Chapter 1 Global Financial Environment

Chapter 1 The Globalization Process

Learning Objectives
Consider how globalization process moves a business
from domestic focus to financial relationships and composition global in scope The implications of phase one of globalization the international trade phase on the risks and rewards of a business Examine process as it moves from international trade to multinational operations

Prepared by Shafiq Jadallah To Accompany Fundamentals of Multinational Finance Michael H. Moffett, Arthur I. Stonehill, David K. Eiteman Copyright 2003 Pearson Education, Inc. Slide 1-1

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Chapter 1 The Globalization Process

Learning Objectives
Discover three major currency exposures that arise
from doing business on a multinational level

The Globalization Process

The globalization process is the structural and
managerial changes and challenges experienced by a firm as it moves from domestic to global in operations

How globalization affects corporate governance and

the creation of value for stakeholders

Global Transition I
Trident moves from the domestic phase to the international trade phase

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The Globalization Process

Phase One: Domestic Operations
U.S. Suppliers (domestic) U.S. Buyers (domestic)

The Globalization Process

Trident may not be global or international itself, yet
its competitors, suppliers and buyers may be working across borders This is often a key driver to push a firm like Trident into first phase international trade

All payments in US dollars; All credit risk under U.S. law

The second half of this phase is the international trade

Trident Corporation
(Los Angeles, USA)

phase

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The Globalization Process

Phase Two: Expansion into International Trade

Trident Corp: Initiation of Globalization

Phase One: Domestic Operations
U.S. Suppliers (domestic)
All payments in US dollars; All credit risk under U.S. law

U.S. Buyers (domestic)

Trident Corporation
(Los Angeles, USA)

Trident Corporation
(Los Angeles, USA)

Mexican Suppliers

Canadian Buyers Mexican Suppliers Canadian Buyers

Are Canadian buyers creditworthy? Will payment be made in US$ or C$?

Are Mexican suppliers dependable? Will Trident pay US$ or Mexican pesos?

Are Canadian buyers creditworthy? Will payment be made in US$ or C$?

Are Mexican suppliers dependable? Will Trident pay US$ or Mexican pesos?

Phase Two: Expansion into International Trade

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The Globalization Process

Trident responds to globalization factors by importing
inputs from Mexican suppliers and making exports sales to Canadian buyers This stage is called the international trade phase

The Globalization Process

Trident will now experience significant risks from the
daily volatility in exchange rates

Trident also faces risks associated with credit quality

and evaluation of international counterparts

Exporting and importing products increases the

demands and requirements of a domestic only business

This credit risk management task is much more

difficult in international business as buyers and suppliers are new and subject to differing business practices and legal systems

The first is direct foreign exchange risks borne by

Trident

Trident may have to quote prices and receive payments

in foreign currencies
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The Globalization Process

Global Transition II
The move from the international trade phase to the
multinational phase If Trident is successful in international trade then the time will come for the next step in the globalization process
Trident will eventually need to establish foreign sales and services affiliates This step is followed by the establishment of manufacturing operations or licensing agreements abroad
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The Globalization Process

Global Transition II
Tridents continued globalization will require it to
identify the sources of it competitive advantages

This variety of strategic alternatives available to

Trident is called the foreign direct investment sequence
These alternatives include the creation of foreign sales offices, licensing agreements, manufacturing, etc.

Once Trident owns assets and enterprises in foreign

countries it has entered the multinational phase of globalization
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Foreign Direct Investment Sequence

Trident and its Competitive Advantage

Foreign Exchange Exposure

Due to the fact that more cash flows are denominated in foreign currencies, Trident and other corporations must manage these new exposures

Greater Foreign Presence

Change Competitive Advantage

Exploit Existing Competitive Advantage Abroad

There are three main foreign exchange exposures that must be

Production at Home: Exporting

managed by multinationals
Production Abroad

Licensing Management Contract

Control Assets Abroad

Greater Foreign Investment

Joint Venture

Wholly-Owned Subsidiary

Transaction Exposure comes from cash flows associated from payments and receivables in foreign currencies Operating Exposure comes from the changes in cash flows caused by an unexpected exchange change in exchange rates Translation Exposure is an accounting exposure associated with the restatement of foreign currency denominated financial statements

Greenfield Investment Copyright 2003 Pearson Education, Inc.

