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Chapter 01. Comparative Corporate Governance and Financial Goals. Comparative Corporate Governance and Financial Goals. Multinational Enterprise (MNE) Multinational Business Finance Goal of Management Shareholder Wealth Maximization Stakeholder Capitalism Model

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Chapter 01

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Chapter 01

Comparative Corporate Governance and Financial Goals

Comparative Corporate Governance and Financial Goals

  • Multinational Enterprise (MNE)

  • Multinational Business Finance

  • Goal of Management

    • Shareholder Wealth Maximization

    • Stakeholder Capitalism Model

  • Comparative Corporate Governance

  • Currency Terminology

The Multinational Enterprise (MNE)

  • A multinational enterprise (MNE) is defined as one that has operating subsidiaries, branches or affiliates located in foreign countries.

  • The ownership of some MNEs is so dispersed internationally that they are known as transnational corporations.

  • The transnationals are usually managed from a global perspective rather than from the perspective of any single country.

Multinational Business Finance

  • While multinational business finance emphasizes MNEs, purely domestic firms also often have significant international activities:

    • Import & export of products, components and services

    • Licensing of foreign firms to conduct their foreign business

    • Exposure to foreign competition in the domestic market

    • Indirect exposure to international risks through relationships with customers and suppliers

Global Financial Management

  • There are significant differences between international and domestic financial management:

    • Cultural issues

    • Corporate governance issues

    • Foreign exchange risks

    • Political Risk

    • Modification of domestic finance theories

    • Modification of domestic financial instruments

The Goal of Management

  • Maximization of shareholders’ wealth is the dominant goal of management in the Anglo-American world.

  • In the rest of the world, this perspective still holds true (although to a lesser extent in some countries).

  • In Anglo-American markets, this goal is realistic; in many other countries it is not.

  • There are basic differences in corporate and investor philosophies globally.

  • In this context, the universal truths of finance become culturally determined norms.

Shareholder Wealth Maximization

  • In a Shareholder Wealth Maximization model (SWM), a firm should strive to maximize the return to shareholders, as measured by the sum of capital gains and dividends, for a given level of risk.

  • Alternatively, the firm should minimize the level of risk to shareholders for a given rate of return.

  • Assumptions of SWM:

    • The SWM model assumes as a universal truth that the stock market is efficient.

      • An equity share price is always correct because it captures all the expectations of return and risk as perceived by investors, quickly incorporating new information into the share price.

      • Share prices are, in turn, the best allocators of capital in the macro economy.

Shareholder Wealth Maximization – Continued

  • Assumptions of SWM – Continued:

    • The SWM model also treats its definition of risk as a universal truth.

      • Risk is defined as the added risk that a firm’s shares bring to a diversified portfolio.

      • Therefore the unsystematic, or operational risk, should not be of concern to investors (unless bankruptcy becomes a concern) because it can be diversified.

      • Systematic, or market, risk cannot however be eliminated.

Shareholder Wealth Maximization – Continued

  • Agency theory is the study of how shareholders can motivate management to accept the prescriptions of the SWM model.

  • Liberal use of stock options should encourage management to think more like shareholders.

  • If management deviates too extensively from SWM objectives, the board of directors should replace them.

  • If the board of directors is too weak (or not at “arms-length”) the discipline of the capital markets could effect the same outcome through a takeover.

  • This outcome is made more possible in Anglo-American markets due to the one-share one-vote rule.

Shareholder Wealth Maximization – Continued

  • Long-term versus short-term value maximization

    • Long-term value maximization can conflict with short-term value maximization as a result of compensation systems focused on quarterly or near-term results.

      • Short-term actions taken by management that are destructive over the long-term have been labeled impatient capitalism.

    • This point of debate is often referred to a firm’s investment horizon (how long it takes for a firm’s actions, investments and operations to result in earnings).

    • In contrast to impatient capitalism is patient capitalism.

      • This focuses on long-term SWM.

      • Many investors, such as Warren Buffet, have focused on mainstream firms that grow slowly and steadily, rather than latching on to high-growth but risky sectors.

Stakeholder Capitalism Model

  • In this context, a firm should treat shareholders on a par with other corporate interest groups, such as management, labor, the local community, suppliers, creditors and even the government.

  • This model, also called the stakeholder capitalism model focuses on earning as much as possible in the long-run while retaining enough to increase the corporate wealth for the benefit of all interest groups.

  • Assumptions of SCM:

    • The SCM model does not assume that equity markets are either efficient or inefficient.

      • In fact, market efficiency does not matter as the firm’s financial goals are not exclusively shareholder-oriented.

