100 and now sell for $150.
Without a tariff the local manufacturers could only charge $100 for the same
machine; now they can charge $149 and make the sale.
A prohibitive tariff is one so high that no one imports any of that item.
The distinction between protective and revenue tariffs is subtle: protective tariffs
in addition to protecting local producers also raise revenue; revenue tariffs
produce revenue but they also offer some protection to local producers. (A pure
revenue tariff is a tax on goods not produced in the country, like coffee perhaps.)
Tax, tariff and trade rules in modern times are usually set together because of
their common impact on industrial policy, investment policy, and agricultural
policy.
There are two main ways of implementing a tariff:
Ad valorem tariff
Fixed percentage of the value of the good that is being imported. Sometimes
these are problematic as when the international price of a good falls, so does the
tariff, and domestic industries become more vulnerable to competition.
Conversely when the price of a good rises on the international market so does
the tariff, but a country is often less interested in protection when the price is
higher. They also face the problem of transfer pricing where a company declares
a value for goods being traded which differs from the market price, aimed at
reducing overall taxes due.

Specific tariff
Tariff of a specific amount of money that does not vary with the price of the
good. These tariffs may be harder to decide the amount at which to set them, and
they may need to be updated due to changes in the market or inflation.
Adherents of supply-side economics sometimes refer to domestic taxes, such as
income taxes, as being a "tariff" affecting inter-household trade.

Quotas
A quota is a prescribed number or share of something.
In common language, especially in business, a quota is a time-measured goal for
production or achievement. An assembly line worker might have a quota for the
number of products made; a salesperson might have a quota to meet for weekly
sales; In trade, a quota is a form of protectionism used to restrict the import of
something to a specific quantity The number of cars imported from Japan may
have a quota of 50,000 vehicles per annum to protect auto manufacturers in the
United States
IMF member‘s quota is broadly determined by its economic position relative to
other members. Various economic factors are considered in determining changes
in quotas, including GDP, current account transactions, and official reserves.
When a country joins the IMF, it is assigned an initial quota in the same range as
the quotas of existing members considered by the IMF to be broadly comparable
in economic size and characteristics.
Quotas are denominated in Special Drawing Rights, the IMF's unit of account.
The largest member of the IMF is the United States, with a quota of
SDR 37.1 billion (about $53.5 billion), and the smallest member is Palau, with a
quota of SDR 3.1 million (about $4.5 million).

e) VERs - Voluntary Export Restraints

A voluntary export restraint is a restriction set by a government on the quantity

of goods that can be exported out of a country during a specified period of time.
Often the word voluntary is placed in quotes because these restraints are
typically implemented upon the insistence of the importing nations.
Typically VERs arise when the import-competing industries seek protection
from a surge of imports from particular exporting countries. VERs are then
offered by the exporter to appease the importing country and to avoid the effects
of possible trade restraints on the part of the importer. Thus VERs are rarely
completely voluntary.
Also, VERs are typically implemented on a bilateral basis, that is, on exports
from one exporter to one importing country. VERs have been used since the
1930s at least, and have been applied to products ranging from textiles and
footwear to steel, machine tools and automobiles. They became a popular form
of protection during the 1980s, perhaps in part because they did not violate
countries' agreements under the GATT. As a result of the Uruguay round of the
GATT, completed in 1994, WTO members agreed not to implement any new
VERs and to phase out any existing VERs over a four year period. Exceptions
can be granted for one sector in each importing country.
Some interesting examples of VERs occured with auto exports from Japan in the
early 1980s and with textile exports in the 1950s and 60s.
US-Japan Automobile VERs

f) Customs Valuation

The rates of customs duties leviable on imported goods (& export items in
certain cases) are either specific or on ad valorem basis or at times specific cum
ad valorem. When customs duties are levied at ad valorem rates, i.e., depending
upon its value, it becomes essential to lay down in the law itself the broad
guidelines for such valuation to avoid arbitrariness and to ensure that there is
uniformity in approach at different Customs formations. Section 14 of the
Customs Act, 1962 lays down the basis for valuation of import & export goods
in the country. It has been subject to certain changes – basic last change being in
July-August, 1988 when present version came into operation. Briefly the
provisions are explained in the following paragraphs.

g) Trade Sanctions

Trade sanctions are trade penalties imposed by one or more countries on one or
more other countries. Typically the sanctions take the form of import
tariffs(duties), licensing schemes or other administrative hurdles. They tend to
arise in the context of an unresolved trade or policy dispute, such as a
disagreement about the fairness of some policy affecting international trade
(imports or exports).
For example, one country may conclude that another is unfairly subsidising
exports of one or more products, or unfairly protecting some sector from
competition (from imported goods or services). The first country may retaliate
by imposing import duties, or some other sanction, on goods or services from
the second.
Trade sanctions are distinguished from economic sanctions, which are used as a
punitive measure in international relations (examples being recent US or
multilateral sanctions against Cuba, Iraq, or North Korea).
Trade policy reviews: ensuring transparency
Individuals and companies involved in trade have to know as much as possible
about the conditions of trade. It is therefore fundamentally important that
regulations and policies are transparent. In the WTO, this is achieved in two
ways: governments have to inform the WTO and fellow-members of specific
measures, policies or laws through regular ―notifications‖; and the WTO
conducts regular reviews of individual countries‘ trade policies — the trade
policy reviews. These reviews are part of the Uruguay Round agreement, but
they began several years before the round ended — they were an early result of
the negotiations. Participants agreed to set up the reviews at the December 1988
ministerial meeting that was intended to be the midway assessment of the
Uruguay Round. The first review took place the following year. Initially they
operated under GATT and, like GATT, they focused on goods trade. With the
creation of the WTO in 1995, their scope was extended, like the WTO, to
include services and intellectual property.
Activity 4.6

Collect and list all the trade policies of Indian government in relation to
International Business
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________

Self-Assessment Questions (SAQs)

1.External Macro Environment Forces involves _________ ,_________,

___________, _____________

a) Political, Economic, Marketing, Cultural

b) Legal, Finance, Technological, Competitors
c) Suppliers, Customers, Creditors, Competitors
d) Political, Economic, Social, Technological
2.List the internal micro environmental forces

__________________________________________________________

3.List the ways of scanning international business environment

_________________, _______________________,_____________

4.Expand the following

a) PEST ___________________________________
b) GDP _____________________________________
c) GNP _____________________________________
d) BPO _____________________________________
e) LPO _____________________________________
f) KPO _____________________________________
g) FDI _______________________________________
h) LPG ______________________________________
 i) NAFTA ___________________________________
j) MNC _____________________________________
k) VER ______________________________________
l) GATT _____________________________________
m) WTO ______________________________________
n) ICJ _______________________________________
o) PPP _______________________________________
p) IMF _______________________________________

5.List all the instruments used by government for trade control

________________________________________________________________
________________________________________________________________
6.The members of WTO has agreed to eliminate all tariffs in 10 industries list
them?
________________________________________________________________
________________________________________________________________
7.List the strategies followed my MNCs to eliminate political risk?
________________________________________________________________
________________________________________________________________
8.List the conditions used in country classification?
______________________________________________________________
9.The Economic System is classified into
________________________________________________________________
________________________________________________________________
10.The Political System is classified into
________________________________________________________________
________________________________________________________________
Summary

 International business provides both opportunities for growth and

success and also poses threat to business
 There are five macro-environmental forces acting on international
business, they are Political, Economic, Social, Technological, Legal etc
 There are three ways of scanning international business environment
Ad-hoc Scanning, Regular Scanning, Continuous Scanning
 PEST analysis is the framework for analyzing international business
environment.
 A stable political system is needed for the success of international
business
 The political system is classified into two they are democracy and
dictatorship
 MNCs can play the strategies like Joint ventures, Expanding the
investment base, Marketing and distribution, Licensing, Planned
domestication, Political payoffs to reduce political risk
 Government can actively control the trade by designing trade policies on
Dumping, Subsidies, Countervailing Duties, Tariffs, Quotas, VERs -
Voluntary Export Restraints
 Political Risks Of Global Business Confiscation, Expropriation,
Domestication
 MNCs can play strategies like Joint ventures, Expanding the investment
base, Marketing and distribution, Licensing, Planned domestication,
Political payoffs to reduce political risk.
 The Legal system is classified into common law system, civil law system
or codified legal system and theocratic law system
 The different cultural behaviour practices will affect international
business
 Technology plays a major role in removing the barriers like distance and
time to promote international business
 Countries can be classified as High-Income countries, Middle-Income
countries and Low-Income countries
 Countries can be classified based on Gross Domestic Product, Gross
National Product, Purchasing Power Parity
 Protectionism is the economic policy of restraining trade between
nations, through methods such as high tariffs on imported goods,
restrictive quotas, and anti-dumping laws in an attempt to protect
domestic industries in a particular nation from foreign take-over or
competition.
Answer Key for Self-Assessment Questions (SAQs)

1.Political, Economic, Social, Technological

2.Competators, Suppliers, Customers, Creditors
3.Ad-hoc Scanning, Regular Scanning, Continuous Scanning
4. a) Political, Economic, Social, Technological
b) Gross Domestic Product
d) Gross National Product
e) Business Process Outsourcing
f) Legal Process Outsourcing
g) Knowledge Process Outsourcing
h) Foreign Direct Investment
i) Liberalization Privatization Globalization
j) North American Free Trade Agreement
k) Multi National Company
l) Voluntary Export Restraints
m) Generally Accepted Tariff and Trade
n) World Health Organization
o) International Court of Justice
p) Purchasing Power Parity
q) International Monitory Fund

5. Trade Restrictions / Trade Barriers

 Dumping
 Subsidies
 Countervailing Duties
 Tariffs
 Quotas
 VERs - Voluntary Export Restraints
6.Beer, Construction equipment, Distilled spirits, Farm machinery, Furniture
Medical equipment, Paper, Pharmaceuticals, Steel, Toys

7. Strategies To Lessen Political Risks

 Joint ventures
 Expanding the investment base
 Marketing and distribution
 Licensing
 Planned domestication
  Political payoffs
8. Factors Conditions and Demand Conditions
9. Market Economy, Centrally Planned Economy, Mixed Economy
10. Democracy and Dictatorship

Keywords
 Globalization
 Tariffs
 Ad Valorem Tariff
 Subsidies
 Dumping
 Polycentrism
 Ethnocentrism
 Stereotypes
 Cultural Shock
 Geocentrism
 Home Country
 Multi-National Company (MNC)
 Protectionism
 Technological Environment
 Economic Environment
 Political Environment
 Legal Environment
 Low-Income Countries
 Middle-Income Countries
 Litigation
 Arbitration
 Diversification
 Political Risk
 Macro Environment
 Micro Environment

Other References
Dr.P.Subba Rao, International Business, Himalaya Publishing House
K.Aswathappa, International Business, Tata McGraw Hill

Review Questions
1.Write short note on
 a) Polycentrism
b) Ethnocentrism
c) Stereotypes
d) Cultural Shock
e) Geocentrism

2. What do you understand by external macro environmental forces explain?

3.Explain the reasons for going global?
4. Give a note on PEST analysis?
5.What is political environment? What are the political risks faced by global
business?
6.What do you mean by good corporate citizenship?
7.Give a note on the instruments used by the government to control trade?
8.What are the reasons for government‘s involvement in business?
9.What do you understand by legal environment?
10. Give a note on International Court of Justice (ICJ)?
11.Give a note on effect of technology on strategy and competition?
12.What is technological cycle explain?
13.What are the behaviour practices affecting business?
14.Write a note on classification of countries?
15.What do you understand by protectionism?

Honesty and Hard Work gives Honor

 Multinational Corporations
Unit Structure:
4.0 Objectives
4.1 Introduction
4.2 Objectives of MNCs
4.3 Essentials of Multi National Corporation
4.4 Factors for Growth of MNCs
4.5 Role of Multinational Corporations
4.6 Designing of Structure of Multinational Corporations
4.7 Relationship between Head Quarters and Subsidiaries
4.8 Control of Multinational Corporation
4.9 Top MNCs in India
4.10 Summary
4.11 Key Words
4.12 Self Assessment Test
4.13 References

4.0 Objectives
After studying this unit you will be able to understand
 The concept and meaning of MNCs
 The role and functions of MNCs
 The advantages and disadvantages of MNCs.

4.0 Introduction
The objective of this unit is to explain the meaning of Multi-National Corporation and to discuss the factors
that contributed for the growth of MNCs, advantages and disadvantages, control over MNCs, organisation
structure of MNCs, relationship between headquarters and subsidiaries, and reasons that attract MNCs in
India. Today’s MNCs are faced with technologically-influenced changes in global markets. Optimizing
global efficiencies, national responsiveness, and worldwide learning all require MNCs to find new strategic
orientations and changes in organizational capabilities. International markets are complex and volatile, requiring
management to find new ways of efficiently meeting rapid changes.

The main challenge for a multinational corporation operating abroad is to exercise its rights with responsibility
and fulfill its duties as a good citizen in a particular environment. In other words, to achieve and maintain a
competitive and profitable business performance, while contributing effectively towards the social, economic
and ecological advancement of the society where it operates. Regulatory power is increasingly exercised by
autonomous non-governmental organizations. Though not lawmaking in the accepted sense, the regulatory
power asserted has come to be asserted within the framework of institutionalized and self-contained systems
that exercise state functions outside the state. At the same time, public law has sought to assert a measure of
legislative control over private regulatory systems, especially those that seek to impose a harmonized and
institutionalized regulatory framework across borders.

46
4.2 Objectives of MNCs
The enormous growth of international e-business that has taken place over the past three to four decades
has been carried out, to large degree, by a relatively small number of very large business firms, which are
called Multinational Corporation (MNC). As the name suggests, any company is referred to as a multinational
corporation when that company manages its operation or production or service delivery from more than
one country. Such a company is also known as international company. As defined by the International
Labor Organization, a MNC is one, which has its operational headquarter based in one country with
several other operating branches in different other countries. The country where the head quarter is located
is called the home country whereas; the other countries with operational branches are called the host countries.
Multinational corporations are companies that manufacture and market products or services in several
countries by assisting the world economy. A Multi National Corporation operates a number of plants abroad
and market products through a large network of fully owned subsidiaries. With the adoption of economic
liberalization across the world has enormously expanded the international corporation also known as
‘Transnational Corporation.’
The phenomenon of MNCs has been ascribed to a combination of two main factors: the uneven geographical
distribution of factor endowments and market failure (Dunning, 1988). That is, because of their national
origins, some firms have assets that are superior to those in many other countries. Moreover, a substantial
proportion of these firms have concluded that they can only successfully exploit these assets by transferring
them across national boundaries within their own organizations rather than by selling their right of use to
foreign-based enterprises. More recently, nationally endowed assets have been supplemented by MNCs
acquiring, developing and integrating strategically important assets located in other countries, thereby making
their national origins somewhat less significant.
There are four categories of multinational corporations: (1) a multinational, decentralized corporation with
strong home country presence, (2) a global, centralized corporation that acquires cost advantage through
centralized production wherever cheaper resources are available, (3) an international company that builds
on the parent corporation’s technology or R&D, or (4) a transnational enterprise that combines the previous
three approaches. According to UN data, some 35,000 companies have direct investment in foreign countries,
and the largest 100 of them control about 40 percent of world trade. According to the parliamentary
concept of Multinational Corporation, it is called the ‘International Company’. Issued capital as equity or
other kinds, current and fixed assets of these corporations of different countries hence, they are known as
‘Heavy Capital Investment Enterprises.’ “An enterprise which allocates company resources without regards
to national frontiers, but is nationally based in terms of ownership and top management.”
Apart from playing an important role in globalization and international relations, these multinational companies
even have notable influence in a country’s economy as well as the world economy. The budget of some of
the MNCs are so high that at times they even exceed the GDP. (Gross Domestic Product) of a nation.
These are not the sole prior causes of the Nokia, Vodafone, Fiat, and Ford Motors and as the list moves
on- to flourish in India. As the basic economic data suggest that after the liberalization in 1991, it has brought
in hosts of foreign companies in India and the share of U.S shows the highest. They account about 37% of
the turnover from top 20 companies that function in India.
The following are the main objectives of MNCs:
1) To expand the business beyond the boundaries of a home country
2) Minimize cost of production, especially labor cost

47
3) Capture lucrative foreign market against international competitors
4) Make diversification internationally effective so that a steady growth of business could be achieved
5) Make best use of technological advantages by setting up production facilities abroad
6) Counter regulatory measures in the parent country

4.3 Essentials of Multi-National Corporation

Multinational corporations are the ‘Owner of Intellectual and physical properties’, in which sources of
production, finished goods, information techniques and technology, top level managerial persons and the
workers are well integrated. It is necessary for multinational corporations to take authorization from the
government of that particular country where its branches or sister-concerns are recognized. Multinational
are also put up with ‘equity participation’ which is determined by the government in position to the investment
in these corporations. These may be characterized by figure 4.1 below:

Permission of
Multinational Ownership & related Countries
Control
International Operations Multi National
Corporation
Giant in Size
Participation in Capital
Investment as per
Government Policies
Creation, Development
& Research as the
world economy
Multinational Transfer
of Resources &
Technology
Multinational management
& Administration

Figue 4.1 : Essentials of MNCs

1. Permission of Related Countries: The controller on the multinational corporations is oppointed.
by the department of company affairs; the Reserve Bank of India (RBI); the ministry of Industrial
Development of India hence there is a need and desire to take authorization for establishment of
associates (branches) from such agencies, under the rules and regulations forced by government of
India, as well.
2. Creation, Development and Research as the World Economy: The economy profit from
multinational and connection effects resulting from superior use of technology. These effects are
more often not attached to change in technology, through new-patterns of development new
innovations and research under world economy, including training, widening of markets and enlistment
of resources.
3. Multinational Transfer of Resources & Technology: Multinational Corporations are rich in
superior and future technology because they expand the resources and technology through incessant
investigations, researches and developments as per the international norms. They have also a greater
advancement in financial and other resources as the demand of 21st century so they invest on
research and development and develop the latest technologies, according the International Markets.
4. Multinational Management & Administration: MNCs have a better and skilled management
system as per the standards of world economy. They have trained and intellectual persons as the

48
 managers to plan, to systematize, to direct and to control the functioning of human and other resources.
MNCs are ultimately controlled by a single managerial authority, typically the top-management
groups of the parent company, which makes the key, strategic decisions relating to the operations of
the parent firm and all its affiliates.
5. Participation in Capital Investment: The capital base of Multinational Corporation has a strong
position and they have more fixed capital with financial resources and working capital so, they are
under the adaptive circumstance to find out the adequate capital from the market of the host country.
Foreign aid is also available to them in an easy way from the side of the government abroad. In such
conditions, they remain always in profit due to the maximum and optimum utilisation of their funds.
6. Giant in Size: Multinational Corporations are giant business organisation. They extend their marketing
activities though a network of branches or their majority owned Foreign Affiliates. These large
institutions having investment and business in a number of countries, island and constituents. MNCs
are earnings many a crore dollars in thousands, as profits. As an estimate, international production
by Multinational Corporation numbering 63,300 parent firms with around eight lacs foreign affiliates
and an excess of interim arrangements, spans virtually all countries of the world.
7. International Operations: A multinational corporations is an integrated world – wide business
system. The parent company and its foreign affiliates act in close alliance and co-operation with one
another, as distinct from functioning separately and autonomously. These corporations are controlled
by a sole institution but their interests and activities (Operations) are spread out the boundaries of
the nations. These companies are called as ‘Global Factories’ to search the opportunities.
8. Multinational Ownership & Control: The decisions as the MNC’s overall product mix, the
sourcing of inputs, including capital funds (Shares, debentures & other kinds of securities), the
location of production facilities, and the markets to be served are made centrally and also controlled
by the parent company, in order to take maximum advantage of cost and market opportunities in
various parts of the world, to ensure interactions among the affiliates.

