8/2/2019 MNC S

1/35

1a. Explain the agency problem of MNCs.ANSWER: The agency problem reflects a conflict of interests between decision-makingmanagers and the owners of the MNC. Agency costs occur in an effort to assurethat managersact in the best interest of the owners.

1b. 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 firmsfor thefollowing reasons. First, MNCs incur larger agency costs in monitoring managersof distantforeign subsidiaries. Second, foreign subsidiary managers raised in differentcultures may notfollow uniform goals. Third, the sheer size of the larger MNCs wouldalso create large agency problems.2a. Explain how the theory of comparative advantage relates to the need for international business.ANSWER: The theory of comparative advantage implies that countries should specializein production, thereby relying on other countries for some products. Consequently, thereis a needfor international business.

2b. 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 willattempt tocapitalize on its perceived advantages in markets other than where it wasinitially established.3a. Explain how the existence of imperfect markets has led to the establishment of subsidiaries in foreignmarkets.ANSWER: Because of imperfect markets, resources cannot be easily and freely retrievedby theMNC. Consequently, the MNC must sometimes go to the resources rather thanretrieve resources(such as land, labor, etc.).

3b. If perfect markets existed, would wages, prices, and interest rates among countriesbe more similar or lesssimilar than under conditions of imperfect markets? Why?ANSWER: If perfect markets existed, resources would be more mobile and couldtherefore betransferred to those countries more willing to pay a high price for them. Asthis occurred,shortages of resources in any particular country would be alleviated and thecosts of suchresources would be similar across countries.4a, Product cycle theoryTheorysuggesting that afirminitially establish itself locally and expand intoforeign marketsinresponse to foreign demand for its product; over time, theMNCwill grow inforeignmarkets; after some point, its foreign business may decline unless it candifferentiate its product fromcompetitors.Product CycleThe period of time from theintroduction of a product to its decline and stagnation. Differentanalyses posit differentnumbers of stages in a product cycle (usually four to five), but allemphasize that aproduct has a beginning, with technological innovation; a period of rapidgrowth; maturityand consolidation; and, finally, decline and possibly death. For example, in thevideocassette recording (VCR) industry, the mid-1970s were a period ofdecentralizedtechnological innovation, with VHS and Betamax formats vying fordominance. Later, videocassettes very quickly became a common household item. In the

8/2/2019 MNC S

2/35

maturity phase, differentcompanies selling VCRs attempted to corner a greatermarketsharefor their own (identical)

versions of the product. Finally, the industry declined and was eventually supplanted byDVD players. Factors that may prolong a product cycle include the opening of newmarkets for the product, finding new uses for the same product, or even attaininggovernment subsidies. Theconcept of product cycles applies most readily to the sale ofgoods and it is difficult to gaugehow it works in a service economy.10.a.What Is the objects of IMF?ANSWER:Promote international monitory supportexpansion of international tradepromotion andmaintenance of high levels of employment and real incomepromote exchange stabilityto

remove foreign exchange restriction's that hinders economic growth10.b.What Is the objects of WB?ANSWER:The term "World Bank" generally refers to the IBRD and IDA, whereas the WorldBankGroup is used to refer to the institutions collectively.[2]The World Bank's (i.e. the IBRD and IDA's) activities are focused on developingcountries, infields such as human development (e.g. education, health), agriculture andrural development(e.g. irrigation, rural services), environmental protection (e.g. pollutionreduction, establishingand enforcing regulations), infrastructure (e.g. roads, urbanregeneration, electricity), andgovernance (e.g. anti-corruption, legal institutions

development). The IBRD and IDA provideloans at preferential rates to membercountries, as well as grants to the poorest countries. Loansor grants for specific projectsare often linked to wider policy changes in the sector or theeconomy. For example, a loanto improve coastal environmental management may be linked todevelopment of newenvironmental institutions at national and local levels and theimplementation of newregulations to limit pollution.10.c.What Is the objects of IFC?ANSWER:

1a.List some of the important characteristics of bank foreign exchange servicesthat MNCs should considerANSWER: The important characteristics are (1) competitiveness of the quote, (2) the

firmsrelationship with the bank, (3) speed of execution, (4) advice about current marketconditions,and (5) forecasting advice.

THE MULTINATIONAL ENTERPRISEIntra-corporate Structure: Structure that deals with what is happening inside of acorporation. An intra-company analysis considers those areas that are internal. Thespecific areas that are addressed are the anatomy of the corporation, the overall goals,objectives and mission of the company, the products and services that the company

8/2/2019 MNC S

3/35

offers, and get to the root consideration of why the company is looking to go internationaland its position in the industry. Once the company analyzes these, it can gain a betterunderstanding of whether or not a global or international strategy makes sense. Acompany should go global, then, to reduce costs of purchasing materials, get suppliers tocompete for your business, enlarge the market, increase profits, the product require new

skill or technology, and the company wants to stay ahead of the competition.Intercorporate Structure: The relationship of the corporation and its environments.What is outside of the corporation. This method of analyzing the company switches thefocus from internal working to external factors.Some examples of external areas analyzed here are external variables, governmentpolicies, geo-cultural and political/legal environments, and market opportunities. Thissecond area looks into how international business strategies will be affected by thingsoutside the companys control. Although the items identified during the intercorporateanalysis are not immediately controllable by the company, they can take action that willenable them to adjust to these factors.M.N.E. (Multinational Enterprise): Large firms whose operations and functions span

national borders. Operates in different countries and adjusts products and practices toeach at a higher relative costs.Transnational Corporation (TNC): Corporations owned and managed by nationals indifferent countries.Criteria Identifying a Multinational: Structure (anatomy itself), performance,coordination, and behavior.Microeconomic advantages of the firm operating internationally: Cost reduction, salesexpansion, income and sales smoothing, and variety.A. Anatomy of a corporationThere are promoters and sponsors.1. The promoters or founders create the corporation. They have the ideas of type ofindustry, products, no liability unless corporation once formed assumes it.2. The sponsors back the ideas of the promoters and incur no liability.Three requirements must be met to form a corporation:1. The Charter of the Corporation must be written2. The Articles of the Corporation, stating the relation between the corporation and theState. This must be filed with the Secretary of the State.3. The by-laws, constitution and regulations of the corporation.Then the corporation comes into existence.CORPORATE STRUCTURE: Shareholders and, stockholders who do not intervene inthe day to day operations of the corporation but the only interest is in the return of theirinvestments , bondholders, Board of Directors, CEOs, management, supervisors,foremen, and employees.The purpose of the corporation is to make a profit (goals and objectives). The board ofdirectors is responsible to the shareholders with right to dividends not the investment perse, they are the legal representatives, and can be sued.There are a minimum of three members on the Board (President, Treasurer, andSecretary), and usually there are seven, nine, or thirteen members. The board acts as awhole, and should be insured because propensity of legal issues such as derivative suits.The anatomy of the corporation differs from the international markets vs. the domestic

8/2/2019 MNC S

4/35

market. It also differs among the various industries and how they serve the globalmarkets. Variables "outside" of the corporation include the consumers (actual customersand potential customers), suppliers, alliances and partners, the investment community,distributors, the media community, trade and professional organizations, internationalorganizations, government, unions and competition, and the public in general.

Minimization of costs is the goal of cost-seeking corporations. In an inelastic marketdemand, corporations may control price and are sometimes impenetrable. They controlquantities geographically. Since tariffs are expensive, foreigners are prevented fromentering the markets.

