Management Financial in the International Business
Chapter 20
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Introduction
Scope of financial management includes three sets of related decisions:
Investment decisions, decisions about what activities to finance. Financing decisions, decisions about how to finance those activities. Money management decisions, decisions about how to manage the firm's financial resources most efficiently.
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Investment Decisions
Capital budgeting:
quantifies the benefits, costs and risks of an investment. Managers can reasonably compare different investment alternatives within and across countries.
Complicated process:
Must distinguish between cash flows to project and those to parent. Political and economic risk can change the value of a foreign investment. Connection between cash flows to parent and the source of financing must be recognized. 20-2 McGraw Hill Companies, Inc., 2000
Project and Parent Cash Flows
Project cash flows may not reach the parent:
Host-country may block cash-flow repatriation. Cash flows may be taxed at an unfavorable rate. Host government may require a percentage of cash flows to be reinvested in the host country.
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Adjusting for Political and Economic Risk
Political risk:
Expropriation - Iranian revolution, 1979. Social unrest - after the breakup of Yugoslavia, company assets were rendered worthless. Political change - may lead to tax and ownership changes.
20-4
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Euromoney Magazine's Country Risk Ratings
Total score= 100 100 90 80 70 60 50 40 30 20 10 0 Highe and lowe st st ranke countrie d s.
Neth
USA
Azerbaijan
Bermuda
Benin
Lux
Ger
Adapted from Table 20.1 in text
Madagascar
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Financing Decisions (a)
Source of financing:
Global capital markets for lower cost financing. Host-country may require projects to be locally financed through debt or equity.
Limited liquidity raises the cost of capital. Host-government may offer low interest or subsidized loans to attract investment.
Impact of local currency (appreciation/depreciation) influences capital and financing decisions.
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Financing Decisions (b)
Financial structure:
Debt/equity ratios vary with countries.
Tax regimes.
Follow local capital structure norms?
More easily evaluate return on equity relative to local competition. Good for company's image.
Best recommendation: adopt a financial structure that minimizes its cost of capital.
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Debt Ratios for Selected Industrial Countries C ountry
Me an 0.8 0.7 De ratio = bt 0.6 total de / total 0.5 bt asse at book 0.4 ts value . 0.3 0.2 0.1 0 Highe and lowe st st ranke countrie d s.
Finland
Argentina
Pakistan
Malaysia
Australia
Singapore
Norway
Adapted from Table 20.2 in text
Italy
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Global Money Management
(The Efficiency Objective)
Minimizing cash balances:
Money market accounts - low interest - high liquidity. Certificates of deposit - higher interest - lower liquidity.
Reducing transaction costs (cost of exchange):
Transaction costs:changing from one currency to another. Transfer fee: fee for moving cash from one location to another.
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Global Money Management
Countries tax income earned outside their boundaries by entities based in their country.
Can lead to double taxation. Tax credit allows entity to reduce home taxes by amount paid to foreign government. Tax treaty is an agreement between countries specifying what items will be taxed by authorities in country where income is earned. Deferral principle specifies that parent companies will not be taxed on foreign income until the dividend is received. Tax haven is used to minimize tax liability.
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(The Tax Objective)
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OECD Corporate Income Tax Rates Top Tax Rate%
60 50 40 30 Highe and lowe st st ranke countrie d s and US A.
Adapted 20 from Table 10 20.3 in text
Finland Japan Germany Canada Norway Sweden Swiss Italy USA 0
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Moving Money Across Borders:
Attaining Efficiencies and Reducing Taxes
Unbundling: a mix of techniques to transfer
liquid funds from a foreign subsidiary to the parent company without piquing the host-country. Dividend remittances. Royalty payments and fees. Transfer Prices. Fronting loans.
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Dividend Remittances
Most common method of transfer. Dividend varies with:
tax regulations. Foreign exchange risk. Age of subsidiary. Extent of local equity participation.
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Dividends
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Royalty Payments and Fees
Royalties represent the remuneration paid to owners of technology, patents or trade names for their use by the firm.
Common for parent to charge a subsidiary for technology, patents or trade names transferred to it. May be levied as a fixed amount per unit sold or percentage of revenue earned.
Fees are compensation for professional services or expertise supplied to subsidiary.
Management fees or `technical assistance' fees. Fixed charges for services provided
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Transfer Prices
Price at which goods or services are transferred within a firm's entities.
Position funds within a company.
Move founds out of country by setting high transfer fees or into a country by setting low transfer fees.
Movement can be within subsidiaries or between the parent and its subsidiaries.
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Benefits of Transfer Fees
Reduce tax liabilities by using transfer fees to shift from a high-tax country to a low-tax country. Reduce foreign exchange risk exposure to expected currency devaluation by transferring funds. Can be used where dividends are restricted or blocked by host-government policy. Reduce import duties (ad valorem) by reducing transfer prices and the value of the goods.
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Problems with Transfer Pricing
Few governments like it.
Believe (rightly) that they are losing revenue.
Has an impact on management incentives and performance evaluations.
Inconsistent with a `profit center'. Managers can hide inefficiencies.
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Fronting Loans
A loan between a parent and subsidiary is channeled through a financial intermediary (bank).
Can circumvent host-country restrictions on remittance of funds from subsidiary to parent. Provides certain tax advantages.
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An Example of the Tax Aspects of a Fronting Loan
De posit $1 Million Loan $1 Million
Tax Have n S ubsidiary
London Bank
Fore ign Ope rating S ubsidiary
Figure 20.1
Pays 8%I nte st (Tax re Fre ) e
Pays 9%I nte st re (Tax De ductible )
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Techniques for Global Money Management
Centralized Depositories
Need cash reserves to service accounts and insuring against negative cash flows. Should each subsidiary hold its own cash balance?
By pooling, firm can deposit larger cash amounts and earn higher interest rates. If located in a major financial center can get information on good investment opportunities. Can reduce the total size of cash pool and invest larger reserves in higher paying, long term, instruments.
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Centralized Depositories
Day-to-Day Cash Ne ds (A) e OneS tandard De viation (B) Re quire Cash d Balance (A+3xB)
S pain Italy Ge any rm Total
$10 $6 $12 $28
$1 $2 $3
$13 $12 $21 $6 $46
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Techniques for Global Money Management
Multilateral Netting
Ability to reduce transaction costs.
Bilateral netting. Multilateral netting - simply extending the bilateral concept to multiple subsidiaries within an international business.
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Cash Flows before Multilateral Netting
$4 Million
Ge an rm S ubsidiary
$3 Million
$6 M illio n
$2 n illio M
Fre nch S ubsidiary
$5 Million
$4 Million
n illio M
$5 M illio n
$5 Million
$3 Million
S panish S ubsidiary
$3
$2 Million $1 Million
I talian S ubsidiary
Figure 20.2a
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Calculation of Net Receipts ($ Million)
Re iving ce S ubsidiary
Ge any rm France S pain Italy $4 5 6
Paying S ubsidiary
Ge an...