TOPIC 1: Business Planning

Part 1-Overview of Strategic Financial

Management
Source: Chapter 1. Madura, J. (2018). International financial management.
Cengage Learning.
 Chapter Objectives
1. To identify the main goal of the multinational
corporation (MNC) and conflicts with that goal;
2. To describe the key theories that justify
international business; and
3. To explain the common methods used to conduct
international business.
Managing Multinational Corporations (MNCs)
 Commonly accepted goal of MNC is maximizing
shareholders’ wealth.
 Managers are expected to make decision that will max the
share price and serve shareholders’ interest.
 Additional goals that managers may have to fulfill include
taking care of the interest of other stakeholders which
covers, government, customers, creditors, and employees.
 In this course, we are going to concentrate on MNC whose
parents wholly own foreign subsidiaries (sole owner).
 Most of examples in the main text book is using United
States as home market. However, there might be other
country cases when you are dealing with tutorial questions
and exam questions.
Managing MNCs
Role of Finance Discipline
 Finance is used to make investment and financing
decisions for the MNCs.
 Common finance decisions include:
 Whether to discontinue operations in particular country
 Whether to pursue new business in a particular country
 Whether to expand business in a particular country
 How to finance expansion in a particular country.
Agency problem
 The conflict of goals between a firm’s managers and
shareholders is referred as agency problem.
 Sometimes, decisions that are made by managers in
MNC may be conflicted with the firm’s goal of
maximizing shareholders’ wealth.
 For example, manager may want to establish a new
subsidiary in a new location (to receive more
compensation) but is not seen as benefiting to
shareholders.
 To minimize the conflict between managers and
shareholders, MNC may have to incur agency costs.
Agency problem (cont’d)
 The agency costs for MNC are normally larger than
purely domestic firms because:
1. Subsidiaries may be scattered around the world makes
it challenging to monitor managers in a distant location
2. Foreign subsidiaries’ managers who are raised in
different cultures may not follow uniform goals.
3. Sheer size of the larger MNC can create significant
agency problems because it complicates the monitoring
of managers.
Agency problem
How parent firms control agency problem?
 Clearly communicate the goals for each subsidiary
 Ensure all subsidiaries focus on maximizing the value of
MNC and not of their respective subsidiaries alone
 Oversee subsidiary decisions to check if the managers
satisfy the MNC’s goals
 Implement compensation plans that reward management
that who satisfy the MNC’s goals
 Example, using stock options
 Remove the weak managers (normally when firm is
acquired by other companies due to low performance)
 Institutional investors with greater voting power may
report about the mismanagement to board of directors.
Sarbanes-Oxley Act (SOX) 2002
 SOX ensures a more transparent process for managers to
report on the productivity and financial performance of their firm.
 It requires firms to implement internal reporting process that will
be monitored by executives and BOD.
 Some of the common methods used by MNCs to improve
internal control process include:
 Establish centralized database of information
 Ensure all data consistently reported across subsidiaries
 Implementing a system that will automatically checks data for unusual
discrepancies relative to norms
 Speeding the process by which all departments and subsidiaries
access needed data
 Making executive more accountable for financial statements by
personally verifying their accuracy.
Management Structure in MNCs
 The size of agency costs will be different based on the MNCs
management style.
 A centralized management can reduce agency cost because it
allows managers of the parent firm to control foreign subsidiary.
This control will reduces the power of subsidiary’s managers.
 Issue: parent’s management may make poor decisions as they are
less informed about the subsidiary’s setting and financial
characteristics.
 A decentralized management is more likely to result in higher
agency cost because managers may make decisions that fail to
maximize the value of entire MNCs.
 Pros: give more authority to managers who are closer to subsidiary’s
operations and environment that may enhance the value of MNCs
 Centralized MNCs Structure

Click icon to add picture

 Decentralized MNCs structure

Click icon to add picture

Reasons for Companies to become
Multinationals
 Three theories that can explain why MNCs are
motivated to expand their business internationally.
1. Theory of comparative advantage
2. Imperfect market theory
3. Product cycle theory
Reasons for Companies to
become Multinationals
Theory of Comparative Advantage

 Specialization by countries which cannot be easily

transported may be used as an advantage.
 Countries with certain advantage may specialize in
production of goods with relative efficiency.
 Example, Japan are large producers of electronic products.
China has an advantage in cost of basic labor.
 Since many countries may not produce other products they
are not specialize in, trade between countries become
essential.
 Comparative advantages allow firms to penetrate into
foreign market since there may be able to provide
products/services which they are specialize in.
Reasons for Companies to become Multinationals
Imperfect Market Theory
 Factors of production in real world
are somewhat immobile.
 There are costs and restrictions
related to transfer of labor and other
resources used for production.
 MNCs often capitalize on a foreign
country’s particular resources to
seek out foreign opportunities.
 For example, Nike is internationally
known brand that use laborers in
developing countries to keep labor
cost down. This will allows the
company to maintain large profits.
 Reasons for Companies to become Multinationals
Product Cycle Theory

 Firms become more established in the home market due to some perceived advantage over
existing competitors.
 As the foreign demand for firm’s products increases, it may feel the need to retain its
advantages over competition in foreign market by producing its products in foreign market.
 This action is taken to prolong foreign demand for its product (as shown in Exhibit 1.2).
 To ensure the competitors cannot duplicate its products, they need to differentiate their
products offered.
 As a firm matures, it may recognize additional opportunities outside its home country.
 The firm’s foreign business performance depend on how successful it maintains some
advantage over its competition.
 Exhibit 1.2 International Product Life Cycle

Click icon to add picture

Methods to Conduct International Business
 Several methods to conduct international business
include:
 International trade
 Licensing
 franchising
 Joint venture
 Acquisitions of existing operations
 Establishment of new foreign subsidiaries
Valuing MNC
 The value of MNC is important to its shareholders
and creditors (bondholders/debt holders)
 The methods described in this section reflects the
key factors affecting an MNCs value in general
sense.
1. Domestic Model
2. Multinational Model
Valuing MNC
Domestic Model
 The value of purely domestic firm is commonly
stated as the PV of its expected cash flows.

 Expected cash flows: funds received by firm less

expenses or taxes
 Cost of capital : denoted by required rate of return. It is
the WACC based on all of the firm’s projects
Valuing MNC
Multinational Model
 The value of MNC are affected by the exchange
rates since there might be various inflows and
outflows denominated in foreign currencies.
 The foreign currencies will be converted into home
currency before computing the net cash flows
received by the MNC.
Valuing MNC
Multinational Model (cont’d)
 The value of MNCs can be expressed formally as:

 Any cash flows received by foreign subsidiaries will only be

counted in the valuation if they are expected to be remitted to the
parent.
 The WACC or discount rate used should reflect the risk of
operating in different countries.
Factors Affecting MNCs value
1. Exposure to international economic conditions
(Example in Exhibit 1.5)
 Demand from foreign consumers
 Foreign country’s national income
 Unemployment rate of foreign market
2. Exposure to International Political Risk
 Tax rate imposed by foreign government
 Trade barriers
3. Exposure to Exchange Rate Risk
 Exhibit 1.5

Click icon to add picture

End of Topic 1 part 1