International Financial Management
Chapter 1, 4, 5, 6, 8, 9, 11, 12, 13 & 15
Chapter 1 - Globalization and the multinational firm
What sets international finance apart from domestic finance
1. Foreign exchange and political risks
2. Market imperfections (legal restrictions, excessive transaction and transportation
costs, information asymmetry, and discriminatory taxation)
3. Expanded opportunity set (firms can locate production in any country or region of the
world to maximize their performance and raise funds in any capital market where the
cost of capital is the lowest)
Goals for international financial management
- Shareholder wealth maximization
Corporate governance -> the financial and legal framework for regulating the relationship
between a companies management and its shareholders.
Several key trends and developments of the world economy
1. The emergence of globalized financial markets
- Big bang -> the London Stock Exchange eliminated fixed brokerage
commissions
- Glass-Steagall Act was repealed in the US - restricted commercial banks from
investment banking activities
2. The emergence of the euro as a global currency
- European central bank (ECB)
3. Europes sovereign debt crisis of 2010
4. Continued trade liberalization and economic integration
- Theory of comparative advantage - mutually beneficial for countries if they
specialize in the production of goods they can produce most efficiently and
trade those goods among them
- GATT (General agreement on tariffs and trade) -> multilateral agreement
among member countries in dismantling barriers to international trade
- WTO (world trade organization) - replacement of the GATT
- NAFTA (North american free trade agreement) - canada, US, mexico
- AFCFTA (African continental free trade agreement)
5. Large-scale privatization of state-owned enterprises
- a country divests itself of the ownership and operation of a business venture
by turning it over to the free market system
6. The global financial crisis of 2008–2009
7. Brexit.
,MNC - Multinational corporation
● Business firm incorporated in one country that has production and sales operations in
many other countries
● MNCs benefit from the economy of scale by
○ Spreading R&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
Chapter 4 - Corporate governance around the world
Corporate governance can be defined as the economic, legal, and institutional framework in
which corporate control and cash flow rights are distributed among shareholders, managers,
and other stakeholders of the company.
Public corporation, which is jointly owned by a multitude of shareholders protected
by limited liability, is a major organizational innovation with powerful economic
consequences - plays a big role in spreading economic growth and capitalism worldwide
Key weakness in corporations - conflicts of interest between managers and shareholders.
- In countries such as US and UK, ownership and control is highly diffused
In principle, shareholders elect the board of directors of the company, which in turn hires
managers to run the company for the interests of shareholders
- In us, managers are legally bound by the “duty of loyalty” to shareholders
Agency problem - The agency problem refers to the possible conflicts of interest between
self-interested managers as agents and shareholders of the firm who are the principals
- It is important to have a complete contract -> specifies exactly what the manager will
do under each of all possible future contingencies, there will be no room for any
conflicts of interest or managerial discretion. - however it is impossible to foresee all
future contingencies
- Self-interested managers may also waste funds by undertaking unprofitable projects
that benefit themselves but not investors. For example, managers may misallocate
funds to take over other companies and overpay for the targets if it serves their
private interests
Free cash flows represent a firm’s internally generated funds in excess of the amount
needed to undertake all profitable investment projects, that is, those with positive net present
values (NPVs)
Managers will not return free cash flow to shareholders as dividends but will undertake
unprofitable projects
,Incentives for managers to retain cash flows
- Provide corporate managers with a measure of independence from the capital
markets, insulating them from external scrutiny and discipline
- Growing the size of the company via retention of cash tends - to raise managerial
compensation
- Senior executives can boost their social and political power and prestige by
increasing the size of their company
In sectors such as biotechnology, financial services and pharma (high-growth industries),
managers are less likely to waste funds, since companies in these industries repeatedly
come back to markets for funding
In many countries with concentrated corporate ownership, conflicts of interest are greater
between large controlling shareholders and small outside shareholders than between
managers and shareholders
Remedies for the agency problem
1. Independent board of directors
- Some companies have union representatives on their boards
- The code recommends that there should be at least three outside directs and that the
board chairman and the CEO should be different individuals
2. Incentive contracts
- Executive pay is nearly insensitive to changes in shareholder wealth. This situation
implies that managers may not be very interested in the maximization of shareholder
wealth - Give executives stocks
3. Concentrated ownership
- Rare in Us and Uk, rest of the world it is normal
4. Accounting transparency
- a greater accounting transparency will reduce the information asymmetry between
corporate insiders and the public and discourage managerial self-dealings.
