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Define how value is created. Provide your own examples of each.
Your response should be at least 200 words in length. All sources used, including the textbook, must be referenced; paraphrased and quoted material must have accompanying citations. [removed] [removed] [removed] [removed]
Moffett, M. H., Stonehill, A. I., & Eiteman, D. K. (2012). Fundamentals of multinational finance. (IV ed., pp. 14-17). New York: Pearson.
In-text citation
(Moffett, Stonehill & Eiteman, 2012)
No Wiki, no dictionary.com, please cite all work.
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cHAPTER 1 current Multinational challenges andthe Global Economy
U.S. Dollar-Denominated lnterest Rates
1-Month Maturities
U.S. Prime Rate 6 00%
Certificate
of
Deposit Rate 0 400%
LIBOR 0.260%
London lnterbank Offer Rate
London interbank rates apply to the buying
and’selling of eurodollar deposits between
banks in the international markets.
Notes:
Average rates for MaY 201 1.
U.S. Federal Funds target rale = o O”/”4 25″/”
Eurodollar DePosit
Offer Rate
I
) Eurodollar SPread
)
Eurodollar DePosll
Bid Bate
0.275%
o.255%rii*:.
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Eurodollar deposits are dollar-denominated
accounts in financial institutions oulside
of
the united states.
rter-
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Deposit rates are higher in the eulocurrency malkets than in most
domesti:c currency
markets because the finicial institutions offering eurocurrency activities are not subject
to
murry of the regulations and reserve requiremen-ts imposed on traditional
domestic banks
and banking activities. with these costs removed, raies are subject to mole competitive
pressures, d*eposit rates are higher, and loan rates are lower. A second majol area of
cost
avoided in the eurocurrency niarkets is the payment of deposit insurance
fees (such as the
Federal Deposit lnsurance” Corporation, FDIb, and assessments paid on deposits
in the
United States). Exhibit 1.3 illustrates how eurodollar deposit and loan rates’
including dollar
LIBOR and LIBID rates, compare with traditionai domestic interest rates’
The Theory of Comparative Aclvantage
The theory of comparative advantage provides a basis for explaining and
justifying interna-
tional trade in a model world assumed to enjoy free trade, perfect competition’
no uncer-
tainty, costless information, and no gou”rn*”
.ri
interference’ The theory’s origins
lie in the
work of Adam Smith, anJ particutarly with his seminal book TheWealth
of Nations published
in 1776-Smith sought io explain why the division of labor in productive activities’ and
subse-
quently international trade of those goods, increased the quality of life
for all citizens’ Smith
based his work on ihe concept ol abiolute advantage,wheie every country
should specialize
in the production of that good it was uniquely suited for’ More would be
produced for less’
10 PAfil” 1 Global Financial Environment
Thus. by each country specializing in products for which it possessed absolute ad,vantage,
countries could produce more in total and exchange products-trade-for goods that were
cheaper in price than those produced at home.
David Ricardo, in his work On the Principles of Politicat Econonzy anrl Taxotion pub-
lished in 18i7, sought to take the basic ideas set down by Adam Smith a ferv iogical steps
further. Ricardo noted that even if a country possessed absolute advantage in the produc-
tion of two products, it might still be relatively more efficient than the other country in
one good’s product than the other. Ricardo termed this comparative aclt,antctge. Each
country would then possess comparative advantage in the production of one of the two
products, and both countries would then benefit by specializing completely in one product
and trading for the other.
Although international trade might have approached the comparative advantage model
during the nineteenth century, it certainly does not today, for avariety ofreasons. Countries
do not appear to specialize only in those products that could be most efficiently produced by
that country’s particuiar factors of production. Instead, governments interfere rvith compara-
tive advantage for a variety of economic and political reasons, such as to achieve full employ-
ment, economic development, national self-sufficiency in defense-related industries
, and
protection of an agricultural sector’s way of life. Government interference takes the form of
tariffs, guotas, and other non-tariff restrictions.
At least two of the factors of production, capital and technology, now flow directly and
easily between countries, rather than only indirectly through traded goods and services. This
direct flow occurs between related subsidiaries and affiliates of multinational firms, as well as
between unrelated firms via loans, and license and management contracts. Even labor flows
between countries such as immigrants into the United States (legal and illegal), immigrants
within the European Union, and other unions.