PHASE I: INTRACORPORATE RESEARCHThere are two analyses: Inter- and intracorporate research and analysis. Thecorporation's purpose is to interact with the environment. When doing this, the corporate"bubble" is pierced. We need to understand and recognize the anatomy of thecorporation, how to enter, why to go international, and how it answers the basiceconomic questions.Firms continually enact strategies to improve their cash flows and therefore enhance

shareholder's wealth. Some strategies involve the penetration of foreign markets.Since foreign markets can be distinctly different from local markets, they createopportunities for improving the firm's cash flows. Many barriers to entry into foreignmarkets have been reduced or removed recently, thereby encouraging firms to pursueinternational business (producing and/or selling goods in foreign countries).Consequently, many firms have evolved into multinational corporations (MNCs), whichare defined as firms that engage in some form of international business.Initially, firms may merely attempt to export products to a particular country or importsupplies from a foreign manufacturer. Over time, however, many of them recognizeadditional foreign opportunities and eventually establish subsidiaries in foreign countries.Some businesses, such as Dow Chemical, Exxon, Intel, and Proctor and Gamble,commonly generate more than half their sales in foreign countries. A prime example isthe Coca-Cola Company, which distributes its products in more than 180 countries anduses 53 different currencies; over 65 percent of its total annual operating income istypically generated outside the United States. Source: corporate information;http://www.corporateinformation.com; corporate world:www.kotra.co.kr/e_main/links/bizlink/. Click on "biz_corp1.html."A. Anatomy of a corporation:The composition of industry differs. It differs in the domestic market vs. the

international market and it differs among businesses. We will use Ohio as the home stateof incorporation. A domestic corporation is any business that is incorporated within thestate of Ohio. A foreign corporation is any business outside the state of Ohio (forexample, California). An international corporation is any business outside of the UnitedStates.B. Definitions of multinationals:An understanding of international financial management is crucial to not only the large

MNCs with numerous foreign subsidiaries but also to the small firms that conductinternational business. Many small U.S. firms generate more than 20 percent of theirsales in foreign markets, for example, Ferro and BPL International (Ohio). The smallU.S. firms that conduct international business tend to focus on the niches that have made

8/2/2019 MNC S

5/35

them successful in the United States. They tend to penetrate specialty markets where theywill not have to compete with large firms that could capitalize on economies of scale, forexample, specialized computer chips and products for small markets such as computersfor disable consumers.While some of the small firms have established subsidiaries, manyof them use exporting to penetrate foreign markets. Seventy-five percent of U.S. firms

that export have fewer than 100 employees. This s more prominent today with e-comerce.International business is even important to companies that have no intention of engagingin international business, since these companies must recognize how their foreigncompetitors will be affected by movements in exchange rates, foreign interest rates, laborcosts, and and any other type of short run macroeconomic fluctuatuins such as inflation.Such economic characteristics can affect the foreign competitors' cost of production andpricing policy.

Companies must also recognize how domestic competitors that obtain foreign suppliesor foreign financing will be affected by economic conditions in foreign countries. If thesedomestic competitors are able to reduce their costs by capitalizing on opportunities ininternational markets, they may be able to reduce their prices without reducing their

profit margins. This could allow them to increase market share at the expense of thepurely domestic companies.MNC: ( multinational corporation) is a firm having operations in more than one

country, international sales and a multinational mix of managers and owners. (e.g., Ford,Toyota, GE, IBM, Intel, Sony with headquarters both in N.Y. and Tokyo). A MNEordinarily consists of a parent company and at least six subsidiaries typically with a highdegree of strategic interaction among the units. Some MNC have more than a hundredsubsidiaries and follow absolute and comparative advantages policies. MNC also havedifferent number of foreign production sites and thus different numbers of internationalmarkets. This company earns profits in different markets and not only operates indifferent countries but, owns alliances in other countries and has no allegiance to aparticular country.

MNC are based and owned in one country with manufacturing facilities in two or morecountries in which profits are not invested. The company is owned by stockholders inseveral countries and is based in two or more countries.Multidomestic corporations: are corporations that operate production facilities in

different countries but make no attempt to integrate overall operations.Global Corporation: operates beyond national borders and in more than one country,

sees the globe as one single market without borders, and earns profits in a global basis. Itpursues integrated activities on a worldwide scale, sees the whole globe as one marketand moves products, manufacturing, capital and even personnel wherever they can gainadvantages. They operate with resolute consistency with relative price as if the wholeworld or large areas are single ones.They sell the commodity the same way everywhere, that is a standardized commodity.They usually have strong base on economic regions such as the Pacific Rim, NAFTA,

and EU. Products are developed for the entire globe market and the company giveschanges in order to be able to move from regional to product line based on profits.Centers and senior executives are from different countries. For example; GE, TexasInstruments, Hitachi, ICI British Chemical, Daewoo, and Hyundai.

8/2/2019 MNC S

6/35

MNE: (Multinational enterprise) is any business which has productive activities intwo or more countries and manufactures and markets products and services in differentcountries. MNE is an efficient agent for transferring capital, managerial skills, culture,technology, industrial know how, product design, line and brand name, and goods andservices across countries. MNE also transfers information such as its superior information

gathering ability, headquarters discoveries, and exploit opportunities beyond thedomestic market. MNE can bear the risks of ventures great size and financial strengthsbetter than the domestic company can do. In the 1980's, there was a rise of non U.S.MNEs and the growth of the mini multinationals in the 1990's. United States. MNEsaccount for 2/3 of all direct investment, but in 2000, of the 260 largest MNE, only 48.5%were U.S. owned multinationals; Great Britain had 18.8%; Japan had 3.5%, and LatinAmerica had 5%. Other countries with MNEs are: France, Germany, Canada, Sweden,Netherlands, Switzerland, Hong Kong, Singapore. Countries with mini multinationals in2000's are Israel, Germany, United States, Australia, Italy, Brazil and Mexico withmedium to small size companies such as Lubricating Systems of Kent, Ohio, SwanOptical and Cardiac Science.

Multinationals do extensive overseas operations including manufacturing in differentcountries. The UNCTAD ( United Nations Conference on Trade and Development) in1999 reported that about 40,000 MNE have about 378,000 affiliates with more than $318trillion in investment. Source: UNCTAD Economic Report, 2002.Service Companies: such as banks, investment financial companies, brokerage houses,

legal, airlines, hotels, health, entertainment, travel agencies, tourism, and accounting arethe growing multinationals of the 21th. Century. For example, orchestras easily makecontracts for one performance for over $150,000.00 ( e.g., The Cleveland Orchestra with$350,000.00 per performance).Internationally oriented firms - Garcias Rule of Thumb which covers all small

firms engaged in international business.Whereby international sales are considered as an expansion of domestic sales.

Corporations of approximately $120 million who want to enter the international market(mid-size corporations), and export less10% of sales, should be considered aninternational organization (Business should be handled internally). For example, thecompanies have on retainer to help with sales, or they hire one internal person forinternational business. Not profitable. ? (Indirect exporting of indirect investment).

If a company's volume of sales is more10% but less 20% of total sales, it should have aseparate department within the company, internally controlled. This department willspecialize in handling the international sales. ? (Direct exporting of indirect investment).

If its volume of sales is more 20%, it will have an international division, consistent inelements of finance, marketing, accounting, engineering, and, so on. The facility isseparate physically and it has more control over the production schedules. If salescontinue over 40%, a subsidiary is formed. There is a separate plant, in form of a jointventure. ? (Direct investment).The larger the firm, the more variables involved.Export Traffic Publications - Department of Commerce - helps with international

corporations, exportations.Other organizations which affect the corporation are: International Organizations;

Common Markets, Free Trade Zones; Financial and Investment Institutions; Alliances

8/2/2019 MNC S

7/35

and Partners; Distributors; Trade and Professional Organizations; Custom Unions;Constituency; General Public, Media; and Trade Areas.World Class Organizations (WCO):Quality is having a major impact on international operations. One reason is because it

transcends national boundaries and allows firms to compete in a borderless world.

Another is because, paradoxically, as technology increases, costs tend to be driven down,and only the most effective MNCs succeed.This emphasis on quality is leading MNCs to become increasingly more competitive in

terms of both products and services. One way in which successful MNCs are goingbeyond total quality to sustain, and even increase.

Their world competitiveness is through learning. Total quality has become just the costof entry into today's highly competitive world economy. Now, MNCs not only mustadapt, they must anticipate and even create change. They must transform themselves intolearning organizations. Three of the major characteristics of learning organizations areopenness, creativity, and self-efficacy.World-class organizations (WCOs) are able to compete with anybody, anywhere,

anytime. There are several major pillars that form the basis for WCOs: customer-basedfocus, continuous improvement, flexible or virtual organizations, creative humanresource management practices, an egalitarian climate, and technological support. Today,more and more firms are adopting the characteristics of WCOs, because they realize thisis the only way of ensuring that they can compete, and in the long run even survive, intoday's environment. Examples of WCO are: IBM, Sony, Hewlett-Packard, GE, Honda,Xerox, Ritz-Carlton and Walt-Mart.

Main Characteristics of WCO:1. Customer based focus2. Continuous improvements3. Fluid, flexible, and virtual organization.4. Global outsourcing: use of worldwide suppliers regardless of where they are

geographically able to conduct business as if it were a very large corporate enterprisewhen in fact small, but able to make competencies, outsource or partner5. Creative human resources6. Egalitarian climate7. Technological support.

Multinational Enterprise (MNE):This company conducts business in more than one country or market area. MNEs are

generally large firms whose operations and functions expand beyond the spectrum ofnational boundaries. They do not have to be a large corporation. However, Peat-Marwick is an MNE, but it is also a partnership.