- To achieve this it is important for countries to reform the accounting rules and
companies to have an active and qualified audit committee.
5. Debt
- In turbulent economic conditions, equities can buffer the company against adversity.
Managers can pare down or skip dividend payments until the situation improves.
, With debt, however, managers do not have such flexibility and the company’s
survival can be threatened.
6. Shareholder activism
- Persuade companies into CSR and gender and ethnic diversity on the board
7. Overseas stock listings
- Generally speaking, the beneficial effects from U.S. listings will be greater for firms
from countries with weaker governance mechanisms.
- institutional investors, such as mutual funds, pension funds, and insurance
companies, who can produce high-quality information about listed companies and
effectively protect shareholders’ rights, play a relatively minor role in China.
8. Market for corporate control
Differences among countries can largely be explained by how well investors are protected by
law from expropriation by the managers and controlling shareholders of firms.
- Mostly to do with the legal origin of the country
- Common law - canada, us and uk (strongest protection)
- Civil law - netherlands, belgium, italy & mexico (weakest protection)
- Scandinavian civil law - fall in the middle
Dominant investors may acquire control through various schemes
1. Shares with superior voting rights
2. Pyramidal ownership structure
3. Interfirm cross-holdings
Pyramidal ownership structure in which they control a holding company that owns a
controlling block of another company, which in turn owns controlling interests in yet another
company, and so on
Equity cross-holdings among a group of companies, such as keiretsu and chaebols, can be
used to concentrate and leverage voting rights to acquire control.
According to Beck, Levine, and Loayza (2000), financial development can contribute to
economic growth in three major ways: (i) It enhances savings; (ii) it channels savings toward
real investments in productive capacities, thereby fostering capital accumulation; and (iii) it
enhances the efficiency of investment allocation through the monitoring and signaling
functions of capital markets.
In both Germany and japan, banks and a few permanent large shareholders play the central
role in corporate governance.
Chapter 1, 4, 5, 6, 8, 9, 11, 12, 13 & 15
Chapter 1 - Globalization and the multinational firm
What sets international finance apart from domestic finance
1. Foreign exchange and political risks
2. Market imperfections (legal restrictions, excessive transaction and transportation
costs, information asymmetry, and discriminatory taxation)
3. Expanded opportunity set (firms can locate production in any country or region of the
world to maximize their performance and raise funds in any capital market where the
cost of capital is the lowest)
Goals for international financial management
- Shareholder wealth maximization
Corporate governance -> the financial and legal framework for regulating the relationship
between a companies management and its shareholders.
Several key trends and developments of the world economy
1. The emergence of globalized financial markets
- Big bang -> the London Stock Exchange eliminated fixed brokerage
commissions
- Glass-Steagall Act was repealed in the US - restricted commercial banks from
investment banking activities
2. The emergence of the euro as a global currency
- European central bank (ECB)
3. Europes sovereign debt crisis of 2010
4. Continued trade liberalization and economic integration
- Theory of comparative advantage - mutually beneficial for countries if they
specialize in the production of goods they can produce most efficiently and
trade those goods among them
- GATT (General agreement on tariffs and trade) -> multilateral agreement
among member countries in dismantling barriers to international trade
- WTO (world trade organization) - replacement of the GATT
- NAFTA (North american free trade agreement) - canada, US, mexico
- AFCFTA (African continental free trade agreement)
5. Large-scale privatization of state-owned enterprises
- a country divests itself of the ownership and operation of a business venture
by turning it over to the free market system
6. The global financial crisis of 2008–2009
7. Brexit.
,MNC - Multinational corporation
● Business firm incorporated in one country that has production and sales operations in
many other countries
● MNCs benefit from the economy of scale by
○ Spreading R&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
Chapter 4 - Corporate governance around the world
Corporate governance can be defined as the economic, legal, and institutional framework in
which corporate control and cash flow rights are distributed among shareholders, managers,
and other stakeholders of the company.