Modern factors of production are more numerous than in this simple model. Factors
considered in the location of production facilities worldwide include local and managerial
skills, a dependable legal structure for settling contract disputes, research and develop-
ment competence, educational levels of available workers, energy resources, consumer
demand for brand name goods, mineral and raw material availability, access to capital, tax
differentials, supporting infrastructure (roads, ports, and communication facilities), and
possibly others.
Although the terms of trade are ultimately determined by supply and demand, the
process by which the terms are set is different from that visualized in traditional trade theo
ry.
They are determined partly by administered pricing in oligopolistic markets.
Comparative advantage shifts over time as less developed countries become more devel-
oped and reahze their latent opportunities. For example, over the past 150 years comparative
advantage in producing cotton textiles has shifted from the United Kingdom to the United
States, to Japan, to Hong Kong, to Taiwan, and to China. The classical model of comparative
advantage also did not really address certain other issues such as the effect of uncertainty and
information costs, the role of differentiated products in imperfectly competitive markets, and
economies of scale.
Nevertheless, although the world is a long way from the classical trade model, the ge
n-
eral principle of comparative advantage is still valid. The closer the world gets to true
international specialization, the more world production and consumption can be
increased, provided the problem of equitable distribution of the benefits can be solved to
the satisfaction of consumerq producers, and political leaders. Complete specialization,
however, remains an unrealistic limiting case, just as perfect competition is a limiting case
in microeconomic theory.
I
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cHAFTERlCurrentMultinationalChallengesandtheGlobalEconomy
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Supply ehain CIutsour*ing: Ccmparative Adv*ntage
Tcday
comparative advantage is still a relevant theory to explain
why particular countries are most
suitable for exporrs
“t
gr.a, and services that suppori the global supply chain of b::1MNEs
and domestic firms. fft”” “o*p-ative
advantug”-of the twenty-first century’ howevet’ ls one
that is based more on services, and their “roSS
iord”‘ facilitation by telecommunications and
the Internet. The source of a nation’s comparative advantage,however’
still is created from
the mixture of its own labor skills, access to capital, and
technology’
Many locations for supply chain outsourcing exist today’
Exhibit 1’4 presents a geograph-
ical overview of this -odein’reincarnation of tlde-based
comparative advantage’ To prove
that these countries ,h;;i;;p””ialize in the activities shown you
would need to know how
costly the same activities would be in the countries that
are importing these services com-
pared to their own other industries. Remember that it takes
a relative advantage in costs’ not
lurt ut cbsolute advantage,to create
comparative advantage’
For example, India iu, d”o”topea a trignty efficient ind low-cost software
industry’ This
inOurtry supplies not o”fy,n” “r”uiion
of custlm software, but also call centers for customer
support, and other information technology r”rui””t.lt” Indian software
industry is co*posed
of subsidiaries of MNEs and independent companies’
If you own.a Hewlett-Packard computer
and call the customet *pp”” “”nt”, “u*t*
Ioi help, you are likely to reach a call center in
India. Answering your cati witt be a knowledgeable Indian
software engineer or programmer
who will ,.walk you ,fr*”gh” your probleti. tnOlu has a large number
of well-educated’
English-speaking technical-experts *^to urtfuid only a.fraction of
the salary and overhead
earned by their IJ.S. counterparts. The overcapacity and
low cost of international telecommu-
nication networks today furiher enhances ttre comparative
advantage of an Indian location’
Eastern Europe
China London
I
Philippines\”/ \\
Manila
,”,,”J
‘/lun”*””‘””
FX.- \
*on,”‘.,”u/ !::”,::”” \soutnnt’ic”
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Guadalajara Johannesburg Hyderabad
Bangalore
MNEs based in many industrial countries are outsourcing
intellectual
functlons to providers based in tradiiionai emetging market
countries
12 FAfi’f i Global Financial Environment
The extent of global outsourcing is already reaching out to every corner of the glo
be.
From financial back-offices in Manila, to information technology engineers in Hungary, mod-
ern telecommunications now take business activities to labor rather than moving labor to the
places of business.
1#i:at ls Different aE:mat{ Gl*bal Financi;e[
l’4anagcffineilg?
