Multinational Finance

1. 1 Multinational Finance Topic: Foreign Direct Investment (Adrian Buckley Chapter 20 21)

2. 2 Objectives This chapter discusses various issues associated with foreign direct investments by Multinational Corporations, i.e. the rationales of FDI, tax considerations, capital control issues MNCs play a key role in shaping the nature of the emerging global economy.

3. 3 Chapter 20 The internationalization process Why Do Firms Invest Overseas? Issues involved in FDI: governance issues in Cross-Border Mergers and Acquisitions Political Risk involved in FDI Global Trends in FDI?

4. 4 Why FDI? Multinational companies owe their existence to market imperfections including: Barriers to entry, Product differentiation, Control of raw materials, Patents, know-how, trademarks, Marketing and organizational skills, etc.

5. 5 Global Trends in FDI: some stylized facts Several developed nations are the sources of FDI outflows: US, Japan, UK, Euro area. About 90% of total world-wide FDI comes from the developed world. inflows of FDI to developing and developed nations: mostly to developed nations. Peer investment

6. FDI INFLOW TO DEVELOPED COUNTRIES AND THE REST OF THE WORLD 6

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8. FDI inflows: developed vs. developing 8

9. FDI outflows: Developed vs. developing 9

10. Net FDI inflows: for country 10

11. Data source of FDI: www.worldbank.org www.imf.org A collection of data sites: http://hcl.harvard.edu/research/guides/fdi/ 11

12. 12 Why Do Firms Invest Overseas? Trade Barriers Labor Market Imperfections Intangible Assets Vertical Integration Product Life Cycle Shareholder Diversification

13. 13 Trade Barriers Government action leads to market imperfections. Tariffs, quotas, and other restrictions on the free flow of goods, services and people. Trade Barriers can also arise naturally due to high transportation costs, particularly for low value-to-weight goods.

14. 14 Labor Market Imperfections Among all factor markets, the labor market is the least perfect. Recall that the factors of production are land, labor, capital. If there exist restrictions on the flow of workers across borders, then labor can be underpriced relative to productivity in one country.

15. 15 Labor Market Costs Around the World (2001) Persistent wage differentials across countries exist. This is one on the main reasons MNCs are making substantial FDIs in less developed nations.

16. 16 Intangible Assets Coca-Cola has a very valuable asset in its closely guarded “secret formula”. To protect that proprietary information, Coca-Cola has chosen FDI over licensing agreement. Since intangible assets are difficult to package and sell to foreigners, MNCs often enjoy a comparative advantage with FDI.

17. 17 Vertical Integration MNCs may go FDI in countries where inputs are available. This is to secure the supply of inputs at a stable price. SC management. Vertical integration may be backward or forward: Backward: e.g. a furniture maker buying a logging company. Forward: e.g. a U.S. auto maker buying a Japanese auto dealership.

18. 18 Shareholder Diversification Firms may be able to provide indirect diversification to their shareholders if there exists significant barriers to the cross-border flow of capital. Capital Market imperfections are of decreasing importance, however. There might be diversification gains due to different business cycle in different countries.

19. 19 Product Life Cycle Theory U.S. firms develop new products in the developed world for the domestic market, and then markets expand overseas. FDI takes place when product maturity hits and cost becomes an increasingly important consideration for the MNC. The standardization phase

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21. 21 Product Life Cycle Does it always work as the model indicates? No, the Product Life Cycle Theory was developed in the 1960s when the U.S. was the unquestioned leader in R&D and product innovation. Increasingly, product innovations are taking place outside the United States as well, and new products are being introduced simultaneously in many advanced countries. Production facilities may be located in multiple countries from product inception.

22. 22 Chapter 20: TYPICAL FOREIGN EXPANSION SEQUENCE

23. 23 Chapter 20: product life cycle theory

24. 24 Chapter 20: product life cycle theory

25. 25 Chapter 20: product life cycle theory

26. 26 Chapter 20 Factors influencing global positioning 2 : to conduct or carry out by planned phases3 : to introduce in stages —usually used with in <phase in new models>2 : to conduct or carry out by planned phases3 : to introduce in stages —usually used with in <phase in new models>

27. 27 Chapter 20: Global competition: some findings

28. 28 Political Risk Transfer Risk Uncertainty regarding cross-border flows of capital. Operational Risk Uncertainty regarding host countries policies on firm’s operations. Control Risk Uncertainty regarding expropriation.

29. 29 Hedging Political Risk Geographic diversification Simply put, don’t put all of your eggs in one basket. Minimize exposure Forming joint ventures with local companies. *Local government may be less inclined to expropriate assets from their own citizens. Joining a consortium of international companies to undertake FDI. *Local government may be less inclined to expropriate assets from a variety of countries all at once. Finance projects with local borrowing.

30. 30 Transaction Cost Theory Multinationals possibly reduce the transaction costs and internalize market imperfections within the firm. Coarse (1937), Williamson (1975,1979): it is more costly for the market to handle a transaction than using a hierarchy of interrelated transactions. The firm may bypass the regular market and use internal prices to overcome the excessive transaction cost of an outside market.

31. 31 Modified Product Life Cycle Model Innovation-based oligopolies: create barriers of entry through continuous introduction of new products and aggressive differentiation of existing ones. High ratio of R&D. Mature oligopolies: keep the entry barrier even after product standardization via experience curve effects and economies of scale. Senescent oligopolies: when barriers to entry eroded, oligopolies move their products to low-cost locations or switch to new products. Critic: can not explain

32. 32 Porter (1986): MNCs FDI strategy: using either low-cost strategy or product differentiation (page 385-386) Four strategic context: Country-focused strategy: with little or no coordination between various subsidiaries of MNCs. High foreign investment with extensive co-ordination among subsidiaries to protect intangible rights, e.g. research and development, technology, create cost spreading among countries.

33. 33 3. Export-based strategy with decentralized marketing: simple and widely used by companies new to international area. 4. Purest global strategy: have a high degree of co-ordination and concentration of activities aimed at producing standardized product for the global market. Four strategic context:

34. 34 Porter’s theory of national advantage: THE DIAMOND OF NATIONAL ADVANTAGE

35. 35 THE DIAMOND OF NATIONAL ADVANTAGE: Porter, 1990 Factor conditions: the ability of a nation to continuously create, upgrade and utilize its factors of production, such as resources and skilled labor. Demand conditions: the spirit of competition the firm faces in its domestic market. Highly competitive and demanding local markets are most likely to give rise to a competitive edge.

36. 36 THE DIAMOND OF NATIONAL ADVANTAGE: Porter, 1990 Related and supporting industries: the competitiveness of related industries and suppliers to the firm. Firm gains and maintains advantages through close working relationships, proximity to suppliers and timeliness of product and information flows. Firm strategy, structure and rivalry: the conditions in the home market influence the ability to compete globally. But nothing is globally applicable: Flexibility is the key.

37. Chapter 21 Exchange control and corporate tax International investment evaluation differs from domestic ones, due to: Difference in Corporate tax rate, and/or Capital control practice in host countries 1) exchange control 2) profits repatriation 37

38. 38 Chapter 21 Exchange control and corporate tax

39. 39 Chapter 21.2

40. 40 Chapter 21.3 example page 405

41. 41 Chapter 21.4 example page 405 cont.

42. 42 Chapter 21.5

43. 43 Chapter 22.1

44. 44 Chapter 22.2