Weeks 1-2 Flashcards
what are agency problems and costs?
- The conflict of goals between managers and shareholders
- ▪ Definition: Cost of ensuring that managers maximize
shareholder wealth
▪ Costs are normally higher for MNCs than for purely
domestic firms for several reasons:
▪ Monitoring managers of distant subsidiaries in foreign
countries is more difficult
▪ Foreign subsidiary managers raised in different cultures
may not follow uniform goals
▪ Sheer size of larger MNCs can create large agency
problems
how to control agency problems?
Corporate control of agency problems
▪ Entire management of the MNC must be focused on maximising
shareholder wealth.
Parent control of agency problems
▪ Parent should clearly communicate the goals for each subsidiary
to ensure managers focus on maximising the value of the MNC
and not of their respective subsidiary.
Sarbanes-Oxley Act (SOX)
▪ Ensures a more transparent process for managers to report on the
productivity and financial condition of their firm.
Why MNCs Pursue International Business
- Theory of competitive advantage:
– Specialisation increases production efficiency. - Imperfect markets theory:
– Factors of production are somewhat immobile, providing
incentive to seek out foreign opportunities. - Product cycle theory:
– As a firm matures, it recognises opportunities outside its
domestic market
How Firms Engage in
International Business
- International Trade
- Licensing
- Franchising
- Joint Ventures
- Acquisitions of Existing Operations
- Establishment of New Foreign Subsidiaries
what is international trade
- Relatively conservative approach that can be
used by firms to:
– penetrate markets (by exporting).
– obtain supplies at a low cost (by importing). - Minimal risk — no capital at risk
– The internet facilitates international trade by
allowing firms to advertise their products and
accept orders on their websites.
what is licensing?
Obligates a firm to provide its technology
(copyrights, patents, trademarks, or trade names) in
exchange for fees or some other specified benefits
▪ Allows firms to use their technology in foreign
markets without a major investment and without
transportation costs that result from exporting
▪ Major disadvantage: difficult to ensure quality
control in foreign production process
what is franchising
Obligates firm to provide a specialised sales or service
strategy, support assistance, and possibly an initial
investment in the franchise in exchange for periodic fees.
▪ Allows penetration into foreign markets without a major
investment in foreign countries.
what are joint ventures?
▪ A venture that is jointly owned and operated by two or
more firms. A firm may enter the foreign market by
engaging in a joint venture with firms that reside in those
markets.
▪ Allows two firms to apply their respective cooperative
advantages in a given project.
what are acquisitions of existing operations
Acquisitions of firms in foreign countries allows
firms to have full control over their foreign
businesses and to quickly obtain a large portion of
foreign market share.
* Subject to the risk of large losses because of
larger investment.
* Liquidation may be difficult if the foreign
subsidiary performs poorly.
what is the establishment of new foreign subsidiaries?
Firms can penetrate markets by establishing new
operations in foreign countries.
▪ Requires a large investment.
▪ Acquiring new as opposed to buying existing
allows operations to be tailored exactly to the
firms needs.
▪ May require smaller investment than buying
existing firm.
what is foreign direct invesment?
Any method of increasing international business
that requires a direct investment in foreign
operations is referred to as foreign direct
investment (FDI).
▪ International trade and licensing usually not
included.
▪ Foreign acquisition and establishment of new
foreign subsidiaries represent the largest portion
of FDI.
what are the objectives of exchange rates
▪ Describe the exchange rate systems used by
various governments.
▪ Describe the development and implications of a
single European currency.
▪ Explain how governments can use direct
intervention to influence exchange rates.
▪ Explain how governments can use indirect
intervention to influence exchange rates.
what are ER systems?
Exchange rate systems can be classified according
to the degree of government control and fall into the
following categories:
▪ Fixed
▪ Freely floating
▪ Managed float
▪ Pegged
what are fixed ER system?
Exchange rates are either held constant or allowed
to fluctuate only within very narrow boundaries.
▪ Central bank can reset a fixed exchange rate by
devaluing or reducing the value of the currency
against other currencies.
▪ Central bank can also revalue or increase the
value of its currency against other currencies.
2 examples
what are examples of fixed ER systems?
▪ Bretton Woods Agreement 1944 – 1971 — Each
currency was valued in terms of gold.
▪ Smithsonian Agreement 1971 – 1973 — called for a
devaluation of the U.S. dollar by about 8% against other
currencies.
what are advantages and disadavntages of fixed ER
▪ Advantages of fixed exchange rates
▪ Insulate country from risk of nominal currency appreciation.
▪ Allow firms to engage in foreign direct investment without
currency risk.
▪ Disadvantages of fixed exchange rates
▪ Governments can still abruptly alter the value of currency.