Transnational corporations ( TNCs) are corporations owned and managed by theUnited States in different countries. Transnational corporations also tend to view theworld as one giant market for purpose of business. TNCs combine elements of function,product, and geographic designs, while relying on network arrangements to linkworldwide subsidiaries.Advantages of MNE:1. Advance Technology: It has better access to advance technological levels which

makes them extremely competitive when entering new foreign markets.

8/2/2019 MNC S

8/35

2. Learning Curve: Productivity of the MNE in manufacturing industries increasesthrough the experience production.3. Product Development: It can capitalize in development of products in one market,

and; if successful, uses that success to exploit other foreign markets.4. Financial Strength: Because of its sheer size, MNEs can be larger than governments

of countries in which they operate. (g. GM is larger than fifty countries. They are able tocapitalize easier, at a lower costs, than local foreign companies. The issue of control isimportant.5. Management: Being large organizations, MNEs have depth in management ranks.

MNCs can afford to employ individuals with specialized business skills to enhancecompanys profits and/or effectiveness.6. Reduction of Political Risk: Because there are different political and economic

systems in existence there is more risk involve for the MNCs, but MNEs do business inmany different sovereignties and therefore, they are able to spread the risk over manyother locations.7. Rationalized Production and Global Sourcing: MNEs are able to produce different

components in different markets and sell their products in different markets.8. Less Interdependence: Because of regionalization and because of realignments at themacro and micro levels.

GOAL OF THE MNCThe commonly accepted goal of an MNC is to maximize shareholder's wealth.

Developing a goal is necessary since all decisions should contribute to itsaccomplishment. Thus, if the objective were to maximize earnings in the near future, thefirm's policies would be different than if the objective were to maximize shareholders'wealth.

The focus of this course is on U.S. based MNCs. Most of the concepts are generallytransferable to MNCs that are based in other countries, but there are several exceptionsthat would have to be considered if the focus was not on MNCs based in the UnitedStates. For example, even a general statement about the goal of the MNC might bequestioned when considering MNCs based in other countries; some MNCs based outsidethe United States tend to focus more on satisfying the respective goals of their respectivegovernments, banks, or employees.

The focus is also on MNCs, whose parents completely own any foreign subsidiaries.This implies that the U.S. parent is the sole owner of the subsidiaries. This is the mostcommon form of ownership of U.S.-based MNCs, and it enables financial managersthroughout the MNC to have a single goal of maximizing the value of the entire MNCinstead of maximizing the value of any particular foreign subsidiary.

Conflicts Against the Goals of MNC:It has often been argued that managers of a firm may make decisions that conflict withthe firm's goal to maximize shareholders' wealth. For example, a decision to establish asubsidiary in one location versus another may be base on the location's appeal to aparticular manager rather than on its potential benefits to shareholders. Decisions toexpand may be determined by the desires of managers to make their respective divisionsgrow, in order to receive more responsibility and compensation.If a firm were composed of only one owner who was also the sole manager (solepropiertorship), a conflict of goals would not occur. However, for corporations with

8/2/2019 MNC S

9/35

shareholders who differ from their managers, a conflict of goals can exist. This conflict isoften referred to as the agency problem.The costs of ensuring that managers maximize shareholders' wealth (referred to as agencycosts) are normally larger for MNCs than for purely domestic firms, for the followingreasons. First, MNCs that have subsidiaries scattered around the world may experience

larger agency problems because monitoring managers of distant subsidiaries in foreigncountries is more difficult. Second, foreign subsidiary managers raised in differentcultures may not follow uniform goals. Third, the sheer size of the larger MNCs can alsocreate large agency problems. Fourth, some non-U.S. managers tend to downplay theshort-term effects of decisions, which may result in decisions for foreign subsidiaries ofthe U.S.-based MNCs that are inconsistent with maximizing shareholder wealth.Financial managers of an MNC with several subsidiaries may be tempted to makedecisions that maximize the values of their respective subsidiaries. This objective will notnecessarily coincide with maximizing the value of the overall MNC. Consider asubsidiary manager who obtained financing from the parent firm (headquarters) todevelop and sell a new product. The manager estimated the costs and benefits of the

project from the subsidiary's perspective and determined that the project was feasible.However, the manager neglected to realize that any earnings from this project remitted tothe parent would be taxed heavily by the host government. The estimated after-taxbenefits received by the parent were more than offset by the cost of financing the project.While the subsidiary's individual value was enhanced, the MNC's overall value wasreduced. If financial managers are to maximize the wealth of their MNC's shareholders,they must implement policies that maximize the value of the overall MNC rather than thevalue of their respective subsidiaries. For many MNCs, major decisions by subsidiarymanagers must be approved by the parent. However, it is difficult for the parent tomonitor all decisions made by subsidiary managers.

Financial Management of the Multinational CorporationSince multinational corporations are involved in payables and receivables denominated indifferent currencies, product shipments across national borders, and subsidiariesoperating in different sovereignties, they face a different set of problems thancorporations with a purely domestic operations. The corporate treasurer and otherfinancial decision makers of the multinational corporations operate in a cosmopolitansetting that offers profit and loss opportunities never considered by the executives ofpurely domestic corporations. Therefore, the attributes of financial management in themultinational corporation are very unique. The basic issues such as control, cashmanagement, intra-corporation transfers, and capital budgeting are face by allcorporations. The problems particular to the internationally oriented corporation are morecomplex than those of the domestic corporations such as financial controls, cashmanagement, intra-corporation transfers, and capital budgeting.

Financial ControlAny business corporation must evaluate its operations and functions periodically to betterallocate resources and increase income and in general to acquire its goals and objectives.The financial management of a multinational corporation involves exercising control overforeign operations. The responsible individuals at the parent office or headquartersreview financial reports from foreign subsidiaries with a view toward modifyingoperations and assessing the performance of foreign managers.

8/2/2019 MNC S

10/35

Typical control systems are based on setting standards with regard the to sales, profits,inventory, or other specific variables and then examining many financial statements andreports to evaluate the achievement of such goals. There is no "correct" system of control.Methods vary across industries and even across corporations in a single industry. Allmethods have the common goal of providing management with a means of monitoring

the performance of the corporation's operations, new strategies, and goals as conditionschange. However, establishing a useful control system is more difficult for amultinational corporation than for a purely domestic corporation. For instance, shouldforeign subsidiary profits be measured and evaluated in foreign currency or the domesticcurrency of the parent corporation? The answer to this question depends on whetherforeign managers are to be held responsible for currency translation gains or losses.If top management wants foreign managers to be involved in currency management andinternational financing issues, then the domestic currency of the parent would be areasonable choice.On the other hand, if top management wants foreign managers to concern themselveswith production operations and functions, and behave as other managers (managers not

themselves a part of a foreign multinational) in the foreign country would, then theforeign currency would be the appropriate currency for evaluation.Some multinational corporations prefer a decentralized management structure in whicheach subsidiary has a great deal of autonomy and makes most financing and productiondecisions subject only to general parent company guidelines. In this management setting,the foreign manager may be expected to operate and think as the stockholders of theparent corporation would want obtain goals and objectives, so the foreign manager makesdecisions aimed at increasing the parent's domestic currency value of the subsidiary. Thecontrol mechanism in such corporations is to evaluate foreign managers based on a theirability to increase that value. Other corporations prefer more centralized management inwhich financial managers at the parent make most of the decisions. They choose to movefunds among divisions based on a system wide view rather than what is best for a singlesubsidiary. A highly centralized system would have foreign managers evaluated on theirability to meet goals established by the parent for key variables like sales or labor costs.The parent-corporation managers assume responsibility for maximizing the value of thecorporation, with foreign managers basically responding to directives from the top.Therefore, the appropriate control system is largely determined by the management styleof the parent.Considering the discussion to this point, it is clear that managers at foreign subsidiariesshould be evaluated only on the basis of things they control. Foreign managers often maybe asked by the parent corporation to follow policies and relations with other subsidiariesof the corporation that the managers would never follow if they sought solely tomaximize their subsidiary's profit. Actions of the parent that lower a subsidiary's profitshould not result in a negative view of the foreign manager. In addition, other actionsbeyond the foreign manager's control such as changing tax laws, foreign exchangecontrols, or inflation rates that could result in reducing foreign profits through no fault ofthe foreign manager. The message to parent company managers is to place blame fairlywhere the blame lies. In a dynamic world, corporate fortunes may rise and fall because ofevents entirely beyond any manager's control.