4.4 Factors Contributed for Growth of MNCs

The changes in the economic environment in a large number of countries, future holds out a vast scope for
the growth of MNCs. Also, the rise of services to comprise the largest single sector in the world economy,
regional economic integration, the globalization of firms and industries, increasing emphasis on market forces,
rapidly change in technologies, and a growing role for the private sector developing countries has a weight
age for development multinational corporations. In this context, several factors contributed for the growth
of MNCs in detail as following:-
1. Financial Superiorities: Multinationals have more financial resources like immovable and working
capital base is stronger. By virtue of the goodwill, they can get the benefit of foreign capital easily.
Multinational Corporations enjoy financial superiorities over national companies, in addition and to
market superiorities. Their resources and be used for turning the environment and circumstances in
their favour. Also, they can mobilise different types of resources of high quality and may access to
international banks and financial institutions.
2. Better and Skilled Management: Multinational Corporations are able to appoint the trained and
intellectual human beings as the management superiorities, on the higher salaries, allowances and by
giving the fringe benefits, when a local company is not capable to pay such attractive emoluments to
their employees. Hence MNCs are most popular today.

49
3. Product Innovation: Multinational Corporations with their better and strong Research and
Development Departments invent new products and develop the existing products. Developing
countries suffer from such limitations. Therefore, they invite Multinationals to their countries for the
development of national and to gain more revenue.
4. Diversification or Expansion of Markets: The growth of Gross- Domestic-production (GDP)
and per capital income resulted in the rise of living standards so the large operations of the MNCs
build the image, which contributed for the expansion of market territory or a wide sector for the
output of inputs
5. Efficient Technology: MNCs are not only rich in advanced and supreme technology but also,
they develop their own innovation techniques to produce and command the production and control
thereon through regular investigation, research and development. They have technological superiorities
due to the following instances, in reference to developing counties:
a) Lack of adequate skilled technology in the developing countries, though they produce goods and
services on their own by importing technology and materials.
b) Developing countries are failing in marketing the products due to serve competition in international
markets, so they call MNCs.
c) When local manpower, material machines, raw-material and capital cannot optimally utilised by
the developing countries on their own, they would require to import such items and for this purpose,
they invite to MNCs in their countries.
d) Developing countries are rich in minerals and natural sources but, they are not able to exploit or
generate them completely due to paucity of financial (monetary) resources and poor status of
technology and thereby industrialisation, MNCs are to be more inevitable in such countries.
6. Marketing Superiorities: Multinational Corporations are superior is marketing over the domestic
companies, in the following cases:-
a) They have a better and trained sales-force for the sale of production.
b) They enjoy market reputation of their own.
c) Availability of more reliable and up-to-date information about the better marketing strategies and
marketing research, they have.
d) They have more effective’s sales promotion schemes, advertising with ethical norms and rapid
transportation facilities.
e) Better maintenance privileges and protection for warehousing rather than the domestic companies,
in market territories.
7. Advertisement Domination: To increase the consumer class in a best way, Multinational
Corporations expend a lot of money on the advertisement of products, in international markets,
according to External strategy of the corporation. MNCs undoubtedly, carrying out business, with
the ultimate objectives of profit making like any other domestic business, though the concept of
business changed so widely to the present stage of relationship business, and for such purpose, to
increase the relationship in between MNC and consumer, they spent about 5-12 percent of net
profits on the advertisement, when local companies cannot bear such expenses so easily.

50
4.5 Role of Multinational Corporations
There are a number of reasons why the multinational companies are coming down to India. India has got a
huge market. It has also got one of the fastest growing economies in the world. Besides, the policy of the
government towards FDI has also played a major role in attracting the multinational companies in India.
For quite a long time, India had a restrictive policy in terms of foreign direct investment. As a result, there
was lesser number of companies that showed interest in investing in Indian market. However, the scenario
changed during the financial liberalization of the country, especially after 1991. Government, nowadays,
makes continuous efforts to attract foreign investments by relaxing many of its policies. As a result, a number
of multinational companies have shown interest in Indian market.
Multinational corporations (MNCs) are huge industrial organizations having a wide network of branches
and subsidiaries spread over a number of countries. The two main characteristics of MNCs are their large
size and the fact that their worldwide activities are centrally controlled by the parent companies. Such a
company may enter into joint venture with a company in another country. There may be agreement among
companies of different countries in respect of division of production, market, etc. These companies are to
be found in almost all the advanced countries, with the USA perhaps the biggest amongst them. Their
operations extend beyond their own countries, and cover not only the advanced countries but also the
LDCs. Many MNCs have annual sales volume in excess of the entire GNPs of the developing countries in
which they operate. MNCs have great impact on the development process of the Underdeveloped countries.
Let us discuss the arguments for and against the operation of MNCs in underdeveloped countries.
4.5.1 Arguments for MNCs
The MNCs play an important role in the economic development of underdeveloped countries.
1. Filling Savings Gap: The first important contribution of MNCs is its role in filling the resource gap
between targeted or desired investment and domestically mobilized savings. For example, to achieve
a 7% growth rate of national output if the required rate of saving is 21% but if the savings that can
be domestically mobilised is only 16% then there is a ‘saving gap’ of 5%. If the country can fill this
gap with foreign direct investments from the MNCs, it will be in a better position to achieve its
target rate of economic growth.
2. Filling Trade Gap: The second contribution relates to filling the foreign exchange or trade gap. An
inflow of foreign capital can reduce or even remove the deficit in the balance of payments if the
MNCs can generate a net positive flow of export earnings.
3. Filling Revenue Gap: The third important role of MNCs is filling the gap between targeted
governmental tax revenues and locally raised taxes. By taxing MNC profits, governments are able
to mobilize public financial resources for development projects.
4. Filling Management/Technological Gap: Fourthly, Multinationals not only provide financial
resources but they also supply a “package” of needed resources including management experience,
entrepreneurial abilities, and technological skills. These can be transferred to their local counterparts
by means of training programs and the process of ‘learning by doing’.
Moreover, MNCs bring with them the most sophisticated technological knowledge about production
processes while transferring modern machinery and equipment to capital poor LDCs. Such transfers
of knowledge, skills, and technology are assumed to be both desirable and productive for the
recipient country.

51
 5. Other Beneficial Roles: The MNCs also bring several other benefits to the host country.
(a) The domestic labour may benefit in the form of higher real wages.
(b) The consumers benefits by way of lower prices and better quality products.
(c) Investments by MNCs will also induce more domestic investment. For example, ancillary units
can be set up to ‘feed’ the main industries of the MNCs
(d) MNCs expenditures on research and development(R&D), although limited is bound to benefit
the host country.
4.5.2 Arguments against MNCs
There are several arguments against MNCs which are discussed below.
1. Although MNCs provide capital, they may lower domestic savings and investment rates by stifling
competition through exclusive production agreements with the host governments. MNCs often fail
to reinvest much of their profits and also they may inhibit the expansion of indigenous firms.
2. Although the initial impact of MNC investment is to improve the foreign exchange position of the
recipient nation, its long-run impact may reduce foreign exchange earnings on both current and
capital accounts. The current account may deteriorate as a result of substantial importation of
intermediate and capital goods while the capital account may worsen because of the overseas
repatriation of profits, interest, royalties, etc.
3. While MNCs do contribute to public revenue in the form of corporate taxes, their contribution is
considerably less than it should be as a result of liberal tax concessions, excessive investment
allowances, subsidies and tariff protection provided by the host government.
4. The management, entrepreneurial skills, technology, and overseas contacts provided by the MNCs
may have little impact on developing local skills and resources. In fact, the development of these
local skills may be inhibited by the MNCs by stifling the growth of indigenous entrepreneurship as
a result of the MNCs dominance of local markets.
5. MNCs’ impact on development is very uneven. In many situations a MNC activity reinforces dualistic
economic structures and widens income inequalities. They tend to promote the interests of some
few modern-sector workers only. They also divert resources away from the production of consumer
goods by producing luxurious goods demanded by the local elites.
6. MNCs typically produce inappropriate products and stimulate inappropriate consumption patterns
through advertising and their monopolistic market power. Production is done with capital-intensive
technique which is not useful for labour surplus economies. This would aggravate the unemployment
problem in the host country.
7. The behaviour pattern of MNCs reveals that they do not engage in R & D activities in underdeveloped
countries. However, these LDCs have to bear the bulk of their costs.
8. MNCs often use their economic power to influence government policies in directions unfavourable
to development. The host government has to provide them special economic and political concessions
in the form of excessive protection, lower tax, subsidized inputs, and cheap provision of factory
sites. As a result, the private profits of MNCs may exceed social benefits.

52
9. Multinationals may damage the host countries by suppressing domestic entrepreneurship through
their superior knowledge, worldwide contacts, and advertising skills. They drive out local competitors
and inhibit the emergence of small-scale enterprises.
4.5.3 Evolution of MNCs
The dynamics of international business created a great need for the evolution of Multinational Corporation.
The multinational corporation is a company engaged in producing and selling goods or services in more than
one country. It normally consists of a parent company located in the home country and few or more foreign
subsidiaries. Some MNCs have more than 100 foreign subsidiaries scattered around the world. It is the
globally coordinated allocation of resources by a single centralized management that differentiates the
multinational enterprise from other firms engaged in international business.
MNCs make decisions about market-entry strategy; ownership of foreign operations; and production,
marketing, and financial activities with an eye to what is best for the corporation as a whole. The true
multinational corporation emphasizes group performance rather than the performance of its individual parts.
There are different types of multinational companies, such as;
a) Raw-Material Seekers: Raw-material seekers were the earliest multinationals and their aim
was to exploit the raw materials that could be found overseas. The modern-day counterparts of
these firms, the multinational oil and mining companies such as British Petroleum, Exxon Mobil,
International Nickel, etc.,
b) Market Seekers: The market seeker is the archetype of the modern multinational firm that
goes overseas to produce and sell in foreign markets. Examples include IBM, Toyota, Unilever,
and Coca-cola.
c) Cost Minimization Company : Cost minimizing is a fairly recent category of firms doing business
internationally. These firms seek out and invest in lower-cost production sites overseas (for example,
Hong Kong, Malaysia, Taiwan, and India) to remain cost competitive both at home and abroad.
4.5.4 Advantages and Disadvantages of Multinational Corporations
Multinational Corporations no doubt, carryout business with the ultimate object of profit making like any
other domestic company. According to ILO report “for some, the multinational companies are an invaluable
dynamic force and instrument for wider distribution of capital, technology and employment; for others they
are monsters which our present institutions, national or international, cannot adequately control, a law to
themselves with no reasonable concept, the public interest or social policy can accept. MNC’s directly and
indirectly help both the home country and the host country.
(1) Advantages of MNC for the host country:
MNC’s help the host country in the following ways
1. The investment level, employment level, and income level of the host country increases due to the
operation of MNCs
2. The industries of host country get latest technology from foreign countries through MNCs
3. The host country’s business also gets management expertise from MNCs
4. The domestic traders and market intermediaries of the host country gets increased business from
the operation of MNCs
5. MNCs break protectionalism, curb local monopolies, create competition among domestic companies
and thus enhance their competitiveness.
6. Domestic industries can make use of R and D outcomes of MNCs

53
 7. The host country can reduce imports and increase exports due to goods produced by MNCs in the
host country. This helps to improve balance of payment.
8. Level of industrial and economic development increases due to the growth of MNCs in the host
country.
(2) Advantages of MNC for the home country:
MNC’s home country has the following advantages.
1. MNCs create opportunities for marketing the products produced in the home country throughout
the world.
2. They create employment opportunities to the people of home country both at home and abroad.
3. It gives a boost to the industrial activities of home country.
4. MNCs help to maintain favourable balance of payment of the home country in the long run.
5. Home country can also get the benefit of foreign culture brought by MNCs
(3) Disadvantages of MNC for the host country:
1. MNCs may transfer technology which has become outdated in the home country.
2. As MNCs do not operate within the national autonomy, they may pose a threat to the economic
and political sovereignty of host countries.
3. MNCs may kill the domestic industry by monopolising the host country’s market.
4. In order to make profit, MNCs may use natural resources of the home country indiscriminately and
cause depletion of the resources.
5. A large sums of money flows to foreign countries in terms of payments towards profits, dividends
and royalty.
(4) Disadvantages of MNC for the home country :
1. MNCs transfer the capital from the home country to various host countries causing unfavourable
balance of payment.
2. MNCs may not create employment opportunities to the people of home country if it adopts geocentric
approach.
3. As investments in foreign countries is more profitable, MNCs may neglect the home countries
industrial and economic development.

4.6 Structure of Multinational Corporations

Organization is only a means to an end. It takes certain inputs from the environment and converts them into
specified outputs desired by the societies of the nation, according to the style, culture and fashion adopted
by the people. They are economic and social entities in which a number of persons perform different tasks
in order to achieve common goals.Organization design deals with structure aspects of undertakings, to
perform the roles, responsibilities and relationship so that collective efforts can be done.

Organization design is the process of systematic and logical grouping of activities, delegation of authority
and responsibility, with establishing working relationships that will enable both the company and employee
to realize their mutual objectives. Hence, it is to explain that in creation of designing the organization (i.e.
Multinational Corps.), the relationships involving exercise of authority and exchange of information’s, between
such units and positions which leads to development of an organization structure, is to pursue.

54
What Steps may be taken for Organization Designing?
a) Present Circumstances;
Analysis
A b) Future Circumstances; and

c) Environment Factors;

a) Planning
Planning
B
Execution
b) Implementation
a) Aims;
C b) Objectives;
Defining
c) Activities;

d) Structure;

Figure 4.1
The structure of organization of a Multinational Corporation may be designed on the basis of two alternatives

On the basis of Hierarchy On the basis of Approachess

.

Vertical Horizontal
Or Or
Tall organization Flat organization

Geographical Decentralized Product Strategic Matrix

Org. Business Org. Business Org.
Structure Structure Units Structure Structure Structure
Figure 4.8
Figure 4.1
A. On the basis of Hierarchy:
When the hierarchical chain of command of a MNC represents its authority and responsibility relationship
between superiors and subordinates, may be divided into two parts-
(i) Vertical or Tall Organisation: These organizations refer to authority responsibility flow from the top to
bottom through all levels of hierarchy. Accountability (Responsibility) flows from the lowest level (grass-
root-level) to the highest level (decision/policy making level). The blue-collar men (Employee), at each level
55
of the organization shall report to their immediate boss, who in turn should report to his superior, to the top
level. A significant characteristics of such MNC organization is “Centralisation of Authority”.
(ii) Horizontal or Flat Organization: In such structure of MNC organization, authority is more decentralised
in relatively flat structures.
 Managers granted more authority to his subordinates;
 They to an increase in breadth of an organization’s structure;
 Professional managers are treated as real professionalist;
 They reduce the number or hierarchical levels of their organizations of MNC’s;
 Managers have a broad span of control with a dignity and empowerment; and
 Decisions are more likely to be made by the employees who are at the helm of affairs with the situations
and ground realities.
B. On the basis of Approaches:
(i) Geographical Organization Structure: This is a type of Multinational Corporation where the functions
or activities are divided in groups or in departments, based on the crucial functions, performed in the
geographical regions or areas. Also –
 Each geographical unit bears all functioning required from production to marketing and after services, in
particular geographical areas;
 This structure is used mainly by ‘Chain-stores’ , ‘Power Companies’ , ‘Banking
Companies’ , ‘Insurance Companies’ , ‘Dairy Products’ , and ‘Restaurant Chains’ etc.
The following figure explains it clearly –
Share holders

Managing Director

- Human
Production resources
Head Quarter Managers
- Research &
Finance Deputy Managers
development
Assistant Managers
- Computer &
Marketing
information
technology

(Geographical Areas)

Africa ASIA Europe America Australia

Continental ( U.S.A)

- China - Britain - Canada

- North - India - North Part
- Germany - Australia
- South - Japan - Russia - Others
- South Site
- Others -Czechoslovac
- Others

i) Subsidiary Unit ii) Manufacturing Unit iii) Sales Unit

Figure 4.9

56
Main Advantage of Geographical Orgranization Structure of MNCs:
i. It allows a firm (MNCs) to respond to the technical needs of different part of International area;
ii. Where the good (Product) and services are better designed, as the climate, cultural and social
needs of various geographical region;
iii. Such structure enables a company (MNC) to adapt various legal systems of different nations ;and
iv. The global location may give the MNC, an opportunity to better serve the consumer needs, in a
better way, to the people of different countries, gaining a high profit according to the style and
fashions of them.
Disadvantages:
i. Such organisational structure has some limitations of freeness, to appoint functional personal;
ii. There may be duplication human resources, equipments and facilities;
iii. You cannot seek the co-operation in between the company –wide activities i.e. it would be difficult;
and
iv. If there is any misunderstanding about uniformity and diversity, it shall be difficult to maintain consistent
company (MNC) good will or its reputation in international markets.
b). Decentralized Business Unit Structure: In this structure of MNCs:-
i. Grouping functions and activities based on the product-line, with a trend among the diversified
i. companies;
ii. The fundamental organisational building blocks are its business units, which are decentralised as a
whole in the organisation (MNC); and
iii. Each and every business unit is operated as a stand-long profit centre, by decentralisation decision
making and delegating authority.
Advantages:
1. There is a decentralised decision-making.
2. Delegation of authority and responsibility to a manager is for a separate business unit;
3. Each and every business unit is separate profile centre, as a standalone;
4. According to the key activities, strategy and operating requirements, each business unit may establish
either the functional or geographical bases;
5. Every business unit is to manage by an entrepreneur or entrepreneurship oriented manager; and
6. Such manager is delegated with authority to make and implemented the business policies, rules
programmes, budget and strategies to fight with the competitions.
Disadvantages:
There may be many lacunas in any system of organisational structure. In this context, decentralised business
unit structure has a some demerits (disadvantage) also, explained as following:-
1. There is an absence of a systematic mechanism by which may coordinate to the activities across
business units; and
57
 2. Chief or general manager of each business unit functions independently hence, he may be autocratic
leader rather than democratic leader and that may be harmful to MNC.
The decentralised business unit structure may be understood through following figure:-

Share Holder

Managing Director - Human

Production resources
- Research &
Finance Head Quarters Managers
development
- Computer &
Marketing
information
( UNITS) technology

General/ Chief U U General / Chief U General/ Chief U

NManager N Manager N Manager N
I I I
Business – ‘A’ T Business – ‘B’ T Business – ‘C’ T

‘W’ ‘X’ ‘Y’ ‘Z’

Manager Manager Manager Manager Manager Manager

(Finance) (HRM) (Production) (Marketing) (R & D) Computer
& IT

Deputy Deputy Deputy Deputy Deputy

Manager Manager Manager Manager Manager Deputy
Manager
Figure 4.4
(c) Product Organisation Structure:
This is a kind of MNC organisation where activities are divided on the basis of individual product, product
line; services related to them are grouped into departments. All managerial functions i.e. production, finance,
marketing, human resource and research & development are involved within each department.
To classify the above statement, it is to say that –
i. Product are categorised by their nature and utility;
ii. Each product is a output of the efforts different managerial departments;
iii. Each managerial function has it share as per pre-determined decision, taken by Managing Director,
on behalf of Board of Directors of Multinational Corporation.

