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Globalization and the Multinational Firm

Chapter one

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Overview
What’s special about “international” finance?

Goals for international financial management

Globalization of the world economy

Multinational corporations

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What’s Special about “International” Finance?

Three major dimensions set international finance apart

from domestic finance
1. Foreign exchange risk and political risks.
2. Market imperfections.
3. Expanded opportunity set.

Largely stem from the fact that sovereign nations have the
right to issue currencies, formulate their own economic
policies, impose taxes, and regulate movements of people,
goods, and capital across their borders

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What’s Special about “International” Finance:

Foreign Exchange Risk
Foreign exchange risk is the risk of facing uncertain future
exchange rates
• In addition to businesses, individuals and households
may also be seriously exposed to uncertain exchange
rates.
• Exchange rates among major currencies (for example,
U.S. dollar, Japanese yen, British pound, and euro)
fluctuate continuously in an unpredictable manner.
• Exchange rate uncertainty influences all major economic
functions, including consumption, production, and
investment.

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Monthly Percentage Change in Japanese Yen—

U.S. Dollar Exchange Rate

Source: Bank for International Settlements, US dollar exchange rates.

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What’s Special about “International”

Finance: Political Risk
Political risk arises from potential losses to the parent firm
resulting from adverse political developments in the host
country
• Ranges from unexpected changes in tax rules to outright
expropriation of assets held by foreigners.
• Arises from the fact that a sovereign country can change
the “rules of the game” and the affected parties may not
have effective recourse.
• Especially relevant in those countries without a
traditional rule of law.

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What’s Special about “International”

Finance: Market Imperfections
Market imperfections may be described as various
frictions, such as transaction costs and legal restrictions,
that prevent the markets from functioning perfectly
• World markets are highly imperfect.
• Numerous barriers hamper the free movement of people,
goods, services, and capital across national boundaries
(for example, legal restrictions, excessive transaction and
transportation costs, information asymmetry, and
discriminatory taxation).
• Restrict the extent to which investors can diversify their
portfolios.

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The Example of Nestlé’s Market Imperfection

Nestlé used to issue two different classes of common

stock, bearer shares and registered shares
• Foreigners were only allowed to hold bearer shares.
• Swiss residents could buy registered shares.
• The bearer stock was more expensive.

On November 18, 1988, Nestlé lifted restrictions imposed

on foreigners, allowing them to hold registered shares as
well as bearer shares
• Price spread between the two types narrowed drastically.

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Daily Prices of Nestlé’s Bearer and Registered

Shares

Source: Loderer, Claudio, and Andreas Jacobs. 1995. “The Nestlé Crash.” Journal of Financial Economics,
37, no. 3: pp. 315–39, Elsevier Science S.A.

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What’s Special about “International” Finance:

Expanded Opportunity Set

Firms may benefit from an expanded opportunity set

when they venture into the arena of global markets
• Firms can gain from greater economies of scale when
their tangible and intangible assets are deployed on a
global basis.
• True for corporations, as well as individual investors.
• “It just doesn’t make sense to play in only one corner of
the sandbox.”

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Goals for International Financial Management

The focus of the text is to provide today’s financial

managers with an understanding of the fundamental
concepts and the tools necessary to be effective global
managers
• Fundamental goal of sound financial management is
shareholder wealth maximization, which means the
firm makes all business decisions and investments with
an eye toward making the owners of the firm (that is,
shareholders) better off financially.
• Generally accepted in Anglo-Saxon countries, but not as
widely embraced in other parts of the world.

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Other Stakeholders
In other countries shareholders are viewed as merely one
among many “stakeholders” of the firm, others being:
• Employees.
• Suppliers.
• Customers.
• Banks.

In Japan, managers have typically sought to maximize the

value of the keiretsu—a family of firms to which the
individual firms belong

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Corporate Governance
As shown by a series of recent corporate scandals at
companies like Enron, WorldCom, Parmalat, and Global
Crossing, managers may pursue their own private interests
at the expense of shareholders when they are not closely
monitored
• This “agency problem” is a major weakness of the public
corporation.
Reinforces the importance of corporate governance, the
financial and legal framework for regulating the relationship
between a firm’s management and its shareholders.

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Globalization of the World Economy: Major

Trends and Developments

I. Emergence of Globalized Financial Markets.

II. Emergence of the Euro as a Global Currency.
III. Europe’s Sovereign Debt Crisis of 2010.
IV. Trade Liberalization and Economic Integration.
V. Privatization.
VI. Global Financial Crisis of 2008 to 2009.
VII. Brexit.

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Emergence of Globalized Financial Markets

Deregulation of foreign exchange and capital markets

Financial innovations resulted in the introduction of various

instruments:
• Currency futures and options.
• Multicurrency bonds.
• International mutual funds.
• Country funds.
• Exchange-traded funds (ETFs).
• Foreign stock index futures and options.