Exhibit 1.5 details some of the main differences between international and domestic financial
management. These component differences include institutions, foreign exchange and poiiti-
cai risks, and the modifications required of financial theory and financial instruments.
International financial management requires an understanding of cultural, historical, and
institutional differences such as those affecting corporate governance. Although both domes-
tic firms and MNEs are exposed to foreign exchange risks, MNEs alone face certain unique
risks, such as political risks, that are not normaliy a threat to domestic operations.
MNEs also face other risks that can be classified as extensions of domestic finance the-
ory. For example, the normal domestic approach to the cost of capital, sourcing debt and
equity, capital tudgeting, working capital management, taxation, and credit analysis needs to
be modified to accommodate foreign complexities. Moreover, a number of financial instru-
ments that are used in domestic financial management have been modified for use in interna-
tional financial management. Examples are foreign currency options and futures, interest
rate and currency swaps, and letters of credit.
The main theme oi this book is to analyze horv a multinational enterprise’s financial man-
agement evolves as it pursues global strategic opportunities and new constraints emerge. In this
cilapter, we will take a brief look at the challenges and risks associated with Tiident Corpora-
tio; (Tiident), a company evolving from domestic in scope to being truly multinational.The dis-
cussion wiil include ihe constraints that a company will face in terms of managerial goals and
governance as it becomes increasingiy involved in multinational operations. But first we need
io clarify the unique value proposition and advantages that the MNE was created to exploit.
And as noted by bUnA Fiianie in Practice 1.2,the objectives and responsibilities of the mod-
ern multinational have grown significantly more complex in the twenty-first century’
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What ls Different about lnternational Financial Management?
lnternational Domestic
Culture, history and
insUtutions
Corporate governance
Foreign exchange risk
Political risk
Modification of domes-
tic finance theories
Modiflcation of domes-
tic financial instruments
Each foreign country is unique and not always
understood by MNE management
Foreign countries’ regulations and rnstrtutional
practices are all uniquely different
MNEs face foreign exchange risks due to their
subsidiaries, as well as impod/expod and foreign
competitors
MNEs face poliiical risks because of their foreign
subsidiaries and high Prollle
MNEs must modiiy finance theories like capital budget-
ing and cost of capital because of foreign complexities
MNEs utilize modified financial instruments such as
options, futures, swaps, and letters of credit
Each country has a known base case
Regulations and institutions are well known
Foreign exchange risks from import/expod and
foreign competition (no subsidiaries)
Negligible political
risks
Traditional financial theory applies
Limited use of financial instrurnents and derivatives
because of fewer foreign exchange and political risks
c H A P T E l? 1 current Multinational challenges and the Global Economy
be.
rd-
.he
rnd
reS-
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he-
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sto
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na-
‘est
eorporate HesPonsibilit
Y
and eorporate $ustainabilitY
Sustainable development is development that meets the
needs of the present without compromising the ability of
future generations to meet their own needs,
-Brundttand Report, 1987, P.54.
What is the purpose of the corporation? lt is increasingly
accepted that the purpose of the corporation is to certainly
create profits and value for its stakeholders, but the respon-
sibility of Ihe corporation is to do so in a way that inflicts no
costs on society, including the environment. As a result of
globalization, this growing responsibility and role of the cor-
poration in society has added a level of complexity to the
leadership challenges faced by the twenty-first ceniury firm’
This developing debate has been somewhat hampered
to date by conflicting terms and labels-corporate goodnxs’
corporate responsibility, corporate social respons/b//ly (CSR)’
corporate philanthropy, and corporate sustainability, to list but
a few. Much of the confusion can be reduced by using a guid-
lng principle-that susfarnability is a goal, while responsibility
is an obligation. lt follows that the obligation of leadership in
the modern multinational is to pursue profit, social develop-
ment, and the environment, all along sustainable principles’
The term sustainable has evolved greaily within the con-
text of global business in the past decade. A traditional pri-
mary objective of the family-owned business has been the
“sustainability of the organization”-the long-term ability of
the company to remain commerclally viable and provide
security and income ior future generations. Although nar-
rower in scope than the concept of environmental sustainabil-
ity, there is a common core thread-the ability of a company’
a culture, or even the earth, to survive and renew over time’
The Triple Bottom-Line
, . . batancing economic growth, social development’
and environmental protection, so that future generations
are not compromised by actions taken today
– 2OOB S u stai n ab ility Report, ExxonMobil Corporation.
