Chapter 1
Multinational Financial Management: An Overview
Lecture Outline
Managing the MNC
How Business Disciplines Are Used to Manage the MNC
Agency Problems
Management Structure of an MNC
Why Firms Pursue International Business
Theory of Comparative Advantage
Imperfect Markets Theory
Product Cycle Theory
Methods to Conduct International Business
International Trade
Licensing
Franchising
Joint Ventures
Acquisitions of Existing Operations
Establishing New Foreign Subsidiaries
Summary of Methods
Valuation Model for an MNC
Domestic Valuation Model
Multinational Valuation Model
Uncertainty Surrounding an MNC’s Cash Flows
How Uncertainty Affects the MNC’s Cost of Capital
Organization of the Text
,Chapter Theme
This chapter introduces the multinational corporation as having similar goals to the purely domestic
corporation, but a wider variety of opportunities. With additional opportunities come potential increased
returns and other forms of risk to consider. The potential benefits and risks are introduced.
Topics to Stimulate Class Discussion
1. What is the appropriate definition of an MNC?
2. Why does an MNC expand internationally?
3. What are the risks of an MNC which expands internationally?
4. Why must purely domestic firms be concerned about the international environment?
POINT/COUNTER-POINT:
Should an MNC Reduce Its Ethical Standards to Compete Internationally?
POINT: Yes. When a U.S.-based MNC competes in some countries, it may encounter some business
norms there that are not allowed in the U.S. For example, when competing for a government contract,
firms might provide payoffs to the government officials who will make the decision. Yet, in the United
States, a firm will sometimes take a client on an expensive golf outing or provide skybox tickets to
events. This is no different than a payoff. If the payoffs are bigger in some foreign countries, the MNC
can compete only by matching the payoffs provided by its competitors.
COUNTER-POINT: No. A U.S.-based MNC should maintain a standard code of ethics that applies to
any country, even if it is at a disadvantage in a foreign country that allows activities that might be viewed
as unethical. In this way, the MNC establishes more credibility worldwide.
WHO IS CORRECT? Use the Internet to learn more about this issue. Which argument do you support?
Offer your own opinion on this issue.
ANSWER: The issue is frequently discussed. It is easy to suggest that the MNC should maintain a
standard code of ethics, but in reality, that means that it will not be able to compete in some cases. For
example, even if it submits the lowest bid on a specific foreign government project, it will not receive the
bid without a payoff to the foreign government officials. The issue is especially a concern for large
projects that may generate substantial cash flows for the firm that is chosen to do the project. Ideally, the
MNC can clearly demonstrate to whoever oversees the decision process that it deserves to be selected. If
there is just one decision-maker with no oversight, an MNC can not ensure that the decision will be
ethical. But if the decision-maker must be accountable to a department who oversees the decision, the
MNC may be able to prompt the department to ensure that the process is ethical.
,Answers to End of Chapter Questions
1. Agency Problems of MNCs.
a. Explain the agency problem of MNCs.
ANSWER: The agency problem reflects a conflict of interests between decision-making managers
and the owners of the MNC. Agency costs occur in an effort to assure that managers act in the best
interest of the owners.
b. Why might agency costs be larger for an MNC than for a purely domestic firm?
ANSWER: The agency costs are normally larger for MNCs than purely domestic firms for the
following reasons. First, MNCs incur larger agency costs in monitoring managers of distant foreign
subsidiaries. Second, foreign subsidiary managers raised in different cultures may not follow
uniform goals, and some managers may focus on satisfying respective employees. Third, the sheer
size of the larger MNCs would also create large agency problems.
2. Comparative Advantage.
a. Explain how the theory of comparative advantage relates to the need for international business.
ANSWER: The theory of comparative advantage implies that countries should specialize in
production, thereby relying on other countries for some products. Consequently, there is a need for
international business.
b. Explain how the product cycle theory relates to the growth of an MNC.
ANSWER: The product cycle theory suggests that at some point in time, the firm will attempt to
capitalize on its perceived advantages in markets other than where it was initially established.
3. Imperfect Markets.
a. Explain how the existence of imperfect markets has led to the establishment of subsidiaries in
foreign markets.
ANSWER: Because of imperfect markets, resources cannot be easily and freely retrieved by the
MNC. Consequently, the MNC must sometimes go to the resources rather than retrieve resources
(such as land, labor, etc.).
b. If perfect markets existed, would wages, prices, and interest rates among countries be more
similar or less similar than under conditions of imperfect markets? Why?
ANSWER: If perfect markets existed, resources would be more mobile and could therefore be
transferred to those countries more willing to pay a high price for them. As this occurred, shortages
of resources in any particular country would be alleviated and the costs of such resources would be
similar across countries.