58
Advantages:
1. The product organization structure is more appropriate for those multinational companies producing
different types of the products (multiple-product);
2. The decision are taken by each product department, without taking the help of top management;
3. Each separate product department is responsible and accountable for market share, sales returns,
profit and loss fixed by the top management in its strategies. The success or failure of a product
launching and for gaining the markets is depend separately to each department.
Disadvantages:
1. There is a lack of specialisation due to the duplication of personnel and equipments among different
product departments;
2. Inter – departmental conflicts may arise regarding sharing or allocation of overhead expenses and
various resources; and
3. The decision for salaries, promotion, transfer, product, designing and quality and pricing strategy
may be inconsistent, in between the departments, relating to the product.
1.

Share Holders

Managing Director Department

to Support
Manager to
the Head
Support
Office
Production
Product Division
Research & Development
Product Designing

Product Product Product Product Product

Category Category Category Category Category
‘A’ ‘B’ ‘C’ ‘D’ ‘E’

Figure 4.5
d) Strategic Business Unit Structure:
To control the business effectively, it is necessary to make a good strategy. A single CE (chief executive) is
not enable to control, a number of decentralised units of a broadly diversified corporation, but if the concerning
businesses are grouped into strategic units and the senior and experienced executive is delegated with the
authority and responsibility for its administration, management and control, the arrangement shall improve
strategic planning and implementation. It may be understand by following figure 6:
Advantages:
1. SBU structure promote more cohesiveness (mutual co-operation) in between the new initiatives of
related business;

59
2. It helps in allocation of corporate resource to areas with best growth opportunities;
3. It provides a strategically relevant path to manage the business units of a broadly diversified
corporation; and
4. SBU structure allows for a long term strategies planning to be done at the most relevant level within
the
1. total undertaking.

Share Holder

Managing Director - Human

Production resources
- Research &
Head Quarters Managers
Finance development
- Computer
Marketing &
information
technology

General Manager General Manager General Manager

(Executive) (Executive) (Executive)
SBU-I SBU-II SBU-III

SRBU SRBU SRBU

(Strategic related (Strategic related (Strateg ic related
business unit) business unit) business unit)

Figure 4.6
e) Matrix organization Structure:
The organization structure which possesses the characteristics of functional and project management, where
the managers exercise authority over organizational activities is called matrix organization. Such structure
has dual chain of command.
In an appropriate matrix organizational pattern of MNC-
a) Management attention must be focused on consumer needs and technical issues i.e. key issues;
b) Diverse information need to be processed in between the functional and project staff.
Advantages:
1. Functional and project manager give the formal attention to each instance and dimension of strategic
primacy;
2. The decisions are taken on the basis of the best efforts for the organisation, as a whole;
3. In such structure, there may be efficient use of functional expertise; and
4. It facilitates operation in dynamic and complex environment, by encouraging optimisation of
organisation goals.
60
Disadvantages:
1. It is a very complex organisation where management is too difficult;
2. There may be a conflict in between functional and Project Manager for their status; and
3. Share Holder
It promotes an internal bureaucracy in the corporation by which decision taken may be delayed.

Managing Director - Human resources

- Research &
Production development
- Computer &
Finance Head Quarters Managers information
technology
Marketing

Project Production Specialist Specialist

Manager Finance Specialist Computer &IT
Country Marketing Specialist R&D Specialist
HR Specialist

Production Specialist HR Specialist

Project
Manager R&D Specialist
Finance Specialist
Country ‘B’ Computer &IT
Marketing Specialist specialist

Figure 4.7

4.7 Relationship between Head Quarter and Subsidiaries

Any multinational corporation which have a few subsidiaries can be managed directly and easily, but when
subsidiaries are more, it must make a permanent relationship in its structure, be co-ordinate and controll the
activities, to provide and implement the information technology. There are ‘six aspects’ of relationship
between Head quarter and subsidiaries, as following-
1. Resources Sharing : MNC head quartar and its subsidiaries, also participate and share different
type of resources in between them, just like human, material, machine, markets, information and
technology with new innovations, for their improvement.
2. Strategy Formulation : The MNC headquarter formulates the global strategies to co-operate the
subsidiaries, for their countries where they are running the business. Also, MNC HQs guide and
direct them in evaluation, implementation and motivation of strategies, regularly
3. Information Sharing: In between the MNC headquarter and Subsidiaries, Information flows
both directions, viz HQ receives the information from the branches relating to their demand, daily
sales, financial situations, about markets, customer’s difficulties, environment of host and abroad
country and for product design etc. and similarly, the subsidiaries get the information from the MNC
HQs regarding the total record of human resources.
4. Co-ordination of Activities : Multinational Corporation’s headquarters coordinates the activities
of subsidiaries and suppliers, market intermediaries, bankers, foreign governments, custom and
excise officials and different external parties, demand and supply of human resources, finance for
subsidiaries.
61
 5. Control of Operations : The MNC headquarter as a status that they are controlling authority of
subsidiaries, to control on competitor’s positions, customs and excise regulations, govt. policies
and rules, laws relating to business, terms and conditions decided by suppliers of raw-material and
the contracts made with the financial institutions, so on.

6. Decisions Flows : Mainly, policy making and decision making is the job of MNC HQ. When HQ
has taken the decision, it flows to the subsidiaries to communicate and implement them. Similarly,
subsidiaries communicate the decisions made by them, for creation the working process and to plan
for implementation, for approval.

4.8 Control of Multinational Corporations

Multinational Companies have become very large and very powerful. Some, for example, are worth more
than the entire GDP of many countries. So MNCs can have an enormous effect, for good and for ill, on the
countries they do business in, especially if those countries are small and/or poor. This revision note examines
the main areas of influence:

(1) The Balance of Payments:

MNCs import large amounts of capital in order to pay for their new business investments; factories, offices
or whatever. This surplus on the capital account creates a deficit on the current account i.e. the country is
importing more goods and services than it is exporting. This lifts local standards of living until the import of
capital stops for whatever reason and then standards fall again. If the new business is for import substitution
(producing locally what had been imported) then imports fall and the current account improves. If the new
business is developing local raw materials for export (eg oil exploration) then the exports of raw material
also improve the current account.

But, the MNC may need to import large amounts of technical equipment not available locally, and this will
worsen the current account. If the MNC re-invests its profits then there is no effect on the Balance of
Payments, but if it repatriates its profits, the current account worsens. Further, the exchange market of a
small country may not be well-developed, so the attempt by a business to buy or to sell large amounts of
foreign exchange will send the price of that currency sharply up or down unless things are managed very
carefully

(2) Employment:

Generally, MNCs set up new businesses which need new workers and so employment is improved; jobs
are created. However, it depends on the skills match between the new jobs and the local employment
market. The business may set up a factory specifically designed to suit the local employment market. But in
the Middle East oil states, for example, there are many factories producing for the local consumer markets.
Sometimes the jobs are too demanding for the locals, and sometimes the jobs are too demeaning. Either
way, the result is huge numbers of expatriate workers from India, Bangladesh, the Philippines and so on and
at the same time large local unemployment.

But, MNCs can sometimes provide devastating competition for local businesses which may end up closing
which creates unemployment. MNCs usually employ fewer workers; that is part of their greater efficiency.
The MNC may then relocate again after a period of years.

62
(3) Technology Transfer:
An MNC invariably operates to a higher standard of managerial and technical expertise than the local
economy. Local employees can learn about these things and the local economy can benefit from this new
expertise. Even the UK can benefit, so we are not simply talking about developing countries where technology
transfer is enormously important. This will depend on how willing the MNC is to employ and train local
workers.
(4) Social Responsibility:
Standards and regulations are another kind of business cost, and MNCs are always looking for lower
costs. So there is an advantage to locating in countries with few regulations. Some poor countries are prey
to corruption and bribery which means their few regulations are ineffective. India, for example, has excellent
environmental protection laws, on paper. In practice, the inspectors are so badly paid it only costs a matter
of dollars to get them to look the other way. This opens the way for a slippage of standards below the levels
considered acceptable in the MNCs home country.
One of the most scandalous cases was in the 1980s where the US chemical business Union Carbide
tolerated very poor safety standards at a factory in Bhopal, India.. The result was an explosion which
released clouds of toxic gas and killed thousands. Many more thousands are still alive and very ill because
of this. What was particularly irresponsible was the long years it took to force Union Carbide to accept
responsibility and pay compensation. This whole area is a large and important are which it is impossible to
cover completely. It is, for example, one important reason why some western pressure groups are so hostile
to MNCs.
(5) Government Control:
It is quite difficult for some governments to exercise effective control over MNCs because they are so large
and powerful. One MNC may be the dominant force in the local economy. Even large and wealthy countries
such as the UK can’t always control MNCs effectively. They have a wide repertoire of tricks to minimize
government control, especially taxes.
One favorite trick (technically illegal) is transfer pricing. MNCs often buy and sell between different national
offices of the same business, because each is a separate profit centre. For example, the Paris office makes
the product, and the Berlin office sells it. So the Paris office has to sell to the Berlin office. There is then the
question of at what price the sale takes place. Officially, the selling price must be the market price on the
day, but some markets don’t have prices every day, and governments have a difficulty in proving what is
going on.
If, for example, German company taxes are higher than French company taxes, then the Berlin office will
pay too much for the product and make a loss. The Paris office makes a very large profit and pays tax on
this profit at the lower rate. When different governments have completely different tax systems, with thousands
of detailed rules of how tax is paid, and deductions for this, and allowances for that, the opportunities for
MNCs to employ a few clever tax accountants and ‘cook the books’ are enormous.

4.9 Top MNCs in India

The country has got many MNCs operating here. Following are names of some of the most famous
multinational companies, who have their headquarters of operational branches based in the nation:
IBM: IBM India Private Limited, a part of IBM has been operating from this country since the year 1992.
This global company is known for invention and integration of software, hardware as well as services, which
63
assist forward thinking institutions, enterprises and people, who build a smart planet. The net income of this
company post completion of the financial year end of 2010 was $14.8 billion with a net profit margin of
14.9 %. With innovative technology and solutions, this company is making a constant progress in India.
Present in more than 200 cities, this company is making constant progress in global markets to maintain its
leading position.
Microsoft: A subsidiary, named as Microsoft Corporation India Private Limited, of the U. S. (United
States) based Microsoft Corporation, one of the software giants has got their headquarter in New Delhi.
Starting its operation in the country from 1990, this company has got the following business units:
 Microsoft Corporation India (Pvt.) Limited (Marketing Division)
 Microsoft Global Services India
 Microsoft Global Technical Support Centre
 Microsoft India Development Center
 Microsoft IT
 Microsoft Research India
The net income of Microsoft Corporation grew from $ 14, 569 million in 2009 to $ 18, 760 million in 2010.
Working in close association with all the stakeholders including the Government of India, the company is
committed towards the development of the Indian software as well as I. T industry.
Nokia Corporation: Nokia Corporation was started in the year 1865. Being one of the leading mobile
companies in India, their stylish product range includes the following:
 Normal mobile handsets
 Smartphones
 Touch screen phones
 Dual sim phones
 Business phone
The net sales of the company increased by 4 % in the last financial year with sales of EUR 42.4 billion as
compared to 2009’s EUR 41 billion. Over the past few years, this company in India has been acquiring
companies, which have got new and interesting competencies and technologies so as to enhance their ability
of creating the mobile world. Besides new developments to fight against mineral conflicts, they are even to
set up Bridge Centers in the country for supporting re-employment. Their first onsite for the installation of
renewable power generation are already in place.
PepsiCo: PepsiCo. Inc. entered the Indian market with the name of PepsiCo India from the year 1989.
Within a short time span of 20 years, this company has emerged as one of the fast growing as well as largest
beverage and food manufacturer. As per the annual report of the company in the last business year, the net
revenue of PepsiCo grew by 33 %. By the year 2020, this food manufacturing company intends to triple
their portfolio of enjoyable and wholesome offerings. The expansion of their Good-For-You portfolio is
believed to be assisting the company in attaining the competitive advantage of the growing packaged nutrition
market in the world, which is presently valued at $ 500 billion.
Ranbaxy Laboratories Limited: Ranbaxy Laboratories Limited, one of the biggest pharmaceutical
companies in India, started their business in the country from the year 1961. The company made its public
appearance in 1973 though. Headquartered in this nation, this international, research based, integrated
pharmaceutical company is the producer of a huge range of affordable cum quality medicines that are
trusted by both patients and healthcare professionals all over the world. In the business year 2010, the
registered global sales of the company was US $ 1, 868 Mn. Successful development of business forms the

64
key component of their trading strategy. Apart from overseas acquisitions, this company is making a continuous
endeavor to enter the new global markets, which have got high potential. For this, they are offering value
adding products as well.
Reebok International Limited: This global brand is a famous name in the field of sports as well as lifestyle
products. Reebok International Limited, a subsidiary of Adidas AG, is based in U. S. A. (United States of
America) started its operation in 1890s. During the last financial year, Adidas’s currency neutralized group
sales increased by 9 %. Apart from their alliance with CrossFit that is among the largest contemporary
fitness movements, in the current year, Reebok’s announcement of its partnership with artist, designer and
producer Swizz Beatz reflects its long term future growth.
Sony: Sony India is a part of the renowned brand name Sony Corporation, which started their business
operation in the year 1946 in Japan. Established in India in November 1994, this company has captured
one of the leading positions in the field of consumer electronics goods. By the end of the business year 2010
on 31st March, 2011, the company showed a remarkable increase in the share related to numerous
categories. Sony India is planning to invest around INR. 150 crore for the marketing of the activities related
to ATL and BTL. As far as Bravia TVs are concerned, they are looking forward to hold their market share
of 30 %. In between the last and the current financial year, the number of their outlets in the country
increased by 1, 000.
Vodafone: Vodafone Group Plc is an international telecommunication company, which has got it’s headquarter
based in London in the United Kingdom (U. K.). Earlier known as Vodafone Essar and Hutchison Essar,
Vodafone India is among the largest operators of mobile networking in the country. The parent company
Hutchison started its business in the year 1992 along with the Max Group, which was its business partner in
India. Much later in 2011, Vodafone Group Plc decided to buy out mobile operating business of Essar
Group, its partner. The turnover of the Vodafone Group Plc after the completion of the last financial year
grew to £ 44, 472 m from £ 41, 017m that was the turnover of the business year 2009.
Tata Motors Limited: The biggest automobile company in India, Tata Motors Limited, is among the
leading commercial vehicles manufacturer in the country. They are one of the top 3 passenger vehicle
manufacturers. Established in the year 1945, this company, a part of the famous Tata Group, has got its
manufacturing units located in different parts of the nation. Some of their well known products of the company
are categorized in the following heads:
 Commercial Vehicles
 Defence Security Vehicles
 Homeland Security Vehicles
 Passenger Vehicles
Post completion of the financial year 2010 to 2011, the global sales of the company grew by 24.2 % with
sales crossing INR. 1 million.
Profit of MNCs in India:
It is too specify that the companies come and settle in India to earn profit. A company enlarges its jurisdiction
of work beyond its native place when they get a wide scope to earn a profit and such is the case of the
MNCs that have flourished here. More over India has wide market for different and new goods and
services due to the ever increasing population and the varying consumer taste. The government FDI policies
have somehow benefited them and drawn their attention too. The restrictive policies that stopped the
company’s inflow are however withdrawn and the country has shown much interest to bring in foreign
investment here.
65
Besides the foreign directive policies the labour competitive market, market competition and the macro-
economic stability are some of the key factors that magnetize the foreign MNCs here. Following are the
reasons why multinational companies consider India as a preferred destination for business:
 Huge market potential of the country
 FDI attractiveness
 Labor competitiveness
 Macro-economic stability

4.10 Summary
There is no universally accepted definition of the term, Multinational Corporation. As an ILO report observes,
“the essential nature of the multinational enterprises lies in the fact that its managerial headquarters are
located in one country while the enterprise carries out operations in a number of other countries as well.
MNCs have been spreading and growing across the globe very rapidly. Although the MNCs from the
developed countries still dominate the scene, more and more MNCs are emerging from the developing
countries It denotes that the activities of multinationals in developing countries are governed for obtaining,
maintaining or expanding a foreign market, meeting and overcoming competitive forces in the international
bazaar which necessitate the development of foreign bases both at national and regional levels, by taking
advantages of low labour costs so on. MNCs help the host countries to increase domestic investment and
employment generation, boost exports, transfer technology and accelerate economic growth. The liberalization
has paved the way for easy entry and growth of MNCs in India. At the same time a number of Indian firms
have been becoming multinational.

4.11 Key Words

 MNC: Giant business organization operating in many countries.

 Product Organization: Where activitles are divided on the basls of individual product.

 SBUs: Strategic Business groups business into strategic units.

 Matrix Structure: This type of organizations process the characteristics of functional & project
management.

4.12 Self Assessment Test

1. Define ‘Multi-National Corporation’? Whatof characteristics or benchmarks of multinational
corporations.
2. “Multinational Corporations are the owner of intellectual and physical properties.” Discuss it, by
giving the element concerning with these corporations.
3. Explain the concept and objective of ‘Multinational Corporations’. What are the reasons or causes
contributed for the growth of MNCs? Elucidate.
4. What do you mean by Multinational Corporation? Explain the organisational structure of MNCs.
5. Explain the Role and evolution process of Multinational Corporation.
6. Write short notes on the following-
(i) Product organisation structure
(ii) Matrix organisation structure

66
 (iii) MNC Organisation
(iv) Relationship between Head Quarters and Subsidiaries
7. “Where Multinational Corporation has more subsidiaries, it must make a permanent relationship in
its structure, to be coordinated and controlled the activities, to provide and implemented the
information technology.” Discuss.
8. How you will define the multinational corporations in India and foreign collaboration?
9. Write shorts notes on following-
(i) Key points for helping and developing MNCs.
(ii) Drivers of multinationals.
(iii) Designing the MNCs.
(iv Advantages and Disadvantages of Multinational Corporations
10. Explain the control process of Multinational Corporation. Give examples of Top MNCs in India?

4.13 References
 Regar Bennett, “International Business Addison”, Wesky, New Delhi, 2005
 Peter Brucker, “Management”, Allied Publishers, 1975
 James A Lee, “Cultural Analysis in overseas Operation “ Harwards Business Review, 1966
 Warron Keegan, “Global Marketing Management” PHI, New Delhi
 Peter F Druker, Management Challenges for the 21st Century, Harper Business, New York, 1999.