Nearly two decades ago a number of large corporations
began to refine their publicly acknowledged corporate
objective as “the pursuit of the triple bottom line'” This tripte
bottom line – profitability, sociat responsibility,
and environ –
mental sustainability-was considered an enlightened
development of modern capitalism. What some critics
referred to as a softer and gentler form of market capital-
ism, was a growing acceptance on the pad of the corpora-
tion for doing something more than generating a financial
profit.
There have been a variety of theoretical rationalizations
for this more expanded view of corporate responsibilities, one
of which divides the argurnents along tvvo channels, the
economic channeland the moral channel’
Q The economic channel argues that by pursuing corpo-
rate sustainability obiectives the corporation is actually
still pursuing profitability, bui is doing so with a more intel-
ligent longer-term perspective-sometimes refened to as
“enlightened self-interest.” lt has realized that a responsi-
ble organization must assure that its actions over time’
whether or not required by law or markets, conducts its
business in a way which does not reduce future choices’
* The moral channelargues that since the corporation has
all the rights and responsibilities of a citizen, it also has
the moral responsibility to act in the best interests of
society and society’s future, regardless of its impacts on
profitability. This argument assumes that in some
instances, doing the ‘right thing’ may have explicit costs’
even to shareholders
Our Commitment to corporate respansibility is unwa-
vering, even during economic downturns’ Taking a
proactive, integrated approach to managing our impact
on local communities and the environment not only
benefits people and our planet, but is good for our busi-
ness. Making corporate responsibility an integral parl of
lntet’s strategy heips us mitigate risk, build strong rela-
tionships with our stakeholders, and expand our market
oPPortunities.
-Letter from our CEO,
lntet 20AB Corp;sr67s Responsibitity Report, p’ 3
.an-
this
)ra-
dis-
and
eed
loit.
Lod-
:!l
I
j
:.
risks
h€aerE of production, and financial ass””tr. Impeifections in the market for products translate into Let opportunities {or MNEs. Large international firms are better able to expioit such compet-
itive factors as economies of scale, managerial and technological expertise, product best in markets characterized by international oligopolistic competition, where these factors 14 PART i Global Financial Environment
are particularly critical. In addition, once MNEs have established a physical presence abroad, Why ** Firms becom* fl”{ultinati*nal? 1. Market seekers produce in foreign markets either to satisfy local demand or to expoil to 2. Raw material seekers extract raw materials wherever they can be found, either for export 3. Production efficiency seekers produce in countries where one or more of the factors of 4. Knowledge seekers operate in foreign countries to gain access to technology or manage- 5. Political safety seekers acquire or establish new operations in countries that are consid- These five types of strategic considerations are not mutually exclusive. Forest products In industries characterized by worldwide oligopolistic competition, each of the above The G!*balizaticn Frereess &l*bal Transitisrx l: Trident fuloves from the *sntestie Fhase CHAPTER 1 Current Multinational Challenges and the Global Economy
d, ii
.:
ffiltrxtrf Trident Corporation: tnitiation of the Gtobatization process
US Suppliers Phase One: Bomestic Operations
All payments in US dollars. US Buyers :. iii##=.Fiw;:E
Canadian Buyers,
Are Canadian buyers creditworthy? to rrt
n- of Mexican Suppliers,
;_i :: r i:i.?:i;:r:,:q,iit:a*,:iii3:ir::j
Are Mexican suppliers dependable? Phase Two: Expansion into lnternalional Trade
Triclent Corporation
).-
d- .s-
ry. :ts
a {e r/e
n- all suppliers and buyers is established under domestic U.S. practices and procedures. A poten- Tiident was founded by James and Edgar Winston in Los Angeles in 1948 to make As Tiident became a visible and viable competitor in the U.S. market, strategic opportu- Exporting and importing products and services increases the demands of financial man- Second, the evaluation of the credit quality of foreign buyers and sellers is now more h- )n of of 76 Global Financial Environment
Trident’s Foreign Direct lnvestment Sequence
/lZ/fVlzr 2l-rzzz/zlzzgzzzzzzzzgzzzzzzZ.tat))stzzr)zaredjlJicdilz)z/ezza/iozd banzesS legal systems, and
generallr, more chalienging to assess.
