Chapter 1:

Globalization & the Multinational Firm

Chapter Objectives
 Understand why it is important to study international finance.
 Distinguish international finance from domestic finance.

Chapter Outline
1. What’s Special about “International” Finance?
2. Goals for International Financial Management
3. Globalization of the World Economy
4. Multinational Corporations

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 What’s Special about
“International” Finance?

 Foreign Exchange Risk

 Political Risk
 Market Imperfections
 Expanded Opportunity Set

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 What’s Special about
“International” Finance?

 Foreign Exchange Risk

 The risk that foreign currency profits may evaporate in home
currency terms due to unanticipated unfavorable exchange rate
movements.

 Political Risk
 Sovereign governments have the right to regulate the movement of
goods, capital, and people across their borders. These laws
sometimes change in unexpected ways.

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Decomposition of Political Risk

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 What’s Special about
“International” Finance?

 Market Imperfections
 Legal restrictions on movement of goods,
people, and money
 Transactions costs

 Shipping costs

 Tax arbitrage

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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 buy bearer shares.
 Swiss citizens 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.

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 Nestlé’s Foreign Ownership
Restrictions
12,000

10,000
Bearer share
8,000
6,000
SF

4,000
Registered share
2,000

0
11 20 31 9 18 24
Source: Financial Times, November 26, 1988 p.1. Adapted with permission.

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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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 What’s Special about
“International” Finance?
 Expanded Opportunity Set
 It doesn’t make sense to play in only one market.

 True for corporations as well as individual investors.

Investor’s perspective
 Risk reduction through international diversification.

Corporation’s perspective
 Access to cheaper production inputs
 Access to consumers
 Access to capital

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 Goals for International Financial
Management
 Shareholder Wealth Maximization  Corporate Wealth Maximization
France, Germany
Predominant in North America,  All parties associated with the firm are

UK treated equally (shareholders, mgmt.,

 Goal:
Maximize return to shareholders
 “one-share-one-vote”
 Agency theory dictates
labour, suppliers, creditors, govt.)
 Goal:
Maximize long-term return for all interest
groups
 In Japan,Korea, managers have typically

managerial behaviour sought to maximize the value of the

keiretsu—a family of firms to which the
individual firms belongs

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 Other Goals
 As shown by a series of recent corporate scandals at companies like
Enron, WorldCom, managers may pursue their own private interests at
the expense of shareholders when they are not closely monitored.
 These calamities have painfully reinforced the importance of corporate
governance i.e. the financial and legal framework for regulating the
relationship between a firm’s management and its shareholders.
 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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 Globalization of the World
Economy: Recent Trends

 Emergence of Globalized Financial Markets

 Advent of the Euro
 Trade Liberalization and Economic
Integration
 Privatization
 Emergence of Globalized
Financial Markets

 Deregulation of Financial Markets

coupled with
 Advances in Technology
have greatly reduced information and
transactions costs, which has led to:
 Financial Innovations, such as
 Currency futures and options
 Multi-currency bonds
 Cross-border stock listings
 International mutual funds
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 Advent of the Euro

 A momentous event in the history of world financial

systems.
 Currently more than 320 million Europeans in 15
countries are using the common currency on a daily
basis.(Belgium, Germany, Greece, Spain, France, Ireland,
Italy, Luxembourg, the Netherlands, Austria, Portugal,
Slovenia , Finland, Malta, and Cyprus).
 The “transaction domain” of the euro may become
larger than the U.S. dollar’s in the near future.
 For more info on euro, visit the European Central Bank's Web site at
www.ecb.int.
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Value of the Euro in U.S.
Dollars
January 1999 to March 2003

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 Economic Integration

 Over the past 50 years, international trade

increased about twice as fast as world GDP.
 There has been a sea change in the attitudes
of many of the world’s governments who
have abandoned mercantilist views and
embraced free trade as the surest route to
prosperity for their citizenry.

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 Liberalization of
Protectionist Legislation
 The General Agreement on Tariffs and Trade (GATT) a
multilateral agreement among member countries has
reduced many barriers to trade.
 The World Trade Organization has the power to enforce
the rules of international trade.
 The North American Free Trade Agreement (NAFTA)
calls for phasing out impediments to trade between
Canada, Mexico and the U.S. over a 15-year period.
 For Canada, the ratio of exports to GDP has increased
dramatically from 19.2% in 1973 to 45.2% in 2003.
 The increased trade will result in increased numbers of jobs and a
higher standard of living for all member nations.
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 Privatization

 The selling off state-run enterprises to investors is also

known as “Denationalization”.
 Often seen in socialist economies in transition to market
economies.
 By most estimates this increases the efficiency of the
enterprise.
 Often spurs a tremendous increase in cross-border
investment.
 Multinational Corporations

 A firm that has incorporated on one country and has

production and sales operations in other countries.
 There are about 60,000 MNCs in the world.
 Many MNCs obtain raw materials from one nation,
financial capital from another, produce goods with
labor and capital equipment in a third country and
sell their output in various other national markets.
 Top 10 MNCs

1 General Electric United States

2 ExxonMobile Corporation United States
3 Royal Dutch/Shell Group Netherlands/ UK
4 General Motors United States
5 Ford Motor Company United States
6 Toyota Motor Corporation Japan
7 DaimlerChrysler AG Germany
8 TotalFina SA France
9 IBM United States
10 BP United Kingdom

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 Mini Case: Nike’s Decision
Nike, a U.S.-based company with a globally recognized brand name, manufactures
athletic shoes in such Asian developing countries as China, Indonesia, and Vietnam
using subcontractors, and sells the products in the U.S. and foreign markets. The
company has no production facilities in the United States. In each of those Asian
countries where Nike has production facilities, the rates of unemployment and
underemployment are quite high. The wage rate is very low in those countries by the
U.S. standard; hourly wage rate in the manufacturing sector is less than one dollar in
each of those countries, which is compared with about $18 in the U.S. In addition,
workers in those countries often are operating in poor and unhealthy environments and
their rights are not well protected. Understandably, Asian host countries are eager to
attract foreign investments like Nike’s to develop their economies and raise the living
standards of their citizens. Recently, however, Nike came under a world-wide criticism
for its practice of hiring workers for such a low pay, “next to nothing” in the words of
critics, and condoning poor working conditions in host countries.
Evaluate and discuss various ‘ethical’ as well as economic ramifications of Nike’s
decision to invest in those Asian countries.
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