8/2/2019 MNC S

11/35

Cash ManagementCash management involves utilizing the corporation's cash as efficiently as possible.Given the daily uncertainties of economics and business, corporations must maintainsome liquid resources. Liquid assets are those that are readily spent. Cash is the mostliquid asset. But since cash (and traditional checking accounts) earns no interest, the

corporation has a strong incentive to minimize its holdings of cash. There are highlyliquid short-term securities that serve as good substitutes for actual cash balances and yetpay interest. The corporate treasurer is concerned with maintaining the correct level ofliquidity at the minimum possible cost.The multinational faces the challenge of managing liquid assets denominated in differentcurrencies. The challenge is compounded by the fact that subsidiaries operate in foreigncountries where financial market regulations, banking, accounting, monetary policies,and institutions differ.When a subsidiary receives a payment and the funds are not needed immediately by thissubsidiary, the managers at the parent headquarters must decide what to do with thefunds. For instance, suppose a U.S. multinational's Costa Rican subsidiary receives 500

million colones. Should the colones be converted to dollars and invested in the UnitedStates, or placed in Costa Rican colones investments, or converted into any othercurrency in the world? The answer depends on the current needs of the corporation aswell as the current regulations in Costa Rica. If Costa Rica has strict foreign exchangecontrols in place, the 500 million colones may have to be kept in Costa Rica and investedthere until a future time when the Costa Rican subsidiary will need them to make apayment.Even without legal restrictions on foreign exchange movements, we might invest thecolones in Costa Rica for 30 days if the subsidiary faces a large payment in 30 days andwe have no need for the funds in another area of the corporation, and if the return on theCosta Rican investment is comparable to what we could earn in another country on asimilar investment (which interest rate parity would suggest). By leaving the funds incolones we do not incur any transaction costs for converting colones to another currencynow and then going back to colones in 30 days. In any case, we would never let the fundssit idly in the bank for 30 days.There are times when the political, legal, or economic situation in a country is so unstablethat we keep only the minimum possible level of assets in that country. Even when wewill need colones in 30 days for the Costa Rican subsidiary's payables, if there exists asignificant threat that the government or Central Bank could confiscate or freeze bankdeposits or other financial assets, we would incur the transaction costs of currencyconversion to avoid the political risk associated with leaving the money in Costa Rica.Multinational cash management involves centralized management. Subsidiaries andliquid assets may be spread around the world, but they are managed from the home officeof the parent corporation. Through such centralized coordination, the overall cash needsof the corporation are lower. This occurs because subsidiaries do not all have the samepattern of cash flows. For instance, one subsidiary may receive a dollar payment andfinds itself with surplus cash, while another subsidiary faces a dollar payment and mustobtain dollars. If each subsidiary operated independently, there would be more cash heldin the family of multinational foreign units than if the parent headquarters directed thesurplus funds of one subsidiary to the subsidiary facing the payable.

8/2/2019 MNC S

12/35

Centralization of cash management allows the parent to offset subsidiary payments andreceivables in a process called netting. Netting involves the consolidation of payablesand receivables for one currency so that only the difference between them must be boughtor sold. For example, suppose Ohio Instruments in the United States sells $2 millionworth of car phones to its European sales subsidiary and buys $3 million worth of

computer frames from its European manufacturing subsidiary.If the payment and receivable both are due on the same day, then the $2 millionreceivable can be used to fund the $3 million payable, and only $l million must be boughtin the foreign exchange market. Rather than buy $3 million to settle the payable and sellthe $2 million to convert the receivable into dollars, incurring transaction costs twice onthe full $5 million, the corporation has one foreign exchange transaction for $l million.Had the two European operations not been subsidiaries, the financial managers wouldstill practice netting but on a corporate wide basis, buying or selling only the net amountof any currency required after aggregating the receivables and payables of all subsidiariesover all currencies. Effective netting requires accurate and timely reporting oftransactions by all divisions of the corporation.

The parent financial managers determine the net payer or receiver position of eachsubsidiary for the weekly netting. Only these net amounts are transferred within thecorporation. Netting could still occur by leading or lagging currency flows. Leads andlags increase the flexibility of parent financial managers, but require excellentinformation flows between all divisions and headquarters .

Intra-corporation TransfersSince the multinational corporation is made up of subsidiaries located in differentpolitical and economic jurisdictions, transferring funds among divisions of thecorporation often depends on what governments will allow. Beyond the transfer of cash,the corporation will have goods and services and resources moving between subsidiaries.The price that one subsidiary charges another subsidiary for internal goods transfers iscalled a transfer price. The setting of transfer prices can be a sensitive internal corporateissue because it helps to determine how total corporation profits are allocated acrossdivisions. Governments are also interested in transfer pricing since the prices at whichgoods are transferred will determine tariff and tax revenues in those economies.The parent corporation always has an incentive to minimize taxes by pricing transfers inorder to keep profits low in high-tax countries and by shifting profits to subsidiaries inlow-tax countries. This is done by having intra-corporation purchases by the high-taxsubsidiary made at artificially high prices, while intra-corporation sales by the high-taxsubsidiary are made at artificially low prices. Governments often restrict the ability ofmultinationals to use transfer pricing to minimize taxes. The U.S. Internal Revenue Code,for example, requires arm 's-length pricing between subsidiaries charging prices that anunrelated buyer and seller would willingly pay. When tariffs are collected on the value oftrade, the multinational has the incentive to assign artificially low prices to goods movingbetween subsidiaries. Customs officials may determine that a shipment is being "under-invoiced" and may assign a value that more truly reflects the market value of the goods.Transfer pricing may also be used for "window-dressing", that is, to improve the apparentprofitability of a subsidiary. This may be done to allow the subsidiary to borrow at morefavorable terms, since its credit rating will be upgraded as a result of the increasedprofitability. The higher profits can be created by paying the subsidiary artificially high

8/2/2019 MNC S

13/35

prices for its products in intra-corporation transactions.The corporation that uses transfer pricing to shift profits from one subsidiary to anotherintroduces an additional problem for financial control. It is important that the corporationbe able to evaluate each subsidiary on the basis of its contribution to corporate income.Any artificial distortion of profits should be accounted for so that corporate resources are

efficiently allocated. Multinational corporations are frequently called upon by taxauthorities to justify the prices they use for internal transfers.

Capital BudgetingCapital budgeting refers to the evaluation of prospective investment alternatives and thecommitment of funds to preferred projects. Long- term commitments of funds expectedto provide cash flows extending beyond one year are called capital expenditures. Capitalexpenditures are made to acquire capital assets, like machines or factories or wholecompanies. Since such long-term commitments often involve large sums of money,careful planning is required to determine which capital assets to acquire. Plans for capitalexpenditures are usually summarized in a capital budget.Multinational corporations considering foreign investment opportunities face a more

complex problem than do corporations considering only domestic investments. Foreignprojects involve foreign exchange risk, political risk, control, and foreign tax regulations.Comparing projects in different countries requires a consideration of how all factors willchange over countries.There are several alternative approaches to capital budgeting. A useful approach formultinational corporations is the adjusted present value approach. We work with presentvalue because the value Qf a dollar to be received today is worth more than a dollar to bereceived in the future, say one year from now. As a result, we must discount future cashflows to reflect the fact that the value today will fall depending on how long it takesbefore the cash flows are realized.For multinational corporations, the adjusted present value approach is presented here asan appropriate tool for capital budgeting decisions. The adjusted present value (APV)measures total present value as the sum of the present values of the basic cash flowsestimated to result from the in vestment (operations flows) plus all financial effectsrelated to the investment.Capital budgeting is an imprecise science, and forecasting future cash flows is sometimesviewed as more art than science. The typical corporation experiments with severalalternative scenarios to test the sensitivity of the budgeting decision to differentassumptions. One of the key assumptions in projects considered for unstable countries isthe level of political risk that must be accounted for. Cash flows should be adjusted forthe threat of loss resulting from government expropriation or regulation.Impact of Management ControlThe magnitude of agency costs can vary with the management style of the MNC. Acentralized management style can reduce agency costs because it allows managers of theparent to control foreign subsidiaries and therefore reduces the power of subsidiarymanagers. However, the parent's managers may make poor decisions for the subsidiary ifthey are not as informed as subsidiary managers about financial characteristics of thesubsidiary.The alternative style of organizing an MNC's management is a decentralized managementstyle. This style is more likely to result in higher agency costs because subsidiary

8/2/2019 MNC S

14/35

managers may make decisions that do not focus on maximizing the value of the entireMNC. Yet, this style gives more control to those managers who are closer to thesubsidiary's operations and environment.To the extent that subsidiary managers recognize the goal of maximizing the value of theoverall MNC and are compensated in accordance with that goal, the decentralized

management style may be more effective.Given the obvious tradeoff between centralized and decentralized management styles,some MNCs attempt to achieve the advantages of both styles. That is, they allowsubsidiary managers to make the key decisions about their respective operations, but thedecisions are monitored by the parent's management to ensure that they are in the bestinterests of the entire MNC.