4. International Opportunities.
, a. Do you think that either the acquisition of a foreign firm or licensing will result in greater growth
for an MNC? Which alternative is likely to have more risk?
ANSWER: An acquisition will typically result in greater growth, but it is riskier because it normally
requires a larger investment and the decision can not be easily reversed once the acquisition is made.
b. Describe a scenario in which the size of a corporation is not affected by access to international
opportunities.
ANSWER: Some firms may avoid opportunities because they lack knowledge about foreign markets
or expect that the risks are excessive. Thus, the size of these firms is not affected by the
opportunities.
c. Explain why MNCs such as Coca Cola and PepsiCo still have numerous opportunities for
international expansion.
ANSWER: Coca Cola and PepsiCo still have new international opportunities because countries are at
various stages of development. Some countries have just recently opened their borders to MNCs.
Many of these countries do not offer sufficient food or drink products to their consumers.
5. International Opportunities Due to the Internet.
a. What factors cause some firms to become more internationalized than others?
ANSWER: The operating characteristics of the firm (what it produces or sells) and the risk perception
of international business will influence the degree to which a firm becomes internationalized. Several
other factors such as access to capital could also be relevant here. Firms that are labor-intensive could
more easily capitalize on low-wage countries while firms that rely on technological advances could not.
b. Why might the Internet have resulted in more international business.
ANSWER: The Internet allows for easy and low-cost communication between countries, so that
firms could now develop contacts with potential customers overseas by having a website. Many firms
use their website to identify the products that they sell, along with the prices for each product. This
allows them to easily advertise their products to potential importers anywhere in the world without
mailing brochures to various countries. In addition, they can add to their product line and change
prices by simply revising their website, so importers are kept abreast of the exporter’s product
information by monitoring the exporter’s website periodically. Firms can also use their websites to
accept orders online. Some firms with an international reputation use their brand name to advertise
products over the internet. They may use manufacturers in some foreign countries to produce some
of their products subject to their specification
6. Impact of Exchange Rate Movements. Plak Co. of Chicago has several European subsidiaries that
remit earnings to it each year. Explain how appreciation of the euro (the currency used in many
European countries) would affect Plak's valuation.
ANSWER: Plak’s valuation should increase because the appreciation of the euro will increase the
dollar value of the cash flows remitted by the European subsidiaries.
Multinational Financial Management: An Overview
Lecture Outline
Managing the MNC
How Business Disciplines Are Used to Manage the MNC
Agency Problems
Management Structure of an MNC
Why Firms Pursue International Business
Theory of Comparative Advantage
Imperfect Markets Theory
Product Cycle Theory
Methods to Conduct International Business
International Trade
Licensing
Franchising
Joint Ventures
Acquisitions of Existing Operations
Establishing New Foreign Subsidiaries
Summary of Methods
Valuation Model for an MNC
Domestic Valuation Model
Multinational Valuation Model
Uncertainty Surrounding an MNC’s Cash Flows
How Uncertainty Affects the MNC’s Cost of Capital
Organization of the Text
,Chapter Theme
This chapter introduces the multinational corporation as having similar goals to the purely domestic
corporation, but a wider variety of opportunities. With additional opportunities come potential increased
returns and other forms of risk to consider. The potential benefits and risks are introduced.
Topics to Stimulate Class Discussion
1. What is the appropriate definition of an MNC?
2. Why does an MNC expand internationally?
3. What are the risks of an MNC which expands internationally?
4. Why must purely domestic firms be concerned about the international environment?
POINT/COUNTER-POINT:
Should an MNC Reduce Its Ethical Standards to Compete Internationally?
POINT: Yes. When a U.S.-based MNC competes in some countries, it may encounter some business
norms there that are not allowed in the U.S. For example, when competing for a government contract,
firms might provide payoffs to the government officials who will make the decision. Yet, in the United
States, a firm will sometimes take a client on an expensive golf outing or provide skybox tickets to
events. This is no different than a payoff. If the payoffs are bigger in some foreign countries, the MNC
can compete only by matching the payoffs provided by its competitors.
COUNTER-POINT: No. A U.S.-based MNC should maintain a standard code of ethics that applies to
any country, even if it is at a disadvantage in a foreign country that allows activities that might be viewed
as unethical. In this way, the MNC establishes more credibility worldwide.
WHO IS CORRECT? Use the Internet to learn more about this issue. Which argument do you support?
Offer your own opinion on this issue.