Acquisition of a Foreign Enterprise Slide 1-13 Copyright 2003 Pearson Education, Inc. Slide 1-14

Foreign Exchange Exposure

Moment in time when exchange rate changes

Financing the Global Firm

As Trident prospers at home and abroad, it confronts
a constraint on further growth access to cheap and plentiful capital

Accounting exposure
Changes in reported owners equity in consolidated financial statements caused by a change in exchange rates

Operating exposure
Changes in cash flows due to unexpected changes in exchange rates

This can be overcome by accessing global debt and

equity markets while maintaining an optimal financial structure The strategy of globalizing the cost & availability of capital is a critical one for firms wishing to reach true global competitiveness

Transaction exposure
Impact of settling outstanding obligations entered into before change in exchange rates but to be settled after change in exchange rates Time
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Foreign Investment Decisions

Foreign investment decisions combine both strategy
and finance This strategy of expanding operations abroad leads to a corporations transition into a multinational enterprise

Foreign Investment Decisions

As Trident moves from a domestic operation towards
a MNE, it faces new and considerable risks and returns dependent upon the strategies employed for its expansion

An MNE is defined as a firm that has operating

subsidiaries in countries outside of its home production and market

These firms also face evaluation of foreign located

projects using a capital budgeting framework
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Foreign Investment Decisions

Trident Europe
(Hamburg, Germany)

Foreign Investment Issues

Other issues that firms face when expanding abroad
are

Trident Brazil
(So Paulo, Brazil)

Trident China
(Shanghai, China)

Greenfield Investment

Cross-Border Acquisition Investment

Joint Venture Investment

Corporate Governance the different corporate

cultures encountered when dealing with firms abroad

Trident Corporation
(Los Angeles, USA)

Global Portfolio Diversification the management of

the risks and rewards needed to understand the various foreign operations and their affects on the domestic firms results

Greenfield Investment
A long-term physical investment in productive capability in that country Copyright 2003 Pearson Education, Inc.

Cross-Border Acquisition
Identification, valuation, tender, and post-acquisition management of an existing going-concern

Joint Venture Investment

Combining investment capital and managerial know-how to reach specific opportunities Slide 1-19

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Managing Multinational Operations

Thus far the focus on Tridents expansion into international markets has been on operations and financing, but the issue of management has not been addressed Trident must also address the issue of maximizing shareholder value

The Goal of Management

Two different points of view on the goal of
management

The Anglo-American markets believe that a firms

objective should be to maximize shareholder wealth
These countries include the US, Canada, Australia, United Kingdom

Trident must minimize its worldwide burden of taxation

Through transfer pricing (the prices charged on sales of goods between units of Trident itself globally), Trident can reduce its global tax liabilities Trident can also assess charges from the parent (US) to the subsidiaries (foreign) in the form of license fees and royalties Trident must also consider the cash flow effects of blocked funds (governmental regulations that hinder the movement of capital out of a country)
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Shareholder believes that markets are efficient and that

prices are correct
Follow financial theory about markets efficiency, systematic and unsystematic risk

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The Goal of Management

The Continental European and Japanese markets
believe that a firms objective should be to maximize corporate wealth
These countries include the EU, Japan and Latin American countries

The Goal of Management

Impatient Capital
Shareholders

Patient Capital
Shareholders

Definition of corporate wealth is broader than AngloAmerican viewpoint that wealth is strictly financial A corporations role in wealth maximization includes the firms technical, market and human resources
Considerations as to the implications of strategic moves affecting all parties, human resources, towns, state, etc.

Firm
(management)

Main Bank

Firm
(management)

Banks

Employees

The Anglo-American Model has been frequently criticized as focusing on short-term profitability rather than long-term growth.
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The Non-Anglo-American Model has come under increasing criticism for its lack of accountability to equity investors its shareholders while focusing on the demands of too diffuse a group of stakeholders.
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Corporate Governance
These two approaches focus around the issue of
corporate governance

Summary of Learning Objectives

Financial management is an integral part of a firms strategy. This course analyzes how a firms financial management tasks evolve as it pursues global strategic opportunities and new constraints unfold The evolution of firms from domestic to multinational is called the globalization process. A firm may enter into international trade transactions, then international contractual arrangements and ultimately the acquisition of foreign subsidiaries. This final stage is when a firm truly becomes a multinational The decision whether or not to invest abroad may require the MNE to enter into global licensing agreements, joint ventures, acquisitions or Greenfield investments
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Corporate Governance is the method by which an

organization establishes order among various stakeholders to ensure that decisions are made and interests are represented in line with the firms stated objectives
These include failures (Enron), poor performance (AT&T), and emerging markets (China)

As a result, companies are moving towards model of

one share, one vote in their corporate structures

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Summary of Learning Objectives

Three major currency exposures arising from the conduct of multinational business that impact all firms are transaction, operating and translation exposure The definitions of return and risk are not universally accepted. Indeed they may be culturally-denominated norms that vary by country In Anglo-American markets, shareholder wealth maximization model is the norm. In non-Anglo-American markets, the corporate wealth model is the norm. Distinct differences exist as to how these models treat return and risk

Summary of Learning Objectives

As MNEs become more dependant on global capital
markets for financing they may need to modify their policies of corporate governance. A trend exists for firms resident in non-Anglo-American markets to move toward being more stockholder friendly while Anglo-American markets are moving toward being more stakeholder friendly.

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