Impact of Corporate ControlThe MNC is subject to various forms of corporate control that can be used to reduceagency problems. First, the MNC may partially compensate its board members and itsexecutives with its stock, which can encourage them to make decisions that maximize theMNC's stock price.

However, this may only effectively control decisions by managers and board memberswho receive stock as compensation. In addition, some managers may still make decisionsthat conflict with the MNC's goal if they do not expect their decisions to have much of animpact on the stock price. A second form of corporate control is the threat of a hostiletakeover if the MNC is inefficiently managed. In theory, this threat is supposed toencourage managers to make decisions that enhance the MNC's value, since other typesof decisions would cause the MNC's stock price to decline. Other firms would be morelikely to acquire the MNC at such a low price and might terminate the existing managers.In the past, this threat was not very imposing for managers of subsidiaries in foreign

countries because foreign governments commonly protected the employees; therefore, thepotential benefits from a takeover were effectively eliminated. However, governmentshave recently recognized that such protectionism may promote inefficiencies and they arenow more willing to accept takeovers and the subsequent layoffs that occur in followingtakeovers.A third form of corporate control is monitoring by large shareholders. United Statesbased MNCs are commonly monitored by mutual funds and pension funds because alarge proportion of their outstanding shares are held by these institutions. Theirmonitoring tends to focus on broad issues to ensure that the MNC uses a compensationsystem that motivates managers or board members to make decisions to maximize theMNC's value, to use excess cash for repurchasing shares of stock rather than investing inquestionable projects, and to ensure that the MNC does not insulate itself from the threatof a takeover (by implementing anti-takeover amendments, for example). Those MNCsthat tend to make decisions that appear inconsistent with maximizing shareholder wealthare subjected to shareholder activism in which pension funds and other large institutionalshareholders lobby for management changes or other changes. For example, MNCs suchas Eastman Kodak, Ford, IBM, and Sears Roebuck were subjected to various forms ofshareholder activism.Like U.S. mutual funds and pension funds, foreign-owned banks also maintain largestock portfolios (unlike United States commercial banks, which do not use depositedfunds to purchase stocks).

8/2/2019 MNC S

15/35

The foreign banks are large and hold a sufficient proportion of shares of numerous firms(including some United States based MNCs) to have some influence on key corporatepolicies. Their additional role as a tender to many of these firms enhances their ability tomonitor corporate policies. However, these banks have not played a major role incorporate control. In general, they do not attempt to intervene unless a particular firm is

experiencing major financial problems.Corporate control on MNCs based in the United States has increased and is sometimescited as the reason for the unusually strong stock price performance of U.S. firms duringthe 1990's, since corporate policies are now undertaken with more awareness about theirimpact on the stock price. Other countries are adopting U.S. corporate control practices asa means of forcing local firms to make decisions that satisfy their respective shareholders.

Constraints Interfering with the MNC's GoalsWhen financial managers of MNCs attempt to maximize their firm's value, they areconfronted with various constraints that can be classified as environmental, regulatory, orethical in nature.Environmental Constraints: Each country enforces its own environmental constraints.

Some countries may enforce more of these restrictions on a subsidiary whose parent isbased in a different country. Building codes, disposal of production waste materials, andpollution controls are examples of the restrictions that force subsidiaries to incuradditional costs. Many European countries have recently imposed tougher anti-pollutionlaws as a result of severe pollution problems.Regulatory Constraints: Each country also enforces its own regulatory constraintspertaining to taxes, currency convertibility rules, earnings remittance restrictions, andother regulations that can affect cash flows of a subsidiary established there. Becausethese regulations can influence cash flows, they must be recognized by financialmanagers when assessing policies. Also, any change in these regulations may requirerevision of existing financial policies, so financial managers should not only recognizethe regulatory restrictions that exist in a given country but also monitor them for anypotential changes over time.Ethical Constraints: There is no consensus standard of business conduct that applies to allcountries. A business practice that is perceived to be unethical in one country may betotally ethical in another. For example, the United States-based MNCs are well aware ofcommon business practices in some less developed countries that would be declaredillegal in the United States. Bribes to governments in order to receive special tax breaksor other favors are common. A recent report presented to Congress by the JusticeDepartment, estimated that U.S. firms lost out on billions of dollars of internationalbusiness transactions because of bribes provided by foreign competitors. The UnitedStates Foreign Corruption Practices Act forbids U.S. corporations to engage in this typeof behavior. See: Country Reports on Economic Policy and Trade Practices (UnitedStates Department of State)www.state.gov/www/issues/economic/trade_reports/index.html.The MNCs face a dilemma. If they do not participate in such practices, they may be at acompetitive disadvantage. Yet, if they do participate, they receive poor reputations incountries that do not approve of such practices.Some United States-based MNCs have made the costly choice to refrain from businesspractices that are legal in certain foreign countries but not legal in the United States.(e.g.,

8/2/2019 MNC S

16/35

dumping chemicals such as fertilizers, otudated medicines, and food not approved by theFDA in the United States). That is, they follow a worldwide code of ethics. This mayenhance their worldwide credibility, which can increase global demand for the productsthey produce.

Four main criteria to identifying a MNE:

1. Structure of Corporation2. Behavior3. Performance4. Coordination1. Structure refers to the number of countries in which the MNE operates. Also refers

to the nature of corporate ownership. Examples: Suzuki owned by GM, Gillette is U.S.owned, an Mitsubishi is owned by Japan, even though GM owns a large percentage. Forthe majority of MNEs, the ownership of the corporation is maintained in the parentcountry, even though they might list shares of stock and have ownership in differentcountries. For example: Kereitsus in Japan, Chaebols in South Korea such as Samsung,Lucky Star and Daewoo, and mergers in the U.S.

2. Performance is the percentage of total revenues, profits, assets and employeescoming from abroad. The greater the reliance of the corporation on foreign materials,production, personnel and product plants, the more global the corporation is.If they derive 40% or more from outside the home country, the MNE is consideredStateless Corporation. At Nestle, 98% of business is done abroad-Switzerland is homecountry. Hoffman La Roche, 96%-Switzerland, Michelin, 78%-France, Sony, 66%-Japan, Gillette, 65%-U.S.3. Behavior is the attitude of top management toward the role of international

operations within the total corporate strategy. In most of the European corporations, themajority of CEOs are from foreign countries. The U.S. is an exception.4. Coordination is how the firm looks at its worldwide operations, multi-domestic or

global. Multi-domestic is where each country is considered a different market (Japanuses the term multi-cultural corporation). The corporation is really a collection ofsubsidiaries. Global is where the firm views the entire world as one market andstandardizes its products.Globalization Effect ForcesOrganizational Characteristics of a Multinational: Formalization, specialization, and

centralization. Factors: strategies of multinational, employees attitudes, and local marketconditions.1. Formalization: is define as the use of structures and systems in decision making,

communicating and controlling, for example, Korean firms with better workingenvironments when workers expect their jobs to be set forth more strictly and formally.Korea and Japan respond more to formalization than U.S. workers and Taiwan sees moreobjective as opposed to subjective formalization.

Objective Formalization: refers to the number of documents, organizational charts,information booklets, operational instructions, written job schedules and descriptions,procedure manuals, written policies, schedules, and programs.

Subjective Formalization: tends to be vague and with less specific goals andprocedures, informal controls, and more cultural induced values.

2. Specification: are the organizational characteristics that assign individuals to specific

8/2/2019 MNC S

17/35

well define tasks. International specialization can be:Horizontal Specialization: which is the assignment of jobs so that individuals are

given a particular function to perform and tend to stay within the confines of the area, forexample, jobs in costumer service, sales, training, recruiting, purchasing, and marketresearch.

Vertical Specialization: is the assignment of work to groups or departments whereindividuals are collectively responsible to perform. For example, Level of hierarchy(principle/ agent), risk takers and risk avoidance, Keiretsus, in Japan, Chaebols in SouthKorea, and mergers in Taiwan.3. Centralization: Is a management system under which important decisions are made

at the top of the pyramid. ( principle-agent).Decentralization is moving down to the lower level personnel. All important decisions

are taken by individuals or private institutions and the function of the government issimply to provide a framework and stability within which the market operates. Forexample, United States of America and Germany.Philosophical Positions Influencing the Training Process of a MNE:

1. Ethnocentric MNE: put home office people in charge of key internationalmanagement positions. The multinational headquarters group and the affiliated worldcompany managers all have the same basic experiences, attitudes, and beliefs about howto manage operations, run corporations, and market, (e. g., Japanese Keiretsu such asMazda and Mitsubishi, traditional suppliers, and chaebols in Korean firms). It will do alltraining at headquarters.2. Polycentric MNE: is an MNE that places local nationals in key positions and allows

these managers to appoint and develop their own people as long as the operations aresufficiently profitable. For example, East Asia, Australia and in general, markets wherethe expatriates tend to be not expensive for the corporations.