ANSWER: The issue is frequently discussed. It is easy to suggest that the MNC should maintain a
standard code of ethics, but in reality, that means that it will not be able to compete in some cases. For
example, even if it submits the lowest bid on a specific foreign government project, it will not receive the
bid without a payoff to the foreign government officials. The issue is especially a concern for large
projects that may generate substantial cash flows for the firm that is chosen to do the project. Ideally, the
MNC can clearly demonstrate to whoever oversees the decision process that it deserves to be selected. If
there is just one decision-maker with no oversight, an MNC can not ensure that the decision will be
ethical. But if the decision-maker must be accountable to a department who oversees the decision, the
MNC may be able to prompt the department to ensure that the process is ethical.
,Answers to End of Chapter Questions
1. Agency Problems of MNCs.
a. Explain the agency problem of MNCs.
ANSWER: The agency problem reflects a conflict of interests between decision-making managers
and the owners of the MNC. Agency costs occur in an effort to assure that managers act in the best
interest of the owners.
b. Why might agency costs be larger for an MNC than for a purely domestic firm?
ANSWER: The agency costs are normally larger for MNCs than purely domestic firms for the
following reasons. First, MNCs incur larger agency costs in monitoring managers of distant foreign
subsidiaries. Second, foreign subsidiary managers raised in different cultures may not follow
uniform goals, and some managers may focus on satisfying respective employees. Third, the sheer
size of the larger MNCs would also create large agency problems.
2. Comparative Advantage.
a. Explain how the theory of comparative advantage relates to the need for international business.
ANSWER: The theory of comparative advantage implies that countries should specialize in
production, thereby relying on other countries for some products. Consequently, there is a need for
international business.
b. Explain how the product cycle theory relates to the growth of an MNC.
ANSWER: The product cycle theory suggests that at some point in time, the firm will attempt to
capitalize on its perceived advantages in markets other than where it was initially established.
3. Imperfect Markets.
a. Explain how the existence of imperfect markets has led to the establishment of subsidiaries in
foreign markets.
ANSWER: Because of imperfect markets, resources cannot be easily and freely retrieved by the
MNC. Consequently, the MNC must sometimes go to the resources rather than retrieve resources
(such as land, labor, etc.).
b. If perfect markets existed, would wages, prices, and interest rates among countries be more
similar or less similar than under conditions of imperfect markets? Why?
ANSWER: If perfect markets existed, resources would be more mobile and could therefore be
transferred to those countries more willing to pay a high price for them. As this occurred, shortages
of resources in any particular country would be alleviated and the costs of such resources would be
similar across countries.
4. International Opportunities.
, a. Do you think that either the acquisition of a foreign firm or licensing will result in greater growth
for an MNC? Which alternative is likely to have more risk?
ANSWER: An acquisition will typically result in greater growth, but it is riskier because it normally
requires a larger investment and the decision can not be easily reversed once the acquisition is made.
b. Describe a scenario in which the size of a corporation is not affected by access to international
opportunities.
ANSWER: Some firms may avoid opportunities because they lack knowledge about foreign markets
or expect that the risks are excessive. Thus, the size of these firms is not affected by the
opportunities.
c. Explain why MNCs such as Coca Cola and PepsiCo still have numerous opportunities for
international expansion.
ANSWER: Coca Cola and PepsiCo still have new international opportunities because countries are at
various stages of development. Some countries have just recently opened their borders to MNCs.
Many of these countries do not offer sufficient food or drink products to their consumers.
5. International Opportunities Due to the Internet.
a. What factors cause some firms to become more internationalized than others?
ANSWER: The operating characteristics of the firm (what it produces or sells) and the risk perception
of international business will influence the degree to which a firm becomes internationalized. Several
other factors such as access to capital could also be relevant here. Firms that are labor-intensive could
more easily capitalize on low-wage countries while firms that rely on technological advances could not.
b. Why might the Internet have resulted in more international business.
ANSWER: The Internet allows for easy and low-cost communication between countries, so that
firms could now develop contacts with potential customers overseas by having a website. Many firms
use their website to identify the products that they sell, along with the prices for each product. This
allows them to easily advertise their products to potential importers anywhere in the world without
mailing brochures to various countries. In addition, they can add to their product line and change
prices by simply revising their website, so importers are kept abreast of the exporter’s product
information by monitoring the exporter’s website periodically. Firms can also use their websites to
accept orders online. Some firms with an international reputation use their brand name to advertise
products over the internet. They may use manufacturers in some foreign countries to produce some
of their products subject to their specification
6. Impact of Exchange Rate Movements. Plak Co. of Chicago has several European subsidiaries that
remit earnings to it each year. Explain how appreciation of the euro (the currency used in many
European countries) would affect Plak's valuation.
ANSWER: Plak’s valuation should increase because the appreciation of the euro will increase the
dollar value of the cash flows remitted by the European subsidiaries.
