Chapter One

Globalization & the

Multinational Firm

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 Chapter Outline
• What’s Special about “International” Finance?
• Goals for International Financial Management
• Multinational Corporations
• Gain from trade: The theory of comparative
advantage

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 What’s Special about
“International” Finance?

• Three major dimensions set international

finance apart from domestic finance
– Foreign Exchange Risk and Political Risk
– Market Imperfections
– Expanded Opportunity Set

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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
– Exchange rates among major currencies (e.g., 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
– In addition to businesses, individuals and households may also
be seriously exposed to uncertain exchange rates

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Monthly Percentage Change in Japanese Yen—
U.S. Dollar Exchange Rate

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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 (e.g., legal restrictions,
excessive transaction and transportation costs, information asymmetry,
and discriminatory taxation)7
– Restrict the extent to which investors can diversify their
portfolios

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The Example of Nestlé’s Market Imperfection

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The Example of Nestlé’s Market Imperfection
• Following this, the price spread between the two
types of shares narrowed dramatically.
– This implies that there was a major transfer of
wealth from foreign shareholders to Swiss
shareholders.
• Foreigners holding Nestlé bearer shares were exposed
to political risk in a country that is widely viewed as a
haven from such risk.
• The Nestlé episode illustrates both the importance of
considering market imperfections and the peril of
political risk.

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Daily Prices of Nestlé’s Bearer and Registered
Shares

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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 (i.e., 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 belongs
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Other Goals

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 Other Goals
• These types of issues can be much more serious in many
other parts of the world, especially emerging and
transitional economies, such as Indonesia, Korea, and
Russia, where legal protection of shareholders is weak
or virtually non-existing.
• No matter what the other goals, they cannot be achieved
in the long term if the maximization of shareholder
wealth is not given due consideration.

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Multinational Corporations

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 THE RISE OF THE MULTINATIONAL
CORPORATION
• Reasons to go global:
– More raw materials
– New markets
– Minimize costs of production
• The world is larger than the home country and
provides opportunities to gain additional
supplies, sell more products or find lower cost
sources of production.
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 THE RISE OF THE MULTINATIONAL CORPORATION

RAW MATERIAL SEEKERS

exploit the raw materials that can be found in
other countries
British Petroleum
Exxon

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 THE RISE OF THE MULTINATIONAL CORPORATION

MARKET SEEKERS
Produce and sell in foreign markets
Have heavy foreign direct investors
Represented today by firms such as:
IBM
MacDonald’s
Nestle
Levi Strauss
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 THE RISE OF THE MULTINATIONAL CORPORATION

COST MINIMIZERS
seek lower-cost production abroad
Their motive: to remain cost competitive
Represented today by firms such as:
Texas Instruments
Intel
Seagate Technology
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 Top 10 MNCs
1 General Electric United States
2 Vodafone Group PLC United Kingdom
3 Ford Motor Company United States
4 British Petroleum Co. PLC United Kingdom
5 General Motors United States
6 Royal Dutch/Shell Group UK/Netherlands
7 Toyota Motor Corporation Japan
8 Total Fina Elf France
9 France Telecom France
10 ExxonMobile Corporation United States
 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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 Trade Liberalization and Economic Integration

• 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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24
 The Theory of
Comparative Advantage
• Definition: a comparative advantage exists
when one party can produce a good or service at
a lower opportunity cost than another party.

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The Geometry of Comparative Advantage

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 The Geometry of Comparative Advantage
Textiles A production possibilities curve shows the various amounts
of food or textiles that each country can make.
The production possibilities of country A are such that if
they concentrated 100% of their resources into the
production of textiles, they could produce 180 million
yards of textiles.
180 If country A chose to concentrate 100% of their resources
into the production of food, they could produce as much
as 300 million pounds of food.
Food
300 Country A can produce any combination of
food and textiles between these two points.
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 The Geometry of Comparative Advantage
Textiles

As a practical matter, the citizens of country A must

choose a point along their production possibilities curve;
initially they choose 200 million pounds of food, and 60
million yards of textiles.

180

60
Food
200 300

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 The Geometry of Comparative Advantage
Textiles
The production possibilities of country B are such that if
they concentrated 100% of their resources into the
production of textiles, they could produce 240 million
yards of textiles.
If country B chose to concentrate 100% of their resources
240 into the production of food, they could produce as much
180 as 900 million pounds of food.

60
Food
200 300 900 1,200

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 The Geometry of Comparative Advantage
Textiles

As a practical matter, the citizens of country B must

choose a point along their production possibilities curve;
initially they choose 600 million pounds of food, and 80
million yards of textiles.
240
180

80
60
Food
200 300 600 900 1,200

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 The Geometry of Comparative Advantage
Textiles Country A enjoys a comparative advantage in textiles
because they have to give up food at a lower rate than B
when making textiles.
Put another way, country B enjoys a comparative
advantage in food because they have to give up textiles
240 at a lower rate than A when making more food.
180 Geometrically, a comparative advantage exists
80 because the slopes of the production
60 possibilities differ.
Food
200 300 600 900

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 The Geometry of Comparative Advantage
Textiles If the countries specialize according to their comparative
advantage, then country A should make textiles and trade
for food, while country B should grow food and trade for
textiles.

240
180

80
60
Food
200 300 600 900

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 The Geometry of Comparative Advantage
Textiles Before trade, if both countries made only textiles, the
combined production would be 420 million yards of
textiles = 240 + 180.
420 Before trade, if both countries made only food, the
combined production would be 1,200 million
pounds of food = 900 + 300.
240
180

80
60
Food
200 300 600 900 1,200

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 The Geometry of Comparative Advantage
Textiles
The combined production possibilities curve of country
A and B without trade are shown in the green line.
420

240
180

80
60
Food
200 300 600 900 1,200

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 The Geometry of Comparative Advantage
Textiles
Before trade, the combined production is 800 million lbs
of food and 140 million yards of textiles.
420

240
180
140
80
60
Food
200 300 600 800 900 1,200

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 The Geometry of Comparative Advantage
Textiles Country B can produce food at a lower opportunity cost, so
let B produce the first 900 million pounds of food.

420 Country A can produce textiles at a lower

opportunity cost, so let them produce the first 180
million yards of textiles.
240
180
140
80
60
Food
200 300 600 800 900 1,200

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 The Geometry of Comparative Advantage
Textiles
The combined production possibilities curve with trade
is composed of the original curves joined as shown.
420

240
180
140
80
60
Food
200 300 600 800 900 1,200

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 The Geometry of Comparative Advantage
Textiles
The gains from trade are shown by the increase in
consumption available—an extra 100 million pounds of food
and 40 million yards of textiles are now available in excess of
420 the pre-trade consumption.

240
180
140
80
60
Food
200 300 600 800 900 1,200

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