It will do the training of employees relying on local management to assureresponsibility of seeing that the training function is carried out.3. Regiocentric MNE: relies on local managers from particular geographic areas to

handle operations in and around the area, (e.g., in common markets or trade zones). Itoften relies on regional group operation and cooperation of local managers, (e.g., Gillettecorporation).4. Geocentric MNE: seeks to integrate diverse regions of the world through a global

approach to decision making. For example, IBM and John Deere.C. Advantages for the corporation to operate in the international arena from a

micro economic point of view:1. Cost reduction, minimization of costs2. Sales expansion3. Income and sales smoothing4. Greater varietyCost reduction: Corporations go to different markets to take advantage of the

production components and their costs. Corporations that have the advantage of costdifferentials have leadership advantages over other markets. These corporations maintainR&D and technology at home. China, Indonesia and Honduras are examples of a laborcost country. Rationalization of production is where a firm will produce differentcomponents of a product in different markets to take advantage of lower costs.

8/2/2019 MNC S

18/35

Sales expansion: The larger the sales, the more profitable the company is in the longrun. Japan, for example has sales growth. Japan sacrificed profit in the short term formany years to build a large market share in the long run (e.g., 200 years). The UnitedStates is more concerned with short term profits. Companies produce for the largermarket to reduce costs by increasing efficiency and using machines to full capacity.

Income and sales smoothing: Advantages accrue to corporations that can minimizethe year-to-year swing in sales and income and short run fluctuations such asunemployment and inflation. They enhance the smoothing process by their involvementin other countries, because different countries are in different economies and businesscycles. (One country may be coming out of a recession, for example, while another maybe at the peak of its growth cycle.) Employee training helps smooth the situation, anotheris to go to different countries and train them. This helps to minimize risk.Greater variety: Offer as many varieties as possible. Different products and processes

are introduced to different markets. An example: Coca Cola. Latin America likes fruitjuices. Coca Cola sales were good, but in order to capture a greater market share, itoffered a variety of carbonated juices to Latin America, called Fanta. It was

successful. Then they were introduced to the United Staes and other lines such as frozenjuice and Fruitopia.Political Risk: any change in the political environment that may adversely affect thevalue of the firms business activities. Political risk is not only the threat of politicalupheaval but also the likelihood of arbitrary and discriminatory governmental policiesand actions that will result on financial loss or competitive disadvantage;, for example,increase prices, tariffs, quotas, price controls, content requirements, and measuresdirectly to the MNE such as partial divestment of ownership, local content, remittancerestrictions, expatriate employment, and limitations on export requirements.Examples of political risk:1. Expropriation; impact on loss of future profits2. Confiscation; impact on loss of future profits and assets3. Campaigns against foreign goods; impact on loss of sales and increase

in cost of public relations4. Mandatory labor benefits legislation ? increase in operating costs5. Kidnap - Terrorism - Civil Wars and disruption of production, increased security

costs, increased management costs, lower productivity, destructions of supplies, lostsales

6. Inflation; higher operating cost7. Currency Devaluations and currency risks; reduced value of repatriated earnings8. Tax; decreased profits; subsidization, abatements and dumping.

Macro political; Civil Wars, i.e., Somalia, Bosnia, Middle East, decreased inRwanda in 90's, Congo, Zaire

Micro political; Euro-currency, 1970's oil embargo, Financial crash of 89.Euro-Disney by French farmers, Chinese operations

Decrease Political Risk:Match risks with rewards (profits)Overseas Private Investment Corp. (OPIC); U.S. government sponsored which insures

U.S. investments from nationalization, insurrections, revolutions and foreign exportchanges, and currency inconvertibility. Multilateral Investment Guarantee Agency

8/2/2019 MNC S

19/35

(MIGA), subsidiary of World Bank (1988). Lloyds of London underwrites political risk,although it is really expensive.Ways of Overcoming Political Risk1. Sell shares of subsidiary to host citizens such as 10%,10% and 80%.2. Short-term lease in new equipment

3. Good corporate citizen to build domestic support4. Purchase inputs from local suppliers5. Employ and train host country citizens in key management and administrative

decisions6. Support local charities-- Spain; Plant closing (shut down) laws on severance pay India; limited ownership of domestic business in order to avoid control by

foreigners - i.e., pharmaceuticals-- China; in order to sell product, product must have high percentage of materials

bought in China-- South Korea; Banking policies, foreigners (banks) have difficulty obtaining Korean

currency thus making it harder to compete with Korean banks.-- Government can funnel credit at preferential interest-- Mexico; energy industry - oil should be accrued only by citizen-- Greece; restricts ownership on TV (25%)-- Portugal; 15% - Flemish (Dutch-speaking) in Belgium must own 51% of commercial

broadcastIntellectual Property Rights: (Patents, Copyrights) International Convention for the

Protection (Paris Convention) of Industrial Property Rights. Literary and artistic works(Beune Convention), Universal Copyright Convention.-- East European, Poland, repatriation of profits-- Japan with its administrative delays-- Latin America with its administrative delays and briberies

MNC have been criticized by host countries for many reasons:1. Rise of interest rates because capital needed locally.2. Majority of ownership (by shareholders) of subsidiary are owned by parent company,therefore, residents dont have control over operations of company within borders.3. Key managerial and technical positions are held by expatriates, as a result, they do notcontribute in the learning by doing process of host country.4. Little training to host employer/employees.5. They do not adapt technology to host countrys needs.6. Concentration of research and development in home country.7. Lack of contribution to host exports and balance of payments.8. Worsen Y ( income) distribution.9. Earn excessive profits and fees due to their goals, particularly monopoly power.10. Dominate major industrial sector.11. Tend to be more accountable to home country.12. Contribute to inflation by stimulating D (demand) for scarce resources.13. Create alliances with corrupt host country elites.14. They recruit best personnel and managers from host at the expense of localentrepreneurs.

8/2/2019 MNC S

20/35

15. Host country educates and trains employer/employees.16. Disregard to employer/employee safety and environment.17. Disregard culture and social impact

Globalization Effect Forces:1. Advances in computer and communication technology. Increased flow of ideas and

information across borders - cable, www, e-mail.2. Transportation.3. Reduction on barriers of international trade by government host, increase in newmarkets by international firms which are exporting to them or building productionfacilities for local manufacturer.4. Unification and socialization of global community, such as preferential tradearrangements, NAFTA, EU, ASEAN, which group several markets into a single market5. Explosive growth in DI in the trillions of dollars.U.S. DI 25.3% to 43%, Japan from 3% to 13%, Europe 40% to 43%. There are 37,000

MNE with $316 trillion. Source: U.S. Commerce Department, 2001.6. Lessening of U.S. dominance.

7. Mini nationals ? small and medium size firms with exporting, research facilities andsale facilities.8. Privatization.9. Globalization of market economic system.

Globalization forces which changed U.S.A. multinationals in the 1980's and 90's:1. Massive deregulation.2. Collapse of Communism and end of Cold War.3. Sale of hundreds of billions of dollars of state owned firms around the world inmassive privatization efforts designed to shrink the public sector.4. The revolution of information technology.5. The rise in the market for corporate control with its waves of takeovers, mergers,acquisitions and leveraged bought outs.6. The jettisoning of statist policies and their replacement by the free market policies inthe Third World countries.7. The unprecedented number of nations submitting themselves to the exacting regionsand standards of the global market place.8. Degree of internationalization/globalization of the U.S. economy.9. The integration of worldwide operations of flexibility, adaptability, and speed, (e.g,.The Limited with 3,200 stores but headquartered in Columbus, Ohio).10. Increase of foreign direct investment in the U.S. by foreign of other countries.

THE ECLECTIC PARADIGM OF INTERNATIONAL PRODUCTION1. Ownership-Specific Advantages (of enterprise of one nationality or affiliates of same)over those of another.Hierarchical-Related Advantagesa. Property right and/or intangible asset advantages .Product innovations, production management, organizational and marketing systems,

innovator capacity, non-codifiable knowledge, 'bank' of human capital experience,marketing, finance, know-how, and so forth.b. Advantages of common governance, i.e., of organizing with complementary assets.(i) Those that branch plants of established enterprises may enjoy over de novo firms.