      • This model assumes that long-term “loyal” shareholders should influence corporate strategy, not transient investors.

    • The SCM model assumes that total risk, operating and financial risk, does count.

Stakeholder Capitalism Model – Continued

  • Although the SCM model avoids the impatient capitalism as seen in the SWM, it has its own flaw in that management is tasked with meeting the demands of multiple stakeholders.

  • This leaves management without a clear signal about the tradeoffs, which management tries to influence through written and oral disclosures and complex compensation systems.

  • While both forms of wealth maximization have their strengths and weaknesses, two trends in recent years have led to a focus on the SWM model.

  • As non Anglo-American markets privatize their industries the SWM model becomes more important in the overall effort to attract foreign capital

  • Many analysts believe that shareholder-based MNEs are increasingly dominating their global industry segments

Corporate Governance

  • The single overriding objective of corporate governance is the optimization over time of the returns to shareholders.

  • In order to achieve this goal, good governance practices should focus the attention of the board of directors of the corporation by developing and implementing a strategy that ensures corporate growth and improvement in the value of the corporation’s equity.

  • The most widely accepted statement of good corporate governance practices are established by the OECD:

    • The corporate governance framework should protect shareholders rights.

    • The corporate governance framework should ensure the equitable treatment of all shareholders.

    • Stakeholders should be involved in corporate governance.

    • Disclosure and transparency is critical.

    • The board of directors should be monitored and held accountable for what guidance it gives.

Comparative Corporate Governance

  • These regimes are a function of:

    • Financial market developments

    • Degree of separation between managers and owners

    • Disclosure and transparency

    • Historical development of the legal system

Failures in Corporate Governance

  • Failures in corporate governance have become increasingly visible in recent years.

  • In each case, prestigious auditing firms missed the violations or minimized them, presumably because of lucrative consulting relationships or other conflicts of interest.

  • In addition, security analysts urged investors to buy the shares of firms they knew to be highly risky (or even close to bankruptcy).

  • Top executives themselves were responsible for mismanagement and still received overly generous compensation while destroying their firms.

Corporate Governance Reform

  • Within the United States and the United Kingdom, the main corporate governance problem is the one treated by agency theory: with widespread share ownership, how can a firm align management’s interest with that of the shareholders?

  • Because individual shareholders do not have the resources or the power to monitor management, the U.S. and U.K. markets rely on regulators to assist in the agency theory monitoring task.

  • Outside the U.S. and U.K., large, controlling shareholders are in the majority – these entities are able to monitor management in some ways better than the regulators can.

The Sarbanes-Oxley Act

  • This act was passed by the US Congress during 2002 and has three major requirements:

    • CEOs of publicly traded companies must vouch for the veracity of published financial statements;

    • Corporate boards must have audit committees drawn from independent directors;

    • Companies can no longer make loans to corporate directors, and

    • Companies must test their internal financial controls against fraud

  • Penalties have been spelled out for various levels of failure.

  • Most of its terms are appropriate for the US situation, but some terms do conflict with practices in other countries.

Currency Terminology

  • Foreign currency exchange rate or exchange rate is the price of one country’s currency in units of another currency or commodity (gold or silver).

    • If a government determines the exchange rate for its currency then exchange rate system is called fixed or managed exchange rate system

    • The rate at which the currency is fixed or pegged called is called par value

    • If government does not interfere then the system is called flexible or floating

  • Spot exchange rate is the quoted price for foreign exchange to be delivered at once, or in two days for interbank transactions.

  • How can you interpret $1.2670/€?

Currency Terminology – Continued

  • Devaluation of a currency refers to a drop in foreign exchange value of a currency that is pegged to gold or another currency.

    • The opposite is revaluation

  • Weakening, deterioration, or depreciation of a currency refers to a drop in the foreign exchange value of a floating currency.

    • The opposite is strengthening or appreciation

  • Soft or weak describes a currency that is expected to devalue or depreciate relative to major currencies.

  • Hard or strong describes a currency that is expected to revalue or appreciate relative to major trading currencies.

  • Eurocurrencies are domestic currencies of one country on deposit in a bank in a second country.

    • Eurodollar – dollar deposits overseas

    • Euroyen – yen deposits outside Japan

Currency Terminology – Continued

  • Foreign Exchange Rates & Quotations – Direct and Indirect Quotes

    • A direct quote is a home currency price of a unit of a foreign currency

      • Sfr1.6000/$ is a direct quote in Switzerland

    • An indirect quote is a foreign currency price of a unit of the home currency

      • Sfr1.6000/$ is an indirect quote in the US,

      • $0.6250/Sfr is a direct quote in the US and an indirect quote in Switzerland

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