i:-*::-i ir’:;ll:,::ii:-rl: t.’ ,:’.,. l:ti,l: :-‘ -:.;- ‘ ‘ ‘: j j ii::-i:: i:i’:,:::+ If Tridentis successful in its international trade activities, the time will come v’hen the global’ sales and service affiiiates. This step is often followed by estabiishing manufacturing tions abroad or by licensing foreignfirms to produce and service Tiident’s products’ titude of issues and activitls associated rvith this second larger global transition is the real
focus of this book. tive advantage, and with that knowledge, expand its intellectual capital and ence globail-y. A variety of strategic alternatives are available to Tiident-lhe foreign the cre-
ation of foreign sales offices, the licensing of the company name and everything with it, and the manufacturing and distiibution of its products to other firms in markets.AsTi.ident moves farther dorvn and to the right in Exhibit 1.7,lhe degree physical presence in foreign markets increases. It may now own its own distribution and
proOu.tion facilities, and ultimately, may want to acquire other companies’ owns assets and enterprises in foreign countries it has entere d the multinational its globalization.
Trident and lts Foreign Change Greater Exploit Existing ComPetitive I Production at Home: Licensing Joint Venture SubsidiarY
Greenlield Acquisition ol a ,t |;:|:’ii.:i ls,
rd
i, I’ j A i )-f i,, ili i Current Multinational Challenges and the Global Economy 77
Th* i-irriit* t* Fir:***i*l *l*t**iie*ti*n One possible representation of this process can be seen in Exhibit 1.8. If influential insid- This growing dilemma is also something of a composite of what this book is about. The ine potentiai Liritr or Financial Globalization
There is a growing debate over whether many of the insiders and ruiers of organizations i1-
ln rl- ti- ed .nd Actions of Rulers I Lower Firm Value insider value)
: : (PossiblY lower TheTwin Agency Financial Globalization Actions of e lf these influential insiders are building personal wealth over that of the firm, it will indeed Soulce: Constructed by authors based on “The Limits of Financial Globaiization,” Rene M. Stulz,
mar-
differentiation, and financial strength than arJtheir local competitors’ In fact, MNEs thrive
they are in a better position than purely domestic firms to identify and implement market
opportunities through their own internai information network.
Strategic motives drive the decision to invest abroad and become an MNE. These motives
can be summarized under the following categories:
markets other than their home market. U.S. automobile firms manufacturing in Europe
for local consumption are an example of market-seeking motivation.
or for further processing and sale in the country in which they are found-the host coun-
try. Firms in the oil, mining plantation, and forest industries fall into this category.
production are underpriced relative to their productivity. Labor-intensive production of
electronic components inTaiwan, Malaysia, and Mexico is an example of this motiyation.
rial expertise. For example, German, Dutch, and Japanese firms have purchased U.S.-
located electronics firms for their technology.
ered unlikely to expropriate or interfere with private enterprise. For example, Hong
Kong firms invested heavily in the United States, United Kingdom, Canada, and Aus-
tralia in anticipation of the consequences of China’s 1997 lakeover of the British colony.
firms seeking wood fiber in Brazil, for example, may also find a large Brazilian market for a
portion of their output.
strategic motives should be subdivided into proactive and defensive investments. Proactive
investments are designed to enhance the growth and profitability of the firm itself. Defensive
investments are designed to deny growth and profitability to the firm’s competitors. Exam-
ples of the latter are investments that try to preempt a market before competitors can get
established in it, or capture raw material sources and deny them to competitors.
Tiident is a hypothetical U.S.-based firm that will be used as an illustrative example through-
out the book to demonstrate the globalization process -the structural and managerial changes
and challenges experienced by a firm as it moves its operations from domestic to global.
t* the Er:ternationei Trade Pha*e
Tiident is a young firm that manufactures and distributes an array of telecommunication
devices. Its initial strategy is to develop a sustainable competitive advantage in the U.S. mar-
ket. Like many other young firms, it is constrained by its small size, competitors, and lack of
access to cheap and plentiful sources of capital. The top half of Exhibit 1.6 shows Tiident in its
early domestic phase.Tiident sells its products in U.S. dollars to U.S. customers and buys its
manufacturing and service inputs from U.S. suppliers, paying U.S. dollars. The creditworth of
et
(domestic)
All credit risk under US law.