8/2/2019 MNC S

21/35

Those due mainly to size, product diversity and learning experiences of enterprise, (e.g.,economies of scope and specialization). Exclusive or favored access to inputs, (e.g.,labor, natural resources, finance, information). Ability to obtain inputs on favored termsdue to size or monopsonistic influence.

Ability of parent company to conclude productive and cooperative inter-firm

relationships, as between Japanese auto assemblers and their suppliers. Exclusive orfavored access to product markets. Access to resources of parent company at marginalcost. Synergistic economies (not only in production, but in purchasing, marketing,finance arrangements, etc.).

(ii) Those that specifically arise because of multi-nationality. Multi-nationalityenhances operational flexibility by offering wider opportunities for arbitraging,production shifting and global sourcing of inputs. More favored access to and/or betterknowledge about international markets, for information, finance, labor etc.

Ability to take advantage of geographic differences in factor endowments, governmentintervention, markets, etc. Ability to diversify or reduce risks, (e.g., in different currencyareas, and creation of options and/or political and cultural scenarios). Ability to learn

from societal differences in organizational and managerial processes and systems.Balancing economies of integration with ability to respond to differences in country-specific needs and advantages.Alliance or Network-Related Advantagesa. Vertical Alliances(i) Backward access to R&D, design engineering and training facilities of suppliers.

Regular input by them on problem solving and product innovation on the consequencesof projected new production processes for component design and manufacturing. Newinsights into, and monitoring of, developments in materials, and how they might impacton existing products and production processes.

(ii) Forward access to industrial customers, new markets, marketing techniques anddistribution channels, particularly in unfamiliar locations or where products need to beadapted to meet local supply capabilities and markets. Advice by customers on productdesign and performance. Help in strategic market positioning.

b. Horizontal AlliancesAccess to complementary technologies and innovative capacity. Access to additional

capabilities to capture benefits of technology fusion, and to identify new uses for relatedtechnologies. Encapsulation of learning and development times.

Such inter-firm interaction often generates its own knowledge feedback mechanismsand path dependencies.c. Networks(i) Similar firmsReduced transaction and coordination costs arising from better dissemination and

interpretation of knowledge and information, and from mutual support and cooperationbetween members of network.

Improved knowledge about process and product development and markets. Multiple,yet complementary, inputs into innovative developments and exploitation of newmarkets. Access to embedded knowledge of members of networks. Opportunities todevelop 'niche' R&D strategies; shared learning and training experiences, as in the case ofcooperative research associations. Networks may also help promote uniform product

8/2/2019 MNC S

22/35

standards and other collective advantages.(ii) Business districtsAs per (i) plus spatial agglomerative economies, (e.g., labor market pooling). Access to

clusters of specialized intermediate inputs, and linkages with knowledge-basedinstitutions, (e.g., universities, technological spill-overs).

2. Internalization Incentive Advantages (i.e., to circumvent or exploit marketfailure)Hierarchical-Related AdvantagesAlliance or Network-Related AdvantagesAvoidance of search and negotiating costs.To avoid costs of moral hazard, information asymmetries and adverse selection, and to

protect reputation of internalizing firm.To avoid cost of broken contracts and ensuing litigation.Buyer uncertainty (about nature and value of inputs (e.g., technology) being sold).When market does not permit price discrimination.Need of seller to protect quality of intermediate or final products.

To capture economies of interdependent activities (see b. above).To compensate for absence of future markets.To avoid or exploit government intervention (e.g., quotas, tariffs, price controls, taxdifferences, etc.).To control supplies and conditions of sale of inputs (including technology).To control market outlets (including those which might be used by competitors).To be able to engage in practices, (e.g., cross-subsidization, predatory pricing, leads andlags, transfer pricing, etc.) as a competitive (or anti-competitive) strategy.While, in some cases, time- limited inter-firm cooperative relationships may be asubstitute for FDI, in others, they may add to the incentive advantages of the participatinghierarchies, R&D alliances and networking which may help strengthen the overallcompetitiveness of the participating firms.Moreover, the growing structural integration of the world economy is requiring firms togo outside their immediate boundaries to capture the complex realities of know-howtrading and knowledge exchange in innovation, particularly where intangible assets aretacit and need to speedily adapt competitive enhancing strategies to structural change.Alliances or network related advantages are those which prompt a voice rather than an'exit' response to market failure; they also allow many of the advantages of internalizationwithout the inflexibility, bureaucratic or risk-related costs associated with it. Such quasi-internalization is likely to be most successful in cultures in which trust, forbearance,reciprocity, and consensus politics are at a premium. It suggests that firms are moreappropriately likened to archipelagos linked by causeways rather than self-contained'islands' of conscious power. At the same time, flagship or lead MNCS, by orchestratingthe use of mobile 0 advantages and immobile advantages, enhance their role asarbitragers of complementary cross-border value-added activities.3. Location-Specific Variables (these may favor home or host countries)

Hierarchical-Related AdvantagesSpatial distribution of natural and created resource endowments and markets.Input prices, quality and productivity, (e.g. labor, energy, materials, components, semi-

finished goods).

8/2/2019 MNC S

23/35

International transport and communication costs.Investment incentives and disincentives (including performance requirements, etc.).Artificial barriers (e.g., import controls) to trade in goods.Societal and infrastructure provisions (commercial, legal, educational, transport, and

communication).

Cross-country ideological, language, cultural, business, political, etc. differences.Economies of centralization of R&D production and marketing.Economic system and policies of government: the institutional framework for resource

allocation. Source: Dunning, John, Reappraising Eclectic International BusinessStudies, (2001), p. 475-76.The L-specific advantages of alliances arise essentially from the presence of a

portfolio of immobile local complementary assets, which, when organized within aframework of alliances and networks, produce a stimulating and productive industrialatmosphere. The extent and type of business districts, industrial or science parks and theexternal economies they offer participating firms are examples of these advantageswhich, over time, may allow foreign affiliates and cross-border alliances and network

relationships to better tap into, and exploit, the comparative technological andorganizational advantages of host countries. Networks may also help reduce theinformation asymmetries and likelihood of opportunism in imperfect markets. They mayalso create local institutional thickness, intelligent regions and social embededness.Source: Paragism in an Age of Alliance Capitalism, Journal of International BusinessStudies, 1999.

Illustration of types of activity that favor MNEs Natural resource seeking Capital, technology, access to markets; complementary assets;size and negotiating strengths Possession of natural resources and related transport andcommunications infrastructure; tax and other incentives To ensure stability of supplies atright price; control markets To gain privileged access to resources vis--vis competitors(a) Oil, copper, bauxite, bananas, pineapples, cocoa, hotels(b)Export processing, labor-intensive products or processesMarket seeking Capital, technology, information, management and organizational skills;surplus R&D and other capacity; economies of scale; ability to generate brand loyaltyMaterial and labor costs; market size and characteristics; government policy (e.g. withrespect to regulations and to import controls, investment incentives, etc.) Wish to reducetransaction or information costs, buyer ignorance or uncertainty, etc., to protect propertyrights To protect existing markets, counteract behavior or competitors; to preclude rivalsor potential rivals from gaining new markets Computers, pharmaceuticals, motorvehicles, cigarettes, processed foods, airline services

Efficiency seeking(a) of product(b) of processes As above, but also access to markets; economies of scope, geographicaldiversification and international sourcing of inputs (a) Economies of productspecialization and concentration(b) Low labor costs: incentives to local production by host governments (a) As for secondcategory plus gains from economies of common governance(b) The economies of vertical integration and horizontal diversification As part ofregional or global product rationalization and/or to gain advantags of process

8/2/2019 MNC S

24/35

specialization (a) Motor vehicles electrical appliances, business services, some R&D(b) Consumer electronics, textiles and clothing, cameras, pharmaceuticalsStrategic asset seeking Any of first three that offer opportunities for synergy withexisting assets Any of first three that offer technology, markets and other assets in whichfirm is deficient Economies of common governance; improved competitive or strategic

advantage; to reduce or spread risks To strengthen global innovatory or productioncompetitiveness; to gain new product lines or markets Industries that record a high ratioof fixed to overhead costs and which offer substantial economies of scale or synergyTrade and distribution (import and export merchanting) Market access; products todistribute Source of inputs and local markets; need to be near customers; after-salesservicing, etc. Need to protect quality of inputs; need to ensure sales outlets and to avoidunderperformance or misrepresentation by foreign agents Either as entry to new marketsor as part of regional or global marketing strategy A variety of goods, particularly thoserequiring contact with subcontractors and final consumersSupport services Experience of clients in home countries Availability of markets,particularly those of lead clients Various (see above categories) As part of regional or

global product or geographical diversification (a) Accounting advertising, banking,producer goods(b) Where spatial linkages are essential (e.g. airlines and shipping)C. Why should a company go international?There are three important questions that the corporation must answer and there are

several reasons to the above question.1. Does the company have an idea or use which will give a niche or advantage

internationally?2. What causes the firm to go internationally and succeed in a foreign environment

against competitors from both domestic firms and other MNEs?3. What happen to the character, structure, and image of company during the course of

internationalization?