▪ Country and MNC may be more vulnerable to economic
conditions in other countries.
what are advantages n disadavantages of freely floating ER system
Exchange rates are determined by market forces without
government intervention.
▪ Advantages of a freely floating system:
▪ Country is more insulated from inflation of other countries.
▪ Country is more insulated from unemployment of other countries.
▪ Does not require central bank to maintain exchange rates within
specified boundaries.
▪ Disadvantages of a freely floating exchange rate
system:
▪ Can adversely affect a country that has high unemployment
▪ Demand FC Falls, HC Value Rises, Cost of imports fall
▪ Can adversely affect a country with high inflation.
what are managed ER system?
Governments sometimes intervene to prevent their
currencies from moving too far in a certain direction.
* Countries with floating exchange rates: Currencies of
most large developed countries are allowed to float,
although they may be periodically managed by their
respective central banks.
* Criticisms of the managed float system: Critics suggest
that managed float allows a government to manipulate
exchange rates to benefit its own country at the expense
of others.
what is a pegged ER system
Home currency value is pegged to one foreign currency or to an
index of currencies.
* May attract foreign investment because exchange rate is
expected to remain stable.
* Limitations of pegged exchange rate
– Weak economic or political conditions can cause firms and
investors to question whether the peg will be broken.
Currency Boards Used to Peg Currency Values
▪ A system for pegging the value of the local currency to
some other specified currency. The board must maintain
currency reserves for all the currency that it has printed.
Interest Rates of Pegged Currencies
▪ Interest rate will move in tandem with the interest rate of
the currency to which it is tied.
Exchange Rate Risk of a Pegged Currency
▪ Currencies are commonly pegged to the U.S. dollar or to
the euro
what is dollarisiation
Currency Substitution
* Replacement of a foreign currency with U.S. dollars.
▪ This process is a step beyond a currency board because it
forces the local currency to be replaced by the U.S. dollar.
Although dollarisation and a currency board both attempt
to peg the local currency’s value, the currency board does
not replace the local currency with dollars.
what is monetary policy in the eurozone
▪ European Central Bank — Based in Frankfurt and is
responsible for setting monetary policy for all participating
European countries
▪ Objective is to control inflation in the participating
countries and to stabilize (within reasonable boundaries) the
value of the euro with respect to other major currencies.
**Impact on Firms in the Eurozone **— Prices of products are
now more comparable among European countries.
Impact on Financial Flows in the Eurozone — Bond investors
who reside in the eurozone can now invest in bonds issued by
governments and corporations in these countries without
concern about exchange rate risk, as long as the bonds are
denominated in euros.
Exposure of Countries within the Eurozone
▪ A single European monetary policy prevents any individual
European country from solving local economic problems with its
own unique monetary policy.
▪ Any given monetary policy used in the eurozone during a particular
period may enhance conditions in some countries and adversely
affect others.
**Impact of Crises within the Eurozone **— may affect the economic
conditions of the other participating countries because they all rely on the
same currency and the same monetary policy.
ECB Role in Resolving Economic Crises
▪ The bank’s role has expanded to include providing credit for
eurozone countries that are experiencing a financial crisis.
▪ The ECB imposes restrictions intended to help resolve the
country’s budget deficit problems over time.
Impact of Crises within the Eurozone
▪ Financial problems of one bank can easily spread to other
banks.
▪ Banks in Eurozone frequently engage in loan
participations. If companies have trouble repaying, all
banks may be affected.
▪ News about concerns in one area of the Eurozone can
trigger actions in other areas.
▪ Eurozone country governments must rely on fiscal policy
when they experience serious financial problems.
▪ Banks lend heavily to governments. Performance is
related to whether that government can repay its debts.
Government Intervention – Reasons
Smoothing exchange rate movements
▪ If a central bank is concerned that its economy will be affected by
abrupt movements in its home currency’s value, it may attempt to
smooth the currency movements over time.
Establishing implicit exchange rate boundaries
▪ Some central banks attempt to maintain their home currency rates
within some unofficial, or implicit, boundaries.
Responding to temporary disturbances
▪ A central bank may intervene to insulate a currency’s value from a
temporary disturbance.
Stimulate foreign demand for products
▪ Weak home currency
Encourage domestic consumers and corporations to buy
goods from other countries
▪ Strong home currency
what is direct intervention
To force the dollar to depreciate, the Fed can intervene
directly by exchanging dollars that it holds as reserves
for other foreign currencies in the foreign exchange
market.
▪ By “flooding the market with dollars” in this
manner, the Fed puts downward pressure on the
dollar.
▪ If the Fed desires to strengthen the dollar, it can
exchange foreign currencies for dollars in the
foreign exchange market, thereby putting upward
pressure on the dollar.