(domestic)
WiLt payment be made in US$ or C$?
)e
of
n.
Will Trident pay US$ or Mexican pesos?
1g
r’e
et
tial issue for Tiident at this time is that although Tiident is not international or global in its
operations, some of its competitors, suppliers, or buyers may be. This is often the impetus to
push a firm like Tiident into the first transition of the globalization process, into international
trade.
‘telecommunications equipment. The family-owned business expanded slowly but steadily
over the following 40 years. The demands of continual technological investment in the
1980s, however, r’equired that the firm raise additional equity capital in order to compete.
This need led to its initial public offering (IPO) in 1988. As a U.S.-based publicly traded
company on the New York Stock Exchange, Tiident’s management sought to create value
for its shareholders.
nities arose to expand the firm’s market reach try exporting product and services to one or
more foreign markets. The North American Free Tiade Area (NAFTA) made trade with
Mexico and Canada attractive. This second phase of the globalization process is shown in the
lower-half of Exhibit 1.6. Tiident responded to these globalization forces by importing inputs
from Mexican suppliers and making export sales to Canadian buyers. We define this stage of
the globalization process as the International Trade Phase.
agement over and above the traditional requirements of the domestic-only business. First,
direct foreign exchange risks are now borne by the firm. Tiident may now need to quote
prices in foreign currencies, accept payment in foreign currencies, or pay suppliers in foreign
currencies. As the value of currencies change from minute to minute in the global market-
place, Tiident will now experience significant risks from the changing values associated with
these foreign currency payments and receipts.
important than ever. Reducing the possibility of non-payment for exports and non-delivery
of imports becomes one of two main financial management tasks during the international
ES
.r-
ts
tS
as bu1-ers and suppliet’s are new, suuiect to differing business practices and
:”.’:
ization process wiil progress to the next phase’ Trident rvili soon need to establish foreign
opera-
The mul-
Tiident,s continued giobalization will require it to identify the sources of its competi-
physical pres-
direct investment seqttence-as shorvn in Exhibit 1.7. These alternatives include
associated
foreign
of its
Once Tiident
phase of
Competitive Advantage Greater
Presence
Competitive Advantage
,::i:j::i.r”::.i.:i :i:. r:’r:.*i:i:t::1-;p’?:::M :., rri: ;.n
Foreign
lnvestment
Advantage Abroad
Exporiing
Management Contract
Wholly Owned
lnvesiment
Foreign EnterPrise
The theories of international business and international finance introduced in this chapter
have long argued that with an increasingly open and transparent global marketplace in which
capital may flow freely, capital will increasingly flow and support countries and companies
based on the theory of comparative advantage. Since the mid-twentieth century, this has
indeed been the case as more and more countries have pursued more open and competitive
markets. But the past decade has seen the growth of a new kind of limit or impediment to
financial globalization: the growth in the influence and self-enrichment of organizational
insiders.
ers in corporations and sovereign states continue to pursue the increase in firm value, there
will be a definite and continuing growth in financial globalization. But, if these same influen-
tial insiders pursue their own personal agendas, which may increase their personal power and
influence or personal rvealth, or both, then capital will not flow into these sovereign states
and corporations. The result is the growth of financial inefficiency and the segmentation of
globalization outcomes-creating winners and iosers. As we will see throughout this book,
this barrier to international finance may indeed be increasingly troublesome.
three fundamental elements-financial theory, global business, and management beliefs antl
actions-combine to present either the problem or the solution to the growing debate over
the benefits of globalization to countries and cultures worldwide. The Mini-Case sets the
stage for our debate and discussion. Are the controlling famiiy members of this company cre-
ating value for themselves or their shareholders?
with enierprises globally are taking actions consistent with creating firm value or consistent
with increasing their own personal stakes and power.
‘a-
:al
ls-
gn
.gn
its
rnt
‘of
of Sovereign States
(possibly higher
.i inslder value)
Problems Limiting
Y
Corporate Insiders
result in preventing the flow of capital across borders, currencies, and institutions to create
a more open and integrated global financial community.
Journal of Applied Corporate Finance, Volume 19, Number 1, Winter 2002, pp. B-15.