Advances in computer and telecommunications technology

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Emergence of the Euro as a Global Currency

Momentous event in history of world financial system

Currently more than 300 million Europeans in 19 countries

are using the common currency on a daily basis
• Austria, Belgium, Cyprus, Estonia, Finland, France,
Germany, Greece, Ireland, Italy, Latvia, Lithuania,
Luxembourg, Malta, the Netherlands, Portugal, Slovakia,
Slovenia, and Spain.

Transaction domain of the euro may become larger than

that of the U.S. dollar in the future

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Europe’s Sovereign-Debt Crisis of 2010

In December 2009, the new Greek government revealed
that its budget deficit for the year would be 12.7% of GDP,
not the 3.7% previously forecast
• Investors sold off Greek government bonds, and the
ratings agencies downgraded them to “junk”.
• Panic spread to other weak European countries
(especially Ireland, Portugal, and Spain) and quickly
escalated to a Europe-wide debt crisis.
• Revealed a profound weakness of the euro as the
common currency; Lack of fiscal discipline in a euro-
zone country can always become a Europe-wide crisis.

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The Greek Drama

Source: Bloomberg.

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Trade Liberalization and Economic

Integration 1/2

Principal argument for international trade is based on the

theory of comparative advantage
• It is mutually beneficial for countries if they specialize in
the production of those goods they can produce most
efficiently and trade those goods among them.
• Policy implication is that liberalization of international
trade will enhance the welfare of the world’s citizens.

Over the years, international trade has been liberalized at

both the global and regional levels

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Trade Liberalization and Economic Integration 2/2

General Agreement on Tariffs and Trade (GATT) is a

multilateral agreement among member countries that has
reduced many barriers to trade

The World Trade Organization (WTO) has the power to

enforce the rules of international trade

Regional arrangements have also been instituted to

promote economic integration
• The European Union (EU), for example, includes 28
member states that have eliminated barriers to the free
flow of goods, capital, and people.

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North American Free Trade Agreement (NAFTA)

North American Free Trade Agreement (NAFTA) called
for phasing out impediments to trade between Canada,
Mexico, and the United States over a 15-year period
beginning in 1994
• In November 2018, the three countries signed a new
accord, the U.S.-Mexico-Canada-Agreement (USMCA),
but the new accord needs to be ratified in three
countries.

In Mexico, the ratio of export to GDP has increased

dramatically from 2.2% in 1973 to 35.6% in 2017

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Recent Free Trade Agreements

Trans-Pacific Partnership (TPP) designed to slash tariffs
and facilitate trade among 11 Pacific Rim member
countries
• Signed March 2018.
• U.S. withdrew from the pact citing President Trump’s
“America first” philosophy.

African Continental Free Trade Agreement (AfCFTA)

• Signed by 49 African countries.
• Aims to stimulate intra-African trade and investment by
reducing tariffs, protecting intellectual property rights,
and lowering barriers to migration.
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Privatization
Privatization is the act of a country divesting itself of
ownership and operation of business ventures by turning
them over to the free market system
• May be described as a denationalization process and
often viewed as a means to an end.
• Selling state-owned businesses brings in hard-currency
foreign reserves to the national treasury.
• Often seen as a cure for bureaucratic inefficiency and
waste.
• Some economists estimate privatization improves
efficiency and reduces operating costs by as much as
20%.
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Chinese Privatization
State-owned enterprises (SOEs) have been listed on
organized stock exchanges, making them eligible for
private ownership

China launches two stock exchanges in the early 1980s

• As of 2018, approximately 3,600 companies are
currently listed on China’s stock exchanges.
• “A-shares” are primarily reserved for Chinese citizens,
while foreigners may invest in “B-shares” or “H-shares”.

Chinese government still retains the majority stakes in most

public firms

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Global Financial Crisis of 2008 to 2009

Factors that drove the financial crisis:
• Households and financial institutions borrowed too much
and took too much risk.
• Crisis was amplified and transmitted globally by
securitization; financial engineers designed opaque and
complex mortgage-based securities that could be used
for excessive risk-taking.
• “Invisible hands” of free markets apparently failed to
self-regulate excesses, contributing to the banking crisis.
• International financial markets are highly interconnected
and integrated.

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U.S. Unemployment Rate and Dow Jones

Industrial Average (D J I A)

Source: Bloomberg.

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Brexit
“Brexit” describes the voting decision of a majority of
Britons to leave the EU
• Likely to weaken the United Kingdom and the EU, both
economically and politically.
• London’s position as the dominant center of European
finance may deteriorate if the UK loses unrestricted
access to Europe’s single market.
How did this happen?
• Majority of voters outside of London felt alienated from
the globalized economy and were worried about
competition for jobs from immigrants.
• 60% of Londoners voted to remain in the EU; 45% of
voters in the rest of England voted the same way.
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Multinational Corporations
A multinational corporation (MNC) is a firm that has been
incorporated in one country and has production and sales
operations in other countries
• Approximately 60,000 MNCs in the world with over
500,000 foreign affiliates.

Benefit from the economy of scale in many ways:

• Spreading R and D expenditures and advertising costs
over their global sales.
• Pooling global purchasing power over suppliers.
• Utilizing their technological and managerial know-how
globally with minimum additional costs.
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