67
 Foreign Direct Investment (FDI), Foreign
Institutional Investment (FIIs) and
International Financial Management
Learning Objectives
After going through the chapter student shall be able to understand
• Foreign Direct Investment (FDI)
? Costs Involved- By Host Country and Home Country
? Benefits Derived- By Host Country and Home Country
• Foreign Institutional Investment
• International Financial Management - Including raising Of capital abroad (ADRs, GDRs,
ECB)
• Instruments of International Finance
(1) Foreign Currency Convertible Bonds (FCCBs)
(2) Global Depository Receipts (GDRs)
(3) Euro-Convertible Bonds (ECBs)
(4) American Depository Receipts (ADRs)
(5) Other sources
• Euro-Issues- Eligibility, Advantages, Disadvantages, Structuring, Pricing and Methodology
• GDRs Vs. Euro-Bonds
• Cross-Border Leasing
• International Capital Budgeting
• International Working Capital Management

© The Institute of Chartered Accountants of India

 11.2 Strategic Financial Management

Part – A
Foreign Direct Investment (FDI), Foreign Institutional Investment
(FIIS)
1. Costs Involved
1.1 For Host Country: Inflow of foreign investment improves balance of payments position
while outflow due to imports, dividend payments, technical service fees, royalty reduces
balance of payments position. Use of imported raw materials may be harmful to the interest of
the domestic country whereas it may be useful to the interests of the foreign country.Supply of
technology to the host country makes it dependent on the home country resulting in the
payment of higher price for acquisition. The technology may not be suitable to the local
environment causing substantial loss to the host country. MNCs are reluctant to hire and train
local persons. Advanced technology being capital intensive does not ensure bigger job
prospects. Foreign investors do not care to follow pollution standards; nor do they stick to the
optimal use of natural resources nor have any concern about location of industries while
opting for a manufacturing process. Such violation affects host nations interest. Domestic
industries cannot withstand the financial power exercised by the foreign investors and thereby
die a pre-mature death. Because of their oligopolistic position in the market, foreign
companies charge higher prices for their products. Higher prices dampen the spirit of the
buyers and at the same time lead to an inflationary pressure. Foreign culture is infused by
these foreign companies in industrial units as well as to the society at large.Governmental
decisions fall prey to such measures as they become a dominant force to reckon with.
1.2 For Home Country: Cost involvement for the home country is a paltry sum. Any
foreign investment causes a transfer of capital, skilled personnel and managerial talent from
the country resulting in the home country’s interest being hampered. MNCs have the primary
objective of maximising their overall profit while operating in different countries. The standards
followed by them in most cases are not beneficial to the host nation. Such an action leads to
deterioration in bilateral relations between the host and home country.
FDI is a mixed bag of bright features and dark spots. So it requires careful handling by both sides.
2. Benefits Derived
2.1 For Host Country
(a) Improves balance of payment position by crediting the inflow of investment to capital
account.Also current account improves as FDI aids import substitution/export
promotion.Exports get a boost through the expertise of foreign investors possessing export
market intelligence and their mechanism.Updated technology of producing world standard
goods at low cost are available to the host country.Export credits from the cheapest source in
the international market can be availed of quite easily.
(b) Foreign firms foster forward and backward economic linkages.Demand for various inputs

© The Institute of Chartered Accountants of India

 Foreign Direct Investment (FDI) and Foreign Institutional Investment (FIIs) 11.3

give rise to the development of the supplying industries which through employment of labour
force raise their income and increase the demand for domestic industrial production.The living
standard of the domestic consumers improves as quality products at competitive prices are
available.Also a pool of trained personnel is created in this context.
(c) Foreign investors by investing in economic / social infrastructure, financial markets and
marketing systems helps the host country to develop a support base essential for quick
industrialisation. The presence of foreign investors creates a multiplier effect leading to the
emergence of a sound support system.
(d) Foreign investors are a boon to government to revenue with regard to the generation of
additional income tax.Also they pay tariff on their imports.Governmental expenditure
requirements are greatly reduced through supplementing government’s investment activities in
a big way there by lessening the burden on national budget.
(e) FDI aids to maintain a proper balance amongst the factors of production by the supply of
scarce resources thereby accelerating economic growth.Capital brought in by FDI
supplements domestic capital as the savings rate at home is very low to augment heavy
investment.Through the inflow of scarce foreign exchange, domestic savings get a boost to
support the investment process.Foreign investors are bold enough to take risks not prevalent
among local investors resulting in investment projects being implemented in a large way.FDIs
bring in skilled labour force to perform jobs which the local workers are unable to carry
out.There is also a fear of imposition of alien culture being imposed on the local labour force.
Foreign investors make available key raw materials along with updated technology to the host
country.Such a practice helps the host country to obtain access to continued updation of R&D
work of the investing country.
2.2 For Home Country :The home country gets the benefit of the supply of raw materials if
FDI helps in its exploitation.BOP improves due to the parent company getting dividend,
royalty, technical service fees and also from its increased exports to the subsidiary.Also there
is employment generation and the parent company enters into newer financial markets by its
investment outside.The government of the home country increases its revenue income of the
parent organization, imposition of tariff on imports of the parent company from its foreign
subsidiary.FDI helps to develop closer political relationship between the home and the host
country which is advantageous to both.
3. Foreign Institutional Investment
Positive tidings about the Indian economy combined with a fast-growing market have made
India an attractive destination for foreign institutional investors (FIIs). The foreign Institutional
Investors' (FIIs) net investment in the Indian stock markets in calendar year 2005 crossed US$
10 billion, the highest ever by the foreign funds in a single year after FIIs were allowed to
make portfolio investments in the country's stock markets in the early 1990s. As per the
Securities Exchange Board of India (SEBI) figures, FIIs made net purchases of US$ 587.3
million on December 16, 2005, taking the total net investments in the 2005 calendar to US$
10.11 billion. India's popularity among investors can be gauged from the fact that the number
of FIIs registered with SEBI has increased from none in 1992-93 to 528 in 2000-01 to 803 in

© The Institute of Chartered Accountants of India

 11.4 Strategic Financial Management

2005-06. In 2005 alone, 145 new FIIs registered themselves, taking the total registered FIIs to
803 (as on October 31, 2005) from 685 in 2004-05.
A number of these investors are Japanese and European funds aiming to cash in on the rising
equity markets in India. In addition, there was increased registration by non-traditional
countries like Denmark, Italy, Belgium, Canada and Sweden. The Japanese have, in fact,
been increasing their foothold in India. Mizuho Corporate Bank's decision to successfully
expand base in the country has managed to convince almost 60-65 major Japanese
corporates to set up manufacturing or marketing base in India. This list of corporates includes
big names in auto sectors such as Honda, Toyota and Yamaha, as well as those in home
appliances, pharmaceuticals, and communications.
• While Nissan has already set up its base in India, other new entrants include Japanese
business conglomerate Mitsui Metal, Sanyo, and pharma major Eisai. Japanese Telecom
major Nippon Telegraph (NTT) is also in the process of entering the Indian market.
• Sabre Capital and Singapore's Temasek Holding have teamed up to float a fund that will
invest up to US$ 5 billion in Indian equities as well as fixed income instruments over the
next five years.
• Fidelity International, a leading foreign institutional investor, has picked up about 9 per
cent in the Multi Commodity Exchange of India Ltd (MCX) for US$ 49 million.
If FIIs have been flocking to India, it is obvious that the returns are handsome. It is estimated
that all the foreign investors in India, at least 77 per cent make profit and 8 per cent break
even.
These facts are corroborated by recent research on the trend. A landmark survey by the Japan
Bank for International Co-operation (JBIC) shows that in the next three years, India will be the
third most favoured investment destination for Japanese investors in a list, which includes US
and Russia. A Smith Barney (a Citigroup division) study says the estimated market value of FII
investment in the top 200 companies (including ADRs and GDRs) at current market prices is a
whopping US$ 43 billion. This is 18 per cent of the market capitalisation of the BSE 200.
By a recent circular the cumulative debt investment limit for the FIIs/Sub-Accounts was
increased from US $1 billion to US $1.75 billion. Ministry of Finance, Government of India
clarified that the cap of US $1.75 billion will be applicable to FIIs investment in dated
Government Securities and T-bills only, both under 100% debt route and general 70:30 route.
Thus, investment in securities other than dated Government Securities and T-Bills, i.e.
Corporate Debt, would not be reckoned within the sub ceiling of US $1.75 billion. Therefore,
investments by the FIIs/Sub Accounts through 100% debt route in dated Government
securities and T-Bills only will be reckoned for the purpose of monitoring of individual limits
allocated to them.In respect of foreign investment the discussion (FAQ), as given by RBI and
SEBI, are also important. The details are available on the respective web site.

© The Institute of Chartered Accountants of India

 Foreign Direct Investment (FDI) and Foreign Institutional Investment (FIIs) 11.5

Part – B
International Financial Management - Including Raising of Capital
Abroad (ADRs, GDRs, ECB)
1. Introduction
The essence of financial management is to raise and utilise the funds effectively. This also
holds good for the procurement of funds in the international capital markets, for a multi-
national organisation in any currency. There are various avenues for a multi-national
organisation to raise funds either through internal or external sources. Internal funds comprise
share capital, loans from parent company and retained earnings. Now a days external funds
can be raised from a number of sources. The various sources of international finance are
discussed in this chapter.
1.1 External Commercial Borrowings: External Commercial Borrowings (ECB) are
defined to include
1. commercial bank loans,
2. buyer’s credit,
3. supplier’s credit,
4. securitised instruments such as floating rate notes, fixed rate bonds etc.,
5. credit from official export credit agencies,
6. commercial borrowings from the private sector window of multilateral financial institutions
such as IFC, ADB, AFIC, CDC etc. and
7. Investment by Foreign Institutional Investors (FIIs) in dedicated debt funds
Applicants are free to raise ECB from any internationally recognised source like banks, export
credit agencies, suppliers of equipment, foreign collaborations, foreign equity - holders,
international capital markets etc. Offers from unrecognised sources will not be entertained.
ECB entitlement for new projects
All infrastructure and Greenfield projects 50% of the total project cost
upto 50% of the project cost (including license
Telecom Projects
fees)
In the case of power projects, greater flexibility will be allowed, based on merits.
End - use
(a) ECBs are to be utilised for foreign exchange costs of capital goods and services (on FOB
and CIF basis).
Proceeds should be utilized at the earliest and corporates should comply with RBI's guidelines
on parking ECBs outside till actual imports. RBI would be monitoring ECB proceeds parked
outside.

© The Institute of Chartered Accountants of India

 11.6 Strategic Financial Management

However, in the case of infrastructure projects in the power, telecommunications and railway
sectors, ECB can be utilised for project - related rupee expenditure. License fee payments
would be an approved use of ECB in the telecom sector.
(b) ECB proceeds may also be utilised for project - related rupee expenditure, as outlined
above.Proceeds must be brought into the country immediately.
However, under no circumstances, ECB proceeds will be utilized for:
(i) investment in the stock market
(ii) speculation in real estate
(c) ECB may be raised to acquire ships/vessels from Indian shipyards
Proceeds from Bonds & FRN
Corporates who have raised ECB through Bond/ FRN issues are permitted to use the
proceeds from the issue for project related rupee expenditure till actual import of capital
equipments takes place or up to one year, whichever is less. Sanction of additional ECB to the
company would be considered only after the company has certified through its statutory
auditor that it has fully utilised the amount for import of the capital equipment and services.
Other terms and conditions
Apart from the maturity and end - use requirements, the financial terms and conditions of each
ECB proposal are required to be reasonable and market - related. The choice of the sourcing
of ECB, currency of the loan, and the interest rate basis (i.e. floating or fixed), will be left to
the borrowers.
• Security: The choice of security to be provided to the lenders/ suppliers will also be left
to the borrowers. However, where the security is in the form of a guarantee from an
Indian financial institution or from an Indian scheduled commercial bank, counter -
guarantee or confirmation of the guarantee by a foreign bank/ foreign institution will not
be permitted.
• Exemption from withholding tax: All interest payments and fees etc. related to external
commercial borrowings would be eligible for withholding tax exemption under Section
10(15) (iv) (b) to (g) of the Income Tax Act, 1961. Exemptions under section 10(15) (iv)
(b), (d) to (g) are granted by the Department of Economic Affairs while exemption under
section 10(15) (iv) (c) is granted by the Department of Revenue, Ministry of Finance.
• Approval under Foreign exchange regulation: After receiving the approval from the
ECB Division, Department of Economic Affairs, Ministry of Finance, the applicant is
required to obtain approval from the Reserve Bank of India and to submit an executed
copy of the loan agreement to this department for taking the same on record, before
obtaining clearance from the RBI for drawing the loan. Monitoring of end use of ECB will
continue to be done by RBI.
• Short - term loan from RBI: While external commercial borrowing for minimum maturity
of three years and above will be sanctioned by the Department of Economic Affairs,
Ministry of Finance, approvals for short term foreign currency loans with a maturity of
less than three years will be sanctioned by the RBI, according to the RBI guidelines.

© The Institute of Chartered Accountants of India

 Foreign Direct Investment (FDI) and Foreign Institutional Investment (FIIs) 11.7

• Validity of approval: Approvals are valid for an initial period of three months, i.e. the
executed copy of the loan agreement is required to be submitted within this period.
1.2 International Capital Market: It is well known today that modern organizations
including multinationals largely depend upon sizable borrowings in rupees as well as in foreign
currencies to finance their projects involving huge outlays. The taxation benefits available on
borrowings as against the capital often influence this course as interest payment on borrowed
funds is an allowable expenditure for tax purposes.
In order to cater to the financial needs of such organisations international capital markets or
financial centres have sprung up wherever international trade centres have developed.
Lending and borrowing in foreign currencies to finance the international trade and industry has
led to the development of international capital market.
In domestic capital markets of various countries, international capital transactions also take
place. For instance, USA, Japan, UK, Switzerland, West Germany have active domestic
capital markets. Foreign borrowers raise money in these capital markets through issue of
'foreign bonds'. (Note: International bond and Euro bond are NOT the same and hence
deleted). An International Bond issue is managed by a syndicate of international banks and
placed with investors and lenders worldwide. The issue may be denominated in any of the
currencies for which liquid market exist.
In international capital market, the availability of foreign currency is assured under thefour
main systems viz. (1) Euro - currency market; (2) Export Credit Facilities; (3) Bonds issues,
and (4) Financial Institutions. Euro-Currency market was originated with dollar dominated bank
deposits and provide loans in Europe particularly, in London. Euro-dollar deposits form the
main ingredient of Euro-currency market. Euro-dollar deposits are dollar denominated time
deposits available at foreign branches of US banks and at some foreign banks. These
deposits are acquired by these banks from foreign Governments and various firms and
individuals who want to hold dollars outside USA. Banks based in Europe accept dollar
denominated deposits and make dollar denominated loans to the customers. This forms the
basis of Euro-currency market spread over various parts of the world. In Euro-currency
market, funds are made available as loans through syndicated Euro-credit or instruments
known as Floating Rate Notes FRNs/FRCDs (certificates of deposits). London has remained
as the main centre for Euro-currency credit.
The creditors however insist on bank guarantees. Several multinational banks of Japanese,
American, British, German and French origin - operate all over the world, extending financial
assistance for trade and projects. Several multinational banks like Citi Bank, Standard
Chartered bank, American Express, Bank of America, etc. are aggressiveplayers in India and
they issue specific bank guarantees to facilitate the business transactions between various
parties, including government agencies. Commercial borrowings as well as Exim Bank
finance, however, constitute major cost.

© The Institute of Chartered Accountants of India

 11.8 Strategic Financial Management

2. Instruments of International Finance

The various financial instruments dealt with in the international market are briefly described
below :
1. Euro Bonds: A Eurobond is an international bond that is denominated in a currency not
native to the country where it is issued. Also called external bond e.g. A Yen floated in
Germany; a yen bond issued in France.
2. Foreign Bonds: These are debt instruments denominated in a currency which is foreign
to the borrower and is denominated in a currency that is native to the country where it is
issued. A British firm placing $ denominated bonds in USA is said to be selling foreign bonds.
3. Fully Hedged Bonds: In foreign bonds, the risk of currency fluctuations exist. Fully
hedged bonds eliminate that risk by selling in forward markets the entire stream of interest and
principal payments.
4. Floating Rate Notes: These are debt instruments issued upto 7 years maturity. Interest
rates are adjusted to reflect the prevailing exchange rates. They provide cheaper money than
fixed rate debt instruments; however, they suffer from inherent interest rate volatility risk..
5. Euro Commercial Papers: Euro Commercial Papers (ECPs) are short-term money
market instruments. They are for maturities for less than a year. They are usually designated
in US dollars.
3. Financial Sector Reforms in India
The Government of India, as a part of liberalisation and de-regulation of industry and to
augment the financial resources of Indian companies, has allowed the companies to directly
tap foreign resources for their requirements. The Government has allowed foreign institutional
investors to invest upto 24% in the secondary market. As a result of measures initiated by the
Government, various foreign companies established their business and various companies are
coming to do business in India. The Government has given the signals that foreign investment
is now welcome and that non-priority industries are not prohibited. The reasons for the foreign
investors' interest in India are the low returns prevalent in the USA and Europe. India's large
middle class is even more than the population of some of the countries and provides good
marketing potential. Beside this the availability of skilled and cheap labour, the wide-spread
use of English language, are also some of the contributory factors for the globalisation of
Indian business.
It is now possible in India that a foreign company may invest directly in a joint venture or in an
Indian subsidiary. It may also route its investment through a third country by forming a
subsidiary in that country, which in turn, invests in India. Most of foreign companies prefer to
have joint venture with an Indian partner, who understands the local environment and is able
to exploit the business opportunities. India is being used as a low cost manufacturing base for
sourcing exports to third countries also, without paying much tax. A company wanting to start
operations immediately can directly set up a venture undertaking.

© The Institute of Chartered Accountants of India

 Foreign Direct Investment (FDI) and Foreign Institutional Investment (FIIs) 11.9

Indian Depository Receipts (IDRS)

Like ADRs and GDRs developments in financial arena have created enormous investment
opportunities for Indian investors abroad and vice-versa. Indian companies are raising finance
from abroad and are available on foreign exchanges to raise finance by way of American
Depository Receipts (ADRs) and Global Depository Receipts (GDRs).Similarly, foreign
companies can raise finance in India in the form of Indian Depository Receipts (IDRs), which
are listed in India. This enables Indians to invest in foreign companies on Indian Indian Stock
Exchanges. .
The companies would however be required to fulfill a number of guidelines for listing in India
through an IDR issue.This opens up a new possibility for Indian investors where they can also
diversify their portfolios.This kind of phenomena is common across the various markets
throughout the world.
This new development would also benefit the Indian investors.They will become familiar with
this kind of investment opportunities and should make the best use of the choices available to
them.It will provide diversification as well as a chance to sample new companies that would
otherwise not be available for investment.
The liberalised measures have boosted the confidence of foreign investors and also provided
an opportunity to Indian companies to explore the possibility of tapping the European market
for their financial requirements, where the resources are raised through the mechanism of
Euro-issues i.e. Global Depository Receipts (GDRs) and Euro-bonds.
4. International Financial Instruments and Indian Companies
Indian companies have been able to tap global markets to raise foreign currency funds by
issuing various types of financial instruments which are discussed as follows :
4.1 Foreign Currency Convertible Bonds (FCCBs): A type of convertible bond issued
in a currency different than the issuer's domestic currency. In other words, the money being
raised by the issuing company is in the form of a foreign currency. A convertible bond is a mix
between a debt and equity instrument. It acts like a bond by making regular coupon and
principal payments, but these bonds also give the bondholder the option to convert the bond
into stock.
These types of bonds are attractive to both investors and issuers. The investors receive the
safety of guaranteed payments on the bond and are also able to take advantage of any large
price appreciation in the company's stock. (Bondholders take advantage of this appreciation
by means of warrants attached to the bonds, which are activated when the price of the stock
reaches a certain point.) Due to the equity side of the bond, which adds value, the coupon
payments on the bond are lower for the company, thereby reducing its debt-financing costs.
FCCBs is a bond issued in accordance with the guidelines, dated 12th November, 1993 as
amended from time to time and subscribed for by non-residents in foreign Currency and
Convertible into ordinary / equity shares of the issuer company in any manner whether in
whole or in part or on the basis of any equity related warrants attached to debt instruments.

