International Financial Management: INBU 4200

Fall Semester 2004

Lecture 1:The Globalization Process and Some

Initial Concepts and Issues(Chapter 1)

Globalization Defined

• Becoming world wide in scope or application– Applies to markets (where we are selling and

buying):• Industrial goods and consumer goods.

– Applies to factors of production (where we are getting our inputs for production):

• Capital (Financial markets), technology, labor

– Applies to business firms (where we do business; how we set up our enterprises):

• Financial institutions (including exchanges).• Non-financial firms: manufacturing and service firms.

Globalization: Functions

• Consumption (Sales)– McDonalds Corporation– Starbucks

• Production– Nike Corporation

• Finance– Citigroup– Foreign Exchange Market– Euronext Stock Exchange

Consumption (Sales)

McDonalds operates in 120 Countries.

- 64% of 2003 sales were from international operations.

Starbucks has 1500 “licensed” international retail coffee stores operating in

31 countries. - licensed international stores accounted for about 17% of Starbucks 2002 earnings.

Production

• About 99% of all Nike brand apparel is produced outside the US in 35 different countries.

Country Percent

China 38%

Indonesia 27

Vietnam 18

Thailand 16

Finance

• Citigroup with its combined

banking, insurance,

and investment businesses

operates in over 100 countries.

• In 2003, 46% of its revenues from operations resulted from activities outside of North America!

Finance

• Euronext Stock Exchange, based in Paris, France (example of regionalization).– Formed by the merger of the Paris, Brussels,

Amsterdam (in 2000) stock exchanges and Lisbon (in 2002) stock exchange.

– Currently lists over 1,400 firms.– Second largest stock exchange in Europe, behind

London Stock Exchange.

Globalization of Financial Markets

• Resulted from major market deregulations over the last 20 years.– Lifting of U.S. Glass Steagall Act (in 1999)– “Big Bang” in London (in 1986)– “Big Bang” in Japan (in 1998)– Developing nations (especially in Asia; India

and China) also opening their financial markets to non-resident investors.

• Attracting capital and financial institutions.• Threat to traditional financial centers?

The Globalization Process for a Firm

“The globalization process of a firm can be viewed and studied by the operational and managerial changes and challenges experienced by that firm as it moves from a purely domestic firm to one with global operations.”

Moving Beyond a Domestic Firm

• Stage 1: Domestic to International Trade Phase.– Domestic: Suppliers and buyers in home

country.• Payments in home currency; firm operates under

home country legal environment (credit risk).

– International Trade Phase: Suppliers and buyers in foreign countries linked through exporting and importing activities.

• Payments in foreign currencies; firm operates under host country legal environments (credit risk).

Why Does a Firm Move from Domestic to International Trade? • Access to cheaper production inputs through

imports.• Possible economies of scale gained through

expanded foreign markets.– Resulting in higher production volumes/sales to cover

fixed costs.• Home market fully captured.• Stagnant home market.• Competitive forces from home and foreign

country competitors.– Product life cycle of mature firm with mature products.

Viewing The Globalization Process: A Domestic Firm

Phase One: Domestic Operations

Sean Skate Boards IncBoulder, Co

U.S. Suppliers(domestic)

U.S. Buyers(domestic)All payments in US dollars;

All credit risk under U.S. law

From Domestic Firm to International Trade Firm

U.S. Suppliers(domestic)

U.S. Buyers(domestic)

Phase One: Domestic Operations

All payments in US dollarsAll credit risk under U.S. law

Japanese Suppliers Canadian Buyers

Phase Two: Expansion into International Trade

Are Canadian buyers creditworthy?Will payment be made in US$ or C$?

Are Japanese suppliers dependable?Will Sean Inc pay in US$ or Yen?

Sean Skate Boards, IncBoulder, Co

Becoming a Multinational Firm

• Stage 2: International Trade Phase to Multinational Phase (physical presence abroad)

• Multinational Firm Defined: A firm with dispersed production and/or sales around the world. Characterized by:– Involvement in many financial markets– Dealings in many different currencies– Dealings with many different national and business

cultures– Dealings with many different partnering relationships.

The Multinational SequenceDomestic Company

Sean Skate Boards, Inc

Exploit Its CompetitiveAdvantage Abroad

Can it Establish a Competitive Advantage?