Nine reasons:1. Larger market, market power, production possibilities, geographic, product or

both. Check population and income as determinants of market size. The corporation willattain greater profits from foreign markets than those received locally.2. Growth and expansion to secure future market or deal with future competitors.

Factors of growth are: rapid increasing expansion of technology, liberalization ofgovernment policies, privatization, development of institutions encouraging growth, andincrease in global competition.3. Optimization of resources. More people. United States's GDP is less than the

Worlds GDP. Keep the same share of market, but increase market space. Utilize idlematerials, spread the risk, minimized competitive risk, protect investment sand costsmoothing. The corporation can accomplish this because its leadership in innovation9technology intensive industries).4. Corporations need to compete, keep up with the competition. The corporation

watches competitors actions. If a company sets operations in new markets, or markets anew product abroad, companies take immediate actions in order not to loose marketshares. Therefore, when companies go international, others follow in order to minimizedthe risks. International when foreigners come to the United States; so for domestic

8/2/2019 MNC S

25/35

companies to compete, they must go international. (Leadership advantage vs. followingthe leader.) Competitive environment varies from country to country because thenumber and strength of competitors, suppliers and customers and because of regulationson how a company can compete. Competition has become global via new productsbecoming global quickly, companies can now produce in different markets, domestic

companies as new competitors, and suppliers and customers have become international.5. Corporations need to maximize profits. Corporations will obtain greater profitsfrom abroad than from being merely domestic companies. Dynamic vs. staticequilibrium, fixed vs. variable resources. Therefore, there are economic reasons to gointernational such as direct investment, control, access to foreign markets, higher salesinternationally, and partial or total ownership.The next four are very important (items 6-9):6. Vertical integration. This is extremely important in centralization or

decentralization of operating activities in the global market and global production. Itallows a company to control the upswing (upstream) or downswing (downstream) of themarket without actual ownership in the decision to buy or make component parts that go

in their final product. To maximize profits, control market and control customers, thefirm must discern against competition. Companies become vertically integrated to assuresources of supply, dominate distribution channels, avoid dependence on others (suppliers)and to deny such suppliers to the competition. Example: GM attempts to control oremines in Venezuela to guarantee the ore for GM only. Control where production is sold:price, geography, and distribution downstream, (wholesales to retailer, customer,geographic distribution). Component parts in house ( vertical), for example, the autoindustry has more than ten thousand components and the company needs to makedecisions as to make or use these components. Reebok and Nike also have to make thesetype of decisions and all their production has been out source primarily in low wagemarkets. Problems with vertical integration are that the economies and their exchangerates are volatile; there is change in relative factors of production. Vertical integrationgives the corporation control and assurance of supply and distribution without owningthem.

When making these decisions always look at the trade-offs. Advantages of verticalintegration are: protection of technology, when firms are not efficient internally thanexternal suppliers at the performing activity, lower costs, facilitation of specializedinvestment but creates interdependence, proprietary products enable firm to produce aproduct containing superior features and comparative advantage, and, improvescheduling, planning, coordination and inventory systems.

Reasons for vertical => protect secrecy or minimize effects of government restrictions,cost of involvement, costs of negotiations, need for financial, human, and technicalresources to undertake projects, control of key resources and operations, which otherwisemay fall in the hands of competitors.

Horizontal expansion occurs when a company goes abroad at the same level in thevalue chain as its domestic operation. Horizontal integration occurs when

the company integrates its own operations and avoid buying and selling to othercompanies in the same area or industry or licensing technology to them i.e., Xeroxmanufactured and sold copiers in Mexico.

8/2/2019 MNC S

26/35

The Vertical approach involves movement along the value chain, (i.e., Alcoasparticipation in ownership of bauxite production facilities in Australia). Downstream orBackward Vertical, (i.e., Alcoas control over supplies that it needs for its aluminumproduction in United States). Alcoa acquires a Central American plant to make aluminumcans from its United States-made aluminum. Forward or upstream integration.

Horizontal integration may be difficult culturally when the rules of the game aredifferent or you have trouble acquiring or operating. For example, Eastern Europe(Hungary) exporting or licensing is unavailable. There are advantages, however, intransportation costs, market imperfections, following the costumers, product life cycles,and location.7. Oligopoly, monopoly competitor - ownership and control: Colluding,

cooperating, corroborating and coordinating. This gives corporations superior size andlarger scope of operations. Companies jostle with each other for larger shares of theworld market. Monopoly or oligopoly position gives the company size and ability tooperate and produce in foreign markets. Regulated or natural monopolies are where thegovernments allow a company to manufacture the product and control the price.

There is manipulation of price only when the demand is inelastic, no substitutes,consumers can not postpone purchase, and small percentage of consumers budgetcompared to the benefits obtained, and the market can only afford one producer.Examples of oligopolies: GM, Ford, Daimler-Chrysler. Examples of foreign oligopoliesare cartels.

Cartels offer unique products not found outside of the cartel. Example: Oil, diamonds,magnesium, coffee, etc. They collude, cooperate and coordinate. They control the supplyand/or price. All member countries in the cartel must work together for the cartel to besuccessful and control a particular commodity or resource.

Oligopolies (cartels) - various companies producing similar product or service worktogether to control markets for the type of products they produce involve more than apartner.

Formal agreements to set prices, establish levels of production, sales, allocate marketterritories (OPEC). Japan - Recession cartel such as The Ministry of International tradeand Industry (MITI).8. Economies of Scale and Economies of Scope.Economies of Scale - Cost advantages associated with large scale of production. As the

firm produces more units, amounts changed in quantity produced, the cost per unit fallsbecause fixed costs (plant, equipment and supervisory personnel) are spread out overmore units of production. Eventually, the cost per unit might increase or firm incursmore fixed costs to produce additional units. (Whirlpool produces 50% of all washers inUnited States.)

This is the main reason for going international. It is the reduction of the units costs as aproducer that makes larger quantities of the product by changing more than one factor ofproduction. Such a production results from reduction of the marginal cost due toincreased specialization, the use of capital equipment, benefits of quantity purchase oreconomies of mass production.

It deals with how corporations use the factors of production efficiently to minimizecost. Four stages of factors of production:

a. Very Short Run. The Corporation cannot change any of the factors of production,

8/2/2019 MNC S

27/35

because they are all fixed; there are not outputs produced in the very short run. Short runsupply of labor is fixed. Fixed costs are the costs of setting up production facilities inforeign markets, develop a new product lines, sunk costs, and develop markets. The onlyway to recuperate high costs is to sell the product worldwide or to manufacture itworldwide.

b. Short Run. All factors of production are fixed except one. In the U.S., capital orlabor is a factor more able to change. In the Short Run - The Law of DiminishingMarginal Returns. Increase variable input to fixed inputs. Costs decrease. If continueto add inputs, the costs then increase. If factors of production are added, even if free, thecost increases.

c. Long Run. Change all resources, except technology. One reason why companies gointernational. The costs are variable in the long run supply of labor (wages and salaries).

d. Very Long Run. Change all factors of production, including technology. Long Run- Economies of Scale - same as the Law of Diminishing Returns, except it is in the longrun.

If all inputs are changed for only one output or one industry, then we are working

under Economies of Scale. Economies of scale is when production occurs in only oneindustry while economies of scope is producing in more than one industry. If inputsincrease 40% and outputs increase more than 40%, then increasing returns to scale orscope. If inputs increase 40% and outputs increase 40% (they are equal), there isconstant returns to scale or scope. If inputs increase 40% and outputs increase less than40%, there is decreasing returns or diseconomies of scale or scope.

Experience Curve: is the systematic reduction in production costs that have beenobserved to occur over the life of the product. Each time accumulated output doubles, theproducts production costs decrease.

Economies of Scale: is the reduction of unit costs achieved by producing large volumeof product as plant output increases unit costs decrease.

Greater levels of production result in the lower cost per unit, therefore, greaterprofitability.

Economies of scale source is the ability to spread fixed costs over large volume.The ability of the MNE to employ increasing specialized equipment and personnel. For

example,