Public corporation, which is jointly owned by a multitude of shareholders protected
by limited liability, is a major organizational innovation with powerful economic
consequences - plays a big role in spreading economic growth and capitalism worldwide
Key weakness in corporations - conflicts of interest between managers and shareholders.
- In countries such as US and UK, ownership and control is highly diffused
In principle, shareholders elect the board of directors of the company, which in turn hires
managers to run the company for the interests of shareholders
- In us, managers are legally bound by the “duty of loyalty” to shareholders
Agency problem - The agency problem refers to the possible conflicts of interest between
self-interested managers as agents and shareholders of the firm who are the principals
- It is important to have a complete contract -> specifies exactly what the manager will
do under each of all possible future contingencies, there will be no room for any
conflicts of interest or managerial discretion. - however it is impossible to foresee all
future contingencies
- Self-interested managers may also waste funds by undertaking unprofitable projects
that benefit themselves but not investors. For example, managers may misallocate
funds to take over other companies and overpay for the targets if it serves their
private interests
Free cash flows represent a firm’s internally generated funds in excess of the amount
needed to undertake all profitable investment projects, that is, those with positive net present
values (NPVs)
Managers will not return free cash flow to shareholders as dividends but will undertake
unprofitable projects
,Incentives for managers to retain cash flows
- Provide corporate managers with a measure of independence from the capital
markets, insulating them from external scrutiny and discipline
- Growing the size of the company via retention of cash tends - to raise managerial
compensation
- Senior executives can boost their social and political power and prestige by
increasing the size of their company
In sectors such as biotechnology, financial services and pharma (high-growth industries),
managers are less likely to waste funds, since companies in these industries repeatedly
come back to markets for funding
In many countries with concentrated corporate ownership, conflicts of interest are greater
between large controlling shareholders and small outside shareholders than between
managers and shareholders
Remedies for the agency problem
1. Independent board of directors
- Some companies have union representatives on their boards
- The code recommends that there should be at least three outside directs and that the
board chairman and the CEO should be different individuals
2. Incentive contracts
- Executive pay is nearly insensitive to changes in shareholder wealth. This situation
implies that managers may not be very interested in the maximization of shareholder
wealth - Give executives stocks
3. Concentrated ownership
- Rare in Us and Uk, rest of the world it is normal
4. Accounting transparency
- a greater accounting transparency will reduce the information asymmetry between
corporate insiders and the public and discourage managerial self-dealings.
- To achieve this it is important for countries to reform the accounting rules and
companies to have an active and qualified audit committee.
5. Debt
- In turbulent economic conditions, equities can buffer the company against adversity.
Managers can pare down or skip dividend payments until the situation improves.
, With debt, however, managers do not have such flexibility and the company’s
survival can be threatened.
6. Shareholder activism
- Persuade companies into CSR and gender and ethnic diversity on the board
7. Overseas stock listings
- Generally speaking, the beneficial effects from U.S. listings will be greater for firms
from countries with weaker governance mechanisms.
- institutional investors, such as mutual funds, pension funds, and insurance
companies, who can produce high-quality information about listed companies and
effectively protect shareholders’ rights, play a relatively minor role in China.
8. Market for corporate control
Differences among countries can largely be explained by how well investors are protected by
law from expropriation by the managers and controlling shareholders of firms.
- Mostly to do with the legal origin of the country
- Common law - canada, us and uk (strongest protection)
- Civil law - netherlands, belgium, italy & mexico (weakest protection)
- Scandinavian civil law - fall in the middle
Dominant investors may acquire control through various schemes
1. Shares with superior voting rights
2. Pyramidal ownership structure
3. Interfirm cross-holdings
Pyramidal ownership structure in which they control a holding company that owns a
controlling block of another company, which in turn owns controlling interests in yet another
company, and so on
Equity cross-holdings among a group of companies, such as keiretsu and chaebols, can be
used to concentrate and leverage voting rights to acquire control.
According to Beck, Levine, and Loayza (2000), financial development can contribute to
economic growth in three major ways: (i) It enhances savings; (ii) it channels savings toward
real investments in productive capacities, thereby fostering capital accumulation; and (iii) it
enhances the efficiency of investment allocation through the monitoring and signaling
functions of capital markets.
In both Germany and japan, banks and a few permanent large shareholders play the central
role in corporate governance.