Licensing ProductionTo Foreign Manufacturer

Control of Production AssetsAbroad

Acquisition of a ExistingForeign Enterprise

Building a New Facility:Greenfield Investment

Production at Home:Exporting Production Abroad

Joint Venture with Foreign Partners

Establish a Wholly-OwnedSubsidiary

Greater Foreign Presence

GreaterForeignInvestment

Multinational Firms and Risk

• As a firm proceeds along the multinationalization sequence, it takes on new and greater risks.– The initial foreign exchange and credit risk

assumed by an international trade company has expanded for a multinational firm.

– This expanded risk environment facing multinational firms is referred to as country risk!

Country Risk and Multinational Firms

• Foreign exchange exposure, risk and management• Different legal and political environments

– Common law to civil law!• Different economic environments• How best to structure global operations?• Location decisions (based on the comparative

advantages of various countries).• Where to financing globally?• Dealing with different corporate cultures

– Shareholder value or corporate wealth value!– Impact on corporate goals and shared management

decisions.• Impact of foreign operations on domestic results

(consolidated results).

Why is International Finance Difference from Domestic Finance?

• Foreign Exchange Risk

• Political Risk

• Market Imperfections

• Expanded Opportunity Set

• Cultural Differences

• Corporate Governance Issues

Foreign Exchange Risk

• Occurs because you are dealing in different currencies.– Other than your home (reference) currency

• Composition of your production and sales can be a big factor here.– Can be used as an operational offset to foreign

exchange exposure!

• Currencies you are dealing in also critical.– How stable, how volatile?

Political Risk

• Involves:– Contract enforcement; protection of private

property (legal systems important here)– Foreign exchange market controls and

government intervention (manipulation!) – Profit repatriation process– Nationalization of assets– Taxation policies (including withholding taxes

on dividends and tax treaties)

Market Imperfections

• Multinational Firms Operate in a World of Market Imperfections.– Factors which restrict “free trade.”

• Government Restrictions– Tariffs affecting MNC location decisions.– Import substitution policies

• Encouraging a physical presence as opposed to importing.

– Anti-Dumping Actions– Restricting shares of stock to be held by foreigners

(not as much of an issue today).

• Transaction and Transportation Costs

Expanded Opportunities

• Possibility for activities in many markets allows for:– Possible economy of scale in operations.

• Issue of Standardization versus Localization of products and activities.

– Expanded revenues– Expanded financing and investment

opportunities• But not without RISK!

Cultural Differences

• Anglo Saxon Model– Focus on (Long Run) Profit Maximization!

• “Shareholder Wealth.” Stresses Market Price, EPS.

• Continental Europe– Consider all “stakeholders” of enterprise.

• Employees, community, suppliers, state.

• Asia– Japan: Maximize market share to reinforce “keiretsu.”

• Interlocking arrangements between companies and their suppliers and bankers.

• Put in place in the 1970s as a way of discouraging foreign takeovers.

– China: Joint venturing with state owned enterprises with their goals of employment or output.

• Consistent with the planned economy era.

The “Appropriate” Goal of Management

Anglo-American markets believe that a firm’s objective should be to maximize shareholder wealth

• These countries include the US, Canada, Australia, United Kingdom.

Non-Anglo-American markets believe that a firm’s objective should be to maximize corporate (stakeholder) wealth

• These countries include the EU, Japan and Latin American countries

• How does this affect the performance and management of joint ventures between two different business cultures!

Corporate Wealth Concept– Came about because of:

• Distrust of Anglo-American capitalism especially in Europe.

– Definition of corporate wealth is broader than Anglo-American viewpoint (where wealth is strictly financial)

– A corporation’s role in wealth maximization includes the firm’s technical, market and human resources

• Considerations as to the implications of strategic moves affecting all parties, human resources, community, state, etc.

• Advisory Committees in Europe!• Labor laws in Europe.• Life time employment concept in Japan

– Has weakened in the 1990s

Capital and Cultures

Stakeholders

Banks Firm(management)

“Patient Capital”

Shareholders

Firm(management)

Banks Employees

“Impatient Capital”

The Anglo-American Model has beenfrequently criticized as focusing onshort-term profitability rather than

long-term growth.

The Non-Anglo-American Modelhas come under increasing criticism

for its lack of accountability to equityinvestors – its shareholders – while

focusing on the demands of toodiffuse a group of stakeholders.

Corporate Governance

• The financial and legal framework for “regulating the relationship between managers and owners.”– (Relatively) well defined in the United States.– Not so in other parts of the world.

• No independent boards of directors in China!• Who are the owners?