© The Institute of Chartered Accountants of India

 11.10 Strategic Financial Management

Advantages of FCCBs
(i) The convertible bond gives the investor the flexibility to convert the bond into equity at a
price or redeem the bond at the end of a specified period, normally three years if the price
of the share has not met his expectations.
(ii) Companies prefer bonds as it leads to delayed dilution of equity and allows company to
avoid any current dilution in earnings per share that a further issuance of equity would
cause.
(iii) FCCBs are easily marketable as investors enjoys option of conversion into equity if
resulting to capital appreciation. Further investor is assured of a minimum fixed interest
earnings.
Disadvantages of FCCBs
(i) Exchange risk is more in FCCBs as interest on bonds would be payable in foreign
currency. Thus companies with low debt equity ratios, large forex earnings potential only
opt for FCCBs.
(ii) FCCBs mean creation of more debt and a forex outgo in terms of interest which is in
foreign exchange.
(iii) In the case of convertible bonds, the interest rate is low, say around 3–4% but there is
exchange risk on the interest payment as well as re-payment if the bonds are not
converted into equity shares. The only major advantage would be that where the
company has a high rate of growth in earnings and the conversion takes place
subsequently, the price at which shares can be issued can be higher than the current
market price.
Many Indian Companies had raised FCCBs during the bull run period of 2005-2008 (Prime
Data Base: 201 companies raising about Rs.72,000 crores). These FCCBs are due for
conversion from 2011-12, when the current market prices are much below the conversion
prices. Hence, it is expected that FCCB dream could turn out to be a nightmare for India Inc.
As per reports emanating, Wockhardt, Cranes Software, Aftek, JCT, Marksans Pharma,
Mascon Global, Gremach, Pyramid Saimira and Zenith Infotech have defaulted on either
repayment of the FCCB or on the coupon payments. More companies are expected to join this
list.
4.2 Global Depository Receipts (GDRs): A depository receipt is basically a negotiable
certificate, denominated in a currency not native to the issuer, that represents the company's
publicly - traded local currency equity shares. Most GDRs are denominated in USD, while a
few are denominated in Euro and Pound Sterling. The Depository Receipts issued in the US
are called American Depository Receipts (ADRs), which anyway are denominated in USD and
outside of USA, these are called GDRs.In theory, though a depository receipt can also
represent a debt instrument, in practice it rarely does. DRs (depository receipts) are created
when the local currency shares of an Indian company are delivered to the depository's local
custodian bank, against which the Depository bank (such as the Bank of New York) issues

© The Institute of Chartered Accountants of India

 Foreign Direct Investment (FDI) and Foreign Institutional Investment (FIIs) 11.11

depository receipts in US dollar. These depository receipts may trade freely in the overseas
markets like any other dollar-denominated security, either on a foreign stock exchange, or in
the over-the-counter market, or among a restricted group such as Qualified Institutional
Buyers (QIBs). Indian issues have taken the form of GDRs to reflect the fact that they are
marketed globally, rather than in a specific country or market. Rule 144Aof the Securities and
Exchange Commission of U.S.A permits companies from outside USA to offer their GDRs to
certain institutional buyers. These are known as Qualified Institutional Buyers (QIBs). There
are institutions in USA which, in the aggregate, own and invest on a discretionary basis at
least US $ 100 million in eligible securities.
Through the issue of depository receipts, companies in India have been able to tap global
equity market to raise foreign currency funds by way of equity. Quite apart from the specific
needs that Indian companies may have for equity capital in preference to debt and the
perceived advantages of raising equity over debt in general (no repayment of "principal" and
generally lower servicing costs, etc.) the fact of the matter is quite simple, that no other form
of term foreign exchange funding has been available. In addition, it has been perceived that a
GDR issue has been able to fetch higher prices from international investors (even when Indian
issues were being sold at a discount to the prevailing domestic share prices) than those that a
domestic public issue would have been able to extract from Indian investors.
• Impact of GDRs on Indian Capital Market
Since the inception of GDRs a remarkable change in Indian capital market has
beenobserved as follows:
(i) Indian stock market to some extent is shifting from Bombay to Luxemburg.
(ii) There is arbitrage possibility in GDR issues.
(iii) Indian stock market is no longer independent from the rest of the world. Thisputs
additional strain on the investors as they now need to keep updated with world wide
economic events.
(iv) Indian retail investors are completely sidelined. GDRs/Foreign Institutional
Investors' placements + free pricing implies that retail investors can no longer
expect to make easy money on heavily discounted rights/public issues.
As a result of introduction of GDRs a considerable foreign investment has flown into
India.
• Markets of GDRs
(i) GDR's are sold primarily to institutional investors.
(ii) Demand is likely to be dominated by emerging market funds.
(iii) Switching by foreign institutional investors from ordinary shares into GDRs is likely.
(iv) Major demand is also in UK, USA (Qualified Institutional Buyers), South East Asia
(Hong kong, Singapore), and to some extent continental Europe (principally France
and Switzerland).

© The Institute of Chartered Accountants of India

 11.12 Strategic Financial Management

• Profile of GDR investors

The following parameters have been observed in regard to GDR investors.
(i) Dedicated convertible investors
(ii) Equity investors who wish to add holdings on reduced risk or who require income
enhancement.
(iii) Fixed income investors who wish to enhance returns.
(iv) Retail investors: Retail investment money normally managed by continental
European banks which on an aggregate basis provide a significant base for Euro-
convertible issues.
Global Depository Receipt with Warrant (GDR with warrant) :These receipts were more
attractive than plain GDRs in view of additional value of attached warrants. The Government
of India has however, prohibited Indian companies to issue GDRs with warrants as per
guidelines issued on 28.10.94 (Refer to the guidelines contained in this Chapter).
The mechanics of a GDR issue may be described with the help offollowing diagram.
Company issues

Ordinary shares

Kept with Custodian/depository banks

against which GDRs are issued

to Foreign investors
Characteristics
(i) Holders of GDRs participate in the economic benefits of being ordinary shareholders,
though they do not have voting rights.
(ii) GDRs are settled through CEDEL & Euro-clear international book entry systems.
(iii) GDRs are listed on the Luxemburg stock exchange.
(iv) Trading takes place between professional market makers on an OTC (over the counter) basis.
(v) The instruments are freely traded.
(vi) They are marketed globally without being confined to borders of any market or country
as it can be traded in more than one currency.
(vii) Investors earn fixed income by way of dividends which are paid in issuer currency converted
into dollars by depository and paid to investors and hence exchange risk is with investor.

© The Institute of Chartered Accountants of India

 Foreign Direct Investment (FDI) and Foreign Institutional Investment (FIIs) 11.13

(viii) As far as the case of liquidation of GDRs is concerned, an investor may get the GDR
cancelled any time after a cooling off period of 45 days. A non-resident holder of GDRs
may ask the overseas bank (depository) to redeem (cancel) the GDRs In that case
overseas depository bank shall request the domestic custodians bank to cancel the GDR
and to get the corresponding underlying shares released in favour of non-resident
investor. The price of the ordinary shares of the issuing company prevailing in the
Bombay Stock Exchange or the National StockExchange on the date of advice of
redemption shall be taken as the cost of acquisition of the underlying ordinary share.
4.3 Euro-Convertible Bonds (ECBs): A convertible bond is a debt instrument which
gives the holders of the bond an option to convert the bond into a predetermined number of
equity shares of the company. Usually, the price of the equity shares at the time of conversion
will have a premium element. The bonds carry a fixed rate of interest. If the issuer company
desires, the issue of such bonds may carry two options viz.
(i) Call Options: (Issuer's option) - where the terms of issue of the bonds contain a provision
for call option, the issuer company has the option of calling (buying) the bonds for redemption
before the date of maturity of the bonds. Where the issuer's share price has appreciated
substantially, i.e. far in excess of the redemption value of the bonds, the issuer company can
exercise the option. This call option forces the investors to convert the bonds into equity.
Usually, such a case arises when the share prices reach a stage near 130% to 150% of the
conversion price.
(ii) Put options - A provision of put option gives the holder of the bonds a right to put (sell)his
bonds back to the issuer company at a pre-determined price and date. In case of Euro-
convertible bonds, the payment of interest on and the redemption of the bonds will be made by
the issuer company in US dollars.
4.4 American Depository Receipts (ADRs): Depository receipts issued by a company in
the United States of America (USA) is known as American Depository Receipts (ADRs). Such
receipts have to be issued in accordance with the provisions stipulated by the Securities and
Exchange Commission of USA (SEC) which are very stringent.
An ADR is generally created by the deposit of the securities of a non-United States company
with a custodian bank in the country of incorporation of the issuing company. The custodian
bank informs the depository in the United States that the ADRs can be issued. ADRs are
United States dollar denominated and are traded in the same way as are the securities of
United States companies. The ADR holder is entitled to the same rights and advantages as
owners of the underlying securities in the home country. Several variations on ADRs have
developed over time to meet more specialised demands in different markets. One such
variation is the GDR which are identical in structure to an ADR, the only difference being that
they can be traded in more than one currency and within as well as outside the United States.

© The Institute of Chartered Accountants of India

 11.14 Strategic Financial Management

There are three types of ADRs:

ADRs are issued by entities incorporated in the USA in compliance with the conditions laid
down by the Securities and Exchange Commission (SEC) of USA.ADRs are also denominated
in US Dollars, and are traded in the same way as other listed securities are traded in the US
stock markets.The holders of ADRs are entitled to rights and advantages comparable to the
owners of underlying securities in the home country.Over time, a few variants of ADRs have
emerged, features of which are summarized below:

ADRs

Unsponsored Sponsored
No formal arrangement exists
between issuing company
and the depository. Restricted to Unrestricted
Some elements of costs are select investors, All public
borne by investor. by way of private
For issuer, a relatively placements. Exempt
inexpensive method of from the requirements Levels I, II & III
raising capital of SEC
Unsponsored ADRs are issued without any formal agreement between the issuing company and
the depository, although the issuing company must consent to the creation of the ADR facility. With
unsponsored ADRs, certain costs, including those associated with disbursement of dividends, are
borne by the investor. For the issuing company, they provide a relatively inexpensive method of
accessing the United States capital markets (especially because they are also exempt from most of
reporting requirements of the Securities and Exchange Commission).
SponsoredADRs are created by a single depository which is appointed by the issuing
company under rules provided in a deposit agreement. There are two broad types of
sponsored ADRs - those that are restricted with respect to the type of buyer which is allowed,
and are therefore privately placed; and those that are unrestricted with respect to buyer and
are publicly placed and traded. Restricted ADRs (RADRs) are allowed to be placed only
among selected accredited investors and face restrictions on their resale. As these are not
issued to the general public, they are exempt from reporting requirements of the Securities
and Exchange Commission and are not even registered with it. Restricted ADR issues are
sometimes issued by companies that seek to gain some visibility and perhaps experience in
the United States capital markets before makingan unrestricted issue.

© The Institute of Chartered Accountants of India

 Foreign Direct Investment (FDI) and Foreign Institutional Investment (FIIs) 11.15

Unrestricted ADRs (URADRs) are issued to and traded by the general investing public in
United States capital markets. There are three classes of URADR, each increasingly
demanding in terms of reporting requirements to the Securities and Exchange Commission,
but also increasingly attractive in terms of degree of visibility provided. Level I URADRs are
exempt from the requirements that the issuing company conform their financial statistics to
United States. Generally Accepted Accounting Principles (GAAP), as well as from full
reporting requirements of the Securities and Exchange Commission. They are also therefore
relatively low cost. Level II URADRs are generally issued by companies that wish to be listed
on one of the United States national exchanges. The issuing company must meet the
Securities and Exchange Commission's full disclosure requirements, their financial statements
must conform to United States GAAP and the company must meet the listing requirements of
the relevant exchange. They are therefore more costly for the issuing company, but the public
listing allows much higher visibility and makes the facility more attractive to potential investors.
Level III URADRs are issued by companies which seek to raise capital in the United States
securities markets by making a public offering of their securities. They must also make full
Securities and Exchange Commission disclosure, conform to United States GAAP and meet
relevant exchange requirements, and provide the highest degree of visibility of any ADR.
Companies that apply for either listing or public issue of securities on the national exchanges
of the United States must meet exchange requirements. These include specific minimum
requirements with respect to the size of total assets, earnings and/or shareholders equity.
Theserequirements, along with the reporting requirements, serve to make it difficult for small
capitalization companies of emerging markets to issue either Level II or Level III URADRs. A
large number of ADRs are therefore offered through private placement, especially under Rule
144A, where activity is reported to be strong. Rule 144A, passed by the Securities and
Exchange Commission in 1990, eased restrictions on the resale by qualified institutional
buyers of private ADR issues amongst themselves once these issues were made under this
rule. Typical ADR issues appear to be relatively large. Emerging market ADR issuers tend to
be large domestic companies with considerable financial resources and high international
visibility. Relatively small ADR issues appear to measure in the range of between $15 million
and $80 million, while many mid-sized issues fall within the range of $100 million to $300
million. Several exceptionally large issues have exceeded $1 billion in size.
From the investor's point of view, ADRs lower the cost of trading non-United States
companies' securities. Trades are settled in the United States within five working days (or
less, given the increasingly heavy volume of trading in ADRs), whereas trades overseas can
take a much longer time and raise significantly settlement risk. The depository provides both
settlement and clearance services. As the facilities are traded in the United States, there is a
much lower information search cost, and the problems of unfamiliarity with foreign markets
and foreign laws, regulations and trading practices are overcome. The difficulties associated
with locating a broker and/or custodian in the foreign market and the fees charged for these
services are also avoided, and so are the obstacles that foreign languages may present. A
major advantage of ADRs to the investor is that dividends are paid promptly and in United
States dollars. Furthermore, the facilities are registered in the United States so that some
assurance is provided to the investor with respect to the protection of ownership rights. These

© The Institute of Chartered Accountants of India

 11.16 Strategic Financial Management

instruments also obviate the need to transport physically securities between markets.
Communication services are also provided by the depositary including provision of periodic
reports on the issuing company (in English) in a format familiar to United States investors.
Important information pertinent to the issuing company is transmitted to the investor by the
depository. Together, these advantages provide an incentive for investors in the United States
capital markets to invest in the equity of emerging markets via ADRs.
For the issuing company, the main costs of ADRs are the cost of meeting the partial or full
reporting requirements of the Securities and Exchange Commission and the exchange fees
(for relevant classes of ADRs). However, ADRs can be useful means for issuing companies of
gaining access to United States capital markets. Thus, institutional investors that are
precluded by their charter from holding foreign securities are able to invest in such securities
via ADRs. They can also allow foreign investors to avoid constraints that may be placed on
such investments in cases where emerging markets still maintain limits on direct investment
by foreigners. In general, ADRs increase access to United States capital markets by lowering
the costs of investing in the securities of non-United States companies and by providing the
benefits of a convenient, familiar and well regulated trading environment. Issues of ADRs can
increase the liquidity of an emerging market issuer's shares, and can potentially lower the
future cost of raising equity capital by raising the company's visibility and international
familiarity with the company's name, and by increasing the size of the potential investors base.
Emerging-market ADRs are in many instances issued by newly privatised companies. A small
number of economies in transition (the Russian Federation in particular) have started to use
depository receipts as a way of attracting foreign investment, despite lingering difficulties
associated with aspects of their market infrastructure, such as transparency of financial
statements, long settlement periods and potentially unreliable registration practices. The
limited development, or lack of, domestic debt and equity markets in these countries makes
access to foreign capital markets critical. In other cases, issues have been created by large
and well known companies from emerging markets that are active in the ADR market (such as
Mexico, Brazil and India), or countries with relatively good international credit ratings and a
relatively long history of accessing foreign investment (such as the Republic of Korea and
China). There have been noticeably few issues from companies in low-income countries (apart
from India, and to lesser extent, China), and only a handful in least developed countries. The
few issues made by the latter group of countries have been mainly by companies involved in
the minerals, oil, banking and utilities industries that can be expected to be able to attract
foreign financing. The growthin the number of issues from transition economies between 1992
and 1996, however, is quite noticeable (especially from Russia and Hungary).
One disadvantage of depository-receipt issues for the foreign markets in which the issuing
company is incorporated is the disincentive to the development of a local capital market.
Companies in emerging markets may issue ADRs because the underlying share issues may
represent a relatively large volume of weekly or monthly trading activity and the domestic
stock market may be considered too small to absorb the issues. While individual companies
may be able to attract additional financing, at the macro economic level, an increasing trend
towards emerging market issue of ADRs can retard the development of domestic capital
markets by denying domestic markets additional instruments in which to invest.

© The Institute of Chartered Accountants of India

 Foreign Direct Investment (FDI) and Foreign Institutional Investment (FIIs) 11.17

In a bid to bypass the stringent disclosure norms mandated by the Securities Exchange
Commission (SEC) of the US for equity issues, the Indian companies have, however, chosen
the indirect route to tap the vast American financial market through private debt placement of
GDRs listed in London and Luxemburg stock exchanges.
The Indian companies have preferred the GDRs to ADRs (American depository receipts)
because the US market exposes them to a higher level of responsibility than a European
listing in the areas of disclosure costs, liability and timing.
The companies have chosen the private placement route which allows them to mobilise vast
amounts of debt vide Rule 144A of Securities Exchange Commission of USA. Some of the
major power companies have drawn up plans to mobilise debts through this private placement
route.
Even the merchant bankers of international repute have not recommended a SEC- registered
ADR issue as an alternative option for an Indian issuer due to increased responsibilities
required in conjunction with a US listing.
The Securities Exchange Commission's regulations set up to protect the retail investor base,
are somewhat more stringent and onerous, even for companies already listed and held by
retail investors in their home country. The most onerous aspect of a US listing for the
companies is the necessity to provide full and half year account in accordance with, or at least
reconciled to US GAAP.
Another prohibitive aspect of an ADR issue is the cost involved. As per the estimates, the cost
of preparing and filing US GAAP account only ranges from $500,000 to $1,000,000 with the
ongoing cost of $ 150,000 to $ 200,000 per annum. Because of the additional work involved,
legal fees are considerably higher for a US listing, which ranges between $250,000 to $
350,000 for the underwriters, to be reimbursed by the issuer.
In addition, the initial Securities Exchange Commission registration fees which are based on a
percentage of the issue size as well as 'blue sky' registration costs (permitting the securities to
be offered in all States of the US) will have to be met.
It has further been observed that while implied legal responsibility lies on a company's
directors for the information contained in the offering document as required by any stock
exchange, the US is widely recognised as the 'most litigious market in the world'. Accordingly,
the broader the target investor base in the US (such as retail investors), the higher the
potential legal liability.
The increasing legal problem is evident from the larger number of actions being taken by
investors against the directors of companies whose share offerings have not performed
according to expectations. That is why Indian Companies have so far preferred the route of
GDRs rather than ADRs.
4.5 Other Sources
• Euro Bonds: Plain Euro-bonds are nothing but debt instruments. These are not very
attractive for an investor who desires to have valuable additions to his investments.

