MANAGING THE MULTINATIONAL FINANCIAL SYSTEM
Chapter 20 describes the nature of the multinational financial system and why the ability to shift profits and funds
internally is potentially of far greater value to the MNC than to the purely domestic firm. It points out that the value
of the multinational financial system arises out of the firm's ability to use it to take advantage through arbitrage of
market imperfections and tax differences. The three principal forms of arbitrage opportunities discussed include:
--By shifting profits from units located in high-tax nations to those in lower-tax nations or from those
in a taxpaying position to those with tax losses, MNCs can reduce their tax burden.
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-adjusted cost of borrowed funds, and
tap previously unavailable capital sources.
Regulatory system arbitrage
--Where subsidiary profits are a function of government regulations (e.g., where a
government agency sets allowable prices on the firm's goods) or union pressure, rather than the marketplace, the
ability to disguise true profitability by reallocating profits among units may provide the multinational firm with
a negotiating advantage.
The chapter then analyzes at length the most important conduits used by MNCs to transfer funds and profits internally:
transfer pricing, fees and royalties, dividends, loans, leads and lags, and parent investment as debt or equity. It also
illustrates the close relationship between a firm's marketing, production, and logistics decisions (i.e., its real decisions)
and its financial decisions. The greater the internal transfer of goods, technology, capital, and materials worldwide, the
greater the scope for financial activities to enhance the value of the MNC globally. When teaching this material, I
always emphasize the potential conflicts with home and host country governments inherent in taking advantage of the
various arbitrage opportunities presented. An article that illustrates this point is M. Edgar Barrett, "Case of the Tangled
Harvard Business Review
, May-June 1977, pp. 20-36.
SUGGESTED ANSWERS TO CHAPTER 20 QUESTIONS
1.a. What is the internal financial transfer system of the multinational firm?
The internal financial transfer system of the multinational firm is the collection of internal transfer
mechanisms that enables the MNC to move money and profits among its various affiliates. These mechanisms for fund
flows within the MNC stem from the internal transfer of goods, services, technology, and capital.
What are its distinguishing characteristics?