Managing The Internal Capital Markets Of Multinational Corporations Flashcards
What are some of the financial flows between the parent firm and an affiliate?
Dividends
Fees, royalties, corporate overhead costs
Interest and principal payments
Equity investments
Loans and credit on goods and services
What are some of the real flows between the parent firm and an affiliate?
Capital goods
Technology
Management
Intermediate/Finished goods
Technology/Market intelligence
What are some of the decision variables between a parent firm and an affiliate?
Dividends
Transfer prices
Leads and lags
Fees and royalties
Debt vs Equity
What are the exceptions to the similar links between two affiliates that an affiliate with the parent firm?
Equity investment and dividends
What are the factors that enhance the value of internal financing transactions?
- Formal Barriers to International Transactions
- Informal Barriers to International Transactions
- Imperfections in Domestic Capital Markets
What are some of the examples of formal barriers to international transactions?
- Quantitative restrictions (exchange controls) and direct taxes on international movements of funds.
- Differential taxation of income streams according to nationality and global tax situation of the owners.
- Restrictions by nationality of investors and/or investments on access to domestic capital markets.
What are some of the examples of informal barriers to international transactions?
- Costs of obtaining information.
- Difficulty of enforcing contracts across national boundaries.
- Transaction costs.
- Traditional investment patterns.
What are some examples of imperfections in domestic capital markets?
- Ceiling on interest rates.
- Mandatory credit allocations.
- Limited legal and institutional protection for minority shareholders.
Why are the restrictions that enhance the value of internal financing transactions imposed?
The restrictions are imposed to allow nations to maintain artificial high values for their respective currencies.
What are the types of arbitrage opportunities presented by the ability to transfer funds and reallocate profits internally?
Tax arbitrage
Financial market arbitrage
Regulatory system arbitrage
Why is there tax arbitrage?
MNCs can reduce their global tax burden by shifting profits from units located in high-tax nations to those in lower-tax nations. Or they may shift profits from units in a taxpaying position to those with tax losses.
Why is there financial market arbitrage?
By transferring funds among units, MNCs may be able to circumvent exchange controls, earn higher risk-adjusted yields on excess funds, reduce their risk-adjust cost of borrowed funds, and tap previously unavailable capital resources.
Why is there regulatory system arbitrage?
When subsidiary profits are a function of government regulations (e.g., when a government agency sets allowable prices on firm’s goods) or union pressure, rather than the marketplace, the ability to disguise true profitability by reallocating profits among units may give the multinational firm a negotiating advantage
What is a highly favoured means of shifting liquidity among affiliates?
Acceleration or delaying the payment of inter-affiliate accounts by modifying the credit terms extended by one unit to another.
What does the value of leading and lagging depend on?
The value of leading and lagging depends on the opportunity cost of funds to both the paying unit and the recipient.
What are the advantages of shifting liquidity (leading and lagging)?
- No formal note of indebtedness is needed, and the amount of credit can be adjusted up or down by shortening or lengthening the returns on the accounts. Governments do not always allow such freedom on loans.
- Governments are less likely to interfere with payments on intercompany accounts than on direct loans.
- Section 482 allows intercompany accounts up to six months to be interest free. In contrast, interest must be charged on all intercompany loans. The ability to set a zero-interest rate is valuable if the host government does not allow interest payments on parent company loans to be tax deductible or if there are withholding taxes on interest payments.
When are intercompany loans more valuable to the firm than arm’s-length transactions?
At least one of the following market distortion exists:
1. Credit rationing (because of a ceiling on local interest rates);
2. Currency controls;
3. Differential tax rates among countries.
What is a back-to-back loan?
The parent company deposit funds with a bank in country A that in turn lends the money to a subsidiary in country B.
What are the advantages of back-to-back loans?
- Certain countries apply different withholding tax rates to interest paid to a foreign parent and interest paid to a financial institution. A cost saving in the form of lower taxes may be available with a back-to-back loan.
- If currency controls are imposed, the government usually will permit the local subsidiary to honor the amortization schedule of a loan from a major multinational bank; to stop payment would hurt the nation’s credit rating. Conversely, local monetary authorities would have far fewer reservations about not authorizing the repayment of an intercompany loan. In general, back-to-back financing provides better protection than does a parent loan against expropriation and/or exchange controls.
What are parallel loans?
Parallel loans are a method of effectively repatriating blocked funds (at least for the term of the arrangement), circumventing exchange control restrictions, avoiding a premium exchange rate for investments abroad, financing foreign affiliates without incurring additional exchange risk.
How is the difference between the rates of interest on the two loans (parallel loans) determined?
In theory, by the cost of funds in each country and anticipated changes in currency values.
What is the most important means of transferring funds from foreign affiliates to the parent firm?
Dividends. They typically account for more than 50% of all remittances to US firms.
What are the factors than MNCs consider when deciding on dividend payments by their affiliates?
- Taxes;
- Financial Statements Effects;
- Exchange risk;
- Currency controls;
- Financing requirements;
- Availability and cost of funds;
- Parent’s dividend payout ratio.
What is a major consideration behind the dividends decision?
A major consideration behind the dividends decision is the effective tax rate on payments from different affiliates. By varying payout ratios among its foreign subsidiaries, the corporation can reduce its total tax burden.