© The Institute of Chartered Accountants of India

 11.18 Strategic Financial Management

• Euro-Convertible Zero Bonds: These bonds are structured as a convertible bond. No

interest is payable on the bonds. But conversion of bonds takes place on maturity at a
pre-determined price. Usually there is a 5 years maturity period and they are treated as a
deferred equity issue.
• Euro-bonds with Equity Warrants: These bonds carry a coupon rate determined by the
market rates. The warrants are detachable. Pure bonds are traded at a discount. Fixed
income funds' managements may like to invest for the purposes of regular income.
A wide range of funding instruments have evolved over a period of time to raise cheaper funds
from the international markets for the borrower. The following are some of the instruments
used for borrowing funds:
• Syndicated bank loans: One of the earlier ways of raising funds in the form of large
loans from banks with good credit rating, can be arranged in reasonably short time and
with few formalities. The maturity of the loan can be for a duration of 5 to 10 years. The
interest rate is generally set with reference to an index, say, LIBOR plus a spread which
depends upon the credit rating of the borrower. Some covenants are laid down by the
lending institution like maintenance of key financial ratios.
• Euro-bonds: These are basically debt instruments denominated in a currency issued
outside the country of that currency for examples Yen bond floated in France. Primary
attraction of these bonds is the refuge from tax and regulations and provide scope for
arbitraging yields. These are usually bearer bonds and can take the form of
(i) Traditional fixed rate bonds.
(ii) Floating rate Notes.(FRNs)
(iii) Convertible Bonds.
• Foreign Bonds: Foreign bonds are denominated in a currency which is foreign to the
borrower and sold at the country of that currency. Such bonds are always subject to the
restrictions and are placed by that country on the foreigners funds.
• Euro Commercial Papers: These are short term money market securities usually issued
at a discount, for maturities less than one year.
• Credit Instruments: The foregoing discussion relating to foreign exchange risk
management and international capital market shows that foreign exchange operations of
banks consist primarily of purchase and sale of credit instruments. There are many types
of credit instruments used in effecting foreign remittances. They differ in the speed, with
which money can be received by the creditor at the other end after it has been paid in by
the debtor at his end. The price or the rate of each instrument, therefore, varies with
extent of the loss of interest and risk of loss involved. There are, therefore, different rates
of exchange applicable to different types of credit instruments.

© The Institute of Chartered Accountants of India

 Foreign Direct Investment (FDI) and Foreign Institutional Investment (FIIs) 11.19

5. Euro-Issues
A Euro-issue does not mean the shares (directly or indirectly) get listed on a European Stock
Exchange. For example, ADR is a Euro-Issue, as much as a GDR is. And ADRs are listed in
the USA. However, subscription can come from any part of the world except India. Finance
can be raised by Global Depository Receipts (GDRs), Foreign Currency Convertible Bonds
(FCCB) and pure debt bonds. However, GDRs, and FCCBs are more popular instruments.
These instruments have been described earlier:
5.1 Eligibility of Companies for Euro-Issue: The Government of India has formulated a
scheme of allowing Indian companies to issue equity/convertible bonds in the international
markets after Government approval. However, companies with the following profile are the
ones that may embark on a Euro-issue.
(i) Good financial track record at least for a period of three years.
(ii) Market price stability
(iii) Market capitalisation
(iv) Good industry prospects
(v) Good company growth including EPS
(vi) Better quality management
(vii) Sound investment policies
5.2 Advantages of Euro-Issues: The terms of Euro- issues are far more attractive than
those available in the domestic primary market. The international capital markets have
tremendous absorption power.
Moreover, management control may not be immediately affected due to restrictive voting
rights provision in depository agreement or through issues of convertible bonds. Euro-issues
also enhance potential for future offshore fund raising.
• For Company: The advantages of a Euro-issue for a company are many.
(i) First of all the attractive pricing of Euro-issues has drawn the attention of Indian
companies and they have resorted to Euro-issues considerably during the recent
years. Euro-issues are priced around the market price of share. In fact, in the case
of Euro-convertibles, the shares eventually get issued at a premium to the ruling
market price. This results in dramatic reduction in the cost of the capital to the
company.
If we compare the cost of Euro issue which is generally 4.5% with the 17 to 20 per
cent for working capital borrowings (this is a dangerous statement to make because
the companies that can make Euro Issues have to be Blue Chips are next to Blue
Chips and such companies will not be borrowing at 17 to 20% on bank borrowings
for working capital), that has to be paid to the bankers, the former seem to be quite
attractiveand that is why business houses are increasingly resorting to the Euro-

© The Institute of Chartered Accountants of India

 11.20 Strategic Financial Management

issues. This type of pricing is just not possible in the domestic primary market
because the local investors have been so used to issues which have a small
premium on the par value that they do not easily accept an issue at market prices.
(ii) Secondly, the foreign exchange fluctuations are to the account of investor and not
to thecompany. Since the investors in Euro-issues become shareholders, a
depreciation in the value of the Indian rupee only affects investor profits and does
not lead to any extra outflow for the company. Whereas, if a company took a foreign
currency loan, the exchange fluctuations is to the account of the company. That is
why, Indian business has learnt the hard way during the last decade that a
seemingly low interest rate forex loan can be a dangerous proposition when the
local currency (Indian rupee) tumbles.
(iii) Another advantage of Euro-issues, which was earlier available and has however
now been frozen by the revised guidelines, arose out of the fact that earlier there
was very little monitoring over the end-use of funds collected through such issues.
Companies could raise money at cheap cost and make a profit either by investing in
the stock market or lending in the inter-corporate market. If for example, a company
raised `300 crores at 4 per cent cost and lent it at 20 per cent, it makes a profit of `
48 crores. In some of the cases, this may be more than the profit it makes from its
regular business. Further more, its balance sheet also looks healthier with
burgeoning reserves and bonus possibilities.
(iv) This enhances the image of the company's products, services or financial
instruments in a market place outside their home country. This also provides a
mechanism for raising capital or as a vehicle for an acquisition.
• Benefits to the Investors: Euro issues also provides a number of advantages to foreign
investors. Increasingly, investors are aiming to diversify their portfolios internationally.
Obstacles, however, such as undependable settlements, costly conversions, unreliable
custody services, poor information flow, unfamiliar market practices, confusing tax
conventions etc. may discourage institutions and private investors from venturing outside
the local market. As a result, more and more investors are using GDRs route. The
investors are, however, benefited since.
(i) GDRs are usually quoted in dollars, and interest and dividend payments are also in
dollars.
(ii) GDRs overcome obstacles that mutual funds, pension funds and other institutions
may have in purchasing and holding securities outside their domestic markets.
(iii) Global custodians/safe-keeping charges are eliminated, saving GDR investors 30 to
60 basis points annually.
(iv) GDRs are as liquid as the underlying securities because the two are
interchangeable.

© The Institute of Chartered Accountants of India

 Foreign Direct Investment (FDI) and Foreign Institutional Investment (FIIs) 11.21

(v) GDRs are negotiable.

(vi) GDRs overcome foreign investment restrictions.
They, however, suffer from certain disadvantages also which may be described as follows.
5.3 Disadvantages of Euro-Issue
(i) As straight equity, a GDR issue would be immediately earnings dilutive.
(ii) Pricing of GDRs are expected to be at a discount to the local market price.
(iii) It is sometimes necessary to use warrants with GDRs to disguise discount, which can
increase dilution.
(iv) GDR issues of Indian Companies have an uneven track record for international
investors.
5.4 Structuring of Euro-Issue: The structuring of an Euro-issue is a tough task. The
company has to decide whether it has to go for private placement with foreign institutional
investors (FII's) or go for GDR or Euro-convertible bonds.
The dilution of promoters holding as a result of private placement or GDR issues or by way of
conversion in Euro-Convertible Bonds (ECB) issue is a matter of paramount concern for the
management.
Many companies avoid Euro Convertible issues with a convertible option to be exercised after
lock-in-period at a price fixed at the time of closure of the issues. Some companies prefer ECB
issues even at a higher coupon rate but without put option clause.
The companies with low equity base and high reserves built up over a long period would like
to structure Euro-issues without much dilution of their equity holding strength.
Many permutations and combinations are worked out. Some companies toy with the idea of
structuring ECB issues with conversion price ruling at the time of conversion with a discount of
20 per cent to 30 per cent.
Some companies may like to structure Euro-bond issue with warrants enabling investorsto
convert such warrants into limited equity shares without significantly diluting the
existingholdings of the controlling interest. How overseas investors will react to such proposals
is, however, yet to be seen.
5.5 Pricing of the Issues: Whether it is an issue of equity (GDR) or convertible Euro-
bonds, the company has to carefully consider the pricing of the equity shares. A good
company’s shares command premium in the stock market. The price of equity shares offered
through GDR or Euro bonds is usually determined with reference to the market prices which
prevailed during the week and the day prior to the date of issue. If there is a demand for such
securities abroad, the price may be at a premium over the market price. Finalisation of price of
the Equity shares is done in consultation with the lead manager who knows the pulse of the
European investment market.

© The Institute of Chartered Accountants of India

 11.22 Strategic Financial Management

5.6 Methodology for Euro-Issue: In a foreign currency issue of securities, the number of
documents to be prepared by a issuing company is limited as compared to a domestic issue.
Generally the issuing company prepares its accounts for the last 3-5 years (which are already
audited) in a revised format to confirm to the Generally Accepted Accounting Practices
(GAAP) prevalent abroad, say in the United Kingdom (U.K.). This is usually, called
'Reformated Non-Consolidated Financial Statements'. These statements are considered to be
very vital which indicates the financial soundness of issuing company.
The success of a Euro-issue also depends upon proper planning and execution of strategic
action. It is, therefore, essential to study in depth various areas involved in Euro-issue, such
as the investor's market, awareness of the company amongst such investors and correct
pricing of the issue. The merchant banker occupies a pivotal place in organising a Euro-issue.
As a lead manager, he renders very valuable services to the company in a host of areas like:
(i) Formulation of marketing strategy
(ii) Designing issue structure
(iii) Arranging syndication
(iv) Finalising underwriting arrangements
(v) Looking after miscellaneous activities
(vi) Helps in selecting a team of intermediaries such as overseas underwriters, depository
and custodians, bankers etc. Each of these intermediaries has its own distinct role to
play.
(vii) Organising due diligence meetings in which the lead manager, senior executives of the
company, the auditors and legal advisors review the draft offer document, agreements,
consent and comfort letters.
(viii) Organising team arranges interviews and road shows. After having finalised the offer
document, the lead manager helps in arranging interviews of Senior Executives of
issuing company with the fund managers and potential investors to provide opportunity of
interaction between them. Such meetings help in convincing and sustaining a conducive
environment for the success of issue. Wide-spread distribution of pamphlets, brochure
and impressive reports about the issuing company's activities and its global issue
facilitates negotiations with the potential investors. Such meetings with the investors in
common parlance, are known as Road Shows.
6. GDRs vs. Euro-Bonds
Issue of GDR creates equity shares of the issuing company which are kept with a designated
bank. GDRs are freely transferable outside India without any reference to the issuing
company. The dividends in respect of the share represented by the GDRs are paid in Indian
rupees only.
If a GDR holder wishes to exchange his GDR into shares of the company he can surrender his
GDR with such request to the designated international depository. On receipt of the

© The Institute of Chartered Accountants of India

 Foreign Direct Investment (FDI) and Foreign Institutional Investment (FIIs) 11.23

documents the depository will instruct the designated bank having the custody of the shares to
release the relative shares. Depending on the nature of the request, the bank will arrange to
sell the shares through the stock exchange and remit the sale proceeds to him or arrange to
get his name entered as a member of the company. Thereafter, the said shares are subject to
the usual condition applicable to the company's shares.
7. Cross-Border Leasing
In case of cross-border or international lease, the lessor and the lessee are situated in two different
countries. Because the lease transaction takes place between parties of two or more countries, it is
called cross-border lease. It involves relationships and tax implications more complex than the
domestic lease. When the lease transactions take place between three parties
manufacturer/vendor, lessor and lessee in three different countries, this type of cross border
leasing is called foreign to foreign lease. The lease may be routed through a third nation known as
“convenient country” for tax or equipment registration purposes. Fourth nation may be involved for
debt in a particular currency required to give effect to the equipment purchase and lease
transaction. Thus more nations involved in cross border lease would mean more complications in
terms of different legal, fiscal, credit and currency requirements and risk involved.
Cross border lease benefits are more or less the same as are available in domestic lease viz.
100% funding off-balance sheets. Financing, matching of expenditure with earnings from the
assets, the usual tax benefits on leasing, etc. In addition to these benefits, the following are
the more crucial aspects which are required to be looked into: (i) appropriate currency
requirements can be met easily to match the specific cash flow needs of the lessee;(ii) funding
for long period and at fixed rate which may not be available in the lessee home market may be
obtained internationally;(iii) maximum tax benefits in one or more regions could be gained by
structuring the lease in a convenient fashion;(iv) tax benefits can be shared by the lessee or
lessor accordingly by pricing the lease in the most beneficial way to the parties;(v) choice of
assets for cross border lease is different than domestic lease because those assets may find
here attractive bargain which are internationally mobile , have adequate residual value and
enjoy undisputed title.
Note: Students may also refer to Chapter – 3, Leasing Decisions for further discussion on
Cross Border Leasing.
8. International Capital Budgeting
8.1 Complexities Involved: Multinational Capital Budgeting has to take into consideration
the different factors and variables which affect a foreign project and are complex in nature
than domestic projects. The factors crucial in such a situation are:
(a) Cash flows from foreign projects have to be converted into the currency of the parent
organization.
(b) Parent cash flows are quite different from project cash flows
(c) Profits remitted to the parent firm are subject to tax in the home country as well as the
host country

© The Institute of Chartered Accountants of India

 11.24 Strategic Financial Management

(d) Effect of foreign exchange risk on the parent firm’s cash flow
(e) Changes in rates of inflation causing a shift in the competitive environment and thereby
affecting cash flows over a specific time period
(f) Restrictions imposed on cash flow distribution generated from foreign projects by the
host country
(g) Initial investment in the host country to benefit from the release of blocked funds
(h) Political risk in the form of changed political events reduce the possibility of expected
cash flows
(i) Concessions/benefits provided by the host country ensures the upsurge in the
profitability position of the foreign project
(j) Estimation of the terminal value in multinational capital budgeting is difficult since the
buyers in the parent company have divergent views on acquisition of the project.
8.2 Problems Affecting Foreign Investment Analysis: Multinational companies
investing elsewhere are subjected to foreign exchange risk in the sense that currency
appreciates/ depreciates over a span of time. To include foreign exchange risk in the cash
flow estimates of any project, it is necessary to forecast the inflation rate in the host country
during the lifetime of the project. Adjustments for inflation are made in the cash flows depicted
in local currency. The cash flows are converted in parent country’s currency at the spot
exchange rate multiplied by the expected depreciation rate obtained from purchasing power
parity.
Due to restrictions imposed on transfer of profits, depreciation charges and technical
differences exist between project cash flows and cash flows obtained by the parent
organization. Such restriction can be diluted by the application of techniques viz internal
transfer prices, overhead payments. For a proper estimate of project evaluation, repatriable
income through legal and open channels is considered. If positive, no additions are to be
made. If negative, incomes that can be remitted through proper channels have to be added
on. Adjustment for blocked funds depends on its opportunity cost, a vital issue in capital
budgeting process. This is because the project cost will be lower than the local construction
cost. If the opportunity cost of blocked funds is nil, the entire amount released for the project
by unlocking the released funds will result in the decrease of initial outlay.
In multinational capital budgeting, after tax cash flows need to be considered for project
evaluation. The presence of two tax regimes along with other factors such as remittances to
the parent firm in the form of royalties, dividends, management fees etc, tax provisions with
held in the host country, presence of tax treaties, tax discrimination pursued by the host
country between transfer of realized profits vis-à-vis local re-investment of such profits cause
serious impediments to multinational capital budgeting process. MNCs are in a position to
reduce overall tax burden through the system of transfer pricing.
For computation of actual after tax cash flows accruing to the parent firm, higher of home/ host
country tax rate is used. If the project becomes feasible then it is acceptable under a more
favourable tax regime. If infeasible, other tax saving aspects need to be incorporated in order
to find out whether the project crosses the hurdle rate.

© The Institute of Chartered Accountants of India

 Foreign Direct Investment (FDI) and Foreign Institutional Investment (FIIs) 11.25

8.3 Project vis-a-vis Parent Cash Flows: There exists a big difference between the
project and parent cash flows due to tax rules, exchange controls.Management and royalty
payments are returns to the parent firm.The basis on which a project shall be evaluated
depend on one’s own cash flows, cash flows accruing to the parent firm or both.
Evaluation of a project on the basis of own cash flows entails that the project should compete
favourably with domestic firms and earn a return higher than the local competitors.If not, the
shareholders and management of the parent company shall invest in the equity/government bonds
of domestic firms.A comparison can not be made since foreign projects replace imports and are not
competitors with existing local firms.Project evaluation based on local cash flows avoid currency
conversion and eliminates problems associated with fluctuating exchange rate changes.
For evaluation of foreign project from the parent firm’s angle, both operating and financial
cash flows actually remitted to it form the yardstick for the firm’s performance and the basis for
distribution of dividends to the shareholders and repayment of debt/interest to lenders.An
investment has to be evaluated on basis of net after tax operating cash flows generated by the
project.As both types of cash flows (operating and financial) are clubbed together, it is
essential to see that financial cash flows are not mixed up with operating cash flows.
An important aspect in multinational capital budgeting is to adjust cash flows or the discount
rate for the additional risk arising from foreign location of the project.Earlier MNCs adjusted
the discount rate upwards for riskier projects as they considered uncertainties in political
environment and foreign exchange fluctuations.The MNCs considered adjusting the discount
rate to be popular as the rate of return of a project should be in conformity with the degree of
risk.It is not proper to combine all risks into a single discount rate.Political risk/uncertainties
attached to a project relate to possible adverse effects which might occur in future but cannot
be foreseen at present.So adjusting discount rates for political risk penalises early cash flows
more than distant cash flows.Also adjusting discount rate to offset exchange risk only when
adverse exchange rate movements are expected is not proper since a MNC can gain from
favourable currency movements during the life of the project on many occasions.Instead of
adjusting discount rate while considering risk it is worthwhile to adjust cash flows.The annual
cash flows are discounted at a rate applicable to the project either at that of the host country
or parent country.Probability with certainty equivalent method along with decision tree analysis
are used for economic and financial forecasting. Cash flows generated by the project and
remitted to the parent during each period are adjusted for political risk, exchange rate and
other uncertainties by converting them into certainty equivalents.
The Adjusted Present Value Approach (APV) is used in evaluating foreign projects.
Different components of the project’s cash flow have to be discounted separately.
The APV method uses different discount rates for different segments of the total cash flows
depending on the degree of certainty attached with each cash flow. The financial analyst tests
the basic viability of the foreign project before accounting for all complexities. If the project is
feasible no further evaluation based on accounting for other cash flows is done. If not feasible,
an additional evaluation is done taking into consideration the other complexities.

