Chapter 13 The Multinational Corporation and Globalization

Chapter 13 The Multinational Corporation and Globalization

Outline • Globalization • Opportunities of international expansion • Risks faced by a multinational corporation • Exchange rates and exchange rate hedging • Foreign direct investment • Multinational capital budgeting • Repositioning of funds • Multinational transfer pricing

Learning Objectives • Understand how supply and demand are affected in different countries around the world • Define the exchange rate and identify several methods of hedging • Understand multinational capital budgeting and explain how it differs from capital budgeting of a domestic corporation • Show how changing transfer prices can benefit a corporation

Globalization • One of the main reasons a company wants to operate globally is to take advantage of new growth opportunities • Expand to serve new markets (e.g. food products) • Take advantage of new suppliers (manufacturing and back office services)

Globalization Multinational corporations face the same opportunities and problems as a domestic corporation, but also face additional challenges: • Fluctuations in currencies • Different rules and regulations • Different tax systems • Tariffs and other restrictions • Different costs of production • Different cultures, languages, and business practices

Globalization The term ‘globalization’ • Results in a closer integration of the countries of the world – especially the increased level of trade and movements of capital – brought on by lower costs of transportation and communication.

Risks Faced by MNCs • Multinational corporation risk: risks that are present only because it transacts business across national borders • Exchange rate risk: results from changes in exchange rates

Risks Faced by MNCs • Other risks faced by the MNC • blockage of funds and capital controls • differences in cultural and religious philosophies • ownership restrictions • human resource restrictions • intellectual property • discrimination • red tape and corruption • internal and external wars • changes in government

Exchange Rates • Exchange rate: price of one country’s currency in terms of another country’s May be quoted in terms of the domestic or foreign currency e.g. Є1/$1.40 or $1/ Є0.714 • Hedging: various ways that companies can protect themselves from a potential loss from currency fluctuation

Exchange Rates Hedging techniques: • Offsetting Transactions: export goods of the same amount to the same country from which it imported, in the same period of time • Forward Market: permits a company to buy or sell currency at a specific rate at a specific time, customized to its needs • Futures Market: similar to forwards, but on a standardized public exchange (set amounts, maturing on certain days)

Exchange Rates Hedging techniques: • Currency Options: give the holder the right to buy or sell an amount of currency at a specified price during a certain period of time • Currency Swaps: companies swap currencies when they expect a offsetting cash flow from other sources in their respective countries

Foreign Direct Investment Foreign direct investment (FDI): acquiring ownership rights in foreign fixed assets or existing firms, or establishing foreign subsidiaries with their own infrastructure

Foreign Direct Investment • Reasons for FDI • Increase its earning and increase the value of the company • Foreign country may impose import restrictions • Take advantage of economies of scale, as well as lower production and transportation costs

MNC Capital Budgeting • Similar process as for a domestic company, but must take into consideration several extra variables • intercompany fund flows: cash flows between parent to subsidiary • inflation rates: may differ in the country of the parent and of the subsidiary • exchange rates: exchange rate between the parent and subsidiary country will change during the project period

MNC Capital Budgeting • Tax differences: many types can differ between countries • Income tax rates • Tax on remittances to the parent’s country • Double taxation on subsidiary profit and remittance to parent, offset by foreign tax credit

MNC Capital Budgeting Cash flows: cash flows received and recorded by the parent may differ substantially from those in the subsidiary’s country

MNC Capital Budgeting • Cost of capital: difference in cost of capital for parent and subsidiary • Final project valuation: differences are so significant that a project is acceptable in one country and not in the other

MNC Capital Budgeting Repositioning of Funds Examples: • royalties and license fees can be used to channel funds to those areas of the company where they may be used most profitably • dividend payments to the parent • tax rates on distributed and undistributed earnings • taxes levied on dividends transmitted to the parent • re-invoicing centers

MNC Transfer Pricing • Multinational transfer pricing: prices for products or services that are transferred from the parent company to the subsidiary or among subsidiaries • Can affect a transfer of funds by charging high or low prices • Can affect a company’s profitability

MNC Transfer Pricing Tax liability due to a change in transfer price DT = (Q · DP · te) – (Q · DP · tm) DT = change in total tax bill Q = quantity of products shipped by E (exporter) to M (importer) DP = change in the price of the product te = tax rate in the exporting country Tm = tax rate in the importing country

MNC Transfer Pricing • Internal Revenue Code section 482 gives IRS authority to ‘shift around income and expense figures to arrive at what the government considers a more equitable result’. • IRS requires transfer pricing to be done on an ‘arm’s length’ relationship. • Developing countries are becoming more active in the area of regulating transfer pricing

Summary • A multinational corporation must compete not just domestically but worldwide. • The firm must consider the demand for their products, the cost of supplies, their productivity, and changes in technology. • An MNC must consider economic factors, political factors, and social and cultural factors in their business decisions. • Transfer pricing can be used to achieve higher profits, but governments are monitoring this activity more closely.

Chapter 13 The Multinational Corporation and Globalization