A5. Strategic business and financial planning for multinationals Flashcards
Branch or subsidiary.
Firms that want to establish a definite presence in an overseas country may choose to establish a branch rather than a subsidiary. In many instance multinationals will establish a branch and utilise its initial losses against other profits, and then turn the branch into a subsidiary when it starts making profits. A subsidiary is a separate legal entity and gives the impression of long0term commitment. The parent company benefits from limited liability. The normal structure of many multinationals consists of a parent company with subsidiaries in several countries. The subsidiaries may be wholly owned or just partly owned.
Debt or equity (multinationals planning).
Debt or equity. The method of financing a subsidiary will give some indication of the nature and length of time of the investment that the parent company is prepared to make. A sizeable equity investment (or long-term loans from the parent company to subsidiary) would indicate a long-term investment by the parent company. Because subsidiaries may be operating with a guarantee from the parent company, higher gearing structures may be possible. In addition, local governments may directly or indirectly offer subsidised debt finance:
• Direct. Low cost loans may be offered to encourage multinational investment. Other incentives may include exchange control guarantees, grants, tax holidays.
• Indirect. Local governments may reduce the interest rates to stimulate the local economy.
So, it may be desirable for a subsidiary to operate with higher levels of debt, especially if it is operating in a high tax regime.
Thin capitalization.
Many countries have rules that disallow interest deductions above a certain level when the entity is considered to be too highly geared. A company is said to be thinly capitalised when its capital is made up of much greater proportion than usual of debt than equity. Tax authorities may place a limit on the amount that a company can claim as a tax deduction on interest, or may judge that a subsidiary contains artificially high gearing if its gearing level is higher than the group’s gearing.
Stock exchanges.
Role in Corporate Governance
Stock exchanges. Where overseas equity is preferred, a listing on an overseas stock exchange may be considered. If so it will be important to conform to local regulations. Shares are bought and sold through stock exchanges. Each keeps an index of the value of shares on that exchange; In London, for example, the FTSE All Share (Financial Times Stock Exchange) index is a measure of all of the shares listed in London. In New York, it is the Dow Jones index and in Hong Kong, it is the Hang Seng index.
Listing rules are sometimes imposed on listed companies often concerning governance arrangements not covered elsewhere by company law. In the UK, for example, it is a stock exchange requirement that listed companies comply with the Combined Code on Corporate Governance
Procedure for obtaining a listing on an international stock exchange.
Normally, obtaining a listing consists of three steps:
• Legal
• Regulatory
• Compliance
Steps:
• In the UK a firm seeking listing must register as a public limited company. This entails a change in its memorandum and articles agreed by the existing members at a special meeting of the company.
• The company must then meet the regulatory requirements of the Listing Agency which, in the UK, is part of the Financial Services Authority (FSA). These requirements impose a minimum size restriction on the company and other conditions concerning length of time trading.
• Once these requirements are satisfied the company is then placed on an official list and is allowed to make a public offering of its shares.
• Once the company is on the official list it must then seek the approval of the Stock Exchange for its shares to be traded. In principal it is open to any company to seek a listing on any exchange where shares are traded.
• The London Exchange imposes strict requirements and invariably the applicant company will need the services of a sponsoring firm that specialises in this type of work.
The advantages of seeking a public listing
- It opens the capital market to the firm
- It offers the company access to equity capital from both institutional and private investors and the sums that can be raised are usually much greater than can be obtained through private equity sources.
- Enhances its credibility as investors and the general public are aware that by doing so it has opened itself to a much higher degree of public scrutiny than is the case for a firm that is privately financed.
The disadvantages of seeking a public listing
- A distributed shareholding does place the firm in the market for corporate control increasing the likelihood that the firm will be subject to a takeover bid.
- There is also a much more public level of scrutiny with a range of disclosure requirements.
- Financial accounts must be prepared in accordance with IFRS or FASB and with the relevant GAAP as well as the Companies Acts.
- Under the rules of the London Stock Exchange companies must also comply with the governance requirements of the Combined Code
The mobility of capital across borders.
One of the drivers of globalisation has been the increased level of mobility of capital across borders.
Implications of an increased mobility of capital:
• Lower costs of capital.
• Ability of MNCs to switch activities between countries.
• Ability of MNCs to circumnavigate national restrictions.
• Potentially increased exposure to foreign currency risk.
Specific strategic issues for multinational organisations – local risk.
Specific strategic issues for multinational organisations – local risk. Local risk for multinationals includes the following:
• Economic risk is the possibility of loss arising to a firm from changes in the economy of a country.
• Political risk is the possibility of loss arising to a firm from actions taken by the government or people of a country.
Multinational - Political risk
Political risk. Examples of political risk:
• Confiscation political risk. This is the risk of loss of control over the foreign entity through intervention of the local government or other force.
• Commercial political risk
• Financial political risk. This risk takes many forms:
o Restricted access to local borrowings.
o Restrictions on repatriating capital, dividends or other remittances. These can take the form of prohibition or penal taxation.
o Financial penalties on imports from the rest of the group such as heavy interest free import deposits.
• Exchange control risk. One form of exchange control risk is that the group may accumulate surplus cash in the country where the subsidiary operates, either as profits or as amounts owed for imports to the subsidiary, which cannot be remitted out of the country. This can be mitigated by using FOREX hedging.
Specific strategic issues for multinational organisations – control.
Within the hierarchy of firms (in a group) goal incongruence may arise when divisional managers in overseas operations promote their own self-interest over those of other divisions and of the organisation generally. In order to motivate local management and to obtain the benefit of their local knowledge, decision making powers should be delegated to them. However, given the wide geographical spread of divisions, it is difficult for group management to control the behaviour of the local managers. This gives rise to agency costs, and a difficult balance between local autonomy and effective central control.
Sources of finance for foreign trade
Sources of finance for foreign trade • Bank overdrafts either in sterling or in the overseas currency. • Bills of exchange • Promissory notes • Documentary letters of credit • Factoring • Forfaiting • Leasing and hire purchase • Acceptance credits • Produce loans • Requesting payment in advance from the importer if this were possible it would avoid all of the above complications.
Bills of exchange
Bills of exchange a negotiable instrument drafted by the exporter (the drawer), accepted by the importer (the drawee) who thereby agrees to pay for the goods/services either immediately or more commonly after a specified period of credit. If the importer accepts the bill it is known as a “trade bill”, whereas if the importer arranges for its bank to accept the bill, it becomes a less risky “bank bill”. Where payment will be made after the specified period of credit, the exporter can sell the bill at a discount to its face value and receive the cash immediately. If the bill is dishonoured the exporter can seek legal remedies in the country of the importer.
Promissory notes
Promissory notes similar, but less common than bills of exchange, since they cannot usually be discounted prior to maturity.
Documentary letters of credit
Documentary letters of credit the importer obtains a Letter of Credit from its bank, which guarantees payment to the exporter via a trade bill. Though slow to arrange, this method is virtually risk free provided the exporter presents specified error free documents (e.g. shipping documents, certificates of origin and a fully detailed invoice) within a specified time period. The high bank fees for this procedure are normally borne by the importer, and the DLC is normally reserved for expensive goods only.