© The Institute of Chartered Accountants of India

 11.26 Strategic Financial Management

The APV model is a value additive approach to capital budgeting process i.e. each cash flow
is considered individually and discounted at a rate consistent with risk involved in the cash
flow. The APV model is represented as follows.
n n n
Xt Tt St
- I0 + ∑ (1+ k ) + ∑ (1+ i ) + ∑ (1+ i )
t =1
* t
t =1
t
t =1
t
d d

Where I0 →Present Value of Investment Outlay

Xt
→Present Value of Operating Cash Flow
(1+ k ) * t

Tt
→Present Value of Interest Tax Shields
(1+ id )t
St
→Present Value of Interest Subsidies
(1+ id )t
Tt →Tax Saving in year t due to financial mix adopted
St →Before tax value of interests subsidies (on home currency) in year t due to project
specific financing
id →Before tax cost of dollar dept (home currency)
The initial investment will be net of any ‘Blocked Funds’ that can be made use of by the parent
company for investment in the project. ‘Blocked Funds’ are balances held in foreign countries
that cannot be remitted to the parent due to Exchange Control regulations. These are ‘direct
blocked funds’ Apart from this, it is quite possible that significant costs in the form of local
taxes or withholding taxes arise at the time of remittance of the funds to the parent country.
Such ‘blocked funds’ are indirect. If a parent company can release such ‘Blocked Funds’ in
one country for the investment in a overseas project, then such amounts will go to reduce the
‘Cost of Investment Outlay’.
The last two terms are discounted at the before tax cost of dollar debt to reflect the relative
cash flows due to tax and interest savings.
9. International Working Capital Management
9.1 International Working Capital: The management of working capital in an international
firm is much more complex as compared to a domestic one.The reasons for such complexity are:
(1) A multinational firm has a wider option for financing its current assets. A MNC has funds
flowing in from different parts of international financial markets. Therefore, it may choose
to avail financing either locally or from global financial markets. Such an opportunity
does not exist for pure domestic firms.
(2) Interest and tax rates vary from one country to the other. A Treasurer associated with a

© The Institute of Chartered Accountants of India

 Foreign Direct Investment (FDI) and Foreign Institutional Investment (FIIs) 11.27

multinational firm has to consider the interest/ tax rate differentials while financing
current assets. This is not the case for domestic firms.
(3) A multinational firm is confronted with foreign exchange risk due to the value of
inflow/outflow of funds as well as the value of import/export are influenced by exchange
rate variations. Restrictions imposed by the home or host country government towards
movement of cash and inventory on account of political considerations affect the growth
of MNCs. Domestic firm limit their operations within the country and does not face such
problems.
(4) With limited knowledge of the politico-economic conditions prevailing in different host
countries, a Manager of a multinational firm often finds it difficult to manage working
capital of different units of the firm operating in these countries. The pace of
development taking place in the communication system has to some extent eased this
problem.
(5) In countries which operate on full capital convertibility, a MNC can move its funds from
one location to another and thus mobilize and ‘position’ the funds in the most efficient
way possible. Such freedom may not be available for MNCs operating in countries that
have not subscribed to full capital convertibility (like India).
A study of International Working Capital Management requires knowledge of Multinational
Cash Management, International Inventory Management and International Receivables
Management.
9.2 Multinational Cash Management: MNCs are very much concerned with effective
cash management. International money managers follow the traditional objectives of cash
management viz.
(1) effectively managing and controlling cash resources of the company as well as
(2) achieving optimum utilization and conservation of funds.
The former objective can be attained by improving cash collections and disbursements and by
making an accurate and timely forecast of cash flow pattern. The latter objective can be
reached by making money available as and when needed, minimising the cash balance level
and increasing the risk adjusted return on funds that is to be invested.
International Cash Management requires Multinational firms to adhere to the extant rules and
regulations in various countries that they operate in Apart from these rules and regulations,
they would be required to follow the relevant forex market practices and conventions which
may not be practicedin their parent countries.. A host of factors curtail the area of operations
of an international money manager e.g. restrictions on FDI, repatriation of foreign sales
proceeds to the home country within a specified time limit and the, problem of blocked funds.
Such restrictions hinder the movement of funds across national borders and the manager has
to plan beforehand the possibility of such situation arising on a country to country basis. Other
complications in the form of multiple tax jurisdictions and currencies and absence of
internationally integrated exchange facilities result in shifting of cash from one location to
another to overcome these difficulties.

© The Institute of Chartered Accountants of India

 11.28 Strategic Financial Management

The main objectives of an effective system of international cash management are :

(1) To minimise currency exposure risk.
(2) To minimise overall cash requirements of the company as a whole without disturbing
smooth operations of the subsidiary or its affiliate.
(3) To minimise transaction costs.
(4) To minimise country’s political risk.
(5) To take advantage of economies of scale as well as reap benefits of superior knowledge.
The objectives are conflicting in nature as minimising of transaction costs require cash
balance to be kept in the currency in which they are received thereby contradicting both
currency and political exposure requirements.
A centralized cash management group is required to monitor and manage parent subsidiary
and inter-subsidiary cash flows. Centralization needs centralization of information, reports and
decision making process relating to cash mobilisation, movement and investment. This system
benefits individual subsidiaries which require funds or are exposed to exchange rate risk.
A centralised cash system helps MNCs as follows :
(a) To maintain minimum cash balance during the year.
(b) To manage judiciously liquidity requirements of the centre.
(c) To optimally use various hedging strategies so that MNC’s foreign exchange exposure is
minimised.
(d) To aid the centre to generate maximum returns by investing all cash resources optimally.
(e) To aid the centre to take advantage of multinational netting so that transaction costs and
currency exposure are minimised.
(f) To make maximum utilization of transfer pricing mechanism so that the firm enhances its
profitability and growth.
(g) To exploit currency movement correlations:
(i) Payables & receivables in different currencies having positive correlations
(ii) Payables of different currencies having negative correlations
(iii) Pooling of funds allows for reduced holding – the variance of the total cash flows for
the entire group will be smaller than the sum of the individual variances
Consider an MNC with two subsidiaries in different countries. The two subsidiaries periodically
send fees and dividends to the parent as well as send excess cash – all of them represent
incoming cash to the parent while the cash outflows to the subsidiaries include loans and
return on cash invested by them. As subsidiaries purchase supplies from each other they have
cash flows between themselves.

© The Institute of Chartered Accountants of India

 Foreign Direct Investment (FDI) and Foreign Institutional Investment (FIIs) 11.29

Interest and/or principal on

excess cash invested by
Purchase of Securities
Short Term

Loans Funds received

from
Subsidiary A Sale of securities

Long Term
Excess Cash
Long Term

Funds Funds Loans Sources of

for for Parent Debt
Supplier
Suppliers
Repayment on Loans

Excess Cash
Funds paid for
new stock issues
Subsidiary B Sources of
Fees and part of Debt
earnings

Cash Dividends
Interest and/or principal on
excess cash invested by subsidiary

Loans

Cash Flow of the Overall MNC

International Cash Management has two basic objectives:
1. Optimising Cash Flow movements.
2. Investing excess cash.
As no single strategy of international cash management can help in achieving both these
objectives together, its task on such aspects becomes very challenging.
There are numerous ways of optimising cash inflows:
1. Accelerating cash inflows.
2. Managing blocked funds.
3. Leading and Lagging strategy.
4. Using netting to reduce overall transaction costs by eliminating number of unnecessary
conversions and transfer of currencies.
5. Minimising tax on cash flow through international transfer pricing.

© The Institute of Chartered Accountants of India

 11.30 Strategic Financial Management

9.3 Accelerating Cash Inflows: Faster recovery of cash inflows helps the firm to use
them wheneverrequired or to invest them for better returns. Customers all over the world are
instructed to send their payments to lockboxes set up at various locations, thereby reducing
the time and transaction costs involved in collecting payments. Also, through pre-authorised
payment, an organization may be allowed to charge the customer’s bank account up to some
limit.
9.4 Managing Blocked Funds: The host country may block funds of the subsidiary to be
sent to the parent or make sure that earnings generated by the subsidiary be reinvested
locally before being remitted to the parent so that jobs are created and unemployment
reduced. The subsidiary may be instructed to obtain bank finance locally for the parent firm so
that blocked funds may be utilised to pay off bank loans.
The parent company has to assess the potential of future funds blockage in a foreign country.
MNCs have to be aware of political risks cropping up due to unexpected blockage of funds
and devise ways to benefit their shareholders by using different methods for moving blocked
funds through transfer pricing strategies, direct negotiations, leading and lagging and so on.
9.5 Minimising Tax on Cash Flows through Transfer Pricing Mechanism: Large
entities having many divisions require goods and services to be transferred frequently from
one division to another. The profits of different divisions are determined by the price to be
charged by the transferor division to the transferee division. The higher the transfer price, the
larger will be the gross profit of the transferor division with respect to the transferee division.
The position gets complicated for MNCs due to exchange restrictions, inflation differentials,
import duties, tax rate differentials between two nations, quotas imposed by host country, etc.
9.6 Leading and Lagging: This technique is used by subsidiaries for optimizing cash flow
movements by adjusting the timing of payments to determine expectations about future
currency movements. MNCs accelerate (lead) or delay (lag) the timing of foreign currency
payments through adjustment of the credit terms extended by one unit to another. The
technique helps to reduce foreign exchange exposure or to increase available working capital.
Firms accelerate payments of hard currency payables and delay payments of soft currency
payables in order to reduce foreign exchange exposure. A MNC in the USA has subsidiaries
all over the world. A subsidiary in India purchases its supplies from another subsidiary in
Japan. If the Indian subsidiary expects the rupee to fall against the yen, then it shall be the
objective of that firm to accelerate the timing of its payment before the rupee depreciates.
Such a strategy is called Leading. On the other hand, if the Indian subsidiary expects the
rupee to rise against the yen then it shall be the objective of that firm to delay the timing of its
payment before the rupee appreciates. Such a strategy is called Lagging. MNCs should be
aware of the government restrictions in such countries before availing of such strategies.
Leading and Lagging involve the movement of cash inflows and outflows, forward and
backward in time so as to allow netting and achieve various goals. Regulations governing
Leading and Lagging are subject to frequent changes and vary from country to country. So,

© The Institute of Chartered Accountants of India

 Foreign Direct Investment (FDI) and Foreign Institutional Investment (FIIs) 11.31

the global finance manager has to keep himself abreast with such changed regulations before
he can successfully employ this technique. The advantages associated with Leading and
Lagging are:
1. No formal recognition of indebtedness is required and the credit terms can be altered by
increase / decrease of the terms on the accounts.
2. It helps in minimizing foreign exchange exposure and helps in transferring liquidity
among affiliates by changing credit terms and is dependent on the opportunity cost of
funds to both paying and receiving units.
3. It is an aggressive technique aimed at taking advantage of expected revaluations and
devaluations of currency movements.
For example: Affiliate X sells goods $10 lakh to affiliate Y on 90 days credit terms. Affiliate X
then would have $ 30 lakh of Accounts Receivable from Affiliate Y and is financing $ 30 lakh
of working capital for Affiliate Y. If the credit terms are increased to 180 days, there will be a
one time shift of an additional $ 30 lakh to Affiliate Y. On the other hand if the credit terms are
reduced to 30 days, this will lead to a flow of $ 20 lakh from Affiliate Y to Affiliate X.
Fund Transfer effects of Leading and Lagging
Affiliate X sells goods worth $ 10 lakh to Affiliate Y.
Credit Terms
Particulars Normal (90 days) Leading (30 days) Lagging (180 days)
Affiliate X $ 30 lakh $ 10 lakh $ 60 lakh
(Accounts Receivable
from Y)
Affiliate Y $ 30 lakh $ 10 lakh $ 60 lakh
(Accounts Receivable
from X)
Net Cash Transfers
From Y to X $ 20 lakh
From X to Y $ 30 lakh
Illustration:An MNC faces the after tax borrowing and lending rates in UK and US. Both US
and UK affiliates can have surplus (+) / deficit (–) of funds. The four alternatives along with
domestic interest rates (US / UK) and interest differentials (US rate – UK rate) associated with
each state are given below:
Borrowing Rate (%) Lending Rate (%)
US 3.4 2.6
UK 3.2 2.4
(+) (–)

© The Institute of Chartered Accountants of India

 11.32 Strategic Financial Management

Considering both units to have excess funds, the relevant opportunity cost of funds are the US
and UK lending rates of 2.6 % and 2.4% respectively and the associated interest differential is
0.2%. Again if both affiliates require funds the relevant opportunity cost of funds are the US
and UK borrowing rates of 3.4% and 3.2% respectively and the associated interest differential
is 0.2% also. If the US affiliate requires funds while the UK affiliate has excess funds, then the
relevant rates are the US borrowing and UK lending rates of 3.4% and 2.4% respectively and
the interest differential in this case is 1.0%. The following chart depicts the position.
UK
(+) (–)
2.6% / 2.4% (0.2%) 2.6% / 3.2% (– 0.6%)
3.4% / 2.4% (1.0%) 3.4% / 3.2% (0.2%)
If the interest rate differential is positive, the corporate as a body by moving funds to the US
will earn more interest on the investments or pay less on its borrowings. Such a move results
in leading payments to the US and lagging payments to UK. On the other hand if the interest
rate differential is negative it will be better to move funds to the UK by leading payments to UK
and lagging payments to US.
9.7 Netting: It is a technique of optimising cash flow movements with the combined efforts
of the subsidiaries thereby reducing administrative and transaction costs resulting from
currency conversion. There is a co-ordinated international interchange of materials, finished
products and parts among the different units of MNC with many subsidiaries buying /selling
from/to each other. Netting helps in minimising the total volume of inter-company fund flow.
Advantages derived from netting system includes:
1) Reduces the number of cross-border transactions between subsidiaries thereby
decreasing the overall administrative costs of such cash transfers
2) Reduces the need for foreign exchange conversion and hence decreases transaction
costs associated with foreign exchange conversion.
3) Improves cash flow forecasting since net cash transfers are made at the end of each
period
4) Gives an accurate report and settles accounts through co-ordinated efforts among all
subsidiaries
There are two types of Netting:
1) Bilateral Netting System – It involves transactions between the parent and a subsidiary or
between two subsidiaries. If subsidiary X purchases $ 20 million worth of goods from
subsidiary Y and subsidiary Y in turn buy $ 30 million worth of goods from subsidiary X,
then the combined flows add up to $ 50 million. But in a bilateral netting system
subsidiary X would pay subsidiary Y only $10 million. Thus bilateral netting reduces the
number of foreign exchange transactions and also the costs associated with foreign
exchange conversion. A more complex situation arises among the parent firm and
several subsidiaries paving the way to multinational netting system.

© The Institute of Chartered Accountants of India

 Foreign Direct Investment (FDI) and Foreign Institutional Investment (FIIs) 11.33

2) Multilateral Netting System – Each affiliate nets all its inter affiliate receipts against all its
disbursements. It transfers or receives the balance on the position of it being a net
receiver or a payer thereby resulting in savings in transfer / exchange costs. For an
effective multilateral netting system, these should be a centralised communication
system along with disciplined subsidiaries. This type of system calls for the consolidation
of information and net cash flow positions for each pair of subsidiaries.
Subsidiary P sells $ 50 million worth of goods to Subsidiary Q, Subsidiary Q sells $ 50 million
worth of goods to Subsidiary R and Subsidiary R sells $ 50 million worth of goods to
Subsidiary P. Through multilateral netting inter affiliate fund transfers are completely
eliminated.

$ 50 $ 50
million
million

Q R
$ 50
million
The netting system uses a matrix of receivables and payables to determine the net receipt /
net payment position of each affiliate at the date of clearing A US parent company has
subsidiaries in France, Germany, UK and Italy. The amounts due to and from the affiliates is
converted into a common currency viz. US dollar and entered in the following matrix.
Inter Subsidiary Payments Matrix (US $ Thousands)
Paying affiliate
France Germany UK Italy Total
France --- 40 60 100 200
Germany 60 --- 40 80 180
Receiving affiliate UK 80 60 --- 70 210
Italy 100 30 60 --- 190
Total 240 130 160 250 780
Without netting, the total payments are $ 780 Thousands. Through multinational netting these
transfers will be reduced to $ 100 Thousands, a net reduction of 87%. Also currency
conversion costs are significantly reduced. The transformed matrix after consolidation and net
payments in both directions convert all figures to US dollar equivalents to the below form:

© The Institute of Chartered Accountants of India

 11.34 Strategic Financial Management

Netting Schedule (US $ Thousands)

Receipt Payment Net Receipt Net Payments
France 200 240 --- 40
Germany 180 130 50 ---
UK 210 160 50 ---
Italy 190 250 --- 60
100 100
9.8 Investing Excess Cash: Euro Currency market accommodates excess cash in
international money market. Euro Dollar deposits offer MNCs higher yield than bank deposits
in US. The MNCs use the Euro Currency market for temporary use of funds, purchase of
foreign treasury bills / commercial paper. Through better telecommunication system and
integration of various money markets in different countries, access to the securities in foreign
markets has become easier.
Through a centralised cash management strategy, MNCs pool together excess funds from
subsidiaries enabling them to earn higher returns due to the larger deposits lying with them.
Sometimes a separate investment account is maintained for all subsidiaries so that short term
financing needs of one can be met by the other subsidiary without incurring transaction costs
charged by banks for exchanging currencies. Such an approach leads to an excessive
transaction costs. The centralised system helps to convert the excess funds pooled together
into a single currency for investments thereby involving considerable transaction cost and a
cost benefit analysis should be made to find out whether the benefits reaped are not offset by
the transaction costs incurred. A question may arise as to how MNCs will utilise their excess
funds once they have used them to meet short term financing needs. This is vital since some
currencies may provide a higher interest rate or may appreciate considerably. So deposits
made in such currencies will be attractive. Again MNCs may go in for foreign currency deposit
which may give an effective yield higher than domestic deposit so as to overcome exchange
rate risk. Forecasting of exchange rate fluctuations need to be calculated in this respect so
that a comparative study can be effectively made. Lastly an MNC can go for a diversification
of its portfolio in different countries having different currencies because of the exchange rate
fluctuations taking place and at the same time avoid the possibility of incurring substantial
losses that may arise due to sudden currency depreciation.
9.9 International Inventory Management: An international firm possesses normally a
bigger stock than EOQ and this process is known as stock piling. The different units of a firm
get a large part of their inventory from sister units in different countries. This is possible in a
vertical set up. For political disturbance there will be bottlenecks in import. If the currency of
the importing country depreciates, imports will be costlier thereby giving rise to stock piling. To
take a decision against stock piling the firm has to weigh the cumulative carrying cost vis-à-vis
expected increase in the price of input due to changes in exchange rate. If the probability of
interruption in supply is very high, the firm may opt for stock piling even if it is not justified on
account of higher cost.

© The Institute of Chartered Accountants of India

 Foreign Direct Investment (FDI) and Foreign Institutional Investment (FIIs) 11.35

Also in case of global firms, lead time is larger on various units as they are located far off in
different parts of the globe. Even if they reach the port in time, a lot of customs formalities have to
be carried out. Due to these factors, re-order point for international firm’s lies much earlier. The
final decision depends on the quantity of goods to be imported and how much of them are locally
available. Relying on imports varies from unit to unit but it is very much large for a vertical set up.
9.10 International Receivables Management: Credit Sales lead to the emergence of
account receivables. There are two types of such sales viz. Inter firm Sales and Intra firm
Sales in the global aspect.
In case of Inter firm Sales, the currency in which the transaction should be denominated and
the terms of payment need proper attention. With regard to currency denomination, the
exporter is interested to denominate the transaction in a strong currency while the importer
wants to get it denominated in weak currency. The exporter may be willing to invoice the
transaction in the weak currency even for a long period if it has debt in that currency. This is
due to sale proceeds being used to retire debts without loss on account of exchange rate
changes. With regard to terms of payment, the exporter does not provide a longer period of
credit and ventures to get the export proceeds quickly in order to invoice the transaction in a
weak currency. If the credit term is liberal the exporter is able to borrow currency from the
bank on the basis of bills receivables. Also credit terms may be liberal in cases where
competition in the market is keen compelling the exporter to finance a part of the importer’s
inventory. Such an action from the exporter helps to expand sales in a big way.
Incase of Intra firm sales, the focus is on global allocation of firm’s resources.Different parts of
the same product are produced in different units established in different countries and
exported to the assembly units leading to a large size of receivables.The question of quick or
delayed payment does not affect the firm as both the seller and the buyer are from the same
firm though the one having cash surplus will make early payments while the other with cash
crunch will make late payments.This is a case of intra firm allocation of resources where leads
and lags explained earlier will be taken recourse to.

Summary
PART-A–Foreign Direct Investment (FDI), Foreign Institutional Investment (FIIs)
Costs Involved
? For Host Country
• Inflow of foreign investment improves balance of payments position while outflow
due to imports, dividend payments, technical service fees, royalty reduces balance
of payments position.
• Use of imported raw materials may be harmful to the interest of the domestic
country whereas it may be useful to the interests of the foreign country.
• Supply of technology to the host country makes it dependent on the home country
resulting in the payment of higher price for acquisition.

© The Institute of Chartered Accountants of India

 11.36 Strategic Financial Management

• The technology may not be suitable to the local environment causing substantial
loss to the host country.
• Foreign investors do not care to follow pollution standards; nor do they stick to the
optimal use of natural resources nor have any concern about location of industries
while opting for a manufacturing process.
• Domestic industries cannot withstand the financial power exercised by the foreign
investors and thereby die a pre-mature death.
• Because of their oligopolistic position in the market, foreign companies charge
higher prices for their products.
• Foreign culture is infused by these foreign companies in industrial units as well as
to the society at large.
? For Home Country
• Any foreign investment causes a transfer of capital, skilled personnel and
managerial talent from the country resulting in the home country’s interest being
hampered.
• The standards followed by them in most cases are not beneficial to the host nation.
Such an action leads to deterioration in bilateral relations between the host and
home country.
FDI is a mixed bag of bright features and dark spots. So it requires careful handling by
both sides.
Benefits Derived
? For Host Country
(a) Improves balance of payment position by crediting the inflow of investment to
capital account.Also current account improves as FDI aids import substitution/export
promotion.
(b) Foreign firms foster forward and backward economic linkages. The living standard of
the domestic consumers improves as quality products at competitive prices are
available.
(c) The presence of foreign investors creates a multiplier effect leading to the
emergence of a sound support system.
(d) Foreign investors are a boon to government to revenue with regard to the
generation of additional income tax.
(e) FDI aids to maintain a proper balance amongst the factors of production by the
supply of scarce resources thereby accelerating economic growth.
? For Home Country
(a) The home country gets the benefit of the supply of raw materials if FDI helps in its
exploitation.
(b) Also there is employment generation and the parent company enters into newer

© The Institute of Chartered Accountants of India

 Foreign Direct Investment (FDI) and Foreign Institutional Investment (FIIs) 11.37

financial markets by its investment outside.

(c) FDI helps to develop closer political relationship between the home and the host
country which is advantageous to both.
PART-B–International Financial Management - Including Raising of Capital Abroad
(ADRs, GDRs, ECB)
External Commercial Borrowings
External Commercial Borrowings (ECB) are defined to include
1. Commercial bank loans,
2. Buyer’s credit,
3. Supplier’s credit,
4. Securitised instruments such as floating rate notes, fixed rate bonds etc.,
5. Credit from official export credit agencies,
6. Commercial borrowings from the private sector window of multilateral financial
institutions such as IFC, ADB, AFIC, CDC etc. and
7. Investment by Foreign Institutional Investors (FIIs) in dedicated debt funds
Other terms and conditions
• Security
• Exemption from withholding tax
• Approval under Foreign exchange regulation
• Short - term loan from RBI
• Validity of approval
Approvals are valid for an initial period of three months, i.e. the executed copy of the loan
agreement is required to be submitted within this period.
International Capital Market
In international capital market, the availability of foreign currency is assured under the four
main systems viz.
(1) Euro - currency market;
(2) Export Credit Facilities;
(3) Bonds issues, and
(4) Financial Institutions.
Instruments of International Finance
The various financial instruments dealt with in the international market are briefly described below:
1. Euro Bonds: A Eurobond is an international bond that is denominated in a currency not
native to the country where it is issued. Also called external bond e.g. A Yen floated in
Germany; a yen bond issued in France.

© The Institute of Chartered Accountants of India

 11.38 Strategic Financial Management

2. Foreign Bonds: These are debt instruments denominated in a currency which is foreign
to the borrower and is denominated in a currency that is native to the country where it is
issued. A British firm placing $ denominated bonds in USA is said to be selling foreign bonds.
3. Fully Hedged Bonds: In foreign bonds, the risk of currency fluctuations exist. Fully
hedged bonds eliminate that risk by selling in forward markets the entire stream of interest and
principal payments.
4. Floating Rate Notes : These are debt instruments issued upto 7 years maturity. Interest
rates are adjusted to reflect the prevailing exchange rates.
5. Euro Commercial Papers: Euro Commercial Papers (ECPs) are short-term money
market instruments. They are for maturities for less than a year. They are usually designated
in US dollars.
Financial Sector Reforms in India - Indian Depository Receipts (IDRs)
Indian companies are raising finance from abroad and are available on foreign exchanges to
raise finance by way of American Depository Receipts (ADRs) and Global Depository Receipts
(GDRs).Similarly, foreign companies can raise finance in India in the form of Indian Depository
Receipts (IDRs), which are listed in India. This enables Indians to invest in foreign companies.
International Financial Instruments and Indian Companies
Indian companies have been able to tap global markets to raise foreign currency funds by
issuing various types of financial instruments which are discussed as follows:
(1) Foreign Currency Convertible Bonds (FCCBS): A type of convertible bond issued in a
currency different than the issuer's domestic currency.
Advantages of FCCBs
(i) Gives the investor the flexibility to convert the bond into equity at a price or redeem the
bond at the end of a specified period.
(ii) Leads to delayed dilution of equity and allows company to avoid any current dilution in
earnings per share.
(iii) Investors enjoy option of conversion into equity if resulting to capital appreciation.
Disadvantages of FCCBs
(i) Exchange risk is more.
(ii) Creation of more debt and a forex outgo in terms of interest which is in foreign exchange.
(iii) There is exchange risk on the interest payment as well as re-payment if the bonds are not
converted into equity shares.
(2) Global Depository Receipts (GDRs): A depository receipt is basically a negotiable
certificate, denominated in a currency not native to the issuer, that represents a company's
publicly - traded local currency equity shares. Most GDRs are denominated in USD, while a
few are denominated in Euro and Pound Sterling. In theory, though a depository receipt can
also represent a debt instrument, in practice it rarely does.

© The Institute of Chartered Accountants of India

 Foreign Direct Investment (FDI) and Foreign Institutional Investment (FIIs) 11.39

Impact of GDRs on Indian Capital Market

(i) Indian stock market to some extent is shifting from Bombay to Luxemburg.
(ii) There is arbitrage possibility in GDR issues.
(iii) Indian stock market is no longer independent from the rest of the world.
(iv) Indian retail investors are completely sidelined.
(v) As a result of introduction of GDRs a considerable foreign investment has flown into India.
• Markets of GDRs
(i) GDR's are sold primarily to institutional investors.
(ii) Demand is likely to be dominated by emerging market funds.
(iii) Switching by foreign institutional investors from ordinary shares into GDRs is likely.
(iv) Major demand is also in UK, USA (Qualified Institutional Buyers), South East Asia
(Hong Kong, Singapore), and to some extent continental Europe (principally France
and Switzerland).
• Profile of GDR investors
(i) Dedicated convertible investors
(ii) Equity investors who wish to add holdings on reduced risk or who require income
enhancement.
(iii) Fixed income investors who wish to enhance returns.
(iv) Retail investors: Retail investment money normally managed by continental
European banks which on an aggregate basis provide a significant base for Euro-
convertible issues.
• Characteristics
(i) Holders of GDRs participate in the economic benefits of being ordinary
shareholders, though they do not have voting rights.
(ii) GDRs are settled through CEDEL & Euro-clear international book entry systems.
(iii) GDRs are listed on the Luxemburg stock exchange.
(iv) Trading takes place between professional market makers on an OTC (over the
counter) basis.
(v) The instruments are freely traded.
(vi) They are marketed globally without being confined to borders of any market or
country as it can be traded in more than one currency.
(vii) Investors earn fixed income by way of dividends which are paid in issuer currency
converted into dollars by depository and paid to investors and hence exchange risk
is with investor.
(viii) As far as the case of liquidation of GDRs is concerned, an investor may get the GDR
cancelled any time after a cooling off period of 45 days.

© The Institute of Chartered Accountants of India

 11.40 Strategic Financial Management

(3) Euro-Convertible Bonds (ECBs): A convertible bond is a debt instrument which gives
the holders of the bond an option to convert the bond into a predetermined number of equity
shares of the company. The bonds carry a fixed rate of interest. If the issuer company desires,
the issue of such bonds may carry two options viz. – (i) Call Options: (Issuer's option) (ii) Put
options
(4) American Depository Receipts (ADRs): Depository receipts issued by a company in
the United States of America (USA) is known as American Depository Receipts (ADRs). Such
receipts have to be issued in accordance with the provisions stipulated by the Securities and
Exchange Commission of USA (SEC) which are very stringent.
There are three types of ADRs:
Unsponsored ADRs are issued without any formal agreement between the issuing company
and the depository, although the issuing company must consent to the creation of the ADR
facility.
SponsoredADRs are created by a single depository which is appointed by the issuing
company under rules provided in a deposit agreement. There are two broad types of
sponsored ADRs - those that are restricted with respect to the type of buyer which is allowed,
and are therefore privately placed; and those that are unrestricted with respect to buyer and
are publicly placed and traded.
Unrestricted ADRs (URADRs) are issued to and traded by the general investing public in
United States capital markets.
(5) Other Sources
• Euro Bonds: Plain Euro-bonds are nothing but debt instruments. These are not very
attractive for an investor who desires to have valuable additions to his investments.
• Euro-Convertible Zero Bonds: These bonds are structured as a convertible bond. No
interest is payable on the bonds. But conversion of bonds takes place on maturity at a
pre-determined price.
• Euro-bonds with Equity Warrants: These bonds carry a coupon rate determined by the
market rates. The warrants are detachable.
• Syndicated bank loans: One of the earlier ways of raising funds in the form of large
loans from banks with good credit rating, can be arranged in reasonably short time and
with few formalities.
• Euro-bonds: These are basically debt instruments denominated in a currency issued
outside the country of that currency for examples Yen bond floated in France. Primary
attraction of these bonds is the refuge from tax and regulations and provide scope for
arbitraging yields.
• Foreign Bonds: Foreign bonds are denominated in a currency which is foreign to the
borrower and sold at the country of that currency. Such bonds are always subject to the
restrictions and are placed by that country on the foreigners funds.
• Euro Commercial Papers: These are short term money market securities usually issued

© The Institute of Chartered Accountants of India

 Foreign Direct Investment (FDI) and Foreign Institutional Investment (FIIs) 11.41

at a discount, for maturities less than one year.

• Credit Instruments: There are many types of credit instruments used in effecting foreign
remittances. They differ in the speed, with which money can be received by the creditor
at the other end after it has been paid in by the debtor at his end.
Euro- Issues
A Euro-issue does not mean the shares (directly or indirectly) get listed on a European Stock
Exchange.
(1) Advantages of Euro-Issues
• For Company
(i) Euro-issues are priced around the market price of share.
(ii) foreign exchange fluctuations are to the account of investor and not to thecompany.
(iii) This enhances the image of the company's products, services or financial
instruments in a market place outside their home country.
• Benefits to the Investors
(i) GDRs are usually quoted in dollars, and interest and dividend payments are also in
dollars.
(ii) GDRs overcome obstacles that mutual funds, pension funds and other institutions
may have in purchasing and holding securities outside their domestic markets.
(iii) Global custodians/safe-keeping charges are eliminated, saving GDR investors 30 to
60 basis points annually.
(iv) GDRs are as liquid as the underlying securities because the two are
interchangeable.
(v) GDRs are negotiable.
(vi) GDRs overcome foreign investment restrictions.
They, however, suffer from certain disadvantages also which may be described as
follows.
(2) Disadvantages of Euro-Issue
(i) As straight equity, a GDR issue would be immediately earnings dilutive.
(ii) Pricing of Gdrs are expected to be at a discount to the local market price.
(iii) It is sometimes necessary to use warrants with GDRs to disguise discount, which
can increase dilution.
(iv) GDR issues of Indian Companies have an uneven track record for international
investors.

© The Institute of Chartered Accountants of India

 11.42 Strategic Financial Management

(3) Pricing of the Issues: The price of equity shares offered through GDR or Euro bonds is
usually determined with reference to the market prices which prevailed during the week and
the day prior to the date of issue.
(4) GDRs Vs. Euro-Bonds: Issue of GDR creates equity shares of the issuing company
which are kept with a designated bank. GDRs are freely transferable outside India without any
reference to the issuing company. The dividends in respect of the share represented by the
GDRs are paid in Indian rupees only.
Cross-Border Leasing
In case of cross-border or international lease, the lessor and the lessee are situated in two
different countries. Because the lease transaction takes place between parties of two or more
countries, it is called cross-border lease. It involves relationships and tax implications more
complex than the domestic lease. When the lease transactions take place between three
parties manufacturer/vendor, lessor and lessee in three different countries, this type of cross
border leasing is called foreign to foreign lease.
International Capital Budgeting
Complexities Involved:
(a) Cash flows from foreign projects have to be converted into the currency of the parent
organization.
(b) Parent cash flows are quite different from project cash flows
(c) Profits remitted to the parent firm are subject to tax in the home country as well as the
host country
(d) Effect of foreign exchange risk on the parent firm’s cash flow
(e) Changes in rates of inflation causing a shift in the competitive environment and thereby
affecting cash flows over a specific time period
(f) Restrictions imposed on cash flow distribution generated from foreign projects by the
host country
(g) Initial investment in the host country to benefit from the release of blocked funds
(h) Political risk in the form of changed political events reduce the possibility of expected
cash flows
(i) Concessions/benefits provided by the host country ensures the upsurge in the
profitability position of the foreign project
(j) Estimation of the terminal value in multinational capital budgeting is difficult since the
buyers in the parent company have divergent views on acquisition of the project.
Problems affecting Foreign Investment Analysis
(a) Multinational companies investing elsewhere are subjected to foreign exchange risk in
the sense that currency appreciates/ depreciates over a span of time.
(b) Due to restrictions imposed on transfer of profits, depreciation charges and technical

© The Institute of Chartered Accountants of India

 Foreign Direct Investment (FDI) and Foreign Institutional Investment (FIIs) 11.43

differences exist between project cash flows and cash flows obtained by the parent
organization.
(c) The presence of two tax regimes along with other factors such as remittances to the
parent firm in the form of royalties, dividends, management fees etc, tax provisions with
held in the host country, presence of tax treaties, tax discrimination pursued by the host
country between transfer of realized profits vis-à-vis local re-investment of such profits
cause serious impediments to multinational capital budgeting process.
Project vis-a-vis Parent Cash Flows
Different components of the project’s cash flow have to be discounted separately.
The APV method uses different discount rates for different segments of the total cash flows
depending on the degree of certainty attached with each cash flow. The APV model is
represented as follows.
n n n
Xt Tt St
- I0 + ∑ (1+ k ) ∑ (1+ i ) ∑ (1+ i )
t =1
* t
+
t =1
t
+
t =1
t
d d

International Working Capital Management

The management of working capital in an international firm is very much complex as compared
to a domestic one.The reasons for such complexity are:
(1) A multinational firm has a wider option for financing its current assets.
(2) Interest and tax rates vary from one country to the other.
(3) A multinational firm is confronted with foreign exchange risk due to the value of
inflow/outflow of funds as well as the value of import/export are influenced by exchange
rate variations.
(4) With limited knowledge of the politico-economic conditions prevailing in different host
countries, a multinational manager often finds it difficult to manage working capital of
different units of the firm operating in these countries.
(5) Freedom may not be available for MNCs operating in countries that have not subscribed
to full capital convertibility (like India).
Multinational Cash Management: The main objectives of an effective system of international
cash management are:
1. To minimise currency exposure risk.
2. To minimise overall cash requirements of the company as a whole without disturbing
smooth operations of the subsidiary or its affiliate.
3. To minimise transaction costs.
4. To minimise country’s political risk.
5. To take advantage of economies of scale as well as reap benefits of superior knowledge.

© The Institute of Chartered Accountants of India

 11.44 Strategic Financial Management

A centralised cash system helps MNCs as follows:

(a) To maintain minimum cash balance during the year.
(b) To manage judiciously liquidity requirements of the centre.
(c) To optimally use various hedging strategies so that MNC’s foreign exchange exposure is
minimised.
(d) To aid the centre to generate maximum returns by investing all cash resources optimally.
(e) To aid the centre to take advantage of multinational netting so that transaction costs and
currency exposure are minimised.
(f) To make maximum utilization of transfer pricing mechanism so that the firm enhances its
profitability and growth.
(g) To exploit currency movement correlations.
International Cash Management has two basic objectives:
1. Optimising Cash Flow movements.
2. Investing excess cash.
As no single strategy of international cash management can help in achieving both these
objectives together, its task on such aspects becomes very challenging.
There are numerous ways of optimising cash inflows:
1. Accelerating cash inflows.
2. Managing blocked funds.
3. Leading and Lagging strategy.
4. Using netting to reduce overall transaction costs by eliminating number of unnecessary
conversions and transfer of currencies.
5. Minimising tax on cash flow through international transfer pricing.
Investing Excess Cash: Through a centralized cash management strategy, MNCs pool
together excess funds from subsidiaries enabling them to earn higher returns due to the larger
deposits lying with them.
International Inventory Management: An international firm possesses normally a bigger
stock than EOQ and this process is known as stock piling. The different units of a firm get a
large part of their inventory from sister units in different countries. This is possible in a vertical
set up.
International Receivables Management: Credit Sales lead to the emergence of account
receivables.

© The Institute of Chartered Accountants of India